UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended   December 31, 2009
OR
¨
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 checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   YES    ¨    NO    x

Indicate by checkmark 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 checkmark 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 checkmark whether the registrant has submitted electronically and posted on its corporate website, 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   ¨      NO   ¨

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   x

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

Accelerated filer   ¨
Non-accelerated filer   ¨
Smaller reporting company   x
   
(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, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $48.1 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 March 15, 2010, there were 6,984,754 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

PART III of Form 10-K—Portions of registrant’s Proxy Statement for its 2010 Annual Meeting of Stockholders.

 
 

 

Item 1.   Business
 
General
 
MutualFirst Financial, Inc., a Maryland corporation (“ MutualFirst ” or the “Company”), is the holding company of its wholly-owned subsidiary MutualBank, a federal savings bank (“MutualBank” or the “Bank”).   MutualFirst Financial was formed in September 1999 to become the holding company of MutualBank in connection with MutualBank’s conversion from the mutual to stock form of organization on December 29, 1999.  The words “we,” “our” and “us” in this Form 10-K refer to MutualFirst and MutualBank on a consolidated basis, unless indicated otherwise herein.
 
At December 31, 2009, we had total assets of $1.4 billion, deposits of $1.0 billion and stockholders’ equity of $129.7 million.  Our executive offices are located at 110 E. Charles Street, Muncie, Indiana 47305-2400, and our common stock is traded on the Nasdaq Global Market under the symbol “MFSF.”
 
Substantially all of MutualFirst ’s business is conducted through MutualBank, which is a federal savings bank subject to extensive regulation by the Office of Thrift Supervision (“OTS”). MutualBank’s deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation (“FDIC”). MutualBank has 33 retail financial centers, spanning nine Indiana counties and is the 10 th largest depository institution headquartered in Indiana. MutualBank also has trust offices in Carmel and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan.
 
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 first mortgages on owner-occupied, one- to four-family residences, a variety of consumer loans, loans secured by commercial and multi-family real estate and commercial business loans.  Funds not invested in loans generally are invested in investment securities, including mortgage-backed and mortgage-related securities.  MutualWealth is the wealth management division of the bank providing a variety of fee-based financial services, including trust, investment, insurance, broker advisory, retirement plan and private banking services, in the Bank’s market area.  As of December 31, 2009, MutualWealth managed assets of $313.3 million.
 
Our profitability depends primarily on net interest income, which is the difference between interest and dividend income on interest-earning assets, and interest expense on interest-bearing liabilities.  Interest-earning assets include principally loans, investment securities, including mortgage-backed and related securities and interest-earning deposits in other institutions.  Net interest income is dependent upon the level of interest rates and the extent to which such rates are changing.  Our profitability is also dependent on the level of noninterest income, provision for loan losses, noninterest expense and income taxes.  Our operations and profitability are subject to changes in interest rates, applicable statutes and regulations, and general economic conditions, as well as other factors beyond our control.  The Company continues to reduce the impact of interest rate changes on its net interest income by shortening the term of its interest-earning assets to better match the terms of our interest-bearing liabilities and by selling long-term fixed rate loans.  See “Quantitavie and Qualitative Disclosures About Market Risk – Asset and Liability Management and Market Risk” in Item A.
 
During 2008 and 2009, market and economic trends in our industry and in Indiana have declined resulting in increased delinquencies and foreclosures.  A number of federal legislative and regulatory initiatives have been enacted to address these conditions.  See “Asset Quality” and “How We Are Regulated” in Item 1, “Risk Factors” in Item 1A and the “Management’s Discussion and Analysis” in Item 7.
 
On July 18, 2008, the Company acquired MFB Corp and its banking subsidiary, MFB Financial, in a merger transaction involving the issuance of 2.9 million shares of common stock and payment of $11.5 million in cash to former stockholders of MFB Corp.  The Company obtained $167.9 million in residential mortgage loans, $48.5 million in consumer loans, $91.6 million in commercial real estate loans and $75.5 million in commercial business loans and assumed $331.1 million in deposits and $96.4 million in borrowings in the acquisition of MFB Corp.
 
1

 
On December 23, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program, the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with the United States Department of the Treasury (“Treasury”), pursuant to which the Company (i) sold 32,382 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) for a purchase price of $32,382,000 in cash and (ii) issued a warrant (the “Warrant”) to purchase 625,135 shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), for a per share price of $7.77 per share.  The Series A Preferred Stock is entitled to cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter.  The Series A Preferred Stock may be redeemed by the Company at any time, subject to consultation by the Treasury with the Office of Thrift Supervision (“OTS”).  The Warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $7.77 per share of the Common Stock.  If the Series A Preferred Stock is redeemed, the Warrant will be liquidated at the current market price.  Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant that it holds.
 
Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its Junior Stock (as defined below) and Parity Stock (as defined below) will be subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share ($0.16) declared on the Common Stock prior to December 23, 2008.  The redemption, purchase or other acquisition of trust preferred securities of the Company or its affiliates also will be restricted.  These restrictions will terminate on the earlier of (a) the third anniversary of the date of issuance of the Series A Preferred Stock, (b) the date on which the Series A Preferred Stock has been redeemed in whole; and (c) the date Treasury has transferred all of the Series A Preferred Stock to third parties.  In addition, the ability of the Company to declare or pay dividends or distributions on, or repurchase, redeem or otherwise acquire for consideration, shares of its Junior Stock and Parity Stock will be subject to restrictions in the event that the Company fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on its Series A Preferred Stock. “Junior Stock” means the Common Stock and any other class or series of stock of the Company the terms of which expressly provide that it ranks junior to the Series A Preferred Stock as to dividend rights and/or rights on liquidation, dissolution or winding up of the Company. “Parity Stock” means any class or series of stock of the Company the terms of which do not expressly provide that such class or series will rank senior or junior to the Series A Preferred Stock as to dividend rights and/or rights on liquidation, dissolution or winding up of the Company (in each case without regard to whether dividends accrue cumulatively or non-cumulatively).
 
The Company placed $29.1 million of its TARP proceeds in the Bank and retained the remaining $3.2 million as working capital.  The Bank initially placed approximately $20.0 million of the proceeds in highly rated securities.  Of the $20.0 million, approximately $14.8 million was placed in mortgage securities, $3.2 million in municipal securities and $2.0 million in corporate bonds.  These securities provide liquidity as needed to meet current and future loan demand.  The remaining funds held at the Bank were placed in working capital, which was used to fund loans and meet the cash needs of MutualBank.  During 2009, the TARP proceeds have provided the Bank with a continued ability to lend to businesses and individuals along with the ability to purchase agency mortgage backed securities.
 
Forward-Looking Statements
 
This Form 10-K contains various forward-looking statements that are based on assumptions and describe our future plans and strategies and our expectations.  These forward-looking statements are generally identified by words such as “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar words.  Our ability to predict results or the actual effect of future plans or strategies is uncertain.  Factors which could cause actual results to differ materially from those estimated include, but are not limited to, changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of our loan and investment portfolios, demand for our loan products, deposit flows, our operating expenses, competition, demand for financial services in our market areas and accounting principles and guidelines.  These risks and uncertainties should be considered in evaluating forward-looking statements, and you should not rely too much on these statements.  We do not undertake, and specifically disclaim, any obligation to publicly revise 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.
 
2

 
Market Area
 
We are a community-oriented financial institution offering a variety of financial services to meet the needs of the communities we serve. We are headquartered in Muncie, Indiana and we offer our financial services through 33 full service retail financial center offices in Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties. MutualBank also has trust offices in Carmel and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. We also originate mortgage loans in the counties contiguous to these counties, and we have historically originated indirect consumer loans throughout Indiana. See “Lending Activities — Consumer and Other Lending.”
 
Lending Activities
 
General.   Our loans carry either a fixed- or an adjustable-rate of interest.  At December 31, 2009 our net loan portfolio totaled $1.1 billion, which constituted 75.7% of our total assets.
 
Loans up to $600,000 may be approved by certain individual loan officers.  Loans in excess of $600,000, but not in excess of $1.2 million, may be approved by the signature of an Executive Loan Committee member and one other loan officer to the total of their combined individual lending authority.  Loans not to exceed $3.0 million, to a borrower whose aggregate debt is not greater than $5.0 million, may be approved by a majority vote of the Executive Loan Committee.  All loans in excess of $3.0 million and loans of any amount to a borrower whose aggregate debt will exceed $5.0 million must be approved by the Board of Directors.  The aggregate limit may be increased or decreased by a specific guidance by the Board for a specific borrower.
 
At December 31, 2009, the maximum amount that we could lend to any one borrower and the borrower’s related entities was approximately $20.1 million.  As of December 31, 2009, our largest lending relationship to a single borrower or group of related borrowers consisted of fourteen loans totaling a commitment of $8.2 million, with $6.2 million outstanding at year-end. All of the loans in this relationship are secured by real estate and  guaranteed by the principal.  Each of these loans to this group of borrowers was current and performing in accordance with its terms at December 31, 2009.

 
3

 

The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated.
 
   
December 31,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in thousands)
 
Real Estate Loans:
                                                           
One- to four-family
 
$
471,015
(1)
   
43.69
%
 
$
521,364
(2)
   
46.11
%
 
$
431,018
(3)
   
53.02
%
 
$
433,123
(4)
   
53.01
%
 
$
451,914
(5)
   
54.00
%
Multi-family
   
2,621
     
0.24
     
2,698
     
0.24
     
3,929
     
0.48
     
5,073
     
0.62
     
5,505
     
0.66
 
Commercial
   
257,368
     
23.88
     
250,693
     
22.17
     
82,116
     
10.10
     
73,912
     
9.05
     
77,270
     
9.23
 
Construction and development
   
9,817
     
0.91
     
12,232
     
1.08
     
13,560
     
1.67
     
14,451
     
1.77
     
22,938
     
2.74
 
Total real estate loans
 
 
740,821
     
68.72
   
 
786,987
     
69.60
   
 
530,623
     
65.28
     
526,559
     
64.45
     
557,627
     
66.63
 
                                                                                 
Other Loans:
                                                                               
Consumer Loans:
                                                                               
Automobile
 
 
18,848
     
1.75
   
 
22,715
     
2.01
   
 
22,917
     
2.82
     
31,336
     
3.84
     
39,802
     
4.76
 
Home equity
   
64,930
     
6.02
     
66,460
     
5.88
     
27,232
     
3.35
     
30,051
     
3.68
     
31,962
     
3.82
 
Home improvement
   
42,116
     
3.91
     
45,339
     
4.01
     
45,156
     
5.55
     
38,546
     
4.72
     
31,933
     
3.82
 
Manufactured housing
   
689
     
0.06
     
727
     
0.06
     
992
     
0.12
     
1,422
     
0.17
     
2,106
     
0.25
 
R.V.
   
81,663
     
7.58
     
79,884
     
7.07
     
77,805
     
9.57
     
71,321
     
8.73
     
64,222
     
7.67
 
Boat
   
45,581
     
4.23
     
46,928
     
4.15
     
47,816
     
5.88
     
46,311
     
5.67
     
40,631
     
4.85
 
Other
   
5,961
     
0.55
     
6,339
     
0.56
     
3,593
     
0.44
     
3,986
     
.48
     
4,305
     
.51
 
Total consumer loans
   
259,788
     
24.10
     
268,392
     
23.74
     
225,511
     
27.74
     
222,973
     
27.29
     
214,961
     
25.68
 
Commercial business loans
   
77,384
     
7.18
     
 75,290
     
6.66
     
56,764
     
6.98
     
67,476
     
8.26
     
64,353
     
7.69
 
Total other loans
   
337,172
     
31.28
     
 343,682
     
30.40
     
282,275
     
34.72
     
290,449
     
35.55
     
279,314
     
33.37
 
Total loans receivable, gross
   
1,077,993
(1)
   
100.00
%
   
1,130,669
(2)
   
100.00
%
   
812,898
(3)
   
100.00
%
   
817,008
(4)
   
100.00
%
   
836,941
(5)
   
100.00
%
                                                                                 
Less:
                                                                               
Undisbursed portion of loans
   
2,546
             
4,372
             
3,984
             
5,520
             
7,724
         
Deferred loan fees and costs
   
(3,182)
             
(3,484
)
           
(3,519
)
           
(3,623
)
           
(3,453
)
       
Allowance for losses
   
16,414
             
15,107
             
8,352
             
8,156
             
8,100
         
Total loans receivable, net
 
$
1,062,215
           
$
1,114,674
           
$
804,081
           
$
806,955
           
$
824,570
         


(1) 
Includes loans held for sale of $2.5 million.
(2) 
Includes loans held for sale of $1.5 million.
(3) 
Includes loans held for sale of $1.6 million.
(4) 
Includes loans held for sale of $1.3 million.
(5) 
Includes loans held for sale of $2.0 million.
 
 
4

 

The following table shows the composition of our loan portfolio by fixed- and adjustable-rate at the dates indicated.

   
December 31,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in thousands)
 
Fixed-Rate Loans:
                                                           
Real estate:
                                                           
One- to four-family
  $ 248,485
(1)
    23.05 %   $ 261,969
(2)
    23.17 %   $ 254,235
(3)
    31.28 %   $ 271,405
(4)
    33.22 %   $ 305,911
(5)
    36.55 %
Multi-family
    2,339       0.22       2,401       0.21       3,610       0.44       4,488       0.55       4,587       0.55  
Commercial
    129,297       12.00       115,922       10.25       17,281       2.13       9,408       1.15       9,375       1.12  
Construction and development
    8,559       0.79       9,724       0.86       10,197       1.25       8,310       1.02       12,690       1.52  
Total real estate loans
    388,680       36.06       390,016       34.49       285,323       35.10       293,611       35.94       332,563       39.74  
                                                                                 
Consumer
    215,434       19.98       229,326       20.28       198,068       24.37       192,715       23.59       182,784       21.84  
Commercial business
    40,025       3.71       37,865       3.35       19,842       2.44       27,093       3.32       20,000       2.39  
Total fixed-rate loans
    644,139       59.75       657,207       58.12       503,233       61.91       513,419       62.85       535,347       63.97  
                                                                                 
Adjustable-Rate Loans:
                                                                               
Real estate:
                                                                               
One- to four-family
    222,530       20.64       259,395       22.94       176,783       21.75       161,718       19.79       146,003       17.44  
Multi-family
    282       0.03       297       0.03       319       0.04       585       .07       918       0.11  
Commercial
    128,071       11.88       134,771       11.92       64,835       7.98       64,504       7.90       67,895       8.11  
Construction and development
    1,258       0.12       2,508       0.22       3,363       0.41       6,141       .75       10,248       1.22  
Total real estate loans
    352,141       32.67       396,971       35.11       245,300       30.18       232,948       28.51       225,064       26.88  
                                                                                 
Consumer
    44,354       4.11       39,066       3.46       27,443       3.38       30,258       3.70       32,177       3.85  
Commercial business
    37,359       3.47       37,425       3.31       36,922       4.53       40,383       4.94       44,353       5.30  
Total adjustable-rate loans
    433,854       40.25       473,462       41.88       309,665       38.09       303,589       37.15       301,594       36.03  
Total loans
    1,077,993
(1)
    100.00 %     1,130,669
(2)
    100.00 %     812,898
(3)
    100.00 %     817,008
(4)
    100.00 %     836,941
(5)
    100.00 %
                                                                                 
Less:
                                                                               
Undisbursed portion of loans
    2,546               4,372               3,984               5,520               7,724          
Deferred loan fees and costs
    (3,182 )             (3,484 )             (3,519 )             (3,623 )             (3,453 )        
Allowance for loan losses
    16,414               15,107               8,352               8,156               8,100          
Total loans receivable, net
  $ 1,062,215             $ 1,114,674             $ 804,081             $ 806,955             $ 824,570          


(1) 
Includes loans held for sale of $2.5 million.
(2) 
Includes loans held for sale of $1.5 million.
(3) 
Includes loans held for sale of $1.6 million.
(4) 
Includes loans held for sale of $1.3 million.
(5) 
Includes loans held for sale of $2.0 million.

 
5

 

The following schedule illustrates the contractual maturity of our loan portfolio at December 31, 2009.  Mortgages that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due.  The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
 
   
Real Estate
                                     
   
One- to Four-Family (1)
   
Multi-family and
Commercial
   
Construction
and Development (2)
   
Consumer
   
Commercial
Business
   
Total
 
   
   Amount   
   
  Weighted  
Average
Rate
   
Amount
   
Weighted
Average
Rate
   
Amount
   
Weighted
Average
Rate
   
Amount
   
Weighted
Average
Rate
   
Amount
   
Weighted
Average
Rate
   
Amount
   
Weighted
Average
Rate
 
   
(Dollars in thousands)
 
                                                                         
Due During Years Ending December 31,
                                                                       
2010 (3)
  $ 648       6.56 %   $ 65,297       5.07 %   $ 286       6.63 %   $ 10,506       6.73 %   $ 30,135       4.14 %   $ 106,872       4.98 %
2011
    717       5.72       17,165       6.10       214       7.63       10,464       7.23       9,332       5.18       37,892       6.19  
2012
    1,221       6.01       19,548       6.03       166       8.91       13,261       7.37       13,587       5.67       47,783       6.31  
2013 and 2014
    8,054       5.70       76,629       5.95       431       7.51       30,121       6.79       15,444       6.21       130,679       6.16  
2015 to 2016
    9,846       5.98       7,648       7.23       19       9.81       17,886       7.37       4,172       6.11       39,571       6.87  
2017 to 2031
    150,172       5.39       68,794       6.40       1,699       4.81       177,009       6.85       4,714       6.03       402,388       6.21  
2032 and following
    297,836       5.55       4,908       5.85       7,002       5.13       541       5.97             0.00       310,287       5.55  
Total
  $ 468,494       5.51 %   $ 259,989       5.90 %   $ 9,817       5.35 %   $ 259,788       6.91 %   $ 77,384       5.17 %   $ 1,075,472       5.92 %


(1)   Does not include mortgage loans held for sale.
(2)   Once the construction phase has been completed, these loans will automatically convert to permanent financing.
(3)   Includes demand loans, loans having no stated maturity and overdraft loans.

 
6

 

The total amount of loans due after December 31, 2010 that have predetermined interest rates is $599.5 million, and the total amount of loans due after such date which have floating or adjustable interest rates is $369.1 million.
 
One- to Four-Family Residential Real Estate Lending.   We focus our real estate lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences in our market areas.  At December 31, 2009, one- to four-family residential mortgage loans totaled $471.0 million, or 43.7% of our gross loan portfolio.
 
We generally underwrite and document our one- to four-family loans based on the loan applicant’s employment and credit history and the appraised value of the subject property consistent with secondary market standards or other prudent underwriting guidelines.  Generally, we lend up to 95% of the lesser of the appraised value or purchase price for one- to four-family residential loans.  For loans with a loan-to-value ratio in excess of 80%, we generally require private mortgage insurance in order to reduce our exposure to below 80%.  Properties securing our one- to four-family loans are appraised by independent state licensed fee appraisers approved by the Bank’s Board of Directors.  We require borrowers to obtain title insurance in the amount of their mortgage.  Hazard insurance and flood insurance, if necessary, are required in an amount of the lesser of the value of the property improvements or our mortgage amount.
 
We originate one- to four-family mortgage loans on either a fixed- or adjustable-rate basis, as consumer demand dictates.  Our pricing strategy for mortgage loans includes setting interest rates that are competitive with the secondary market and other local financial institutions and are consistent with our internal needs.  Adjustable-rate mortgage or ARM loans are offered with a one-year, three-year, five-year, seven-year or ten-year term to the initial repricing date.  After the initial period, the interest rate for each ARM loan adjusts annually for the remainder of the term of the loan.  We use the weekly average of the one-year Treasury Bill Constant Maturity Index to reprice our ARM loans.  During fiscal 2009, we originated $31.5 million of one- to four-family ARM loans and $218.5 million of one- to four-family fixed-rate mortgage loans.  By way of comparison, during fiscal 2008, we originated $33.1 million of one- to four-family ARM loans and $78.0 million of one- to four-family fixed-rate mortgage loans.
 
Fixed-rate loans secured by one- to four-family residences have contractual maturities of up to 30 years and are generally fully amortizing, with payments due monthly.  These loans normally remain outstanding, however, for a substantially shorter period of time because of refinancing and other prepayments.  A significant change in interest rates could alter considerably the average life of a residential loan in our portfolio.  Our one- to four-family loans are generally not assumable, do not contain prepayment penalties and do not permit negative amortization of principal.  Most are written using underwriting guidelines which make them saleable in the secondary market.  Our real estate loans generally contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.
 
Our one- to four-family residential ARM loans are fully amortizing loans with contractual maturities of up to 30 years, with payments due monthly. Our ARM loans generally provide for specified minimum and maximum interest rates, with a lifetime cap and floor, and a periodic adjustment on the interest rate over the rate in effect on the date of origination. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as is our cost of funds.
 
In order to remain competitive in our market areas, we sometimes originate ARM loans at initial rates below the fully indexed rate.  ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s payment rises, increasing the potential for default.  Our payment history for ARM loans has not been substantially different from fixed rate loans.  See “Asset Quality — Non-performing Assets” and “— Classified Assets.”  At December 31, 2009, our one- to four-family ARM loan portfolio totaled $222.5 million, or 20.6% of our gross loan portfolio.  At that date, the fixed-rate one- to four-family mortgage loan portfolio totaled $248.5 million, or 23.1% of our gross loan portfolio.
 
Multi-family and Commercial Real Estate Lending .  We offer a variety of multi-family and commercial real estate loans for acquisition, renovation or construction.  These loans are secured by the real estate and improvements financed.  The collateral securing these loans ranges from industrial and commercial buildings to churches, office buildings and multi-family housing complexes.  At December 31, 2009, multi-family and commercial real estate loans totaled $260.0 million, or 24.1% of our gross loan portfolio.
 
7

 
Our loans secured by multi-family and commercial real estate are originated with either a fixed or adjustable interest rate.  The interest rate on adjustable-rate loans is based on a variety of indices, generally determined through negotiation with the borrower.  Loan-to-value ratios on our multi-family and commercial real estate loans typically do not exceed 80% of the current appraised value of the property securing the loan.  These loans typically require monthly payments, may not be fully amortizing and generally have maximum maturities of 25 years.  Developmental loans are secured by real estate and repaid by the sale of lots.
 
Loans secured by multi-family and commercial real estate are underwritten based on the income producing potential of the property and the financial strength of the borrower. The net operating income, which is the income derived from the operation of the property less all operating expenses, must be sufficient to cover the payments related to the outstanding debt. We may require personal guarantees of the borrowers in addition to the real estate as collateral for such loans. We also generally require an assignment of rents or leases in order to be assured that the cash flow from the real estate can be used to repay the debt. Appraisals on properties securing multi-family and commercial real estate loans are performed by independent state licensed fee appraisers approved by MutualBank’s Board of Directors. See “Loan Originations, Purchases, Sales and Repayments.”
 
We generally do not maintain a tax or insurance escrow account for loans secured by multi-family and commercial real estate.  In order to monitor the adequacy of cash flows on income-producing properties, the borrower is required to provide periodic financial information.
 
Loans secured by multi-family and commercial real estate are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans.  Multi-family and commercial real estate loans typically involve large balances to single borrowers or groups of related borrowers.  Because payments on loans secured by multi-family and commercial real estate are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy.  If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired.  See “Asset Quality — Non-performing Assets.”
 
Construction and Development Lending . We originate construction loans primarily secured by existing residential building lots. We make construction loans to builders and to individuals for the construction of their residences. Substantially all of these loans are secured by properties located within our market area. At December 31, 2009, we had $9.8 million in construction and development loans outstanding, representing 0.9% of our gross loan portfolio.
 
Construction and development loans are obtained through continued business with builders who have previously borrowed from us, from walk-in customers and through referrals from realtors and architects.  The application process includes submission of complete plans, specifications and costs of the project to be constructed.  This information and an independent appraisal is used to determine the value of the subject property.  Loans are based on the lesser of the current appraised value and/or the cost of construction, including the land and the building.  We generally conduct regular inspections of the construction project being financed.  Residential construction loans are done with one closing for both the construction period and the long term financing.
 
Construction loans for one- to four-family homes are generally granted with a construction period of up to nine months.  During the construction phase, the borrower generally pays interest only on a monthly basis.  Loan-to-value ratios on our construction and development loans typically do not exceed 90% of the appraised value of the project on an as completed basis.  Single family construction loans with loan-to-value ratios over 80% usually require private mortgage insurance.
 
Because of the uncertainties inherent in estimating construction and development costs and the market for the project upon completion, it is difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project.  These loans also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.  In addition, payment of interest from loan proceeds can make it difficult to monitor the progress of a project.
 
8

 
Consumer and Other Lending .  Consumer loans generally have shorter terms to maturity, which reduces our exposure to changes in interest rates, and carry higher rates of interest than one- to four-family residential mortgage loans.  In addition, management believes that offering consumer loan products helps to expand and create stronger ties to our customer base by increasing the number of customer relationships and providing cross-marketing opportunities.  At December 31, 2009, our consumer loan portfolio totaled $259.8 million, or 24.1% of our gross loan portfolio. We offer a variety of secured consumer loans, including home equity and lines of credit, home improvement, auto, boat and recreational vehicle loans, and loans secured by savings deposits.  We also offer a limited amount of credit card and unsecured loans.  We originate our consumer loans both in our market area and throughout Indiana with some customers residing in contiguous states through our indirect lending program.
 
At December 31, 2009, our home equity loans, including lines of credit and home improvement loans, totaled $107.0 million, or 9.9% of our gross loan portfolio.   These loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 100% of the value of the property securing the loan.  The term to maturity on our home equity and home improvement loans may be up to 15 years.  Most home equity lines of credit have a maximum term to maturity of 20 years and require a minimum monthly payment based on the outstanding loan balance per month, which amount may be reborrowed at any time.  A limited number of home equity lines of credit are approved with monthly payments of accrued interest only.  Other consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.
 
We directly and indirectly originate auto, boat and recreational vehicle loans.  We generally buy indirect auto loans on a rate basis, paying the dealer a cash payment for loans with an interest rate in excess of the rate we require.  This premium is amortized over the remaining life of the loan.  As specified in written agreements with these dealers, prepayments or delinquencies are charged to future amounts owed to that dealer, with no dealer reserve or other guarantee of payment if the dealer stops doing business with us.
 
We employ the Fair Isaac’s credit scoring models for all consumer loan applications.  These models evaluate credit and application attributes.  We originate consumer loans through bank financial centers and indirect channels.  These loans are underwritten traditionally, with a review of the borrower’s employment and credit history and an assessment of the borrower’s ability to repay the loan.
 
At December 31, 2009, auto loans totaled $18.8 million, or 1.8% of our gross loan portfolio.  Auto loans may be written for up to six years and usually have a fixed rate of interest.  Loan-to-value ratios are up to 100% of the MSRP or 120% of invoice for new autos and 110% of value on used cars, based on valuation from official used car guides.
 
Loans for boats and recreational vehicles totaled $127.2 million at December 31, 2009, or 11.8% of our gross loan portfolio.  At December 31, 2009, we decided to suspend originations of boat and recreational vehicle loans from indirect sources.
 
Consumer loans may entail greater risk than one- to four-family residential mortgage loans, especially consumer loans secured by rapidly depreciable assets, such as automobiles, boats and recreational vehicles.  In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance.  As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
 
Commercial Business Lending .  At December 31, 2009, commercial business loans totaled $77.4 million, or 7.2% of our gross loan portfolio. Most of our commercial business loans have been extended to finance businesses in our market area.  Credit accommodations extended include lines of credit for working capital needs, term loans to purchase capital goods and real estate, development lending to foster residential, business and community growth and agricultural lending for inventory and equipment financing.
 
9

 
The terms of loans extended on the security of machinery and equipment are based on the projected useful life of the machinery and equipment, generally not to exceed seven years.  Lines of credit generally are available to borrowers for up to 13 months, and may be renewed by us after an annual review of current financial information.
 
We issue a few financial-based standby letters of credit which are offered at competitive rates and terms and are generally on a secured basis.  We continue to expand our volume of commercial business loans.
 
Our commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of other conditions affecting the borrower.  Analysis of the borrower’s past, present and future cash flows also is an important aspect of our credit analysis.  We may obtain personal guarantees on our commercial business loans.  Nonetheless, these loans are believed to carry higher credit risk than traditional single family loans.
 
Unlike residential mortgage loans, commercial business loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial business loans may substantially depend on the success of the business itself (which, in turn, often depends in part upon general economic conditions).  Our commercial business loans are usually secured by business assets.  However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
 
Loan Originations, Purchases, Sales and Repayments
 
We originate loans through referrals from real estate brokers and builders, our marketing efforts, and our existing and walk-in customers. Historically, we have originated many of our consumer loans through relationships with dealerships. While we originate both adjustable-rate and fixed-rate loans, our ability to originate loans depends upon customer demand for loans in our market areas. Demand is affected by local competition and the interest rate environment. During the last several years, due to low market rates of interest, our dollar volume of fixed-rate, one- to four-family loans has exceeded the dollar volume of the same type of adjustable-rate loans. As part of our interest rate risk management efforts, we have from time to time sold our fixed rate, one- to four-family residential loans. We have also purchased adjustable rate one- to four-family residential and commercial real estate loans.
 
In periods of economic uncertainty, the ability of financial institutions, including us, to originate or purchase large dollar volumes of loans may be substantially reduced or restricted, with a resultant decrease in interest income.
 
The following table shows our loan origination, purchase, sale and repayment activities for the years indicated.
 
10

 
   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
   
(Dollars in thousands)
 
                   
Originations by type:
                 
Adjustable rate:
                 
Real estate - one- to four-family
 
$
31,542
   
$
33,083
   
$
28,275
 
- multi-family
   
56
     
1,323
     
 
- commercial
   
7,713
     
7,132
     
11,557
 
- construction or development
   
1,138
     
5,617
     
4,894
 
Non-real estate - consumer
   
317
     
43
     
56
 
- commercial business
   
1,322
     
2,061
     
2,026
 
Total adjustable-rate
   
42,088
     
49,259
     
46,808
 
Fixed rate:
                       
Real estate - one- to four-family
   
218,546
     
78,040
     
58,338
 
- multi-family
   
1,444
     
2,052
     
 
- commercial
   
16,536
     
12,737
     
2,171
 
- construction or development
   
7,382
     
9,171
     
11,687
 
Non-real estate - consumer
   
39,745
     
42,465
     
44,423
 
- commercial business
   
9,447
     
5,409
     
3,153
 
Total fixed-rate
   
293,100
     
149,874
     
119,772
 
Total loans originated
   
335,188
     
199,133
     
166,580
 
                         
Purchases: (1)
                       
Real estate - one- to four-family
   
     
213,441
     
16,058
 
- commercial
   
     
93,479
     
 
- construction or development
   
     
1,770
     
 
Non-real estate - consumer
   
     
9,677
     
 
- commercial business
   
     
75,496
     
 
Total loans purchased
   
     
393,863
(2)
   
16,058
 
                         
Sales and Repayments:
                       
Sales:
                       
Real estate - one- to four-family
   
160,019
     
92,914
     
24,113
 
Total loans sold
   
160,019
     
92,914
     
24,113
 
Principal repayments
   
231,254
     
179,187
     
162,159
 
Total reductions
   
391,273
     
272,101
     
186,272
 
Increase (decrease) in other items, net
   
2,409
     
(3,124
)
   
(476
)
Net increase (decreases)
 
$
(53,676)
   
$
317,771
   
$
(4,110
)
 

(1)
Does not include market value adjustment for loans related to acquisitions of branches from other financial institutions.
(2)
Includes $385.3 million of loans acquired as part of the Company’s acquisition of MFB.

Asset Quality
 
When a borrower fails to make a payment on a mortgage loan on or before the default date, a late charge and delinquency notice is mailed. All delinquent accounts are reviewed by a collector, who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due. If the loan becomes 30 days delinquent, the collector will generally contact the borrower by phone or send a letter to the borrower in order to identify the reason for the delinquency. Once the loan becomes 60 days delinquent, the borrower is asked to pay the delinquent amount in full, or establish an acceptable repayment plan to bring the loan current. Prior to foreclosure a drive-by inspection is made to determine the condition of the property. If the account becomes 120 days delinquent, and an acceptable repayment plan has not been agreed upon, a collection officer will generally refer the account to legal counsel, with instructions to prepare a notice of intent to foreclose. The notice of intent to foreclose allows the borrower up to 30 days to bring the account current. During this 30 day period, the collector may accept a repayment plan from the borrower which would bring the account current prior to foreclosure. The Bank has suspended foreclosure activities when directed by government sponsored entities or the Bank’s regulator.
 
11

 
For consumer loans, a similar process is followed, with the initial written contact being made once the loan is 20 days past due.
 
Commercial loan relationships exceeding $250,000 are reviewed on a regular basis by the commercial credit department.  Larger relationships are monitored through a system of internal and external loan review.  All relationships that are deemed to warrant special attention are monitored at least quarterly.  Individual commercial officers maintain communication with borrowers and recommend action plans to a Loan Quality Review committee which meets monthly to discuss credits graded Special Mention or worse.  The Asset Classification committee meets quarterly and establishes specific reserves for losses on relationships that are deemed to be under-collateralized and at risk of continued non-payment.  Collection and loss mitigation efforts are a cooperative effort between the Commercial Loan Department and the Risk Management Division.
 
Delinquent Loans.   The following table sets forth, as of December 31, 2009, our loans delinquent for 60 to 89 days by type, number, amount and percentage of type.
 
   
Loans Delinquent For:
 
   
60-89 Days
 
   
Number
   
Amount
   
Percent
of Loan
Category
 
   
(Dollars in thousands)
 
                   
Real Estate:
                 
One- to four-family
   
58
   
$
4,411
     
0.94
%
Multi-family
   
     
     
 
Commercial
   
6
     
667
     
0.26
 
Construction and development
   
3
     
729
     
7.43
 
Consumer
   
116
     
1,992
     
0.77
 
Commercial business
   
2
     
111
     
0.14
 
                         
Total
   
185
   
$
7,910
     
0.74
%

As of December 31, 2008, our total loans delinquent for 60 to 89 days was $9.1 million or .81% of total loans.

Non-performing Assets.   The table below sets forth the amounts and categories of non-performing assets in our loan portfolio at the dates indicated.  Generally, loans are placed on non-accrual status when the loan becomes more than 90 days delinquent or when collection of interest becomes doubtful.  Foreclosed assets owned include assets acquired in settlement of loans.
 
12

 
   
December 31,
 
   
2009
   
2008
 
2007
   
2006
 
2005
 
   
(Dollars in thousands)
 
Non-accruing loans:
                         
One- to four-family
 
$
14,617
   
$
7,917
 
$
2,997
   
$
2,762
 
$
2,967
 
Multi-family
   
     
   
     
   
 
Commercial real estate
   
8,986
     
7,723
   
2,656
     
356
   
569
 
Construction and development
   
     
   
     
   
 
Consumer
   
3,610
     
1,851
   
1,294
     
983
   
628
 
Commercial business
   
1,873
     
2,507
   
2,002
     
1,468
   
1,257
 
Total
   
29,086
     
19,998
   
8,949
     
5,569
   
5,421
 
                                     
Accruing loans delinquent 90 days or more:
                                   
One- to four-family
   
1,861
     
1,284
   
     
   
67
 
Multi-family
   
     
   
     
   
 
Commercial real estate
   
     
189
   
1,421
     
   
1,858
 
Construction and development
   
     
   
     
   
 
Consumer
   
73
     
   
     
   
35
 
Commercial business
   
     
   
     
   
 
Total
   
1,934
     
1,473
   
1,421
     
   
1,960
 
Total nonperforming loans
   
31,020
     
21,471
   
10,370
     
5,569
   
7,381
 
                                     
Restructured loans
   
1,563
     
293
   
107
     
111
   
116
 
                                     
Foreclosed assets:
                                   
One- to four-family
   
3,483
     
1,786
   
927
     
947
   
912
 
Multi-family
   
     
   
     
   
 
Commercial real estate
   
1,941
     
1,193
   
437
     
326
   
595
 
Construction and development
   
     
   
     
   
 
Consumer
   
1,927
     
1,861
   
1,137
     
1,322
   
978
 
Commercial business
   
     
   
     
   
 
Total
   
7,351
     
4,840
   
2,501
     
2,595
   
2,485
 
                                     
Non-performing investments
   
100
     
   
     
   
 
                                     
Total non-performing assets
 
$
40,034
   
$
26,604
 
$
12,978
   
$
8,275
 
$
9,982
 
Total as a percentage of total assets
   
2.86
%
   
1.92
%  
1.35
%
   
0.86
%  
1.03
%

The majority of the increase in 2009 in non-performing assets is a result of consumer real estate and other consumer loans increasing in delinquency.  Commercial loan delinquency has remained mainly flat between December 31, 2008 and December 31, 2009.

For the year ended December 31, 2009, gross interest income that would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $1.8 million.  The amount included in interest income on these loans for the year ended December 31, 2009, was $827,000.
 
At December 31, 2009, foreclosed commercial real estate consisted of seven commercial buildings, one in Delaware County, three in Grant County, one in Elkhart County, one in St. Joseph County and one in Florida, all of which are currently being offered for sale.  In addition, forty-one residential properties with a book value of $3.5 million remain as foreclosed assets at December 31, 2009. These properties are being offered for sale.  Non-accruing one- to four-family loans increased to $14.6 million at December 31, 2009.  Non-accruing commercial real estate loans increased from $7.7 million at December 31, 2008, to $9.0 million at December 31, 2009.   At the same time, non-accrual commercial business loans decreased from $2.5 million to $1.9 million. The increases in non-performing assets are primarily a result of the current economic slowdown.  Management continues to monitor these loans aggressively and it is management’s opinion that the non-accruing loans are sufficiently reserved as of December 31, 2009.
 
13

 
Other Loans of Concern.   In addition to the non-performing assets set forth in the table above, as of December 31, 2009, there was an aggregate of $28.8 million in loans with respect to which known information about the possible credit problems of the borrowers have caused management to have doubts as to the abilities of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories.  Due to current economic conditions, we have seen an increase in the amount of these loans during 2009.  These loans have been considered in management’s determination of the adequacy of our allowance for loan losses.  Management reviews each of these relationships at least quarterly to determine if further downgrades and specific loan reserves are prudent.
 
Included in the $28.8 million above are 20 commercial business loans totaling $6.9 million, 35 commercial real estate loans totaling $15.7 million and 48 residential mortgage loans totaling $4.5 million. Loans of $2.1 million had specific loan loss reserves established and the majority of these loans were current as of December 31, 2009.
 
Classified Assets.   Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the OTS to be of lesser quality, as “substandard,” “doubtful” or “loss.”  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected.  Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”  Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
 
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management and approved by the board of directors.  General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets.  When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount.  An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS and the FDIC, which may order the establishment of additional general or specific loss allowances.
 
In connection with the filing of the Bank’s periodic reports with the OTS and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations.  On the basis of management’s review, at December 31, 2009, we had classified $68.1 million of the Bank’s assets as substandard, $2.2 million as doubtful and $2.8 million as loss. Loans classified as loss are fully reserved but not charged off, because there are certain indications that collection is still possible.  The total amount classified represented 56.32% of our stockholders’ equity and 5.22% of our assets at December 31, 2009, compared to 26.20% and 2.46%, respectively, at December 31, 2008.
 
Provision for Loan Losses .  We recorded a provision for loan losses during the year ended December 31, 2009 of $6.5 million, compared to $7.0 million for the year ended December 31, 2008 and $2.2 million for the year ended December 31, 2007.  The provision for loan losses is charged to income to bring our allowance for loan losses to a level deemed appropriate by management based on the factors discussed below under “— Allowance for Loan Losses.”
 
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.
 
14

 
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 collectibility 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 collectibility 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 collectibility of the portfolio as of the evaluation date are not reflected in the loss factors.  By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.  Due to the loss of numerous manufacturing jobs in the communities we serve during recent years, including 2009, 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.
 
