The following presents management's discussion and analysis of the Company's consolidated results of operations, financial position and changes in condition. This review highlights the major factors affecting results of operations and any significant changes in financial condition for the two-year period ended December 31, 2008. It should be read in conjunction with the accompanying Consolidated Financial Statements included herein at pages F-1 through F-55 and other financial statistics appearing elsewhere in this annual report, as well as the section titled "Caution Regarding Forward-Looking Statements" set forth above in Item 1. Business.

Overview

The following discussion is provided for the consolidated operations of the Company, which as of December 31, 2008, includes its wholly-owned banking subsidiary, MidWestOne Bank, and its insurance subsidiary, MidWestOne Insurance Services, Inc. On March 14, 2008, the Company (which was at such time named ISB Financial Corp.) consummated its merger with the Former MidWestOne. At the time of the Merger, the Company had two wholly-owned banking subsidiaries-Iowa State Bank & Trust Company and First State Bank. At the time of the Merger, Former MidWestOne had one bank subsidiary, MidWestOne Bank; an insurance subsidiary, MidWestOne Insurance Services, Inc.; and an investment brokerage subsidiary, MidWestOne Investment Services, Inc., the operations of which were transferred to MidWestOne Bank substantially contemporaneous with the Merger. The Company operated the three bank subsidiaries from March 15, 2008 to August 9, 2008, at which time the three banks were consolidated under the charter of Iowa State Bank & Trust Company with the surviving bank renamed MidWestOne Bank. MidWestOne Insurance Services continues to operate as a separate subsidiary of the Company. The results of operations for the year ended December 31, 2007 include the Company's operations for such year and its two bank subsidiaries. The results of operations for the year ended December 31, 2008 include the Company and its two bank subsidiaries for the entire year plus the results of operation for the Former MidWestOne and its subsidiaries from March 15, 2008 through December 31, 2008. Because the Company was deemed to be the acquirer for purposes of applying purchase accounting, the discussion below compares the consolidated financial condition and results of operations of the Company and its subsidiaries as of and for the year ended December 31, 2008 the consolidated financial condition and results of operations of the Company (which at the time was referred to as ISB Financial Corp.) and its two subsidiaries as of and for the year ended December 31, 2007.

As explained above, because the Merger was consummated in 2008, the Company's financial information for fiscal year 2007 does not include any of the financial information attributable to the Former MidWestOne or its subsidiaries, but the Company's financial information for fiscal year 2008 does include the Former MidWestOne operations (except, as noted above, for the operations of the Former MidWestOne between January 1, 2008 and March 14, 2008). Prior to the Merger, the Company and the Former MidWestOne were comparable in total size; thus, the comparison of the Company's 2008 financial information to its 2007 financial information often shows significant changes, which generally makes the year-to-year changes significantly larger than they generally would be expected for a company that has not undergone a significant merger during the year.

Critical Accounting Estimates

The Company has identified five critical accounting policies and practices relative to the reporting of its results of operation and financial condition. These five accounting policies relate to the allowance for loan losses, participation interests in loan pools, application of purchase accounting, goodwill and intangible assets, and fair value of available for sale investment securities.

Allowance for Loan Losses

The allowance for loan losses is based on management's estimate. Management believes the allowance for loan losses is adequate to absorb probable losses in the existing portfolio. In evaluating the portfolio, management takes into consideration numerous factors, including current economic conditions, prior loan loss experience, the composition of the loan portfolio, and management's estimate of probable credit losses. The allowance for loan losses is established through a provision for loss based on management's evaluation of the risk inherent in the loan portfolio, the composition of the portfolio, specific impaired loans, and current economic conditions. Such evaluation, which includes a review of all loans on which full collectability may not be reasonably assured, considers, among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loss experience, and other factors that warrant recognition in providing for an adequate allowance for loan losses. In the event that management's evaluation of the level of the allowance for loan losses is inadequate, the Company would need to increase its provision for loan losses.

