Summary of MUTUALFIRST FINANCIAL INC

ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

General

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

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

Mutual subsidiaries include, Mutual Federal Investment Company ("MFIC") and Mishawaka Financial Services. MFIC is a Nevada corporation holding approximately $101 million in investments. MFIC currently owns one subsidiary, Mutual Federal REIT. The assets of Mutual Federal REIT consist of approximately $102 million in one-to four-family mortgage loans. Mishawaka Financial Services was acquired with MFB Corp. and is engaged in the sale of life and health insurance to customers of the bank.

The following should be read in conjunction with the Management's Discussion and Analysis in the Company's December 31, 2008 Annual Report on Form 10-K.

Critical Accounting Policies

The notes to the consolidated financial statements contain a summary of the Company's significant accounting policies presented on pages 77 to 81 of the Annual Report on Form 10-K for the year ended December 31, 2008. Certain of these policies are important to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of foreclosed assets, mortgage servicing rights and intangible assets.

Allowance for Loan Losses

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

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

Foreclosed Assets

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

Mortgage Servicing Rights

Mortgage servicing rights ("MSRs") associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible 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

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

Securities

Under SFAS No. 115, Accounting for Certain Investments in 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 effect 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 FSP 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments and the newly adopted FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, the company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition.

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 shareholders' 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.

Forward Looking Statements

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

The Company does not undertake - and specifically disclaims any obligation - to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Overview

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

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

It has been the Company's strategic objective to change the repricing structure of its interest-earning assets from longer term to shorter term to better match the structure of our interest-bearing liabilities and therefore reduce the impact interest rate changes have on our net interest income. Strategies employed to accomplish this objective have been to increase the originations of variable rate commercial loans and shorter term consumer loans and to sell longer term mortgage loans. The percentage of consumer and commercial loans to total loans has increased from 44% at the end of 2004 to 54% currently. As we continue to increase our investment in business-related loans, which are considered to entail greater risks than one-to four- family residential loans, in order to help offset the pressure on our net interest margin, our provision for loan losses may increase to reflect this increased risk. On the liability side of the balance sheet, the Company is employing strategies to increase the balance of core deposit accounts such as low cost checking and money market accounts. The percentage of core deposits to total deposits is currently 37% at June 30, 2009. The remaining total deposits are mostly retail certificates of deposit which continue to provide stable funding for the Company. These are ongoing strategies that are dependent on current market conditions and competition.

During the first six months of 2009, in keeping with its strategic objective to reduce interest rate risk exposure, the Company also sold $94.9 million of long term fixed rate loans that had been held for sale, which reduced potential earning assets and therefore had a negative impact on net interest income. This was offset, in the short term, by recognizing a gain on the sale of these loans of $1.6 million.

On July 18, 2008, the Company completed the purchase of MFB Corp. The assets purchased primarily included residential mortgage loans of $167.9 million, consumer loans of $48.5 million, commercial real estate loans of $91.6 million and commercial business loans of $75.5 million. The liabilities assumed included $331.1 million in deposits and $96.4 million in borrowings. This purchase of MFB Corp was consistent with the Company's strategic objective to change the re-pricing structure of its interest earning assets from longer term to shorter term and reduce interest rate risk to net interest income.

Results of operations also depend upon the level of the Company's non-interest income, including fee income, service charges, commissions, and the level of its non-interest expense, including general and administrative expenses. The acquisition of MFB Corp. added trust services to Mutual, which are being leveraged through Mutual's existing footprint. The Company also opened two new branches in Elkhart County in 2008. The intent of these initiatives has been to increase income over the long term. However, on a short term basis, expenses relating to expanding trust services and new branches will have the affect of increasing non-interest expense with limited immediate offsetting income.

Financial Condition

Assets totaled $1.4 billion at June 30, 2009, a decrease from December 31, 2008 of $4.3 million, or 0.3%. Gross loans, excluding loans held for sale, decreased $27.8 million, or 2.5%. Commercial loans increased $6.4 million, or 2.0%, while consumer loans decreased $3.7 million, or 1.4%, and residential mortgage loans held in the portfolio decreased $30.5 million, or 5.8%. Residential mortgage loans held for sale increased $15.5 million and mortgage loans sold during the first half of 2009 totaled $94.9 million compared to $28.2 million sold in the first half of last year. Mortgage loan sales are the primary reasons for the decreased loan balances and are consistent with our objective to reduce interest rate risk. Cash and cash equivalents decreased $18.7 million primarily due to the purchase of additional investment securities. Investment securities available for sale increased $30.3 million, or 39.2% primarily due to investments in highly rated municipal, corporate and mortgage-backed securities. Investment securities increased due to utilizing excess cash which provides additional yield on those assets and maintains a high level of liquidity.

