SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

Commission File Number: 0-18415

Isabella Bank Corporation

(Exact name of registrant as specified in its charter)

Michigan		38-2830092
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		identification No.)

401 N. Main Street, Mt. Pleasant, Michigan 48858

Registrant’s telephone number, including area code (989) 772-9471

Securities registered pursuant to Section 12(b) of the Act:

Title of each class		Name of each exchange on which registered

Securities registered pursuant to Section 12(g) of the Act:

Common Stock — No Par Value

(Title of Class)

Indicated by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o Yes þ No

Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

o Yes þ No

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.

þ Yes o 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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

o Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

þ

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 “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check One).

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes þ No

The aggregate market value of the voting stock held by non-affiliates of the registrant was $142,705,542 as of the last business day of the registrant’s most recently completed second fiscal quarter.

The number of shares outstanding of the registrant’s Common Stock (no par value) was 7,540,301 as of February 19, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

(Such documents are incorporated herein only to the extent specifically set forth in response to an item herein.)

Documents		Part of Form 10-K Incorporated into
Isabella Bank Corporation Proxy Statement
for its Annual Meeting of Shareholders		Part III
to be held May 4, 2010

 

 

ISABELLA BANK CORPORATION
ANNUAL REPORT ON FORM 10-K
Table of Contents

PART I					3
Item 1		Business			3
Item 1A		Risk Factors			8
Item 1B		Unresolved Staff Comments			10
Item 2		Properties			10
Item 3		Legal Proceedings			10
PART II					10
Item 4		Market for Registrant’s Common Equity, Related Shareholders’ Matters and Issuer Purchases of Equity Securities			10
Item 5		Selected Financial Data			13
Item 6		Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 6A		Quantitative and Qualitative Disclosures about Market Risk			33
Item 7		Financial Statements and Supplementary Data			35
Item 8		Changes in and Disagreements With Accountants and Accounting and Financial Disclosure			80
Item 8A		Controls and Procedures			80
Item 8B		Other Information			81
PART III					81
Item 9		Directors, Executive Officers and Corporate Governance			81
Item 10		Executive Compensation			81
Item 11		Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters			81
Item 12		Certain Relationships and Related Transactions, and Director Independence			82
Item 13		Principal Accountant Fees and Service			82
PART IV					83
Item 14		Exhibits and Financial Statement Schedules			83
SIGNATURES					85
EX-21
EX-23
EX-31.A
EX-31.B
EX-32

Part I

Item 1. Business (All dollars in thousands)

General

Isabella Bank Corporation (the “Corporation”) is a registered financial services holding company incorporated in September 1988 under Michigan law. The Corporation has three subsidiaries: Isabella Bank (the “Bank”), IB&T Employee Leasing, LLC, and Financial Group Information Services. Isabella Bank has twenty four banking offices located throughout Clare, Gratiot, Isabella, Mecosta, Montcalm, and Saginaw Counties. IB & T Employee Leasing, LLC, is an employee leasing company. Financial Group Information Services renders computer services to the Corporation and its subsidiaries. All employees of the Corporation are employed by IB&T Employee Leasing and are leased to each individual subsidiary. The principal city in which the Corporation operates is Mount Pleasant, Michigan which has a population of approximately 26,000. Markets served include Isabella, Gratiot, Mecosta, southwestern Midland, western Saginaw, Montcalm, and southern Clare counties of Michigan. The area includes significant agricultural production, light manufacturing, retail, gaming and tourism, and five universities.

On January 1, 2008, the Corporation acquired Greenville Community Financial Corporation (GCFC). This acquisition helped the Corporation expand its market area. For further discussion, see “Note 2 — Business Combinations and Joint Venture Formation” of Notes to Consolidated Financial Statements.

On March 1, 2008, IBT Title and Insurance Agency, Inc. (IBT Title), a wholly owned subsidiary of Isabella Bank Corporation, merged its assets and liabilities with those of Corporate Title Agency, LLC (“Corporate Title”), a third-party title business based in Traverse City, Michigan, to form CT/IBT Title Agency, LLC. As a result of this transaction, the Corporation became a 50 percent joint venture owner in CT/IBT Title Agency, LLC. The purpose of this joint venture was to help IBT Title and Insurance Agency, Inc. expand its service area and to take advantage of economies of scale. For further discussion, see “Note 2 — Business Combinations and Joint Venture Formation” of Notes to Consolidated Financial Statements.

The Bank sponsors the IBT Foundation (the “Foundation”), which is a nonprofit entity formed for the purpose of distributing charitable donations to recipient organizations generally located in the communities serviced by the Bank. The Bank periodically makes charitable contributions in the form of cash transfers to the Foundation. The Foundation is administered by members of the Bank’s Board of Directors. The assets and transactions of the Foundation are not included in the consolidated financial statements of Isabella Bank Corporation. The assets of the Foundation as of December 31, 2009 were $985.

