10-Q 1 v377917_10q.htm QUARTERLY REPORT

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2014

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

For the transition period from ___________________ to ___________________

Commission File Number 000-27905

MutualFirst Financial, Inc.

(Exact name of registrant as specified in its charter)

Maryland		35-2085640
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

110 E. Charles Street, Muncie, Indiana		47305-2419
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (765) 747-2800

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
Common Stock, par value $.01 per share	Nasdaq Global Market

Securities Registered Pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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 ¨

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 ¨

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

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

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the last sale price of such stock on the Nasdaq Global Market as of June 30, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $81.5 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date. As of May 6, 2014, there were 7,128,549 shares of the registrant’s common stock outstanding.

MutualFirst Financial, Inc.

Form 10-Q Quarterly Report for the Period Ended March 31, 2014

Table of Contents

		Page
		Number
PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Condensed Balance Sheets	1
	Consolidated Condensed Statements of Income	2
	Consolidated Condensed Statements of Comprehensive Income	3
	Consolidated Condensed Statement of Stockholders’ Equity	4
	Consolidated Condensed Statements of Cash Flows	5
	Notes to Unaudited Consolidated Condensed Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	35

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	48

Item 4.	Controls and Procedures	51

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	53

Item 1A.	Risk Factors	53

Item 2.	Unregistered Sales of Equity Changes in Securities and Use of Proceeds	53

Item 3.	Defaults Upon Senior Securities	53

Item 4.	Mine Safety Disclosure	53

Item 5.	Other Information	53

Item 6.	Exhibits	54

Signature Page		56

Exhibits		57

MutualFirst Financial, Inc.

Consolidated Condensed Balance Sheets
(In Thousands, Except Share and Per Share Data)

	March 31,			December 31,
	2014			2013
	(Unaudited)
Assets
Cash and due from banks	$	7,317		$	8,013
Interest-bearing demand deposits		14,805			17,272
Cash and cash equivalents		22,122			25,285
Investment securities available for sale		269,106			264,348
Loans held for sale		1,542			1,888
Loans, net of allowance for loan losses of $13,370 and $13,412,
at March 31, 2014 and December 31, 2013, respectively		964,479			965,966
Premises and equipment, net		31,419			31,471
Federal Home Loan Bank stock		14,391			14,391
Investment in limited partnerships		1,965			2,092
Deferred tax asset		15,468			17,002
Cash value of life insurance		50,110			49,843
Core deposit and other intangibles		1,461			1,629
Other assets		16,479			17,490
Total assets	$	1,388,542		$	1,391,405

Liabilities and Stockholders' Equity
Liabilities
Deposits
Noninterest-bearing	$	148,856		$	144,195
Interest-bearing		956,105			968,889
Total deposits		1,104,961			1,113,084
Federal Home Loan Bank advances		144,128			142,928
Other borrowings		10,711			10,890
Other liabilities		13,431			12,861
Total liabilities		1,273,231			1,279,763

Commitments and Contingencies

Stockholders' Equity
Common stock, $.01 par value
Authorized - 20,000,000 shares
Issued and outstanding - 7,122,249 and 7,117,179 shares		71			71
Additional paid-in capital		73,370			73,336
Retained earnings		43,186			41,650
Accumulated other comprehensive loss		(1,316	)		(3,415	)
Total stockholders' equity		115,311			111,642
Total liabilities and stockholders' equity	$	1,388,542		$	1,391,405

See notes to consolidated condensed financial statements.

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Income
(Unaudited)

(In Thousands, Except Share and Per Share Data)

	Three Months Ended
	March 31,
	2014			2013
Interest and Dividend Income
Loans receivable	$	10,766		$	11,023
Investment securities		1,767			1,745
Federal Home Loan Bank stock		200			127
Deposits with financial institutions		5			6
Total interest and dividend income		12,738			12,901

Interest Expense
Deposits		1,701			2,510
Federal Home Loan Bank advances		474			263
Other interest expense		144			149
Total interest expense		2,319			2,922

Net Interest Income		10,419			9,979
Provision for loan losses		350			950
Net Interest Income After Provision for Loan Losses		10,069			9,029

Other Income
Service fee income		1,341			1,571
Net realized gain on sales of available-for-sale securities		150			339
Commissions		1,082			982
Equity in losses of limited partnerships		(93	)		(126	)
Net gains on sales of loans		104			436
Net servicing expenses		(24	)		(28	)
Increase in cash value of life insurance		267			317
Gain (loss) on sale of other real estate and repossessed assets		(62	)		19
Other income		108			127
Total other income		2,873			3,637

Other Expenses
Salaries and employee benefits		5,873			5,551
Net occupancy expenses		670			694
Equipment expenses		458			466
Data processing fees		406			384
Advertising and promotion		301			270
ATM expense		290			241
Deposit insurance		270			324
Professional fees		438			336
Software subscriptions and maintenance		416			369
Other real estate and repossessed assets		135			173
Other expenses		990			1,105
Total other expenses		10,247			9,913

Income Before Income Tax		2,695			2,753
Income tax expense		732			777

Net Income		1,963			1,976
Preferred stock dividends and accretion		-			362

Net Income Available to Common Shareholders	$	1,963		$	1,614

Earnings Per Share
Basic	$	0.28		$	0.23
Diluted	$	0.27		$	0.22

Dividends per common share	$	0.06		$	0.06

See notes to consolidated condensed financial statements.

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Comprehensive Income
(Unaudited)

(In Thousands)

	Three Months Ended
	March 31,
	2014			2013
Net Income	$	1,963		$	1,976
Other Comprehensive Income
Net unrealized holding gain (loss) on securities available-for-sale		2,681			(940	)
Net unrealized gain (loss) on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income		634			(10	)
Reclassification adjustment for realized gains included in net income		(150	)		(339	)
Net unrealized gain on derivative used for cash flow hedges		32			37
		3,197			(1,252	)
Income tax (expense) benefit related to other comprehensive income		(1,098	)		438
Other comprehensive income (loss)		2,099			(814	)

Comprehensive Income	$	4,062		$	1,162

See notes to consolidated condensed financial statements.

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Stockholders’ Equity
For the Period Ended March 31, 2014

(Unaudited)

(In Thousands, Except Share and Per Share Data)

	Common Stock		Paid-in Capital Common		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
Balances December 31, 2013	$	71	$	73,336	$	41,650		$	(3,415	)	$	111,642
Net income						1,963						1,963
Other comprehensive income, net of taxes									2,099			2,099
Stock options, exercised				34								34
Cash dividends, common stock ($.06 per share)						(427	)					(427	)
Balances March 31, 2014	$	71	$	73,370	$	43,186		$	(1,316	)	$	115,311

See notes to consolidated condensed financial statements.

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Cash Flows
(Unaudited)

(In Thousands, Except Share and Per Share Data)

	Three Months Ended
	March 31,
	2014			2013
Operating Activities
Net income	$	1,963		$	1,976
Items not requiring (providing) cash
Provision for loan losses		350			950
Depreciation and amortization		1,030			1,231
Deferred income tax		435			(62	)
Loans originated for sale		(2,650	)		(27,664	)
Proceeds from sales of loans held for sale		3,061			26,287
Gain on sale of loans held for sale		(104	)		(436	)
Gain on sale of securities - available for sale		(150	)		(339	)
(Gain) loss on sale of other real estate and repossessed assets		62			(19	)
Loss on sale of premises and equipment		8			-
Prepaid FDIC premium		-			303
Change in
Interest receivable and other assets		70			862
Interest payable and other liabilities		602			167
Cash value of life insurance		(267	)		(317	)
Other equity adjustments		138			112
Other adjustments		-			140
Net cash provided by operating activities		4,548			3,191

Investing Activities
Purchases of securities, available for sale		(24,119	)		(39,922	)
Proceeds from maturities and paydowns of securities, available for sale		6,967			18,169
Proceeds from sales of securities, available for sale		15,508			17,429
Net change in loans		544			11,957
Purchases of premises and equipment		(383	)		(102	)
Proceeds from real estate owned sales		1,278			1,106
Net cash provided by (used in) investing activities		(205	)		8,637

Financing Activities
Net change in
Noninterest-bearing, interest-bearing demand and savings deposits		16,334			14,115
Certificates of deposit		(24,457	)		(30,397	)
Proceeds from FHLB advances		117,800			60,000
Repayment of FHLB advances		(116,600	)		(53,150	)
Repayment of other borrowings		(190	)		(190	)
Cash dividends		(427	)		(785	)
Other financing activities		34			197
Net cash used in financing activities		(7,506	)		(10,210	)

Net Change in Cash and Cash Equivalents		(3,163	)		1,618

Cash and Cash Equivalents, Beginning of Period		25,285			32,778

Cash and Cash Equivalents, End of Period	$	22,122		$	34,396

Additional Cash Flows Information
Interest paid	$	2,275		$	2,934
Income tax paid		500			500
Transfers from loans to foreclosed real estate		360			506
Mortgage servicing rights capitalized		39			154

See notes to consolidated condensed financial statements.

MutualFirst Financial, Inc.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

(In Thousands, Except Share and Per Share Data)

Note 1: Basis of Presentation

The consolidated condensed financial statements include the accounts of MutualFirst Financial, Inc. (MutualFirst or the “Company”), its wholly owned subsidiary MutualBank, an Indiana commercial 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 year ended December 31, 2013, filed with the Securities and Exchange Commission on March 14, 2014.

The interim consolidated condensed financial statements at March 31, 2014, 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, 2013 has been derived from the Audited Consolidated Balance Sheet of the Company as of that date.

