Attached files

file filename
EX-32 - MUTUALFIRST FINANCIAL INCv222777_ex32.htm
EX-31.1 - MUTUALFIRST FINANCIAL INCv222777_ex31-1.htm
EX-31.2 - MUTUALFIRST FINANCIAL INCv222777_ex31-2.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

 
(Mark One)

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended        March 31, 2011     
or

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXHANGE ACT OF 1934
 
 
For the transition period from _______________ to _______________________
Commission File Number:   000-27905

MutualFirst Financial, Inc.
(Exact name of registrant specified in its charter)
 
Maryland
 
35-2085640
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
     
110 East Charles Street
   
Muncie, Indiana
 
47305
(Address of principal executive offices)
 
(Zip Code)
 
(765) 747-2800
(Registrant’s telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes ¨  No ¨

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
The number of shares of the Registrant’s common stock, with $.01 par value, outstanding as of May 13, 2011 was 6,985,920.
 
 
 

 
 
FORM 10 – Q
MutualFirst Financial, Inc.

INDEX
 
Page
 
Number
PART I – FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
 
 
Consolidated Condensed Balance Sheets
1
 
Consolidated Condensed Statements of Operations
2
 
Consolidated Condensed Statement of Stockholders’ Equity
3
 
Consolidated Condensed Statements of Cash Flows
4
 
Notes to Unaudited Consolidated Condensed Financial Statements
5
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
31
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
40
     
Item 4.
Controls and Procedures
41
     
PART II – OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
43
     
Item 1A.
Risk Factors
43
     
Item 2.
Unregistered Sales of Equity Changes in Securities and Use of Proceeds
43
     
Item 3.
Defaults Upon Senior Securities
43
     
Item 4.
Submission of Matters to a Vote of Security Holders
43
     
Item 5.
Other Information
43
     
Item 6.
Exhibits
43
     
Signature Page
 
44
     
Exhibits
 
 
 
 
 

 
 
PART 1 
FINANCIAL INFORMATION
ITEM 1. 
Financial Statements

MUTUALFIRST FINANCIAL, INC. AND SUBSIDIARY
Consolidated Condensed Balance Sheets

   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
       
             
Assets
           
Cash
  $ 12,105,319     $ 9,288,748  
Interest-bearing demand deposits
    66,605,295       17,531,932  
Cash and cash equivalents
    78,710,614       26,820,680  
Investment securities available for sale
    270,081,460       245,165,189  
Loans held for sale
    924,740       10,482,734  
Loans
    965,642,997       995,273,005  
Allowance for loan losses
    (15,797,009 )     (16,372,093 )
Net loans
    949,845,988       978,900,912  
Premises and equipment
    32,583,795       32,966,112  
Federal Home Loan Bank of Indianapolis stock, at cost
    16,682,200       16,682,200  
Investment in limited partnerships
    3,495,947       3,623,564  
Cash surrender value of life insurance
    45,916,390       45,565,611  
Prepaid FDIC premium
    3,730,406       4,207,592  
Core deposit and other intangibles
    4,224,482       4,533,085  
Deferred income tax benefit
    19,100,578       20,030,022  
Income tax receivable
    2,437,012       1,412,938  
Other assets
    19,484,377       16,510,902  
                 
Total assets
  $ 1,447,217,989     $ 1,406,901,541  
                 
Liabilities
               
Deposits
               
Non-interest-bearing
  $ 119,650,146     $ 113,454,542  
Interest bearing
    1,054,808,705       1,008,114,181  
Total deposits
    1,174,458,851       1,121,568,723  
Federal Home Loan Bank advances
    114,769,238       128,537,407  
Other borrowings
    12,980,603       13,167,316  
Other liabilities
    14,037,781       12,488,073  
Total liabilities
    1,316,246,473       1,275,761,519  
                 
Commitments and Contingent Liabilities
               
                 
Stockholders' Equity
               
Preferred stock, $.01 par value
               
Authorized and unissued — 5,000,000 shares
               
Issued and outstanding — 32,382 shares; liquidation preference $1,000 per share
    324       324  
Common stock, $.01 par value
               
Authorized — 20,000,000 shares
               
Issued and outstanding —6,985,087 and 6,984,754 shares in 2011 and 2010, respectively
    69,851       69,847  
Additional paid-in capital - preferred stock
    31,875,771       31,829,779  
Additional paid-in capital - common stock
    72,436,099       72,424,460  
Retained earnings
    30,193,877       31,757,156  
Accumulated other comprehensive income (loss)
    (2,730,480 )     (3,988,158 )
Unearned employee stock ownership plan (ESOP) shares
    (873,926 )     (953,386 )
Total stockholders' equity
    130,971,516       131,140,022  
                 
Total liabilities and stockholders' equity
  $ 1,447,217,989     $ 1,406,901,541  

See notes to consolidated condensed financial statements.
 
