Those are some very impressive models indeed. I could never commit myself to such an endeavour even if I had the skill, which I'm far from having.
About the background of the army, I'd think that to fit a properly sized island in a river, it'd have to be somewhere far down the Reik for the river to be wide enough. Somewhere not far from Marienburg would put it as close as possible to Bretonnia as well. Since that part of the Reik is the border between Reikland and Middenland, that gives me an idea.
How about: Herr von Panama (placeholder name) was of noble birth but from a cadet branch of a cadet branch, and thus the last guy in his branch to actually be landed was five generations above him. As is common for noblemen in such a situation, he went for a military career, in which his success brought him some amount of riches, but something else too. On campaign, he encountered and noticed the Arabyan Tajir ibn al-Tajir (another placeholder name), a minor trader of untapped business genius. With Herr von Panama providing startup capital and Tajir using it to conduct business from Marienburg while Herr von Panama was out warring, they were soon filthy rich. Rich enough that they could have retired to live the decadent life, but Herr von Panama had aspirations for more, to be a landed noble again. He remembered having seen a number of times an archipelago in the Reik river some distance upriver from Marienburg, approximately where the ill-defined border between the Wasteland and the Empire is usually considered to be. The islands were lush and fertile and he wondered why nobody had ever settled them. He set out to find out who the islands belonged to. What he found out was interesting indeed. Neither Reikland nor Middenland claimed them. On the contrary, the fiefdom and land ownership registries of both electorates simply assumed the islands belonged to the other. Seeing an opportunity, he simply moved in and claimed the islands for himself. Rather than fight for others, he decided to gather around his most loyal veterans and settle them on the islands as his own private military company. His knights were granted fiefs. His infantrymen were granted rent-free use of farmland while not campaigning. Given this arrangement, the islands are really an aristocratic vanity and a money sink for him, but Tajir manages business and keeps the money to pay for it rolling it, as well as acts as regent for the islands when Herr von Panama is out warring. Lending his privately funded company to the service of the Empire, he managed to accumulate such a reputation and such an amount of goodwill that when the legal status of his islands eventually was found out, Karl Franz and Boris Todbringer just decided to let him be and kept pretending not to notice.