Note 2: Earnings Per Share

Earnings per share were computed as follows:

	Three Months Ended March 31,
	2014						2013
	Income		Weighted- Average Shares		Per- Share Amount		Income			Weighted- Average Shares		Per- Share Amount
Basic Earnings Per Share
Net income	$	1,963		7,118,853			$	1,976			7,037,166
Dividends and accretion on preferred stock		-						(362	)
Income available to common stockholders		1,963		7,118,853	$	0.28		1,614			7,037,166	$	0.23
Effect of Dilutive Securities
Stock options				234,191							157,926
Diluted Earnings Per Share
Income available to common stockholders and assumed conversions	$	1,963		7,353,044	$	0.27	$	1,614			7,195,092	$	0.22

Options to purchase 44,161 and 240,312 shares of common stock were outstanding at March 31, 2014 and 2013, respectively, but were not included in the computation of diluted EPS because the options’ exercise price was greater than the average market price of the common shares.

Note 3: Impact of Accounting Pronouncements

In January 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-04, "Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure,” to reduce diversity by clarifying when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. Adoption of the ASU is not expected to have a significant effect on the Company’s consolidated financial statements.

In January 2014, the FASB issued ASU 2014-01, "Accounting for Investments in Qualified Affordable Housing Projects,” to permit entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. The ASU modifies the conditions that an entity must meet to be eligible to use a method other than the equity or cost methods to account for qualified affordable housing project investments. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. Adoption of the ASU is not expected to have a significant effect on the Company’s consolidated financial statements.

Note 4: Investment Securities

The amortized costs and approximate fair values, together with gross unrealized gains and losses on securities, are as follows:

	March 31, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for Sale Securities
Mortgage-backed securities
Government-sponsored agencies	$	110,919	$	1,821	$	(1,397	)	$	111,343
Collateralized mortgage obligations
Government-sponsored agencies		107,074		1,277		(1,646	)		106,705
Federal agencies		5		-		-			5
Municipal obligations		28,270		922		(33	)		29,159
Corporate obligations		24,646		32		(2,784	)		21,894
Total investment securities	$	270,914	$	4,052	$	(5,860	)	$	269,106

	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for Sale Securities
Mortgage-backed securities
Government-sponsored agencies	$	104,006	$	1,700	$	(2,189	)	$	103,517
Collateralized mortgage obligations
Government-sponsored agencies		108,305		1,207		(1,934	)		107,578
Federal agencies		5,005		-		(231	)		4,774
Municipal obligations		27,357		257		(276	)		27,338
Corporate obligations		24,648		18		(3,525	)		21,141
Total investment securities	$	269,321	$	3,182	$	(8,155	)	$	264,348

The amortized cost and fair value of securities available for sale at March 31, 2014, 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
Description Securities	Amortized Cost		Fair Value
Security obligations due
One to five years	$	9,722	$	9,729
Five to ten years		10,614		10,537
After ten years		32,585		30,792
		52,921		51,058
Mortgage-backed securities
Government-sponsored agencies		110,919		111,343
Collateralized mortgage obligations
Government-sponsored agencies		107,074		106,705
Totals	$	270,914	$	269,106

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $2.0 million and $2.1 million at March 31, 2014 and December 31, 2013, respectively.

Proceeds from sales of securities available for sale during the three months ended March 31, 2014 and 2013 were $15.5 million and $17.4 million, respectively. Gross gains of $315,000 and $339,000 for the quarter ended March 31, 2014 and 2013, respectively, were recognized on those sales. Gross losses of $165,000 and $0 for the three months ended March 31, 2014 and 2013, respectively, were recognized on those sales.

All mortgage-backed securities and collateralized-mortgage obligations held by the Company as of March 31, 2014 were in government-sponsored or federal agency securities.

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at March 31, 2014 and December 31, 2013 was $123.0 million and $147.8 million, which is approximately 45.7 percent and 55.9 percent of the Company’s investment portfolio at those dates.

Based on our evaluation of available evidence, including recent changes in market interest rates, management believes the declines in fair value for these 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.

During the first quarter of 2014 and 2013, the Bank determined that its holdings in trust preferred securities had no further other than temporary impairment.

The following tables show the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2014 and December 31, 2013:

	March 31, 2014
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Available for Sale
Mortgage-backed securities
Government-sponsored agencies	$	53,895	$	(1,397	)	$	-	$	-		$	53,895	$	(1,397	)
Collateralized mortgage obligations
Government-sponsored agencies		48,246		(1,394	)		4,442		(252	)		52,688		(1,646	)
Municipal obligations		2,764		(8	)		748		(25	)		3,512		(33	)
Corporate obligations		4,487		(13	)		8,432		(2,771	)		12,919		(2,784	)
Total temporarily impaired securities	$	109,392	$	(2,812	)	$	13,622	$	(3,048	)	$	123,014	$	(5,860	)

	December 31, 2013
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Available for Sale
Mortgage-backed securities
Government-sponsored agencies	$	67,130	$	(2,189	)	$	-	$	-		$	67,130	$	(2,189	)
Collateralized mortgage obligations
Government-sponsored agencies		51,753		(1,934	)		-		-		$	51,753	$	(1,934	)
Federal agencies		4,769		(231	)							4,769		(231	)
Municipal obligations		11,264		(245	)		741		(31	)		12,005		(276	)
Corporate obligations		8,849		(151	)		3,336		(3,374	)		12,185		(3,525	)
Total temporarily impaired securities	$	143,765	$	(4,750	)	$	4,077	$	(3,405	)	$	147,842	$	(8,155	)

Mortgage-Backed Securities (MBS), Collateralized Mortgage Obligations (CMO) and Federal Agencies

The unrealized losses on the Company’s investment in MBSs, CMOs and Federal Agencies were caused by interest rate changes. The Company expects to recover the amortized cost basis over the term of the securities. Because (1) the decline in market value is attributable to changes in interest rates and not credit quality, (2) the Company does not intend to sell the investments and (3) 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 at maturity, the Company does not consider these investments to be other-than-temporarily impaired at March 31, 2014.

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 (1) a decrease in performance and regulatory capital resulting from exposure to subprime mortgages and (2) 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 these investments and it is likely that the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be at maturity, it does not consider the remainder of the investments to be other-than-temporarily impaired at March 31, 2014.

Other-Than-Temporary Impairment (OTTI)

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 whether it 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. For securities that are a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. For securities where the security is not a beneficial interest in securitized financial assets, the Company uses debt and equity securities impairment model.

The Company conducts periodic 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 primarily impacted by other-than-temporary impairment testing are private-label mortgage-backed securities and trust preferred securities.

The Bank’s trust preferred securities valuation was prepared by an independent third party. Their 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.

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 table provides 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
	March 31,
	2014		2013
Credit losses on debt securities held
Beginning of year	$	1,205	$	1,205
Reductions related to actual losses incurred		-		-
As of March 31,	$	1,205	$	1,205

Pooled Trust Preferred Securities. The Company has invested in pooled trust preferred securities. At March 31, 2014, the current par balance of our pooled trust preferred securities was $8.2 million. The original par value of these securities was $10.3 million prior to the OTTI write-downs in 2011 and earlier, based on valuations by a third party. OTTI taken on trust preferred securities previously was the result of deterioration in the performance of the underlying collateral. The deterioration was the result of increased defaults and deferrals of dividend payments in that year, creating credit impairment along with weakening financial performance of performing collateral, increasing the risk of future deferrals of dividends and defaults. No additional OTTI was determined in the first quarter of 2014. All pooled trust preferred securities owned by the Bank are exempt from the Volcker Rule.

The following table provides additional information related to the Bank’s investment in trust preferred securities as of March 31, 2014.

Deal Name	Class	Original Par		Book Value		Fair Value		Unrealized gain (loss)			Realized Losses YTD		Lowest Ratings	Number of Banks / Insurance Cos. Currently Performing		Total Number of Banks and Insurance Cos. In Issuance (Unique)		Actual Deferrals/ Defaults (as a % of original collateral)			Total Projected Defaults (as a % of performing collateral) ⁽¹⁾			Excess subordination (after taking into account best estimate of future deferrals/ defaults) ⁽²⁾
	(Dollars in Thousands)
Alesco Preferred Funding IX	B+	$	1,000	$	908	$	559	$	(349	)	$	-	B2		41		52		14.69	%		15.78	%		54.50	%
Preferred Term Securities XIII	Ca		1,000		777		427		(350	)		-	Ca		44		61		25.75	%		20.21	%		4.36	%
Preferred Term Securities XVIII	Ca		1,000		917		435		(482	)		-	Ca		52		72		22.51	%		10.03	%		6.43	%
Preferred Term Securities XXVII	C		1,000		710		390		(320	)		-	C		33		46		22.62	%		16.29	%		10.02	%
U.S. Capital Funding I	Caa1		3,000		2,890		1,936		(954	)		-	Caa1		28		33		9.44	%		8.60	%		8.90	%
U.S. Capital Funding III	Ca		1,000		500		296		(204	)		-	Ca		29		37		18.01	%		11.61	%		-	%
		$	8,000	$	6,702	$	4,043	$	(2,659	)	$	-

(1)

A 10% recovery is applied to all projected defaults by depository institutions. A 15% recovery is applied to all projected defaults by insurance companies.

No recovery is applied to current defaults.

(2)

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.

(1)

A 10% recovery is applied to all projected defaults by depository institutions. A 15% recovery is applied to all projected defaults by insurance companies. No recovery is applied to current defaults.

(2)

Note 5: Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income, included in stockholders’ equity, are as follows:

	March 31,			December 31,
	2014			2013
Net unrealized gain (loss) on securities available-for-sale	$	502		$	(2,029	)
Net unrealized loss on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income		(2,311	)		(2,945	)
Net unrealized loss on derivative used for cash flow hedges		(227	)		(259	)
Net unrealized loss relating to defined benefit plan liability		100			100
		(1,936	)		(5,133	)
Tax benefit		(620	)		(1,718	)
Net of tax amount	$	(1,316	)	$	(3,415	)

The following table presents the reclassification adjustments out of accumulated other comprehensive income (loss) that were included in net income in the Consolidated Statements of Income for the three months ended March 31, 2014 and 2013.