 
1

 
 
MUTUALFIRST FINANCIAL, INC. AND SUBSIDIARY
Consolidated Condensed Statements of Operations
(Unaudited)

   
Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
Interest Income
           
Loans receivable, including fees
  $ 13,684,114     $ 15,500,545  
Investment securities:
               
Mortgage-backed securities
    1,733,084       1,348,189  
Federal Home Loan Bank stock
    105,442       93,923  
Other investments
    138,136       258,818  
Deposits with financial institutions
    21,820       43,009  
Total interest income
    15,682,596       17,244,484  
                 
Interest Expense
               
Passbook savings
    34,991       34,459  
Certificates of deposit
    3,829,663       4,326,167  
Daily Money Market accounts
    121,640       147,156  
Demand and NOW acounts
    270,871       198,008  
Federal Home Loan Bank advances
    900,279       1,814,769  
Other interest expense
    210,822       236,012  
Total interest expense
    5,368,266       6,756,571  
                 
Net Interest Income
    10,314,330       10,487,914  
Provision for losses on loans
    4,200,000       1,525,000  
Net Interest Income After Provision for Loan Losses
    6,114,330       8,962,914  
                 
Other Income
               
Service fee income
    1,604,310       1,739,889  
Net realized gain (loss) on sale of securities
    74,047       284,828  
Equity in losses of limited partnerships
    (33,517 )     (127,215 )
Commissions
    950,701       941,516  
Net gains on sales of loans
    91,800       354,309  
Net servicing fees
    26,661       36,848  
Increase in cash surrender value of life insurance
    350,779       382,939  
Loss on sale of other real estate and repossessed assets
    (273,757 )     (213,113 )
Other-than-temporary losses on securities
               
Total other-than-temporary losses
    (768,914 )     (1,831,057 )
Portion of loss recognized in other comperehensive income (before taxes)
    575,472       1,254,239  
Net impairment losses recognized in earnings
    (193,442 )     (576,818 )
Other income
    49,214       104,210  
Total other income
    2,646,796       2,927,393  
                 
Other Expenses
               
Salaries and employee benefits
    5,523,124       5,335,825  
Net occupancy expenses
    674,959       660,877  
Equipment expenses
    480,545       485,095  
Data processing fees
    401,216       410,641  
Automated teller machine
    307,463       279,079  
Deposit insurance
    507,596       445,954  
Professional fees
    359,971       342,319  
Advertising and promotion
    300,031       297,889  
Software subscriptions and maintenance
    317,658       397,123  
Intangible amortization
    308,603       352,980  
Other real estate and repossessed assets
    160,829       253,772  
Other expenses
    858,539       859,432  
Total other expenses
    10,200,534       10,120,986  
                 
Income (Loss) Before Income Tax
    (1,439,408 )     1,769,321  
Income tax expense (benefit)
    (746,000 )     426,000  
                 
Net Income (Loss)
    (693,408 )     1,343,321  
Preferred stock dividends and amortization
    450,766       450,766  
Net Income (Loss) Available to Common Shareholders
  $ (1,144,174 )   $ 892,555  
                 
Basic earnings (loss) per common share
  $ (0.17 )   $ 0.13  
                 
Diluted earnings (loss) per common share
  $ (0.17 )   $ 0.13  
                 
Dividends per common share
  $ 0.06     $ 0.06  

See notes to consolidated condensed financial statements.
 
