MidWestOne Financial Group, Inc. - Quarter Report: 2009 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2009

OR

For the transition period from              to             

Commission file number 000-24630

MIDWESTONE FINANCIAL GROUP, INC.

102 South Clinton Street

Iowa City, IA 52240

(Address of principal executive offices, including Zip Code)

Registrant’s telephone number: 319-356-5800

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.    x  Yes    ¨  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 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 definition of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

As of May 6, 2009, there were 8,605,202 shares of common stock, $1.00 par value per share, outstanding.

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MIDWESTONE FINANCIAL GROUP, INC.

Form 10-Q Quarterly Report

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PART I – Item 1. Financial Statements

MIDWESTONE FINANCIAL GROUP, INC.

AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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PART I – Item 1. Financial Statements, Continued

MIDWESTONE FINANCIAL GROUP, INC.

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.

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PART I – Item 1. Financial Statements, Continued

MIDWESTONE FINANCIAL GROUP, INC.

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND OTHER COMPREHENSIVE INCOME (LOSS)

See accompanying notes to consolidated financial statements.

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PART I – Item 1. Financial Statements, Continued

MIDWESTONE FINANCIAL GROUP, INC.

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated financial statements.

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MidWestOne Financial Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

On March 14, 2008, MidWestOne Financial Group, Inc. merged with and into ISB Financial Corp. in accordance with the Agreement and Plan of Merger dated as of September 11, 2007. As a result of the merger, MidWestOne Financial Group, Inc. (“Former MidWestOne”) ceased to exist as a legal entity and ISB Financial Corp. survived the merger and changed its name to “MidWestOne Financial Group, Inc.” The surviving organization is referred to in this document as the “Company.”

Prior to the merger, ISB Financial Corp’s wholly-owned bank subsidiaries were Iowa State Bank & Trust Co. and First State Bank. Subsequent to the merger, the Company added MidWestOne Bank, MidWestOne Investment Services, Inc. and MidWestOne Insurance Services, Inc. as wholly-owned subsidiaries. On August 9, 2008, the three bank subsidiaries were merged with the resulting bank known as MidWestOne Bank headquartered in Iowa City, IA. On December 31, 2008, MidWestOne Investment Services, Inc., was merged into MidWestOne Bank.

The results of operations for the three-month period ended March 31, 2008 include the Company’s operations for such three-month period as well as the operations of the Former MidWestOne for the period beginning March 15, 2008 through March 31, 2008. The results of operations for the three-month period ended March 31, 2009, however, include the operations of the combined Company for the entire period. The Company’s consolidated balance sheet as of December 31, 2008 includes information for both the Company and the Former MidWestOne as a consolidated entity.

The accompanying consolidated statements of operations for the three months ended March 31, 2009 include the accounts and transactions of the Company and its wholly-owned subsidiaries MidWestOne Bank and MidWestOne Insurance Services, Inc. All material intercompany balances and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U. S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Management believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, the accompanying consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of March 31, 2009, and the results of operations and cash flows for the three months ended March 31, 2009 and 2008.

The results for the three months ended March 31, 2009 may not be indicative of results for the year ending December 31, 2009, or for any other period.

In the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in banks, and federal funds sold.

Federal income tax expense for the three months ended March 31, 2009 and 2008 was computed using the consolidated effective federal tax rate. The Company also recognized income tax expense pertaining to state franchise taxes payable by the subsidiary bank. The Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48 “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109” (“FIN 48”) effective January 1, 2007. There were no unrecognized tax benefits or any interest or penalties on any unrecognized tax benefits as of March 31, 2009.

Preferred Stock: On January 23, 2009, the shareholders of the Company approved a proposal to amend the Company’s articles of incorporation to authorize the issuance of up to 500,000 shares of preferred stock.