At December 31, 2009, our allowance for loan losses was $16.4 million, or 1.53% of the total loan portfolio, and approximately 50.4% of total non-performing loans.  Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans, that are susceptible to significant change.  In the opinion of management, the allowance, when taken as a whole, is adequate to absorb reasonable estimated loan losses inherent in our loan portfolio.
 
15

 
The following table sets forth an analysis of our allowance for loan losses.
 
   
Year Ended December 31,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
   
(Dollars in thousands)
 
                                         
Balance at beginning of period
 
$
15,107
   
$
8,352
   
$
8,156
   
$
8,100
   
$
6,867
 
                                         
Charge-offs:
                                       
One- to four-family
   
1,728
     
480
     
645
     
526
     
303
 
Multi-family
   
     
     
     
     
 
Commercial real estate
   
1,291
     
1,548
     
44
     
102
     
6
 
Construction and development
   
     
     
     
     
 
Consumer
   
3,154
     
2,174
     
1,731
     
1,288
     
1,276
 
Commercial business
   
83
     
230
     
303
     
387
     
954
 
     
6,256
     
4,432
     
2,723
     
2,303
     
2,539
 
                                         
Recoveries:
                                       
One- to four-family
   
110
     
42
     
121
     
81
     
22
 
Multi-family
   
     
     
     
     
 
Commercial real estate
   
184
     
558
     
     
     
120
 
Construction and development
   
     
     
     
     
 
Consumer
   
767
     
556
     
357
     
199
     
194
 
Commercial business
   
2
     
57
     
201
     
11
     
15
 
     
1,063
     
1,213
     
679
     
291
     
351
 
                                         
Net charge-offs
   
5,193
     
3,219
     
2,044
     
2,012
     
2,188
 
Amount acquired in acquisitions
   
     
2,954
     
     
     
1,646
 
Provisions charged to operations
   
6,500
     
7,020
     
2,240
     
2,068
     
1,775
 
Balance at end of period
 
$
16,414
   
$
15,107
   
$
8,352
   
$
8,156
   
$
8,100
 
                                         
Ratio of net charge-offs during the period to average loans outstanding during the period
   
0.47
%
   
0.34
%
   
0.25
%
   
0.24
%
   
0.29
%
                                         
Allowance as a percentage of non- performing loans
   
50.38
%
   
69.41
%
   
79.72
%
   
143.59
%
   
109.74
%
                                         
Allowance as a percentage of total loans (end of period)
   
1.53
%
   
1.34
%
   
1.03
%
   
1.00
%
   
0.98
%
 
 
16

 

The distribution of our allowance for loan losses at the dates indicated is summarized as follows:
 
   
December 31,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
   
Amount of
Loan Loss
Allowance
   
Loan
Amounts
by
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
   
Amount of
Loan Loss
Allowance
   
Loan
Amounts
by
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
   
Amount of
Loan Loss
Allowance
   
Loan
Amounts
by
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
   
Amount of
Loan Loss
Allowance
   
Loan
Amounts
by
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
   
Amount of
Loan Loss
Allowance
   
Loan
Amounts
by
Category
   
Percent
of Loans
in Each
Category
to Total
Loans
 
   
(Dollars in thousands)  
 
One- to four-family
  $ 2,359     $ 471,015 (1)     43.69 %   $ 1,997       521,364 (2)     46.11 %   $ 1,200       431,018 (3)     53.02 %   $ 1,219     $ 433,123 (4)     53.01 %   $ 1,267       451,914 (5)     54.00 %
Multi-family
    17       2,621       0.24       73       2,698       .24       20       3,929       0.48       61       5,073       0.62       68       5,505       .66  
Commercial real estate
    7,555       257,368       23.88       6,869       250,693       22.17       2,158       82,116       10.10       2,000       73,912       9.05       2,039       77,270       9.23  
Construction or development
    10       9,817       0.91       12       12,232       1.08       14       13,560       1.67       72       14,451       1.77       115       22,938       2.74  
Consumer
    4,052       259,788       24.10       3,990       268,392       23.74       3,885       225,511       27.74       3,801       222,973       27.29       3,605       214,961       25.68  
Commercial business
    2,421       77,384       7.18       2,166       75,290       6.66       1,075       56,764       6.99       1,003       67,476       8.26       1,006       64,353       7.69  
Unallocated
                                                                                           
Total
  $ 16,414     $ 1,077,993       100.00 %   $ 15,107     $ 1,130,669       100.00 %   $ 8,352     $ 812,898       100.00 %   $ 8,156     $ 817,008       100.00 %   $ 8,100     $ 836,941       100.00 %
 

(1) 
Includes loans held for sale of $2.5 million.
(2) 
Includes loans held for sale of $1.5 million.
(3) 
Includes loans held for sale of $1.6 million.
(4) 
Includes loans held for sale of $1.3 million.
(5) 
Includes loans held for sale of $2.0 million.

 
17

 

Investment Activities
 
MutualBank may invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, including callable agency securities, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds.  Subject to various restrictions, it also may invest in investment grade commercial paper and corporate debt securities and mutual funds the assets of which conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.  See “How We Are Regulated – MutualBank” for a discussion of additional restrictions on our investment activities.
 
The Chief Financial Officer has the basic responsibility for the management of our investment portfolio, subject to the direction and guidance of the Asset and Liability Management Committee.  The Chief Financial Officer considers various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment.  The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.
 
The general objectives of our investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk.  See “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of this Form 10-K.
 
Our investment securities currently consist of U.S. Agency securities, mortgage-backed securities, collateralized mortgage obligations, municipal securities, marketable equity securities (which consist of shares in mutual funds that invest in government obligations, corporate obligations, mortgage-backed securities and asset-backed securities) and corporate obligations.  See Note 5 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.  Our mortgage-backed securities portfolio currently consists of securities issued under government-sponsored agency programs.
 
While mortgage-backed securities carry a reduced credit risk as compared to whole loans, these securities remain subject to the risk that a fluctuating interest rate environment, along with other factors like the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of the mortgage loans and affect both the prepayment speed and value of the securities.
 
In the past, we also have maintained a trading portfolio of U.S. Government securities.  We are permitted by the board of directors to have a portfolio of up to $5.0 million and to trade up to $2.0 million in these securities at any one time.  At December 31, 2009, however, we did not have a trading portfolio. See Note 5 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
 
In 2007, MutualBank transferred the management of a portion of its securities portfolio to its wholly owned subsidiary, Mutual Federal Investment Company.  Mutual Federal Investment Company, a Nevada corporation, holds, services, manages and invests that portion of the Bank’s investment portfolio as may be transferred from time to time by the Bank to Mutual Federal Investment Company.  Mutual Federal Investment Company’s investment policy, for the most part, mirrors that of the Bank.  At December 31, 2009, MutualBank had $139.1 million in consolidated investment securities.  The portfolio is comprised of $130.9 million in investments available for sale and $8.1 in investments held to maturity.  Mutual Federal Investment Company managed $118.4 million of the total available for sale portfolio.
 
MutualBank evaluates all securities for other-than-temporary impairment (“OTTI”) on a quarterly basis.  During the year ending December 31, 2009, the Bank determined that several securities met the definition of OTTI.  The first security was a Lehman’s corporate bond that was written down $200,000.  Four securities were pooled trust preferred securities that had a total write-down of $1.8 million.  Seven securities were private label mortgage backed securities that were written down $548,000.  Impairment on these securities was determined after analyzing the underlying collateral and determining the amount of additional losses needed in the individual pools to create a shortfall in interest or principal payments.  All trust preferred securities were priced using a discounted cash flow analysis as of December 31, 2009.
 
18

 
P ooled Trust Preferred Securities.   Mutual First Financial has a current par balance in pooled trust preferred securities of $7.2 million, which was originally $10.3 million prior to other than temporary impairment write-downs in 2008 and 2009.  These securities have been written down through other comprehensive income to a book balance of $2.4 million.  The following table provides additional information related to the Bank’s investment in trust preferred securities as of December 31, 2009 :
 
         
Original
   
Book
   
Fair
   
Unrealized
   
Realized
Losses
 
Lowest
 
Deal
 
Class
   
Par
   
Value
   
Value
   
Loss
   
2009
   
2008
 
Rating
 
   
(Dollars in thousands)
 
Alesco Preferred Funding IX
 
A2A
    $ 1,000     $ 893     $ 431     $ (462 )   $ -     $ -
 
BB
 
Alesco Preferred Funding XVII
 
C1
      1,000       100       2       (98 )     (900 )     -  
Ca
 
Preferred Term Securities XIII
 
B1
      1,000       823       298       (525 )     (177 )     -  
Ca
 
Preferred Term Securities XVIII
 
C
      1,000       965       252       (713 )     -       -  
Ca
 
Preferred Term Securities XXVII
 
C1
      1,000       1,004       189       (815 )     -       -  
Ca
 
U.S. Capital Funding I
 
B1
      3,000       2,891       995       (1,896 )     (109 )     -  
CC
 
U.S. Capital Funding III
 
B1
      1,000       500       268       (232 )     -       (500 )
Caa1
 
U.S. Capital Funding V
 
B1
      1,300       45       1       (44 )     (605 )     (650 )
CC
 
                                                           
Total
        $ 10,300     $ 7,221     $ 2,436     $ (4,785 )   $ (1,791 )   $ (1,150 )    
 
The OTTI taken on trust preferred securities in 2009 was the result of significant deterioration in the performance of the underlying collateral.  The deterioration was the result of increased defaults and deferrals of dividend payments in the current year, creating credit impairment along with weakening financial performance of performing collateral, increasing the risk of future deferrals of dividends and defaults.

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.
 
19

 
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.

Private Label Mortgage Backed Securities.   In 2008, the Company redeemed two mutual funds and received cash and underlying securities in the mutual fund as payment.  These held to maturity securities had a par value of $10.1 million and a book value of $7.6 million.  The securities received were agency and private label mortgage backed securities.  The agency MBS have a par value of $2.9 million and a book value of $2.7 million.  The private labeled MBS have a par value of $7.2 million and a book value of $4.9 million.  In 2009, the private label MBS had other than temporary impairment of $548,000.  An independent analysis was performed on several MBS that met certain criteria to determine if OTTI was present.  The average book value of the private label securities is $51,000.    All of these securities are monitored on a quarterly basis by management.

Other information about the private label mortgage backed securities received in the redemption in-kind transaction include:
 
·
The securities have vintage years between 1993 and 2007, with the majority being between 2002 and 2007.
 
·
The securities include sub-prime, Alt-A, and home equity loans.
 
·
Investment grade securities total $1.6 million in book value and $3.3 million in book value are below investment grade.
 
Investment in Limited Partnerships.   MutualBank has investments in eight separate Indiana limited partnerships that were organized to construct, own and operate two multi-unit apartment complexes in the Indianapolis area, one in Findley, Ohio, two in Goshen, Indiana, one in Elkhart, Indiana, and two in Niles, Michigan (the Pedcor Projects).  The general partner in each of these Pedcor Projects is Pedcor Investments.  All of the Pedcor Projects are operated as multi-family, low and moderate-income housing projects, and have been performing as planned for several years.  At the inception of the Findley, Ohio Pedcor Project in February 1998, we invested $2.1 million and committed to invest an additional $1.9 million.  As of December 31, 2009, $226,000 of this commitment remained payable over the next year.
 
A low and moderate-income housing project qualifies for certain federal income tax credits if (1) it is a residential rental property, (2) the units are used on a non-transient basis, and (3) at least 20% of the units in the project are occupied by tenants whose incomes are 50% or less of the area median gross income, adjusted for family size, or alternatively, at least 40% of the units in the project are occupied by tenants whose incomes are 60% or less of the area median gross income. Qualified low-income housing projects generally must comply with these and other rules for 15 years, beginning with the first year the project qualified for the tax credit, or some or all of the tax credit together with interest may be recaptured. The tax credit is subject to the limitation for use as a general business credit, but no basis reduction is required for any portion of the tax credit claimed. As of December 31, 2009, at least 83% of the units in the Pedcor Projects were occupied, and all of the tenants met the income test required for the tax credits.
 
We received tax credits totaling $874,000 for the year ended December 31, 2009, $1.2 million for the year ended December 31, 2008 and $811,000 for the year ended December 31, 2007 from the Pedcor Projects.   The Pedcor Projects have incurred operating losses in the early years of their operations primarily due to accelerated depreciation of assets.  We have accounted for our investment in the Pedcor Projects on the equity method.  Accordingly, we have recorded our share of these losses as reductions to MutualBank’s investment in the Pedcor Projects.

 
20

 

The following summarizes MutualBank’s equity in the Pedcor Projects’ losses and tax credits recognized in our consolidated financial statements.
 
   
For the Year Ended December 31,
 
   
2009
   
2008
   
2007
 
   
(Dollars in thousands)
 
                   
Investments in Pedcor low income housing projects
 
$
4,161
   
$
4,561
   
$
3,246
 
                         
Equity in income (losses), net of income tax effect
 
$
71
   
$
(104
)
 
$
(66
)
Tax credit
   
874
     
1,214
     
811
 
Increase in after-tax income from Pedcor Investments
 
$
945
   
$
1,110
   
$
745
 

See Note 10 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional information regarding our limited partnership investments.
 
The following table sets forth the composition of our investment and mortgage-related securities portfolio and other investments at the dates indicated.  As of December 31, 2009, our investment securities portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our equity capital, excluding those issued by the United States Government or its agencies.
 
   
December 31,
 
   
2009
   
2008
   
2007
 
   
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
 
   
(Dollars in thousands)
 
                                     
Investment securities available-for-sale:
                                   
Mutual funds
 
$
1,685
   
$
1,643
   
$
1,635
   
$
1,497
   
$
16,382
   
$
15,914
 
Government sponsored entities
   
158
     
157
     
570
     
572
     
608
     
605
 
Mortgage-backed securities
   
29,175
     
29,890
     
14,771
     
15,163
     
2,310
     
2,352
 
Collateralized mortgage obligations
   
85,726
     
87,029
     
43,821
     
43,639
     
8,327
     
8,322
 
Corporate obligations
   
7,321
     
2,539
     
18,797
     
15,527
     
16,655
     
16,399
 
Municipal obligations
   
9,313
     
9,656
     
857
     
857
     
     
 
Total investment securities held for sale
   
133,378
     
130,914
     
80,451
     
77,255
     
44,282
     
43,592
 
                                                 
Investment securities held to maturity:
                                               
Mortgage-backed securities
   
4,619
     
3,275
     
5,498
     
4,983
     
     
 
Collateralized mortgage obligations
   
3,028
     
2,554
     
4,178
     
3,545
     
     
 
Government sponsored entities
   
500
     
504
     
     
     
     
 
Total investment securities held to maturity
   
8,147
     
6,333
     
9,676
     
8,528
     
     
 
                                                 
Investment in limited partnerships
   
4,161
     
N/A
     
4,561
     
N/A
     
3,246
     
N/A
 
Investment in insurance company
   
     
N/A
     
590
     
N/A
     
590
     
N/A
 
Federal Home Loan Bank stock
   
18,632
     
N/A
     
18,632
     
N/A
     
10,037
     
N/A
 
                                                 
Total investments
 
$
164,318
   
$
137,247
   
$
113,910
   
$
85,783
   
$
58,155
   
$
43,592
 
 
 
21

 

The following table indicates, as of December 31, 2009, the composition and maturities of our investment securities, excluding Federal Home Loan Bank stock.
 
   
Due in
 
   
Less Than
1 Year
   
1 to 5
Years
 
5 to 10
Years
   
Over
10 Years
   
Total
Investment Securities
 
   
Amortized
Cost
   
Amortized
Cost
 
Amortized
Cost
   
Amortized
Cost
   
Amortized
Cost
   
Fair
Value
 
   
(Dollars in thousands)
 
                                     
Available-for-sale:
                                   
Corporate obligations
 
$
100
   
$
   
$
   
$
7,221
   
$
7,321
   
$
2,539
 
Government sponsored entities
   
87
     
10
     
2,626
     
6,748
     
9,471
     
9,813
 
Mutual funds
   
1,685
     
     
     
     
1,685
     
1,643
 
Mortgage-backed securities:
                                               
Freddie Mac
   
     
52
     
753
     
47,327
     
48,132
     
49,418
 
Fannie Mae
   
     
806
     
36
     
20,382
     
21,224
     
22,097
 
Ginnie Mae
   
     
     
     
33,867
     
33,867
     
33,939
 
Other
   
193
     
     
7,177
     
4,308
     
11,678
     
11,465
 
   
$
2,065
   
$
868
   
$
10,592
   
$
119,853
   
$
133,378
   
$
130,914
 
                                                 
Weighted average yield
   
4.00
%
   
4.97
%
   
5.52
%
   
4.35
%
   
4.44
%
       
                                                 
Held-to-maturity:
                                               
Government sponsored entities
 
$
   
$
500
   
$
   
$
   
$
500
   
$
504
 
Mortgage-backed securities:
                                               
Freddie Mac
   
     
     
     
802
     
802
     
762
 
Fannie Mae
   
     
     
     
2,067
     
2,067
     
2,205
 
Other
   
     
     
     
4,778
     
4,778
     
2,862
 
   
$
   
$
500
   
$
   
$
7,647
   
$
8,147
   
$
6,333
 
                                                 
Weighted average yield
           
2.00
%
           
3.46
%
   
3.46
%
       

Sources of Funds
 
General.   Our sources of funds are deposits, borrowings, payment of principal and interest on loans, interest earned on or maturation of other investment securities and funds provided from operations.
 
Deposits .   We offer deposit accounts to consumers and businesses having a wide range of interest rates and terms.  Our deposits consist of savings deposit accounts, NOW and demand accounts and certificates of deposit.  We solicit deposits in our market areas.  We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits.  Occasionally we will accept brokered deposits from a broker without paying a fee to that broker.  At December 31, 2009, our brokered deposits totaled $6.9 million, or .7% of total deposits, with an average interest rate of 1.87% and a 1.5 year weighted average maturity.
 
The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates, and competition.  The variety of our deposit accounts has allowed us to be competitive in obtaining funds and to respond to changes in consumer demand.  We have become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious.  We try to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors.  Based on our experience, we believe that our deposits are relatively stable sources of funds.  Our ability to attract and maintain these deposits, however, and the rates paid on them, has been and will continue to be affected significantly by market conditions.
 
The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts, primarily checking, NOW and Super NOW checking accounts.  At December 31, 2009, we were in compliance with these reserve requirements.
 
22

 
The following table sets forth the dollar amount of savings deposits in the various types of deposit programs we offered at the dates indicated.
 
   
December 31,
 
   
2009
   
2008
   
2007
 
   
Amount
   
Percent
of Total
   
Amount
   
Percent
of Total
   
Amount
   
Percent
of Total
 
   
(Dollars in thousands)
 
                                     
Transactions and Savings Deposits:
                                   
                                     
Noninterest bearing accounts
 
$
98,025
     
9.38
%
 
$
93,393
     
9.70
%
 
$
47,172
     
7.08
%
Passbook accounts
   
84,553
     
8.09
     
79,111
     
8.22
     
50,388
     
7.56
 
Interest-bearing NOW and demand accounts
   
154,431
     
14.77
     
156,787
     
16.29
     
117,863
     
17.69
 
Money market accounts
   
60,479
     
5.79
     
47,584
     
4.94
     
22,664
     
3.40
 
Total non-certificates
   
397,488
     
38.03
     
376,875
     
39.16
     
238,087
     
35.73
 
                                                 
Certificates:
                                               
                                                 
0.00 -1.99%
   
188,995
     
18.08
     
55,064
     
5.72
     
8,627
     
1.29
 
2.00 -3.99%
   
355,758
     
34.04
     
359,899
     
37.39
     
47,500
     
7.13
 
4.00 -5.99%
   
102,894
     
9.84
     
170,611
     
17.73
     
372,145
     
55.84
 
6.00 -7.99%
   
61
     
.01
     
65
     
0.01
     
48
     
0.01
 
8.00 -9.99%
   
     
     
     
     
     
 
10.00% and over
   
     
     
     
     
     
 
                                                 
Total certificates
   
647,708
     
61.97
     
585,639
     
60.84
     
428,320
     
64.27
 
Total deposits
 
$
1,045,196
     
100.00
%
 
$
962,514
(1)
   
100.00
%
 
$
666,407
     
100.00
%
 

(1) 
Includes $332.1 million due to MFB acquisition

The following table shows rate and maturity information for our certificates of deposit as of December 31, 2009.
 
     
1.00-
1.99%
     
2.00-
3.99%
     
4.00-
5.99%
     
6.00-
7.99%
   
Total
 
Percent
of Total
 
   
(Dollars in thousands)
 
Certificate accounts maturing in quarter ending:
                                         
March 31, 2010
 
$
67,890
   
$
53,162
   
$
12,163
   
$
   
$
133,215
 
20.57
%
June 30, 2010
   
38,224
     
53,025
     
9,948
     
     
101,197
 
15.61
%
September 30, 2010
   
42,161
     
43,011
     
5,019
     
     
90,191
 
13.92
%
December 31, 2010
   
20,743
     
36,417
     
1,944
     
     
59,104
 
9.13
%
March 31, 2011
   
7,362
     
15,741
     
1,305
     
     
24,408
 
3.77
%
June 30, 2011
   
1,453
     
34,402
     
2,151
     
     
38,006
 
5.87
%
September 30, 2011
   
8,149
     
18,104
     
2,863
     
     
29,116
 
4.50
%
December 31, 2011
   
1,000
     
22,118
     
5,746
     
61
     
28,925
 
4.47
%
March 31, 2012
   
     
13,296
     
8,929
     
     
22,225
 
3.43
%
June 30, 2012
   
384
     
6,101
     
9,178
     
     
15,663
 
2.42
%
September 30, 2012
   
671
     
1,259
     
5,463
     
     
7,393
 
1.14
%
December 31, 2012
   
958
     
802
     
2,563
     
     
4,323
 
0.67
%
Thereafter
   
     
58,320
     
35,622
     
     
93,942
 
14.50
%
Total
 
$
188,995
   
$
355,758
   
$
102,894
   
$
61
   
$
647,708
 
100.00
%
                                             
Percent of total
   
29.18
%
   
54.92
%
   
15.89
%
   
.01
%
   
100.00
%
   
 
23

 
The following table indicates, as of December 31, 2009, the amount of our certificates of deposit and other deposits by time remaining until maturity.
 
   
Maturity
       
   
3 Months
or Less
   
Over
3 to 6
Months
   
Over
6 to 12
Months
   
Over
12 months
   
Total
 
   
(Dollars in thousands)
 
                               
Certificates of deposit less than $100,000
 
$
92,626
   
$
71,066
   
$
100,063
   
$
171,496
   
$
435,251
 
                                         
Certificates of deposit of $100,000 or more
   
39,720
     
29,413
     
48,127
     
92,005
     
209,265
 
                                         
Public funds (1)
   
869
     
718
     
1,105
     
500
     
3,192
 
                                         
Total certificates of deposit
 
$
133,215
   
$
101,197
   
$
149,295
   
$
264,001
   
$
647,708
 
 

(1)
Deposits from governmental and other public entities.

Borrowings .   Although deposits are our primary source of funds, we utilize borrowings when they are a less costly source of funds and can be invested at a positive interest rate spread, when we desire additional capacity to fund loan demand or when they meet our asset/liability management goals.  Our borrowings historically have consisted of advances from the Federal Home Loan Bank of Indianapolis.  See Note 14 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
 
We may obtain advances from the Federal Home Loan Bank of Indianapolis upon the security of certain of our mortgage loans and mortgage-backed securities.  These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features.  At December 31, 2009, we had $198.0 million in Federal Home Loan Bank advances outstanding.  Based on current collateral levels we could borrow an additional $82.4 million from the Federal Home Loan Bank at prevailing interest rates.  We believe that we will continue to have sufficient funds, through deposits and borrowings, to meet our current commitments.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity” contained in Item 7 of this Form 10-K.
 
In order to have access to Federal Home Loan Bank advances, we are required to own stock in the Federal Home Loan Bank of Indianapolis.  At December 31, 2009, we had $18,632,000 in that stock.  We continue to monitor the activities of the Federal Home Loan Bank of Indianapolis and believe they have the ability to meet our borrowing needs during this difficult economic environment.
 
We also have a term note with a balance of $10.0 million from First Tennessee Bank, N.A. as of December 31, 2009. See Note 15 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
 
We also are authorized to borrow from the Federal Reserve Bank of Chicago’s “discount window” after we have exhausted other reasonable alternative sources of funds, including Federal Home Loan Bank borrowings.  We have never borrowed from our Federal Reserve Bank.
 
The Company acquired $5.0 million of issuer trust preferred securities as part of the acquisition of MFB.  The net balance of the note as of December 31, 2009 was $3.9 million due to the purchase accounting adjustment from the acquisition.  The securities mature 30 years from the date of issuance, July 29, 2005.  The securities bear a fixed rate of interest of 6.22% for the first five years, resetting quarterly thereafter 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 may redeem the trust preferred securities, in whole or in part, without penalty, on or after September 15, 2010, or earlier upon the occurrence of certain events with the payment of a premium upon redemption.  These securities mature on September 15, 2035.
 
24

 
The following table sets forth, for the years indicated, the maximum month-end balance and average balance of Federal Home Loan Bank advances and other borrowings.
 
   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
   
(Dollars in thousands)
 
                   
Maximum Balance:
                 
Federal Home Loan Bank advances
 
$
250,566
   
$
300,147
   
$
191,675
 
Notes payable
   
231
     
1,123
     
1,427
 
Other borrowings
   
15,359
     
15,967
     
4,311
 
                         
Average Balance:
                       
Federal Home Loan Bank advances
 
$
221,896
   
$
224,822
   
$
157,309
 
Notes payable
   
228
     
718
     
1,160
 
Other borrowings
   
15,076
     
7,967
     
155
 

The following table sets forth certain information as to our borrowings at the dates indicated.
 
   
December 31,
 
   
2009
   
2008
   
2007
 
   
(Dollars in thousands)
 
                   
Federal Home Loan Bank advances
 
$
197,960
   
$
263,113
   
$
191,675
 
Notes payable
   
226
     
647
     
1,055
 
Other borrowings
   
13,888
     
15,345
     
3,908
 
                         
Total borrowings
 
$
212,074
   
$
279,105
   
$
196,638
 
                         
Weighted average interest rate of FHLB advances
   
4.00
%
   
4.27
%
   
4.88
%
                         
Weighted average interest rate of notes payable (1)
   
     
     
 
                         
Weighted average interest rate of other borrowings (2)
   
5.99
%
   
5.28
%
   
6.48
 
 

(1) 
Our notes payable are capitalized loans with no current interest expense as of December 31, 2009.
(2) 
Our other borrowings are a term loan and subordinate debt as of December 31, 2009.

Subsidiary and Other Activities
 
As a federal savings bank, MutualBank is permitted by OTS regulations to invest up to 2% of its assets, or $28.0 million at December 31, 2009, in the stock of, or unsecured loans to, service corporation subsidiaries.  MutualBank may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes.  Service corporations may engage in activities not permitted for MutualBank and are not required to be controlled by MutualBank.  MutualBank also is authorized to invest an unlimited amount in operating subsidiaries that only may engage in activities authorized for MutualBank and must be controlled by MutualBank.
 
The Bank's insurance agency subsidiary, Mishawaka Financial Services, Inc., is engaged in the sale, as agent, of life insurance and credit-life and health insurance to the Bank's customers and the general public.
 
25

 
At December 31, 2009, MutualBank had one active subsidiary, Mutual Federal Investment Company, which is an operating subsidiary.  Mutual Federal Investment Company is a Nevada corporation that holds and manages a portion of MutualBank’s investment portfolio.  As of December 31, 2009, the market value of securities managed was $118.4 million.  Mutual Federal Investment Company has one active subsidiary, Mutual Federal REIT, Inc.  Mutual Federal REIT, Inc. is a Maryland corporation holding approximately $91.7 million in one-to four-family mortgage loans.
 
Competition
 
We face strong competition in originating real estate and other loans and in attracting deposits.  Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, credit unions and mortgage bankers.  Other savings institutions, commercial banks, credit unions and finance companies provide vigorous competition in consumer lending.
 
We attract our deposits through our branch office system.  Competition for deposits comes principally from other savings institutions, commercial banks and credit unions located in the same community, as well as mutual funds and other alternative investments.  We compete for deposits by offering superior service and a variety of account types at competitive rates.
 
Employees
 
At December 31, 2009, we had a total of 369 full-time and 67 part-time employees. Our employees are not represented by any collective bargaining group.  Management considers its employee relations to be good.
 
How We Are Regulated
 
Set forth below is a brief description of certain laws and regulations that apply to us. This description, as well as other descriptions of laws and regulations contained in this Form 10-K, is not complete and is qualified in its entirety by reference to the applicable laws and regulations.
 
Legislation is introduced from time to time in the United States Congress that may affect our operations.  In addition, the regulations by which we are governed may be amended from time to time.  Any such legislation or regulatory changes could adversely affect us.  We cannot assure you as to whether or in what form any such changes will occur.
 
Congress is currently considering significant regulatory reform legislation initially proposed by the Obama administration.  This legislation, if enacted, would have a significant impact on the regulation and operations of financial institutions and their holding companies.  It currently provides for the elimination of the OTS, our primary regulator, and would require the Company to become a bank holding company and be subject to regulatory capital requirements for the first time.  This elimination of OTS may require MutualBank to convert to a national bank or state bank charter.  The legislation also provides for the creation of a new consumer financial protection agency that would issue and enforce consumer protection initiatives governing financial products and services.  The details and impact of this regulatory reform proposal cannot be determined until the proposal is enacted into law.
 
MutualFirst .   MutualFirst is a unitary savings and loan holding company subject to regulatory oversight by the OTS. MutualFirst is required to register and file reports with the OTS and is subject to regulation and examination by the OTS.  In addition, the OTS has enforcement authority over us and our non-savings institution subsidiaries.
 
MutualFirst generally is not subject to activity restrictions.  If MutualFirst acquired control of another savings institution as a separate subsidiary, it would become a multiple savings and loan holding company, and its activities and any of its subsidiaries (other than MutualBank or any other savings institution) would generally become subject to additional restrictions.
 
If MutualBank fails the qualified thrift lender test described below, MutualFirst must obtain the approval of the OTS prior to continuing, directly or through other subsidiaries, any business activity other than those approved for multiple thrift holding companies or their subsidiaries.  In addition, within one year of such failure MutualFirst must register as, and will become subject to, the restrictions applicable to bank holding companies.  The activities authorized for a bank holding company are more limited than the activities authorized for a unitary or multiple thrift holding company.
 
26

 
MutualBank .  MutualBank, as a federally chartered savings institution, is subject to federal regulation, periodic examination and oversight by the OTS extending to all aspects of MutualBank’s operations. MutualBank also is subject to regulation and examination by the FDIC, which insures the deposits of MutualBank to the maximum extent permitted by law.  This regulation and supervision primarily is intended for the protection of depositors and not for the purpose of protecting stockholders.
 
The investment and lending authority of federal savings institutions are prescribed by federal laws and regulations, and federal savings institutions are prohibited from engaging in any activities not permitted by such laws and regulations.  In addition, all savings institutions, including MutualBank, are required to maintain qualified thrift lender status to avoid certain restrictions on their operations.  This status is maintained by meeting the OTS qualified thrift lender test, which requires a savings institution to have at least 65% of its portfolio assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis.  As an alternative, the savings institution may maintain 60% of its assets in the assets specified in Section 7701(a)(19) of the Internal Revenue Code.  Under either test, such assets primarily consist of residential housing related loans and investments.  At December 31, 2009, MutualBank met the test and has met the test since its effectiveness.  If MutualBank loses qualified thrift lender status, it becomes subject to national bank investment and activity limits.
 
The OTS regularly examines MutualBank and prepares reports for the consideration of MutualBank’s board of directors on any deficiencies that it may find in MutualBank’s operations.  When these examinations are conducted, the examiners may require MutualBank to provide for higher general or specific loan loss reserves.  MutualBank’s relationship with its depositors and borrowers also is regulated to a great extent by both Federal and state laws, especially in such matters as the ownership of savings accounts and the form and content of MutualBank’s mortgage requirements.  The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including MutualBank and MutualFirst.
 
MutualBank’s general permissible lending limit for loans extended to one-borrower (including a group of certain related borrowers) is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus).  At December 31, 2009, MutualBank’s lending limit under this restriction was $20.1 million.  MutualBank has no loans in excess of the lending limit.
 
The OTS, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits.  Any institution which fails to comply with these standards must submit a compliance plan.
 
FDIC Regulation and Insurance of Accounts.   The Bank’s deposits are insured up to the applicable limits by the FDIC, and such insurance is backed by the full faith and credit of the United States Government.  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions.  Our deposit insurance premiums for the year ended December 31, 2009 were $2.3 million.  Those premiums have increased in recent years due to strains on the FDIC deposit insurance fund due to the cost of large bank failures and the increase in the number of troubled banks.
 
The Bank is a member of the deposit insurance fund administered by the FDIC.  Deposits are insured up to the applicable limits by the FDIC.  Through December 31, 2013, the basic deposit insurance is $250,000, instead of the $100,000 limit that had been in effect prior to October 2008.  The FDIC also provides unlimited deposit insurance coverage for noninterest-bearing transaction accounts (typically business checking accounts), NOW accounts bearing interest at 0.5% or less, and certain funds swept into noninterest-bearing savings accounts at institutions that opt into this enhanced deposit insurance coverage.  MutualBank opted into this program, which is set to expire on June 30, 2010.  The Bank pays a fee of 10 basis points (annualized) on the balance of each covered account in excess of $250,000 during the period through June 30, 2010.  During 2009, we paid total fees of $14,000 for participating in this program.
 
27

 
The FDIC assesses deposit insurance premiums quarterly on each FDIC-insured institution based on annualized rates for one of four risk categories applied to its deposits subject to certain adjustments. Each institution is assigned to one of four risk categories based on its capital, supervisory ratings and other factors. Well capitalized institutions that are financially sound with only a few minor weaknesses are assigned to Risk Category I. Risk Categories II, III and IV present progressively greater risks to the deposit insurance fund. Under the FDIC’s risk-based assessment rules, effective April 1, 2009, the initial base assessment rates prior to adjustments range from 12 to 16 basis points for Risk Category I, and are 22 basis points for Risk Category II, 32 basis points for Risk Category III, and 45 basis points for Risk Category IV. Initial base assessment rates are subject to adjustments based on an institution’s unsecured debt, secured liabilities and brokered deposits, such that the total base assessment rates after adjustments range from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for Risk Category IV. Rates increase uniformly by 3 basis points effective January 1, 2011.
 
In addition to the regular quarterly assessments, due to losses and projected losses attributed to failed institutions, the FDIC imposed a special assessment of 5 basis points on the amount of each depository institution’s assets reduced by the amount of its Tier 1 capital (not to exceed 10 basis points of its assessment base for regular quarterly premiums) as of June 30, 2009, which was collected on September 30, 2009.
 
As a result of a decline in the reserve ratio (the ratio of the net worth of the deposit insurance fund to estimated insured deposits) and concerns about expected failure costs and available liquid assets in the deposit insurance fund, the FDIC required each insured institution to prepay on December 30, 2009, the estimated amount of its quarterly assessments for the fourth quarter of 2009 and all quarters through the end of 2012 (in addition to the regular quarterly assessment for the third quarter which was due on December 30, 2009). The prepaid amount is recorded as an asset with a zero risk weight and the institution will continue to record quarterly expenses for deposit insurance. For purposes of calculating the prepaid amount, assessments are measured at the institution’s assessment rate as of September 30, 2009, with a uniform increase of 3 basis points effective January 1, 2011, and are based on the institution’s assessment base for the third quarter of 2009, with growth assumed quarterly at an annual rate of 5%. If events cause actual assessments during the prepayment period to vary from the prepaid amount, institutions will pay excess assessments in cash, or receive a rebate of prepaid amounts not exhausted after collection of assessments due on January 13, 2013, as applicable. Collection of the prepayment does not preclude the FDIC from changing assessment rates or revising the risk-based assessment system in the future. The rule includes a process for exemption from the prepayment for institutions whose safety and soundness would be affected adversely.
 
The FDIC estimates that the reserve ratio will reach the designated reserve ratio of 1.15% by 2017 as required by statute.
 
The FDIC also may prohibit any FDIC-insured institution from engaging in any activity that it determines by regulation or order to pose a serious risk to the deposit insurance fund. The FDIC also has the authority to initiate enforcement actions against the Bank and may terminate our deposit insurance if it determines that we have engaged in unsafe or unsound practices or are in an unsafe or unsound condition.
 
Regulatory Capital Requirements. MutualBank is required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a leverage ratio or core capital requirement and a risk-based capital requirement applicable to such savings institutions. The OTS also may impose capital requirements in excess of these standards on individual institutions on a case-by-case basis.
 
The capital standards generally require core capital equal to at least 4.0% of adjusted total assets. Core capital consists of tangible capital plus certain intangible assets, including a limited amount of purchased credit card relationships. At December 31, 2009, MutualBank had core capital equal to $130.3 million, or 9.4% of adjusted total assets, which is $74.8 million above the minimum requirement of 4% in effect on that date.
 
28

 
The OTS also requires savings institutions to have total capital of at least 8.0% of risk-weighted assets.  Total capital consists of core capital, as defined above, and supplementary capital.  Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets.  The OTS is also authorized to require a savings institution to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities.  In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset.  As of December 31, 2009, MutualBank had total risk-based capital of $133.9 million and risk-weighted assets of $1.0 billion; or total capital of 12.8% of risk-weighted assets.  This amount was $50.3 million above the 8% requirement in effect on that date.
 
The OTS and the FDIC are authorized and, under certain circumstances, required to take actions against savings institutions that fail to meet their capital requirements.  The OTS is generally required to restrict the activities of an “undercapitalized institution,” which is an institution with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital ratio or an 8.0% risk-based capital ratio.  Any such institution must submit a capital restoration plan and, until such plan is approved by the OTS, may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions.
 
Any savings institution that fails to comply with its capital plan or has Tier 1 risk-based or core capital ratio of less than 3.0% or a risk-based capital ratio of less than 6.0% and is considered “significantly undercapitalized” must be made subject to one or more additional specified actions and operating restrictions which may cover all aspects of its operations and may include a forced merger or acquisition of the institution.  An institution that becomes “critically undercapitalized” because it has a tangible capital ratio of 2.0% or less is subject to further restrictions on its activities in addition to those applicable to significantly undercapitalized institutions.  In addition, the OTS must appoint a receiver, or conservator with the concurrence of the FDIC, for a savings institution, with certain limited exceptions, within 90 days after it becomes critically undercapitalized.  Any undercapitalized institution is also subject to the general enforcement authority of the OTS and the FDIC, including the appointment of a conservator or a receiver.
 
The OTS is also generally authorized to reclassify an institution into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
 
The imposition by the OTS or the FDIC of any of these measures on MutualBank may have a substantial adverse effect on our operations and profitability.
 
Limitations on Dividends and Other Capital Distributions .  OTS regulations impose various restrictions on distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account.
 
Generally, for savings institutions such as MutualBank, it is required that before and after the proposed distribution the institution remain well-capitalized.  Savings institutions may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus retained net income for the two preceding years.  However, an institution deemed to be in need of more than normal supervision by the OTS may have its dividend authority restricted by the OTS.  MutualBank may pay dividends in accordance with this general authority.
 
Savings institutions proposing to make any capital distribution need not submit written notice to the OTS prior to such distribution unless they are a subsidiary of a holding company or would not remain well-capitalized following the distribution.  Savings institutions that do not, or would not meet their current minimum capital requirements following a proposed capital distribution or propose to exceed these net income limitations must obtain OTS approval prior to making such distribution.  The OTS may object to the distribution during that 30-day period based on safety and soundness concerns.  See “– Regulatory Capital Requirements.”
 