 
2

 
 
MUTUALFIRST FINANCIAL, INC. AND SUBSIDIARY
Consolidated Condensed Statement of Stockholders' Equity
For the Period Ended March 31, 2011
(Unaudited)

    
Common Stock
   
Preferred Stock
               
Accumulated
             
               
Additional
               
Additional
               
Other
   
Unearned
       
   
Shares
         
paid-in
   
Shares
         
paid-in
   
Comprehensive
   
Retained
   
Comprehensive
   
ESOP
       
   
Outstanding
   
Amount
   
capital
   
Outstanding
   
Amount
   
capital
   
Income
   
Earnings
   
Income (Loss)
   
shares
   
Total
 
                                                                   
Balances,  January 1, 2011
    6,984,754     $ 69,847     $ 72,424,460       32,382     $ 324     $ 31,829,779           $ 31,757,156     $ (3,988,158 )   $ (953,386 )   $ 131,140,022  
                                                                                       
Comprehensive income
                                                                                     
                                                                                       
Net loss for the period
                                                  $ (693,408 )     (693,408 )                     (693,408 )
                                                                                         
Other comprehensive income, net of tax
                                                                                       
                                                                                         
Net unrealized gain on securities
                                                    1,217,978             $ 1,217,978               1,217,978  
                                                                                         
Net unrealized gain on derivatives
                                                    39,700               39,700               39,700  
                                                                                         
Comprehensive income
                                                    $ 564,270                                  
                                                                                         
ESOP shares earned
                    (3,377 )                                                     79,460       76,083  
                                                                                         
Accretion of discount on preferred stock
                                            45,992               (45,992 )                     0  
                                                                                         
Share-based compensation
                    13,029                                                               13,029  
                                                                                         
Stock options exercised
    333       4       1,987                                                               1,991  
                                                                                         
Cash dividends ($.06 per common share)
                                                            (419,105 )                     (419,105 )
                                                                                         
Cash dividends - preferred stock
                                                            (404,774 )                     (404,774 )
                                                                                         
Balances,  March 31, 2011
    6,985,087     $ 69,851     $ 72,436,099       32,382     $ 324     $ 31,875,771               $ 30,193,877     $ (2,730,480 )   $ (873,926 )   $ 130,971,516   

See notes to consolidated condensed financial statements.
 
 
3

 
 
MutualFirst Financial, Inc.
Consolidated Condensed Statements of Cash Flows
(Unaudited)

   
Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
Operating Activities
           
Net income (loss)
  $ (693,408 )   $ 1,343,321  
Items not requiring (providing) cash
               
Provision for loan losses
    4,200,000       1,525,000  
Depreciation and amortization
    1,575,940       1,278,720  
Deferred income tax
    (746,001 )     (42,441 )
Loans originated for sale
    (7,343,400 )     (15,466,632 )
Proceeds from sales of loans held for sale
    16,867,034       14,480,091  
Gains on sales of loans held for sale
    (91,800 )     (354,309 )
Gain on sale of securities-available for sale
    (74,047 )     (284,828 )
(Gain) loss on sale of other real estate and repossessed assets
    273,757       213,113  
Loss on other-than-temporary impairment, securities
    193,442       576,818  
Other equity adjustments
    76,083       49,643  
Change in
               
Prepaid FDIC premium
    477,186       416,153  
Interest receivable and other assets
     34,675       (360,391 )
Interest payable and other liabilities
    466,427       479,389  
Cash value of life insurance
    (350,779 )     (382,939 )
Other adjustments
    1,024,069       755,103  
Net cash provided by operating activities
    15,889,178       4,225,811  
                 
Investing Activities
               
Purchases of securities available for sale
    (34,666,397 )     (56,426,287 )
Proceeds from maturities and paydowns of securities:
               
Available for sale
    7,997,904       6,019,368  
Held to maturity
    -       322,120  
Proceeds from sale of securities-available for sale
    3,010,702       8,408,554  
Net change in loans
    19,692,484       25,525,197  
Purchases of premises and equipment
    (147,999 )     (85,045 )
Proceeds from real estate owned sales
    882,050       1,312,736  
Net cash used in investing activities
    (3,231,256 )     (14,923,357 )
                 
Financing Activities
               
Net change in
               
Noninterest-bearing, interest-bearing demand and savings deposits
    39,917,024       42,662,481  
Certificates of deposit
    12,973,104       34,528,835  
Proceeds from FHLB advances
    -       20,000,000  
Repayment of FHLB advances
    (13,720,045 )     (10,733,315 )
Repayment of other borrowings
    (197,474 )     (421,598 )
Cash dividends paid
    (823,879 )     (823,860 )
Other financing activities
    1,083,282       1,148,552  
Net cash provided by financing activities
    39,232,012       86,361,095  
                 