	Amount Reclassified from Accumulated Other Comprehensive Income For the Period Ended March 31,
Details about Accumulated Other Comprehensive Income Components	2014			2013			Affected Line Item in the Statements of Income
Unrealized gains (losses) on available-for-sale securities
Realized securities gains reclassified into income	$	150		$	339		Other income - net realized gains on sale of available-for-sale securities
Related income tax expense		(51	)		(115	)	Income tax expense

Total reclassifications for the period, net of tax	$	99		$	224

Note 6: Fair Values of Financial Instruments

Fair value is 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. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of 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 supported by little or no market activity and 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 comparative balance sheet, 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. Prices are evaluated by a third party. 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, marketable equity, municipal, federal agency and certain 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 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 measurements of assets measured at fair value on a recurring basis and level within the ASC 820 fair value hierarchy in which the fair value measurements fall:

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
March 31, 2014
Mortgage-backed securities
Government sponsored agencies	$	111,343	$	-	$	111,343	$	-
Collateralized mortgage obligations
Government sponsored agencies		106,705		-		106,705		-
Federal agencies		5		-		5		-
Municipal obligations		29,159		-		29,159		-
Corporate obligations		21,894		-		17,851		4,043
Available-for-sale securities	$	269,106	$	-	$	265,063	$	4,043

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
December 31, 2013
Mortgage-backed securities
Government sponsored agencies	$	103,517	$	-	$	103,517	$	-
Collateralized mortgage obligations
Government sponsored agencies		107,578		-		107,578		-
Federal agencies		4,774		-		4,774		-
Municipal obligations		27,338		-		27,338		-
Corporate obligations		21,141		-		17,805		3,336
Available-for-sale securities	$	264,348	$	-	$	261,012	$	3,336

The following is a reconciliation of the beginning and ending balances for the three months ended March 31, 2014 and 2013 of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable (Level 3) inputs:

	2014			2013
Beginning balance	$	3,336		$	2,475
Total realized and unrealized gains (losses)
Included in net income		-			-
Included in other comprehensive income (loss)		714			(10	)
Purchases, issuances and settlements		(7	)		-
Ending balance	$	4,		$	2,465
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets still held at the reporting date	$	0		$	0

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 the Bank will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include 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, market discount rates, cost to service, float earnings rates and other ancillary income, including late fees. 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 nonrecurring basis and the level within the ASC 820 fair value hierarchy in which the fair value measurements fall:

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
March 31, 2014
Impaired loans	$	434	$	-	$	-	$	434
Other real estate owned		160		-		-		160
Mortgage-servicing rights		1,659		-		-		1,659

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
December 31, 2013
Impaired loans	$	925	$	-	$	-	$	925
Other real estate owned		1,677		-		-		1,677
Mortgage-servicing rights		2,106		-		-		2,106

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements.

March 31, 2014	Fair Value		Valuation Technique	Unobservable Inputs	Range
Trust Preferred Securities	$	4,043	Discounted cash flow	Discount rate		8.0-14.0 %
				Constant prepayment rate		2.0%
				Cumulative projected prepayments		40.0%
				Probability of default		1.8-2.8 %
				Projected cures given deferral		0-15.0 %
				Loss severity		35.4-70.4 %
Impaired loans (collateral dependent)	$	434	Third party valuations	Discount to reflect realizable value		7.8-32.0 %
Other real estate owned	$	160	Third party valuations	Discount to reflect realizable value less estimated selling costs		3.8-16.2 %
Mortgage-servicing rights	$	1,659	Third party valuations	Prepayment speeds		105-700 %
				Discount rates		10.0%
				Servicing fee		0.25%

December 31, 2013	Fair Value		Valuation Technique	Unobservable Inputs	Range
Trust Preferred Securities	$	3,336	Discounted cash flow	Discount rate		10.0-17.0 %
				Constant prepayment rate		2.0%
				Cumulative projected prepayments		40.0%
				Probability of default		1.5-2.7 %
				Projected cures given deferral		0-15.0 %
				Loss severity		46.9-73.7 %
Impaired loans (collateral dependent)	$	925	Third party valuations	Discount to reflect realizable value		7.3-78.3 %
Other real estate owned	$	1,677	Third party valuations	Discount to reflect realizable value less estimated selling costs		0-25.0 %
Mortgage-servicing rights	$	2,106	Third party valuations	Prepayment speeds		105-700 %
				Discount rates		10.0%
				Servicing fee		0.25%

The following methods and assumptions were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value:

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

Loans Held For Sale - Fair values are based on quoted market prices.

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.

FHLB Advances - The fair value of these borrowings is 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 these borrowings is estimated using discounted cash flow analyses using interest rates for similar financial instruments.

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 these instruments is insignificant.

The estimated fair values of the Company’s financial instruments not carried at fair value in the consolidated balance sheets as of the dates noted below are as follows:

					Fair Value Measurements Using
March 31, 2014	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	22,122	$	22,122	$	22,122	$		$
Loans held for sale		1,542		1,579				1,579
Loans, net		964,479		939,868						939,868
FHLB stock		14,391		14,391				14,391
Interest receivable		3,570		3,570				3,570
Liabilities
Deposits		1,104,961		1,064,483		609,342				455,141
FHLB advances		144,128		143,147				143,147
Other borrowings		10,711		10,711				10,711
Interest payable		201		201				201

					Fair Value Measurements Using
December 31, 2013	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	25,285	$	25,285	$	25,285	$	-	$	-
Loans held for sale		1,888		1,905		-		1,905		-
Loans, net		965,966		935,414		-		-		935,414
FHLB stock		14,391		14,391		-		14,391		-
Interest receivable		3,775		3,775		-		3,775		-
Liabilities
Deposits		1,113,084		1,068,422		593,457		-		474,965
FHLB advances		142,928		141,526		-		141,526		-
Other borrowings		10,890		10,890		-		10,890		-
Interest payable		157		157		-		157		-

Note 7 Loans and Allowance

Classes of loans at March 31, 2014 and December 31, 2013 include:

	March 31,			December 31,
	2014			2013
Real estate
Commercial	$	197,327		$	200,817
Commercial construction and development		16,304			13,321
Consumer closed end first mortgage		524,220			531,272
Consumer open end and junior liens		68,917			69,354
		806,768			814,764
Other loans
Consumer loans
Auto		14,476			14,856
Boat/RVs		81,826			79,419
Other		5,404			5,766
Commercial and industrial		77,776			75,402
		179,482			175,443
Total loans		986,250			990,207
Undisbursed loans in process		(10,974	)		(13,346	)
Unamortized deferred loan costs, net		2,573			2,517
Allowance for loan losses		(13,370	)		(13,412	)
Net loans	$	964,479		$	965,966

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 and Industrial

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.

Consumer Real Estate and Other Consumer Loans

With respect to residential loans that are secured by consumer closed end first mortgages and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires PMI if that ratio is exceeded. Consumer open end and junior lien loans are typically secured by a subordinate interest in 1-4 family residences, and other 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 Loans 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. Loans are placed on non-accrual status when, in managements’ opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions, but never greater than 90 days past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

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 and generally only after six months of satisfactory performance.

Nonaccrual loans, segregated by class of loans, as of March 31, 2014 and December 31, 2013 are as follows:

	March 31,		December 31,
	2014		2013
Real estate
Commercial	$	1,085	$	1,349
Commercial construction and development		1,003		1,103
Consumer closed end first mortgage		3,743		4,057
Consumer open end and junior liens		325		421
Consumer loans
Auto		9		10
Boat/RVs		302		339
Other		22		12
Commercial and industrial		1,157		1,109
	$	7,646	$	8,400

An age analysis of the Company’s past due loans, segregated by class of loans, as of March 31, 2014 and December 31, 2013 are as follows:

	March 31, 2014
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90Days		Total Past Due		Current		Total Loans Receivable		Total Loans 90 Days and Accruing
Real estate
Commercial	$	3,874	$	-	$	828	$	4,702	$	192,625	$	197,327	$	-
Commercial construction and development		-		-		813		813		15,491		16,304		-
Consumer closed end first mortgage		7,064		1,272		3,230		11,566		512,654		524,220		206
Consumer open end and junior liens		298		70		308		676		68,241		68,917		-
Consumer loans
Auto		4		1		9		14		14,462		14,476		-
Boat/RVs		979		164		255		1,398		80,428		81,826		-
Other		55		4		10		69		5,335		5,404		-
Commercial and industrial		1,314		-		591		1,905		75,871		77,776		-
	$	13,588	$	1,511	$	6,044	$	21,143	$	965,107	$	986,250	$	206

	December 31, 2013
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90Days		Total Past Due		Current		Total Loans Receivable		Total Loans 90 Days and Accruing
Real estate
Commercial	$	763	$	196	$	1,196	$	2,155	$	198,662	$	200,817	$	-
Commercial construction and development		333		-		915		1,248		12,073		13,321		-
Consumer closed end first mortgage		11,680		2,122		3,515		17,317		513,955		531,272		175
Consumer open end and junior liens		609		185		394		1,188		68,166		69,354		-
Consumer loans
Auto		54		8		9		71		14,785		14,856		-
Boat/RVs		1,410		262		202		1,874		77,545		79,419		13
Other		61		3		-		64		5,702		5,766		-
Commercial and industrial		67		393		531		991		74,411		75,402		-
	$	14,977	$	3,169	$	6,762	$	24,908	$	965,299	$	990,207	$	188

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 the contract for impaired loans that are performing.