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On February 6, 2009, the Company issued 16,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, together with a ten-year warrant to acquire 198,675 shares of common stock to the U.S. Department of the Treasury (the “Treasury”) under the Capital Purchase Program (the “CPP”) for an aggregate purchase price of $16,000,000. The senior preferred stock has no par value per share and a liquidation preference of $1,000 per share, or $16,000,000 in the aggregate. Dividends are payable quarterly at the rate of five percent per annum until the fifth anniversary date of the issuance and at a rate of nine percent per annum thereafter. The dividends are computed on the basis of a 360-day year consisting of twelve 30-day months. The dividends are payable quarterly in arrears on February 15, May 15, August 15, and November 15 of each year, with the first dividend payment being May 15, 2009.

The senior preferred stock is non-voting, other than class voting rights on any authorization or issuance of shares ranking senior to the senior preferred stock, any amendment to the rights of senior preferred stock, or any merger, exchange, or similar transaction that would adversely affect the rights of the senior preferred stock. If dividends are not paid in full for six dividend periods, whether or not consecutive, the Treasury will have the right to elect two directors to the Company’s Board. The right to elect directors would end when full dividends have been paid for four consecutive dividend periods.

Effective February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) eliminated the restrictions on a CPP participant’s ability to repay the Treasury’s investment until the third anniversary of the date of the Treasury’s investment. Prior to ARRA, CPP participants were prohibited from redeeming the Treasury’s senior preferred stock except with the proceeds of an offering of qualifying Tier 1 capital. ARRA now allows CPP participants, such as the Company, the option to repay the Treasury’s investment under the CPP at any time without regard to whether the Company has raised new capital, subject to consultation with the Federal Reserve and the Federal Deposit Insurance Corporation (the “FDIC”). If the Company were to repay the Treasury’s investment, it would be permitted to redeem the warrant issued to Treasury for fair market value.

The CPP requires that the Company be subject to specified standards for executive compensation and corporate governance as long as any obligation arising from financial assistance provided under the statute remains outstanding. The Congress and Treasury may create additional provisions that could become retroactively applicable to the preferred stock.

Common Stock: On January 23, 2009, the shareholders of the Company approved a proposal to amend the Company’s articles of incorporation to increase the number of authorized shares of common stock from 10,000,000 to 15,000,000.

Common Stock Warrants: In connection with the CPP described above, a warrant exercisable for 198,675 shares of Company common stock was issued to the Treasury. The warrant entitles the Treasury to purchase 198,675 shares of common stock at $12.08 per share at any time on or before February 6, 2019. If the Company issues common stock, or another security that qualifies as Tier 1 capital, for aggregate gross proceeds of at least $16,000,000 prior to December 31, 2009, the number of common shares underlying the warrant will be reduced to 99,338 shares. As noted above, under ARRA, if the Company repays the Treasury’s investment in full, the Company would be permitted to redeem the warrant issued to Treasury at its then current fair market value. If the warrant is not redeemed at such time, however, it will remain outstanding and transferable by the Treasury.

As holder of the common stock warrant, the Treasury is not entitled to vote, to receive dividends, or to exercise any other rights of common shareholders for any purpose until such warrants have been duly exercised. The Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise. The Company intends to file and maintain at all times during the period the preferred stock is outstanding and during the period the warrant is exercisable, a “shelf” registration statement relating to the issuance of common shares underlying the warrant for the benefit of the warrant holder.

Earnings per Common Share: Basic earnings per common share computations are based on the weighted average number of shares of common stock actually outstanding during the period. The weighted average number of shares outstanding for the three months ended March 31, 2009 and 2008 was 8,603,055 and 5,822,863, respectively. Diluted earnings per share amounts are computed by dividing net income by the weighted average number of shares outstanding and all dilutive potential shares outstanding during the period. The computation of diluted earnings per share used a weighted average diluted number of shares outstanding of 8,603,548 and 5,829,168 for the three months ended March 31, 2009 and 2008, respectively. The following table presents the computation of earnings per common share for the respective periods:

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Earnings per Share Information

The Company adopted the Emerging Issues Task Force (“EITF”) Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”, on January 1, 2008. The EITF Issue 06-4 addresses accounting for separate agreements that split life insurance policy benefits between the employer and employee, and requires the employer to recognize a liability for future benefits payable to an employee under these agreements. The effects of adoption must be recognized through either a change in accounting principle through an adjustment to equity or through the retrospective application to all prior periods. Upon adoption, the Company recognized a liability of $133,000 by recording a cumulative effect through shareholders’ equity.

Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157, “Fair Value Measurements,” for financial assets and liabilities. Effective January 1, 2009, the Company adopted the provisions of SFAS No. 157, “Fair Value Measurements,” for non-financial assets and liabilities. These include foreclosed real estate, long-lived assets, goodwill and other intangibles; which are recorded at fair value only upon impairment. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.

SFAS 157 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. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and seller in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

SFAS 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, SFAS 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

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A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and liabilities carried at fair value effective January 1, 2008.

Securities Available for Sale. Investment securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Included in the securities available for sale are common stock equities, which are reported at fair value using Level 1 inputs. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy.

At March 31, 2009 the trading market for six of the Company’s investment securities was determined to be “not active” based on the existence of no reported trades for the bonds. Accordingly, the Company engaged an external entity to develop a model for pricing these securities based on the present value of expected cash flows of the instruments at an appropriate risk-adjusted discount rate. In developing the appropriate risk-adjusted discount rate, the Company used a corporate bond index with comparable maturities to these securities. Additionally, the Company reviews other information such as historical and current performance of the bonds, performances of underlying collateral, if any, deferral or default rates, if any, cash flow projections, liquidity and credit premiums required by market participants, financial trend analysis with respect to the individual issuing entities and other factors in determining the appropriate risk-adjusted discount rate and expected cash flows. Due to current market conditions, the estimated fair value of this investment security is highly sensitive to assumption changes and market volatility.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of March 31, 2009, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:

The following table presents additional information about assets measured at fair market value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

Valuation methods for instruments measured at fair value on a nonrecurring basis.

Federal Home Loan Bank Stock. Federal Home Loan Bank Stock carried in other assets represents our carrying value which is approximately equal to fair value. Fair value measurements for these securities are classified as Level 3 based on the undeliverable nature related to credit risk.

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Collateral Dependent Impaired Loans. While the overall loan portfolio is not carried at fair value, adjustments are recorded on certain loans to reflect partial write-downs that are based on the underlying collateral. In determining the value of real estate collateral, the Company relies on external appraisals and assessment of property values by the Company staff. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgments based on the experience and expertise of internal specialists. Because many of the inputs are not observable, the measurements are classified as Level 3.

The following table summarizes financial assets and financial liabilities measured at fair value on a non recurring basis as of March 31, 2009, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value.

In December 2007, the FASB issued Statement No. 141 (Revised 2007) “Business Combinations” (“SFAS No. 141R”) and Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS No. 160”). SFAS No. 141R and SFAS No. 160 require significant changes in the accounting and reporting for business acquisitions and the reporting of a noncontrolling interest in a subsidiary. Among many changes under SFAS No. 141R, an acquirer will record 100% of all assets and liabilities at fair value at the acquisition date with changes possibly recognized in earnings, and acquisition related costs will be expensed rather than capitalized. SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary. Key changes under the standard are that noncontrolling interests in a subsidiary will be reported as part of equity, losses allocated to a noncontrolling interest can result in a deficit balance, and changes in ownership interests that do not result in a change of control are accounted for as equity transactions and upon a loss of control, gain or loss is recognized and the remaining interest is remeasured at fair value on the date control is lost. SFAS No. 141R and SFAS No. 160 apply prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is not permitted. The Company adopted these statements on January 1, 2009, and the adoption did not have an impact on its financial condition or results of operations.

In March 2008, the FASB issued Statement No. 161 “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”). SFAS No. 161 requires companies with derivative instruments to disclose information that should enable financial-statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. SFAS is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company adopted this guidance effective January 1, 2009, and the adoption did not have a material impact on its financial condition or results of operations.