Net Change in Cash and Cash Equivalents
    51,889,934       75,663,549  
                 
Cash and Cash Equivalents, Beginning of Year
    26,820,680       46,340,897  
                 
Cash and Cash Equivalents, End of Year
  $ 78,710,614     $ 122,004,446  
                 
Additional Cash Flows Information
               
Interest paid
  $ 5,338,163     $ 6,617,556  
Income tax paid
    -       -  
Transfers from loans to foreclosed real estate
    4,896,441       3,409,821  
Mortgage servicing rights capitalized
    126,160       142,685  

See Notes to Consolidated Condensed Financial Statements
 
 
4

 

MutualFirst Financial, Inc. and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
  
Note 1:  Basis of Presentation

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

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

The interim consolidated financial statements at March 31, 2011, have not been audited by independent accountants, but in the opinion of management, reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for such periods. The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

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

Note 2: Earnings (loss) per share

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

   
Three Months Ended Ended December 31,
 
   
2011
   
2010
 
         
Weighted-
               
Weighted-
       
   
Income
   
Average
   
Per-Share
         
Average
   
Per-Share
 
   
(loss)
   
Shares
   
Amount
   
Income
   
Shares
   
Amount
 
   
(000's)
               
(000's)
             
                                     
Basic Earnings (Loss) Per Share
                                   
Net income (loss)
  $ (693 )     6,893,695     $ (0.10 )   $ 1,344       6,861,589     $ 0.20  
Dividends and accretion on preferred stock
    (451 )                     (451 )                
Income (loss) available to common shareholders
  $ (1,144 )     6,893,695     $ (0.17 )   $ 893       6,861,589     $ 0.13  
Effect of Dilutive securities
                                               
Stock options and RRP grants
            -                       2,549          
Diluted Earnings (Loss) Per Share
                                               
                                                 
Income (loss) available to common stockholders and assumed conversions
  $ (1,144 )     6,893,695     $ (0.17 )   $ 893       6,864,138     $ 0.13  

Options of 602,132 and 570,718 shares and warrants of 625,135 shares, in each period, were not included in the calculation above due to being anti-dilutive to earnings per share as of March 31, 2011 and 2010, respectively.
 
 
5

 
 
Note 3:  Impact of Accounting Pronouncements

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

In July 2010, the FASB issued an updated (ASU) No. 2010-20, Receivables (Topic 310):  Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  This update provides guidance to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses.  This update became effective for the Company for first interim or annual reporting period ending on or after December 15, 2010 and did not have a material impact on the statements taken as a whole.
 
 
6

 

Note 4: Investments

The amortized cost and approximate fair values of securities as of March 31, 2011 and December 31, 2010 are as follows.
 
   
March 31, 2011
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Loss
   
Value
 
Available for Sale Securities
                       
Mortgage-backed securities
                       
Government sponsored agencies
  $ 143,789     $ 1,389     $ (1,542 )   $ 143,636  
Collateralized mortgage obligations
                               
Government sponsored agencies
    110,053       1,564       (1,049 )     110,568  
Federal Agencies
    7,926       9       (59 )     7,876  
Municipals
    3,485       52       (186 )     3,351  
Small Business Administration
    15       -       -       15  
Corporate obligations
    6,713       -       (3,789 )     2,924  
Marketable equity securities
    1,730       -       (19 )     1,711  
Total
  $ 273,711     $ 3,014     $ (6,644 )   $ 270,081  

   
December 31, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Loss
   
Value
 
Available for Sale Securities
                       
Mortgage-backed securities
                       
Government sponsored agencies
  $ 119,017     $ 1,076     $ (1,818 )   $ 118,275  
Collateralized mortgage obligations
                            -  
Government sponsored agencies
    112,615       1,251       (1,642 )     112,224  
Federal agencies
    7,925       -       (104 )     7,821  
Municipals
    2,460       33       (11 )     2,482  
Small Business Administration
    16       -       -       16  
Corporate obligations
    6,888       -       (4,243 )     2,645  
Marketable equity securities
    1,723       -       (21 )     1,702  
Total
  $ 250,644     $ 2,360     $ (7,839 )   $ 245,165  
 