Participation Interests in Loan Pools

The loan pool accounting practice relates to management's estimate that the investment amount reflected on the Company's financial statements does not exceed the estimated net realizable value or the fair value of the underlying collateral securing the purchased loans. In evaluating the purchased loan pool, management takes into consideration many factors, including the borrowers' current financial situation, the underlying collateral, current economic conditions, historical collection experience, and other factors relative to the collection process. If the estimated net realizable value of the loan pool participations is overstated, the Company's yield on the loan pools would be reduced.

Application of Purchase Accounting

We completed the acquisition of the former MidwestOne Financial Group, Inc., which generated significant amounts of goodwill and intangible assets and related amortization. The values assigned to goodwill and intangibles, as well as their related useful lives, are subject to judgment and estimation by our management. Goodwill and intangibles related to acquisitions are determined and based on purchase price allocations. Valuation of intangible assets is generally based on the estimated cash flows related to those assets, while the initial value assigned to goodwill is the residual of the purchase price over the fair value of all identifiable assets acquired and liabilities assumed. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment loss would be recorded in an amount equal to that excess. Performing such a discounted cash flow analysis involves the use of estimates and assumptions. Useful lives are determined based on the expected future period of the benefit of the asset, the assessment of which considers various characteristics of the asset, including the historical cash flows. Due to the number of estimates involved related to the allocation of purchase price and determining the appropriate useful lives of intangible assets, we have identified purchase accounting as a critical accounting policy.

Goodwill and Intangible Assets

Goodwill and intangible assets arise from purchase business combinations. On March 14, 2008, we completed our merger with the former MidWestOne. We were deemed to be the purchaser for accounting purposes and thus recognized goodwill and other intangible assets in connection with the merger. The goodwill was assigned to our one reporting unit, banking. As a general matter, goodwill and other intangible assets generated from purchase business combinations and deemed to have indefinite lives are not subject to amortization and are instead tested for impairment at least annually. Core deposit and customer relationship intangibles arising from acquisitions are being amortized over their estimated useful lives of up to 10 years.

In 2008, the extreme volatility in the banking industry that first started to surface in the latter part of 2007 had a significant impact on banking companies and the price of banking stocks, including our common stock. At December 31, 2008, our market capitalization was less than our total shareholders' equity, providing an indication that goodwill may be impaired as of such date. Thus, the Company performed an impairment analysis as a result of the significant decline in its stock price. Based on this analysis, we wrote off $27.3 million of goodwill in the fourth quarter of 2008, which represented all of the goodwill that resulted from the Merger. Such charge had no effect on the Company's or the Bank's cash balances or liquidity. In addition, because goodwill and other intangible assets are not included in the calculation of regulatory capital, the Company's and the Bank's December 31, 2008 regulatory ratios were not adversely affected by this non-cash expense and exceeded the minimum amounts required to be considered "well-capitalized."

Our other intangible assets are core deposit and customer relationship intangibles. The establishment and subsequent amortization of these intangible assets requires several assumptions including, among other things, the estimated cost to service deposits acquired, discount rates, estimated attrition rates and useful lives. We assess these intangible assets for impairment quarterly. If the value of the core deposit intangible or the customer relationship intangible is determined to be less than the carrying value in future periods, a writedown would be taken through a charge to our earnings. The most significant element in evaluation of these intangibles is the attrition rate of the acquired deposits or loans. If such attrition rate were to accelerate from that which we expected, the intangible may have to be reduced by a charge to earnings. The attrition rate related to deposit flows or loan flows is influenced by many factors, the most significant of which are alternative yields for loans and deposits available to customers and the level of competition from other financial institutions and financial services companies.