In April 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, “Determination of the Useful Life of Intangible Assets.” This FSP is an amendment of SFAS No. 142, Goodwill and Other Intangible Assets. FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The objective of the FSP is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows. This FSP is effective for the Company beginning January 1, 2009. The Company adopted this guidance effective January 1, 2009, and the adoption did not have an impact on its financial condition or results of operations.

In October 2008, the FASB issued FASB Staff Position No. 157-3 (“FAS 157-3”), “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” which clarifies the application of FAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. This FSP was effective upon issuance, including prior periods for which financial statements have not been issued. The Company adopted this guidance effective March 31, 2009, and the adoption did not have an impact on its financial condition or results of operations.

In April 2009, the FASB issued the following three FSPs intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities:

FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have decreased significantly. FSP FAS 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly. The provisions of FSP

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FAS 157-4 are effective for the Company’s interim period ending on June 30, 2009. Management is currently evaluating the effect that the provisions of FSP FAS 157-4 may have on the Company’s financial condition or results of operation.

FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” requires disclosures about fair value of financial instruments in interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. The provisions of FSP FAS 107-1 and APB 28-1 are effective for the Company’s interim period ending on June 30, 2009. As FSP FAS 107-1 and APB 28-1 amends only the disclosure requirements about fair value of financial instruments in interim periods, the adoption of FSP FAS 107-1 and APB 28-1 is not expected to affect the Company’s financial condition or results of operation.

FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” amends current other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The provisions of FSP FAS 115-2 and FAS 124-2 are effective for the Company’s interim period ending on June 30, 2009. Management is currently evaluating the effect that the provisions of FSP FAS 115-2 and FAS 124-2 may have on the Company’s financial condition or results of operation.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 reported period. Actual results could differ from those estimates. Significant estimates that are particularly sensitive to change are the allowance for loan losses and the fair value of available for sale securities.

PART I – Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

On March 14, 2008, the Company (which was at such time named ISB Financial Corp.) consummated its merger with the Former MidWestOne. The results of operations for the three-month period ended March 31, 2008 include the Company’s operations for such three-month period as well as the operations of the Former MidWestOne for the period beginning March 15, 2008 through March 31, 2008. The results of operations for the three-month period ended March 31, 2009; however, include the operations of the combined Company for the entire period. Accordingly, the comparison of the Company’s results of operations for the three-month period ended March 31, 2009 to the three-month period ended March 31, 2008 often shows significant changes, many of which are largely attributable to the merger and the resulting larger entity.

The comparison of the Company’s financial condition as of March 31, 2009 to its financial condition at December 31, 2008 is not similarly impacted by the merger because the Company’s consolidated balance sheet as of December 31, 2008 includes information for both the Company and the Former MidWestOne as a combined entity.

RESULTS OF OPERATIONS

Summary

The Company earned net income of $1.2 million for the quarter ended March 31, 2009, compared with $2.3 million for the quarter ended March 31, 2008, a decrease of 47.8%. Basic and diluted earnings per common share for the first quarter of 2009 were $0.12 versus $0.39 for the first quarter of 2008. The Company’s return on average assets for the first quarter of 2009 was 0.32% compared with a return of 1.09% for the same period in 2008. The Company’s return on average shareholders’ equity was 3.38% for the quarter ended March 31, 2009 versus 9.79% for the quarter ended March 31, 2008. The return on average tangible common equity was 3.60% for the first quarter of 2009 compared with 10.48% for the same period in 2008.

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The following table presents selected financial results and measures for the first quarter of 2009 and 2008.