The amortized cost and fair value of available-for-sale securities at March 31, 2011, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
7

 
 
   
Available for Sale
 
   
Amortized
   
Fair
 
Description Securities
 
Cost
   
Value
 
Security obligations due
           
Five to ten years
  $ 1,025     $ 1,025  
After ten years
    17,099       13,126  
      18,124       14,151  
Mortgage-backed securities
    143,789       143,636  
Collateralized mortgage obligations
    110,053       110,568  
Small Business Administration
    15       15  
Marketable equity securities
    1,730       1,712  
Totals
  $ 273,711     $ 270,082  
 
The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $1.5 million at March 31, 2011.
 
Gross gains of $74,000 and $285,000 resulting from sales of securities were realized for the three months ended March 31, 2011 and 2010, respectively.  There were no losses recognized on the sale of securities during this period in either 2011 or 2010.  Other-than-temporary impairment losses were recognized on securities for the three months ended March 31, 2011 and 2010 of $193,000 and $577,000, respectively.
 
Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments at March 31, 2011, was $136.0 million, a decrease from $141.3 million at December 31, 2010, which is approximately 50% and 58%, respectively, of the Bank's portfolio.  The Bank has continued to see an improvement since year-end due to increased market values.
 
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.
 
 
8

 

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 March 31, 2011 and December 31, 2010:
   
March 31, 2011
 
   
Less than 12 months
   
12 months or more
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
Available for Sale
                                   
Mortgage-backed securities
                                   
Government sponsored agencies
  $ 68,048     $ (1,542 )   $ -     $ -     $ 68,048     $ (1,542 )
Collateralized mortgage obligations
                                               
Government sponsored agencies
    58,286       (1,049 )     -       -       58,286       (1,049 )
Federal agencies
    3,938       (59 )     -       -       3,938       (59 )
Municipals
    1,089       (186 )     -       -       1,089       (186 )
Corporate obligations
    -       -       2,924       (3,789 )     2,924       (3,789 )
Marketable equity securities
    -       -       1,711       (19 )     1,711       (19 )
Total temporarily impaired securities
  $ 131,361     $ (2,836 )   $ 4,635     $ (3,808 )   $ 135,996     $ (6,644 )

   
December 31, 2010
 
   
Less than 12 months
   
12 months or more
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
Available for Sale
                                   
Mortgage-backed securities
                                   
Government sponsored agencies
  $ 69,971     $ (1,818 )   $ -     $ -     $ 69,971     $ (1,818 )
Collateralized mortgage obligations
                                               
Government sponsored agencies
    58,466       (1,642 )     -       -       58,466       (1,642 )
Federal agencies
    7,821       (104 )     -       -       7,821       (104 )
Municipals
    661       (11 )     -       -       661       (11 )
Corporate obligations
    -       -       2,645       (4,243 )     2,645       (4,243 )
Marketable equity securities
    -       -       1,702       (21 )     1,702       (21 )
Total temporarily impaired securities
  $ 136,919     $ (3,575 )   $ 4,347     $ (4,264 )   $ 141,266     $ (7,839 )
 
Mortgage-Backed Securities (MBS) and Collateralized Mortgage Obligations (CMO)
 
The unrealized losses on the Company’s investment in MBSs and CMOs were caused by interest rate changes.  The Company expects to recover the amortized cost basis over the term of the securities.  Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at March 31, 2011.
 
 
9

 
 
Corporate Obligations
 
The Company’s unrealized loss on investments in corporate obligations primarily relates to investments in pooled trust preferred securities. The unrealized losses were primarily caused by (a) a decrease in performance and regulatory capital at the underlying banks resulting from exposure to subprime mortgages and (b) a sector downgrade by several industry analysts. The Company currently expects some of the securities to settle at a price less than the amortized cost basis of the investment (that is, the Company expects to recover less than the entire amortized cost basis of the security). The Company has recognized a loss equal to the credit loss for these securities, establishing a new, lower amortized cost basis. The credit loss was calculated by comparing expected discounted cash flows based on performance indicators of the underlying assets in the security to the carrying value of the investment. Because the Company does not intend to sell the investments and it is likely the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be maturity, it does not consider the remainder of the investments to be other-than-temporarily impaired at March 31, 2011.
 