The following tables present impaired loans for the three months ended March 31, 2014 and 2013 and the year ended December 31, 2013:

	March 31, 2014
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Real estate
Commercial	$	2,952	$	2,952	$	-	$	3,050	$	32
Commercial construction and development		1,230		3,154		-		1,262		8
Consumer closed end first mortgage		856		856		-		1,045		2
Consumer open end and junior liens		250		250		-		250		1
Commercial and industrial		736		736		-		750		-

Loans with a specific valuation allowance
Real estate
Commercial construction and development		344		371		165		344		-
Commercial and industrial		424		624		170		424		5

Total
Real estate
Commercial	$	2,952	$	2,952	$	-	$	3,050	$	32
Commercial construction and development	$	1,574	$	3,525	$	165	$	1,606	$	8
Consumer closed end first mortgage	$	856	$	856	$	-	$	1,045	$	2
Consumer open end and junior liens	$	250	$	250	$	-	$	250	$	1
Commercial and industrial	$	1,160	$	1,360	$	170	$	1,174	$	5

	December 31, 2013
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Real estate
Commercial	$	3,148	$	3,660	$	-	$	3,894	$	160
Commercial construction and development		1,294		3,218		-		5,386		46
Consumer closed end first mortgage		1,483		2,071		-		2,582		33
Commercial and industrial		764		764		-		897		2

Loans with a specific valuation allowance
Real estate
Commercial construction and development		344		371		100		344		-
Commercial and industrial		424		624		235		566		20

Total
Real estate
Commercial	$	3,148	$	3,660	$	-	$	3,894	$	160
Commercial construction and development	$	1,638	$	3,589	$	100	$	5,730	$	46
Consumer closed end first mortgage	$	1,483	$	2,071	$	-	$	2,582	$	33
Commercial and industrial	$	1,188	$	1,388	$	235	$	1,463	$	22

	March 31, 2013
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Real estate
Commercial	$	3,992	$	5,056	$	-	$	4,136	$	41
Commercial construction and development		2,667		4,842		-		2,804		8
Consumer closed end first mortgage		2,341		3,280		-		2,463		13
Commercial and industrial		936		936		-		954		3

Loans with a specific valuation allowance
Real estate
Commercial		208		208		100		208		3
Commercial construction and development		5,265		7,879		1,159		5,297		6
Consumer closed end first mortgage		833		833		57		833		9
Commercial and industrial		634		634		380		773		6

Total
Real estate
Commercial	$	4,200	$	5,264	$	100	$	4,344	$	44
Commercial construction and development	$	7,932	$	12,721	$	1,159	$	8,101	$	14
Consumer closed end first mortgage	$	3,174	$	4,113	$	57	$	3,296	$	22
Commercial and industrial	$	1,570	$	1,570	$	380	$	1,727	$	9

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of March 31, 2014.

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 conform to the Bank's policy and 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 Bank’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 Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

Substandard. Substandard credits 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 Bank will sustain some loss of the deficiencies are not corrected.

Doubtful. A doubtful extension of credit has all the weaknesses inherent in a substandard asset 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. 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.

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 Bank’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 Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

Substandard. Substandard credits are loans that have reason to be considered to have a weakness and placed on non-accrual. This would include all retail loans over 90 days and troubled debt restructurings.

March 31, 2014
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real Estate		Construction and Development		Commercial and Industrial
Pass	$	186,797	$	13,005		76,082
Special Mention		3,335		1,653		212
Substandard		7,195		1,646		974
Doubtful		-		-		508
Total	$	197,327	$	16,304	$	77,776

Retail Credit Exposure Credit Risk Profile
Internal Rating	Closed End First Mortgage		Real Estate Open End and Junior Liens		Auto		Boat/RV		Other
Pass	$	515,339	$	68,033	$	14,466		81,273	$	5,344
Special Mention		1,762		-		-		-		-
Substandard		7,119		884		10		553		60
Total	$	524,220	$	68,917	$	14,476	$	81,826	$	5,404

December 31, 2013
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real Estate		Construction and Development		Commercial and Industrial
Pass	$	190,041	$	9,910	$	73,648
Special Mention		3,308		1,659		223
Substandard		7,468		1,752		1,000
Doubtful		-		-		531
Total	$	200,817	$	13,321	$	75,402

Retail Credit Exposure Credit Risk Profile
Internal Rating	Closed End First Mortgage		Real Estate Open End and Junior Liens		Auto		Boat/RV		Other
Pass	$	522,352	$	68,445	$	14,834	$	78,863	$	5,415
Special Mention		1,783		-		-		-		-
Substandard		7,137		909		22		556		351
Total	$	531,272	$	69,354	$	14,856	$	79,419	$	5,766

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 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 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 table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2014 and 2013 and year ended December 31, 2013. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other segments.

	Three Months Ended March 31, 2014
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	8,148		$	3,124		$	2,140		$	13,412
Provision charged to expense		(265	)		257			358			350
Losses charged off		-			(80	)		(367	)		(447	)
Recoveries		16			4			35			55
Balance, end of period	$	7,899		$	3,305		$	2,166		$	13,370
Ending balance:
Individually evaluated for impairment	$	335		$	-		$	-		$	335
Collectively evaluated for impairment		7,564			3,305			2,166			13,035
Total allowance for loan losses	$	7,899		$	3,305		$	2,166		$	13,370

Loans:
Ending balance
Individually evaluated for impairment	$	5,686		$	856		$	250		$	6,792
Collectively evaluated for impairment		285,721			523,364			170,373			979,458
Total Loans	$	291,407		$	524,220		$	170,623		$	986,250

	Three Months Ended March 31, 2013
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	9,908		$	3,394		$	2,736		$	16,038
Provision charged to expense		200			500			250			950
Losses charged off		(237	)		(383	)		(480	)		(1,100	)
Recoveries		2			23			78			103
Balance, end of period	$	9,873		$	3,534		$	2,584		$	15,991

	Year Ended December 31, 2013
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	9,908		$	3,394		$	2,736		$	16,038
Provision charged to expense		884			343			73			1,300
Losses charged off		(2,713	)		(886	)		(940	)		(4,539	)
Recoveries		69			273			271			613
Balance, end of period	$	8,148		$	3,124		$	2,140		$	13,412
Ending balance:
Individually evaluated for impairment	$	335		$	-		$	-		$	335
Collectively evaluated for impairment		7,813			3,124			2,140			13,077
Total allowance for loan losses	$	8,148		$	3,124		$	2,140		$	13,412

Loans:
Ending balance
Individually evaluated for impairment	$	5,974		$	1,483		$	-		$	7,457
Collectively evaluated for impairment		283,566			529,789			169,395			982,750
Total Loans	$	289,540		$	531,272		$	169,395		$	990,207

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 consumer real estate and other consumer loans, 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 consumer real estate and other 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.

Troubled Debt Restructurings

Certain categories of impaired loans include loans that have been modified in a troubled debt restructuring, that involves granting economic concessions 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 we use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine 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.

At March 31, 2014, the Company had a number of loans that were modified in troubled debt restructurings and impaired. The modification of terms of such loans included one or a combination of the following: an extension of maturity, a reduction of the stated interest rate or a permanent reduction of the recorded investment in the loan.

The following tables describe troubled debts restructured during the three month periods ended March 31, 2014 and 2013.

Three Months Ended March 31, 2014

No. of Loans

Pre-Modification
Outstanding
Recorded
Balance

Post-Modification
Outstanding
Recorded Balance

Real estate

Consumer closed end first mortgage

381

394

	Three Months Ended March 31, 2013
	No. of Loans		Pre-Modification Outstanding Recorded Balance		Post-Modification Outstanding Recorded Balance
Real estate
Commercial		1	$	50	$	50
Consumer closed end first mortgage		11		750		1,056
Consumer open end and junior liens		4		220		229
Consumer loans
Auto		2		22		22
Boat/RVs		1		30		30
Other		1		11		11
Commercial and industrial		2		1,009		723

The impact on the allowance for loan losses was insignificant as a result of these modifications.

Newly restructured loans by type for the three months ended March 31, 2014 and 2013 are as follows:

Three Months Ended March 31, 2014

Interest Only

Term

Combination

Total
Modification

Real Estate

Consumer closed end first mortgage

394

	Three Months Ended March 31, 2013
	Interest Only		Term		Combination		Total Modification
Real Estate
Commercial	$	-	$	-	$	50	$	50
Consumer closed end first mortgage		-		-		1,057		1,057
Consumer open end junior lien		-		213		16		229
Consumer Loans
Auto		-		4		18		22
Boat/RVs		-		30		-		30
Other		-		-		11		11
Commercial and industrial		-		88		635		723

Defaults of any loans modified as troubled debt restructurings made in the three months ended March 31, 2014 and 2013, respectively, are listed in the table below. Defaults are defined as any loans that become 90 days past due.

	Three Months Ended March 31, 2014
	No. of Loans		Post-Modification Outstanding Recorded Balance
Real Estate
Consumer closed end first mortgage		2	$	92
Consumer open end and junior liens		1		23

	Three Months Ended March 31, 2013
	No. of Loans		Post-Modification Outstanding Recorded Balance
Real Estate
Commercial		1	$	518
Commercial and industrial		1		109

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

The following should be read in conjunction with the Management’s Discussion and Analysis in Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the SEC on March 14, 2014.

The Company is a Maryland corporation and a bank holding company headquartered in Muncie, Indiana, with operations in Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties in Indiana. It owns MutualBank, an Indiana commercial bank with 30 bank branches in Indiana, trust offices in Carmel and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. The Company is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (“FRB”), and the Bank is subject to regulation, supervision and examination by the Indiana Department of Financial Institutions and the Federal Deposit Insurance Corporation.

Our principal business consists of attracting retail deposits from the general public, including some brokered deposits, and investing those funds primarily in loans secured by consumer closed end first mortgages and consumer open end and junior liens on owner-occupied, one- to four-family residences, a variety of other consumer loans, loans secured by commercial real estate, commercial construction and development and commercial and industrial loans. Funds not invested in loans generally are invested in investment securities, including mortgage-backed and mortgage-related securities. We also obtain funds from FHLB advances and other borrowings.

Our results of operations depend primarily on the level of our net interest income, which is the difference between interest income on interest-earning assets, such as loans, mortgage-backed securities and investment securities, and interest expense on 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 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 interest-earning assets. Conversely, in an increasing rate environment, assuming a normally shaped yield curve, net interest income would be impacted unfavorably as rates on interest-earning assets would increase at a slower rate than rates on interest-bearing liabilities.