Net Interest Income

Net interest income is computed by subtracting total interest expense from total interest income. Fluctuations in net interest income can result from the changes in the volumes of assets and liabilities as well as changes in interest rates. The Company’s net interest income for the quarter ended March 31, 2009 increased $5.8 million, or 95.5%, to $11.9 million from $6.1 million from the quarter ended March 31, 2008. Total interest income was $7.4 million greater in the first quarter of 2009 compared with the same period in 2008. Most of the increase in interest income was due to increased interest on loans, which was mainly attributable to increased volumes resulting from the merger. The increase in interest income was offset by increased interest expense on deposits and borrowed funds. Total interest expense for the first quarter of 2009 increased $1.5 million, or 28.6%, compared with the same period in 2008 due primarily to increased volumes related to the merger. The Company’s net interest margin on a tax-equivalent basis for the first quarter of 2009 increased to 3.60% compared with 3.35% in the first quarter of 2008. Net interest margin is a measure of the net return on interest-earning assets and is computed by dividing annualized net interest income by the average of total interest-earning assets for the period. The Company’s overall yield on earning assets declined to 5.58% for the first quarter of 2009 from 6.10% for the first quarter of 2008. The rate on interest-bearing liabilities decreased in the first quarter of 2009 to 2.29% from 3.12% for the first quarter of 2008.

The following table presents a comparison of the average balance of earning assets, interest-bearing liabilities, interest income and expense, and average yields and costs for the quarters ended March 31, 2009 and 2008. Interest income on tax-exempt securities and loans is reported on a fully tax-equivalent basis assuming a 34% tax rate. Dividing annualized income or expense by the average balances of assets or liabilities results in average yields or costs.

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The following table sets forth an analysis of volume and rate changes in interest income and interest expense on the Company’s average earning assets and average interest-bearing liabilities reported on a fully tax-equivalent basis assuming a 34% tax rate. The table distinguishes between the changes related to average outstanding balances (changes in volume holding the initial interest rate constant) and the changes related to average interest rates (changes in average rate holding the initial outstanding balance constant). The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Interest income and fees on loans increased $6.4 million, or 74.5%, in the first quarter of 2009 compared to the same period in 2008. Average loans were $1.0 billion, or 98.7% higher in the first quarter of 2009 compared with 2008, which contributed to the growth in interest income. The increase in average loan volume was primarily attributable to the merger. The yield on the Company’s loan portfolio is affected by the amount of nonaccrual loans (which do not earn interest income), the mix of the portfolio (real estate loans generally have a lower overall yield than commercial and agricultural loans), the effects of competition and the interest rate environment on the amounts and volumes of new loan originations, and the mix of variable rate versus fixed rate loans in the Company’s portfolio. The average rate on loans decreased from 6.79% in the first quarter of 2008 to 6.00% in first quarter of 2009, primarily due to the overall decline in market interest rates between the periods.

Interest and discount income on loan pool participations was $1.0 million for the first quarter of 2009 compared with $121,000 for the first quarter of 2008. Such increase is due to the fact that the Company did not begin engaging in this line of business until the closing of the merger on March 14, 2008, so the first quarter of 2008 income amount reflects only a partial quarter. The Former MidWestOne had engaged in this business since 1988 and the Company continued the business following the merger. These loan pool participations are pools of performing, sub-performing and nonperforming loans purchased at varying discounts from the aggregate outstanding principal amount of the underlying loans. The loan pools are held and serviced by a third-party independent servicing corporation. The Company invests in the pools that are purchased by the servicer from nonaffiliated banking organizations and from the FDIC acting as receiver of failed banks and savings associations. The Company has very minimal exposure in loan pools to consumer real estate, subprime credit or to construction and real estate development loans. Currently, the Company holds $95.3 million in loan pool participations.

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Income is derived from this investment in the form of interest collected and the repayment of the principal in excess of the purchase cost which is herein referred to as “discount recovery.” The loan pool participations were historically a high-yield activity, but this yield has fluctuated from period to period based on the amount of cash collections, discount recovery, and net collection expenses of the servicer in any given period. The net “all-in” yield on loan pool participations was 5.52% for the first quarter of 2009, down from 8.41% for the 2008 calendar year and 6.55% for the fourth quarter of 2008. The net yield was lower in the first quarter of 2009 than for 2008 primarily due to elevated charge-off levels in the portfolio as well as slowed collections, as borrowers saw their ability to refinance debt decline due to the tightening in the credit markets.