MutualBank evaluates securities for other-than-temporary impairment (“OTTI”) on a quarterly basis. During the quarter ending March 31, 2011, the Bank’s evaluation indicated other-than-temporary impairment of $193,000. Impairment on securities is determined after analyzing the estimated cash flows to be received, underlying collateral and determining the amount of additional losses needed in the individual pools to create a shortfall in interest or principal payments. All trust preferred securities were valued using a discounted cash flow analysis as of March 31, 2011.
 
Other-than-temporary Impairment
 
Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.
 
The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities. 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. Where the security is not a beneficial interest in securitized financial assets, the Company uses the debt and equity securities impairment model.
 
The Company routinely conducts reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred.  Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities.  While all securities are considered, the securities primarily impacted by other-than-temporary impairment testing are pooled trust preferred securities.  For each pooled trust preferred security in the investment portfolio (including but not limited to those whose fair value is less than their amortized cost basis), an extensive, regular review is conducted to determine if an other-than-temporary impairment has occurred.  Various inputs to the economic models are used to determine if an unrealized loss is other-than-temporary.
 
The Bank’s trust preferred securities valuation was prepared by an independent third party.  The approach to determining fair value involved several steps including:
 
 
10

 

 
·
Detailed credit and structural evaluation of each piece of collateral in the trust preferred securities;
 
 
·
Collateral performance projections for each piece of collateral in the trust preferred security;
 
 
·
Terms of the trust preferred structure, as laid out in the indenture; and
 
 
·
Discounted cash flow modeling.
 
MutualFirst Financial uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific trust preferred securities.  The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis.  There is currently no active market for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market.  The next step is to make a series of adjustments to reflect the differences that exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific trust preferred security.  Importantly, as part of the analysis described above, MutualFirst considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.
 
 The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions.  For collateral that has already defaulted, the Company assumed no recovery.  For collateral that was in deferral, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions, and 15% of par for insurance companies.  Although the Company conservatively assumed that the majority of the deferring collateral continues to defer and eventually defaults, we also recognize there is a possibility that some deferring collateral may become current at some point in the future.
 
 
11

 

Pooled Trust Preferred Securities.MutualFirst Financial, Inc. has a current amortized cost in pooled trust preferred securities of $6.7 million, which had an original par value of $10.3 million.  These securities have a current fair value of $2.9 million.  The following table provides additional information related to the Bank’s investment in trust preferred securities as of March 31, 2011:

Deal
 
Class
 
Original
Par
 
Book
Value
 
Fair
Value
 
Unrealized
Loss
 
Realized
Losses 2011
 
Lowest
Rating
 
Number of
Banks/Insurance
Companies Currently
Performing
 
Actual
Deferrals/Defaults (as %
of original collateral)
   
Total Projected
Defaults (as a %
of performing
collateral)a
   
Excess Subordination
(after taking into
account best estimate of
future
deferrals/defaults)b
 
(Dollars in thousands)
 
                                                   
Alesco Preferred Funding IX
  A2A   $ 1,000   $ 897   $ 504   $ 393   $ -  
CCC-
    40     31.04 %     23.51 %     38.03 %
Alesco Preferred Funding XVII
  C1     1,000     -     -     -     100   C     34     38.75 %     30.88 %     0.00 %
Preferred Term Securities XIII
  B1     1,000     812     232     580     25  
Ca
    43     33.57 %     25.44 %     0.00 %
Preferred Term Securities XVIII
  C     1,000     909     339     570     -  
Ca
    53     23.08 %     14.00 %     4.68 %
Preferred Term Securities XXVII
  C1     1,000     704     167     537     -   C     34     27.07 %     23.50 %     0.00 %
U.S. Capital Funding I
  B1     3,000     2,891     1,367     1,524     -  
Caa1
    35     12.92 %     14.04 %     4.10 %
U.S. Capital Funding III
  B1     1,000     500     315     185     -   C     31     26.22 %     17.48 %     0.00 %
U.S. Capital Funding V
  B1     1,300     -     -     -     68   C     21     55.06 %     39.12 %     0.00 %
                                                                     
Total
      10,300   6,713   2,924   3,789   $ 193                                  

(a)
A 10% recovery is applied to all projected defaults.  A 15% recovery is applied to all projected insurance defaults.  No recovery is applied to current defaults.
(b)
Excess subordination represents the additional defaults in excess of both current and projected defaults that the CDO can absorb before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a deal can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future default percentages.
 