Fair Value of Available for Sale Securities

Securities available for sale are reported at fair value, with unrealized gains and losses reported as a separate component of accumulated other comprehensive income, net of deferred income taxes. Declines in fair value of individual securities, below their amortized cost, are evaluated by management to determine whether the decline is temporary or "other than temporary." Declines in the fair value of available for sale securities below their cost that are deemed "other than temporary" are reflected in earnings as impairment losses. In estimating "other than temporary" impairment losses, management considers a number of factors including: (1) the length of time and extent to which the fair value has been less than cost; (2) the financial condition and near-term prospects of the issuer; and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Summary of Performance

For the year ended December 31, 2008, the Company recorded a net loss of $24,562,000, or a loss of $3.09 per share basic and diluted. This compares with net income of $6,648,000, or $1.29 per share basic and diluted, for the year ended December 31, 2007. The Company's significant net loss in 2008 was primarily attributable to two one-time charges totaling $33.5 million that were recognized in the fourth quarter. The first was a $27.3 million non-cash goodwill impairment charge; this goodwill represented all of the goodwill that was recognized as a result of the Merger. The second was a $6.2 million (pre-tax) "other than temporary impairment" charge to the Company's investment securities portfolio as a result of the decline in the market value of certain debt securities secured by pools of trust preferred securities issued by multiple banks and insurance companies. If these two charges were excluded from the Company's earnings, the Company would have had earnings for the year ended December 31, 2008 of $6.6 million, or $0.76 basic and diluted earnings per share. The Company's net interest income for the year ended December 31, 2008 was $39,811,000 as compared to net interest income for the year ended December 31, 2007 of $19,267,000, an increase of 106.6% that resulted primarily from the Merger. This increase in net interest income was offset in part, however, by an increase in noninterest expense (excluding the aggregate $27.3 million charge due to the goodwill impairment) of $20,960,000 and an increase in the provision for loan losses of $3,866,000.

Total assets of the Company increased $806,979,000, or 115.0%, to $1,508,962,000 as of December 31, 2008 from $701,983,000 as of December 31, 2007, with $784,461,000 of the increase in total assets resulting from the Merger. The Company's total loans outstanding (excluding loan pool participations) increased $613,260,000, or 152.7%, to $1,014,814,000 at December 31, 2008 from $401,554,000 at December 31, 2007. Approximately 87.4% of the increase in total loans was a result of the Merger; the remainder came from organic loan growth generated by the Company in 2008. The Company's deposits increased $601,574,000, or 114.2%, to $1,128,189,000 as of December 31, 2008 from $526,615,000 at December 31, 2007. Approximately 95.5% of the increase in deposits was a result of the Merger; the remainder came from organic deposit growth generated by the Company in 2008.

Various operating and equity ratios for the Company are presented in the table below for the years indicated. Due to the significant net loss recognized by the Company for the year ended December 31, 2008 as a result of the $27.3 million goodwill impairment charge and the $6.2 million other-than-temporary impairment charge to the Company's investment securities portfolio, the Company's return on average assets and return on equity were negative in 2008, as shown in the table below. The dividend payout ratio represents the percentage of the Company's prior year's net income that is paid to shareholders in the form of cash dividends. Average equity to average assets is a measure of capital adequacy that presents the percentage of average total shareholders' equity compared to the average assets of the Company. The equity to assets ratio expresses this ratio using the period-end amounts instead of on an average basis.

                                            12/31/08         12/31/07       12/31/06       12/31/05

Return on average total assets                  (1.61 ) %         0.98 %         0.87 %         1.06 %
Return on average equity                       (15.96 )           8.83           8.16          10.27
Dividend payout ratio                           59.49            57.90          23.96          20.53
Average equity to average assets                10.10            10.94          10.62          10.32
Equity to assets ratio (at period end)           8.66            11.02          10.95          10.30

Results of Operations

Net Interest Income

Net interest income is the total of interest income earned on earning assets less interest expense paid on interest bearing liabilities. Net interest income is affected by changes in the volume and yields on earning assets and the volume and rates paid on interest-bearing liabilities. Net interest margin is a measurement, expressed as a ratio, of the net return on interest earning assets computed by dividing net interest income on a tax-equivalent basis by the annual average balance of all interest earning assets.