The income and yield on loan pool participations may vary in future periods due to the volume and accretable yield on loan pools purchased.

Interest income on investment securities on a tax-equivalent basis increased $329,000, or 10.5%, in the first quarter of 2009 compared with the first quarter of 2008 mainly due to higher volume of securities in the portfolio as a result of the merger, offset in part by a lower yield in 2009. Interest income on investment securities totaled $3.5 million in the first quarter of 2009 compared with $3.1 million for the first quarter of 2008. The average balance of investments in the first quarter of 2009 was $291.0 million compared with $250.9 million in the first quarter of 2008. The tax-equivalent yield on the Company’s investment portfolio in the first quarter of 2009 decreased to 4.83% from 5.03% in the comparable period of 2008 reflecting reinvestment of maturing securities and purchases of new securities at lower market interest rates.

Interest expense on deposits was $1.5 million, or 36.0%, greater in the first quarter of 2009 compared with the same period in 2008 mainly due to the increased volume of deposits following the merger. Offsetting this increase in deposits was a decrease in interest rates paid on deposits as the weighted average rate paid on interest-bearing deposits was 2.31% in the first quarter of 2009 compared with 2.96% in the first quarter of 2008. This decline reflects the overall reduction in market interest rates on deposits throughout the markets in which we operate. Average interest-bearing deposits for the first quarter of 2009 were $429.0 million greater compared with the same period in 2008 as a result of the merger.

Interest expense on borrowed funds was $33,000 greater in the first quarter of 2009 compared with the same period in 2008. Interest on borrowed funds totaled $1.2 million for the first quarter of 2009. The Company’s average borrowed funds balances were greater in 2009 mainly due to the merger, which resulted in the additional interest expense. Average borrowed funds for the first quarter of 2009 were $102.0 million greater compared to the same period in 2008. The majority of the difference was created through advances by the Federal Home Loan Bank. Lower market interest rates in 2009 helped to offset the higher volume of borrowed funds, as the weighted average rate paid on borrowed funds decreased to 2.18% in the first quarter of 2009 compared with 3.86% in the first quarter of 2008.

Provision for Loan Losses

The Company recorded a provision for loan losses of $2.4 million in the first quarter of 2009 compared with a $70,000 provision in the first quarter of 2008. Net loans charged off in the first quarter of 2009 totaled $390,000 compared with net loans charged off of $393,000 in the first quarter of 2008. The increase in the provision in the first quarter of 2009 compared with the same period in 2008 reflects the higher level of nonperforming loans and general concerns with the overall economic environment. Management determines an appropriate provision based on its evaluation of the adequacy of the allowance for loan losses in relationship to a continuing review of problem loans, the current economic conditions, actual loss experience and industry trends. Management believed that the allowance for loan losses was adequate based on the inherent risk in the portfolio as of March 31, 2009; however, there is no assurance losses will not exceed the allowance and any growth in the loan portfolio and the uncertainty of the general economy require that management continue to evaluate the adequacy of the allowance for loan losses and make additional provisions in future periods as deemed necessary.

Noninterest Income

Noninterest income results from the charges and fees collected by the Company from its customers for various services performed, miscellaneous other income, and gains from the sale of investment securities held in the available for sale category. Total noninterest income was $982,000, or 38.4%, greater in the first quarter of 2009 compared with the same period in 2008. Most of the change between the periods is due to the merger although mortgage origination and loan servicing fees increased by $522,000, or 209.6% to $771,000 through March 31, 2009 compared with $249,000 through March 31, 2008. Many of the loans originated during the first quarter were sold in the secondary market with servicing rights retained. The largest component in this category, trust and investment fees, increased by $84,000, or 8.2%, to $1,107,000 during the quarter ended March 31, 2009 from $1,023,000 during the quarter ended March 31, 2008. This increase was primarily attributable to the merger but was mitigated somewhat by the steep decline in the Dow Jones Industrial Average, the Standard & Poors 500 Index and other market indices over the course of the last year. Noninterest income also was positively impacted in the first quarter by a general increase in deposit account fees and service charges resulting from the merger.