First Quarter Highlights. At March 31, 2014, we had $1.4 billion in assets, $964.5 million in loans, $1.1 billion in deposits and $115.3 million in stockholders’ equity. The Company’s total risk-based capital ratio at March 31, 2014 was 12.9%, exceeding the 10.0% requirement for a well-capitalized institution. Tangible common equity increased to 8.2% as of March 31, 2014 compared to 7.9% and 7.7% at December 31, 2013 and March 31, 2013, respectively. For the quarter ended March 31, 2014, net income available to common shareholders was $2.0 million, or $.28 per basic and $.27 per diluted share, compared with net income available to common shareholders of $1.6 million, or $0.23 per basic and $0.22 per diluted share for the quarter ended March 31, 2013.

Financial highlights for the first quarter ended March 31, 2014 included:

Core transactional deposit accounts increased $16.3 million.

Allowance for loan losses to non-performing loans as of March 31, 2014 was 170.28% compared to 156.15% as of December 31, 2013. Allowance for loan losses to loans receivable was unchanged at 1.37% as of March 31, 2014 compared to December 31, 2013.

Net charge offs on an annualized basis were 0.16% in the first quarter of 2014 compared to 0.41% in the same period in 2013.

Net interest margin increased to 3.26% for the first quarter of 2014 compared to 3.07% for the first quarter of 2013.

Provision for loan losses decreased $600,000 in the first quarter of 2014 compared to the first quarter of 2013.

Non-interest income for the quarter ended March 31, 2014 decreased $764,000 compared to the first quarter of 2013 primarily due to a reduction in gains on sale of loans and investments.

Non-interest expense for the first quarter of 2014 increased $334,000 over the first quarter of 2013. The increase is primarily due to increased salary and benefit expenses.

The Management’s Discussion and Analysis in Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, contains a summary of our management strategy. The financial highlights of our strategy during the quarter include: increasing commercial and non-real estate consumer lending by $3.5 million since year-end 2013; core deposits increased to 60%, from 58% at year-end 2013, and decreasing non-performing assets to total assets from 1.22% at year-end 2013 to 1.12% at the end of the quarter.

Critical Accounting Policies

Note 1 to the Consolidated Financial Statements in Item 8 of the Form 10-K for the year ended December 31, 2013 contains a summary of the Company’s significant accounting policies. 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, valuation of intangible assets and securities, deferred tax asset and income tax accounting.

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.

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.

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.

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.

Intangible Assets. MutualFirst periodically assesses the impairment of its core deposit intangible. Impairment is the condition that exists when the carrying amount exceeds its implied fair value. If actual external conditions and future operating results differ from MutualFirst’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 and do not affect earnings until realized.

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 all 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 condition 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.

If management determines that an investment experienced an OTTI, management must then determine the amount of the OTTI to be recognized in earnings. 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 stockholders’ equity) and not recognized in income until the security is ultimately sold.

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.

Deferred Tax Asset. The Company has evaluated its deferred tax asset to determine if it is more likely than not that the asset will be utilized in the future. The Company’s most recent evaluation indicated that it is more likely than not that the asset will be fully utilized. The Company has generated average positive pre-tax pre-provision earnings of $14.5 million, or 1.0% of pre-tax pre-provision ROA over the previous five calendar years. These earnings would be sufficient to utilize the net operating losses, tax credit carryforwards and temporary tax differences over the allowable periods. The valuation allowances established from 2009 through 2013 were the result of capital losses sustained in those years with no tax benefit recorded. The analyses at March 31, 2014 and December 31, 2013 supported no additional valuation allowance was necessary.

At the end of 2013, the Company had $548,000 in capital losses, a decrease from $557,000 in capital losses in 2012 as capital gains from the sale of available for sale securities were generated. The Company has avoided and will continue to avoid taking any book tax benefit on future capital losses without capital gains to offset the current capital losses. See Note 14 to the Consolidated Financial Statements in Item 8 of the Form 10-K for the year ended December 31, 2013.

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 Form 10-Q contains and our future filings with the SEC, Company press releases, other public pronouncements, stockholder communications and oral statements made by or with the approval of an authorized executive officer, will contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements include, but are not limited to: (i) statements of our goals, intentions and expectations; (ii) statements regarding our business plans, prospects, growth and operating strategies; (iii) statements regarding the asset quality of our loan and investment portfolios; and (iv) estimates of our risks and future costs and benefits. These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The Company does not undertake and specifically declines any obligation to publicly release the result of any revisions that 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 unanticipated events.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: (i) the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets; (ii) changes in general economic conditions, either nationally or in our market areas; (iii) changes in the levels of general interest rates and the relative differences between short- and long-term interest rates, deposit interest rates, our net interest margin and funding sources; (v) fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; (vi) decreases in the secondary market for the sale of loans that we originate; (vii) results of examinations of us by the IDFI, FDIC, FRB or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; (viii) legislative or regulatory changes that adversely affect our business including the effect of Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act”), changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including changes that increase our capital requirements; (ix) our ability to attract and retain deposits; (x) increases in premiums for deposit insurance; (xi) management’s assumptions in determining the adequacy of the allowance for loan losses; (xii) our ability to control operating costs and expenses; (xiii) the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; (xiv) difficulties in reducing risks associated with the loans on our balance sheet; (xv) staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; (xvi) a failure or security breach in the computer systems on which we depend; (xvii) our ability to retain key members of our senior management team; (xviii) costs and effects of litigation, including settlements and judgments; (xix) our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; (xx) increased competitive pressures among financial services companies; (xxi) changes in consumer spending, borrowing and savings habits; (xxii) the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; (xxiii) adverse changes in the securities markets; (xxiv) inability of key third-party providers to perform their obligations to us; (xv) changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board; and (xvi) other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this report.

The Company wishes to advise readers that these factors could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

Financial Condition

General. Total assets at March 31, 2014 were $1.4 billion, reflecting a $2.9 million decrease during the quarter, primarily as a result of a $1.5 million decrease in loans. Average interest-earning assets decreased $14.4 million, or 1.1%, to $1.28 billion at March 31, 2014 from $1.29 billion at December 31, 2013. Average interest-bearing liabilities decreased by $4.4 million, or 0.4% to $1.11 billion at March 31, 2014 reflecting a decrease in term deposits. Average stockholders’ equity decreased by $17.8 million or 13.5% at March 31, 2014 due to the redemption of the preferred stock associated with the United State Treasury’s Small Business Lending Fund program.

Loans. Our gross loan portfolio, excluding loans held for sale, decreased to $986.3 million at March 31, 2014 from $990.2 million at December 31, 2013. The following table reflects the changes in the gross amount of loans, excluding loans held for sale, by type during the quarter:

	At
	March 31,		December 31,		Amount			Percent
	2014		2013		Change			Change
	(Dollars in thousands)
Real estate
Commercial	$	197,327	$	200,817	$	(3,490	)		(1.74	)%
Commercial construction and development		16,304		13,321		2,983			22.39
Consumer closed end first mortgage		524,220		531,272		(7,052	)		(1.33	)
Consumer open end and junior liens		68,917		69,354		(437	)		(0.63	)
Total real estate loans		806,768		814,764		(7,996	)		(0.98	)

Consumer loans
Auto		14,476		14,856		(380	)		(2.56	)
Boat/RV		81,826		79,419		2,407			3.03
Other		5,404		5,766		(362	)		(6.28	)
Total consumer other		101,706		100,041		1,665			1.66
Commercial and industrial		77,776		75,402		2,374			3.15
Total other loans		179,482		175,443		4,039			2.30

Total Loans	$	986,250	$	990,207	$	(3,957	)		(0.40	)%

The Bank’s strategy to increase commercial and consumer loans remains a primary focus as we continued to see growth in these areas during the first quarter of 2014 as commercial and non-real estate consumer loans grew by $3.5 million. We continue to seek opportunities to provide refinancing opportunities to sound commercial borrowers currently served by other financial institutions and building relationships with commercial clients in our footprint. The increase in the commercial and other consumer portfolios was offset by the decrease in the consumer real estate portfolios during the period. Lower rates have allowed consumers to refinance their mortgage loans; however we have seen a significant decrease in those activities. The Bank continues to sell longer term fixed-rate mortgage loans to reduce related interest rate risk.

Delinquencies and Non-performing Assets. As of March 31, 2014, our total loans delinquent 30-to-89 days were $15.1 million or 1.6% of total loans, compared to $18.1 million or 1.8% of total loans at the end of 2013.

At March 31, 2014, our non-performing assets totaled $15.5 million or 1.12% of total assets, compared to $17.0 million or 1.22% of total assets at December 31, 2013. This $1.5 million, or 8.9% decrease was due to a decrease in non-performing commercial and consumer first mortgage loans as well as a reduction in foreclosed assets. The table below sets forth the amounts and categories of non-performing assets in our loan portfolio at the dates indicated.

	At
	March 31,		December 31,		Amount			Percent
	2014		2013		Change			Change
	(Dollars in thousands)
Non-accruing loans	$	7,646	$	8,400	$	(754	)		(8.98	)%
Accruing loans delinquent 90 days		206		188		18			9.57
Foreclosed assets		7,647		8,433		(786	)		(9.32	)
Total	$	15,499	$	17,021	$	(1,522	)		(8.94	)%

Our non-performing assets continued to decrease in the first quarter of 2014 as local economic conditions improved. The Bank continues to diligently monitor and write down loans that appear to have irreversible weaknesses. The Bank works to ensure possible problem loans have been identified and steps have been taken to reduce loss by restructuring loans to improve cash flow or by increasing collateral. In addition to the decrease in non-performing assets, the Company saw improvement during the quarter in total classified assets. Total classified assets decreased by 4.4% from $35.1 million at December 31, 2013 to $33.5 million at March 31, 2014.

At March 31, 2014 foreclosed commercial real estate totaled $3.0 million and consisted of eight commercial properties in our existing lending footprint. The Bank has seen a decrease in this area as overall real estate owned sales volumes are up. At March 31, 2014, the Bank had 21 residential properties with a book value of $4.2 million. Two properties, one commercial construction and development and the other is residential real estate, account for $4.1 million of the total REO balance. All foreclosed real estate is currently for sale. As of March 31, 2014, the Bank also held $454,000 in other repossessed assets, such as autos, boats, RVs and horse trailers.