Allowance for loan losses was $16.3 million at June 30, 2009, an increase of $1.2 million from December 31, 2008. Net charge offs for the quarter ended June 30, 2009 were $992,000, or .36% of average loans on an annualized basis compared to $569,000, or .28% of average loans for the comparable period in 2008. Net charge offs for the first half of 2009 were $2.0 million, or .35% of average loans on an annualized basis compared to $1.1 million, or .27% of average loans for the comparable period in 2008. On a linked quarter basis net charge offs increased from an annualized .34% of average loans for the quarter ended March 31, 2009 to .36% for the current quarter. The allowance for loan losses as a percentage of non-performing loans and total loans was 57.05% and 1.49%, respectively at June 30, 2009 compared to 69.38% and 1.41%, respectively at March 31, 2009. The increase in the allowance for loan losses was primarily due to the level of current delinquencies and economic conditions in the markets that Mutual serves. Mutual continues to actively monitor loan portfolios to determine the adequacy of its allowance.

Total deposits were $1.0 billion at June 30, 2009 an increase of $37.7 million, or 3.9% from December 31, 2008. This increase was due primarily to increases in retail certificates of deposit and savings deposits of $45.7 million, partially offset by declines in demand and money market deposits of $8.0 million. Total borrowings decreased $43.1 million to $236.0 million at June 30, 2009 from $279.1 million at December 31, 2008 primarily due to the payment of maturing and variable rate FHLB advances.

Stockholders' equity was $129.5 million at June 30, 2009, a decrease of $1.0 million, or 0.7% from December 31, 2008. The decline was due primarily to a decrease in accumulated other comprehensive income of $1.9 million from a loss of $2.0 million at December 31, 2008 to a loss of $3.9 million at June 30, 2009 due to increased discount rates used to price trust preferred securities in an inactive market. Discount rates were increased due to downgrades by various credit rating agencies. Other reasons for the decline include dividend payments of $1.7 million to common shareholders and $639,000 to preferred shareholders. These were partially offset by net income of $3.1 million and Employee Stock Ownership Plan (ESOP) shares earned of $102,000. All of Mutual's capital ratios are in excess of "well-capitalized" levels as defined by all regulatory standards.

Comparison of the Operating Results for the Three Months Ended June 30, 2009 and 2008

Net income available to common shareholders for the second quarter ended June 30, 2009 was $864,000, or $.13 for basic and diluted earnings per common share. This compared to net income for the same period in 2008 of $1.2 million, or $.30 for basic and diluted earnings per common share. Annualized return on assets was .25% and return on average tangible common equity was 3.82% for the second quarter of 2009 compared to .49% and 6.58% respectively, for the same period last year.

Net interest income before the provision for loan losses increased $3.5 million from $6.8 million for the three months ended June 30, 2008 to $10.3 million for the three months ended June 30, 2009. The primary reason for the increase was an increase in average earning assets of $418.6 million due to the acquisition of MFB Corp in the third quarter of 2008. In addition, net interest margin increased 8 basis points to 3.21% in the second quarter 2009 compared to 3.13% for the second quarter 2008 as interest-bearing liabilities decreased faster than the decrease in interest-earning assets.

The provision for loan losses for the second quarter of 2009 was $1.8 million, an increase from $733,000 for last year's comparable period. The increase was due primarily to an increased loan portfolio, increased net charge offs, increased non-performing loans and increased delinquency over the comparable period in 2008. Non-performing loans to total loans at June 30, 2009 were 2.60% compared to 2.03% at March 31, 2009 and 1.37% at June 30, 2008. This increase in non-performing loans, on the linked quarter basis, was primarily due to an increased level of non-performing residential property loans and non-performing commercial business loans. Non-performing assets to total assets were 2.41% at June 30, 2009 compared to 1.90% at March 31, 2009 and 1.51% at June 30, 2008.

