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 quarter ended September 30, 2008 includes the results of operations for the combined Company for the entire period. The results of operations for the nine-month period ended September 30, 2008 include the Company's operations for such nine-month period as well as the operations of Former MidWestOne for the period beginning March 15, 2008 through September 30, 2008. The results of operations for the three and nine-month periods ended September 30, 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 nine-month period ended September 30, 2009 to the nine-month period ended September 30, 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 September 30, 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 Former MidWestOne as a combined entity.

RESULTS OF OPERATIONS

Summary

The Company earned net income of $834,000 for the quarter ended September 30, 2009, compared with $1.7 million for the quarter ended September 30, 2008, a decrease of 50.9%. Net income for the quarter ended September 30, 2009 was affected by "other than temporary impairment" charges on securities of $1.4 million. Basic and diluted earnings per common share for the third quarter of 2009 were $0.07 versus $0.20 for the third quarter of 2008. The Company's return on average assets for the third quarter of 2009 was 0.21% compared with a return of 0.44% for the same period in 2008. The Company's return on average shareholders' equity was 2.21% for the quarter ended September 30, 2009 versus 4.23% for the quarter ended September 30, 2008. The return on average tangible common equity was 2.02% for the third quarter of 2009 compared with 5.46% for the same period in 2008.

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

                                                               Quarter Ended September 30,
($ amounts in thousands)                                        2009                  2008
Net Income                                                 $           834        $      1,704
Average Assets                                                   1,550,847           1,532,809
Average Shareholders' Equity                                       149,769             160,320
Return on Average Assets                                             0.21%               0.44%
Return on Average Shareholders' Equity                               2.21%               4.23%
Return on Average Tangible Common Equity                             2.02%               5.46%
Total Equity to Assets (end of period)                               9.93%              10.66%
Tangible Common Equity to Tangible Assets (end of
period)                                                              8.15%               8.48%

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 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 September 30, 2009 remained flat at $10.9 million, decreasing only $22,000 compared to the quarter ended September 30, 2008. Total interest income was $1.4 million lower in the third quarter of 2009 compared with the same period in 2008. Most of the decrease in interest income was due to reduced interest on loans and loan pool participations. The decrease in interest income was largely offset by reduced interest expense on deposits and borrowed funds. Total interest expense for the third quarter of 2009 decreased $1.4 million, or 16.3%, compared with the same period in 2008 due primarily to lower interest rates in 2009. The Company's net interest margin on a tax-equivalent basis for the third quarter of 2009 decreased to 3.13% compared with 3.26% in the third 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 on a tax-equivalent basis by the average of total interest-earning assets for the period. The Company's overall yield on earning assets declined to 5.05% for the third quarter of 2009 from 5.67% for the third quarter of 2008. The average cost of interest-bearing liabilities decreased in the third quarter of 2009 to 2.25% from 2.83% for the third quarter of 2008.

The following tables present 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 September 30, 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.

                                                            Quarter ended September 30,
                                                    2009                                     2008
                                                    Interest      Average                    Interest    Average
                                     Average      Income (2) /     Rate/         Average      Income/     Rate/
(in thousands)                       Balance        Expense        Yield         Balance      Expense     Yield
Average earning assets:
Loans (tax equivalent) (1)         $   983,999   $       14,744      5.94 %    $   997,948   $  14,842      5.92 %
Loan pool participations                89,942               28      0.12 %         92,787       1,228      5.27 %
Investment securities (tax
equivalent)                            378,758            3,872      4.06 %        291,352       3,690      5.04 %
Federal funds sold and
interest-bearing balances               13,127                9      0.27 %         22,199         238      4.27 %

Total earning assets               $ 1,465,826   $       18,653      5.05 %    $ 1,404,286   $  19,998      5.67 %


Average interest-bearing
liabilities:
Savings and interest-bearing
demand deposits                    $   461,467   $        1,127      0.97 %    $   403,960   $   2,234      2.20 %
Time certificates of deposit           585,892            4,175      2.83 %        555,027       4,218      3.02 %