Allowance for Loan Loss. Allowance for loan losses decreased $2.6 million from $16.0 million at March 31, 2013 to $13.4 million at March 31, 2014 as reflected below:

	At and For the Three Month Ended
	March 31,
	2014			2013
	(Dollars in thousands)
Balance at beginning of period	$	13,412		$	16,038
Charge-offs		447			1,100
Recoveries		55			103
Net charge-offs		392			997
Provisions charged to operations		350			950
Balance at end of period	$	13,370		$	15,991

Ratio of net charge-offs during the period to
average loans outstanding during the period		0.16	%		0.41	%

Allowance as a percentage of non-performing loans		170.28	%		64.90	%
Allowance as a percentage of total loans (end of period)		1.37	%		1.65	%

Specific loan loss allocation related to loans that have been individually evaluated for impairment decreased $1.4 million, and general loan loss reserves have decreased $1.2 million as the non-performing loans and classified assets have improved. Net charge offs for the first quarter of 2014 were $392,000, or 0.16% of loans on an annualized basis, compared to $997,000, or 0.41% of loans on an annualized basis, for the first quarter of 2013. The allowance for loan losses to non-performing loans as of March 31, 2014 increased to 170.3% compared to 156.2% as of December 31, 2013. The allowance for loan losses to total loans as of March 31, 2014 was 1.37%, the same as of December 31, 2013.

Deposits. Deposits decreased by $8.1 million as the Bank allowed wholesale deposits to run off, which was partly responsible for a $24.4 million decline in certificates of deposit. This decrease was partially offset by increases in core transactional accounts, which increased $16.3 million in the first quarter of 2014. Core transactional deposits increased to 60% of the Bank’s total deposits as of March 31, 2014 compared to 58% as of December 31, 2013 and 53% as of March 31, 2013. These changes are consistent with the Bank’s strategy to grow and strengthen core deposit relationships.

	At
	March 31, 2014					December 31, 2013
	Amount		Weighted Average Rate			Amount		Weighted Average Rate
	(Dollars in thousands)
Type of Account:
Non-interest Checking	$	148,856		0.00	%	$	144,195		0.00	%
Interest-bearing NOW		252,456		0.22			262,114		0.23
Savings		126,794		0.01			119,380		0.01
Money Market		129,509		0.23			115,600		0.24
Certificates of Deposit		447,346		1.25			471,795		1.39
Total	$	1,104,961		0.58	%	$	1,113,084		0.67	%

Borrowings. Total borrowings increased slightly to $154.8 million at March 31, 2014, up $1.0 million, or 0.7%, since year-end 2013 primarily due to a $1.2 million increase in FHLB advances. Other borrowings, consisting of a bank loan and subordinate debenture, decreased $179,000 to $10.7 million at March 31, 2014 due to regular loan payments.

The Company borrowed $7.6 million from First Tennessee Bank, N.A. to refinance existing long-term debt. The loan was originated at a variable rate of LIBOR plus 2.80%; however the Company entered into a forward interest rate swap that fixed the rate of the note at 3.915%. The balance of the loan at March 31, 2014 was $6.6 million and it matures in December 2017.

The Company acquired $5.0 million of issuer trust preferred securities in a 2008 acquisition of another financial institution, which had a net balance of $4.1 million at March 31, 2014 due to the purchase accounting adjustment in the acquisition. These securities mature 30 years from the date of issuance, or September 15, 2035. The securities bore a fixed rate of interest of 6.22% through July 2010 and thereafter were to reset quarterly at the prevailing three-month LIBOR rate plus 170 basis points. In December 2009, the Company entered into a cash flow hedge with FTN Financial to fix the floating portion of the issued trust preferred security at 5.15% for the next five years starting on September 15, 2010. The Company has had the right to redeem the trust preferred securities, in whole or in part, without penalty, since establishing the cash flow hedge.

Stockholders’ Equity. Stockholders’ equity was $115.3 million at March 31, 2014, an increase of $3.7 million from December 31, 2013. The increase was a result of net income of $2.0 million and an increase in unrealized gains on the investment portfolio of $2.1 million. This increase was partially offset by dividend payments of $427,000 to common shareholders. The Company’s tangible book value per share as of March 31, 2014 increased to $15.99 compared to $15.46 as of December 31, 2013 and tangible common equity ratio was 8.21% as of March 31, 2014 compared to 7.92% as of December 31, 2013. Stockholders’ equity declined $24.9 million compared to March 31, 2013 as the Company redeemed all $28.9 million of its preferred shares purchased by the United States Treasury in the Small Business Lending Fund in the second and fourth quarters of 2013. The Company’s and the Bank’s risk-based capital ratios were well in excess of “well-capitalized” levels as defined by all regulatory standards as of March 31, 2014.

Comparison of Results of Operations for the Three Months Ended March 31, 2014 and 2013.

General. Net income available to common shareholders for the three months ended March 31, 2014 was $2.0 million or $.28 basic and $.27 diluted earnings per common share compared to net income available to common shareholders of $1.6 million, or $.23 basic and $.22 diluted earnings per common share for the three months ended March 31, 2013. The primary reason for this increase was a decrease in the provision for loan loss of $600,000 due to the stabilization of the loan portfolio and the real estate market and an increase in net interest income. Our return on assets and on average tangible equity was 0.57% and 6.98%, respectively for the quarter ended March 31, 2014 compared to 0.56% and 5.95% for the quarter ended March 31, 2013.

Interest Income. Total interest income decreased $163,000, or 1.3%, to $12.7 million during the three months ended March 31, 2014 from $12.9 million during the same period in 2013, reflecting the $23.9 million decline in average interest-earning assets during the quarter ended March 31, 2014, primarily due to the decrease in our mortgage-backed securities and consumer real estate loan portfolios. The impact of the decrease in average earning assets was partially offset by the increase in net interest margin from 3.07% in the first quarter of 2013 to 3.26% in the first quarter of 2014.

Interest Expense. Interest expense decreased $603,000, or 20.6%, to $2.3 million during the three months ended March 31, 2014 compared to $2.9 million during the three months ended March 31, 2013. The primary reason for this decrease was a decline of 21 basis points on interest-bearing liabilities from 1.04% as of March 31, 2013 to 0.83% at March 31, 2014, which was primarily due to continued re-pricing of deposit accounts and a changing mix of the deposits or a larger amount of transaction accounts as a percentage of interest bearing liabilities.

Net Interest Income. Net interest income before the provision for loan losses increased $440,000 for the quarter ended March 31, 2014 compared to the same period in 2013 for the reasons discussed above. On a linked quarter basis, net interest income before the provision for loan losses increased $214,000 as net interest margin increased 9 basis points. A decline in average earning assets of $11.9 million partially offset the increase of the net interest margin. For more information on our asset/liability management especially as it relates to interest rate risk, see “Item 7A - Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-K.

Provision for Loan Losses. The provision for loan losses for the first quarter of 2014 decreased to $350,000 compared to $950,000 during last year’s comparable period. The decrease was due to management’s ongoing evaluation of the adequacy of the allowance for loan losses and was impacted by a decrease in net charge offs to $392,000 for the first quarter of 2014 compared to net charge offs of $997,000 in the first quarter of 2013. Non-performing loans to total loans at March 31, 2014 were 0.80% compared to 0.88% at December 31, 2013. Non-performing assets to total assets were 1.12% at March 31, 2014 compared to 1.22% at December 31, 2013.

Other Income. Other (non-interest) income decreased by $764,000 to $2.9 million in the first quarter of 2014 compared to $3.6 million in the first quarter of 2013.

	Three Months Ended						Amount			Percent
	3/31/2014			3/31/2013			Change			Change
	(Dollars in thousands)
Non-Interest Income:
Service fee income	$	1,341		$	1,571		$	(230	)		(14.64	)%
Net realized gain on sale of securities		150			339			(189	)		(55.75	)
Equity in losses of limited partnerships		(93	)		(126	)		33			(26.19	)
Commissions		1,082			982			100			10.18
Net gains on sales of loans		104			436			(332	)		(76.15	)
Net servicing costs		(24	)		(28	)		4			(14.29	)
Increase in cash surrender value of life insurance		267			317			(50	)		(15.77	)
Gain (loss) on sale of other real estate and repossessed assets		(62	)		19			(81	)		(426.32	)
Other income		108			127			(19	)		(14.96	)
Total	$	2,873		$	3,637		$	(764	)		(21.01	)%

Non-interest income decreased because gains on sales of loans declined as sold loans declined by approximately $21 million in the first quarter of 2014 compared to the first quarter of 2013. Service fee income on deposit accounts decreased primarily due to an annual incentive payment received for card services in the 2013 period which was not repeated in the 2014 period. Typically this incentive payment is received in the fourth quarter. Gain on sale of investments declined in the first quarter of 2014 compared to the first quarter of 2013 as fewer opportunities exist within the investment portfolio for gains as market rates increased in late 2013. These declines were partially offset by an increase in commission income from trust, wealth management, and brokerage business lines.

On a linked quarter basis, non-interest income declined $308,000 as a result of a decline in service fee income primarily due to seasonality and the reason described above. Gain on sale of loans and net servicing gains also declined as mortgage production slowed which resulted in fewer loans being sold and a mortgage servicing rights recovery in the fourth quarter of 2013 was not repeated in the first quarter of 2014.

Other Expense. Other (non-interest) expense increased $334,000 to $10.2 million for the first quarter 2014 compared to $9.9 million for the first quarter 2013.