Our ability to pay dividends on or to repurchase our common stock is subject to limits due to our participation in the TARP Capital Purchase Program.  See “General” and Item 1A.
 
29

 
Federal Taxation
 
General. We are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to us. MutualBank’s federal income tax returns have been closed without audit by the IRS through its year ended December 31, 2005. MutualFirst and MutualBank will file a consolidated federal income tax return for fiscal year 2009.
 
Taxable Distributions and Recapture. Prior to 1998, bad debt reserves created prior to the year ended December 31, 1997 were subject to recapture into taxable income if MutualBank failed to meet certain thrift asset and definitional tests. Federal legislation eliminated these thrift recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should MutualBank make certain non-dividend distributions or cease to maintain a thrift/bank charter.
 
Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. MutualBank is subject to the alternative minimum tax, and has $173,000 available as credits for carryover.
 
Corporate Dividends-Received Deduction. MutualFirst may eliminate from its income dividends received from MutualBank as a wholly owned subsidiary of MutualFirst if it elects to file a consolidated return with MutualBank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payor of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.
 
State Taxation
 
MutualBank is subject to Indiana’s financial institutions tax, which is imposed at a flat rate of 8.5% on “adjusted gross income” apportioned to Indiana. “Adjusted gross income,” for purposes of the financial institutions tax, begins with taxable income as defined by Section 63 of the Internal Revenue Code and incorporates federal tax law to the extent that it affects the computation of taxable income. Federal taxable income is then adjusted by several Indiana modifications including only considering members of the combined group which have Indiana nexus.
 
Other applicable state taxes include generally applicable sales and use taxes plus real and personal property taxes.
 
Internet Website
 
We maintain a website with the address of www.bankwithmutual.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. This Annual Report on Form 10-K and our other reports, proxy statements and other information, including earnings press releases, filed with the SEC are available on that website through a link to the SEC’s website at “Resource Center – Investor Relations - SEC Filings.” For more information regarding access to these filings on our website, please contact our Corporate Secretary, MutualFirst Financial, Inc., 110 E. Charles Street, Muncie, Indiana, 47305-2419; telephone number (765) 747-2800.
 
30

 
Item1A.              Risk Factors
 
The following are certain risk factors that could impact our business, financial results and results of operations. Investing in our common stock involves risks, including those described below. These risk factors should be considered by prospective and current investors in our common stock when evaluating the disclosures in this Annual Report on Form 10-K (particularly the forward-looking statements). These risk factors could cause actual results and conditions to differ materially from those projected in forward-looking statements. If any of the events in the following risks actually occur, or if additional risks and uncertainties not presently known to us or that we believe are immaterial do materialize, then our business, financial condition or results of operations could be materially adversely impacted. In addition, the trading price of our common stock could decline due to any of the events described in these risks.
 
Our financial condition and results of operations are dependent on the economy, particularly in the Bank’s market area. The current economic recession in the market area we serve may continue to impact our earnings adversely and could increase the credit risk of our loan portfolio.
 
Our primary market area is concentrated in north central and eastern Indiana. Adverse economic conditions in that market area can reduce our rate of growth, affect our customers’ ability to repay loans and adversely impact our financial condition and earnings. General economic conditions, including inflation, unemployment and money supply fluctuations, also may affect our profitability adversely. Our market area is undergoing a recession, which has resulted in higher levels of loan delinquencies, problem assets and foreclosures, decreased demand for our products and services and a decline in the value of our loan collateral. If this recession continues or becomes more severe, this negative impact on our business, financial condition and earnings may increase.
 
A continuation of recent turmoil in the financial markets could have an adverse effect on our financial position or results of operations.
 
Beginning in 2008, United States and global financial markets have experienced severe disruption and volatility, and general economic conditions have declined significantly. Adverse developments in credit quality, asset values and revenue opportunities throughout the financial services industry, as well as general uncertainty regarding the economic, industry and regulatory environment, have had a marked negative impact on the industry. Dramatic declines in the U.S. housing market over the past two years, with falling home prices, increasing foreclosures and increasing unemployment, have negatively affected the credit performance of mortgage loans and resulted in significant write-downs of asset values by many financial institutions. The United States and the governments of other countries have taken steps to try to stabilize the financial system, including investing in financial institutions, and have also been working to design and implement programs to improve general economic conditions. Notwithstanding the actions of the United States and other governments, these efforts may not succeed in restoring industry, economic or market conditions and may result in adverse unintended consequences. Factors that could continue to pressure financial services companies, including the Company, are numerous and include (i) worsening credit quality, leading among other things to increases in loan losses and reserves, (ii) continued or worsening disruption and volatility in financial markets, leading among other things to continuing reductions in asset values, (iii) capital and liquidity concerns regarding financial institutions generally, (iv) limitations resulting from or imposed in connection with governmental actions intended to stabilize or provide additional regulation of the financial system, or (v) recessionary conditions that are deeper or last longer than currently anticipated.
 
Our allowance for loan losses may prove to be insufficient to absorb probable losses in our loan portfolio.
 
Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
 
 
cash flow of the borrower and/or the project being financed;
 
 
·
in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral;
 
 
·
the credit history of a particular borrower;
 
 
·
changes in economic and industry conditions; and
 
31

 
 
·
the duration of the loan.
 
We maintain an allowance for loan losses which we believe is appropriate to provide for potential losses in our loan portfolio. The amount of this allowance is determined by our management through a periodic review and consideration of several factors, including, but not limited to:
 
 
·
an ongoing review of the quality, size and diversity of the loan portfolio;
 
 
·
evaluation of non-performing loans;
 
 
·
historical default and loss experience;
 
 
·
historical recovery experience;
 
 
·
existing economic conditions;
 
 
·
risk characteristics of the various classifications of loans; and
 
 
·
the amount and quality of collateral, including guarantees, securing the loans.
 
If our loan losses exceed our allowance for probable loan losses, our business, financial condition and profitability may suffer.
 
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans.  In determining the amount of the allowance for loan losses, we review our loans and the loss and delinquency experience, and evaluate economic conditions and make significant estimates of current credit risks and future trends, all of which may undergo material changes.  If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for additions to our allowance through an increase in the provision for loan losses.  Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.  Our allowance for loan losses was 1.5% of gross loans held for investment and 50.4% of nonperforming loans at December 31, 2009.  In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than that of management.  If charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses.  Any increases in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and our capital.
 
Our provision for loan losses has increased substantially and additional increases in the provision and loan charge-offs may be required, adversely impacting operations.
 
For the year ended December 31, 2009, we recorded a provision for loan losses of $6.5 million compared to $7.0 million for the 2008 fiscal year.  We also recorded net loan charge-offs of $5.2 million in 2009, compared to $3.2 million in 2008.  During 2008 and 2009, we have experienced increasing loan delinquencies and credit losses.  As a result, nonperforming loans increased from $21.8 million at the end of 2008 to $32.6 million at the end of 2009.  If the declining trends in the housing, real estate and local business markets continue, we expect increased levels of delinquencies and credit losses to continue, which adversely impacts our financial condition and results of operations.
 
32

 
If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.
 
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property taken in as real estate owned (“REO”), and at certain other times during the assets holding period. Our net book value (“NBV”) in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s NBV over its fair value. If our valuation process is incorrect, the fair value of our investments in real estate may not be sufficient to recover our NBV in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations. Our bank regulator periodically reviews our REO and may require us to recognize further charge-offs. Any increase in our charge-offs, as required by such regulator, may have a material adverse effect on our financial condition and results of operations.
 
Other-than-temporary impairment charges in our investment securities portfolio could result in losses and adversely affect our continuing operations.
 
During the year ended December 31, 2009, we recognized a $5.3 million non-cash other than temporary impairment (“OTTI”) charge on available-for-sale and held-to-maturity securities we hold for investment. At December 31, 2009, the fair value of these securities were $2.8 million. Management concluded that the decline of the estimated fair value below the cost of the security was other than temporary and recorded a credit loss of $2.6 million through non-interest income. We determined the remaining decline in value was not related to specific credit deterioration. We do not intend to sell these securities and it is not more than likely than not we will be required to sell the securities before anticipated recovery of the remaining amortized cost basis. We closely monitor our investment securities for changes in credit risk. The valuation of our investment securities also is influenced by external market and other factors, including implementation of Securities and Exchange Commission and Financial Accounting Standards Board guidance on fair value accounting. Our valuation of our securities will be influenced by the default rates of specific financial institutions whose securities provide the underlying collateral for these securities. The current market environment significantly limits our ability to mitigate our exposure to valuation changes in these securities by selling them. Accordingly, if market conditions deteriorate further and we determine our holdings of these or other investment securities are OTTI, our future earnings, shareholders’ equity, regulatory capital and continuing operations could be materially adversely affected.
 
Our business may be adversely affected by credit risk associated with residential property.
 
At December 31, 2009, $578.1 million, or 53.6% of our total loan portfolio, was secured by one-to four-family mortgage loans and home equity loans (including home equity lines of credit). This type of lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. The decline in residential real estate values as a result of the downturn in the Indiana housing markets has reduced the value of the real estate collateral securing these types of loans and increased the risk that we would incur losses if borrowers default on their loans. Continued declines in both the volume of real estate sales and the sales prices coupled with the current recession and the associated increases in unemployment may result in higher than expected loan delinquencies or problem assets, a decline in demand for our products and services, or lack of growth or a decrease in deposits. These potential negative events may cause us to incur losses, adversely affect our capital and liquidity and damage our financial condition and business operations.
 
Our loan portfolio possesses increased risk due to our substantial number of multi-family, commercial real estate, consumer and commercial business loans.
 
Approximately 46.4% of our loan portfolio as of December 31, 2009, consisted of multi-family, commercial real estate, construction, consumer (non-mortgage) and commercial business loans. Multi-family, commercial and construction real estate loans accounted for approximately 25.0% of our total loan portfolio as of December 31, 2009. Our commercial business and consumer (non-mortgage) loans accounted, respectively, for approximately 7.2% and 14.2% of our total loan portfolio as of December 31, 2009. Generally, we consider these types of loans to involve a higher degree of risk compared to first mortgage loans on one- to four-family, owner-occupied residential properties. For further information concerning the risks associated with multi-family, commercial real estate, consumer loans and commercial business loans, see “Lending Activities” and “Asset Quality” in Item 1.
 
33

 
Rising interest rates may hurt our profits.
 
To be profitable, we have to earn more money in interest we receive on loans and investments that we make than we pay to our depositors and lenders in interest. If interest rates rise, our net interest income and the value of our assets could be reduced if interest paid on interest-bearing liabilities, such as deposits and borrowings, increases more quickly than interest received on interest-earning assets, such as loans, other mortgage-related investments and investment securities. This is most likely to occur if short-term interest rates increase at a faster rate than long-term interest rates, which would cause income to go down. In addition, rising interest rates may hurt our income, because they may reduce the demand for loans and the value of our securities. In a rapidly changing interest rate environment, we may not be able to manage our interest rate risk effectively, which would adversely impact our financial condition and results of operations. For a further discussion of how changes in interest rates could impact us, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and “Asset and Liability Management and Market Risk” in Item 7A.
 
We face risks related to covenants in our loan sales to investors and secondary mortgage market conditions.
 
Our agreements with investors to sell our loans generally contain covenants that require us to repurchase loans under certain circumstances, including some delinquencies, or to return premiums paid by those investors if the loans are paid off early. If we are required to repurchase sold loans under these covenants, they may be deemed troubled loans, with the potential for charge-offs and/or loss provision changes, which could impact our earnings and asset quality ratios adversely. The Bank was not required to repurchase any loans from our investors during 2009.
 
Our ability to sell loans on the secondary mortgage market is impacted by interest rate changes and investor demand or expected return. If this market becomes less liquid, we may not be able to rely as much on loan sales to reduce our interest rate and credit risk.
 
Declining economic conditions may adversely impact the fees generated by our asset management and trust business.
 
To the extent our asset management and trust clients and their assets become adversely impacted by weak economic and stock market conditions, they may choose to withdraw the assets managed by us and the value of their assets may decline. Our asset management revenues are based on the value of the assets we manage. If our clients withdraw assets or the value of their assets decline, our revenues from these activities may be adversely affected.
 
We face significant operational risks.
 
We operate in many different financial service businesses and rely on the ability of our employees and systems to process a significant number of transactions. Operational risk is the risk of loss from operations, including fraud by employees or outside persons, employees’ execution of incorrect or unauthorized transactions, data processing and technology errors or hacking and breaches of internal control systems.
 
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
 
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.
 
34

 
We may elect or be compelled to seek additional capital in the future, but that capital may not be available when it is needed.
 
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to repay our TARP funds, support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. In that regard, a number of financial institutions have recently raised considerable amounts of capital in response to a deterioration in their results of operations and financial condition arising from the turmoil in the mortgage loan market, deteriorating economic conditions, declines in real estate values and other factors. Should we be required by regulatory authorities to raise additional capital, we may seek to do so through the issuance of, among other things, our common stock or preferred stock. The issuance of additional shares of common stock or convertible securities to new stockholders would be dilutive to our current stockholders.
 
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects.
 
There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock.
 
We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.
 
Anti-takeover provisions could negatively impact our shareholders.
 
Provisions in our charter and bylaws, the corporate law of the State of Maryland and federal regulations could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our stockholders, or otherwise adversely affect the market price of any class of our equity securities, including our common stock. These provisions include: a prohibition on voting shares of common stock beneficially owned in excess of 10% of total shares outstanding, supermajority voting requirements for certain business combinations with any person who beneficially owns more than 10% of our outstanding common stock; the election of directors to staggered terms of three years; advance notice requirements for nominations for election to our Board of Directors and for proposing matters that stockholders may act on at stockholder meetings, a requirement that only directors may fill a vacancy in our Board of Directors, supermajority voting requirements to remove any of our directors and the other provisions of our charter. Our charter also authorizes our Board of Directors to issue preferred stock , and preferred stock could be issued as a defensive measure in response to a takeover proposal. In addition, pursuant to OTS regulations, as a general matter, no person or company, acting individually or in concert with others, may acquire more than 10% of our common stock without prior approval from the OTS.
 
These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for holders of our common stock to elect directors other than the candidates nominated by our Board of Directors.
 
35

 
The voting limitation provision in our charter could limit your voting rights as a holder of our common stock.
 
Our charter provides that any person or group who acquires beneficial ownership of our common stock in excess of 10% of the outstanding shares may not vote the excess shares. Accordingly, if you acquire beneficial ownership of more than 10% of the outstanding shares of our common stock, your voting rights with respect to the common stock will not be commensurate with your economic interest in our company.
 
Our core deposit premium could be deemed partially or fully impaired, which could reduce our earnings and the values of that intangible asset.
 
At December 31, 2009, we had a core deposit premium of $5.9 million due mainly to the MFB acquisition. Under GAAP, we are required to periodically assess the value of this intangible asset based on a number of factors to determine if there is partial or full impairment. The factors taken into consideration include the market price of our stock, the net present value of our assets and liabilities and valuation information for similar financial institutions. This evaluation involves a substantial amount of judgment. If actual conditions underlying the factors differ from our assessment, the core deposit intangible could be subjected to faster amortization or partial or complete impairment, which would reduce the value of this asset and reduce our earnings, perhaps materially.
 
We currently hold a significant amount of bank-owned life insurance.
 
At December 31, 2009, we held $93.5 million of bank-owned life insurance or BOLI on key employees and executives, with a cash surrender value of $44.2 million. The policies are maintained to fund amounts owed under executive supplemental retirement plans. The eventual repayment of the cash surrender value is subject to the ability of the various insurance companies to pay death benefits or to return the cash surrender value to us if needed for liquidity purposes. We continually monitor the financial strength of the various companies with whom we carry these policies. However, any one of these companies could experience a decline in financial strength, which could impair its ability to pay benefits or return our cash surrender value. If we need to liquidate these policies for liquidity purposes, we would be subject to taxation on the increase in cash surrender value and penalties for early termination, both of which would adversely impact earnings.
 
We may not be able to realize our deferred tax asset fully.
 
At December 31, 2009, we had a $19.5 million deferred income tax benefit based on differences between the financial statement amounts and tax bases of assets and liabilities and reflecting mainly an allowance for loan loss timing difference and business tax and AMT carryover. The value of our deferred income tax benefit is reviewed regularly under various forecasts and assumptions, including anticipated levels of taxable net income, to determine the likelihood of realizing the benefit. If actual results or subsequent forecasts differ from our current judgments, so that this benefit will not be fully realized, we would have to write down this asset, which would negatively impact results of operation and reduce our asset size.
 
If our investment in the Federal Home Loan Bank of Indianapolis becomes impaired, our earnings and stockholders’ equity could decrease.
 
At December 31, 2009, we owned $18.6 million in Federal Home Loan Bank of Indianapolis stock. We are required to own this stock to be a member of and to obtain advances from our Federal Home Loan Bank. This stock is not marketable and can only be redeemed by our Federal Home Loan Bank, which currently is not redeeming any excess member stock. Our Federal Home Loan Bank’s financial condition is linked, in part, to the eleven other members of the Federal Home Loan Bank System and to accounting rules and asset quality risks that could materially lower their capital, which would cause our Federal Home Loan Bank stock to be deemed impaired, resulting in a decrease in our earnings and assets.
 
36

 
We operate in a highly regulated environment and our operations and income may be affected adversely by changes in laws and regulations governing our operations, including regulatory reform initiatives of the Obama administration that are pending in Congress.
 
We are subject to extensive regulation, supervision and examination by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. These regulators govern the activities in which we may engage, primarily for the protection of depositors and the deposit insurance fund. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on a bank’s operations, reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed. Any change in such regulation and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums could have a material impact on our operations. Because our business is highly regulated, the laws and applicable regulations are subject to frequent change. Any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects. For example, initiatives to limit our fees on overdraft protection programs or our creditor rights could impact our fee income or ability to resolve problem assets. Pending regulatory reform legislation proposed by the Obama administration and under consideration by Congress, if enacted, could change our primary regulator, create a new consumer finance protection agency, change the Company into a bank holding company with new capital requirements and require MutualBank to convert to a different charter. These changes could possibly adversely impact our operations and net income.
 
Our earnings are adversely impacted by increases in deposit insurance premiums and special FDIC assessments.
 
Beginning in late 2008, the economic environment caused higher levels of bank failures, which dramatically increased FDIC resolution costs and led to a significant reduction in the deposit insurance fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. The base assessment rate was increased by seven basis points (seven cents for every $100 of deposits) for the first quarter of 2009. Effective April 1, 2009, initial base assessment rates were changed to range from 12 basis points to 45 basis points across all risk categories with possible adjustments to these rates based on certain debt-related components. These increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions due to recent bank and savings association failures. The emergency assessment amounts to five basis points on each institution’s assets minus Tier 1 capital as of June 30, 2009, subject to 10 basis points times the institution’s assessment base. Our FDIC deposit insurance expense for fiscal 2009 was $2.3 million, including the special assessment of $630,000 recorded in June 2009 and paid on September 30, 2009.
 
Additionally, in November 2009, the FDIC adopted a rule that requires each financial institution to prepay its estimated quarterly risk-based assessment for the fourth quarter of 2009 and for all of 2010, 2011 and 2012, which will be amortized over these periods and adjusted for changes in premium levels or our financial condition. As a result, this prepayment will not immediately impact our earnings.
 
Strong competition within our market area may limit our growth and profitability.
 
Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have substantially greater name recognition, resources and lending limits than we do and may offer certain services or prices for services that we do not or cannot provide. Our profitability depends upon our continued ability to successfully compete in our market.
 
37

 
The securities purchase agreement between us and Treasury limits our ability to pay dividends on and repurchase our common stock.
 
The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) December 23, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) increase the cash dividend on our common stock or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock (other than the Series A Preferred Stock) or any trust preferred securities then outstanding. In addition, we are unable to pay any dividends on our common stock unless we are current in our dividend payments on the Series A Preferred Stock. These restrictions, together with the potentially dilutive impact of the warrant described in the next risk factor, could have a negative effect on the value of our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our Board of Directors. Although we have historically paid cash dividends on our common stock, we are not required to do so and our Board of Directors could reduce or eliminate our common stock dividend in the future.
 
The Series A Preferred Stock impacts net income available to our common shareholders and earnings per common share, and the warrant we issued to Treasury may be dilutive to holders of our common stock.
 
The dividends declared on the Series A Preferred Stock will reduce the net income available to common shareholders and our earnings per common share. The Series A Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of MutualFirst Financial. Additionally, the ownership interest of the existing holders of our common stock will be diluted to the extent the warrant we issued to Treasury in conjunction with the sale to Treasury of the Series A Preferred Stock is exercised. The shares of common stock underlying the warrant represent approximately 8.2% of the shares of our common stock outstanding (including the shares issuable upon exercise of the warrant). Although Treasury has agreed not to vote any of the shares of common stock it receives upon exercise of the warrant, a transferee of any portion of the warrant or of any shares of common stock acquired upon exercise of the warrant is not bound by this restriction.
 
If we are unable to redeem our Series A Preferred Stock before December 2013, the cost of this capital to us will increase substantially.
 
If we are unable to redeem the Series A Preferred Stock before December 2013, the cost of the TARP capital will increase substantially from 5.0% per annum (approximately $1.6 million annually) to 9.0% per annum (approximately $2.9 million annually). Depending on our financial condition at the time, this increase in the annual dividend rate on the Series A Preferred Stock could have a material negative effect on our liquidity.
 
We rely on dividends from MutualBank for substantially all of the Company’s revenue.
 
MutualFirst ’s primary source of revenue is dividends from the Bank. The OTS regulates and must approve the amount of Bank dividends to the Company. If the Bank is unable to pay dividends, MutualFirst may not be able to service its debt, pay its other obligations or pay dividends on the Company’s common stock which could have a material adverse impact on our financial condition or the value of your investment in our common stock.
 
Our common stock trading volume may not provide adequate liquidity for investors.
 
Our common stock is listed on the Nasdaq Global Market. However, the average daily trading volume in our common stock is less than that of many larger financial services companies. A public trading market having the desired depth, liquidity and orderliness depends on the presence of a sufficient number of willing buyers and sellers for our common stock at any given time. This presence is impacted by general economic and market conditions and investors’ views of our Company. Because our trading volume is limited, any significant sales of our shares could cause a decline in the price of our common stock.
 
Our directors and executive officers have the ability to influence stockholder actions in a manner that may be adverse to the personal investment objectives of our stockholders.
 
As of December 31, 2009, our directors and executive officers as a group beneficially owned 1,291,870 shares, or 18.5%, of our common stock (including options for 417,390 shares). In addition, our employee stock ownership plan and charitable foundation controlled, respectively, 7.2% and 3.2% of our common stock on that date. In addition, as of December 31, 2009, 314,702 shares were reserved under various stock benefit plans for future awards for our directors, officers and employees. Due to this significant collective ownership of or control over our common stock, our directors and executive officers may be able to influence the outcome of director elections or block significant transactions, such as a merger or acquisition, or any other matter that might otherwise be favored by other shareholders.
 
38

 
Item 1B.
Unresolved Staff Comments
 
None
 
Item 2.               Properties
 
At December 31, 2009 we had 33 full service offices. We own the office building in which our home office and executive offices are located. At December 31, 2009 we owned all but two of our other branch offices. The net book value of our investment in premises, equipment and leaseholds, excluding computer equipment, was approximately $32.4 million at December 31, 2009. We believe that our current facilities are adequate to meet our present and immediately foreseeable needs.
 
We utilize a third party service provider to maintain our database of depositor and borrower customer information. At December 31, 2009 the net book value of the data processing and computer equipment utilized by us was $2.1 million .
 
Item 3.               Legal Proceedings
 
From time to time, we are involved as plaintiff or defendant in various legal actions arising in the normal course of business.  We do not anticipate incurring any material liability as a result of such litigation.
 
Item 4.               (Reserved)
 
PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
The common stock of MutualFirst Financial, Inc. is traded under the symbol “MFSF” on the Nasdaq Global Market. The table below shows the high and low closing prices for our common stock for the periods indicated. This information was provided by the Nasdaq. At December 31, 2009, there were 6,984,754 shares of common stock outstanding and at that date we also had 32,382 shares of preferred stock outstanding and approximately 1,400 shareholders of record.
 
   
Stock Price
 
Dividends
per
Share
 
2009 Quarters:
 
High
   
Low
     
First Quarter (ended 03/31/09)
 
$
7.40
   
$
3.51
 
$
0.12
 
Second Quarter (ended 06/30/09)
 
$
10.00
   
$
5.05
 
$
0.12
 
Third Quarter (ended 09/30/09)
 
$
8.50
   
$
6.60
 
$
0.12
 
Fourth Quarter (ended 12/31/09)
 
$
7.83
   
$
5.57
 
$
0.06
 

   
Stock Price
 
Dividends
per
Share
 
2008 Quarters:
 
High
   
Low
       
First Quarter (ended 03/31/08)
 
$
13.98
   
$
12.80
 
$
0.16
 
Second Quarter (ended 06/30/08)
 
$
13.66
   
$
9.81
 
$
0.16
 
Third Quarter (ended 09/30/08)
 
$
11.00
   
$
9.34
 
$
0.16
 
Fourth Quarter (ended 12/31/08)
 
$
10.50
   
$
6.20
 
$
0.16
 
 
39

 
Our cash dividend payout policy is continually reviewed by management and the Board of Directors. The Company intends to continue its policy of paying quarterly dividends; however, future dividend payments will depend upon a number of factors, including capital requirements, regulatory limitations, the Company’s financial condition, results of operations and the Bank’s ability to pay dividends to the Company. The Company relies significantly upon such dividends originating from the Bank to accumulate earnings for payment of cash dividends to shareholders. Our TARP agreement limits our ability to pay dividends to common stockholders if dividends on the TARP preferred shares are not paid in full to date.
 
Information regarding our equity compensation plans is included in Item 11 of this Form 10-K.
 
On August 13, 2008, the Company’s Board of Directors authorized management to repurchase an additional 5% of the Company’s outstanding stock, or approximately 350,000 shares. Our ability to repurchase shares is limited under the securities purchase agreement with Treasury. See Item 1A.

 
40

 

Item 6.
Selected Financial Data
 
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
 
The following information is only a summary and you should read it in conjunction with our consolidated financial statements and accompanying notes contained in Item 8 of this Form 10-K.
 
   
At or For the Year Ended December 31,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
   
(In thousands)
 
                               
Selected Financial Condition Data
                             
                               
Total assets
 
$
1,399,034
   
$
1,388,827
   
$
962,517
   
$
960,842
   
$
971,829
 
Cash and cash equivalents
   
46,341
     
39,703
     
23,648
     
24,915
     
22,365
 
Loans, net
   
1,059,694
     
1,113,132
     
802,436
     
805,625
     
822,547
 
Investment securities:
                                       
Available-for-sale, at fair value
   
130,914
     
77,255
     
43,592
     
41,070
     
39,788
 
Held to maturity
   
8,147
     
9,676
     
     
     
 
Total deposits
   
1,045,196
     
962,514
     
666,407
     
703,359
     
684,554
 
Total borrowings
   
212,074
     
279,104
     
196,638
     
158,852
     
187,791
 
Total stockholders’ equity
   
129,727
     
130,515
     
87,014
     
87,264
     
88,794
 
                                         
Selected Operations Data
                                       
Total interest income
 
$
71,852
   
$
65,179
   
$
56,374
   
$
56,119
   
$
48,478
 
Total interest expense
   
30,624
     
31,639
     
32,227
     
29,890
     
21,170
 
Net interest income
   
41,228
     
33,540
     
24,147
     
26,229
     
27,308
 
Provision for loan losses
   
6,500
     
7,020
     
2,240
     
2,068
     
1,775
 
Net interest income after provision for loan losses
   
34,728
     
26,520
     
21,907
     
24,161
     
25,533
 
Service fee income
   
7,458
     
6,257
     
4,831
     
4,370
     
4,026
 
Gain (loss) on sale of loans and investment securities
   
3,132
     
(927
)
   
391
     
(669
)
   
228
 
Other-than-temporary impairment, securities
   
(2,555)
     
(1,350
)
   
     
     
 
Other non-interest income (loss)
   
5,118
     
2,542
     
2,549
     
2,941
     
2,478
 
Total non-interest income
   
13,153
     
6,522
     
7,771
     
6,642
     
6,732
 
Salaries and employee benefits
   
23,047
     
19,118
     
14,759
     
14,617
     
13,792
 
Other expenses
   
21,460
     
44,508
     
10,397
     
10,402
     
9,620
 
Total non-interest expense
   
44,507
     
63,626
     
25,156
     
25,019
     
23,412
 
Income (loss) before taxes
   
3,374
     
(30,584
)
   
4,522
     
5,784
     
8,853
 
Income tax expense (benefit)
   
211
     
(8,485
)
   
296
     
1,028
     
2,401
 
Net income (loss)
   
3,163
     
(22,099
)
   
4,226
     
4,756
     
6,452
 
Preferred stock dividends and amortization
   
1,803
     
31
     
     
     
 
Net income (loss) available to common shareholders
 
$
1,360
   
$
(22,130
)
 
$
4,226
   
$
4,756
   
$
6,452
 
 
 
41

 

   
At or For the Year Ended December 31,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
Selected Financial Ratios and Other Financial Data:
                             
                               
Performance Ratios:
                             
                               
Return on average assets (ratio of  net income to average total assets)
   
0.23
%
   
(1.91
)%
   
0.44
%
   
0.49
%
   
0.73
%
Return on average tangible equity  (ratio of net income to average tangible equity)
   
1.49
     
(28.04
)
   
5.86
     
6.43
     
7.79
 
Interest rate spread information:
                                       
Average during the period
   
2.98
     
3.01
     
2.50
     
2.70
     
3.13
 
Net interest margin (1)
   
3.22
     
3.22
     
2.79
     
2.96
     
3.37
 
Ratio of operating expense to average total assets
   
3.17
     
5.49
     
2.64
     
2.57
     
2.89
 
Ratio of average interest-earning assets to average interest-bearing liabilities
   
110.67
     
107.14
     
107.92
     
107.65
     
109.30
 
Efficiency ratio (2)
   
81.84
     
158.81
     
78.81
     
76.11
     
68.78
 
                                         
Asset Quality Ratios: (3)
                                       
                                         
Non-performing assets to total assets
   
2.86
     
1.92
     
1.35
     
0.86
     
1.03
 
Non-performing loans to total loans
   
3.03
     
1.93
     
1.29
     
0.70
     
0.90
 
Allowance for loan losses to non-performing loans
   
50.38
     
69.41
     
79.72
     
143.59
     
108.04
 
Allowance for loan losses to loans receivable, net
   
1.53
     
1.34
     
1.03
     
1.00
     
0.98
 
                                         
Capital Ratios:
                                       
Equity to total assets (3)
   
9.27
     
9.40
     
9.04
     
9.08
     
9.14
 
Average equity to average assets
   
9.29
     
8.89
     
9.16
     
9.08
     
9.90
 
                                         
Share and Per Share Data:
                                       
                                         
Average common shares outstanding:
                                       
Basic
   
6,840,659
     
5,249,135
     
4,103,940
     
4,196,059
     
4,328,965
 
Diluted
   
6,840,748
     
5,249,135
     
4,151,173
     
4,274,039
     
4,439,686
 
Per share:
                                       
Basic earnings
 
$
0.20
   
$
(4.22
)
 
$
1.03
   
$
1.13
   
$
1.49
 
Diluted earnings
 
$
0.20
   
$
(4.22
)
 
$
1.02
   
$
1.11
   
$
1.45
 
Dividends
 
$
0.42
   
$
0.64
   
$
0.60
   
$
0.58
   
$
0.49
 
                                         
Dividend payout ratio (4)
   
210.00
%
   
(15.20
)%
   
58.25
%
   
52.25
%
   
36.55
%
                                         
Other Data:
                                       
Number of full-service offices
   
33
     
33
     
21
     
21
     
20
 
 

(1) 
Net interest income divided by average interest earning assets.
(2) 
Total non-interest expense divided by net interest income plus total non-interest income.
(3) 
At the end of the period.
(4) 
Dividends per share divided by diluted earnings per share.
 
 
42

 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
 
Introduction
 
MutualFirst is a savings and loan holding company and MutualBank is its wholly-owned subsidiary. MutualBank has been in business since 1889 and currently conducts its business from 33 full service financial centers located in Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties, Indiana, with its main office located in Muncie. MutualBank also has trust offices in Carmel and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan. MutualBank’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. MutualBank’s deposit accounts are insured by the Federal Deposit Insurance Corporation up to applicable limits. We also originate mortgage loans in counties contiguous to these counties, and we originate indirect consumer loans throughout Indiana. We provide investment money management and trust services for our customers.
 
In July 2008, the Company acquired MFB Corp. and merged MFB’s subsidiary bank, MFB Financial into MutualBank. MutualFirst issued an aggregate of 2.9 million shares of its common stock and paid approximately $11.5 million in cash to MFB stockholders in the transaction. MutualFirst also assumed 114,500 MFB stock options, which have converted into approximately 296,555 MutualFirst stock options with a weighted average exercise price of $9.90 per share. As a result of the transaction, MutualBank now has 33 retail financial centers, spanning nine Indiana counties and is the 10 th largest depository institution headquartered in Indiana.
 
In December 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program, the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with the United States Department of the Treasury (“Treasury”), pursuant to which the Company (i) sold 32,382 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) for a purchase price of $32,382,000 in cash and (ii) issued a warrant (the “Warrant”) to purchase 625,135 shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), for a per share price of $7.77 per share. The Series A Preferred Stock is entitled to cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series A Preferred Stock may be redeemed by the Company at any time, subject to consultation by the Treasury with the Office of Thrift Supervision (“OTS”). The Warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $7.77 per share of the Common Stock. If the Series A Preferred Stock is redeemed, the Warrant will be liquidated at the current market price. Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant that it holds.
 
Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its Junior Stock (as defined below) and Parity Stock (as defined below) will be subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share ($0.16) declared on the Common Stock prior to December 23, 2008. The redemption, purchase or other acquisition of trust preferred securities of the Company or its affiliates also will be restricted. These restrictions will terminate on the earlier of (a) the third anniversary of the date of issuance of the Series A Preferred Stock, (b) the date on which the Series A Preferred Stock has been redeemed in whole; and (c) the date Treasury has transferred all of the Series A Preferred Stock to third parties. In addition, the ability of the Company to declare or pay dividends or distributions on, or repurchase, redeem or otherwise acquire for consideration, shares of its Junior Stock and Parity Stock will be subject to restrictions in the event that the Company fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on its Series A Preferred Stock. “Junior Stock” means the Common Stock and any other class or series of stock of the Company the terms of which expressly provide that it ranks junior to the Series A Preferred Stock as to dividend rights and/or rights on liquidation, dissolution or winding up of the Company. “Parity Stock” means any class or series of stock of the Company the terms of which do not expressly provide that such class or series will rank senior or junior to the Series A Preferred Stock as to dividend rights and/or rights on liquidation, dissolution or winding up of the Company (in each case without regard to whether dividends accrue cumulatively or non-cumulatively).
 
The Company placed $29.1 million of TARP proceeds into its wholly-owned subsidiary MutualBank, while maintaining $3.2 million with the Company. MutualBank placed approximately $20.0 million of the proceeds in highly rated securities. Approximately $14.8 million was placed in mortgage securities, $3.2 million in municipal securities and $2.0 million in corporate bonds. These securities provide liquidity as needed to meet current and future loan demand. The remaining funds held at MutualBank were placed in working capital, which was used to fund loans and meet the cash needs of MutualBank.
 
43


The following discussion is intended to assist your understanding of our financial condition and results of operations. The information contained in this section should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements.
 
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 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 MutualBank 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 MutualBank’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 December 31, 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 intended 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 38% at December 31, 2009 compared to 39% at the end of 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 2009, in keeping with our strategic objective to reduce interest rate risk exposure, the Company also sold $160.0 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 $2.4 million. The Company also will lengthen out FHLB advances when advantageous to lengthen repricing of the liability side of the balance sheet to reduce interest rate risk exposure.
 
The acquisition of MFB Corp. added trust services to MutualBank, which are being leveraged through MutualBank’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.
 
Net interest income should be less vulnerable to changes in interest rates. The Federal Funds rate set by the Board of Governors of the Federal Reserve System has decreased to a range of 0 to 25 basis points as of December 31, 2008 and was the same as of December 31, 2009. The Federal Funds rate flat at this level decreases the ability to reprice deposits lower in future months. Certificates of deposit and borrowings may, however, still reprice to lower rates at their maturities in future time periods, which could reduce the amount of interest expense assuming rates stay low. Interest income is expected to decrease without any changes in the current rate environment primarily due to the rates on newly originated interest-earning assets being lower than the rates on maturing interest-earning assets. Another factor that may lead to changes in net interest income is the level of non-performing assets. An increase in non-performing assets (i.e., loans, repossessed assets, or securities) would also decrease interest income and may decrease overall net interest income without additional decreases in interest-bearing liabilities.
 
Results of operations are also dependent upon the level of the Company’s non-interest income, including fee income and service charges, and the level of its non-interest expense, including general and administrative expenses. Regulatory changes that will take effect in July 2010 are expected to have an impact in non-interest income later this year. Reg. E has been amended to require that customers “opt-in” to the overdraft privilege program. The Bank is working diligently to ensure customers understand this program and sign up for the continued benefits.
 
44

 
MutualWealth, the wealth management division of the Bank, produces non-interest income for the Bank that is tied primarily to the market value of the portfolios being managed. As of December 31, 2009, MutualWealth had $313.3 million of assets under management. Decreases in market value could have a negative impact on the non-interest income generated by this division of the Bank.
 
During 2008 and 2009, the Indiana and national economy and financial markets have undergone significant decline, which has impacted our financial condition, operations, net income, stock price and regulatory limitations. The Indiana and national economy may improve prior to significant improvements in financial condition and net income. Current troubled loans and securities may continue to incur losses after recovery has started to occur.
 
Management Strategy
 
Our strategy is to operate as an independent, retail-oriented financial institution dedicated to serving customers in our market areas. Our commitment is to provide a broad range of products and services to meet the needs of our customers. As part of this commitment, we are looking to increase our emphasis on commercial business products and services. We also operate a fully interactive transactional website and allow consumers to open accounts. In addition, we are continually looking at cost-effective ways to expand our market area.
 
Financial highlights of our strategy have included:
 
 
·
Continuing as a Diversified Lender. We have been successful in diversifying our loan portfolio to reduce our reliance on any one type of loan. From 1995 through 2000, approximately 36% of our loan portfolio consisted of loans other than one- to four-family real estate loans. Since that time to the end of 2009, that percentage has increased to 56%.
 
 
·
Continuing as a Leading One- to Four-Family Lender. We are one of the largest originators of one- to four-family residential loans in our market area. During 2009, we originated $250.0 million of one- to four-family residential loans.
 
 
·
Continuing To Focus On Asset Quality. Non-performing assets to total assets was 2.86% at December 31, 2009, an increase from 1.92% at December 31, 2008. While we are currently higher than we desire, we believe that our current underwriting standards will provide for a quality loan portfolio once economic activity and unemployment return to more normal levels.
 
 
·
Continuing Our Strong Capital Position. As a result of our consistent operating profitability, we have historically maintained a strong capital position. At December 31, 2009, our ratio of stockholders’ equity to total assets was 9.3%. We have suspended our origination of RV and boat lending to increase our regulatory capital ratios as we continue to strengthen our capital position.
 
 
·
Decreasing Interest Rate Risk. It has been MutualFirst ’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.
 
Financial Condition at December 31, 2009 Compared to December 31, 2008
 
General. Our assets increased $10.2 million during 2009, ending the year at $1.4 billion, approximately the same as of December 31, 2008. The increase was primarily due to increases in the investment portfolio. Liabilities increased $11.0 million during 2009 to $1.3 billion, approximately the same as of December 31, 2008. The increase was primarily due to increases in deposits. Stockholders’ equity decreased $788,000 to $129.7 million at December 31, 2009.
 