Total deposits                       1,047,359            5,302      2.01 %        958,987       6,452      2.68 %

Federal funds purchased and
repurchase agreements                   42,462               98      0.92 %         58,900         321      2.17 %
Federal Home Loan Bank advances        146,418            1,533      4.15 %        158,310       1,528      3.84 %
Long-term debt and other                16,510              171      4.11 %         15,792         188      4.74 %

Total interest-bearing
liabilities                        $ 1,252,749   $        7,104      2.25 %    $ 1,191,989   $   8,489      2.83 %


Net interest income                              $       11,549                              $  11,509

Net interest margin (3)                                              3.13 %                                 3.26 %

(1) Loan fees included in interest income are not material.

(2) Includes interest income and discount realized on loan pool participations.

(3) Net interest margin is net interest income (computed on a tax-equivalent basis) divided by average total earning assets.

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. As the table below shows, the small increase in net interest income was nearly equally split between volume and rate components.

                                                             Quarter ended September 30,
                                                                2009 Compared to 2008
                                                             Increase/ (Decrease) Due to
                                                         Volume          Rate           Net
                                                                    (in thousands)
Interest income from average earning assets:
Loans (tax equivalent)                                  $   (167 )     $     69       $    (98 )
Loan pool participations                                     (34 )       (1,166 )       (1,200 )
Investment securities (tax equivalent)                     1,120           (938 )          182
Federal funds sold and interest-bearing balances             (97 )         (132 )         (229 )

Total income from earning assets                             822         (2,167 )       (1,345 )


Interest expense from average interest-bearing
liabilities:
Savings and interest-bearing demand deposits                 325         (1,432 )       (1,107 )
Time certificates of deposit                                 247           (290 )          (43 )

Total deposits                                               572         (1,722 )       (1,150 )

Federal funds purchased and repurchase agreements            (89 )         (134 )         (223 )
Federal Home Loan Bank advances                             (111 )          116              5
Long-term debt and other                                       9            (26 )          (17 )

Total expense from interest-bearing liabilities              381         (1,766 )       (1,385 )

Net interest income                                     $    441       $   (401 )     $     40

Interest income and fees on loans on a tax-equivalent basis decreased $98,000, or 0.7%, in the third quarter of 2009 compared to the same period in 2008. Average loans were $13.9 million, or 1.4%, lower in the third quarter of 2009 compared with 2008. The decrease in average loan volume was partially attributable to a slowing in real estate lending refinance activity. 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 remained virtually unchanged, increasing slightly from 5.92% in the third quarter of 2008 to 5.94% in third quarter of 2009.

Interest and discount income on loan pool participations was $28,000 for the third quarter of 2009 compared with $1.2 million for the third quarter of 2008, a decrease of $1.2 million. 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 the loan pools to consumer real estate, subprime credit or construction and real estate development loans. Currently, the Company holds $88.7 million in loan pool participations.

Income is derived from this investment in the form of interest collected and the repayment of principal in excess of the purchase cost, which is 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 1.39% for the third quarter of 2009, down from 8.41% for the 2008 calendar year. The net yield was lower in the third quarter of 2009 than for the third quarter of 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 continued tightness 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 $182,000, or 4.9%, in the third quarter of 2009 compared with the third quarter of 2008 mainly due to a higher investment balance, and despite a lower yield on investments in 2009. Interest income on investment securities totaled $3.9 million in the third quarter of 2009 compared with $3.7 million for the third quarter of 2008. The average balance of investments in the third quarter of 2009 was $378.8 million compared with $291.4 million in the third quarter of 2008. The tax-equivalent yield on the Company's investment portfolio in the third quarter of 2009 decreased to 4.06% from 5.04% 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 $1.2 million, or 17.8%, lower in the third quarter of 2009 compared with the same period in 2008 mainly due to the decrease in interest rates during 2009. The weighted average rate paid on interest-bearing deposits was 2.01% in the third quarter of 2009 compared with 2.68% in the third 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 third quarter of 2009 were $88.4 million greater compared with the same period in 2008.