	Three Months Ended				Amount			Percent
	3/31/2014		3/31/2013		Change			Change
	(Dollars in thousands)
Non-Interest Expense:
Salaries and employee benefits	$	5,873	$	5,551	$	322			5.80	%
Net occupancy expenses		670		694		(24	)		(3.46	)
Equipment expenses		458		466		(8	)		(1.72	)
Data processing fees		406		384		22			5.73
Advertising and promotion		301		270		31			11.48
ATM expense		290		241		49			20.33
Deposit insurance		270		324		(54	)		(16.67	)
Professional fees		438		336		102			30.36
Software subscriptions and publications		416		369		47			12.74
Other real estate and repossessed assets		135		173		(38	)		(21.97	)
Other expenses		990		1,105		(115	)		(10.41	)
Total	$	10,247	$	9,913	$	334			3.37	%

The increase in salaries and benefits was a result of annual salary increases and a reduction of $105,000 on compensation deferred due to fewer loan originations when compared to the first quarter of 2013. The increase in professional fees was primarily a result of a revenue enhancement consulting engagement. On a linked quarter basis, non-interest expense decreased $425,000 primarily due to a reduction in salaries and benefits primarily due to year-end incentive accruals, a reduction in repossessed asset expenses, and a reduction in other operating expenses.

Income Tax Expense. Income tax expense for the first quarter 2014 decreased by $45,000 compared to the same period in 2013. The Company’s effective tax rate decreased to 27.2% for the three months ended March 31, 2014 compared to 28.2% for the three months ended March 31, 2013 because of the additional non-taxable income.

Liquidity

We are required to have enough cash and investments that qualify as liquid assets in order to maintain sufficient liquidity to ensure safe and sound operation. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, we have maintained liquid assets above levels believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained. Since 2011, we have maintained higher levels of liquidity as we grew our deposits and marketable equity securities and received paydowns within our loan portfolio.

Liquidity management involves the matching of cash flow requirements of customers, who may be either depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs and the ability of the Company to manage those requirements. The Company strives to maintain an adequate liquidity position by managing the balances and maturities of interest-earning assets and interest-bearing liabilities so that the balance it has in short-term investments at any given time will cover adequately any reasonably anticipated, immediate need for funds. Additionally, the Bank maintains relationships with correspondent banks, which could provide funds on short-term notice if needed. Our liquidity, represented by cash and cash-equivalents and investment securities, is a product of our operating, investing and financing activities.

Liquidity management is both a daily and long-term function of the management of the Company and the Bank. It is overseen by the Asset and Liability Management Committee. The Board of Directors required the Bank to maintain a minimum liquidity ratio of 10% of deposits. At March 31, 2014, our ratio was 27.1%. The Company is currently in excess of the minimum liquidity ratio set by the Board due to a larger than historical investment portfolio. Management continues to seek to utilize liquidity off of the investment portfolio to fund loan growth over the next few years as demand for loans increase. Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds. On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed securities. The Bank uses its sources of funds primarily to meet its ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments.

We maintain cash and investments that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operation and meet demands for funds (particularly withdrawals of deposits). At March 31, 2014, on a consolidated basis, the Company had $291.2 million in cash and investment securities available for sale and $1.5 million in loans held for sale generally available for its cash needs. We can also generate funds from borrowings, primarily FHLB advances, and, to a lesser degree, third party loans. At March 31, 2014, the Bank had the ability to borrow an additional $138.5 million in FHLB advances. In addition, we have historically sold 15- and 30-year long-term, fixed-rate mortgage loans in the secondary market in order to reduce interest rate risk and to create another source of liquidity. The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its own operating expenses (many of which are paid to the Bank), the Company is responsible for paying amounts owed on its trust preferred securities, any dividends declared to its common stockholders, and interest and principal on outstanding debt. The Company’s primary source of funds is Bank dividends, the payment of which is subject to regulatory limits. At March 31, 2014, the Company, on an unconsolidated basis, had $1.2 million in cash, interest-bearing deposits and liquid investments generally available for its cash needs.

Our liquidity, represented by cash and cash equivalents and investment securities, is a product of our operating, investing and financing activities. Our primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other short-term investments and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. In addition, we invest excess funds in short-term interest-earning assets, which provide liquidity to meet lending requirements. We also generate cash through borrowings. We utilize FHLB advances to leverage our capital base and provide funds for our lending and investment activities, and to enhance our interest rate risk management.

We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. At March 31, 2014, the approved outstanding loan commitments, including unused lines of credit, amounted to $191.2 million. Certificates of deposit scheduled to mature in one year or less at March 31, 2014, totaled $200.5 million. It is management’s policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that a majority of maturing deposits will remain with the Bank.

Except as set forth above, management is not aware of any trends, events, or uncertainties that will have, or that are reasonably likely to have a material impact on liquidity, capital resources or operations. Further, management is not aware of any current recommendations by regulatory agencies, which, if they were to be implemented, would have this effect.

Off-Balance Sheet Activities

In the normal course of operations, the Bank engages in a variety of financial transactions that are not recorded in our financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. We also have off-balance sheet obligations to repay borrowings and deposits. For the quarter ended March 31, 2014, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows. At March 31, 2014, the Bank had $88.7 million in commitments to make loans, $11.6 million in undisbursed portions of closed loans, $88.1 million in unused lines of credit and $2.8 million in standby letters of credit. In addition, on a consolidated basis, at March 31, 2014, the Company had $154.8 million in outstanding non-deposit borrowings, of which $32.1 million is due in the next twelve months.

Capital Resources

The Bank is subject to minimum capital requirements imposed by the FDIC. See ‘Item 1 - Business- How We Are Regulated - Regulatory Capital Requirements.” The FDIC may require the Bank to have additional capital above the specific regulatory levels if it believes the Bank is subject to increased risk due to asset problems, high interest rate risk and other risks. The Company is subject to minimum capital requirements imposed by the FRB, which are substantially similar to those imposed on the Bank, including guidelines for bank holding companies to be considered well-capitalized. The FDIC and FRB have issued proposals to revise these capital requirements, which would increase the levels required, particularly if the Bank and the Company want to continue paying dividends or executive bonuses.

At March 31, 2014, the Bank’s regulatory capital exceeded the FDIC regulatory requirements, and the Bank was well-capitalized under regulatory prompt corrective action standards. In addition, at March 31, 2014, the Company’s capital levels exceeded the FRB’s requirements, and the Company was considered well-capitalized under FRB guidelines. Consistent with our goals to operate a sound and profitable organization, our policy is for the Bank to maintain well-capitalized status.

Our capital ratios at March 31, 2014 are reflected below:

	Actual Capital Levels					Minimum Regulatory Capital Levels					Minimum Required To be Considered Well- Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Leverage Capital Level^(1):
MutualFirst Consolidated	$	112,817		8.2	%	$	55,543		4.0	%	$	69,429		5.0	%
MutualBank		118,028		8.5			55,290		4.0			69,112		5.0
Tier 1 Risk-Based Capital Level⁽²⁾ :
MutualFirst Consolidated	$	112,817		11.6	%	$	38,823		4.0	%	$	58,234		6.0	%
MutualBank		118,028		12.2			38,807		4.0			58,210		6.0
Total Risk-Based Capital Level⁽³⁾ :
MutualFirst Consolidated	$	124,959		12.9	%	$	77,645		8.0	%	$	97,057		10.0	%
MutualBank		130,170		13.4			77,614		8.0			97,017		10.0

(1) Tier 1 Capital to Average Total Assets of $1.4 billion for the Bank and $1.4 billion for the Company at March 31, 2014

(2) Tier 1 Capital to Risk-Weighted Assets of $970.2 million for the Bank and $970.6 million for the Company at March 31, 2014.

(3) Total Capital to Risk-Weighted Assets.

Impact of Inflation

The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the economic value of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the consumer price index (“CPI”) coincides with changes in interest rates. For example, the price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by us. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In other years, the opposite may occur.

Item 3 Quantitative and Qualitative Disclosures About Market Risk

Information about the Company’s asset and liability management and market and interest-rate risks is included in Item 7A of the Form 10-K for the year ended December 31, 2013, filed with the SEC on March 14, 2014.

Asset and Liability Management and Market Risk

Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally is established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is one of our most significant market risks.

Management continues to evaluate options to mitigate interest rate risk in an increasing interest rate environment during this cycle of extremely low interest rates. This includes shortening assets and lengthening liabilities when possible.

How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates, we monitor our interest rate risk. In monitoring interest rate risk, we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to actual or potential changes in market interest rates. In order to minimize the potential for adverse effects of material and prolonged changes in interest rates on our results of operations, the Bank’s board of directors establishes asset and liability management policies to better match the maturities and repricing terms of our interest-earning assets and interest-bearing liabilities.

These asset and liability policies are implemented by the Asset and Liability Management Committee, which is chaired by the Chief Financial Officer and is comprised of members of our senior management team. The purpose of the Asset and Liability Management Committee is to communicate, coordinate and control asset/liability management issues consistent with our business plan and board-approved policies. The committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objective of these actions is to manage assets and funding sources consistent with liquidity, capital adequacy, growth, risk and profitability goals. The Asset and Liability Management Committee generally meets monthly to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections pursuant to a net present value of portfolio equity analysis and income simulations. At each meeting, the Asset and Liability Management Committee recommends appropriate strategy changes based on this review. The Chief Financial Officer is responsible for reviewing and reporting on the effects of the policy implementations and strategies to the Board of Directors, at least quarterly.

In order to manage our assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, we have sought to:

originate and purchase adjustable rate mortgage loans and commercial business loans;

originate shorter-duration consumer loans,

manage our deposits to establish stable deposit relationships,

acquire longer-term borrowings at fixed rates, when appropriate, to offset the negative impact of longer-term fixed rate loans in our loan portfolio, and

limit the percentage of long-term fixed-rate loans in our portfolio.

Depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, the Asset and Liability Management Committee may increase our interest rate risk position somewhat in order to maintain our net interest margin and improve earnings. We will continue to increase our emphasis on the origination of relatively short-term and/or adjustable rate loans. In addition, in an effort to avoid an increase in the percentage of long-term, fixed-rate loans in our portfolio, during the first quarter of 2014 we sold in the secondary market $5.8 million of fixed rate, one- to four-family mortgage loans with a term to maturity of 15 years or greater.