45

 
Loans . Our net loan portfolio decreased $53.4 million, remaining at $1.1 billion at December 31, 2008 and December 31, 2009. Consumer loans decreased $8.6 million or 3.2% from $268.4 million at December 31, 2008 to $259.8 million at December 31, 2009. The decline in consumer loans came from a decrease of $10.3 million in auto loans, home equity loans, home improvement loans, boat loans and other consumer loans. These decreases in consumer loans were partially offset by an increase in recreational vehicle loans of $1.8 million. Commercial business loans increased $2.1 million or 2.8% from $75.3 million to $77.4 million at December 31, 2009. It has been our strategy to increase non-real estate mortgage loans as a percentage of our loan portfolio in order to mitigate interest rate risk and enhance the portfolio yield. Accordingly, we sold $160.0 million of our fixed rate one- to four-family mortgage loans in 2009. In conjunction with the sales of mortgage loans, real estate mortgage loans decreased $47.1 million or 6.0% from $785.4 million to $738.3 million at December 31, 2009. Mortgage loans held for sale increased $979,000 to $2.5 million at December 31, 2009.
 
Allowance For Loan Loss. Allowance for loan losses increased $1.3 million to $16.4 million at December 31, 2009 when compared to December 31, 2008. Specific loan loss reserves increased $1.3 million, while general loan loss reserves have remained approximately the same as loan balances declined. Net charge offs for the year 2009 were $5.2 million, or .47% of average loans on an annualized basis, compared to $3.2 million, or .34% of average loans for 2008. The increase was primarily due to increased charge offs on one-to four-family mortgage and consumer loans resulting from the depressed economic conditions in our marker area. As of December 31, 2009, the allowance for loan losses as a percentage of loans receivable and non-performing loans was 1.53% and 50.38%, respectively, compared to 1.34% and 69.41%, respectively, at December 31, 2008. Allowance for loan losses as a percentage of loans receivable increased due to the $1.3 million increase in allowance and a decline in the net loan portfolio of $53.4 million. Allowance for loan losses as a percentage of non-performing loans decreased due to an increase in non-performing loans of $10.8 million which was offset by the $1.3 million increase in the allowance.
 
Securities. Investment securities available for sale increased $53.7 million, or 69.5%, compared to December 31, 2008 due primarily to utilizing cash from loan pay downs. Investment securities held to maturity decreased $1.5 million due to repayment received and other than temporary impairment write-down on these securities. More discussion on trust preferred securities and private labeled mortgage backed securities can be found in Item 1 under investment activities.
 
Liabilities. Our total liabilities increased $11.0 million or 0.9% to $1.3 billion at December 31, 2009. Deposits increased $82.7 million as certificates of deposit increased by $62.1 million and noninterest bearing, interest-bearing, savings and money market savings deposits increased by $20.6 million as consumers trended to safe investments for their liquid assets. Borrowed funds decreased $67.0 million with FHLB advances decreasing $65.2 million. This decrease was primarily a result of increased deposits.
 
Stockholders’ Equity. Stockholders’ equity was $129.7 million at December 31, 2009, a decrease of $788,000, or 0.6% from December 31, 2008. The decrease was due primarily to dividend payments of $2.9 million to common shareholders and $1.4 million to preferred shareholders. This decrease was partially offset by net income of $3.2 million. Accumulated other comprehensive income increased $170,000 as unrealized gains on securities and derivatives of $325,000 were partially offset by a $155,000 unrealized loss on a benefit plan. The Bank’s risk-based capital ratio is 12.81% and the tier one capital ratio is 11.56%. The Bank’s capital ratios are well in excess of “well-capitalized” levels as defined by all regulatory standards.
 
Average Balances, Net Interest Income, Yields Earned and Rates Paid
 
The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.
 
46

 
Average Balances, Net Interest Income, Yields Earned and Rates Paid
 
     
Year ended December 31,
  
     
2009
     
2008
     
2007
  
     
Average
   
Interest
   
Average
   
Average
   
Interest
   
Average
   
Average
   
Interest
   
Average
 
   
Outstanding
   
Earned/
   
Yield/
   
Outstanding
   
Earned/
   
Yield/
   
Outstanding
   
Earned/
   
Yield/
 
   
Balance
   
Paid
   
Rate
   
Balance
   
Paid
   
Rate
   
Balance
   
Paid
   
Rate
 
   
(Dollars in thousands)
 
                                                       
Interest-Earning Assets:
                                                     
Interest -bearing deposits
 
$
36,415
   
$
49
     
0.13
%
 
$
8,711
   
$
118
     
1.35
%
 
$
2,982
   
$
115
     
3.86
%
Mortgage-backed securities available-for-sale (1)
   
81,317
     
4,019
     
4.94
 
   
28,648
     
1,596
     
5.57
 
   
8,875
     
467
     
5.26
 
Investment securities available-for-sale (1)
   
26,903
     
1,015
     
3.77
 
   
28,987
     
1,303
     
4.50
 
   
31,234
     
1,644
     
5.26
 
Investment securities held-to-maturity
   
9,439
     
594
     
6.30
 
   
3,360
     
314
     
9.35
 
                       
Loans (2)
   
1,107,274
     
65,865
     
5.95
 
   
956,788
     
61,128
     
6.39
 
   
811,991
     
53,686
     
6.61
 
Stock in FHLB of Indianapolis
   
18,632
     
310
     
1.66
 
   
14,010
     
720
     
5.14
 
   
9,939
     
462
     
4.65
 
Total interest-earning assets
   
1,279,980
     
71,852
     
5.61
 
   
1,040,504
     
65,179
     
6.26
 
   
865,021
     
56,374
     
6.52
 
Non-Interest Earning Assets (net of allowance for loan losses and unrealized gain/loss)
   
125,668
                     
118,673
                     
87,879
                 
Total assets
 
$
1,405,648
                   
$
1,159,177
                   
$
952,900
                 
                                                                         
Interest-Bearing Liabilities:
                                                                       
Demand and NOW accounts
 
$
162,572
     
776
     
0.48
 
 
$
148,703
     
1,564
     
1.05
 
 
$
126,034
     
2,841
     
2.25
 
Savings deposits
   
84,883
     
230
     
0.27
 
   
66,315
     
317
     
0.48
 
   
54,975
     
281
     
0.51
 
Money market accounts
   
45,559
     
510
     
1.12
 
   
34,000
     
615
     
1.81
 
   
24,588
     
621
     
2.53
 
Certificate accounts
   
633,360
     
19,354
     
3.06
 
   
492,405
     
18,920
     
3.84
 
   
444,271
     
20,755
     
4.67
 
Total deposits
   
926,374
     
20,870
     
2.25
 
   
741,423
     
21,416
     
2.89
 
   
649,868
     
24,498
     
3.77
 
Borrowings
   
234,886
     
9,754
     
4.15
 
   
229,768
     
10,223
     
4.45
 
   
151,636
     
7,729
     
5.10
 
Total interest-bearing accounts
   
1,161,260
     
30,624
     
2.64
 
   
971,191
     
31,639
     
3.26
 
   
801,504
     
32,227
     
4.02
 
Non-Interest Bearing Accounts
   
95,762
                     
66,746
                     
48,589
                 
Other Liabilities
   
18,077
                     
18,138
                     
15,478
                 
Total Liabilities
   
1,275,099
                     
1,056,075
                     
865,571
                 
Stockholders’ Equity
   
130,549
                     
103,102
                     
87,329
                 
Total liabilities and stockholders’ equity
 
$
1,405,648
                   
$
1,159,177
                   
$
952,900
                 
                                                                         
Net Earning Assets
 
$
118,720
                   
$
69,313
                   
$
63,517
                 
                                                                         
Net Interest Income
         
$
41,228
                   
$
33,540
                   
$
24,147
         
                                                                         
Net Interest Rate Spread (3)
                   
2.98
%
                   
3.01
%
                   
2.50
%
                                                                         
Net Yield on Average Interest-Earning Assets (4)
                   
3.22
%
                   
3.22
%
                   
2.79
%
                                                                         
Average Interest-Earning Assets to Average Interest-Bearing Liabilities
   
110.22
%
                   
107.14
%
                   
107.92
%
               

(1)
Average balances were calculated using amortized cost, which excludes FASB 115 valuation allowances.
(2)
Calculated net of deferred loan fees, loan discounts and loans in process.
(3)
Interest rate spread is calculated by subtracting weighted average interest rate cost from weighted average interest rate yield for the period indicated.
(4)
The net yield on weighted average interest-earning assets is calculated by dividing net interest income by weighted average interest-earning assets for the period indicated.

 
47

 

Rate/Volume Analysis
 
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume, which are changes in volume multiplied by the old rate, and (2) changes in rate, which is a change in rate multiplied by the old volume. Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
 
   
Year Ended December 31,
 
   
2009 vs. 2008
   
2008 vs. 2007
 
   
Increase
(decrease)
Due to
   
Total
Increase
   
Increase
(decrease)
Due to
   
Total
Increase
 
   
Volume
   
Rate
   
(decrease)
   
Volume
   
Rate
   
(decrease)
 
   
(Dollars in thousands)
Interest-earning assets:
                                               
Interest-bearing deposits
 
$
112
   
$
(181
 
$
(69
 
$
114
   
$
(111
)
 
$
3
 
Investment securities available-for-sale
   
2,613
     
(198
   
2,415
     
1,259
     
(157
)
   
1,102
 
Loans receivable
   
9,154
     
(4,417
   
4,737
     
9,302
     
(1,860
)
   
7,442
 
Stock in FHLB of Indianapolis
   
185
     
(595
   
(410
   
205
     
53
     
258
 
                                                 
Total interest-earning assets
 
$
12,064
   
$
(5,391
 
$
6,673
   
$
10,880
   
$
(2,075
)
 
$
8,805
 
                                                 
Interest-bearing liabilities:
                                               
Savings deposits
 
$
74
   
$
(161
 
$
(87
 
$
55
   
$
(19
)
 
$
36
 
Money market accounts
   
172
     
(277
   
(105
   
199
     
(205
)
   
(6
)
Demand and NOW accounts
   
134
     
(922
   
(788
   
442
     
(1,719
)
   
(1,277
)
Certificate accounts
   
4,770
     
(4,336
   
434
     
2,097
     
(3,932
)
   
(1,835
)
Borrowings
   
224
     
(693
   
(469
   
3,576
     
(1,082
)
   
2,494
 
                                                 
Total interest-bearing liabilities
 
$
5,374
   
$
(6,389
 
$
(1,015
 
$
6,369
   
$
(6,957
)
 
$
(588
)
                                                 
Change in net interest income
                 
$
7,688
                   
$
9,393
 
 
Comparison of Results of Operations for Years Ended December 31, 2009 and 2008.
 
General . Net income for the year ended December 31, 2009 was $1.4 million, or $.20 for basic and diluted income per common share. This compared to a net loss in 2008 of $22.1 million, or $4.22 for basic and diluted loss per common share. Return on assets was .23% and return on average tangible common equity was 1.49% for the year ended 2009 compared to a negative 1.91% and a negative 28.04% respectively, for the year ended 2008.
 
Net Interest Income . Net interest income before the provision for loan losses increased $7.7 million from $33.5 million for the year ended December 31, 2008 to $41.2 million for the year ended December 31, 2009. The primary reason for the increase was an increase in average earning assets of $239.5 million due to the acquisition of MFB Corp in the third quarter of 2008. Net interest margin remained unchanged at 3.22% for the years ended December 31, 2009 and 2008.
 
Interest Income . Interest income increased $6.7 million to $71.9 million at December 31, 2009, compared to $65.2 million at December 31, 2008. The increase in interest income during the year ended December 31, 2009 was due to an increase in average earning assets of $239.5 million due to the acquisition of MFB in the third quarter of 2008. This increase was partially offset by a 65 basis point decrease in the average yield on our earning assets from 6.26% in 2008 to 5.61% in 2009 as a result of interest earning assets repricing at lower rates.
 
48

 
Interest Expense . Interest expense decreased $1.0 million, or 3.2% to $30.6 million at December 31, 2009, from $31.6 million at December 31, 2008. The decrease in interest expense was due to a decline of 62 basis points on interest-bearing liabilities from 3.26% for the year ended December 31, 2008 to 2.64% for the year ended December 31, 2009. This decrease was partially offset by an increase in average interest-bearing liabilities of $190.1 million as a result of the acquisition of MFB in the third quarter of 2008. Interest expense on deposits decreased $546,000 due to a 64 basis point decline in average rates paid. This decrease was partially offset by increases in average interest-bearing deposits of $185.0 million. Interest expense on borrowings decreased $469,000 due to a 30 basis point decline in average rates, partially offset by an increase in average borrowings of $5.1 million.
 
Provision for Loan Losses . The provision for loan losses for the year ended December 31, 2009 was $6.5 million, compared to $7.0 million for 2008. Non-performing loans to total loans at December 31, 2009 were 3.03% compared to 1.93% at December 31, 2008. Non-performing assets to total assets were 2.86% at December 31, 2009 compared to 1.92% at December 31, 2008. The decrease in provision was due primarily to a decline in the loan portfolio in 2009. While the provision decreased in 2009 compared to 2008, allowance for loan losses to total loans increased to 1.53% compared to 1.34%.
 
Other Income . Non-interest income increased $6.6 million to $13.2 million in 2009, compared to $6.5 million for 2008. The primary reason for the increase was a full year of operations after the MFB acquisition in the third quarter of 2008. Service fee income, commission income and increase in cash surrender value of life insurance increased by $2.7 million, mostly related to operating a full year after the acquisition. The increase in gain on sale of available for sale securities of $3.1 million was due primarily to a loss related to the redemption of the AMF Ultra Funds of $2.6 million in 2008, which was not repeated in 2009. An increase in equity in limited partnerships was due to gains in refinanced properties in 2009, and an increase in gains on sales of loans and net servicing fees of $1.5 million was primarily due to $160.0 million in loan sales in 2009 and a $500,000 impairment charge on mortgage servicing rights in 2008 not repeated in 2009. The increases were partially offset by an increase in net other than temporary losses on securities of $1.2 million as certain trust preferred securities and private labeled mortgage backed securities were written down. More discussion on trust preferred securities and private labeled mortgage backed securities can be found in Item 1 under “Investment Activities.”
 
Other Expense . Non-interest expense decreased $19.1 million to $44.5 million for the year ended December 31, 2009 compared to $63.6 million for 2008. The decrease was due primarily to a goodwill impairment charge of $29.0 million in December 2008. Non-interest expense increased $9.9 million, excluding the goodwill impairment, primarily due to a full year of operations after the acquisition of MFB in the third quarter of 2008. Increase in salaries and employee benefits of $3.9 million, net occupancy expenses of $891,000, equipment expenses of $150,000, data processing fees of $319,000, advertising and promotion $69,000, ATM expense of $127,000, professional fees of $158,000, software, subscriptions and maintenance of $368,000 and other expenses of $940,000 are directly related to the acquisition of MFB. Increases in deposit insurance of $1.8 million is due to a $630,000 special assessment as of June 30, 2009, increases in premium rates required to be paid and increases in deposits as a result of the acquisition and organic growth. An increase in repossessed asset expense of $1.1 million is directly related to the increased repossessed assets being held by the bank and to the current economic challenges.

Income Tax Expense . Income tax expense increased $8.7 million in 2009 compared to the year ended 2008. The increase was due primarily to increased taxable income. The effective tax rate also increased to 6.3% due to a lower percentage of non-taxable income to total income before income tax and an decreased percentage of low income housing tax credits to taxable income when comparing the year ended 2009 to the year ended 2008.
 
Comparison of Results of Operations for Years Ended December 31, 2008 and 2007.
 
General . Net loss for the year ended December 31, 2008 was $22.1 million, or $4.22 for basic and diluted loss per common share. This compared to net income in 2007 of $4.2 million, or $1.03 for basic and $1.02 for diluted earnings per common share. Annualized return on average assets was negative 7.13% and return on average tangible equity was negative 108.92% for year end 2008 compared to .44% and 5.86%, respectively, for 2007.
 
 
49

 

Net Interest Income . Net interest income before the provision for loan losses increased $9.4 million for the year ended December 31, 2008 compared to the year ended December 31, 2007. Average interest earning assets increased $175.5 million, or 20.3% and the net interest margin increased by 43 basis points from 2.79% for the year ended December 31, 2007 to 3.22% for 2008 primarily due to the acquisition of MFB and the declining rate environment.
 
Interest Income . Interest income increased $8.8 million to $65.2 million at December 31, 2008, compared to $56.4 million at December 31, 2007. The increase in interest income during the year ended December 31, 2008 was due to an increase in average earning assets of $175.5 million due to the acquisition of MFB. This increase was partially offset by a 26 basis point decrease in the average yield on our earning assets from 6.52% in 2007 to 6.26% in 2008 as a result of decreasing market interest rates.
 
Interest Expense . Interest expense decreased $588,000, or 1.8% to $31.6 million at December 31, 2008, from $32.2 million at December 31, 2007. The decrease in interest expense was due to a decrease in interest rates which lead to a decline of 76 basis points on interest-bearing liabilities from 4.02% for the year ended December 31, 2007 to 3.26% for the year ended December 31, 2008. This decrease was partially offset by an increase in average interest-bearing liabilities of $169.7 million as a result of the acquisition of MFB. Interest expense on deposits decreased $3.1 million due to an 88 basis point decline in average rates paid. This decrease was partially offset by increases in average interest-bearing deposits of $91.6 million. Interest expense on borrowings increased $2.5 million due to an increase in average borrowings of $78.1 million, partially offset by a 65 basis point decrease in average rate.
 
Provision for Loan Losses . The provision for loan losses for the year ended December 31, 2008 was $7.0 million, compared to $2.2 million for 2007. Non-performing loans to total loans at December 31, 2008 were 1.93% compared to 1.29% at December 31, 2007. Non-performing assets to total assets were 1.92% at December 31, 2008 compared to 1.35% at December 31, 2007. The increase in provision was due primarily to deteriorated asset quality, a weakened economy and an increased loan portfolio due to the acquisition of MFB.
 
Other Income . Non-interest income decreased $1.2 million, or 16.1%, to $6.5 million in 2008, compared to $7.8 million for 2007. The decrease was due primarily to a loss related to the sale of the AMF Ultra Funds of $2.6 million, a $1.2 million write down on two trust preferred securities, a $200,000 write-down on a Lehman’s corporate bond, a $329,000 loss on the sale of a title insurance subsidiary, and a $500,000 impairment charge on mortgage servicing rights. These decreases were offset by increases in fees and service charges on deposit accounts of $1.4 million and commission income of $795,000 due primarily to the acquisition of MFB in the third quarter of 2008, and increases in gains on sale of loans of $1.0 million primarily due to the sale of $92.9 million of fixed rate mortgage loans in 2008.
 
Other Expense . Non-interest expense increased $38.5 million to $63.6 million for the year ended December 31, 2008 compared to $25.2 million for 2007. The increase was due primarily to a goodwill impairment charge of $29.0 million. Management engaged a third party business valuation specialist to perform the annual impairment test of goodwill. The step one impairment test indicated the fair value of the reporting unit was below the carrying value as of December 31, 2008. The step two impairment test was performed by allocating the fair value of the Company to all of the assets and liabilities of the reporting unit to determine the implied fair value of the Company. Management determined the carrying amount of goodwill exceeded, in its entirety, the implied fair value of goodwill. Other expenses also increased due to increases in salaries and employee benefits of $4.4 million, increases in occupancy, equipment, data processing and ATM expense of $1.1 million, increases in marketing expense of $574,000, increases in professional fees of $369,000, increases in software subscriptions and maintenance of $494,000, increases in amortization of intangibles of $559,000 and increases in other expenses, such as supplies, postage and repossessed asset expense of $2.1 million. These increases were primarily due to the acquisition of MFB Corp. and rebranding of the Bank in 2008.

Income Tax Expense . Income tax expense decreased $8.8 million in 2008 compared to the year ended 2007. The decrease was due primarily to decreased taxable income. The effective tax rate also decreased 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 year ended 2008 to the year ended 2007.
 
50

 
Liquidity
 
Liquidity management is both a daily and long-term function of the management of the Company and the Bank. 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.
 
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 at levels adequate to meet the requirements of normal operations, including potential deposit outflows. Cash flow projections are regularly reviewed and updated to ensure that adequate liquidity is maintained.
 
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 December 31, 2009, the Company had $177.3 million in cash and investment securities available for sale and $2.5 million in loans held for sale generally available for its cash needs. We can also generate funds from borrowings, primarily Federal Home Loan Bank advances and, to a lesser degree, third party loans. At December 31, 2009, the Bank had the ability to borrow an additional $82.4 million in Federal Home Loan Bank advances. In addition, we have historically sold 30 year fixed-rate mortgage loans in the secondary market in order to reduce interest rate risk and to create another source of liquidity. The Company utilizes dividends from the Bank as a source of funds to service debt and meet obligations of the Company. These dividends, however, require regulatory approval.
 
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 Federal Home Loan Bank 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 December 31, 2009, the approved outstanding loan commitments, including unused lines of credit, amounted to $150.5 million. Certificates of deposit scheduled to mature in one year or less at December 31, 2009, totaled $383.7 million. It is management’s policy to manage 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. For the year ended December 31, 2009, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.
 
51

 
The following table presents our contractual obligations (excluding deposit products).
 
   
Payments due by period
 
         
Less than
     
1-3
     
3-5
   
More
than
 
   
Total
   
1 year
   
years
   
Years
   
5 years
 
         
(Dollars in thousands)
       
Contractual Obligations
                                 
                                   
Federal Home Loan Bank Advances
 
$
197,960
   
$
92,923
   
$
95,867
   
$
7,460
   
$
1,710
 
Notes Payable
   
226
     
226
                         
Other Borrowings
   
13,888
     
764
     
2,549
     
6,687
     
3,888
 
                                         
Total
 
$
212,074
   
$
93,913
   
$
98,416
   
$
14,147
   
$
5,598
 

Capital
 
Consistent with our goals to operate a sound and profitable financial organization, MutualBank actively strives to remain a “well-capitalized” institution in accordance with regulatory standards. Total stockholders’ equity of MutualFirst Financial, Inc. was $129.7 million at December 31, 2009, or 9.3% of total assets on that date. As of December 31, 2009, MutualBank exceeded all capital requirements of the OTS, with regulatory capital ratios as follows: core capital, 9.4%; Tier I risk-based capital, 11.6%; and total risk-based capital, 12.8%. The regulatory capital requirements to be considered well-capitalized are 5.0%, 6.0% and 10.0%, respectively.
 
Impact of Inflation
 
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth 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. 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 affect on interest rates or upon the cost of those goods and services normally purchased by the Bank. 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.
 
Critical Accounting Policies
 
The notes to the consolidated financial statements in Item 8 of this Form 10-K contain a summary of MutualFirst ’s significant accounting policies. Certain of these policies are important to the portrayal of MutualFirst ’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 real estate held for development and the valuation of intangible assets.
 
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.
 
52

 
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 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 of 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 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.
 
53

 
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.
 
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 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 $8.1 million, or .71% of pre-tax pre-provision ROA over the previous 5 years, after excluding the goodwill impairment in 2008. Over the last 5 years, the Company has grown and at its current asset size, the pre-tax pre-provision earnings would be approximately $9.9 million using the same historical pre-tax pre-provision ROA. These earnings would be sufficient to utilize the net operating losses, tax credit carryforwards and temporary tax differences over the allowable periods. The valuation allowance established in 2009 and 2008 is the result of capital losses sustained in those years with no tax benefit recorded. The analysis supports no further valuation is necessary.

At the end of 2009, the Company had $1.2 million in capital losses down from $1.6 million in 2008 as capital gains from the sale of a building and investments generated the reduction. The Company plans to generate the capital gains needed to offset the remaining capital loss through capital gains on possible sale of buildings, investments, and deferred tax liabilities that can generate capital gain income prior to losing the ability to utilize the capital losses. The Company will also avoid taking any book tax benefit on future capital losses without capital gains to offset the current capital losses. See Note 17 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

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.
 
 
54

 
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
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.
 
How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, 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, we adopted asset and liability management policies to better match the maturities and repricing terms of our interest-earning assets and interest-bearing liabilities. MutualBank’s Board of Directors sets and recommends asset and liability policies, which are implemented by the Asset and Liability Management Committee. The Asset and Liability Management Committee is chaired by the chief financial officer and is comprised of members of our senior management. 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. This 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 objectives are 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. 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, in 2009, we sold $160.0 million of fixed rate, one- to four-family mortgage loans with a term to maturity of over 10 years in the secondary market.
 
 
The Asset and Liability Management Committee regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on net interest income and market value of portfolio equity, which is defined as the net present value of an institution’s existing assets, liabilities and off-balance sheet instruments, and evaluating such impacts against the maximum potential changes in net interest income and market value of portfolio equity that are authorized by our board of directors.
 
An internal asset-liability model provides MutualBank with the information presented in the following tables. The tables present the change in our net portfolio value at December 31, 2009 and 2008 that would occur upon an immediate and sustained change in market interest rates of 100 to 300 basis points as required by the OTS, and do not give any effect to actions that management might take to counteract that change. The changes in net portfolio value under all rate changes shown were within guidelines approved by the board of directors.
 
December 31, 2009
 
Net Portfolio Value
(Dollars in thousands)
 
Changes
                   
NPV as % of PV of Assets
 
In Rates
 
$ Amount
   
$ Change
   
% Change
   
NPV Ratio
   
Change
 
                               
+300 bp   162,643       -38,114       -19 %     12.26 %     -180 bp
+200 bp   180,333       -20,424       -10 %     13.23 %     -82 bp
+100 bp   190,330       -10,426       -5 %     13.66 %     -40 bp
0 bp   200,757                       14.06 %        
-100 bp
NM
   
NM
   
NM
   
NM
   
NM
 
-200 bp
NM
   
NM
   
NM
   
NM
   
NM
 
-300 bp
NM
   
NM
   
NM
   
NM
   
NM
 

December 31, 2008
 
   
Net Portfolio Value
 
(Dollars in thousands)
 
Changes
                   
NPV as % of PV of Assets
 
In Rates
 
$ Amount
   
$ Change
   
% Change
   
NPV Ratio
   
Change
 
                               
+300 bp   168,752       -16,815       -9 %     12.65 %     -50 bp
+200 bp   178,643       -6,924       -4 %     13.12 %     -3 bp
+100 bp   185,612       45       0 %     13.37 %     22 bp
0 bp   185,567                       13.15 %        
-100 bp
NM
   
NM
   
NM
   
NM
   
NM
 
-200 bp
NM
   
NM
   
NM
   
NM
   
NM
 
-300 bp
NM
   
NM
   
NM
   
NM
   
NM
 
                                         
NM= Not meaningful due to certain market interest rates that would be below zero at that level of rate shock.
 
The internal asset-liability model uses certain assumptions in assessing the interest rate risk of MutualBank. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market value of certain assets under differing interest rate scenarios, among others.
 
The increase in the interest rate sensitivity at December 31, 2009 compared to December 31, 2008 is a result of an increased slope on the yield curve in 2009 as certain market interest rates increased on the longer end of the curve.
 
As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing tables. 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.
 
 
56

 

Item 8. 
Financial Statements and Supplementary Data

MutualFirst Financial, Inc.

Accountants’ Report and Consolidated Financial Statements

December 31, 2009, 2008 and 2007
 
 
57

 
 
Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors and Stockholders
MutualFirst Financial, Inc.
Muncie, Indiana

We have audited the accompanying consolidated balance sheets of MutualFirst Financial, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2009.  The Company's management is responsible for these financial statements.  Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement.  Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MutualFirst Financial, Inc. as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with accounting principles generally accepted in the Unites States of America.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), MutualFirst Financial, Inc.'s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 18, 2010, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
 
BKD, LLP
 
Indianapolis, Indiana
March 18, 2010
 
 
58

 

MutualFirst Financial, Inc.
 
Consolidated Balance Sheets
December 31, 2009 and 2008
 
   
2009
   
2008
 
Assets
           
             
Cash and due from banks
  $ 27,245,633     $ 21,654,283  
Interest-bearing demand deposits
    19,095,264       18,049,169  
Cash and cash equivalents
    46,340,897       39,703,452  
Investment securities available for sale
    130,913,670       77,254,925  
Investment securities held to maturity
    8,147,407       9,675,891  
Total investment securities
    139,061,077       86,930,816  
Loans held for sale
    2,520,546       1,541,110  
Loans, net of allowance for loan losses of $16,414,000 and $15,107,000
    1,059,694,135       1,113,132,480  
Premises and equipment
    34,556,318       36,500,979  
Federal Home Loan Bank stock
    18,631,500       18,631,500  
Investment in limited partnerships
    4,160,629       4,560,690  
Deferred income tax benefit
    19,514,151       21,237,513  
Cash value of life insurance
    44,247,277       42,637,240  
Prepaid FDIC premiums
    5,907,149        
Core deposit and other intangibles
    5,881,075       7,406,572  
Other assets
    18,519,603       16,545,134  
                 
Total assets
  $ 1,399,034,357     $ 1,388,827,486  
                 
Liabilities and Stockholders’ Equity
               
                 
Liabilities
               
Deposits
               
Noninterest-bearing
  $ 98,024,890     $ 93,393,362  
Interest-bearing
    947,171,169       869,120,808  
Total deposits
    1,045,196,059       962,514,170  
Federal Home Loan Bank advances
    197,960,396       263,112,728  
Other borrowings
    14,113,526       15,991,690  
Other liabilities
    12,037,299       16,693,959  
Total liabilities
    1,269,307,280       1,258,312,547  
                 
Commitments and Contingencies
               
                 
Stockholders’ Equity
               
Preferred stock, $.01 par value
               
Authorized - 5,000,000 shares
               
Issued and outstanding - 32,382 and 32,382 shares; liquidation preference $1,000 per share
    324       324  
Common stock, $.01 par value
               
Authorized - 20,000,000 shares
               
Issued and outstanding - 6,984,754 and 6,984,754 shares
    69,847       69,847  
Additional paid-in capital - preferred stock
    31,645,814       31,461,848  
Additional paid-in capital - common stock
    72,485,756       72,610,939  
Retained earnings
    28,654,285       29,989,003  
Accumulated other comprehensive loss
    (1,857,723 )     (2,027,956 )
Unearned benefit plan shares
    (1,271,226 )     (1,589,066 )
Total stockholders’ equity
    129,727,077       130,514,939  
                 
Total liabilities and stockholders’ equity
  $ 1,399,034,357     $ 1,388,827,486  
 
See Notes to Consolidated Financial Statements

 
59

 

MutualFirst Financial, Inc.
 
Consolidated Statements of Income
Years Ended December 31, 2009, 2008 and 2007
 
   
2009
   
2008
   
2007
 
Interest and Dividend Income
                 
Loans receivable
  $ 65,864,742     $ 61,127,725     $ 53,686,297  
Investment securities
    5,628,312       3,213,272       2,110,916  
Federal Home Loan Bank stock
    310,589       719,886       461,949  
Deposits with financial institutions
    48,665       118,064       114,596  
Total interest and dividend income
    71,852,308       65,178,947       56,373,758  
                         
Interest Expense
                       
Deposits
    20,870,515       21,416,502       24,498,471  
Federal Home Loan Bank advances
    8,762,340       9,698,795       7,656,748  
Other interest expense
    991,472       523,793       71,833  
Total interest expense
    30,624,327       31,639,090       32,227,052  
                         
Net Interest Income
    41,227,981       33,539,857       24,146,706  
Provision for loan losses
    6,500,000       7,020,000       2,240,000  
Net Interest Income After Provision for Loan Losses
    34,727,981       26,519,857       21,906,706  
                         
Other Income
                       
Service fee income
    7,457,642       6,256,694       4,831,161  
Net realized gain (loss) on sales of available-for-sale securities
    754,990       (2,365,531 )      
Commissions
    3,046,798       1,796,332       1,000,687  
Equity in gains (losses) of limited partnerships
    108,081       (157,575 )     (99,654 )
Net gains on sales of loans
    2,377,222       1,438,626       390,778  
Net servicing fees
    244,807       (298,473 )     81,033  
Increase in cash value of life insurance
    1,573,096       1,322,724       1,230,000  
Other-than-temporary losses on securities
                       
Total other-than-temporary losses
    (5,335,121 )     (1,350,000 )      
Portion of loss recognized in other comprehensive income (before taxes)
    2,779,828              
Net impairment losses recognized in earnings
    (2,555,293 )     (1,350,000 )      
Other income (loss)
    146,359       (120,503 )     336,554  
Total other income
    13,153,702       6,522,294       7,770,559  
                         
Other Expenses
                       
Salaries and employee benefits
    23,046,656       19,117,989       14,758,489  
Net occupancy expenses
    2,802,258       1,911,495       1,549,331  
Equipment expenses
    1,780,267       1,629,898       1,318,932  
Data processing fees
    1,510,194       1,191,655       1,058,357  
Advertising and promotion
    1,529,744       1,461,225       887,237  
Automated teller machine expense
    1,094,893       968,078       723,128  
Deposit Insurance
    2,262,697       512,129       83,086  
Professional fees
    1,291,389       1,133,012       764,007  
Software subscriptions and maintenance
    1,378,329       1,010,518       516,503  
Repossessed asset expenses
    2,025,182       875,223       609,042  
Goodwill impairment
          28,968,993        
Other expenses
    5,785,596       4,845,170       2,887,311  
Total other expenses
    44,507,205       63,625,385       25,155,423  
                         
Income (Loss) Before Income Tax
    3,374,478       (30,583,234 )     4,521,842  
Income tax expense (benefit)
    211,000       (8,485,000 )     295,700  
                         
Net Income (Loss)
    3,163,478       (22,098,234 )     4,226,142  
Preferred stock dividends and amortization
    1,803,064       31,482        
                         
Net Income (Loss) Available to Common Shareholders
  $ 1,360,414     $ (22,129,716 )   $ 4,226,142  
                         
Earnings Per Share
                       
Basic
  $ 0.20     $ (4.22 )   $ 1.03  
Diluted
    0.20       (4.22 )     1.02  
 
See Notes to Consolidated Financial Statements
 
 
60

 

MutualFirst Financial, Inc.
 
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2009, 2008 and 2007
 
                           
Accumulated
             
                           
Other
   
Unearned
       
         
Paid-in
         
Paid-in
         
Comprehensive
   
Benefit
       
   
Preferred
   
Capital
   
Common
   
Capital
   
Retained
   
Income
   
Plan
       
   
Stock
   
Preferred
   
Stock
   
Common
   
Earnings
   
(Loss)
   
Shares
   
Total
 
Balances, January 1, 2007
  $     $     $ 43,666     $ 33,101,586     $ 56,698,546     $ (354,734 )   $ (2,224,746 )   $ 87,264,318  
Comprehensive income
                                                               
Net income
                                    4,226,142                       4,226,142  
Other comprehensive income, net of tax - unrealized holding gains on securities
                                            (59,646 )             (59,646 )
Total comprehensive income
                                                            4,166,496  
Cash dividends ($.60 per share)
                                    (2,440,121 )                     (2,440,121 )
Exercise of stock options
                    154       208,459                               208,613  
Stock repurchased
                    (1,554 )     (1,032,936 )     (1,758,782 )                     (2,793,272 )
RRP shares earned
                            21,056                               21,056  
Tax benefit on stock options and RRP shares
                            3,382                               3,382  
ESOP shares earned
                            265,538                       317,840       583,378  
                                                                 
Balances, December 31, 2007
                    42,266       32,567,085       56,725,785       (414,380 )     (1,906,906 )     87,013,850  
Comprehensive loss
                                                               
Net loss
                                  $ (22,098,234 )                     (22,098,234 )
Other comprehensive income, net of tax - unrealized holding losses on securities
                                            (1,503,877 )             (1,503,877 )
Total comprehensive loss
                                                            (23,602,111 )
Preferred stock issued
    324       31,461,848               919,828                               32,382,000  
Common stock issued in acquisition, net of costs
                    29,117       39,758,791                               39,787,908  
Cash dividends ($.64 per share)
                                    (3,489,747 )                     (3,489,747 )
Stock repurchased
                    (1,536 )     (660,334 )     (1,148,801 )                     (1,810,671 )
RRP shares earned
                            21,056                               21,056  
Tax expense on stock options and RRP shares
                            (20,529 )                             (20,529 )
                                                                 
ESOP shares earned
                            25,042                       317,840       342,882  
Other adjustment
                                            (109,699 )             (109,699 )
                                                                 
Balances December 31, 2008
    324       31,461,848       69,847       72,610,939       29,989,003       (2,027,956 )     (1,589,066 )     130,514,939  
Comprehensive loss
                                                               
Net income
                                    3,163,478                       3,163,478  
Other comprehensive income, net of taxes
                                                               
Unrealized holding gains on  available-for-sale securities
                                            1,985,376               1,985,376  
Unrealized holding losses on available-for-sale securities for which a portion of an other-than-temporary impairment has been recognized in income
                                            (1,689,510 )             (1,689,510 )
Unrealized gain on derivative used for cash flow hedge
                                            29,348               29,348  
Unrealized loss on defined benefit plan
                                            (154,981 )             (154,981 )
Total comprehensive income
                                                            3,333,711  
Stock options
                            13,401                               13,401  
Cash dividends, common stock ($.42 per share)
                                    (2,866,034 )                     (2,866,034 )
Cash dividends, preferred stock (5%)
                                    (1,448,196 )                     (1,448,196 )
Tax expense on stock options and RRP shares
                            (35,559 )                             (35,559 )
ESOP shares earned
                            (103,025 )                     317,840       214,815  
Accretion of discount on preferred stock
            183,966                       (183,966 )                        
                                                                 
Balances December 31, 2009
  $ 324     $ 31,645,814     $ 69,847     $ 72,485,756     $ 28,654,285     $ (1,857,723 )   $ (1,271,226 )   $ 129,727,077  
 
See Notes to Consolidated Financial Statements
 
 
61

 

MutualFirst Financial, Inc.
 