Interest expense on borrowed funds was $235,000 lower in the third quarter of 2009 compared with the same period in 2008. Interest on borrowed funds totaled $1.8 million for the third quarter of 2009. Average borrowed funds for the third quarter of 2009 were $27.6 million lower compared to the same period in 2008. The majority of the difference was due to a reduction in the level of federal funds purchased, repurchase agreements, and FHLB advances. Elimination of the purchase accounting benefit on FHLB advances related to the March 2008 merger in the first quarter of 2009 led to the weighted average rate on borrowed funds increasing marginally to 3.51% in the third quarter of 2009 compared with 3.50% in the third quarter of 2008.

Provision for Loan Losses

The Company recorded a provision for loan losses of $2.1 million in the third quarter of 2009 compared with an $838,000 provision in the third quarter of 2008. Net loans charged off in the third quarter of 2009 totaled $2.1 million compared with net loans charged off of $416,000 in the third quarter of 2008. The increase in the provision in the third quarter of 2009 compared with the same period in 2008 reflects the higher level of nonperforming loans, increased charge-offs, 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, current economic conditions, actual loss experience and industry trends. Management believes that the allowance for loan losses was adequate based on the inherent risk in the portfolio as of September 30, 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 may 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. Noninterest income for the quarter was $2.6 million, down $471,000, or 15.6%, from $3.0 million for the third quarter of 2008. This decrease reflects the other than temporary impairment charge mentioned above. The impairment loss was partially offset by a gain on sales of securities available for sale which totaled $482,000 in the third quarter of 2009 as compared to $9,000 in the same period of 2008, and significantly higher mortgage origination fees which were $613,000 for the third quarter of 2009 as compared to $187,000 for the third quarter of 2008, an increase of $426,000, or 227.8%. The increase in mortgage origination fees was attributable to the low interest rate environment. Management's strategic goal is for noninterest income to constitute 30% of total revenues over time.

Noninterest Expense

Noninterest expense for the third quarter of 2009 was $11.2 million compared with $11.0 million for the third quarter of 2008. Noninterest expense includes salaries and employee benefits, occupancy and equipment expense, FDIC insurance premiums, professional fees and data processing expense. The primary reasons for the increase in noninterest expense were the significantly higher FDIC insurance premiums of $615,000 compared to $292,000 for the three months ended September 30, 2009 and 2008, respectively, and the increase in professional fees, which were $727,000 for the third quarter 2009, from $348,000 for the third quarter of 2008.

Income Tax Expense

The Company realized an income tax benefit of $636,000 for the quarter ended September 30, 2009 compared with a $477,000 expense for the same period in 2008, for a net effect of $1.1 million. The effective income tax rates as a percentage of income before taxes for the three months ended September 30, 2009 and 2008 were -321.2% and 21.9%, respectively.

The effective tax rate varies from the statutory rate due to state taxes, the result of tax-exempt income on tax-exempt bonds, and the recognition of a tax benefit of approximately $330,000 on certain merger related expenses. Combined, these items drove the effective tax rate lower than for the same period in 2008.

Federal Deposit Insurance Corporation ("FDIC") Assessments

On September 29, 2009, the FDIC issued a proposal to amend its assessment regulations to require insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012. This proposal indicates that depository institutions are to prepay their assessments on December 30, 2009. Should this proposed rule become final, the Company estimates its prepaid assessment to be approximately $9.9 million.

Summary

The Company earned net income of $2.8 million for the nine months ended September 30, 2009, compared with $6.9 million for the nine months ended September 30, 2008, a decrease of 59.8%. Basic and diluted earnings per common share for the first three quarters of 2009 were $0.26 versus $0.90 for the first three quarters of 2008. The Company's return on average assets for the first nine months of 2009 was 0.24% compared with a return of 0.70% for the same period in 2008. The Company's return on average shareholders' equity was 2.56% for the nine months ended September 30, 2009 versus 6.61% for the nine months ended September 30, 2008. The return on average tangible common equity was 2.49% for the nine months ended September 30, 2009, compared with 8.91% for the same period in 2008.