Net interest income for the year ended December 31, 2008 totaled $39,811,000, an increase of $20,544,000, or 106.6%, compared with the $19,267,000 of net interest income for the year ended December 31, 2007. This increase was due primarily to the greater loan volumes as a result of the Merger followed by a wider net interest margin resulting from a steepening of the yield curve between December 31, 2007 and December 31, 2008. The net interest margin (on a tax-equivalent basis) increased during 2008 to 3.28% compared with 3.27% for 2007 as the increase in net interest income was proportionately greater than the increase in average earning assets.

Total interest income increased $31,901,000, or 83.3%, for the year ended December 31, 2008 compared with the year ended December 31, 2007. This increase in interest income was experienced in all earning asset categories (loans, investment securities and federal funds sold and interest-bearing balances) and was primarily a result of the Merger. Interest income on loans totaled $53,104,000 for 2008, an increase of $25,540,000 or 92.7%, compared to 2007. The higher interest income on loans was due primarily to growth in loan volumes as a result of the Merger, partially offset by lower market interest rates. The decrease in the national prime rate has affected the Company as the overall average rate on the total loan portfolio decreased to 5.94% for the year ended December 31, 2008 compared with 7.11% for the year ended December 31, 2007. The average volume of loans outstanding for 2008 was $502,589,000 greater than the average volume of loans for 2007. Most of this increase was due to the Merger. Interest income on investment securities increased $2,109,000, or 20.7%, in 2008 to $12,302,000. This compares with $10,193,000 in 2007. The average balance of investment securities increased $47,462,000. Most of this increase was a result of the Merger, but such increase was partially offset by the proceeds from maturing investment securities utilized to fund loan growth. The average tax-equivalent yield on the investment portfolio decreased slightly to 4.90% for the year ended December 31, 2008 compared to 4.91% for the year ended December 31, 2007, as higher-yielding securities matured and were replaced with securities having a lower interest rate due to the overall decline in market interest rates in 2008. The overall yield on earning assets decreased to 5.68% for the year ended December 31, 2008 from 6.25% for the year ended December 31, 2007, while total earning assets averaged $1,262,392,000 for the year ended December 31, 2008, or $624,871,000 higher than for the year ended December 31, 2007.

The growth in deposits and federal funds purchased, which growth was attributable primarily to the Merger, contributed to an increase in total interest expense for the year ended December 31, 2008 when compared to the year ended December 31, 2007. Total interest expense increased $11,357,000, or 59.7%, for 2008 to $30,395,000, up from $19,038,000 for 2007. Total deposits averaged $453,402,000 higher for 2008 compared with 2007, while the average rate paid on these deposits during 2008 decreased to 2.59% from 3.35% for 2007. Interest expense on deposits was $23,157,000 for the year ended December 31, 2008, an increase of $8,359,000, or 56.5%, from the $14,798,000 in interest expense for the year ended December 31, 2007. The primary factor contributing to this increase in interest expense on deposits was the large increase in the balance of outstanding deposits resulting from the Merger. This increase in interest expense was offset partially by decreases in the average rate paid on deposits due to the overall declined in market interest rates in 2008. For the year ended December 31, 2008, the Company averaged $55,069,000 in federal funds purchased and repurchase agreements compared with $49,629,000 for 2007. Interest expense on federal funds purchased and repurchase agreements decreased $992,000 to $1,122,000 for 2008 compared with $2,114,000 for 2007. This was also primarily due to the Merger, offset partially by decreases in market interest rates. The interest rates on federal funds purchased and repurchase agreements correlate directly with the actions taken by the Federal Reserve in lowering the discount rate during 2008. The average rate paid by the Company on federal funds purchased and repurchase agreements decreased to 2.04% for the year ended December 31, 2008 compared with 4.26% for the year ended December 31, 2007, which decreased interest expense. The average balance of Federal Home Loan Bank advances was $91,803,000 higher for the year ended December 31, 2008, while the average rate paid decreased to 3.93% for 2008 from 4.58% for 2007. The increase in Federal Home Loan Bank advances was due primarily to the Merger.