Consolidated Statements of Cash Flows
Years Ended December 31, 2009, 2008 and 2007
 
   
2009
   
2008
   
2007
 
Operating Activities
                 
Net income (loss)
  $ 3,163,478     $ (22,098,234 )   $ 4,226,142  
Items not requiring (providing) cash
                       
Provision for loan losses
    6,500,000       7,020,000       2,240,000  
Impairment of goodwill
          28,968,993        
Depreciation and amortization
    4,561,919       2,812,118       2,554,786  
Deferred income tax
    1,471,381       (9,121,613 )     (758,000 )
Loans originated for sale
    (160,998,914 )     (41,018,545 )     (24,427,954 )
Proceeds from sales of loans held for sale
    160,817,418       41,737,644       24,262,686  
Gain on loans held for sale
    (2,377,222 )     (1,438,626 )     (390,778 )
(Gain) loss on sale of available for sale
    (541,992 )     2,365,531        
Loss on impairment of securities
    2,555,293       1,350,000        
Gain on sale of premises and equipment
    (187,651 )            
Other equity adjustments
    214,815       384,467       601,052  
Change in
                       
Prepaid FDIC premiums
    (5,907,149 )            
Interest receivable and other assets
    2,093,289       1,811,318       10,356  
Interest payable and other liabilities
    (3,197,149 )     (387,104 )     1,463,546  
Cash value of life insurance
    (1,573,096 )     (1,322,724 )     (1,230,000 )
Other adjustments
    (925,984 )     547,009       434,930  
Net cash provided by operating activities
    5,668,436       11,610,234       8,986,766  
                         
Investing Activities
                       
Net change in interest earning deposits
          100,000       193,000  
Purchases of securities
                       
Available for sale
    (84,539,462 )     (59,806,429 )     (7,810,905 )
Held to maturity
    (500,000 )            
Proceeds from redemption-in-kind - investments
          2,282,409        
Proceeds from maturities and paydowns of securities
                       
Available for sale
    19,079,510       9,342,878       4,357,422  
Held to maturity
    1,577,833       348,629        
Proceeds from sales of securities available for sale
    11,167,302       21,519,205       802,748  
Net change in loans
    38,722,418       4,435,817       (2,214,872 )
Proceeds from sales of loans transferred to held for sale
          51,577,741        
Proceeds from sale of premises and equipment
    1,033,151              
Purchases of premises and equipment
    (1,091,423 )     (3,422,071 )     (2,146,757 )
Proceeds from real estate owned sales
    1,841,994       1,781,701       1,314,027  
Cash received (paid) in acquisition, net
          331,065       (515,257 )
Other investing activities
    2,916,496       (61,895 )     100,671  
Net cash provided by (used in) investing activities
    (9,792,181 )     28,429,050       (5,919,923 )
                         
Financing Activities
                       
Net change in
                       
Noninterest-bearing, interest-bearing demand and savings deposits
    20,106,823       (19,540,396 )     (543,777 )
Certificates of deposits
    62,575,065       (16,808,138 )     (36,407,524 )
Proceeds from FHLB advances
    63,100,000       500,225,000       466,550,000  
Repayment of FHLB advances
    (127,290,189 )     (521,337,084 )     (432,014,627 )
Proceeds from other borrowings
    10,000,000       11,500,000       3,907,394  
Repayment of other borrowings
    (11,921,210 )     (4,383,382 )     (433,760 )
Proceeds from issuance of preferred stock
          32,382,000        
Stock repurchased
          (1,810,671 )     (2,793,272 )
Cash dividends
    (4,314,230 )     (3,489,747 )     (2,440,121 )
Other financing activities
    (1,495,069 )     (721,585 )     (157,857 )
Net cash provided by (used in) financing activities
    10,761,190       (23,984,003 )     (4,333,544 )
                         
Net Change in Cash and Cash Equivalents
    6,637,445       16,055,281       (1,266,701 )
Cash and Cash Equivalents, Beginning of Year
    39,703,452       23,648,171       24,914,872  
                         
Cash and Cash Equivalents, End of Year
  $ 46,340,897     $ 39,703,452     $ 23,648,171  
                         
Additional Cash Flows Information
                       
Interest paid
  $ 31,548,480     $ 31,989,878     $ 31,589,021  
Income tax paid
    550,000       900,000       445,000  
Transfers from loans to foreclosed real estate
    7,172,727       3,138,785       1,970,782  
Mortgage servicing rights capitalized
    1,579,282       823,032       241,131  
Redemption in kind - investments
          9,934,943        
 
See Notes to Consolidated Financial Statements

 
62

 
 
MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 1:
Nature of Operations and Summary of Significant Accounting Policies
 
The accounting and reporting policies of MutualFirst Financial, Inc. (Company) and its wholly owned subsidiary, MutualBank (Bank) and the Bank’s wholly owned subsidiaries, Mishawaka Financial Services, Mutual Federal Investment Company and the wholly owned subsidiary of Mutual Federal Investment Company, Mutual Federal REIT, Inc., conform to accounting principles generally accepted in the United States of America and reporting practices followed by the banking industry.  The more significant of the policies are described below.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.
 
The Company is a thrift holding company whose principal activity is the ownership of the Bank.  The Bank operates under a federal thrift charter and provides full banking services.  As a federally chartered thrift, the Bank is subject to regulation by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation.
 
The Bank generates mortgage, consumer and commercial loans and receives deposits from customers located primarily in north central Indiana.  The Bank’s loans are generally secured by specific items of collateral including real property, consumer assets and business assets.  Mutual Federal Investment Company invests in various investment securities and loans through Mutual Federal REIT, Inc.
 
Consolidation - The consolidated financial statements include the accounts of the Company, the Bank, and the Bank’s subsidiaries, after elimination of all material intercompany transactions.
 
Cash Equivalents - The Company considers all liquid investments with original maturities of three months or less to be cash equivalents.  At December 31, 2009 and 2008, cash equivalents consisted primarily of money market accounts with brokers and checking accounts with government sponsored entities.
 
Effective October 3, 2008, the FDIC’s insurance limits increased to $250,000.  The increase in federally insured limits is currently set to expire December 31, 2013.  At December 31, 2009, the Company’s cash accounts exceeded federally insured limits by approximately $14,718,000.  The Company also had uninsured accounts of approximately $10,524,000 primarily at the Federal Reserve and Federal Home Loan Bank.
 
Investment Securities - Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost.  Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.  Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.  Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

 
63

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Effective April 1, 2009, the Company adopted new accounting guidance related to recognition and presentation of other-than-temporary impairment (ASC 320-10).  When the Company does not intend to sell a debt security, and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income.  For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
 
As a result of this guidance, the Company’s consolidated statement of income as of December 31, 2009, reflects the full impairment (that is, the difference between the security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis.  For available-for-sale and held-to-maturity debt securities that management has no intent to sell and believes that it more likely than not will not be required to sell prior to recovery, only the credit loss component of the impairment is recognized in earnings, while the noncredit loss is recognized in accumulated other comprehensive income.  The credit loss component recognized in earnings is identified as the amount of principal cash flows not expected to be received over the remaining term of the security as projected based on cash flow projections.
 
Prior to the adoption of the recent accounting guidance on April 1, 2009, management considered, in determining whether other-than-temporary impairment exists, (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer and (3) the intent and ability 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.
 
For equity securities, when the Company has decided to sell an impaired available-for-sale security and the entity does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made.  The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.
 
Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses.  In estimating other-than-temporary losses, management considers the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, and the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
 
Loans held for sale are carried at the lower of aggregate cost or market.  Market is determined using the aggregate method.  Net unrealized losses, if any, are recognized through a valuation allowance by charges to income based on the difference between estimated sales proceeds and aggregate cost.

 
64

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Loans are carried at the principal amount outstanding.  A loan is impaired when, based on current information or events, it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement.  Payments with insignificant delays not exceeding 90 days are not considered impaired.  Certain significant nonaccrual and substantially delinquent loans may be considered to be impaired.  The Company considers its investment in one-to-four family residential loans and consumer loans to be homogeneous and therefore excluded from separate identification for evaluation of impairment.  Interest income is accrued on the principal balances of loans.  The accrual of interest on impaired and nonaccrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.  When interest accrual is discontinued, all unpaid accrued interest is reversed when considered uncollectible.  Interest income is subsequently recognized only to the extent cash payments are received.  Certain loan fees and direct costs are being deferred and amortized as an adjustment of yield on the loans over the contractual maturity of the loans.
 
Allowance for loan losses is maintained to absorb loan losses based on management’s continuing review and evaluation of the loan portfolio and its judgment as to the impact of economic conditions on the portfolio.  The evaluation by management includes consideration of past loss experience, changes in the composition of the portfolio, the current condition and amount of loans outstanding, and the probability of collecting all amounts due.  Impaired loans are measured by the present value of expected future cash flows, or the fair value of the collateral of the loan, if collateral dependent.  The allowance is increased by the provision for loan losses, which is charged against current period operating results.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.
 
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.  Management believes that as of December 31, 2009, the allowance for loan losses is adequate based on information currently available.  A worsening or protracted economic decline in the areas within which the Bank operates would increase the likelihood of additional losses due to credit and market risks and could create the need for additional loss reserves.
 
Premises and equipment are carried at cost net of accumulated depreciation.  Depreciation is computed using the straight-line method based principally on the estimated useful lives of the assets which range from 3 to 50 years.  Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized.  Gains and losses on dispositions are included in current operations.
 
Federal Home Loan Bank stock is a required investment for institutions that are members of the Federal Home Loan Bank (FHLB) system.  The required investment in the common stock is based on a predetermined formula and is carried at cost.
 
Mortgage servicing rights on originated loans that have been sold are recorded at fair value.  Capitalized servicing rights are amortized in proportion to and over the period of estimated servicing revenues.  Impairment of mortgage servicing rights is based on the fair value of those rights.  Fair values are estimated using discounted cash flows based on a current market interest rate.  For purposes of measuring impairment, the rights are stratified based on the predominant risk characteristics of the underlying loans.  The predominant characteristic currently used for stratification is type of loan.  The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights for a stratum exceed their fair values.
 

 
65

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Investment in limited partnerships is recorded primarily on the equity method of accounting.  Losses due to impairment are recorded when it is determined that the investment no longer has the ability to recover its carrying amount.  The benefits of low income housing tax credits associated with the investment are accrued when earned.
 
Deferred tax assets are evaluated on a quarterly basis for recoverability based on all available evidence.   This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between our future projected operating performance and our actual results.  We are required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized.  In determining the more-likely-than-not criterion, we evaluate all positive and negative available evidence as of the end of each reporting period.  Future adjustments to the deferred tax asset valuation allowance, if any, will be determined based upon changes in the expected realization of the net deferred tax assets.  The realization of the deferred tax assets ultimately depends on the existence of sufficient taxable income in either the carry back or carry forward periods under applicable tax laws.  Due to significant estimates utilized in establishing the valuation allowance and the potential for changes in facts and circumstances, it is reasonably possible that we will be required to record adjustments to the valuation allowance in the near term if estimates of future taxable income during the carry forward period are reduced.  Such a charge could have a material adverse effect on our results of operations, financial condition, and capital position.
 
Intangible assets are being amortized on an accelerated basis over periods ranging from five to eleven years.  Such assets are periodically evaluated as to the recoverability of their carrying value.
 
Goodwill is tested annually for impairment.  If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value.  Subsequent increases in goodwill value are not recognized in the financial statements.
 
As of December 31, 2008, the total balance of goodwill was considered impaired and it was written off completely.
 
Income tax in the consolidated statements of income includes deferred income tax provisions or benefits for all significant temporary differences in recognizing income and expenses for financial reporting and income tax purposes.  The Company files consolidated income tax returns with the Bank.
 
Earnings per share is computed based upon the weighted-average common and common equivalent shares outstanding during each year.  Unearned ESOP shares and RRP shares which have not vested have been excluded from the computation of average shares outstanding.
 
Reclassifications of certain amounts in the 2007 and 2008 consolidated financial statements have been made to conform to the 2009 presentation.
 
Stock Options are accounted for in accordance with FASB ASC 718, Stock Compensation .  At December 31, 2009, the Company has a stock-based employee compensation plan, which is described more fully in Note 24.

 
66

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Current Economic Conditions.   The current protracted economic decline continues to present financial institutions with circumstances and challenges, which in some cases have resulted in large and unanticipated declines in the fair values of investments and other assets, constraints on liquidity and capital and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans.
 
At December 31, 2009, the Company held $334,752,000 in commercial loans, including $257,368,000 in loans collateralized by commercial and development real estate.  Due to national, state and local economic conditions, values for commercial and development real estate have declined significantly, and the market for these properties is depressed.
 
The accompanying financial statements have been prepared using values and information currently available to the Company.
 
Given the volatility of current economic conditions, the values of assets and liabilities recorded in the financial statements could change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses and capital that could negatively impact the Bank’s ability to meet regulatory capital requirements and maintain sufficient liquidity.
 
Note 2:
Impact of Accounting Pronouncements
 
On June 29, 2009, the FASB issued an accounting pronouncement establishing the FASB Accounting Standards Codification TM  (the “ASC”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities.  This pronouncement was effective for financial statements issued for interim and annual periods ending after September 15, 2009, for most entities.  On the effective date, all non-SEC accounting and reporting standards will be superseded.  The Company adopted this new accounting pronouncement for the quarterly period ended September 30, 2009, as required, and adoption did not have a material impact on the statements taken as a whole.
 
In June 2009, the FASB issued new a new standard regarding accounting for transfers and servicing of financial assets and extinguishments of liabilities, and will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures.
 
At the same time, FASB also issued another new standard regarding consolidation of variable interest entities, and changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance.
 

 
67

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The new standards will require a number of new disclosures. The first enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets and an entity’s continuing involvement in transferred financial assets.  The second will require a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements.
 
The Federal Reserve is reviewing regulatory capital requirements associated with the adoption of the new accounting standards by financial institutions. In conducting this review, the Federal Reserve is considering a broad range of factors including the maintenance of prudent capital levels, the record of recent bank experiences with off-balance sheet vehicles, and the results of the recent Supervisory Capital Assessment Program (SCAP). As part of the SCAP, participating banking organizations' capital adequacy was assessed using assumptions consistent with standards ultimately included in these two new standards.
 
The two new standards discussed above will be effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, or January 1, 2010, for a calendar year-end entity. Early application is not permitted.  The Company is currently evaluating the potential impact, if any, of the adoption of these two statements on the Company.
 
In January 2010, the FASB issued an accounting standard providing additional guidance relating to fair value measurement disclosures.  Specifically, companies will be required to separately disclose significant transfers into and out of Level 1 and Level 2 measurements in the fair value hierarchy including when such transfers were recognized and the reasons for those transfers.  For Level 3 fair value measurements, the new guidance requires presentation of separate information about purchases, sales, issuances and settlements.  Additionally, the FASB also clarified existing fair value measurement disclosure requirements relating to the level of disaggregation, inputs, and valuation techniques.  This accounting standard will be effective at the beginning of 2010, except for the detailed Level 3 disclosures, which will be effective at the beginning of 2011.  The company is currently evaluating the impact of this standard on its financial statements.
 
Note 3:
Acquisitions
 
On July 18, 2008, the Bank acquired 100% of the outstanding stock of MFB Corp., the holding company for MFB Financial (“MFB”) and MFB Statutory Trust I (“Trust”).  MFB Corp. was merged into the Company, and MFB was merged into MutualBank.  The Trust was also maintained as a wholly-owned subsidiary of the Company.
 
The Company issued 2,911,714 shares of its common stock and approximately $11,526,000 in cash to complete the transaction.  As a result of the acquisition, the Company will have an opportunity to increase its customer base and continue to increase its market share. The purchase had a recorded acquisition price of $51,985,000, including goodwill of $14,781,000. Additionally, core deposit intangibles totaling $6,645,000 were recognized and will be amortized over approximately 11 years using the sum of the year digits or a weighted average term of 3.8 years.  The goodwill generated as a result of this transaction is not deductible for tax purposes.
 

 
68

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The combination was accounted for under the purchase method of accounting. All assets and liabilities were recorded at their fair values as of July 18, 2008.  The purchase accounting adjustments will be amortized over the life of the respective asset or liability.  MFB's results of operations are included in the Company's consolidated income statement beginning July 18, 2008.
 
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands).
 
Cash and cash equivalents
  $     11,179  
Investments
    23,490  
Loans
    378,075  
Premises and equipment
    18,565  
Core deposit intangible
    6,645  
Goodwill
    14,781  
Other assets
    19,263  
Total assets acquired
    471,998  
         
Deposits
    332,075  
Borrowings
    97,361  
Other liabilities
    5,346  
Total liabilities assumed
    434,782  
         
Net assets acquired
  $ 37,216  
 
The following pro forma information discloses the results of operations as though the merger had taken place at the beginning of the year.
 
Year Ended December 31
 
2008
 
       
Net Interest Income
  $      42,151  
         
Net Income (Loss)
  $ (21,202 )
         
Net Income per Share - Combined
       
Basic
  $ (3.04 )
Diluted
  $ (3.04 )
 
 
69

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 4:
Restriction on Cash
 
The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank.  The reserve required at December 31, 2009 was $4,556,000.
 
Note 5:
Investment Securities
 
   
2009
 
Available for Sale Securities
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
                                 
Mortgage-backed securities
  $ 29,175     $ 824     $ (109 )   $ 29,890  
Collateralized mortgage obligations
    85,726       1,874       (571 )     87,029  
Municipals
    9,313       360       (17 )     9,656  
Small Business Administration
    158             (1 )     157  
Corporate obligations
    7,321             (4,782 )     2,539  
Marketable equity securities
    1,685             (42 )     1,643  
                                 
Total investment securities
  $ 133,378     $ 3,058     $ (5,522 )   $ 130,914  
       
Held to Maturity Securities
                               
                                 
Mortgage-backed securities
  $ 4,619     $ 29     $ (1,373 )   $ 3,275  
Collateralized mortgage obligations
    3,028       158       (632 )     2,554  
Federal agencies
    500       4             504  
                                 
Total investment securities
  $ 8,147     $ 191     $ (2,005 )   $ 6,333  
   
2008
 
Available for Sale Securities
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
                                 
Mortgage-backed securities
  $ 14,771     $ 393     $ (1 )   $ 15,163  
Collateralized mortgage obligations
    43,821       786       (968 )     43,639  
Federal agencies
    499       3             502  
Municipals
    857                   857  
Small Business Administration
    71             (1 )     70  
Corporate obligations
    18,797       9       (3,279 )     15,527  
Marketable equity securities
    1,635             (138 )     1,497  
                                 
Total investment securities
  $ 80,451     $ 1,191     $ (4,387 )   $ 77,255  
                                 
Held to Maturity Securities
                               
                                 
Mortgage-backed securities
  $ 5,498     $ 247     $ (762 )   $ 4,983  
Collateralized mortgage obligations
    4,178       138       (771 )     3,545  
                                 
Total investment securities
  $ 9,676     $ 385     $ (1,533 )   $ 8,528  
 
 
70

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Marketable equity securities consist of shares in mutual funds which invest in government obligations and mortgage-backed securities.
 
Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments at December 31, 2009 and 2008 was $35,317,000 and $18,868,000, which is approximately 27 percent and 24 percent of the Company’s investment portfolio at those dates.  These declines in fair value primarily resulted from changes in market conditions.
 
Based on evaluation of available evidence, including recent changes in market interest rates, management believes the declines in fair value for these securities, other than those discussed below, 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 2009, the Bank determined that four trust preferred securities, one corporate bond, and seven private labeled mortgage backed securities were other than temporarily impaired.  The amount of the impairment totaled $2,555,000 and $1,350,000 in 2009 and 2008, respectively and is reflected in the statement of operations.
 
The following tables show our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2009 and 2008:
 
   
2009
 
   
Less than 12 Months
   
12 Months or More
   
Total
 
Available for Sale
 
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
                                                 
Mortgage-backed securities
  $ 8,511     $ (109 )   $     $     $ 8,511     $ (109 )
Collateralized mortgage obligations
    16,829       (251 )     4,609       (320 )     21,438       (571 )
Municipals
    1,025       (17 )                 1,025       (17 )
Small Business Administration
                157       (1 )     157       (1 )
Corporate obligations
                2,539       (4,782 )     2,539       (4,782 )
Marketable equity securities
                1,647       (42 )     1,647       (42 )
                                                 
Total temporarily impaired securities
  $ 26,365     $ (377 )   $ 8,952     $ (5,145 )   $ 35,317     $ (5,522 )
                                                 
Held to Maturity
                                               
                                                 
Mortgage-backed securities
  $ 239     $ (559 )   $ 1,521     $ (814 )   $ 1,760     $ (1,373 )
Collateralized mortgage obligations
    199       (157 )     420       (475 )     619       (632 )
                                                 
Total temporarily impaired securities
  $ 438     $ (716 )   $ 1,941     $ (1,289 )   $ 2,379     $ (2,005 )
 
 
71

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
   
2008
 
   
Less than 12 Months
   
12 Months or More
   
Total
 
Available for Sale
 
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
                                                 
Mortgage-backed securities
  $ 228     $ (1 )   $     $     $ 228     $ (1 )
Collateralized mortgage obligations
    3,841       (516 )     1,559       (452 )     5,400       (968 )
Small Business Administration
                71       (1 )     71       (1 )
Corporate obligations
    9,407       (2,100 )     2,265       (1,179 )     11,672       (3,279 )
Marketable equity securities
                1,497       (138 )     1,497       (138 )
                                                 
Total temporarily impaired securities
  $ 13,476     $ (2,617 )   $ 5,392     $ (1,770 )   $ 18,868     $ (4,387 )
                                                 
Held to Maturity
                                               
                                                 
Mortgage-backed securities
  $ 3,356     $ (762 )   $     $     $ 3,356     $ (762 )
Collateralized mortgage obligations
    2,394       (771 )                 2,394       (771 )
                                                 
Total temporarily impaired securities
  $ 5,750     $ (1,533 )   $     $     $ 5,750     $ (1,533 )
 
Collateralized Mortgage Obligations (CMO)
 
The unrealized losses on the Company’s investment in CMOs were caused by interest rate changes.  The Company expects to recover the amortized cost basis over the term of the securities.  Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2009.
 
Corporate Obligations
 
The Company’s unrealized loss on investments in corporate obligations primarily relates to investments in pooled trust preferred securities.  The unrealized losses were primarily caused by (a) a recent decrease in performance and regulatory capital resulting from exposure to subprime mortgages and (b) a recent sector downgrade by several industry analysts.  The Company currently expects some of the securities to settle at a price less than the amortized cost basis of the investment (that is, the Company expects to recover less than the entire amortized cost basis of the security).  The Company has recognized a loss equal to the credit loss for these securities, establishing a new, lower amortized cost basis.  The credit loss was calculated by comparing expected discounted cash flows based on performance indicators of the underlying assets in the security to the carrying value of the investment.  Because the Company does not intend to sell the investment and it is likely the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be maturity, it does not consider the remainder of the investments to be other-than-temporarily impaired at December 31, 2009.

 
72

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Other-than-temporary Impairment
 
Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.
 
The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities.  For securities where the security is 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 routinely 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 pooled trust preferred and private-label mortgage-backed securities.  For each pooled trust preferred and private-label mortgage-backed security in the investment portfolio (including but not limited to those whose fair value is less than their amortized cost basis), an extensive, regular review is conducted to determine if an other-than-temporary impairment has occurred.  Various inputs to the economic models are used to determine if an unrealized loss is other-than-temporary.
 
The Bank’s trust preferred securities valuation was 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.

 
73

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
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.
 
To determine if the unrealized loss for private-label mortgage-backed securities is other-than-temporary, the Company projects total estimated defaults of the underlying assets (mortgages) and multiplies that calculated amount by an estimate of realizable value upon sale in the marketplace (severity) in order to determine the projected collateral loss.  The Company also evaluates the current credit enhancement underlying the bond to determine the impact on cash flows.  If the Company determines that a given mortgage-backed security position will be subject to a write-down or loss, the Company records the expected credit loss as a charge to earnings.
 
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
   
Accumulated
Credit Losses
 
   
2009
   
2008
 
             
Credit losses on debt securities held
           
Beginning of year
  $ (1,350 )   $  
Additions related to increases in previously recognized other-than-temporary losses
    (2,555 )     (1,350 )
                 
As of December 31,
  $ (3,905 )   $ (1,350 )
 
 
74

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The amortized cost and fair value of securities available for sale at December 31, 2009, 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.
 
   
2009
 
   
Available for Sale
   
Held to Maturity
 
Description Securities
 
Amortized
Cost
   
Fair 
Value
   
Amortized
Cost
   
Fair 
Value
 
                         
Within one year
  $ 100     $ 100     $     $ —-  
One to five years
                       
Five to ten years
    2,564       2,709              
After ten years
    13,970       9,386              
      16,634       12,195              
Mortgage-backed securities
    29,175       29,890       4,619       3,275  
Collateralized mortgage obligations
    85,726       87,029       3,028       2,554  
Marketable equity securities
    1,685       1,643              
Small Business Administration
    158       157              
Agency
                500       504  
                                 
Totals
  $ 133,378     $ 130,914     $ 8,147     $ 6,333  

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $2,071,000 and $1,997,000 at December 31, 2009 and 2008.
 
Proceeds from sales of securities available for sale during 2009, 2008 and 2007 were $11,167,000, $21,519,000 and $803,000.  Gross gains of $542,000, $204,000, and $0 in 2009, 2008 and 2007 were recognized in those sales.  In 2009, the realized gain on sale of securities reported also reflects a gain on sale of subsidiary of $137,000 and the sale of Mastercard stock of $75,000.  Gross losses of $0, $2,570,000 and $0 in 2009, 2008 and 2007 were recognized on those sales.

 
75

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 6:
Fair Values of Financial Instruments
 
FASB Codification Topic 820 (ASC 820), Fair Value Measurements and Disclosures , defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value:
 
Level 1
 
Quoted prices in active markets for identical assets or liabilities
     
Level 2
 
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
     
Level 3
 
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities
 
Items Measured at Fair Value on a Recurring Basis
 
Following is a description of the valuation methodologies and inputs used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance 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 and no securities are priced as Level 1 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 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.

 
76

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

         
Fair Value Measurements Using
 
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
                         
December 31, 2009
                       
Mortgage-backed securities
  $ 29,890     $     $ 29,890     $  
Collateralized mortgage obligations
    87,029             87,029        
Municipals
    9,656             9,656        
Small Business Administration
    157             157        
Corporate obligations
    2,539                   2,539  
Marketable equity securities
    1,643       1,643              
                                 
Available-for-sale securities
  $ 130,914     $ 1,643     $ 126,732     $ 2,539  
                                 
December 31, 2008
                               
Mortgage-backed securities
  $ 15,163     $     $ 15,163     $  
Collateralized mortgage obligations
    43,639             43,639        
Federal agencies
    502             502        
Municipals
    857             857        
Small Business Administration
    70             70        
Corporate obligations
    15,527             9,210       6,317  
Marketable equity securities
    1,497             1,497        
                                 
Available-for-sale securities
  $ 77,255     $     $ 70,938     $ 6,317  
 
The following is a reconciliation of the beginning and ending balances for the years ended December 31, 2009 and 2008 of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:
 
   
2009
   
2008
 
             
Beginning balance
  $ 6,317     $ 9,923  
                 
Total realized and unrealized gains and losses
               
Included in net income (loss)
    (2,007 )     (1,350 )
Included in other comprehensive loss
    (1,811 )     (2,745 )
Purchases, issuances and settlements
    40       (11 )
Transfers in/out of Level 3
          500  
                 
Ending balance
  $ 2,539     $ 6,317  
                 
Total gains or losses for the period included in net income (loss) attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date
  $ 2,007     $ 1,350  


 
77

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

Items Measured at Fair Value on a Non-Recurring Basis
From time to time, certain assets may be recorded at fair value on a non-recurring basis.  These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period.  The following is a description of the valuation methodologies used for certain assets that are recorded at fair value.
 
Impaired Loans (Collateral Dependent)
 
Loans for which it is probable that Mutual will not collect all principal and interest due according to contractual terms are measured for impairment.  Allowable methods for determining the amount of impairment include estimating fair value include 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.

 
78

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The following table presents the fair value measurement of assets and liabilities measured at fair value on a nonrecurring basis and the level within the ASC 820 fair value hierarchy in which the fair value measurements:
 
         
Fair Value Measurements Using
 
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
                         
December 31, 2009
                       
Impaired loans
  $ 4,614     $     $     $ 4,614  
Other real estate owned
    977                   977  
                                 
December 31, 2008
                               
Impaired loans
  $ 5,997     $     $     $ 5,997  
Mortgage servicing rights
    2,776                   2,776  
 
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
 
Cash and Cash Equivalents - The fair value of cash and cash equivalents approximates carrying value.
 
Investment Securities Available-For-Sale - Fair values are based on quoted market prices.
 
Investment Securities Held-To-Maturity - The fair values of held-to-maturity securities approximate carrying values.
 
Loans Held For Sale - Fair values are based on quoted market prices.
 
Loans - The fair value for loans are 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.

 
79

 
 
MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Federal Home Loan Bank Advances - The fair value of these borrowings are estimated using a discounted cash flow calculation, based on current rates for similar debt for periods comparable to the remaining terms to maturity of these advances.
 
Other Borrowings - The fair value of these borrowings approximate carrying values.
 
Advances by Borrowers for Taxes and Insurance - The fair value approximates carrying value.
 
Off-Balance Sheet Commitments - Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature.  The fair values of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  The carrying amounts of these investments are reasonable estimates of the fair value of these financial statements.
 
The estimated fair values of the Company’s financial instruments are as follows:
 
   
2009
   
2008
 
   
Carrying
Amount
   
Fair
Value
   
Carrying
Amount
   
Fair
Value
 
Assets
                       
Cash and cash equivalents
  $ 46,341     $ 46,341     $ 39,703     $ 39,703  
Investment securities available-for-sale
    130,914       130,914       77,255       77,255  
Investment securities held-to-maturity
    8,147       6,333       9,676       8,528  
Loans held for sale
    2,521       2,527       1,541       1,574  
Loans
    1,059,694       1,086,805       1,113,132       1,144,394  
FHLB stock
    18,632       18,632       18,632       18,632  
Interest receivable
    4,376       4,376       5,205       5,205  
                                 
Liabilities
                               
Deposits
    1,045,196       1,007,530       962,514       974,072  
FHLB advances
    197,960       194,717       263,113       273,853  
Other borrowings
    14,114       15,083       15,992       16,813  
Interest payable
    1,192       1,192       2,116       2,116  
Advances by borrowers for taxes and insurance
    1,734       1,734       3,229       3,229  
 
 
80

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 7:
Loans and Allowance
 
   
2009
   
2008
 
Real estate loans
           
One-to-four family
  $ 468,494     $ 519,822  
Multi-family
    2,621       2,698  
Commercial
    257,368       250,693  
Construction and development
    9,817       12,232  
      738,300       785,445  
Consumer loans
               
Auto
    18,848       22,715  
Home equity
    64,930       66,460  
Home improvement
    42,116       45,339  
Mobile home
    689       727  
Recreational vehicles
    81,663       79,884  
Boats
    45,581       46,928  
Other
    5,961       6,339  
      259,788       268,392  
Commercial business loans
    77,384       75,290  
Total loans
    1,075,472       1,129,127  
                 
Undisbursed loans in process
    (2,546 )     (4,372 )
Unamortized deferred loan costs, net
    3,182       3,484  
Allowance for loan losses
    (16,414 )     (15,107 )
                 
Net loans
  $ 1,059,694     $ 1,113,132  
 
   
2009
   
2008
   
2007
 
Allowance for loan losses
                 
Balances, January 1
  $ 15,107     $ 8,352     $ 8,156  
Provision for losses
    6,500       7,020       2,240  
Allowance acquired in acquisition
          2,954        
Recoveries on loans
    1,063       1,213       679  
Loans charged off
    (6,256 )     (4,432 )     (2,723 )
                         
Balances, December 31
  $ 16,414     $ 15,107     $ 8,352  
 
At December 31, 2009 and 2008, accruing loans delinquent 90 days or more totaled $1,934,000 and $1,473,000. Non-accruing loans at December 31, 2009 and 2008 were $29,086,000 and $19,998,000.
 
Impaired loans totaled $28,048,000 and $20,178,000 at December 31, 2009 and 2008, respectively. An allowance for loan losses of $1,463,000 and $781,000 relates to impaired loans of $6,102,000 and $2,973,000 at December 31, 2009 and 2008, respectively. At December 31, 2009, impaired loans of $21,946,000 had no related allowance for loan losses.
 
 
81

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Interest of $781,000, $839,000 and $449,000 was recognized on average impaired loans of $22,109,000, $16,481,000 and $9,488,000 for 2009, 2008 and 2007, respectively. Interest of $138,000, $140,000 and $151,000 was recognized on impaired loans on a cash basis during 2009, 2008 and 2007, respectively.
 
Note 8:
Related Party Transactions
 
The Bank has entered into transactions with certain directors, executive officers and significant shareholders of the Company and Bank and their affiliates or associates (“related parties”). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.
 
The aggregate amount of loans, as defined, to such related parties was as follows:
 
Balances, January 1, 2009
  $ 7,575  
Change in composition
    245  
New loans, including renewals
    1,573  
Payments, etc., including renewals
    (893 )
         
Balances, December 31, 2009
  $ 8,500  
 
Note 9:
Premises and Equipment
 
   
2009
   
2008
 
             
Cost
           
Land
  $ 12,758     $ 13,248  
Buildings and land improvements
    25,267       25,272  
Equipment
    13,738       14,381  
Total cost
    51,763       52,901  
Accumulated depreciation and amortization
    (17,207 )     (16,400 )
                 
Net
  $ 34,556     $ 36,501  
 
Note 10:
Investment In Limited Partnerships
 
   
2009
   
2008
 
                 
Pedcor Investments 1990-XIII (99.00 percent ownership)
  $     $ 625  
Pedcor Investments 1997-XXVIII (99.00 percent ownership)
    1,981       2,145  
Pedcor Investments 1987-XXXI (49.50 percent ownership)
    313       361  
Pedcor Investments 2000-XLI (50.00 percent ownership)
    742       862  
Pedcor Investments 2001-LI (9.90 percent ownership)
    223       268  
Pedcor Investments 2008-CIII (21.50 percent ownership)
    902       300  
                 
    $ 4,161     $ 4,561  
 
 
82

 
 
MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The limited partnerships build, own and operate apartment complexes.  The Company records its equity in the net income or loss of the limited partnerships based on the Company’s interest in the partnerships.  The Company recorded income (losses) from these limited partnerships of $108,000, $(158,000) and $(100,000) for 2009, 2008 and 2007.  In addition, the Company has recorded the benefit of low income housing credits of $874,000, $1,214,000 and $811,000 for 2009, 2008 and 2007.  Combined financial statements for the limited partnerships recorded under the equity method of accounting are as follows:
 
   
2009
   
2008
 
Combined condensed balance sheets
           
Assets
           
Cash
  $ 573     $ 7,487  
Land and property
    55,070       43,038  
Other assets
    2,174       4,693  
                 
Total assets
  $ 57,817     $ 55,218  
                 
Liabilities
               
Notes payable
  $ 47,878     $ 46,189  
Other liabilities
    1,087       1,835  
Total liabilities
    48,965       48,024  
                 
Partners' equity (deficit)
               
General partners
    (3,124 )     (3,120 )
Limited partners
    11,976       10,314  
Total partners’ equity
    8,852       7,194  
                 
Total liabilities and partners' equity
  $ 57,817     $ 55,218  
 
   
2009
   
2008
   
2007
 
Combined condensed statements of operations
                 
Total revenue
  $ 5,394     $ 5,994     $ 4,007  
Total expenses
    (6,027 )     (6,833 )     (4,647 )
                         
Net loss
  $ (633 )   $ (839 )   $ (640 )
 
Note 11:
Intangibles
 
   
2009
   
2008
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Gross
Carrying
Amount
   
Accumulated
Amortization
 
                                 
Core deposits
  $ 8,047     $ 2,692     $ 8,047     $ 1,249  
Other
    675       149       675       66  
                                 
    $ 8,722     $ 2,841     $ 8,722     $ 1,315  

 
83

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Amortization expense for the years ended December 31, 2009 and 2008, was $1,525,000 and $805,000, respectively.  Estimated amortization expense for each of the following five years is:
 
2010
  $ 1,348  
2011
    1,160  
2012
    962  
2013
    782  
2014
    616  
Thereafter
    1,013  
         
    $ 5,881  
 
Note 12:
Goodwill
 
The changes in the carrying amount of goodwill for the year ended December 31, 2008, were:
 
   
2008
 
         
Balance as of January 1
  $ 14,188  
Goodwill acquired during the year
    14,781  
Impairment losses
    (28,969 )
         
Balance as of December 31
  $  

During the fourth quarter 2008, the decline in the market value of the Company’s stock below its book value and the decline in the economic environment in which the Company operates caused management to engage a third party business valuation specialist to perform the annual impairment test of goodwill.  The third-party specialist used three methods of evaluation to determine the fair value of the reporting unit.  The methods considered comparable transactions based on pricing ratios recently paid in the sale or merger of comparable banking franchises, the Company’s trading price and application of an industry based control premium and the present value of projected dividends and a terminal value.  The value of each approach was weighted and an overall summary of the Company’s fair value was calculated.
 
The step one impairment test indicated the fair value of the reporting unit was below the carrying amount as of December 31, 2008.  The third-party was then engaged to perform step two impairment testing by allocating the fair value of the Company to all of the assets and liabilities of the reporting unit to determine the implied fair value of the Company.  The implied fair value of goodwill was then compared to the actual carrying amount of goodwill.  From this testing, management determined the carrying amount of goodwill exceeded, in its entirety, the implied fair value of goodwill.
 
 
84

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 13:
Deposits
 
   
2009
   
2008
 
                 
Noninterest-bearing demand
  $ 98,025     $ 93,393  
Interest-bearing demand
    154,431       156,787  
Savings
    84,553       79,111  
Money market savings
    60,479       47,584  
Certificates and other time deposits of $100,000 or more
    212,457       192,445  
Other certificates
    435,251       393,194  
                 
Total deposits
  $ 1,045,196     $ 962,514  

Certificates, including other time deposits of $100,000 or more, maturing in years ending December 31:
 
2010
  $ 383,707  
2011
    120,456  
2012
    49,603  
2013
    37,956  
2014
    49,420  
Thereafter
    6,566  
         
    $ 647,708  
 
Note 14:
Federal Home Loan Bank Advances
 
Maturities Years Ending December 31
     
         
2010
  $ 92,923  
2011
    41,986  
2012
    40,306  
2013
    13,575  
2014
    7,347  
Thereafter
    1,823  
         
    $ 197,960  
 
At December 31, 2009, the Company has pledged $429,299,000 in qualifying first mortgage loans as collateral for advances and outstanding letters of credit.  Advances, at interest rates from 0.57 to 7.33 percent at December 31, 2009, are subject to restrictions or penalties in the event of prepayment.
 
At December 31, 2009, the Company had a total of $47 million in putable advances with Federal Home Loan Bank.
 
 
85

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 15:
Other Borrowings
 
In 2009, the Company borrowed $10,000,000 from First Tennessee Bank, N.A..  The Company borrowed these funds at a fixed rate of 5.90%, with principal and interest payments made quarterly.  The loan is collateralized by the Bank’s stock.  The loan matures in December 2014.
 
As a condition of the Company’s loan agreements with First Tennessee Bank, N.A., MutualFirst must maintain an annual ROA of .40%.  As of December 31, 2009 the Company was not in compliance with this debt covenant.  This covenant has been waived by First Tennessee.
 
The Company assumed $5,000,000 in debentures as the result of the acquisition of MFB in 2008.  In July 2005, MFB formed MFBC Statutory Trust (MFBC), as wholly owned business trust, to sell trust preferred securities.  The proceeds from the sale of the trust preferred securities were used by the trust to purchase an equivalent amount of subordinated debentures from MFB.  The junior subordinated debentures are the sole assets of MFBC and are fully and unconditionally guaranteed by the Company.  The junior subordinated debentures and the trust preferred securities pay interest and dividends, respectively, on a quarterly basis.  The securities bear a fixed rate of interest of 6.22% for the first five years, resetting quarterly thereafter at the prevailing three-month LIBOR rate plus 170 basis points.  In 2009, the Company entered into a forward interest rate swap that will fix the variable rate portion for five years at 5.15%.  The Company may redeem the trust preferred securities, in whole or in part, without penalty, on or after September 15, 2010, or earlier upon the occurrence of certain events with the payment of a premium upon redemption.  These securities mature on September 15, 2035.  The net balance of the note as of December 31, 2009 was $3,888,000 due to the fair value of the note as of the acquisition.
 
The Bank has a noninterest-bearing, unsecured term note payable to Pedcor Investments 1997-XXVIII, L.P. of $226,000 and $647,000 at December 31, 2009 and 2008 payable in semiannual installments through January 1, 2010.  At December 31, 2009 and 2008, the Bank was obligated under an irrevocable direct pay letter of credit for the benefit of a third party in the amount of $223,000 and $628,000, respectively, relating to this note and the financing for an apartment project by Pedcor Investments 1997-XXVIII L.P.
 
Note Payable Principal Payments Due in Years Ending December 31
     
         
2010
  $ 989  
2011
    800  
2012
    848  
2013
    901  
2014
    6,688  
         
Total notes payable
  $ 10,226  

Other borrowings consisted of the following components as of December 31:
 
   
2009
   
2008
 
             
Notes payable
  $ 10,226     $ 12,147  
Subordinate debentures
    3,888       3,845  
                 
Total
  $ 14,114     $ 15,992  
 
 
86

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 16:
Loan Servicing
 
Loans serviced for others are not included in the accompanying consolidated balance sheets.  The unpaid principal balances of these loans consist of the following:
 
   
2009
   
2008
   
2007
 
                   
Loans serviced for
                 
Freddie Mac
  $ 431,815     $ 384,808     $ 137,973  
Fannie Mae
    1,589       2,148       1,936  
Federal Home Loan Bank
    27,012       37,070       33,998  
Other investors
    2,282       4,064       4,757  
                         
    $ 462,698     $ 428,090     $ 178,664  
 
The aggregate fair value of capitalized mortgage servicing rights is based on comparable market values and expected cash flows, with impairment assessed based on portfolio characteristics including product type and interest rates.  The fair value of mortgage servicing rights at December 31, 2009 was $3,484,000.
 