The following chart reflects the Bank’s percentage change in net income and capital assuming the most severe movement in interest rates as an immediate parallel rate shock in a range from down 100 basis points to up 400 basis points as of March 31, 2014.

	Percentage Change in
	Net Interest Income			Capital
Rate Shock:
Up 400 basis points		(34.5	)%		(43.7	)%
Up 300 basis points		(24.9	)%		(35.7	)%
Up 200 basis points		(15.7	)%		(23.0	)%
Up 100 basis points		(7.4	)%		(11.0	)%
Down 100 basis points		1.0	%		(5.0	)%

The above chart assumes instantaneous rate shocks that reprice all loans and deposits that can reprice at the same amount as the rate shock. If past rate movements are an indication of future changes, they usually are neither instantaneous nor do a majority of core deposits reprice at the same level as rates change. The following chart indicates the Company’s percentage change in net interest income and capital assuming rate movements that are not instantaneous, but change over a period of time, and a majority of core deposits changing at a percentage of the rate shock instead of the full amount of the rate shock.

	Percentage Change in
	Net Interest Income			Capital
Rate Shock:
Up 400 basis points		(8.3	)%		6.6	%
Up 300 basis points		(4.5	)%		3.9	%
Up 200 basis points		(1.2	)%		5.5	%
Up 100 basis points		1.2	%		5.2	%
Down 100 basis points		-	%		(7.1	)%

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the chart. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the tables. Therefore, the Company also considers potential interest rate shocks that are not immediate parallel shocks in various rate scenarios. Management currently believes that interest rate risk is managed appropriately in more practical rate shock scenarios than those in the chart above.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain a system of disclosure controls and (as defined in sec Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) that is designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported accurately and within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate. An evaluation of the Company’s disclosure controls and procedures as of March 31, 2014, was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management preceding the filing date of this annual report. Our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2014, the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company’s management (including our Chief Executive Officer and 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.

The Company does not expect that its disclosure controls and procedures will prevent all error and all 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 are 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 MutualFirst have been detected. These inherent limitations include the realities that judgment 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 future 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.

Management’s Report on Internal Control over Financial Reporting

The management of MutualFirst Financial, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in sec Rule 13a-15(f). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance to the Company’s management and board of directors regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2014. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (1992). Based on our assessment, we believe that, as of March 31, 2014, the Company’s internal control over financial reporting was effective based on those criteria.

Date: May 9, 2014	By:	/s/David W. Heeter
		David W. Heeter
		President and Chief Executive Officer

	By:	/s/Christopher D. Cook
		Christopher D. Cook
		Senior Vice President, Treasurer and Chief Financial Officer

Changes in Internal Controls over Financial Reporting

There were no changes in our internal controls over financial reporting (as defined in SEC Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended March 31, 2014, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.

OTHER INFORMATION

Item 1.

Legal Proceedings

None.

Item 1A.

Risk Factors

There are no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults Upon Senior Securities.

None.

Item 4.

Mine Safety Disclosures.

Not applicable.

Item 5.

Other Information.

None.

Item 6.

Exhibits.

Regulation S-K Exhibit Number	Document	Reference to Prior Filing or Exhibit Number Attached Hereto
3.1	Articles of Incorporation	b
3.2	Articles Supplementary for the Series A Preferred Stock	c
3.3	Articles Supplementary for the SBLF Preferred Stock	a
3.4	Amended Bylaws	k
3.5	Articles Supplementary to the Company’s Charter re: term of appointed directors	l
4.1	Form of Common Stock Certificate	b
4.2	Form of Certificate for the Series A Preferred Stock	c
4.3	Form of Certificate for the SBLF Preferred Stock	a
9	Voting Trust Agreement	None
10.1	Employment Agreement with David W. Heeter	e
10.2	Employment Agreement with Patrick C. Botts	e
10.3	Form of Supplemental Retirement Plan Income Agreements for Patrick C. Botts and David W. Heeter	f
10.4	Named Executive Officer Salaries and Bonus Arrangements for 2013	n
10.5	Form of Director Shareholder Benefit Program Agreement, as amended, for Jerry D. McVicker	g
10.6	Form of Agreements for Executive Deferred Compensation Plan for Patrick C. Botts and David W. Heeter	f
10.7	Registrant’s 2001 Stock Option and Incentive Plan	h
10.8	Registrant’s 2001 Recognition and Retention Plan	h
10.9	Director Fee Arrangements for 2013	10.9
10.10	Director Deferred Compensation Plan	i
10.11	MutualFirst Financial, Inc. 2008 Stock Option and Incentive Plan	d
10.12	MFB Corp. 2002 Stock Option Plan	d
10.13	MFB Corp. 1997 Stock Option Plan	d
10.14	Employment Agreement with Charles J. Viater	e
10.15	Salary Continuation Agreement with Charles J. Viater	d
10.16	Loan Agreement with First Tennessee Bank National Association dated January 4, 2013.	10.16
10.17	Form of Incentive Stock Option Agreement for 2008 Stock Option and Incentive Plan	j
10.18	Form of Non-Qualified Stock Option Agreement for 2008 Stock Option and Incentive Plan	j
10.21	Employment Agreement with Christopher D. Cook.	e
11	Statement re computation of per share earnings	None
12	Statements re computation of ratios	None
14	Code of Ethics	o
16	Letter re change in certifying accountant	None
18	Letter re change in accounting principles	None

21	Subsidiaries of the registrant	21
22	Published report regarding matters submitted to vote of security holders	None
23	Consents of experts and counsel	23
24	Power of Attorney	None
31.1	Rule 13(a)-14(a) Certification (Chief Executive Officer)	31.1
31.2	Rule 13(a)-14(a) Certification (Chief Financial Officer)	31.2
32	Section 1350 Certification	32
101	Financial Statements from the Company’s Form 10-K for the year ended December 31, 2013, formatted in Extensive Business Reporting Language (XBRL); (i) Consolidated Condensed Balance Sheets as of December 31, 2013 and 2012; (ii) Consolidated Condensed Statements of Income for the Years Ended December 31, 2013, 2012 and 2011; (iii) Consolidated Condensed Statements of Comprehensive Income for the Years Ended December 31, 2013, 2012 and 2011; (iv) Consolidated Condensed Statement of Stockholders’ Equity for the Years Ended December 31, 2013, 2012 and 2011 (v) Consolidated Condensed Statements of Cash Flows for the Years Ended December 31, 2013, 2012 and 2011; and (vi) Notes to Consolidated Financial Statements, December 31, 2013, 2012 and 2011, as follows:
	101.INS XBRL Instance Document	101.INS
	101.SCH XBRL Taxonomy Extension Schema Document	101.SCH
	101.CAL XBRL Taxonomy Extension Calculation Linkbase Document	101.CAL
	101.DEF XBRL Taxonomy Extension Definition Linkbase Document	101.DEF
	101.LAB XBRL Taxonomy Extension Labels Linkbase Document	101.LAB
	101.PRE XBRL Taxonomy Extension Presentation Linkbase Document	101.PRE

a	Filed as an exhibit to the Company’s Form 8-K filed on August 26, 2011 and incorporated herein by reference.
b	Filed as an exhibit to the Company’s Form S-1 registration statement filed on September 16, 1999 and incorporated herein by reference.
c	Filed as an exhibit to the Company’s Form 8-K filed on December 23, 2008 and incorporated herein by reference.
d	Filed as an Exhibit to the Company’s Annual Report on Form 10-K filed on March 23, 2009 and incorporated herein by reference.
e	Filed as an exhibit to the Company’s Form 10-Q filed on November 14, 2012 and incorporated herein by reference.
f	Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 30, 2001 and incorporated herein by reference.
g	Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on April 2, 2002 and incorporated herein by reference.
h	Filed as an Appendix to the Company’s Form S-4/A Registration Statement filed on October 19, 2001 and incorporated herein by reference.
i	Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 16, 2007 and incorporated herein by reference.
j	Filed as an exhibit to the Company’s Form 10-K filed on March 23, 2010 and incorporated herein by reference.
k	Filed as an exhibit to the Company’s Form 8-K filed on October 15, 2007 and incorporated herein by reference.
l	Filed as an exhibit to the Company’s Form 8-K filed on July 15, 2008 and incorporated herein by reference.
m	Filed as an exhibit to the Company’s Form 8-K filed on December 24, 2009 and incorporated herein by reference.
n	Filed as an exhibit to the Company’s Form 8-K filed on February 15, 2012 and incorporated herein by reference.
o	Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 15, 2004 and incorporated herein by reference.

(b) Exhibits - See list in (a)(3) and the Exhibit Index following the signature page.

(c) Financial Statements Schedules – None

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.

Date: May 9, 2013	By:	/s/David W. Heeter
		David W. Heeter
		President and Chief Executive Officer

Date: May 9, 2013	By:	/s/Christopher D. Cook
		Christopher D. Cook
		Senior Vice President, Treasurer and Chief Financial Officer

INDEX TO EXHIBITS

Number		Description

10.16		Loan Agreement with First Tennessee Bank, N.A.

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

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

32		Section 1350 Certification

101		Financial Statements from the Company’s Form 10-Q for the three months ended March 31, 2014 and year ended December 31, 2013, formatted in Extensive Business Reporting Language (XBRL); (i) Consolidated Condensed Balance Sheets as of March 31, 2014 and 2013; (ii) Consolidated Condensed Statements of Income for the Three Months Ended March 31, 2014 and 2013; (iii) Consolidated Condensed Statement of Stockholders’ Equity for the Period Ended March 31, 2014; (iv) Consolidated Condensed Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013; and (vi) Notes to Consolidated Financial Statements Three Months Ended March 31, 2014 and 2013, as follows:

		101.INS	XBRL Instance Document
		101.SCH	XBRL Taxonomy Extension Schema Document
		101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
		101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
		101.LAB	XBRL Taxonomy Extension Labels Linkbase Document
		101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document