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 years indicated. Interest income on tax-exempt securities is reported on a fully tax-equivalent basis assuming a 34% tax rate. Dividing income or expense by the average balances of assets or liabilities results in such yields and costs. Nonaccrual loans are included in the loan category.

                                                         Year ended December 31,
                                            2008                                          2007
                                           Interest        Average                      Interest       Average
                           Average        Income(2)/        Rate/         Average       Income/         Rate/
                           Balance         Expense          Yield         Balance       Expense         Yield
                                                         (dollars in thousands)
Average earning
assets:
Loans(1)                 $   893,451     $     53,104           5.94 %   $ 390,862     $   27,771           7.11 %
Loan pool
participations                72,558            4,459           6.15             -              -              -
Investment securities:
Taxable investments          180,787            8,222           4.55       163,608          7,552           4.62
Tax exempt investments       102,035            5,625           5.51        71,752          4,001           5.58
Total investment
securities                   282,822           13,847           4.90       235,360         11,553           4.91
Federal funds sold and
interest-bearing
balances                      13,561              341           2.51        11,299            548           4.85
Total earning assets     $ 1,262,392     $     71,751           5.68 %   $ 637,521     $   39,872           6.25 %

Average
interest-bearing
liabilities:
Savings and
interest-bearing
demand deposits          $   392,603     $      5,511           1.40 %   $ 193,044     $    3,109           1.61 %
Time Certificates of
deposit                      502,220           17,646           3.51       248,377         11,689           4.71
Total deposits               894,823           23,157           2.59       441,421         14,798           3.35
Federal funds
purchased and
repurchase agreements         55,069            1,122           2.04        49,629          2,114           4.26
Federal Home Loan Bank
advances                     135,984            5,348           3.93        44,181          2,023           4.58
Long-term debt and
other                         11,968              768           6.42         1,582            103           6.51

Total interest-bearing
liabilities              $ 1,097,844     $     30,395           2.77 %   $ 536,813     $   19,038           3.55 %
Net interest income                      $     41,356           2.92 %                 $   20,834           2.71 %
Net interest margin
(3)                                                             3.28 %                                      3.27 %

(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.

                                                            Year ended December 31,
                                                             2008 Compared to 2007
                                                          Increase/ (Decrease) Due to
                                                       Volume         Rate           Net
                                                                 (in thousands)
Interest income from average earning assets:
Loans                                                $   29,022     $  (3,689 )   $  25,333
Investment securities:
Taxable investments                                         779          (109 )         670
Tax exempt investments                                    1,669           (45 )       1,624
Total investment securities                               2,448          (154 )       2,294
Federal funds sold and interest-bearing balances            147          (354 )        (207 )
Total income from earning assets                         31,618        (4,198 )      27,420

Interest expense from average interest-bearing
liabilities:
Savings and interest-bearing demand deposits             (3,969 )       6,371         2,402
Time Certificates of deposit                              7,921        (1,964 )       5,957
Total deposits                                            3,952         4,407         8,359
Federal funds purchased and repurchase agreements           264        (1,256 )        (992 )
Federal Home Loan Bank advances                           3,567          (242 )       3,325
Other long-term debt                                        666            (1 )         665
Total expense form interest-bearing liabilities           8,449         2,908        11,357
Net interest income                                  $   23,169     $  (7,106 )   $  16,063



                                                      Year ended December 31,
                                         2007                                        2006
                                       Interest       Average                      Interest       Average
                         Average       Income/         Rate/         Average       Income/         Rate/
                         Balance       Expense         Yield         Balance       Expense         Yield
                                                      (dollars in thousands)
Average earning
assets:
Loans                   $ 390,862     $   27,771           7.11 %   $ 381,269     $   26,024           6.83 %
Investment
securities:
Taxable investments       163,608          7,552           4.62       183,057          7,076           3.87
Tax exempt
investments                71,752          4,001           5.58        62,888          3,181           5.06
Total investment
securities                235,360         11,553           4.91       245,945         10,257           4.17
Federal funds sold
and interest-bearing
. . .