   
2009
   
2008
   
2007
 
                   
Mortgage Servicing Rights
                 
Balances, January 1
  $ 3,276     $ 1,126     $ 1,261  
Servicing rights capitalized
    1,579       823       241  
Servicing rights acquired
          1,844        
Amortization of servicing rights
    (871 )     (517 )     (376 )
      3,984       3,276       1,126  
Valuation allowance
    (500 )     (500 )      
                         
Balances, December 31
  $ 3,484     $ 2,776     $ 1,126  
 
The fair value of servicing rights subsequently measured using the amortization method was as follows:
 
   
2009
   
2008
 
Mortgage Servicing Rights
           
Fair value, beginning of period
  $ 2,776     $ 1,629  
Fair value, end of period
    3,510       2,776  
 
Activity in the valuation allowance for mortgage servicing right was as follows:
 
   
2009
   
2008
   
2007
 
                         
Balance, beginning of year
  $ 500     $     $  
Additions
          500        
Reductions
                 
                         
Balances, end of year
  $ 500     $ 500     $  
 
 
87

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 17:
Income Tax
 
   
2009
   
2008
   
2007
 
Income tax expense (credit)
                 
Currently payable
                 
Federal
  $ (1,270 )   $ 281     $ 1,012  
State
    9       356       42  
Deferred
                       
Federal
    1,481       (7,781 )     (691 )
State
    (9 )     (1,341 )     (67 )
                         
Total income tax expense (credit)
  $ 211     $ (8,485 )   $ 296  
                         
Reconciliation of federal statutory to actual tax expense
                       
Federal statutory income tax at 34%
  $ 1,147     $ (10,398 )   $ 1,537  
Effect of state income taxes
          (650 )     (17 )
Low income housing credits
    (874 )     (1,214 )     (811 )
Tax-exempt income
    (733 )     (539 )     (525 )
Increase in valuation allowance
    615              
Goodwill impairment
          4,280        
Other
    56       36       112  
                         
Actual tax expense (credit)
  $ 211     $ (8,485 )   $ 296  
                         
Effective tax rate
    6.25 %     (27.74 )%     6.50 %
 
 
88

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The components of the deferred asset included on the balance sheets are as follows:
 
   
2009
   
2008
 
Assets
           
Unrealized loss on securities available for sale
  $ 843     $ 1,095  
Allowance for loan losses
    6,815       6,072  
Deferred compensation
    3,516       3,102  
Business tax and AMT credit carryovers
    5,386       4,891  
Capital loss carryover
    1,860       1,627  
Net operating loss carryover
    2,057       1,940  
Goodwill impairment
    4,859       5,682  
Other
    2,582       2,265  
Total assets
    27,918       26,674  
                 
Liabilities
               
Depreciation and amortization
    (2,036 )     (468 )
FHLB stock
    (731 )     (738 )
State income tax
    (1,044 )     (525 )
Loan fees
          (184 )
Investments in limited partnerships
    (1,830 )     (1,649 )
Mortgage servicing rights
    (1,428 )     (1,152 )
Total liabilities
    (7,069 )     (4,716 )
                 
Valuation Allowance
               
Beginning balance
    (720 )      
(Increase) decrease during period
    (615 )     (720 )
Ending balance
    (1,335 )     (720 )
                 
Net deferred tax asset
  $ 19,514     $ 21,238  
 
The Company has unused business income tax credits of $5,213,000 that begin to expire in 2024.  In addition, the Company has an AMT credit carryover of $173,000 with an unlimited carryover period.
 
Retained earnings include approximately $14,743,000 for which no deferred income tax liability has been recognized.  This amount represents an allocation of income to bad debt deductions as of December 31, 1987 for tax purposes only.  Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which income would be subject to the then-current corporate income tax rate.  The unrecorded deferred income tax liability on the above amounts was approximately $5,013,000.
 
The Company’s federal income tax returns have been closed without audit by the IRS through its year ended December 31, 2005.
 
 
89

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 18:
Other Comprehensive Income (Loss)
 
         
2009
       
   
Before-Tax
Amount
   
Tax
(Expense)
Benefit
   
Net-of-Tax
Amount
 
                   
Net unrealized gain on securities available-for-sale
  $ 1,825     $ (723 )   $ 1,102  
Less: reclassification adjustment for losses realized in net income
    (1,465 )     582       (883 )
Net unrealized loss on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income
    (2,796 )     1,107       (1,689 )
Net unrealized gain on derivative used for cash flow hedges
    44       (15 )     29  
Net unrealized loss relating to defined benefit plan liability
    (257 )     102       (155 )
                         
Net unrealized gains
  $ 281     $ (111 )   $ 170  
 
         
2008
       
   
Before-Tax
Amount
   
Tax
(Expense)
Benefit
   
Net-of-Tax
Amount
 
Unrealized holding losses arising during the year
  $ (6,206 )   $ 2,458     $ (3,748 )
Less: reclassification adjustment for losses realized in net income
    (3,716 )     1,472       (2,244 )
Net unrealized loss relating to defined benefit plan liability
    (182 )     72       (110 )
                         
Net unrealized losses
  $ (2,673 )   $ 1,058     $ (1,614 )
 
         
2007
       
   
Before-Tax
Amount
   
Tax
Benefit
   
Net-of-Tax
Amount
 
                   
Unrealized holding losses arising during the year
  $ (99 )   $ 39     $ (60 )
Less: reclassification adjustment for losses realized in net income
                 
                         
Net unrealized losses
  $ (99 )   $ 39     $ (60 )
 
 
90

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The components of accumulated other comprehensive income, included in stockholders’ equity, are as follows:
 
   
2009
   
2008
   
2007
 
Net unrealized gain (loss) on securities available-for-sale
  $ 331     $ (3,176 )   $ (686 )
Net unrealized loss on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income
    (2,796 )            
Net unrealized gain on derivative used for cash flow hedges
    44              
Net unrealized loss relating to defined benefit plan liability
    (438 )     (182 )      
      (2,859 )     (3,358 )     (686 )
Tax benefit
    (1,001 )     (1,330 )     (272 )
                         
Net of tax amount
  $ (1,858 )   $ (2,028 )   $ (414 )
 
Note 19:
Commitments and Contingent Liabilities
 
In the normal course of business there are outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying financial statements.  The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments.  The Company uses the same credit policies in making such commitments as it does for instruments that are included in the consolidated statements of financial condition.
 
Financial instruments whose contract amount represents credit risk as of December 31 were as follows:
 
   
2009
   
2008
   
2007
 
                         
Loan commitments
  $ 145,136     $ 164,922     $ 93,662  
Standby letters of credit
    5,370       7,065       4,160  
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation.  Collateral held varies, but may include residential real estate, income-producing commercial properties, or other assets of the borrower.
 
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.
 
 
91

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The Company and Bank are also subject to claims and lawsuits which arise primarily in the ordinary course of business.  It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Company.
 
The Company has entered into employment agreements with certain officers that provide for the continuation of salary and certain benefits for a specified period of time under certain conditions. Under the terms of the agreement, these payments could occur in the event of a change in control of the Company, as defined, along with other specific conditions.
 
Commitments to originate mortgage loans that will be held for resale are recorded at their fair values with subsequent changes in fair value included in current earnings.  Commitments to originate or acquire fixed-rate mortgage loans that will be held for resale were $1,600,000 and $12,500,000 at December 31, 2009 and 2008, respectively.
 
Note 20:
Stockholders’ Equity
 
The Company is not subject to any regulatory restrictions on the payment of cash dividends to its stockholders up to $.16 per share (see note below for further information).
 
Without prior approval, current regulations allow the Bank to pay dividends to the Company not exceeding retained net income for the previous two calendar years.  In the event the Bank becomes unable to pay dividends to the Company, the Company may not be able to service its debt, pay its other obligations or pay dividends on its common stock.  At December 31, 2009, the Bank had no regulatory approval to pay dividends to the Company.
 
Note 21:
Capital Purchase Program
 
On December 23, 2008, the Company entered into a Letter Agreement (Purchase Agreement) with the U.S. Treasury (Treasury), pursuant to which the Company agreed to issue and sell (a) 32,382 of the Company’s fixed Rate Cumulative Perpetual Preferred Stock and (b) a warrant to purchase 625,135 shares of the Company’s common stock for an aggregate purchase price of $32,382,000 in cash.
 
The preferred Stock qualifies as Tier I capital and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter.  The preferred Stock is non-voting except with respect to certain matters affecting the rights of the holders thereof, and may be redeemed by the Company at any time with regulatory approval.  The Warrant has a ten year term and is immediately exercisable with an exercise price of $7.77 per share of Common Stock.  Pursuant to the Purchase Agreement, Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant.
 
 
92

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
In the Purchase Agreement, the Company agreed that, until such time as Treasury ceases to own any debt or equity securities of the Company, acquired pursuant to the Purchase Agreement, the Company will take all necessary action to ensure that its benefit plans with respect to its senior executive officers comply with Section 111(b) of the Emergency Economic Stabilization Act of 2008 (EESA) as implemented by any guidance or regulation under EESA that has been issued and is in effect as of the date of issuance of the Preferred Stock and the Warrant, and has agreed to not adopt any benefit plans with respect to, or which cover, its senior executive officers that do not comply with the EESA, and the applicable executives have consented to the foregoing.
 
Upon issuance of the Preferred Stock on December 23, 2008, the ability of the Company to declare or pay dividends on, or purchase, redeem or otherwise acquire for consideration, shares of its Common Stock will be subject to restrictions, including the Company’s restriction against increasing dividends from the last quarterly cash dividend per share of $.16 declared on the Common Stock prior to December 23, 2008.  The redemption, purchase or other acquisition of trust preferred securities of the Company or its affiliates also is restricted.  These restrictions will terminate the earlier of (a) the third anniversary of the date of issuance of the Preferred Stock or (b) the date on which the Preferred Stock has been redeemed in whole or Treasury has transferred all of the Preferred Stock to third parties.  In addition, the ability of the Company to declare or pay dividends, or repurchase, redeem or otherwise acquire for consideration, shares of its Common Stock will be subject to restrictions in the event that the Company fails to declare and pay full dividends on its Preferred Stock.
 
Note 22:
Regulatory Capital
 
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies and is assigned to a capital category.  The assigned capital category is largely determined by three ratios that are calculated according to the regulations: total risk adjusted capital, Tier 1 risk-based capital, and core leverage ratios.  The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity.  The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity’s activities that are not part of the calculated ratios.
 
There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized.  Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank’s operations.  At December 31, 2009 and 2008, the Bank was categorized as well capitalized and met all subject capital adequacy requirements.  There are no conditions or events since December 31, 2009 that management believes have changed the Bank’s classification.
 
 
93

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The Bank’s actual and required capital amounts and ratios are as follows:
 
   
Actual
   
Required for Adequate
Capital
   
To Be Well
Capitalized
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
                                     
As of December 31, 2009
                                   
Total risk-based capital (to risk-weighted assets)
  $ 133,872       12.8 %   $ 83,579       8.0 %   $ 104,474       10.0 %
Tier 1 risk-based capital (to risk-weighted assets)
    130,340       11.6 %     41,790       4.0 %     62,685       6.0 %
Core capital (to adjusted total assets)
    130,340       9.4 %     55,580       4.0 %     69,475       5.0 %
Core capital (to adjusted tangible assets)
    130,340       9.4 %     27,790       2.0 %     N/A       N/A  
Tangible capital (to adjusted total assets)
    130,340       9.4 %     20,843       1.5 %     N/A       N/A  
                                                 
As of December 31, 2008
                                               
Total risk-based capital (to risk-weighted assets)
  $ 144,897       13.3 %   $ 87,091       8.0 %   $ 108,864       10.0 %
Tier 1 risk-based capital (to risk-weighted assets)
    131,289       12.1 %     43,546       4.0 %     65,318       6.0 %
Core capital (to adjusted total assets)
    131,289       9.5 %     55,211       4.0 %     69,014       5.0 %
Core capital (to adjusted tangible assets)
    131,289       9.5 %     27,606       2.0 %     N/A       N/A  
Tangible capital (to adjusted total assets)
    131,289       9.5 %     20,704       1.5 %     N/A       N/A  
 
Note 23:
Employee Benefits
 
The Company has a retirement savings 401(k) plan in which substantially all employees may participate.  The contributions are discretionary and determined annually.  The Company matches employees' contributions at the rate of 100 percent of participant contributions to the 401(k) up to a maximum of 6% of their compensation and made a discretionary contribution to the plan of 3% of qualified compensation.  The Company’s expense for the plan was $716,000, $505,000 and $330,000 for 2009, 2008 and 2007.
 
The Company has a supplemental retirement plan and deferred compensation arrangements for the benefit of certain officers.  The Company also has deferred compensation arrangements with certain directors whereby, in lieu of currently receiving fees, the directors or their beneficiaries will be paid benefits for an established period following the director’s retirement or death.  These arrangements are informally funded by life insurance contracts which have been purchased by the Company.  The Company records a liability for these vested benefits based on the present value of future payments.  The Company’s expense for the plan was $857,000, $717,000 and $682,000 for 2009, 2008 and 2007.
 
 
94

 
 
MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The Company has an ESOP covering substantially all of its employees.  At December 31, 2009, 2008 and 2007, the Company had 127,138, 158,922 and 190,706 unearned ESOP shares with a fair value of $760,285, $1,072,724 and $2,658,000.  Shares are released to participants proportionately as ESOP debt is repaid.  Dividends on allocated shares are recorded as dividends and charged to retained earnings.  Dividends on unallocated shares are used to repay the loan.  Compensation expense is recorded equal to the fair market value of the stock committed-to-be-released when contributions, which are determined annually by the Board of Directors of the Company and Bank, are made to the ESOP.  Expense under the ESOP for 2009, 2008 and 2007 was $215,000, $343,000 and $583,000.  The following table provides information on ESOP shares at December 31.
 
   
2009
   
2008
   
2007
 
                         
Allocated shares
    345,195       256,089       207,274  
Suspense shares
    127,138       158,922       190,709  
Committed-to-be released shares
    31,783       31,783       31,783  
 
The Company has a Recognition and Retention Plan (RRP) for the award of up to 232,784 shares of the common stock of the Company to directors and executive officers.  Common stock awarded under the RRP vests ratably over a three or five-year period commencing with the date of the grants.  Expense recognized on the vested shares totaled approximately $0, $21,000 and $21,000 in 2009, 2008 and 2007.
 
A summary of the status of the Company’s RRP shares as of December 31, 2009 and changes during the year then ended, is presented below:
 
   
2009
 
   
Shares
   
Weighted-
Average
Grant-Date
Fair Value
 
                 
RRP, beginning of year
    4,917     $ 25.66  
Vested
    4,917       25.66  
                 
RRP, end of year
        $  
 
As of December 31, 2009 and 2008, there was $0 and $0 of total unrecognized compensation cost related to RRP share-based compensation arrangements granted under the Plan.  The total fair value of shares vested during the years ended December 31, 2009, 2008 and 2007, was $22,000, $66,000 and $99,000, respectively.
 
 
95

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 24:
Stock Option Plan
 
Under the Company’s stock option plan, which has been accounted for in accordance with FASB ASC 718, Stock Compensation , the Company grants selected executives and other key employees and directors incentive and non-qualified stock option awards which vest and become fully exercisable at the discretion of the stock option committee as the options are granted.  The Company is authorized to grant options for up to 934,702 shares of the Company’s common stock under two separate stock option plans.  Under certain provisions of the plan, the number of shares available for grant may be increased without shareholder approval by the amount of shares surrendered as payment of the exercise price of the stock option and by the number of shares of common stock of the Company that could be repurchased by the Company using proceeds from the exercise of stock options.
 
The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table.  Expected volatility is based on historical volatility of the Company’s stock and other factors.  The Company uses historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes.  The expected term of options granted represents the period of time that options are expected to be outstanding; the range given below results from certain groups of employees exhibiting different behavior.  The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.  The discount rate for post-vesting restrictions is estimated based on the Company’s credit-adjusted risk-free rate of return.
 
Assumptions
 
2009
 
Expected volatility
    36.9 %
Expected dividends
    4.4 %
Expected term (in years)
 
5.6 years
 
Risk-free rate
    2.7 %

The following is a summary of the status of the Company’s stock option plan and changes in that plan for 2009.
 
   
2009
 
Options
 
 
Shares
   
Weighted-
Average
Exercise Price
 
Weighted-
Average
Remaining
Contractual Life
 
Aggregate
Intrinsic
Value
 
                         
Outstanding, beginning of year
    643,498     $ 13.99          
Granted
    59,000       5.98          
Exercised
                   
Forfeited/expired
    (72,780 )     12.39          
                         
Outstanding, end of year
    629,718     $ 11.58  
5.2 years
  $  
                           
Options exercisable at year end
    580,718                    
 
 
96

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
The weighted-average grant-date fair value of options granted during 2009 was $1.34.  The total intrinsic value of options exercised during the years ended December 31, 2009, 2008 and 2007, was $0, $0 and $79,000, respectively.
 
Cash received from options exercised under all share-based payment arrangements for years ended December 31, 2009, 2008 and 2007 was $0, $0 and $209,000, respectively.  The actual tax benefit (expense) realized for the tax deductions from options exercised and RRP shares vested totaled ($36,000), ($21,000) and $3,000, respectively, for the years ended December 31, 2009, 2008 and 2007.
 
Note 25:
Stock Repurchase Plan
 
On September 12, 2007, the Company announced that its Board of Directors approved a stock repurchase program for up to 215,000 of the outstanding common shares of the Company.  As of July 8, 2008 all 215,000 shares under this plan had been purchased.
 
On August 13, 2008, the Company announced that its Board of Directors approved a stock repurchase program for up to 350,000 of the outstanding common shares of the Company.  Shares may be purchased from time to time in the open market and in large block privately negotiated transactions.  The Company is not obligated to purchase any shares under the program, and the program may be discontinued at any time before the maximum number of shares specified by the program are purchased.  As of December 31, 2009, the Company had purchased 10,000 shares under the program.
 
Note 26:
Earnings Per Share
 
Earnings per share were computed as follows:
 
   
2009
 
   
 
Income
   
Weighted-
Average
Shares
   
Per-Share
Amount
 
Basic Earnings Per Share
                 
Net income
  $ 3,163       6,840,659     $ 0.46  
Dividends and amortization on preferred stock
    (1,803 )                
Income available to common stockholders
    1,360       6,840,659     $ 0.20  
                         
Effect of Dilutive Securities
                       
Stock options
            89          
                         
Diluted Earnings Per Share
                       
Income (loss) available to common stockholders and assumed conversions
  $ 1,360       6,840,748     $ 0.20  
 
 
97

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
   
2008
 
   
 
Loss
   
Weighted-
Average
Shares
   
Per-Share
Amount
 
Basic Earnings Per Share
                 
Net loss
  $ (22,098 )     5,249,135     $ (4.21 )
Dividends and amortization on preferred stock
    (31 )                
Income available to common stockholders
    (22,129 )     5,249,135     $ (4.22 )
Effect of Dilutive Securities
                       
Stock options
                     
Diluted Earnings Per Share
                       
Income (loss) available to common stockholders and assumed conversions
  $ (22,129 )     5,249,135     $ (4.22 )
 
   
2007
 
   
 
Income
   
Weighted-
Average
Shares
   
Per-Share
Amount
 
                   
Basic Earnings Per Share
                 
Income available to common stockholders
  $ 4,226       4,103,940     $ 1.03  
Effect of Dilutive Securities
                       
Stock options
            47,233          
Diluted Earnings Per Share
                       
Income available to common stockholders and assumed conversions
  $ 4,226       4,151,173     $ 1.02  

Options to purchase 586,988, 638,318, and 91,000 shares of common stock at $14.33, $13.89 and $25.02 per share, respectively, were outstanding at December 31, 2009, 2008 and 2007, 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.
 
Warrants to purchase 625,135, 625,135 and 0 shares of common stock at $7.77, $7.77 and $0 per share, respectively, were outstanding at December 31, 2009, 2008 and 2007, 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.
 
 
98

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 27:
Condensed Financial Information (Parent Company Only)
 
Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company:
 
Condensed Balance Sheets

   
2009
   
2008
 
Assets
           
Cash on deposit with Bank
  $ 2,666     $ 2,896  
Cash on deposit with others
    250        
Total cash
    2,916       2,896  
Investment in common stock of Bank
    140,463       142,417  
Deferred and current income tax
    226       669  
Other assets
    50       40  
                 
Total assets
  $ 143,655     $ 146,022  
                 
Liabilities
               
Other borrowings
  $ 13,888     $ 15,345  
Other liabilities
    40       162  
Total liabilities
    13,928       15,507  
                 
Stockholders' Equity
    129,727       130,515  
                 
Total liabilities and stockholders' equity
  $ 143,655     $ 146,022  
 
 
99

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Condensed Statements of Income

   
2009
   
2008
   
2007
 
Income
                 
Interest income from Bank
  $ 23     $ 10     $ 29  
Dividends from Bank
    6,000       3,000       2,200  
Other income
    16             56  
Total income
    6,039       3,010       2,285  
                         
Expenses
    1,463       1,221       383  
                         
Income before income tax and equity in undistributed income of the Bank
    4,576       1,789       1,902  
                         
Income tax benefit
    (484 )     (412 )     (118 )
                         
Income before equity in undistributed income (distributions in excess of income) of the Bank
    5,060       2,201       2,020  
                         
Equity in undistributed income (distributions in excess of income) of the Bank
    (1,897 )     (24,299 )     2,206  
                         
Net income (loss)
    3,163       (22,098 )     4,226  
                         
Preferred stock dividends and amortization
    1,803       31        
                         
Net Income (Loss) Available to Common Shareholders
  $ 1,360     $ (22,130 )   $ 4,226  
 
 
100

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)

Condensed Statements of Cash Flows

   
2009
   
2008
   
2007
 
Operating Activities
                 
Net income (loss)
  $ 3,163     $ (22,098 )   $ 4,226  
Item not requiring cash
                       
ESOP shares earned
    215       343       583  
Deferred income tax benefit
    3       (251 )      
Distributions in excess of income (equity in undistributed income) of the Bank
    1,897       24,299       (2,206 )
Other
    591       (13 )     620  
Net cash provided by operating activities
    5,869       2,280       3,223  
                         
Investing Activities
                       
Proceeds from sale of investment
          431        
Loss on sale of investment
          329        
Investment in bank
          (29,144 )      
Cash paid in acquisition, net
          (9,115 )      
Maturity of certificate of deposit
                100  
Net cash provided by (used in) investing activities
          (37,499 )     100  
                         
Financing Activities
                       
Repayment of other borrowings
    (11,500 )     (496 )      
Proceeds from issuance of long-term debt
    10,000       11,500        
Proceeds from issuance of preferred stock
          32,382        
Stock repurchased
          (1,811 )     (2,793 )
Cash dividends
    (4,314 )     (3,490 )     (2,440 )
Proceeds from stock options exercised
                209  
Tax benefit on stock options and RRP shares
    (35 )     (21 )     3  
Net cash provided by (used in) financing activities
    (5,849 )     38,064       (5,021 )
                         
Net Change in Cash
    20       2,845       (1,698 )
                         
Cash, Beginning of Year
    2,896       51       1,749  
                         
Cash, End of Year
  $ 2,916     $ 2,896     $ 51  
 
 
101

 

MutualFirst Financial, Inc.
 
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
(Table Dollar Amounts in Thousands, Except Share and Per Share Data)
 
Note 28:
Quarterly Results of Operations (Unaudited)
 
Quarter
Ended
 
Interest
Income
   
Interest
Expense
   
Net
Interest
Income
   
Provision
for
Loan
Losses
   
Net
Income
(Loss)
   
Net
Income
(Loss)
Available to
Common
Shareholders
   
Basic
Earnings
Per
Common
Share
   
Diluted
Earnings
Per
Common
Share
 
                                                 
2009
                                               
March
  $ 18,656     $ 8,264     $ 10,392     $ 1,450     $ 1,796     $ 1,345     $ 0.20     $ 0.20  
June
    18,136       7,824       10,312       1,750       1,315       864       0.13       0.13  
September
    17,682       7,439       10,243       1,650       1,242       791       0.12       0.12  
December
    17,378       7,097       10,281       1,650       (1,189 )     (1,640 )     (0.24 )     (0.24 )
                                                                 
Total
  $ 71,852     $ 30,624     $ 41,228     $ 6,500     $ 3,164     $ 1,360       0.20       0.20  
                                                                 
2008
                                                               
March
  $ 13,757     $ 7,397     $ 6,360     $ 612     $ 1,215     $ 1,215     $ 0.30     $ 0.30  
June
    13,489       6,689       6,800       733       1,175       1,175       0.30       0.30  
September
    18,825       8,989       9,836       913       359       359       0.06       0.06  
December
    19,108       8,564       10,544       4,762       (24,847 )     (24,879 )     (3.65 )     (3.65 )
                                                                 
Total
  $ 65,179     $ 31,639     $ 33,540     $ 7,020     $ (22,098 )   $ (22,130 )     (4.22 )     (4.22 )
                                                                 
2007
                                                               
March
  $ 13,809     $ 7,814     $ 5,995     $ 332     $ 1,044     $ 1,044     $ 0.25     $ 0.25  
June
    14,056       7,941       6,115       533       1,129       1,129       0.27       0.27  
September
    14,128       8,277       5,851       532       1,161       1,161       0.28       0.28  
December
    14,380       8,195       6,185       843       892       892       0.22       0.22  
                                                                 
Total
  $ 56,373     $ 32,227     $ 24,146     $ 2,240     $ 4,226     $ 4,226       1.03       1.02  
 
Other-than-temporary impairment of securities of $2.4 million, net of tax, had an adverse impact on the fourth quarter 2009.  Earnings in the fourth quarter 2008 were negatively impacted primarily due to a goodwill impairment of $22.6 million, net of tax and increased loan loss provisions due to the current decline in the economy.
 
 
102

 

Item 9.  Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
 
None.
 
Item 9A.
Controls and Procedures.
 
An evaluation of our disclosure controls and procedures (as defined in Section 13(a)-14(c) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of December 31, 2009, was carried out under the supervision and with the participation of our Chief Executive Officer, Principal Financial Officer and several other members of our senior management within the 90-day period preceding the filing date of this annual report. Our Chief Executive Officer and Principal Financial Officer concluded that, as of December 31, 2009, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is (i) accumulated and communicated to our management (including our Chief Executive Officer and Principal Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
 
There were no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) under the Act) that occurred during the quarter ended December 31, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. The annual report of management on the effectiveness of internal control over financial reporting is set forth below under “Management’s Report on Internal Control Over Financial Reporting.”
 
We do not expect that our 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 Exchange Act 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.
 
103

 
Our management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. 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 . Based on our assessment, we believe that, as of December 31, 2009, the Company’s internal control over financial reporting was effective based on those criteria.
 
Date: March 18, 2010
By: 
/s/David W. Heeter
   
David W. Heeter
   
President and Chief Executive Officer
     
 
By:
/s/Timothy J. McArdle
   
Timothy J. McArdle
   
Treasurer and Chief Financial Officer
 
 
104

 

Item 9B. 
Other Information

None.
 
PART III

Item 10.
Directors, Executive Officers and Corporate Governance
 
Directors
 
Information concerning the Company’s directors is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in April 2010, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
Executive Officers
 
Information concerning the executive officers of the Company who are directors is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in April 2010, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
The business experience for at least the past five years for each of our executive officers who do not serve as directors is set forth below.
 
John H. Bowles . Age 64 years. Mr. Bowles has served as Senior Vice President and Manager of consumer Banking since January 2009. From November 2004 until January 2009, he served as Senior Vice President and Manager of Investment and Private Banking. Prior to 2004, he was president of Star Financial Bank/NewCastle Region from 1987 to 2004.
 
Timothy J. McArdle . Age 59 years. Mr. McArdle, a certified public accountant, has served as Senior Vice President and Chief Financial Officer of MutualBank since 1995, and Treasurer of MutualBank since 1986. He also serves as Senior Vice President, Treasurer and Controller of MutualFirst Financial. He has been employed by MutualBank since 1981.
 
Stephen C. Selby . Age 64 years. Since 1995, Mr. Selby has served as Senior Vice President of the Operations Division at MutualBank. Prior to 1995, he served as Vice President of the Operations Division for nine years. Mr. Selby has served in various other capacities at MutualBank since 1964.
 
Donald R. Kyle . Age 63 years. Mr. Kyle has served as Senior Vice President of the Business Banking Division of the Bank since July 2008. Prior to joining the Bank, he had served as Executive Vice President and Chief Operating Officer of MFB Financial since July 1999. Previously, he served as Regional President of National City Bank.
 
Sharon L. Ferguson . Age 54 years. Ms. Ferguson has served as Senior Vice President of Risk Management of the Bank since February 2009. From April 2008 until February 2009, she served as Senior Vice President of Consumer Banking. From September 2007 to April 2008 she served as Vice President of Retail Products. From October 2005 until September 2007 she served as Assistant Vice President, Retail Products Manager. Prior to October 2005 she served as Assistant Vice President, Consumer Lending and Deposits Manager. She has been with the Bank since March 1998.
 
Audit Committee Matters and Audit Committee Financial Expert
 
The Board of Directors of the Company has a standing Audit/Compliance Committee, which has been established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of that committee are Directors Linn A. Crull (Chairman), Wilbur R. Davis, Edward J. Dobrow, Jerry D. McVicker, Edward J. Levy, Jonathan C. Kintner and James D. Rosema, all of whom are considered independent under applicable Nasdaq listing standards. The Board of Directors has determined that Mr. Crull and Mr. Levy are both considered to be an “audit committee financial expert” as defined in applicable SEC rules. Additional information concerning the audit committee of the Company’s Board of Directors is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in April 2010, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
105

 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Exchange Act requires the Company’s directors and executive officers, and persons who own more than 10% of a registered class of the Company’s equity securities, to file with the SEC reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.
 
To the Company’s knowledge, based solely on a review of the copies of such reports furnished to the Company and written representations that no other reports were required during the fiscal year ended December 31, 2009, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% beneficial owners were complied with.
 
Code of Ethics
 
The Company adopted a written Code of Ethics based upon the standards set forth under Item 406 of Regulation S-K of the Securities Exchange Act. The Code of Ethics applies to all of the Company’s directors, officers and employees. A copy of the Company’s Code of Ethics was filed with the SEC as Exhibit 14 to the Annual Report on Form 10-K for the year ended December 31, 2003. You may obtain a copy of the Code of Ethics on our website at www.bankwithmutual.com at “Resource Center – About Us – Code of Ethics,” or free of charge from the Company by writing to our Corporate Secretary at MutualFirst Financial, Inc., 110 E. Charles Street, Muncie, Indiana 47305-2419 or by calling (765) 747-2800.
 
Nomination Procedures
 
There have been no material changes to the procedures by which stockholders may recommend nominees to the Company’s Board of Directors.
 
Item 11.
Executive Compensation
 
Information concerning executive compensation is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in April 2010, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
Item 12.               Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in April 2010, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
Equity Compensation Plan Information. The following table summarizes our equity compensation plans as of December 31, 2009.
 
106

 
Plan Category
 
Number of securities to
be issued upon exercise
of outstanding options
warrants and rights
   
Weighted-average
exercise price of
outstanding options
warrants and rights
   
Number of securities
remaining available for
future issuance under
equity compensation plans
 
                   
Equity compensation plans approved by security holders
    629,718     $ 11.58       314,702 (1)
                         
Equity compensation plans not approved by security holders
                 

(1)
Includes 20,961 shares available for future grants under MutualFirst Financial, Inc’s 2001 stock option plan and 293,741 shares available for future grants under M utualFirst Financial, Inc.’s 2008 stock option plan.

Item 13.
Certain Relationships and Related Transactions
 
Information required by this item concerning certain relationships and related transactions, our independent directors and our audit and nominating committee charters is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in April 2010, which will be filed no later than 120 days after the close of the fiscal year.
 
Item 14.
Principal Accountant Fees and Services
 
Information required by this item concerning principal accountant fees and services is incorporated herein by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in April 2010, a copy of which will be filed not later than 120 days after the close of the fiscal year
 
PART IV
 
Item 15.
Exhibits and Financial Statement Schedules
 
(a)(1) List of Financial Statements
 
The following are contained in Item 8 of this Form 10-K:
 
Annual Report Section
Report of Independent Registered Public Accounting Firm
58
Consolidated Balance Sheets at December 31, 2009 and 2008
59
Consolidated Statements of Income for the Years Ended December 31, 2009, 2008 and 2007
60
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2009, 2008 and 2007
61
Consolidated Statements of Cash Flows for the Years Ended December 31, 2009, 2008 and 2007
62
Notes to Consolidated Financial Statements, December 31, 2009, 2008 and 2007
63

(a)(2) List of Financial Statement Schedules:
 
All financial statement schedules have been omitted as the information is not required under the related instructions or is not applicable.
 
 
107

 

(a)(3) List of Exhibits:
 
Regulation
S-K
Exhibit
Number
 
Document
 
Reference
to Prior
Filing or
Exhibit
Number
Attached
Hereto
2.1
 
Agreement and Plan of Merger, dated as of January 7, 2008, by and among MutualFirst Financial, Inc., MutualFirst Acquisition Corp. and MFB Corp.
 
#
3.1
 
Articles of Incorporation
 
*
3.2
 
Articles Supplementary for the Series A Preferred Stock
 
+
3.3
 
Amended Bylaws
 
###
3.4
 
Articles Supplementary to the Company’s Charter re: term of appointed directors effective July 15, 2008
 
$
4.1
 
Form of Common Stock Certificate
 
*
4.2
 
Warrant for Purchase of Shares of Common Stock
 
+
4.3
 
Form of Certificate for the Series A Preferred Stock
 
++++
9
 
Voting Trust Agreement
 
None
10.1
 
Employment Agreement with David W. Heeter
 
+++
10.2
 
Employment Agreement with Patrick C. Botts
 
+++
10.3
 
Employment Agreement with Timothy J. McArdle
 
**
10.4
 
Form of Supplemental Retirement Plan Income Agreements for Steven Campbell, Patrick C. Botts, David W. Heeter, Timothy J. McArdle and Stephen C. Selby
 
**
10.5
 
Blank
   
10.6
 
Form of Director Shareholder Benefit Program Agreement, as amended, for Jerry D. McVicker
 
++
10.7
 
Form of Agreements for Executive Deferred Compensation Plan for Patrick C. Botts, Steven Campbell, David W. Heeter, Timothy J. McArdle and Stephen C. Selby
 
**
10.8
 
Registrant’s 2001 Stock Option and Incentive Plan
 
***
10.9
 
Registrant’s 2001 Recognition and Retention Plan
 
***
10.11
 
Director Fee Arrangements for 2010
 
10.11
10.12
 
Director Deferred Compensation Plan
 
##
10.13
 
MutualFirst Financial, Inc. 2008 Stock Option and Incentive Plan
 
++++
10.14
 
MFB Corp. 2002 Stock Option Plan
 
++++
10.15
 
MFB Corp. 1997 Stock Option Plan
 
++++
10.16
 
Employment Agreement with Charles J. Viater
 
++++
10.17
 
Salary Continuation Agreement with Charles J. Viater
 
++++
10.18
 
Letter Agreement (including Schedule A, Securities Purchase Agreement, dated December 23, 2008 between MutualFirst Financial, Inc. and United States Department of the Treasury with respect to the issuance and sale of the Series A Preferred Stock and Warrant
 
+
10.19
 
Form of compensation modification agreement and waiver for named executive officers
 
+
10.20
 
Loan Agreement with First Tennesee Bank National Association dated December 21, 2009.
 
10.20
10.21
 
Form of Incentive Stock Option Agreement for 2008 Stock Option and Incentive Plan
 
10.21
10.22
 
Form of Non-Qualified Stock Option Agreement for 2008 Stock Option and Incentive Plan
 
10.22
11
 
Statement re computation of per share earnings
 
None
12
 
Statements re computation of ratios
 
None
14
 
Code of Ethics
 
+++
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
99.1
 
Certification of Principal Executive Officer Pursuant to 31 CFR § 30.15
 
99.1
99.2
 
Certification of Principal Financial Officer Pursuant to 31 CFR § 30.15
 
99.2
 
108

 
*
Filed as an exhibit to the Company’s Form S-1 registration statement filed on September 16, 1999 (File No. 333-87239) pursuant to Section 5 of the Securities Act of 1933 and incorporated herein by reference.
**
Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 30, 2001.  Such previously filed document is incorporated herein by reference in accordance with Item 601 of Regulation S-K.
***
Filed as an Appendix to the Company’s Form S-4/A Registration Statement filed on October 19, 2001 (File No. 333-46510).  Such previously filed document is incorporated herein by reference in accordance with Item 601 of Regulation S-K.
+
Filed as an exhibit to the Company’s Form 8-K filed on December 23, 2008 (File No. 000-27905) and incorporated herein by reference.
++
Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on April 2, 2002.  Such previously filed document is incorporated herein by reference in accordance with Item 601 of Regulation S-K.
+++
Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 15, 2004.  Such previously filed document is incorporated herein by reference in accordance with Item 601 of Regulation S-K.
++++
Filed as an Exhibit to the Company’s Annual Report on Form 10-K filed on March 23, 2009 and incorporated herein by reference.
#
Filed as an exhibit to the Company’s Form 8-K filed on January 8, 2008 and incorporated herein by reference.
##
Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 16,2007.  Such previously filed document is incorporated herein by reference in accordance with Item 601 of Regulation S-K.
###
Filed as an exhibit to the Company’s Form 8-K filed on October 15, 2007 (File No. 000-27905).  Such previously filed document is incorporated herein by reference in accordance with Item 601 of Regulation S-K.
$
Filed as an exhibit to the Company’s Form 8-K filed on July 15, 2008 and incorporated herein by reference.
$$
Filed as an exhibit to the Company’s Form 8-K filed on December 24, 2009 and incorporated herein by reference.

(b)  Exhibits - See list in (a)(3) and the following signature page.
 
(c)  Financial Statements Schedules - None
 
 
109

 

SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
   
MutualFirst Financial, Inc.
 
       
Date:  March 18, 2010
By:
/s/David W. Heeter
   
David W. Heeter, President and
  Chief Executive Officer
 
   
Duly Authorized Representative)
 

POWER OF ATTORNEY
 
We, the undersigned officers and directors of MutualFirst Financial, Inc., hereby severally and individually constitute and appoint David W. Heeter and Timothy J. McArdle, and each of them, the true and lawful attorneys and agents of each of us to execute in the name, place and stead of each of us (individually and in any capacity stated below) any and all amendments to this Annual Report on Form 10-K and all instruments necessary or advisable in connection therewith and to file the same with the Securities and Exchange Commission, each of said attorneys and agents to have the power to act with or without the others and to have full power and authority to do and perform in the name and on behalf of each of the undersigned every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as any of the undersigned might or could do in person, and we hereby ratify and confirm our signatures as they may be signed by our said attorneys and agents or each of them to any and all such amendments and instruments.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
/s/David W. Heeter
 
/s/Wilbur R. Davis
David W. Heeter, President and Director
 
Wilbur R. Davis, Chairman of the Board
(Principal Executive Officer)
   
     
Date:  March 18, 2010
 
Date:  March 18, 2010
     
/s/Patrick C. Botts
 
/s/Edward J. Dobrow
Patrick C. Botts, Director
 
Edward J. Dobrow, Director
     
Date:  March 18, 2010
 
Date:  March 18, 2010
     
/s/Linn A. Crull
 
/s/James D. Rosema
Linn A. Crull, Director
 
James D. Rosema, Director
     
Date:  March 18, 2010
 
Date:  March 18, 2010
     
/s/William V. Hughes
 
/s/Jerry D. McVicker
William V. Hughes, Director
 
Jerry D. McVicker, Director
     
Date: March 18, 2010
 
Date:  March 18, 2010
     
/s/Jon R. Marler
 
/s/Jonathan E. Kintner, O.D.
Jon R. Marler, Director
 
Jonathan E. Kintner, O.D., Director
     
Date:  March 18, 2010
 
Date:  March 18, 2010
 
110

 
/s/Edward C. Levy
 
/s/Michael J. Marien
Edward C. Levy, Director
 
Michael J. Marien, Director
     
Date:  March 18, 2010
 
Date:  March 18, 2010
     
/s/Charles J. Viater
 
/s/ Timothy J. McArdle
Charles J. Viater, Director
 
Timothy J. McArdle, Senior Vice President
   
Treasurer and Controller
   
(Principal Financial and Accounting Officer)
     
Date:  March 18, 2010
 
Date:  March 18, 2010
 
 
111

 

INDEX TO EXHIBITS
 
Number
 
Description
     
10.11
 
Director Fee Arrangements for 2010
     
10.20
 
Loan Agreement with First Tennessee Bank, N.A.
     