12

 
 
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
 
   
2011
   
2010
 
Credit losses on debt securities held
           
Beginning of year
  $ (4,746 )   $ (3,905 )
Additions related to increases in previously recognized other-than-temporary losses for the three months ended
    (193 )     (577 )
                 
As of March 31,
  $ (4,939 )   $ (4,482 )
 
Note 5:  Accumulated Other Comprehensive Income (Loss)
 
Other comprehensive income (loss) components and related taxes for the three months ended March 31 were as follows:
 
   
2011
   
2010
 
Net unrealized gain on securities available-for-sale
  $ 2,310     $ 1,332  
Net unrealized loss on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income
    (580 )     (1,261 )
Net unrealized gain (loss) on derivative used for cash flow hedges
    60       (134 )
                 
Less reclassification adjustment for realized losses included in income
    119       108  
Other comprehensive income, before tax effect
    1,909       45  
Tax expense
    651       22  
                 
Other comprehensive income
  $ 1,258     $ 23  
 
 
13

 

The components of accumulated other comprehensive gain (loss), included in stockholders’ equity are as follows:
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
Net unrealized loss on securities available-for-sale
  $ (3,049 )   $ (4,172 )
Net unrealized loss on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income
    (580 )     (1,307 )
Net unrealized loss on derivative used for cash flow hedges
    (278 )     (339 )
Net unrealized loss relating to defined benefit plan liability
    (251 )     (251 )
      (4,158 )     (6,069 )
Tax benefit
    (1,428 )     (2,081 )
                 
Net-of-tax amount
  $ (2,730 )   $ (3,988 )
 
Note 6: Disclosures About Fair Value of Assets and Liabilities

FASB Codification Topic 820 (ASC 820), Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value:
 
Level 1 
Quoted prices in active markets for identical assets or liabilities
 
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
 
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities
 
Items Measured at Fair Value on a Recurring Basis
 
Following is a description of the valuation methodologies and inputs used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.
 
 
14

 
 
Available-for-Sale Securities
 
Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  The Company uses a third-party provider to provide market prices on its securities.  Level 1 securities include the marketable equity securities.  If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.  Level 2 securities include mortgage-backed, collateralized mortgage obligations, small business administration, marketable equity, municipal, federal agency and certain corporate obligation securities.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain corporate obligation securities.
 
Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on investment securities relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

The following table presents the fair value measurement of assets and liabilities measured at fair value on a recurring basis and the level within the ASC 820 fair value hierarchy used for such fair value measurements:
 
 
15

 

         
Fair Value Measurements Using
 
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
March 31, 2011
                       
Mortgage-backed securities 
                               
Agency
  $ 143,636     $ -     $ 143,636     $ -  
Collateralized mortgage obligations
                               
Agency
    110,568       -       110,568       -  
Federal agencies
    7,876       -       7,876       -  
Municipals
    3,351       -       3,351       -  
Small Business Administration
    15       -       15       -  
Corporate obligations
    2,924       -       -       2,924  
Marketable equity securities
    1,711       1,711       -       -  
                                 
Available-for-sale securities
  $ 270,081     $ 1,711     $ 265,446     $ 2,924  
                         
December 31, 2010
                       
Mortgage-backed securities
                       
Government sponsored agencies
  $ 118,275     $ -     $ 118,275     $ -  
Collateralized mortgage obligations
                               
Government sponsored agencies
    112,224       -       112,224       -  
Federal agencies
    7,821       -       7,821       -  
Municipals
    2,482       -       2,482       -  
Small Business Administration
    16       -       16       -  
Corporate obligations
    2,645       -       -       2,645  
Marketable equity securities
    1,702       1,702       -       -  
                                 
Available-for-sale securities
  $ 245,165     $ 1,702     $ 240,818     $ 2,645  
 
 
16

 

The following is a reconciliation of the beginning and ending balances for the three months ended March 31, 2011 and 2010 of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:
 
   
2011
   
2010
 
             
Beginning balance
  $ 2,645     $ 2,539