Non-interest income increased $2.0 million to $4.1 million, or 96.5% for the three months ended June 30, 2009 compared to the same period in 2008. The increase was primarily due to an increase in gains on sales and servicing of loans sold of $521,000, or 331.8%, as a result of increases in mortgage loan production and commitments to sell loans as of June 30, 2009. Another reason for the increase was the increase in gain on sale of investments of $358,000, which includes a gain on sale of a subsidiary of $137,000 and $221,000 gain on the sale of investments. Other increases included increases in service fees on transaction accounts of $511,000, or 37.5%, increases in commission income of $552,000, or 179.4%, and increases in cash surrender value of life insurance of $136,000, or 49.4%, all primarily due to the acquisition of MFB Corp in the third quarter of 2008. On a linked quarter basis, non-interest income increased $565,000 mainly due to increases in gains on sales of investments of $557,000, increases in service fees on transaction accounts of $187,000, and increases in commission income of $232,000. These increases were partially offset by a decrease in gains on sales and servicing of loans sold of $425,000.

Non-interest expense increased $4.4 million to $11.3 million for the three months ended June 30, 2009 compared to $6.9 million for the same period in 2008. Increases in current quarter non-interest expense compared to the same period in 2008 include increases in salaries and employee benefits of $1.8 million, increases in occupancy and equipment expense of $345,000, increases in professional fees expense of $96,000 and increases in marketing expense of $45,000. All of these increases were primarily due to the acquisition of MFB Corp in the third quarter of 2008. Other increases during the quarter included an increase in FDIC insurance of $969,000 partially due to FDIC special assessment of $630,000, increases in intangible amortization of $340,000 and increases in other expenses $539,000. On a linked quarter basis, non-interest expense increased by $937,000 compared to the three months ended March 31, 2009, primarily due to the FDIC special assessment of $630,000 and increases in salaries and benefits of $228,000 primarily due to the increased mortgage production.

Income tax expense decreased $48,000 for the three months ended June 30, 2009 compared to the same period in 2008 due primarily to decreased taxable income. The effective tax rate also decreased from 10.0% to 5.9% due to a higher percentage of non-taxable income to total income before income tax and an increased percentage of low income housing tax credits to taxable income when comparing the second quarter of 2009 to the second quarter of 2008, respectively.

Comparison of the Operating Results for the Six Months Ended June 30, 2009 and 2008

Net income available to common shareholders for the six months ended June 30, 2009 was $2.2 million or $.32 for basic and diluted earnings per common share. This compared to net income for the comparable period in 2008 of $2.4 million or $.60 for basic and diluted earnings per share. Annualized return on average assets was .31% and return on average tangible common equity was 4.85% for the first half of 2009 compared to .50% and 6.69% respectively, for the same period last year.

Net interest income before the provision for loan losses increased $7.5 million from $13.2 million for the six months ended June 30, 2008 to $20.7 million for the six months ended June 30, 2009. As mentioned above, the primary reason for the increase was an increase in average earning assets of $420.5 million due to the acquisition of MFB Corp in the third quarter of 2008. In addition, net interest margin increased 18 basis points to 3.22% for the six months ended June 30, 2009 compared to 3.04% for the comparable period in 2008 as interest-bearing liabilities decreased faster than the decrease in interest-earning assets.

The provision for loan losses for the first half of 2009 was $3.2 million, an increase from $1.3 million for last year's comparable period. Non-performing loans to total loans at June 30, 2009 were 2.60% compared to 1.37% for the prior year comparable period. Non-performing assets to total assets were 2.41% at June 30, 2009 compared to 1.51% at June 30, 2009. The reason for the increase in provision for loan losses is higher loan balances, increased delinquency and higher non-performing loans.

For the six month period ended June 30, 2009 non-interest income increased $3.5 million, or 82.7%, to $7.7 million compared to $4.2 million for the same period in 2008. The increase was primarily due to an increase in gains on sales and servicing of loans sold of $1.4 million, or 385.3%, as a result of increases in mortgage loan production and commitments to sell loans for the six months ended June 30, 2009. Other increases included service fee income of $1.0 million, or 41.26%, increases in commission income of $888,000, or 148.9%, and increases in cash surrender value of life insurance of $246,000, or 44.6%, all primarily due to the acquisition of MFB Corp in the third quarter of 2008.

For the six month period ended June 30, 2009 non-interest expense increased $8.3 million, to $21.7 million compared to $13.4 million for the same period in 2008. Increases largely due to the acquisition of MFB Corp, in the third quarter of 2008, include salaries and employee benefits of $3.4 million, intangible amortization of $681,000, occupancy and equipment expenses of $612,000, data processing fees of $204,000, ATM expense of $163,000, professional fees expense of $222,000, marketing expense of $178,000, and software subscriptions and . . .