10.21
 
Incentive Stock Option Award Agreement
     
10.22
 
Non-qualified Stock Option Award Agreement
     
21
 
Subsidiaries of the Registrant
     
23
 
Consent of Accountants
     
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
     
99.1
 
Certification of Principal Executive Officer Pursuant to 31 CFR § 30.15
     
99.2
 
Certification of Principal Financial Officer Pursuant to 31 CFR § 30.15
 
 
i

 
 

Exhibit 10.11

Director Fee Arrangements for 2010

Each director of MutualFirst Financial, Inc. (the “Company”) also is a director of MutualBank.  For 2010, each non-employee director will receive an annual fee of $27,750 for serving on MutualBank’s Board of Directors.  In addition to this annual fee, Wilbur R. Davis will receive a $6,000 annual fee for serving as Chairman of the Board of Directors, Linn Crull will receive a $5,000 annual fee for serving as Chairman of the Audit Committee, Jerry McVicker will receive a $3,000 annual fee for serving as Chairman of the Compensation Committee and Jon Kintner will receive a $3,000 annual fee for serving as Chairman of the Trust Management Committee.  Directors are not compensated for their service on the Company’s Board of Directors.

MutualBank maintains deferred compensation arrangements with some directors that allows them to defer all or a portion of their Board fees and receive income when they are no longer active directors.  Deferred amounts earn interest at the rate of 10 percent per year.

 
 

 

Exhibit 10.20

Loan Agreement with First Tennessee Bank, N.A.

LOAN AGREEMENT
 
THIS LOAN AGREEMENT (as amended, restated or supplemented or otherwise modified from time to time, hereinafter called the “ Agreement ”) made and entered into this 21 st day of December, 2009, (“ Effective Date ”) by and between MutualFirst Financial, Inc., a Maryland corporation, (hereinafter called “ Borrower ”) and FIRST TENNESSEE BANK NATIONAL ASSOCIATION , a national banking association having its principal office located in Memphis, Tennessee (“ Lender ”).

WITNESSETH:

WHEREAS, the Borrower has requested that Lender provide a loan in the amount of Ten Million Dollars ($10,000,000.00) (“ Loan ”) and Lender has agreed to make this Loan on the terms and conditions hereinafter set forth;

WHEREAS, Borrower and Lender wish to enter into this Loan Agreement to set forth certain terms of the Loan and to secure the Loan by a pledge of all of the capital stock of MutualBank (the “ Bank ”) which constitutes One Hundred percent (100%) of the outstanding shares of the Bank, which is a wholly-owned subsidiary of Borrower.

NOW, THEREFORE, in consideration of the premises and the mutual agreements, covenants and conditions herein contained, the receipt and sufficiency of which is hereby acknowledged, the parties hereto intending to be legally bound hereby agree as follows:

AGREEMENTS

1.             AMOUNT AND TERMS OF BORROWINGS .
 
1.1             Defined Terms .  Any capitalized term used but not defined in the body of this Agreement shall have the meaning set forth on Appendix A attached hereto and incorporated herein by reference.
 
1.2             Loan .  Lender hereby agrees to lend, and Borrower hereby agrees to borrow, upon the terms and conditions set forth in this Agreement, the sum of up to Ten Million Dollars ($10,000,000.00), as the Loan, to be evidenced by a promissory note (the “ Note ”), as set forth in Exhibit A and included herein by reference.  The Loan shall bear interest and be payable in accordance with the terms and provisions of the Note.  The Loan shall expire and mature, and the outstanding principal balance of the Loan and all accrued interest thereon shall be due and payable, on the Maturity Date.
 
1.3             Collateral .  All indebtedness and obligations of Borrower to Lender under this Agreement shall be secured by Lender’s lien and security interest in the Collateral.  The pledging of such Collateral shall be evidenced by the Pledge Agreement.  Borrower agrees that all of the rights of Lender with regard to the Pledge Agreement set forth in this Agreement shall apply to any modification of, or supplement to this Agreement.
 
1.4             Fees .  A loan origination fee in the amount of Ten Thousand Dollars ($10,000.00) shall be paid by Borrower to Lender on or before the closing of this Loan.
 
2.             USE OF PROCEEDS .
 
2.1             Use of Loan Proceeds .  The proceeds of the Loan shall be used by the Borrower for the sole purpose of repaying in full an existing term loan with Bank of America that is secured by the capital stock of the Bank.
 
 
H-1

 

3.             CONDITIONS TO LOAN CLOSING .
 
The obligation of Lender to extend any loan or credit to Borrower under this Agreement or to make any Loan disbursements is subject to the strict satisfaction of each of the following conditions:

3.1             No Defaults; Certificate .  Borrower and the Bank shall be in full compliance with all the terms and conditions of this Agreement, and no Event of Default, nor any event which upon notice or lapse of time or both would constitute such an Event of Default, shall have occurred.  At Lender’s request, Lender shall have received from Borrower and the Bank a certificate, in form and content reasonably acceptable to Lender dated as of and delivered on the date of the Loan, certifying that (1) the representations and warranties set forth herein, and the exhibits attached hereto, are accurate, true and correct on and as of such date, (2) show that neither the transactions contemplated hereby or by any other Loan Document will cause or result in any violation of (or creation of any right in third parties under the provisions of) any laws restricting or otherwise regulating the use, application or distribution of corporate funds and assets, and (3) that no Event of Default nor any event which upon notice or lapse of time or both would constitute such an Event of Default, exists.
 
3.2             Accuracy of Representations and Warranties .  At the time of the initial Loan disbursement and any subsequent Loan disbursement, the representations and warranties set forth herein and in any other Loan Document shall be true and correct.
 
3.3             Corporate Action and Authority .  The Borrower shall have delivered to Lender: (i) a certificate from the Secretary of State of Maryland that Borrower is in good standing and certificates from the Secretaries of State and of each other State in which the Borrower owns any property, has stationed any employees or agents, or otherwise conducts business, certifying the Borrower’s good standing as a corporation in each such State; (ii) a copy of the Resolutions passed by the Borrower’s and the Bank’s Boards of Directors authorizing the execution and delivery of the performance of Borrower’s obligations under the Loan Documents certified by the Secretary or Assistant Secretary to be true and correct; and (iii) a certificate or certificates, dated as of and delivered on the date of the execution of this Agreement and signed on behalf of the Borrower and the Bank by the Secretary or Assistant Secretary, certifying the names of the officers authorized to execute and deliver the Loan Documents on behalf of the Borrower and the Bank, together with the original, not photocopied, signatures of each officer.  Borrower shall also deliver the same items specified in (i) above pertaining to the Bank from the appropriate regulatory agency.
 
3.4             Delivery of Note, Loan Agreement, Pledge Agreement, and Stock Certificates .  At the time of the extension of the Loan, Borrower shall have delivered the Loan Documents.  The security interest in the Collateral shall be prior to all other liens.
 
3.5             Proceedings .  The Loan Documents, upon their execution, and all proceedings in connection with the authorization, execution and delivery of and the performance of the obligations under the Loan Documents shall be satisfactory in substance and form to Lender.
 
3.6             Payment of Fees and Expenses .  Borrower shall have paid, at or prior to the date of the extension of the Loan, all costs and expenses in accordance with Section 8.9, to the extent then determined by Lender.
 
3.7             Other Writings .  The Lender shall receive such other agreements, instruments, documents, certificates, affidavits and other writings as Lender may reasonably require.
 
 
 

 

3.8             Opinion of Counsel .  Borrower shall have delivered to Lender at Borrower’s expense, favorable written opinions of counsel for Borrower dated as of and delivered on the date of the extension of the Loan, in form and content acceptable to Lender, as set forth in Exhibit B .
 
3.9             Financial Statements .  Prior to any disbursement under the Loan, Borrower shall have delivered to Lender, true and exact copies of the current financial statements of the Borrower and the Bank, audit report and opinion of  the Borrower’s independent accounting firm, with respect thereto (it being understood that Lender is relying upon such audit report and opinion in entering into this Loan Agreement) and the unaudited financial statements of Borrower and Bank filed with the Office of Thrift Supervision (TFR and Schedule HC) as of September 30, 2009.
 
3.10           No Material Adverse Change .  At the time the Loan is funded hereunder, there shall have occurred, in the opinion of Lender, no material adverse changes in the condition, financial or otherwise, of Borrower or Bank from that reflected in the financial statements furnished pursuant to Section 3.9 hereof or furnished to Lender from time to time hereafter as required herein.
 
4.             REPRESENTATIONS AND WARRANTIES .
 
In order to induce the Lender to enter into this Agreement and to make the Loan, the Borrower and the Bank represent and warrant to the Lender (which representations and warranties shall survive the delivery of the Loan Documents and the funding of the Loan) that:

4.1             Corporate Status .  Borrower is a corporation duly organized and existing under the laws of the State of Maryland, is duly qualified to do business and is in good standing under the laws of other states where the Borrower does business, if any, and has the corporate power and authority to own its properties and assets and conduct its affairs and business.
 
4.2             Corporate Power and Authority .  Borrower has full power and authority to enter into this Agreement, to borrow funds as contemplated herein, to execute and deliver this Agreement, the Note and other Loan Documents executed and delivered by it, and to incur the obligations provided for herein, all of which have been duly authorized by all proper and necessary corporate action; and the officer executing each of the Loan Documents is duly authorized to do so by all necessary corporate action.  Any consents or approval of shareholders or directors of Borrower, or any other party (including without limitation any regulatory agency or authority) required as a condition to the execution, delivery, or validity of any Loan Document have been obtained; and each of said Loan Documents is the valid, legal, and binding obligation of Borrower enforceable in accordance with its terms.
 
4.3             No Violation of Agreements or Law .  Neither Borrower, Bank, nor any other Subsidiary of Borrower is in default under any indenture, agreement or instrument to which it is a party or by which it may be bound, nor in violation of any state or federal statute, rule, ruling, or regulation governing its operations and the conduct of its business, operations or financial condition of Borrower, Bank, or any other Subsidiary.  Neither the execution and delivery of the Loan Documents nor the consummation of the transactions herein contemplated, or compliance with the provisions hereof will conflict with, or result in the breach of, or constitute a default under, any indenture, agreement or other instrument to which Borrower is a party or by which it may be bound, or result in the creation or imposition of any lien, charge or encumbrance upon any of the property of Borrower, or violate or be in conflict with any provision of the charter or bylaws of Borrower, the Bank or any other Subsidiary.
 
 
 

 
 
4.4             Compliance With Law; Government Approvals .
 
(a)            Borrower has complied and is complying with all requirements, made all applications, and submitted all reports required by Section 10(b)(2) of the Home Owners’ Loan Act, as amended, and 12C.F.R. Section 584.1(a), as amended, and any regulations or rulings issued in connection therewith, and the transaction contemplated hereby will not violate any such statutes, rules, rulings, or regulations nor will the consummation of said actions and transactions cause Borrower to be in violation thereof.  Borrower has, if required, made all filings and received all governmental or regulatory approvals necessary for the consummation of the transactions described herein, including without limitation the approval of the Office of Thrift Supervision of the United States Treasury Department.
 
(b)            Borrower has complied and is complying with all other applicable state or federal statutes, rules, rulings and regulations.  The borrowing of money and said actions and transactions required hereunder will not violate any of such statutes, rules, rulings, or regulations.
 
4.5             Litigation .  There are no actions, suits or proceedings pending or, to the knowledge of the Borrower threatened against the Borrower, the Bank or any other Subsidiary before any court, arbitrator or governmental or administrative body or agency which, if adversely determined, would result in any material and adverse change in the financial condition, business operation, or properties or assets of the Borrower, the Bank, or any other Subsidiary except as set forth in Exhibit C .
 
4.6             Supervisory Action .  Neither Borrower, the Bank, nor any other Subsidiary is subject to any Supervisory Action by any federal or state bank regulatory authority.
 
4.7             Financial Condition .  The balance sheets and the related statements of income of Borrower, the Bank, and the other Subsidiaries and the financial reports of Borrower, the Bank, and the other Subsidiaries which will be delivered to Lender pursuant to Section 3.9 hereof are, or will be as of their respective dates and for the respective periods stated therein, complete and correctly and fairly present the financial condition of Borrower, the Bank, and the other Subsidiaries, and the results of their operations, respectively, as of the dates and for the periods stated therein, and have been, or will be as of their respective dates and for the respective periods stated therein, prepared in accordance with generally accepted accounting principles consistently applied throughout the period involved and consistent with that of the preceding fiscal year or period, as the case may be.  There are no liabilities of the Borrower, the Bank, or any other Subsidiary not included in such financial statements.  There has been no material adverse change in the business, properties or condition of Borrower, the Bank, or the other Subsidiaries since the date of the financial statement furnished to Lender pursuant to Section 3.9 hereof.
 
4.8             Tax Liability .  Borrower, the Bank, and the other Subsidiaries have filed all federal, state and other tax returns, which are required to be filed by them, and have paid all taxes which have become due pursuant to such returns or pursuant to any assessments received by Borrower, the Bank, and the other Subsidiaries.
 
4.9             Subsidiaries .  Borrower has no Subsidiaries and owns stock in no corporation or banking association other than the Subsidiaries listed in Exhibit D .
 
4.10             Bank Stock .  The common stock of the Bank owned by Borrower or any other Subsidiary of Borrower is duly authorized and validly issued by the Bank or other Subsidiary.  The total number of shares of common stock of the Bank and each other Subsidiary issued and outstanding as of the date hereof  are all owned by Borrower, the Bank or other Subsidiaries of Borrower.  Except as set forth on Exhibit E , the stock of the Bank and each other Subsidiary is free and clear of all liens, encumbrances, security interests; said common stock is fully paid and non-assessable. There are no outstanding warrants or options to acquire any common stock of the Bank and any other Subsidiary.  There are no outstanding securities convertible or exchangeable into shares of common stock of any Subsidiary; and there are no restrictions on the transfer or pledge of any shares of common stock of any Subsidiary, except as set forth on Exhibit E .  Borrower has the right to pledge and transfer the Collateral and assign the income therefrom without obtaining the consent of any other person or authority except as set forth on Exhibit E ; and the Pledge Agreement creates for the benefit of Lender a first lien security interest in the Collateral subject to no other interests or claims.
 
 
 

 

4.11           Liens .  There are no liens or any assets of the Borrower, the Bank or any other Subsidiaries other than as set forth in Exhibit E .  The Borrower will not incur any additional debt or allow any additional lien to be placed on the Collateral without the written consent of the Lender.  Neither the Bank nor any other Subsidiary shall incur any debt or allow any lien to be placed on any asset, other than in the ordinary course of business, without the written consent of Lender.
 
4.12           Options, Warrants, Etc. Related to Shares .  Except as set forth in Exhibit F , there are no options, warrants or other rights agreements or commitments (including conversion rights and preemptive rights) obligating the Bank to issue, sell, purchase or redeem shares of the Bank or securities convertible to such shares.
 
4.13           Environmental Laws .
 
 (a)            The Borrower and each of its Subsidiaries have obtained all permits, licenses, and other authorizations which are required under all Environmental Laws and are in compliance in all respects with all applicable Environmental Laws.
 
 (b)            On or prior to the date hereof, no notice, demand, request for information, citation, summons, or order has been issued, no complaint has been filed, no penalty has been assessed, and no investigation or review is pending or, to the best of the knowledge of the Borrower, threatened by any governmental or other Person with respect to any alleged or suspected failure by the Borrower or any of its Subsidiaries to comply in any material respect with any Environmental Laws.
 
 (c)            There are no material Liens arising under or pursuant to any Environmental Laws on any of the property owned or leased by the Borrower or any of its Subsidiaries.
 
 (d)            There are no conditions existing currently or anticipated to exist during the term of this Agreement which would subject the Borrower or any of its Subsidiaries or any of their property to any material Lien, damages, penalties, injunctive relief, or cleanup costs under any Environmental Laws or which require or are likely to require cleanup, removal, remedial action, or other responses by the Borrower and its Subsidiaries pursuant to Environmental Laws.
 
4.14           Disclosure .  The Borrower has disclosed to the Lender (i) all agreements, instruments and corporate or other restrictions to which it, Bank or any of the other Subsidiaries is subject, the termination of which could reasonably be expected to result in a material and adverse change in the financial condition, business operation, or properties or assets of the Borrower, the Bank  or any of the other Subsidiaries and (ii) all matters known to it that, individually or in the aggregate, could reasonably be expected to result in a material and adverse change in the financial condition, business operation, or properties or assets of the Borrower, the Bank or any of the other Subsidiaries.  No report, financial statement, certificate or other information furnished (whether in writing or orally) by or on behalf of the Borrower to Lender in connection with the transactions contemplated hereby and the negotiation of this Agreement or delivered hereunder or under any other Loan Document (in each case as modified or supplemented by other information so furnished) contains any material misstatement of fact or omits to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided that, with respect to projected financial information, the Borrower represents only that such information was prepared in good faith based upon assumptions believed to be reasonable at the time.
 
 
 

 

5.             AFFIRMATIVE COVENANTS .
 
Borrower and the Bank covenant and agree that, until the Note together with interest thereon is paid in full, unless specifically waived by the Lender in writing, Borrower and the Bank will, or will cause the Subsidiaries to:

5.1             Business and Existence; Compliance with Laws .  Perform all things necessary to preserve and keep in full force and effect the existence, rights and franchises of Borrower, the Bank and the other Subsidiaries and to comply with and cause the Bank and the other Subsidiaries to comply with all laws and regulations applicable to Borrower, the Bank, and each other Subsidiary, including, but not limited to, laws, rules and regulations of state and federal authorities applicable to banks and bank holding companies.
 
5.2             Maintain Property .  Maintain, preserve, and protect all properties used or useful in the conduct of Borrower’s, the Bank’s, and each other Subsidiary’s business and keep the same in good repair, working order and condition.
 
5.3             Insurance .  At all times keep the insurable properties of Borrower, the Bank, and each other Subsidiary adequately insured and maintain in force (i) insurance, to such an extent and against such risks, including fire and theft, as is customary with companies in the same or similar business, (ii) necessary workmen’s compensation insurance, fidelity bonds and directors’ and officers’ insurance coverage in amounts satisfactory to Lender, and (iii) such other insurance as may be required by law; and if required by Lender, deliver to the Lender a copy of the bonds and policies providing such coverage and a certificate of Borrower’s, the Bank’s, or each other Subsidiary’s chief executive officer, as the case may be, setting forth the nature of the risks covered by such insurance, the amount carried with respect to each risk, and the name of the insurer.
 
5.4             Taxes and Liens .  Pay and discharge promptly all taxes, assessments, and governmental charges or levies imposed upon Borrower, the Bank, or each other Subsidiary or upon any of their respective income and profits, or their properties, real, personal or mixed, or any part thereof, before the same shall become delinquent; provided, however, that Borrower, the Bank, and each other Subsidiary shall not be required to pay and discharge or to cause to be paid and discharged any such tax, assessment, charge, levy or claim so long as the amount or validity thereof shall be contested in good faith by appropriate proceedings and provided that procedures satisfactory to Lender are carried out to prevent foreclosure of any lien therefrom.
 
5.5             Financial Reports and ERISA .
 
 (a)            Furnish to Lender as soon as available and in any event within one hundred and twenty (120) days after the end of each calendar year, (1) consolidated and consolidating balance sheets of Borrower, the Bank, and each other Subsidiary, as of the end of such year and consolidated and consolidating statements of income of Borrower, the Bank, and each other Subsidiary for the year then ended, together with the audit report and opinion of independent Certified Public Accountants acceptable to the Lender with respect thereto, such audit report and opinion shall contain no exceptions or qualifications unacceptable to Lender; (2) promptly upon receipt, copies of all management letters and other assessments and recommendations, formal or informal, submitted by the Certified Public Accountants to Borrower or each Subsidiary; (3) a copy of Borrower’s TFR Schedule HC financial statement(s) and (4) a copy of Borrower’s Annual Report promptly upon the filing of the same with the Office of Thrift Supervision; and (5) a copy of the Bank’s Thrift Financial Report promptly upon the filing with the appropriate regulatory agency.
 
 
 

 

 (b)            Upon senior management of the Borrower obtaining knowledge thereof, the Borrower will give written notice to the Lender promptly (and in any event within five (5) business days), of:  (1) any event or condition, including, but not limited to, any Reportable Event, that constitutes, or might reasonably lead to, an ERISA Event; (2) with respect to any Multiemployer Plan, the receipt of notice as prescribed in ERISA or otherwise of any withdrawal liability assessed against the Borrower or any of its ERISA Affiliates, or of a determination that any Multiemployer Plan is in reorganization or insolvent (both within the mean of Title IV of ERISA); (3) the failure to make full payment on or before the due date (including extensions) thereof of all amounts which the Borrower, the Bank, or any other Subsidiary or any ERISA Affiliate is required to contribute to each Plan pursuant to its terms and as required to meet the minimum funding standard set forth in ERISA and the Code with respect thereto; or (4) any change in the funding status of any Plan that could have a material adverse effect, together with a description of any such event or condition or a copy of any such notice and a statement by the chief financial officer of the Borrower briefly setting forth the details regarding such event, condition, or notice, and the action, if any, which has been or is being taken or is proposed to be taken by the Borrower with respect thereto.  Promptly upon request, the Borrower shall furnish the Lender and the Lenders with such additional information concerning any Plan as may be reasonably requested, including, but not limited to, copies of each annual report/return (Form 5500 series), as well as all schedules and attachments thereto required to be filed with the Department of Labor and/or the Internal Revenue Service pursuant to ERISA and the Code, respectively, for each “plan year” (within the meaning of Section 3(39) of ERISA).
 
 (c)            Promptly upon the transmission thereof, copies of all material financial statements, proxy statements, notices, reports and other communications sent by the Borrower or any other Subsidiary to the shareholders of the Borrower and any other such communications as may be requested by Lender and copies of any and all regular or periodic reports, registration statements, prospectuses or other written communications that the Borrower or the Bank or any other Subsidiary is or may be required to file with the Securities and Exchange Commission or any governmental department, bureau, commission or agency succeeding to the functions of the Securities and Exchange Commission if any.
 
 (d)            With reasonable promptness, such other financial information for the Borrower or the Bank or any other Subsidiary as Lender may reasonably request.
 
5.6             Regulatory Examinations .  (a)  Promptly notify Lender of every examination by, or any material correspondence, report, memoranda or other written communication from or with, any federal or state regulatory body or authority, with respect to the properties, loans, operations and/or condition of Borrower, the Bank, or any other Subsidiary, and of the receipt by Borrower, the Bank, or any other Subsidiary of every examination or other report prepared by such body or authority with respect thereto; and (b) if required by Lender, fully and completely assist and cooperate with Lender in requesting approval by such regulatory body or authority of the furnishing to Lender of any such report, and furnish such report to Lender if such approval is given; provided, however, that Lender shall take such steps as may be necessary to assure that all such reports shall remain confidential and shall be used by Lender solely in connection with the administration of the Loan in accordance with the provisions of this Agreement.
 
5.7             Additional Information .  Furnish such other information regarding the operations, business affairs and financial condition of Borrower, the Bank, and each other Subsidiary as Lender may from time to time reasonably request, including but not limited to true and exact copies of any monthly management reports to their respective directors, their respective tax returns, and all information furnished to shareholders, or any governmental authority, including the results of any stock valuation performed.
 
 
 

 

5.8             Right of Inspection .  Except to the extent, if any, prohibited by applicable law, permit any person designated by Lender, to inspect any of the properties, books and financial and other reports and records of Borrower, the Bank, and each other Subsidiary, including, but not limited to, all documentation and records pertaining to the Bank’s loans, investments and deposits; and to discuss their affairs; finances and accounts with Borrower’s, the Bank’s, and each other Subsidiary’s principal officers, at all such reasonable times and as often as Lender may reasonable request; provided, however, prior to occurrence of an Event of Default, such inspections shall occur no more frequently than once per calendar quarter; provided, further, that Lender shall, and shall cause each person designated by Lender to conduct such inspections to, take such steps as may be reasonably necessary to assure that all such inspections, together with information resulting therefrom, shall remain confidential and shall be used by Lender and such persons solely in connection with the administration of the Loan in accordance with the provisions of this Agreement.  If required by Lender, Borrower will pay Lender loan fees in an amount determined by Lender to be necessary to cover the costs of such inspections, including a reasonable allowance for Lender’s overhead as well as out-of-pocket expenses in connection with such inspection.
 
5.9             Notice of Default .  At the time of Borrower’s first knowledge or notice, furnish the Lender with written notice or the occurrence of any event or the existence of any condition which constitutes or upon written notice or lapse of time or both would constitute an Event of Default under the terms of this Loan Agreement or other Loan Documents or an event of default or default under any other loan documents for any other loan to the Borrower, the Bank, or any other Subsidiary.
 
5.10           Notice of Litigation .  Borrower shall notify Lender of any actions, suits or proceedings instituted by any person against the Borrower, the Bank or other Subsidiary claiming money damages or other monetary liability in an amount of Five Hundred Thousand Dollars ($500,000) or more, said notice to be given within ten days of the first notice to Borrower or other party of the institution of such action, suit or proceeding and to specify the amount of damages being claimed or other relief being sought, the nature of the claim, the person instituting the action, suit or proceeding, and any other significant features of the claim.
 
5.11           Perfection of Security Interest .  The Borrower or other Subsidiary shall perform such acts as may be necessary, in the reasonable judgment of Lender, now or in the future, to perfect or continue perfection of the security interests granted to Lender, or otherwise provided for, under any and all Loan Documents.
 
5.12           Dividends to Borrower from the Bank .  Borrower shall cause the Bank and other Subsidiary to pay dividends or otherwise make such cash contributions at such times and in such amounts, as is necessary to enable Borrower to meet all of its obligations under the Loan Documents on a timely basis, including the payment, when due, of each installment of interest and the payment of principal on the Loan to the extent permitted by law including applicable bank regulatory agency rules and regulations. Without limiting the generality of the foregoing, should any prepayment, accelerated payment or other payment ever be due with respect to the Loan, Borrower shall cause the Bank and other Subsidiary to pay dividends or otherwise make such additional distributions to the Borrower as necessary to enable the Borrower to make such prepayment, accelerated payment or other payment, to the extent permitted by law including applicable bank regulatory agency rules and regulations.
 
5.13           Capital Ratio/Equity Capital Adequacy .
 
 (a)            Borrower and Bank shall maintain at all times a “Well Capitalized” rating as required by any applicable regulatory authority as such requirement may be revised from time to time.
 
 
 

 

 (b)            Bank shall maintain as of each Covenant Compliance Date a Tier 1 Leverage Ratio of not less than Eight and One Half Percent (8.50%).
 
 (c)            Bank shall maintain as of each Covenant Compliance Date a Risk-Based Capital Ratio of not less than Eleven and One Half Percent (11.50%).
 
5.14           Minimum Liquidity .  With respect to Borrower, maintain a minimum balance of cash in the amount of One Million Dollars ($1,000,000) at the end of each calendar quarter.
 
5.15          THIS SECTION LEFT INTENTIONALLY BLANK.
 
5.16          THIS SECTION LEFT INTENTIONALLY BLANK.
 
5.17           Non-Performing Asset Ratio .  The Non-Performing Asset Ratio of the Bank as of each Covenant Compliance Date shall not exceed Three and one-quarter percent (3.25%) of the Bank’s total assets as of December 31, 2009; Three percent (3.00%) of the Bank’s total assets as of March 31, 2010 and June 30, 2010; Two and three-quarter percent (2.75%) of the Bank’s total assets as of September 30, 2010 and December 31, 2010; Two and one-half percent (2.50%) of the Bank’s total assets as of March 31, 2011 and each calendar quarter thereafter.
 
5.18           Return on Average Assets .  Bank shall maintain an annualized return on Average Assets of at least forty one hundredths of one percent (0.40%) as reported quarterly on an annualized basis for the quarters ending through and including December 31, 2010 and at least fifty one hundredths of one percent (.50%) as reported quarterly on an annualized basis for periods ending after December 31, 2010.  For purposes of this covenant “total average assets” shall be deemed to mean the year-to-date average of total assets of Bank.
 
5.19           Loan Loss Reserves .  With respect to the Bank, maintain at all times loan loss reserves in amounts deemed adequate by all federal and state regulatory authorities.
 
5.20           Compliance Certificate .  Furnish Lender a Certificate of Compliance duly certified by the Chief Executive Officer, Chief Financial Officer or Chief Operating Officer of Borrower within forty-five (45) days after the end of each calendar quarter stating that Borrower and each Bank Subsidiary and the Borrower and all Subsidiaries, as applicable, are in compliance with all terms, covenants and conditions of this Loan Agreement and all related Loan Documents, including, but not limited to, Sections 5.1 – 5.19 of this Agreement.  Such Certificate of Compliance shall be as set forth in Exhibit H and otherwise be in form and substance satisfactory to Lender.
 
6.             NEGATIVE COVENANTS .
 
Borrower covenants and agrees with Lender that Borrower shall comply and cause the Bank and other Subsidiaries to comply with the following negative covenants unless the prior written consent of Lender shall be obtained, so long as Borrower may borrow under this Agreement or so long as any indebtedness remains outstanding under the Loan Documents, and, in addition, the Bank covenants and agrees to comply with the following as and to the extent such provisions apply to the Bank:

6.1             Indebtedness .  Neither Borrower nor the Bank shall create, incur, assume or suffer to exist, contingently or otherwise, any indebtedness, except for the following indebtedness:
 
 (a)            The indebtedness of Borrower under the Loan;
 
 
 

 

 (b)            Indebtedness owed by the Borrower to the Bank or any other Subsidiary;
 
 (c)            Debt for operating expenses or otherwise incurred by the Bank or any other Subsidiary in the ordinary course of business;
 
 (d)            Indebtedness as set forth in Exhibit G ;
 
 (e)            Obligations (contingent or otherwise) existing or arising under any Swap Contract approved in advance by Lender; and
 
 (f)            Additional indebtedness not to exceed One Million Dollars ($1,000,000) in the aggregate.
 
6.2             Merger, Dissolution, Acquisition of Assets .  Borrower shall not enter into, or permit the Bank or any other Subsidiary to enter into, any transaction of merger or consolidation, or any reorganization, reclassification of stock, readjustment or change in capital structure; or acquire, or permit any Subsidiary to acquire, all of the stock, or other ownership interest, property or assets of any other person, corporation, partnership or other entity.
 
6.3             Subsidiaries .  Borrower shall not create, establish or acquire Subsidiaries or acquire or own stock or any other interest in any bank other than the Bank, or permit the creation, establishment or acquisition of any such Subsidiaries by any other Subsidiary.
 
6.4             Sale of Stock, Merger, or Asset Disposition .
 
 (a)            Borrower shall not sell, transfer, pledge, assign, or otherwise dispose of, or otherwise encumber, any of the Borrower’s stock of the Bank or the Borrower’s or the Bank’s or any other Subsidiary’s common Capital Stock in any the Subsidiary nor permit the Bank or any other Subsidiary to issue additional shares of stock or rights, options or securities convertible into Capital Stock of the Bank or any other Subsidiary.
 
 (b)            The Borrower will not, nor will it permit any of its Subsidiaries to, make any Asset Disposition except in the ordinary course of business.
 
6.5             Dividends, Redemptions and Other Payments .  Borrower shall not declare or pay any dividends on the stock of Borrower or redeem any stock of Borrower if an Event of Default has occurred and is continuing under this Agreement or allow the payment of such a dividend that would create an Event of Default. The payment of any dividend or the redemption of any stock not otherwise prohibited shall in all respects comply with the rules and regulations of the Federal Reserve Board.
 
6.6             Capital Expenditures .  Borrower shall not make or become committed to make, or permit any Subsidiary to make or to become committed to make, directly or indirectly, during any calendar year, capital expenditures which for Borrower and the Subsidiary exceed amounts deemed acceptable to applicable regulatory authorities.
 
6.7             Relocation .  The Borrower shall not cause or permit Borrower or any Subsidiary to relocate their principal office, principal banking office, principal registered office or approved charter location without the written consent of Lender.
 
 
 

 

6.8             Transactions with Affiliates .  The Borrower shall not, nor will it permit any of its Subsidiaries to, enter into or permit to exist any transaction or series of transactions with any officer, director, shareholder, Subsidiary or Affiliate of such person or entity other than (a) normal compensation and reimbursement of expenses of officers and directors and (b) except as otherwise specifically limited in this Agreement, other transactions which satisfy the applicable requirements under Section 23A of the Federal Reserve Act, 12 USC §371c and Section 23B of the Federal Reserve Act, 12 USC §371c-1.  For purposes of this Agreement, the term affiliates shall have the same meaning as set forth in applicable bank regulations.
 
6.9             Charter or By-Law Amendments .  Neither Borrower, Bank nor any other Subsidiary shall adopt, amend or enter into, as applicable, any charter, articles of incorporation, bylaws (or any amendments thereto) or other provisions or agreements that would affect in any way the rights, obligations and/or preferences of the Collateral.
 
6.10           No Defaults .  Borrower shall not permit or suffer the occurrence of any event nor allow any Subsidiary or other Affiliate to knowingly permit or suffer the occurrence of any event which constitutes an event of default under any indenture or loan agreement or otherwise with respect to any indebtedness of the Borrower, the Bank, or any other Subsidiary.
 
7.             DEFAULT AND REMEDIES .
 
7.1             Events of Default .  Any one or more of the following events shall constitute an Event of Default under the terms of this Agreement and the other Loan Documents:
 
 (a)            Default in the payment when due and payable any payment of the principal or interest on the Note or any other fees or payments due under the Note, this Agreement or other Loan Documents.
 
 (b)            Default in compliance with or in the performance or observance of any term, covenant, obligation, condition, or agreement in this Agreement or any other Loan Document.
 
 (c)            If any representation, warranty or any other statement made or deemed to be made by the Borrower herein, in any other Loan Document, or in any writing, certificate, or report or statement at any time furnished to Lender pursuant to or in connection with this Agreement shall to be false or misleading in any material respect, either now or at the time made or furnished or becomes false or misleading at any time thereafter.
 
 (d)            Borrower, the Bank or any other Subsidiary shall fail to pay when due and before the expiration of any grace period, any debt for borrowed money which it is primarily obligated to pay as borrower, or in any other capacity, whether such debt shall have become due because of acceleration of maturity or otherwise, other than debt created by this Agreement.
 
 (e)            An event occurs which constitutes an event of default as defined in the Note or any other Loan Document; or an event occurs which constitutes an event of default (following the expiration of applicable grace, notice or cure periods) under any present or future loan agreement between Lender and Borrower for any other loan.
 
 (f)            The Borrower, the Bank, or any other Subsidiary shall
 
 
 

 

 
  (i)
be unable or admits in writing its inability to pay its debts as they become due; or
 
 
  (ii)
file a petition in bankruptcy or for reorganization or for the adoption of an arrangement under the Bankruptcy Act as now or in the future amended, or file a pleading asking such relief, or have or suffer to be filed an involuntary petition in bankruptcy against it which is not contested and discharged within sixty (60) days; or
 
 
  (iii)
make an assignment for the benefit of creditors generally; or
 
 
  (iv)
consent to the appointment of a trustee, custodian, or receiver for all or a major portion of its property; or
 
 
  (v)
be adjudicated a bankrupt or insolvent under any federal or state law; or
 
 
  (vi)
suffer the entry of a court order under any federal or state law appointing a receiver, custodian, or trustee for all or a major part of its property or ordering the winding up or liquidation of its affairs, or approving a petition filed against it under the Bankruptcy Act, as now or in the future amended; or
 
 
  (vii)
suffer the entry of a final judgment for the payment of money in excess of $500,000 and the same shall not be discharged or provision made for its discharge within 45 days from the date of entry thereof or an appeal or other appropriate proceeding for review thereof shall not be taken within said period and a stay of execution pending such appeal shall not be obtained; or
 
 
  (viii)
suffer a writ or warrant of attachment or any similar process to be issued by any court against all or any substantial portion of its property.
 
 (g)            The issuance of any letter agreement, memorandum of understanding, cease and desist order, injunction, directive, or restraining order or notice of changes under 12 USC §1818 against the Borrower, the Bank or other Subsidiaries or the Borrower’s, the Bank’s or the other Subsidiaries’ directors, whether temporary or permanent, by or at the request of any bank regulatory agency; or
 
 (h)            The failure of the Borrower, the Bank, or any other Subsidiary, or the Borrower’s, the Bank’s, or any other Subsidiary’s directors to comply with the terms of any memorandum of understanding or letter agreement with any bank regulatory agency, including but not limited to any applicable state bank regulatory agency, Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Board of Governors of the Federal Reserve System and such failure has not been fully corrected within thirty (30) business days of the Borrower’s or the Bank’s awareness of its failure to comply.
 
7.2             Cure Provisions .  In any Event of Default, other than a default in payment, is curable and if Borrower has not been given a notice of a breach in the same provision of the Note within the preceding twelve (12) months, it may be cured if Borrower, after receiving written notice from Lender demanding cure of such default:  (1) cures the default within fifteen (15) days; or (2) if the cure requires more than fifteen (15) days, immediately initiates steps which Lender deems in Lender’s sole discretion to be sufficient to cure the default and thereafter continues and completes all reasonable and necessary steps sufficient to product compliance as soon as reasonably practical.
 
 
 

 

7.3             Remedies on Default .  Upon the occurrence of an Event of Default, Lender may (i) terminate all obligations of Lender to Borrower, the Bank, or any other Subsidiary including, without limitation, all obligations to lend money to Borrower under this Agreement, (ii) declare the Note immediately due and payable, without presentment, demand, protest, notice of intent to accelerate and notice of acceleration of the maturity date of this Note, or any other notice of any kind, all of which are expressly waived, (iii) declare immediately due and payable from Borrower the expenses set forth in Section 8.14 hereof, and (iv) pursue any remedy available to it under this Agreement, the Note, the Pledge Agreement or any other Loan Document, or available at law or in equity, concurrently or subsequently, in such order as the Lender may elect, all of which remedies shall be cumulative.
 
7.4             Liens; Setoff by Lender .  Borrower and the Bank hereby grants to Lender a continuing lien for all indebtedness of Borrower, the Bank, or the other Subsidiaries to Lender upon any and all of its monies, securities and other property and the proceeds thereof, now or hereafter held or received by or in transit to Lender from or for Borrower, the Bank, or the other Subsidiaries, and also upon any and all deposits (general or special, matured or unmatured) and credits of Borrower, the Bank, or the other Subsidiaries against Lender at any time existing. Upon the occurrence of any Event of Default as specified above, Lender is hereby authorized at any time and from time to time, without notice to Borrower, the Bank, or the other Subsidiaries, to set off, appropriate, and apply any and all items hereinabove referred to against any or all indebtedness of Borrower, the Bank, or the other Subsidiaries to Lender, whether under this Agreement, or otherwise, whether now existing or hereafter arising.  Lender shall give written notice to Borrower of such setoff appropriation or application after such setoff, appropriation or application occurs.
 
