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 $107 million in investments. MFIC currently owns one subsidiary, Mutual Federal REIT. The assets of Mutual Federal REIT consist of approximately $95 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 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 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 ASC 320. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, the company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition.

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.

Income Tax Accounting

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

Forward Looking Statements

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

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

Overview

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

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

It has been the Company's strategic objective to change the repricing structure of its interest-earning assets from longer term to shorter term to better match the structure of our interest-bearing liabilities and therefore reduce the impact interest rate changes have on our net interest income. Strategies employed to accomplish this objective, in addition to the MFB Corp. acquisition, 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 55% as of September 30, 2009. As we continue to increase our investment in business-related loans, which are considered to entail greater risks than one-to four- family residential loans, in order to help offset the pressure on our net interest margin, our provision for loan losses has increased to reflect this increased risk. On the liability side of the balance sheet, the Company is employing strategies to increase the balance of core deposit accounts, such as low cost checking and money market accounts. The percentage of core deposits to total deposits was 37% at September 30, 2009 compared to 39% at the end of the third quarter 2008. 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 nine months of 2009, in keeping with its strategic objective to reduce interest rate risk exposure, the Company also sold $143.5 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 $2.2 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 September 30, 2009, an increase from December 31, 2008 of $8.3 million, or 0.6%. Gross loans, excluding loans held for sale, decreased $44.1 million, or 3.9%. Increases in commercial loans of $4.4 million, or 1.3% were offset by decreases in consumer loans of $2.7 million, or 1.0% and residential mortgage loans held in the portfolio of $45.8 million, or 8.6%. Residential mortgage loans held for sale increased $1.1 million and mortgage loans sold during the first nine months of 2009 totaled $143.5 million compared to $86.6 million sold in the first nine months of last year. Mortgage loan originations for the nine months ended September 30, 2009 were approximately $190 million, a 92% increase over the same time period in 2008. Despite the increased originations, mortgage loan sales have led to a decrease in loan balances. Increases in investment securities available for sale of $40.0 million, or 51.8% primarily due to investments in highly rated municipal, corporate and mortgage-backed securities and cash and cash equivalents of $14.7 million helped offset the decreases in the loan portfolio.

Allowance for loan losses was $16.6 million at September 30, 2009, an increase of $1.5 million from December 31, 2008. Net charge offs for the quarter ended September 30, 2009 were $1.4 million, or .50% of average loans on an annualized basis compared to $253,000, or .09% of average loans for the comparable period in 2008. Net charge offs for the first nine months of 2009 were $3.3 million, or .40% of average loans on an annualized basis compared to $1.3 million, or .20% of average loans for the comparable period in 2008. On a linked quarter basis net charge offs increased from an annualized .36% of average loans for the quarter ended June 30, 2009 to .50% for the current quarter. The allowance for loan losses as a percentage of non-performing loans and total loans was 50.68% and 1.53%, respectively at September 30, 2009 compared to 57.05% and 1.49%, respectively at June 30, 2009.

Total deposits were $1.0 billion at September 30, 2009 an increase of $68.9 million, or 7.2% from December 31, 2008. This increase was due primarily to increases in certificates of deposit of $65.4 million and transactional deposits of $3.5 million. Total borrowings decreased $59.6 million to $219.5 million at September 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 $130.9 million at September 30, 2009, an increase of $422,000, or 0.3% from December 31, 2008. The increase was due primarily to net income of $4.4 million and Employee Stock Ownership Plan (ESOP) shares earned of $163,000. These increases were partially offset by increases in accumulated other comprehensive losses of $537,000 from a loss of $2.0 million at December 31, 2008 to a loss of $2.6 million at September 30, 2009 due to increased discount rates used to price trust preferred securities in an inactive market. Other offsets to net income include dividend payments of $2.5 million to common shareholders and $1.0 million to preferred shareholders. The Bank's risk-based capital ratio is well in excess of "well-capitalized" levels as defined by all regulatory standards.

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

Net income available to common shareholders for the third quarter ended September 30, 2009 was $791,000, or $.12 for basic and diluted earnings per common share. This compared to net income for the same period in 2008 of $359,000, or $.06 for basic and diluted earnings per common share. Annualized return on assets was .23% and return on average tangible common equity was 3.48% for the third quarter of 2009 compared to .11% and 1.77% respectively, for the same period last year.

Net interest income before the provision for loan losses increased $407,000 from $9.8 million for the three months ended September 30, 2008 to $10.2 million for the three months ended September 30, 2009. The primary reason for the increase was an increase in average earning assets of $86.9 million due to the acquisition of MFB Corp in the third quarter of 2008. This increase was partially offset by a decrease in net interest margin of 10 basis points to 3.21% in the third quarter 2009 compared to 3.31% for the third quarter 2008. The decrease in the interest margin was due to rates on interest earning assets repricing more than those on interest earning liabilities.