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Noninterest Expense

Noninterest expense for the first quarter of 2009 was $11.9 million and includes all costs incurred to operate the Company except for interest expense, the loan loss provision and income taxes. Noninterest expense includes salaries and employee benefits, occupancy and equipment expense, FDIC insurance expense, professional fees and data processing expense. Noninterest expense for the first quarter of 2009 increased $6.5 million over the first quarter of 2008 primarily due to the merger, which led to significant increases in all noninterest expense categories. Salaries and benefits increased from $3.2 million during the first quarter of 2008 to $5.8 million during the first quarter of 2009 and occupancy and equipment expenses increased from $933,000 during the first quarter of 2008 to $1.7 million during the first quarter of 2009. However, in addition to the proportionate increases attributable to the merger, the Company experienced a disproportionate increase in the FDIC assessment fee which increased from $21,000 for the first quarter of 2008 to $898,000 for the first quarter of 2009. Professional fees increased from $123,000 to $1.1 million due to the transition of the Company from a predominately privately-held company to an SEC-registered and Nasdaq-listed company.

Income Tax Expense

The Company incurred income tax expense of $43,000 for the first quarter ended March 31, 2009 compared with $862,000 for the same period in 2008. The effective income tax rates as a percentage of income before taxes for the three months ended March 31, 2009 and 2008 were 3.5% and 27.5%, respectively. The effective tax rate varies from the statutory rate due to state taxes and the amount of tax-exempt income on municipal bonds earned during the period. The relationship of tax-exempt income to pre-tax income was higher during the three-months ended March 31, 2009, which drove the effective tax rate lower than for the same period in 2008.

FINANCIAL CONDITION

Total assets of the Company increased to $1.54 billion as of March 31, 2009 from $1.51 billion on December 31, 2008. This modest increase in assets resulted from an increase in deposits together with the receipt of a $16.0 million investment from the Treasury pursuant to the CPP, which closed on February 6, 2009. Total deposits as of March 31, 2009 were $1.15 billion compared with $1.13 billion as of December 31, 2008, an increase of $22.0 million, primarily due to increased consumer deposits as a result of continued sales efforts by our associates.

Investment Securities

Investment securities available for sale totaled $287.7 million as of March 31, 2009. This was an increase of $15.3 million from December 31, 2008. The increase in the balance was primarily due to a net increase of purchases over maturities of $13.7 million during the period. Investment securities classified as held to maturity decreased to $7.9 million as of March 31, 2009 largely as a result of security maturities. The investment portfolio consists mainly of U.S. government agency securities, mortgage-backed securities and obligations of states and political subdivisions.

As of March 31, 2009, the Company owned $3.5 million of debt securities that were backed by pools of trust preferred securities issued by various commercial banks (approximately 80%) and insurance companies (approximately 20%). No real estate holdings secure these debt securities. These debt securities had an original purchase cost of approximately $9.7 million and were rated investment grade securities when purchased between March 2006 and December 2007. However, as the banking climate eroded over the past year, these debt securities began experiencing cashflow problems, resulting in a significant decline in estimated market value and little to no pricing information available. Accordingly at December 31, 2008 the Company performed an analysis that determined that $6.2 million of the original value was other than temporarily impaired, and the resulting charge was taken in the fourth quarter of 2008. Management continues to monitor the values of these debt securities for purposes of determining other than temporary impairment in future periods given the instability in the financial markets and continues to obtain updated cash flow analysis as required.