8.             MISCELLANEOUS .
 
8.1             No Waiver .  No delay or failure on the part of Lender or on the part of any holder of the Note in the exercise of any right, power or privilege granted under this Agreement, or under any other Loan Document, or available at law or in equity, shall impair any such right, power or privilege or be construed as a waiver of any Event of Default or any acquiescence therein. No single or partial exercise of any such right, power or privilege shall preclude the further exercise of such right, power or privilege. No waiver shall be valid against Lender unless made in writing and signed by Lender, and then only to the extent expressly specified therein.
 
8.2             Notices .  All notices and communications provided for hereunder shall be in writing, delivered by hand or sent by first-class, registered or certified mail, postage prepaid, or express courier to the following addresses:
 
 
(1)
If to Lender:
First Tennessee Bank National Association
     
845 Crossover Lane, Suite 150
     
Memphis, Tennessee  38117
     
Attention:  Financial Institutions Division
       
 
(2)
If to Borrower:
MutualFirst Financial Inc.
     
110 E. Charles Street
     
Muncie, Indiana  47305
     
Attention:  Tim McArdle
 
 
 

 

Any party hereto may change its address for notice purposes by notice to the other parties in the manner provided herein. Notice shall be deemed given when hand delivered or first class, certified or registered mail, postage prepaid, or when delivered by express courier.

8.3             Governing Law .  This Agreement and all other Loan Documents shall be governed by and interpreted in accordance with the laws of the State of Tennessee except with respect to interest which shall be governed by and construed in accordance with applicable Federal laws in effect from time to time.
 
8.4             Survival of Representations and Warranties .  All representations, warranties and covenants contained herein or made by or furnished on behalf of Borrower, the Bank, or the other Subsidiaries in connection herewith shall survive the execution and delivery of this Agreement and all other Loan Documents and the extension or funding of the loan hereunder.
 
8.5             Descriptive Headings .  The descriptive headings of the several sections of this Agreement are inserted for convenience only and do not constitute a part of this Agreement.
 
8.6             Severability .  If any part of any provision contained in this Agreement or in any other Loan Document shall be invalid or unenforceable under applicable law, said part shall be ineffective to the extent of such invalidity only, without in any way affecting the remaining parts of said provision or the remaining provisions.
 
8.7             Time is of the Essence .  Time is of the essence in interpreting and performing this Agreement and all other Loan Documents.
 
8.8             Counterparts .  This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which, taken together, shall constitute one and the same instrument.
 
8.9             Payment of Costs .  Borrower shall pay, promptly demand by Lender, all reasonable costs, expenses, taxes and fees incurred by Lender in connection with the preparation, execution and delivery of this Agreement and all other Loan Documents and the recording and filing and rerecording and refiling thereof, including, without limitation, the reasonable costs and professional fees of counsel for Lender, any and all transfer, mortgage or other taxes and all recording costs that may be payable.  In the future, Borrower shall pay promptly following written demand by the Lender, all such costs and expenses determined to be payable, in connection therewith.
 
8.10           Successors and Assigns .  This Agreement shall bind and inure to the benefit of Borrower and Lender, and their respective successors and assigns; provided, however, Borrower, the Bank, and the other Subsidiaries shall not have any right to assign their rights or obligations hereunder to any person.  Notwithstanding anything in this Agreement to the contrary, Lender shall have the right, but shall not be obligated, to sell participation in the loan made pursuant hereto to other banks, financial institutions and investors.
 
8.11           Amendments; No Implied Waiver .  This Agreement may be amended or modified, and Borrower, the bank, and the other Subsidiaries may take any action herein prohibited, or omit to perform any act herein required to be performed by it, only if Borrower shall obtain the prior written consent of Lender to that specific amendment, modification, action or omission to act, and no course of dealing between Borrower, the Bank, or the other Subsidiaries and Lender shall operate as a waiver of any right, power or privilege granted to Lender under this Agreement or under any other Loan Document, or available to Lender at law or in equity.
 
 
 

 

8.12           Rights Cumulative .  All rights, powers and privileges granted hereunder shall be cumulative to and shall not be exclusive of any other rights, powers and privileges granted by any other Loan Document or available at law or in equity.
 
8.13           Indemnity .  Borrower, the Bank, and the other Subsidiaries agree to protect, indemnify and save harmless Lender, and all directors, officers, employees and agents of Lender, from and against any and all (i) claims, demands and causes of action of any nature whatsoever brought by any Person not a party to this Agreement and arising from or related or incident to this Agreement or any other Loan Document, including, without limitation, any liability under federal or state securities laws arising out of Lender’s disposition of all or part of the Collateral, (ii) costs and expenses incident to the defense of such claims, demands and causes of action, including, without limitation, reasonable attorneys’ fees, and (iii) liabilities, judgments, settlements, penalties and assessments arising from such claims, demands and causes of action; provided, however, that Borrower, the Bank, and the other Subsidiaries do not agree to indemnify Lender against Lender’s own willful misconduct. The indemnity contained in this section shall survive the termination of this Agreement.
 
8.14           Expenses .  Borrower agrees to promptly reimburse Lender for (i) all costs and expenses of collection of the Note, including reasonable attorneys’ fees, and (ii) all expenses incurred by Lender in acting on behalf of Borrower, the Bank or the other Subsidiaries in accordance with the terms of this Agreement or to maintain or preserve the value of the Collateral, or Lender’s interest therein pursuant to the Pledge Agreement, or any other Loan Document.  Such sums shall include interest at the maximum rate allowed by law accruing from the date Lender requests such reimbursement.
 
8.15           Usury .  It is the intent of the parties hereto not to violate any federal or state law, rule or regulation pertaining either to usury or to the contracting for or charging or collecting of interest, and Borrower, the Bank, and the other Subsidiaries, and Lender agree that, should any provision of this Agreement, or of the Note, or of any other Loan Document or any act performed hereunder or thereunder, violate any such law, rule or regulation, then the excess of interest contracted for or charged or collected over the maximum lawful rate of interest shall be applied to the outstanding principal indebtedness due to Lender by Borrower under this Agreement, and if the principal indebtedness has been paid in full, any remaining excess shall forthwith be paid to Borrower.
 
8.16           Jurisdiction and Venue .  Borrower, the Bank, and the other Subsidiaries, and Lender agree, without power of revocation, that any civil suit or action brought against them as a result of, or which relates to, any of their obligations under this Agreement or under any other Loan Document may be brought against them, jointly or singly, in the United States District Court for the Western District of Tennessee, Eastern Division, and Borrower, the Bank, the other Subsidiaries, and Lender irrevocably submit to the jurisdiction of such court and irrevocably waive, to the fullest extent permitted by law, any objections that they may now or hereafter have to the laying of the venue of such civil suit or action and any claim that such civil suit or action has been brought in an inconvenient forum, and Borrower, the Bank, and the other Subsidiaries, and Lender agree that final judgment in any such civil suit or action shall be conclusive and binding upon them and shall be enforceable against them by suit upon such judgment in any court of competent jurisdiction.  Not withstanding anything to the contrary in this Agreement or in related loan documents, the Jurisdiction and Venue indicated by this Agreement shall supersede all other references to Jurisdiction and/or Choice of Venue contained elsewhere in this Agreement, the Promissory Note, and other related loan documents.
 
8.17           Construction .  Should any provision of this Agreement require judicial interpretation, the parties hereto agree that the court interpreting or construing the same shall not apply a presumption that the terms hereof shall be more strictly construed against one party by reason of the rule of construction that a document is to be more strictly construed against the party who itself or through its agents prepared the same, it being agreed that Borrower, Lender and their respective agents have participated in the preparation hereof.
 
 
 

 

8.18           Holidays .  In any case where the date for any action required to be performed under this Agreement or under any other Loan Document shall be, in the city where the performance is to be made, a Saturday, a Sunday, a legal holiday or a day on which banking institutions are authorized by law to close, then such performance may be made on the next succeeding business day not a Saturday, a Sunday, a legal holiday or a day on which banking institutions are authorized by law to close.
 
8.19           Entire Agreement .  This Agreement and the other Loan Documents executed and delivered contemporaneously herewith, together with the exhibits attached hereto and thereto, constitute the entire understanding of the parties with respect to the subject matter hereof, and any other prior or contemporaneous agreements, whether written or oral, with respect thereto are expressly superseded hereby. The execution of this Agreement and the other Loan Documents by Borrower, the Bank, and the other Subsidiaries was not based upon any facts or materials provided by Lender, nor was Borrower, the Bank, and the other Subsidiaries induced to execute this Agreement or any other Loan Document by any representation, statement or analysis made by Lender. In the event that the provisions of this Loan Agreement shall conflict with provisions of any of the other Loan Documents, the provisions of this Agreement shall control.
 
 This written Loan Agreement represents the final agreement between the parties and may not be contradicted by evidence of prior, contemporaneous, or subsequent oral agreements of the parties.  There are no unwritten oral agreements between the parties.

8.20           Consent .  Borrower, the Bank, and the other Subsidiaries hereby represent and warrant that to the best of Borrower’s knowledge there is no consent from any lender or creditor needed to prevent Borrower, the Bank, or the other Subsidiaries from being in default by Borrower executing the Note or Borrower, the Bank, and the other Subsidiaries executing, this Loan Agreement or any other loan document associated with this Loan.
 
8.21           Waiver Of Right To Trial By Jury .  EACH PARTY TO THIS AGREEMENT HEREBY EXPRESSLY WAIVES ANY RIGHT TO TRIAL BY JURY OF ANY CLAIM, DEMAND, ACTION OR CAUSE OF ACTION (a) ARISING UNDER THIS AGREEMENT OR ANY OTHER INSTRUMENT, DOCUMENT OR AGREEMENT EXECUTED OR DELIVERED IN CONNECTION HEREWITH, OR (b) IN ANY WAY CONNECTED WITH OR RELATED OR INCIDENTAL TO THE DEALINGS OF THE PARTIES HERETO OR ANY OF THEM WITH RESPECT TO THIS AGREEMENT OR ANY OTHER INSTRUMENT, DOCUMENT OR AGREEMENT EXECUTED OR DELIVERED IN CONNECTION HEREWITH, OR THE TRANSACTIONS RELATED HERETO OR THERETO, IN EACH CASE WHETHER NOW EXISTING OR HEREAFTER ARISING; AND EACH PARTY HEREBY AGREES AND CONSENTS THAT ANY SUCH CLAIM, DEMAND, ACTION OR CAUSE OF ACTION SHALL BE DECIDED BY COURT TRIAL WITHOUT A JURY, AND THAT ANY PARTY TO THIS AGREEMENT MAY FILE AN ORIGINAL COUNTERPART OR A COPY OF THIS SECTION WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF THE PARTIES HERETO TO THE WAIVER OF THEIR RIGHT TO TRIAL BY JURY.
 
8.22           Further Assurances .  Borrower agrees to furnish a current financial statement upon the request of Lender from time to time, and further agrees to execute and deliver all other instruments and take such other actions as Lender may from time to time reasonably request in order to carry out the provisions and intent hereof.
 
 
 

 

8.23           Bank Joined As Party .  The undersigned Bank is joining this Agreement as a party hereto and hereby confirms the Bank’s obligations hereunder and the agreements, covenants, representations, and warranties of the Bank.  The Borrower and the Bank are executing this Agreement on behalf of the other Subsidiaries as to the other Subsidiary’s obligations hereunder and the agreements, covenants, representations, and warranties of the other Subsidiaries.
 
8.24           No Inference of Extension Past Maturity Date .  Notwithstanding any other provision herein, the terms, conditions, and requirements provided for herein that would, by their express terms, be applicable to time periods after the Maturity Date of the Note, are not to be interpreted as an inference that the Lender has agreed to any extension, automatic or otherwise, to the extension of the Maturity Date.  The Lender has not agreed and is under no obligation to extend the Maturity Date of the Note.
 
WITNESS the hand and seal of the parties hereto through their duly authorized officers as of the date first above written.

LENDER:
  
BORROWER:
             
FIRST TENNESSEE BANK NATIONAL 
ASSOCIATION
  
MUTUALFIRST FINANCIAL INC.
             
By:
    
By:
  
Printed Name:
    
Printed Name:
  
Title:
    
Title:
  
             
       
BANK:
  
             
       
MUTUALBANK
  
             
       
By:
  
       
Printed Name:
 
     
Title:
 
 
 
 

 
 
 
Exhibit 10.21
 
MUTUALFIRST FINANCIAL, INC.
2008 STOCK OPTION AND INCENTIVE PLAN
 
INCENTIVE STOCK OPTION AWARD AGREEMENT
 
.1           ISO No. _______________                                                            Grant Date: _______________

This Incentive Stock Option Award is granted by MutualFirst Financial, Inc. (the “Company”) to [Name] (the “Option Holder”) in accordance with the terms of this Incentive Stock Option Award Agreement (“Agreement”) and subject to the provisions of the MutualFirst Financial, Inc. 2008 Stock Option and Incentive Plan, as amended from time to time (“Plan”).  The Plan is incorporated herein by reference.

1.
ISO Award .  The Company grants to the Option Holder an Incentive Stock Option (the “ISO”) to purchase [ Number ]   Shares at an Exercise Price of $ [ Number ]   per Share.
 
2.
Vesting Dates :  The ISO shall vest as follows[, subject to earlier vesting as provided in Section[s] 6 [and 7] and] subject to forfeiture of the ISO as provided in Section 6:
 
 
ISO for
Vesting Date
Number of Shares Vesting

[Indicate vesting period]

3.
Exercise :        The Option Holder (or other person to whom the ISO has been validly transferred) may exercise the ISO during the Exercise Period by giving written notice to the Committee, care of the Secretary of the Company, in the form required by the Committee (“Exercise Notice”).  The Exercise Notice must specify the number of Shares to be purchased.  The exercise date is the date the Exercise Notice is received by the Company.  The Exercise Period commences on the Vesting Date and expires at 5:00 p.m., Muncie, Indiana time, on the date ten years [five years for over 10% owners of Company on the Grant Date] after the Grant Date, subject to earlier expiration in the event of a termination of Service as provided in Section 6.  Any portion of the ISO not exercised as of the close of business on the last day of the Exercise Period shall be cancelled without consideration at that time.
 
The Exercise Notice shall be accompanied by payment in full of the Exercise Price for the Shares being purchased.  Payment shall be made: (a) in cash, which may be in the form of a check, money order, cashier’s check or certified check, payable to the Company, or (b) by delivering Shares of the Company already owned by the Option Holder having a Fair Market Value on the exercise date equal to the aggregate Exercise Price to be paid, or (c) a combination of cash and such Shares.  Payment also may be made by delivering a properly executed Exercise Notice to the Company, together with a copy of irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds to pay the purchase price and applicable tax withholding amounts (if any), in which event the Shares acquired shall be delivered to the broker promptly following receipt of payment.
 
4.
Related Awards : The ISO [is not related to any other Award under the Plan.] or [is related to a stock appreciation right granted on the Grant Date and designated SAR No. ___ .   The related stock appreciation right does not receive the special tax treatment afforded the ISO.  To the extent any portion of the related stock appreciation right is exercised, the ISO shall terminate with respect to the same number of Shares.]
 
 
 

 
 
5.
Transferability .  The Option Holder may not sell, assign, transfer, pledge or otherwise encumber any portion of the ISO, except: (i) in the event of the Option Holder’s death, by will or by the laws of descent and distribution or pursuant to the Option Holder’s prior designation of a Beneficiary in accordance with the Plan to receive any portion of the ISO that may be exercised after the Option Holder’s death; or (ii) pursuant to a Qualified Domestic Relations Order.
 
6.
Termination   of Service .  If the Option Holder terminates Service for any reason other than on account of the death or Disability of the Option Holder, any portion of the ISO that has not vested as of the date of that termination shall be forfeited to the Company, and the Exercise Period shall expire three months after that termination of Service, except in the case of a Termination for Cause, when it shall expire immediately.  If the Option Holder’s Service terminates on account of the Option Holder’s death or Disability[, the Vesting Date for all portions of the ISO that have not vested or been forfeited shall be accelerated to the date of that termination of Service, and] the Exercise Period shall expire on the earlier of one year after that termination of Service and the date ten years after the Grant Date [five years for over 10% owners of Company on the Grant Date] .
 
7.
[Effect of Change in Control .  Upon a Change in Control, the Vesting Date for any portion of the ISO that has not vested or been forfeited shall be accelerated to the date of the earliest event constituting a Change in Control.]
 
8.
Option Holder’s Rights .  The ISO awarded hereby does not entitle the Option Holder to any rights of a stockholder of the Company.
 
9.
Delivery of Shares to Option Holder .  Promptly after receipt of an Exercise Notice and full payment of the Exercise Price for the Shares being acquired, the Company shall take such action as is necessary to cause the issuance of a stock certificate for such Shares or the issuance of such Shares in uncertificated form to the Option Holder (or other person validly exercising the ISO), registered in the name of the Option Holder (or such other person), or, upon request, in the name of the Option Holder (or such other person) and in the name of another person in such form of joint ownership as requested by the Option Holder (or such other person) pursuant to applicable state law.  The Company’s obligation to deliver Shares purchased upon the exercise of the ISO may be conditioned upon the receipt of a representation of investment intent from the Option Holder (or other person validly exercising the ISO) in such form as the Committee requires.  The Company shall not be required to deliver any Shares purchased prior to: (a) the listing of those Shares on the NASDAQ Stock Market or such other stock exchange or automated quotation system on which Shares may then be listed or quoted; or (b) the completion of any registration or qualification of those Shares required under applicable law.
 
10.
Notice of Sale of Shares .  The Option Holder (or other person who received Shares from the exercise of the ISO) shall give written notice to the Company promptly in the event of the sale or other disposition of Shares received from the exercise of the ISO within either: (a) two years from the Grant Date; or (b) one year from the exercise date.
 
11.
Adjustments in Shares .  In the event of any recapitalization, forward or reverse stock split, reorganization, merger, consolidation, spin-off, combination, exchange of Shares or other securities, stock dividend, special or recurring dividend or distribution (whether in the form of cash, securities or other property), liquidation, dissolution or other similar corporate transaction or event, the Committee shall, in such manner as it may deem equitable in order to prevent dilution or enlargement of rights, adjust the number of Shares or class of securities of the Company covered by the ISO and/or the Exercise Price of the ISO.  The Option Holder agrees to execute any documents required by the Committee in connection with an adjustment under this Section 11.
 
12.
Tax Withholding .  The Company shall have the right to require the Option Holder to pay to the Company the amount of any tax that the Company is required to withhold with respect to the Shares acquired upon exercise of the ISO, or in lieu thereof, to retain or sell without notice, a sufficient number of Shares to cover the minimum amount required to be withheld.
 
13.
Plan and Committee Decisions are Controlling .  This Agreement, the award of the ISO to the Option Holder and the issuance of Shares upon the exercise of the ISO are subject in all respects to the provisions of the Plan, which are controlling.  Capitalized terms herein not defined in this Agreement shall have the meaning ascribed to them in the Plan.  All decisions, determinations and interpretations by Committee respecting the Plan, this Agreement, the award of the ISO or the issuance of Shares upon the exercise of the ISO shall be binding and conclusive upon the Option Holder, any Beneficiary of the Option Holder or the legal representative thereof or any other person to whom the ISO is transferred as permitted hereby.
 
 
 

 
 
14.
Option Holder’s Service .  Nothing in this Agreement shall limit the right of the Company or any of its Affiliates to terminate the Option Holder’s service or employment as a director, advisory director, officer or employee, or otherwise impose upon the Company or any of its Affiliates any obligation to employ or accept the services or employment of the Option Holder.
 
15.
Amendment .  The Committee may waive any conditions of or rights of the Company or modify or amend the terms of this Agreement; provided, however, that the Committee may not amend, alter, suspend, discontinue or terminate any provision of this Agreement if such action may adversely affect the Option Holder without the Option Holder’s written consent.  [To the extent permitted by applicable laws and regulations, the Committee shall have the authority, in its sole discretion, to accelerate the vesting of the ISO or remove any other restrictions imposed on the Option Holder with respect to the ISO or the Shares that may be purchased thereunder, whenever the Committee may determine that such action is appropriate by reason of any unusual or nonrecurring events affecting the Company, any Affiliate or their financial statements or any changes in applicable laws, regulations or accounting principles.]
 
16.
Loss of ISO Status .  If any portion of the ISO shall fail, for any reason, to qualify for the special tax treatment afforded the ISO, it shall be treated as a Non-Qualified Stock Option under the Plan.  The Option Holder acknowledges that the ISO will lose this special tax treatment if and to the extent that: (a) the Shares acquired upon the exercise of the ISO are sold or disposed of within one of the time periods described in Section 10; or (b) the ISO is transferred pursuant to a Qualified Domestic Relations Order, as permitted under Section 5.
 
17.
Option Holder Acceptance .  The Option Holder shall signify acceptance of the terms and conditions of this Agreement and acknowledge receipt of a copy of the Plan by signing in the space provided below and returning the signed copy to the Company.
 
 
 

 
 
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written.
 
 
MUTUALFIRST FINANCIAL, INC.
 
     
 
By
   
 
Its
   
     
 
ACCEPTED BY OPTION HOLDER
 
     
     
 
(Signature)
 
     
     
 
(Print Name)
 
     
     
 
(Street Address)
 
     
     
 
(City, State & Zip Code)
 

Beneficiary Designation:

The Option Holder designates the following Beneficiary to have the right to exercise the ISO following the Option Holder’s death:

________________________________________________________________________
 
 
 

 

Exhibit 10.22
 
MUTUALFIRST FINANCIAL, INC.
2008 STOCK OPTION AND INCENTIVE PLAN
 
.2 
NON-QUALIFIED STOCK OPTION AWARD AGREEMENT
 
.1           NQSO No. _______________                                                            Grant Date: _______________

This Non-Qualified Stock Option Award is granted by MutualFirst Financial, Inc. (the “Company”) to [Name] (the “Option Holder”) in accordance with the terms of this Non-Qualified Stock Option Award Agreement (“Agreement”) and subject to the provisions of the MutualFirst Financial, Inc. 2008 Stock Option and Incentive Plan, as amended from time to time (“Plan”).  The Plan is incorporated herein by reference.

18.
NQSO Award .  The Company grants to the Option Holder a Non-Qualified Stock Option (the “NQSO”) to purchase [ Number ]   Shares at an Exercise Price of $ [ Number ]   per Share.
 
19.
Vesting Dates :  The NQSO shall vest as follows[, subject to earlier vesting as provided in Section[s] 6 [and 7] and] subject to forfeiture of the NQSO as provided in Section 6:
 
 
NQSO for
Vesting Date
Number of Shares Vesting

[Indicate vesting period]

20.
Exercise :          The Option Holder (or other person to whom the NQSO has been validly transferred) may exercise the NQSO during the Exercise Period by giving written notice to the Committee, care of the Secretary of the Company, in the form required by the Committee (“Exercise Notice”).  The Exercise Notice must specify the number of Shares to be purchased.  The exercise date is the date the Exercise Notice is received by the Company.  The Exercise Period commences on the Vesting Date and expires at 5:00 p.m., Muncie, Indiana time, on the date ten years after the Grant Date, subject to earlier expiration in the event of a termination of Service as provided in Section 6.  Any portion of the NQSO not exercised as of the close of business on the last day of the Exercise Period shall be cancelled without consideration at that time.
 
The Exercise Notice shall be accompanied by payment in full of the Exercise Price for the Shares being purchased.  Payment shall be made: (a) in cash, which may be in the form of a check, money order, cashier’s check or certified check, payable to the Company, or (b) by delivering Shares of the Company already owned by the Option Holder having a Fair Market Value on the exercise date equal to the aggregate Exercise Price to be paid, or (c) a combination of cash and such Shares.  Payment also may be made by delivering a properly executed Exercise Notice to the Company, together with a copy of irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds to pay the purchase price and applicable tax withholding amounts (if any), in which event the Shares acquired shall be delivered to the broker promptly following receipt of payment.
 
21.
Related Awards The NQSO [is not related to any other Award under the Plan.] or [is related to a stock appreciation right granted on the Grant Date and designated SAR No. ___ .   To the extent any portion of the related stock appreciation right is exercised, the NQSO shall terminate with respect to the same number of Shares.]
 
 
 

 
 
22.
Transferability .  The Option Holder may not sell, assign, transfer, pledge or otherwise encumber any portion of the NQSO, except: (i) in the event of the Option Holder’s death, by will or by the laws of descent and distribution or pursuant to the Option Holder’s prior designation of a Beneficiary in accordance with the Plan to receive any portion of the NQSO that may be exercised after the Option Holder’s death; or (ii) pursuant to a Qualified Domestic Relations Order.  In addition, the Committee, in its sole and absolute discretion, may allow the Option Holder to transfer all or any portion of the NQSO which is then unexercised to a Family Member of the Option Holder, as provided in the Plan.
 
23.
Termination   of Service .  If the Option Holder terminates Service for any reason other than on account of the death or Disability of the Option Holder, any portion of the NQSO that has not vested as of the date of that termination shall be forfeited to the Company, and the Exercise Period shall expire [three months] after that termination of Service, except in the case of a Termination for Cause, when it shall expire immediately.  If the Option Holder’s Service terminates on account of the Option Holder’s death or Disability[, the Vesting Date for all portions of the NQSO that have not vested or been forfeited shall be accelerated to the date of that termination of Service, and] the Exercise Period shall expire on the earlier of [one year] after that termination of Service and the date ten years after the Grant Date.
 
24.
[Effect of Change in Control .  Upon a Change in Control, the Vesting Date for any portion of the NQSO that has not vested or been forfeited shall be accelerated to the date of the earliest event constituting a Change in Control.]
 
25.
Option Holder’s Rights .  The NQSO awarded hereby does not entitle the Option Holder to any rights of a stockholder of the Company.
 
26.
Delivery of Shares to Option Holder .  Promptly after receipt of an Exercise Notice and full payment of the Exercise Price for the Shares being acquired, the Company shall take such action as is necessary to cause the issuance of a stock certificate for such Shares or the issuance of such Shares in uncertificated form to the Option Holder (or other person validly exercising the NQSO), registered in the name of the Option Holder (or such other person), or, upon request, in the name of the Option Holder (or such other person) and in the name of another person in such form of joint ownership as requested by the Option Holder (or such other person) pursuant to applicable state law.  The Company’s obligation to deliver Shares purchased upon the exercise of the NQSO may be conditioned upon the receipt of a representation of investment intent from the Option Holder (or other person validly exercising the NQSO) in such form as the Committee requires.  The Company shall not be required to deliver any Shares purchased prior to: (a) the listing of those Shares on the NASDAQ Stock Market or such other stock exchange or automated quotation system on which Shares may then be listed or quoted; or (b) the completion of any registration or qualification of those Shares required under applicable law.
 
27.
Adjustments in Shares .  In the event of any recapitalization, forward or reverse stock split, reorganization, merger, consolidation, spin-off, combination, exchange of Shares or other securities, stock dividend, special or recurring dividend or distribution (whether in the form of cash, securities or other property), liquidation, dissolution or other similar corporate transaction or event, the Committee shall, in such manner as it may deem equitable in order to prevent dilution or enlargement of rights, adjust the number of Shares or class of securities of the Company covered by the NQSO and/or the Exercise Price of the NQSO.  The Option Holder agrees to execute any documents required by the Committee in connection with an adjustment under this Section 10.
 
28.
Tax Withholding .  The Company shall have the right to require the Option Holder to pay to the Company the amount of any tax that the Company is required to withhold with respect to the Shares acquired upon exercise of the NQSO, or in lieu thereof, to retain or sell without notice, a sufficient number of Shares to cover the minimum amount required to be withheld.
 
29.
Plan and Committee Decisions are Controlling .  This Agreement, the award of the NQSO to the Option Holder and the issuance of Shares upon the exercise of the NQSO are subject in all respects to the provisions of the Plan, which are controlling.  Capitalized terms herein not defined in this Agreement shall have the meaning ascribed to them in the Plan.  All decisions, determinations and interpretations by Committee respecting the Plan, this Agreement, the award of the NQSO or the issuance of Shares upon the exercise of the NQSO shall be binding and conclusive upon the Option Holder, any Beneficiary of the Option Holder or the legal representative thereof or any other person to whom the NQSO is transferred as permitted hereby.
 
 
 

 
 
30.
Option Holder’s Service .  Nothing in this Agreement shall limit the right of the Company or any of its Affiliates to terminate the Option Holder’s service or employment as a director, advisory director, officer or employee, or otherwise impose upon the Company or any of its Affiliates any obligation to employ or accept the services or employment of the Option Holder.
 
31.
Amendment .  The Committee may waive any conditions of or rights of the Company or modify or amend the terms of this Agreement; provided, however, that the Committee may not amend, alter, suspend, discontinue or terminate any provision of this Agreement if such action may adversely affect the Option Holder without the Option Holder’s written consent.  [To the extent permitted by applicable laws and regulations, the Committee shall have the authority, in its sole discretion, to accelerate the vesting of the NQSO or remove any other restrictions imposed on the Option Holder with respect to the NQSO or the Shares that may be purchased thereunder, whenever the Committee may determine that such action is appropriate by reason of any unusual or nonrecurring events affecting the Company, any Affiliate or their financial statements or any changes in applicable laws, regulations or accounting principles.]
 
32.
Option Holder Acceptance .  The Option Holder shall signify acceptance of the terms and conditions of this Agreement and acknowledge receipt of a copy of the Plan by signing in the space provided below and returning the signed copy to the Company.
 
 
 

 
 
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written.
 
 
MUTUALFIRST FINANCIAL, INC.
 
     
 
By
   
 
Its
   
     
 
ACCEPTED BY OPTION HOLDER
 
     
     
 
(Signature)
 
     
     
 
(Print Name)
 
     
     
 
(Street Address)
 
     
     
 
(City, State & Zip Code)
 

Beneficiary Designation:

The Option Holder designates the following Beneficiary to have the right to exercise the NQSO following the Option Holder’s death:

________________________________________________________________________

 
 

 

Exhibit 21

SUBSIDIARIES OF THE REGISTRANT

Parent
 
Subsidiary
 
Percentage
of
Ownership
 
State of
Incorporation
or
Organization
MutualFirst Financial, Inc.
 
MutualBank
    100 %
United States
   
MFBC Statutory Trust I
    100 %
Indiana
               
MutualBank
 
Mutual Federal Investment Co.
    100 %
Nevada
   
Mishawaka Financial Services, Inc.
    100 %
Indiana
               
Mutual Federal Investment Company
 
Mutual Federal REIT, Inc.
    100 %
Maryland
 
 
 

 
 
Exhibit 23
 
Consent of Independent Registered Public Accounting Firm
 
We consent to the incorporation by reference in the Registration Statements on Form S-3 (File No. 333-156881) and on Form S-8 (File Nos. 333-156882 and 333-53600) of our report dated March 18, 2010, on the consolidated financial statements of MutualFirst Financial, Inc. as of December 31, 2009 and 2008, and for the years ended December 31, 2009, 2008 and 2007, which report is included in MutualFirst Financial, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2009.
 
/s/ BKD ,   LLP
 
Indianapolis, Indiana
March 18, 2010

 
 

 

EXHIBIT 31.1
CERTIFICATIONS

I, David W. Heeter, certify that:

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

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

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

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

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

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

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

d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

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

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

Date:  March 18, 2010
By:
/s/  David W. Heeter
   
David W. Heeter
   
President and Chief Executive Officer
 
 
 

 

EXHIBIT 31.2
CERTIFICATIONS

I, Timothy J. McArdle, certify that:

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

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

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

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

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

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

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

d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

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

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

Date:  March 18, 2010
By: 
/s/  Timothy J. McArdle
   
Timothy J. McArdle
   
Treasurer and Chief Financial Officer
   
(Principal Financial and Accounting Officer)
 
 
 

 

EXHIBIT 32

SECTION 1350 CERTIFICATION

Each of the undersigned hereby certifies in his capacity as an officer of MutualFirst Financial, Inc. (the “Registrant”) that the Annual Report of the Registrant on Form 10-K for the period ended December 31, 2009 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained in such report fairly presents, in all material respects, the consolidated financial condition of the Registrant at the end of such period and the results of operations of the Registrant for such period.

Date:  March 18, 2010
By:
/s/  David W. Heeter
   
David W. Heeter
   
President and Chief Executive Officer
     
Date:  March 18, 2010
By:
/s/  Timothy J. McArdle
   
Timothy J. McArdle
   
Treasurer and Chief Financial Officer
 
 
 

 

Exhibit 99.1

MutualFirst Financial, Inc.

Certification of Principal Executive Officer Pursuant to 31 CFR § 30.15

I, David W. Heeter, the President and Chief Executive Officer of MutualFirst Financial, Inc. (the “Company”) certify, based on my knowledge, that:

(i)            The Company’s Compensation Committee has discussed, reviewed, and evaluated with senior risk officers at least once every six months during the period beginning on September 14, 2009 and ending with the last day of the Company’s fiscal year containing that date (the applicable period), the senior executive officer (SEO) compensation plans and employee compensation plans and the risks these plans pose to the Company;

(ii)           The Company’s Compensation Committee has identified and limited during the applicable period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company and during the same applicable period has identified any features of the employee compensation plans that pose risks to the Company and has limited those features to ensure that the Company is not unnecessarily exposed to risks;

(iii)          The Company’s Compensation Committee has reviewed at least every six months during the applicable period the terms of each employee compensation plan and identified any features of the plan that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee and has limited any such features;

(iv)          The Company’s Compensation Committee will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;

(v)           The Company’s Compensation Committee will provide a narrative description of how it limited during any part of the most recently completed fiscal year that included a TARP period, to the extent required by the regulations and guidance established under Section 111 of EESA, the features in:

(A)           SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company;

(B)           Employee compensation plans that unnecessarily expose the Company to risks; and

(C)           Employee compensation plans that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee;

(vi)          The Company has required that bonus payments, as defined in the regulations and guidance established under section 111 of EESA (bonus payments), of the SEOs and twenty next most highly compensated employees be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year that was a TARP period, to the extent required by the regulations and guidance established under section 111 of EESA, if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;

(vii)         The Company has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to an SEO or any of the next five most highly compensated employees during the period beginning on June 15, 2009, and ending with the last day of the Company’s fiscal year containing that date;
 
 
 

 
 
(viii)        The Company has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations and guidance established thereunder during the period beginning on June 15, 2009 and ending with the last day of the Company’s fiscal year containing that date;

(ix)           The board of directors of the Company has established an excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, by September 14, 2009, this policy has been provided to Treasury and the Company’s primary regulatory agency; the Company and its employees have complied with this policy during the applicable period; and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were properly approved;

(x)            The Company will permit a non-binding shareholder resolution in compliance with any applicable federal securities rules and regulations on the disclosures provided under the federal securities laws related to SEO compensation paid or accrued during the period beginning on June 15, 2009, and ending with the last day of the Company’s fiscal year containing that date;

(xi)           The Company will disclose the amount, nature, and justification for the offering during the period beginning on June 15, 2009, and ending with the last day of the Company’s fiscal year containing that date of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for each employee subject to the bonus payment limitations identified in paragraph (viii);

(xii)          The Company will disclose whether the Company, the board of directors of the Company, or the Company’s Compensation Committee has engaged a compensation consultant during any part of the most recently completed fiscal year that was a TARP period; and the services the compensation consultant or any affiliate of the compensation consultant provided during this period;

(xiii)        The Company has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during the period beginning on June 15, 2009, and ending with the last day of the Company’s fiscal year containing that date;

(xiv)        The Company has substantially complied with all other requirements related to employee compensation that are provided in the agreement between the Company and Treasury, including any amendments;

(xv)         The Company has submitted to Treasury a complete and accurate list of the SEOs and the twenty next most highly compensated employees for the current fiscal year (2010) and the most recently completed fiscal year (2009), with the non-SEOs ranked in descending order of level of annual compensation, and with the name, title and employer of each SEO and most highly compensated employee identified; and

(xvi)        I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both.  (See, for example 18 USC 1001).

Date:  March 18, 2010
By:
  /s/  David W. Heeter
   
  David W. Heeter
   
  Principal Executive Officer
 
 
 

 

Exhibit 99.2

MutualFirst Financial, Inc.

Certification of Principal Financial Officer Pursuant to 31 CFR § 30.15

I, Timothy J. McArdle, the Senior Vice President, Treasurer and Controller of MutualFirst Financial, Inc. (the “Company”) certify, based on my knowledge, that:

(i)            The Company’s Compensation Committee has discussed, reviewed, and evaluated with senior risk officers at least once every six months during the period beginning on September 14, 2009 and ending with the last day of the Company’s fiscal year containing that date (the applicable period), the senior executive officer (SEO) compensation plans and employee compensation plans and the risks these plans pose to the Company;

(ii)           The Company’s Compensation Committee has identified and limited during the applicable period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company and during the same applicable period has identified any features of the employee compensation plans that pose risks to the Company and has limited those features to ensure that the Company is not unnecessarily exposed to risks;

(iii)          The Company’s Compensation Committee has reviewed at least every six months during the applicable period the terms of each employee compensation plan and identified any features of the plan that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee and has limited any such features;

(iv)          The Company’s Compensation Committee will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;

(v)           The Company’s Compensation Committee will provide a narrative description of how it limited during any part of the most recently completed fiscal year that included a TARP period, to the extent required by the regulations and guidance established under Section 111 of EESA, the features in:

(A)           SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company;

(B)           Employee compensation plans that unnecessarily expose the Company to risks; and

(C)           Employee compensation plans that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee;

(vi)          The Company has required that bonus payments, as defined in the regulations and guidance established under section 111 of EESA (bonus payments), of the SEOs and twenty next most highly compensated employees be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year that was a TARP period, to the extent required by the regulations and guidance established under section 111 of EESA, if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;

(vii)         The Company has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to an SEO or any of the next five most highly compensated employees during the period beginning on June 15, 2009, and ending with the last day of the Company’s fiscal year containing that date;
 
 
 

 
 
(viii)        The Company has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations and guidance established thereunder during the period beginning on June 15, 2009 and ending with the last day of the Company’s fiscal year containing that date;

(ix)           The board of directors of the Company has established an excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, by September 14, 2009, this policy has been provided to Treasury and the Company’s primary regulatory agency; the Company and its employees have complied with this policy during the applicable period; and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were properly approved;

(x)            The Company will permit a non-binding shareholder resolution in compliance with any applicable federal securities rules and regulations on the disclosures provided under the federal securities laws related to SEO compensation paid or accrued during the period beginning on June 15, 2009, and ending with the last day of the Company’s fiscal year containing that date;

(xi)           The Company will disclose the amount, nature, and justification for the offering during the period beginning on June 15, 2009, and ending with the last day of the Company’s fiscal year containing that date of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for each employee subject to the bonus payment limitations identified in paragraph (viii);

(xii)          The Company will disclose whether the Company, the board of directors of the Company, or the Company’s Compensation Committee has engaged a compensation consultant during any part of the most recently completed fiscal year that was a TARP period; and the services the compensation consultant or any affiliate of the compensation consultant provided during this period;

(xiii)         The Company has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during the period beginning on June 15, 2009, and ending with the last day of the Company’s fiscal year containing that date;

(xiv)        The Company has substantially complied with all other requirements related to employee compensation that are provided in the agreement between the Company and Treasury, including any amendments;

(xv)         The Company has submitted to Treasury a complete and accurate list of the SEOs and the twenty next most highly compensated employees for the current fiscal year (2010) and the most recently completed fiscal year (2009), with the non-SEOs ranked in descending order of level of annual compensation, and with the name, title and employer of each SEO and most highly compensated employee identified; and

(xvi)        I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both.  (See, for example 18 USC 1001).

Date:  March 18, 2010
By:
  /s/  Timothy J. McArdle
   
  Timothy J. McArdle
   
  Principal Financial Officer