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

           ($ amounts in thousands)                       Nine Months Ended September 30,
                                                                  2009                    2008
Net Income                                           $           2,793       $           6,942
Average Assets                                               1,541,141               1,322,393
Average Shareholders' Equity                                   145,997                 140,297
Return on Average Assets                                         0.24%                   0.70%
Return on Average Shareholders' Equity                           2.56%                   6.61%
Return on Average Tangible Common Equity                         2.49%                   8.91%
Total Equity to Assets (end of period)                           9.93%                  10.66%
Tangible Common Equity to Tangible Assets (end
of period)                                                       8.15%                   8.48%

Net Interest Income

The Company's net interest income for the nine months ended September 30, 2009 increased $5.3 million, or 18.5%, to $33.7 million from $28.5 million from the nine months ended September 30, 2008. Total interest income was $4.5 million greater in the nine months ended September 30, 2009, compared with the same period in 2008. Most of the increase in interest income was due to increased interest and fees on loans, which was mainly attributable to increased volumes resulting from the merger. Total interest expense for the nine months ended September 30, 2009, decreased $742,000, or 3.3%, compared with the same period in 2008 due primarily to the overall decline in market interest rates between the periods. The Company's net interest margin on a tax-equivalent basis for the nine months ended September 30, 2009, decreased to 3.27% compared with 3.31% in the nine months ended September 30, 2008. Net interest margin is a measure of the net return on interest-earning assets and is computed by dividing annualized net interest income on a tax-equivalent basis by the average of total interest-earning assets for the period. The Company's overall yield on earning assets declined to 5.27% for the nine months ended September 30, 2009, from 5.83% for the nine months ended September 30, 2008. The average cost of interest-bearing liabilities decreased in the nine months ended September 30, 2009, to 2.33% from 2.49% for the nine months ended September 30, 2008.

The following tables present a comparison of the average balance of earning assets, interest-bearing liabilities, interest income and expense, and average yields and costs for the nine months ended September 30, 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.

                                                          Nine months ended September 30,
                                                    2009                                     2008
                                                    Interest      Average                    Interest    Average
                                     Average      Income (2) /     Rate/         Average      Income/     Rate/
(in thousands)                       Balance        Expense        Yield         Balance      Expense     Yield
Average earning assets:
Loans (tax equivalent) (1)         $   999,313   $       44,633      5.97 %    $   828,823   $  38,238      6.16 %
Loan pool participations                93,716            1,707      2.44 %         65,138       3,145      6.45 %
Investment securities (tax
equivalent)                            333,561           11,024      4.42 %        286,429      10,413      4.86 %
Federal funds sold and
interest-bearing balances               29,412               48      0.22 %         14,506         324      2.98 %

Total earning assets               $ 1,456,002   $       57,412      5.27 %    $ 1,194,896   $  52,120      5.83 %


Average interest-bearing
liabilities:
Savings and interest-bearing
demand deposits                    $   454,578   $        3,624      1.07 %    $   423,578   $   4,469      1.41 %
Time certificates of deposit           579,437           13,160      3.04 %        557,997      12,856      3.08 %

Total deposits                       1,034,015           16,784      2.17 %        981,575      17,325      2.36 %

Federal funds purchased and
repurchase agreements                   46,634              359      1.03 %         62,618         874      1.86 %
Federal Home Loan Bank advances        154,047            4,115      3.57 %        153,914       3,812      3.31 %
Long-term debt and other                16,549              554      4.48 %         10,718         543      6.77 %

Total interest-bearing
liabilities                        $ 1,251,245   $       21,812      2.33 %    $ 1,208,825   $  22,554      2.49 %


Net interest income                              $       35,600                              $  29,566

Net interest margin (3)                                              3.27 %                                 3.31 %

(1) Loan fees included in interest income are not material.

(2) Includes interest income and discount realized on loan pool participations.

(3) Net interest margin is net interest income (computed on a tax-equivalent basis) divided by average total earning assets.

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. As the table below shows, the increase in net interest income was predominantly volume related.

. . .