Loans

Total loans (excluding loan pool participations) decreased slightly, by $10.7 million, to $1.0 billion as of March 31, 2009 as compared to December 31, 2008. Although total loans decreased, the Company experienced a $3.6 million, or 1.2%, increase in the commercial, financial and agricultural sector. Such increase in commercial, financial and agricultural loans was offset, however, by a $13.0 million, or 2.2% decrease, in real estate mortgage loans, which resulted from the significant refinancing activity seen during the first quarter of 2009. Additionally, construction real estate remained flat from quarter to quarter while loans to individuals decreased $1.9 million or 7.9%. As of March 31, 2009 the Company’s bank loan (excluding loan pool participations) to deposit ratio was 87.3% compared with a year-end 2008 bank loan to deposit ratio of 89.9%. Management anticipates that the loan to deposit ratio will be reduced in future periods. As of March 31, 2009, loans secured by commercial real estate comprised the largest category in the portfolio at approximately 43% of total loans. Residential real estate loans were the next largest category at 27%. Commercial loans

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made up approximately 19% of the total loan portfolio and agricultural loans were approximately 8% of the total loan portfolio, with the remaining 3% of the portfolio in consumer loans. All of these percentages relate to our direct loans and do not include loan pool participations. Included in commercial real estate are construction and development loans totaling approximately $89.4 million, or 9% of total loans.

The Company has minimal direct exposure to subprime mortgages in its loan portfolio. The Company’s loan policy provides a guideline that real estate mortgage borrowers have a Beacon score of 640 or greater. Exceptions to this guideline have been noted but the overall exposure is deemed minimal by management. Mortgages originated by the Company and sold on the secondary market are typically underwritten according to the guidelines of the secondary market investors. These mortgages are on a non-recourse basis, thereby eliminating any subprime exposure.

Loan Pool Participations

As of March 31, 2009, the Company had loan pool participations, net, totaling $96.0 million, up from $93.4 million at December 31, 2008. Loan pools are participation interests in performing, sub-performing and nonperforming loans that have been purchased from various non-affiliated banking organizations. The Former MidWestOne had engaged in this activity since 1988, and the Company continued this line of business following the merger. The loan pool investment balance shown as an asset on the Company’s Statement of Condition represented the discounted purchase cost of the loan pool participations. The Company acquired new loan pool participations totaling $8.4 million during the first quarter of 2009. As of March 31, 2009, the categories of loans by collateral type in the loan pools were commercial real estate—61%, commercial loans—9%, agricultural and agricultural real estate – 6%, single-family residential real estate—11% and other loans—13%. The Company has minimal exposure in the loan pools to consumer real estate subprime credit or to construction and real estate development loans.

The loans in the pools provide some geographic diversification to the Company’s balance sheet. As of March 31, 2009, loans in the southeast region of the United States represented approximately 39% of the total. The northeast was the next largest area with 37%, the central region with 21%, and the southwest and northwest represented a minimal amount of the portfolio, at 2% and 1%, respectively. The highest concentration of assets is in Florida at approximately 19% of the basis total, with the next highest state level being Ohio at 13% and then Pennsylvania and New Jersey both at 7% and 6% respectively. As of March 31, 2009, approximately 60% of the loans were contractually current or less than 90 days past-due, while 40% were contractually past-due 90 days or more. It should be noted that many of the loans were acquired in a contractually past due status, which is reflected in the discounted purchase price of the loans. Performance status is monitored on a monthly basis. The 40% contractually past-due includes loans in litigation and foreclosed property. As of March 31, 2009, loans in litigation totaled approximately $19.4 million, while foreclosed property was approximately $7.6 million. As of March 31, 2009, the Company’s investment basis in its loan pool participations was approximately 52.5% of the “face” amount of the underlying loans.

Other Intangible Assets

Other intangible assets decreased to $13.1 million as of March 31, 2009 from $13.4 million as of December 31, 2008 as a result of normal amortization. Amortization of intangible assets is recorded using an accelerated method based on the estimated life of the intangible. The following table summarizes the amounts and carrying values of intangible assets as of March 31, 2009.