The provision for loan losses for the third quarter of 2009 was $1.7 million, an increase from $738,000 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 delinquencies over the comparable period in 2008. Non-performing loans to total loans at September 30, 2009 were 3.02% compared to 2.60% at June 30, 2009. This increase in non-performing loans was primarily due to an increased level of non-performing residential property loans. Non-performing assets to total assets were 2.74% at September 30, 2009 compared to 2.41% at June 30, 2009.

Non-interest income increased $2.5 million to $3.6 million for the three months ended September 30, 2009 compared to the same period in 2008. This was primarily due to an increase in gain on sale of investments of $2.8 million due to an impairment charge on securities taken in the third quarter of 2008 with no similar impairment charges taken in the current period. Other increases in the quarter included increases in service fees on transaction accounts of $140,000, increases in commission income of $119,000 and increases in cash surrender value of life insurance of $28,000. Most of these other increases are due to the acquisition of MFB Corp which occurred in the third quarter of 2008. These increases were partially offset by a decrease in gains on sales and servicing of loans sold of $529,000 and a decrease in other income of $19,000.

Non-interest expense increased $813,000 to $10.9 million for the three months ended September 30, 2009 compared to $10.1 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 $545,000 which was primarily due to commissions paid for mortgage origination. Other increases included increases in occupancy and equipment expense of $171,000, increases in data processing of $29,000, increases in deposit insurance of $222,000, increases in software subscriptions and maintenance of $68,000, increases in intangible amortization of $84,000 and increases in other expenses of $121,000. Most of the increases are due to the acquisition of MFB Corp which occurred in the third quarter of 2008. These increases were partially offset by decreases in professional fees of $71,000, decreases in marketing expense of $36,000 and decreases in supplies of $320,000, which were largely due to costs associated with rebranding and system changes in 2008.

Income tax expense increased $510,000 for the three months ended September 30, 2009 compared to the same period in 2008 due primarily to increased taxable income. The effective tax rate also increased from (461.3)% to 4.0% due to a higher percentage of taxable income when comparing the third quarter of 2009 to the third quarter of 2008, respectively.

Comparison of the Operating Results for the Nine Months Ended September 30, 2009 and 2008

Net income available to common shareholders for the nine months ended September 30, 2009 was $3.0 million, or $.44 for basic and diluted earnings per common share. This compared to net income for the comparable period in 2008 of $2.7 million, or $.58 for basic and diluted earnings per share. Annualized return on average assets was .28% and return on average tangible common equity was 4.39% for the first nine months of 2009 compared to .34% and 4.91% respectively, for the same period last year.

Net interest income before the provision for loan losses increased $8.0 million from $23.0 million for the nine months ended September 30, 2008 to $30.9 million for the nine months ended September 30, 2009. As mentioned above, the primary reason for the increase was an increase in average earning assets of $307.7 million due to the acquisition of MFB Corp in the third quarter of 2008. In addition, net interest margin increased 7 basis points to 3.22% for the nine months ended September 30, 2009 compared to 3.15% for the comparable period in 2008. The increase in the interest margin was due to rates on interest earning assets repricing less than those on interest earning liabilities.

The provision for loan losses for the first nine months of 2009 was $4.9 million, an increase from $2.6 million for last year's comparable period. Non-performing loans to total loans at September 30, 2009 were 3.02% compared to 1.63% at September 30, 2008. Non-performing assets to total assets were 2.74% at September 30, 2009 compared to 1.64% at September 30, 2008. The reason for the increase in provision for loan losses is increased loan portfolio, increased net charge-offs, increased non-performing loans and increased delinquencies over the first nine months of 2008. Management continues to diligently review loans with inherent risk at least quarterly to ensure proper classification and adequate reserves.

For the nine month period ended September 30, 2009 non-interest income increased $6.0 to $11.4 million compared to $5.3 million for the same period in 2008. The increase was primarily due to an increase in gain on sale of investments of $2.9 million mainly due to an impairment charge on securities taken in the third quarter of 2008 with no similar impairment charges taken this year. Other changes, which were mainly due to the acquisition of MFB Corp., included increases in service fees of $1.2 million, increases in commission income of $1.0 million and increases in cash surrender value of life insurance of $274,000, which were partially offset by increased losses in limited partnerships of $141,000. Other increases include gains on sales and servicing of loans sold of $885,000, due to the increased volume in loan sales during the first nine months of 2009. These increases were partially offset by decreases in other income of $26,000.

For the nine month period ended September 30, 2009 non-interest expense increased $9.1 million to $32.6 million compared to $23.5 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 $4.0 million, . . .