The Corporation’s reportable segments are based on legal entities that account for at least 10 percent of net operating results. Retail banking operations for 2009, 2008, and 2007 represent approximately 90% or greater of the Corporation’s total assets and operating results. As such, the Corporation has only one reportable segment.

Competition

The Corporation competes with other commercial banks, many of which are subsidiaries of other bank holding companies, savings and loan associations, mortgage brokers, finance companies, credit unions, and retail brokerage firms. The Bank is a community bank with a focus on providing high-quality, personalized service at a fair price. The Bank offers a broad array of banking services to businesses, institutions, and individuals. Deposit services offered include checking accounts, savings accounts, certificates of deposit, direct deposits, cash management services, mobile and internet banking, electronic bill pay services, and automated teller machines. Lending activity includes loans made pursuant to lines of credit, real estate loans, agricultural loans, consumer loans, and credit card loans. Other financial related products include trust services, stocks, investment securities, bonds and mutual fund sales.

Lending

The Bank limits lending activities primarily to local markets and has not purchased any loans from the secondary market. The Bank does not make loans to fund leveraged buyouts, has no foreign corporate or government loans, and has limited holdings of corporate debt securities. The general lending philosophy is to avoid concentrations to individuals and business segments. The following table sets forth the composition of the Corporation’s loan portfolio as of December 31, 2009:

LOANS BY MAJOR LENDING CATEGORY
(in thousands)		Amount				%
Residential real estate
1 to 4 family residential		$	272,570				37.69	%
Construction and land development			13,268				1.83	%
Total			285,838				39.52	%
Commercial
Real estate			224,176				30.99	%
Farmland			38,236				5.29	%
Agricultural production			26,609				3.68	%
Commercial operating and other			116,098				16.05	%
Total			405,119				56.01	%
Other consumer installment			32,359				4.47	%
TOTAL		$	723,316				100.00	%

There were no significant changes in loan concentrations or underwriting standards in 2009.

First and second residential real estate mortgages are the single largest category of loans. The Corporation, through its Bank, offers adjustable rate mortgages, 3 and 5 year fixed rate balloon mortgages, and fixed rate mortgage loans which typically have amortization periods up to a maximum of 30 years. Fixed rate loans with an amortization of greater than 15 years are generally sold upon origination to the Federal Home Loan Mortgage Association. Fixed rate residential mortgage loans with an amortization of 15 years or less may be held in the Bank’s portfolio, held for future sale, or sold upon origination. Factors used in determining when to sell these mortgages include management’s judgment about the direction of interest rates, the Corporation’s need for fixed rate assets in the management of its interest rate sensitivity, and overall loan demand.

Lending policies generally limit the maximum loan-to-value ratio on residential mortgages to 95% of the lower of the appraised value of the property or the purchase price, with the condition that private mortgage insurance is required on loans with loan-to-value ratios in excess of 80%. Substantially all loans upon origination have a loan-to-value ratio of less than 80%. Underwriting criteria for residential real estate loans include: evaluation of the borrower’s ability to make monthly payments, the value of the property securing the loan, ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income, all debt servicing does not exceed 36% of income, acceptable credit reports, verification of employment, income, and financial information. Appraisals are performed by independent appraisers. Escrow accounts for taxes and insurance are required on all loans with loan-to-value ratio in excess of 80%. All mortgage loan requests are reviewed by a mortgage loan committee; loans in excess of $400 require the approval of the Bank’s Internal Loan Committee, Board of Directors, or its loan committee.

Construction and land development loans consist primarily of 1 to 4 family residential properties. These loans primarily have a 6 to 9 month maturity and are made using the same underwriting criteria as residential mortgages. Loan proceeds are disbursed in increments as construction progresses and inspections warrant. Construction loans are typically converted to permanent loans at the completion of construction.

Commercial loans include loans for commercial real estate, farmland and agricultural production, state and political subdivisions, and commercial operating loans. The largest concentration of commercial loans is commercial real estate, which represented 30.99% of total loans as of December 31, 2009. Repayment of commercial loans is often dependent upon the successful operation and management of a business; thus, these loans generally involve greater risk than other types of lending. The Corporation minimizes its risk by limiting the amount of loans to any one borrower to $12,500. Borrowers with credit needs of more than $12,500 are serviced through the use of loan participations with other commercial banks. All commercial real estate loans require loan-to-value limits of less than 80%. Depending upon the type of loan, past credit history, and current operating results, the Corporation may require the borrower to pledge accounts receivable, inventory, and fixed assets. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and proprietorships. In addition, the Corporation requires annual financial statements, prepares cash flow analyses, and reviews credit reports as deemed necessary.

Consumer loans granted include automobile loans, secured and unsecured personal loans, credit cards, student loans, and overdraft protection related loans. Loans are amortized generally for a period of up to 6 years. The underwriting emphasis is on a borrower’s ability to pay rather than collateral value. No consumer loans are sold to the secondary market.

Supervision and Regulation

The Corporation is subject to supervision and regulation by the Securities and Exchange Commission under the Securities Act of 1933 and the Securities Exchange Act of 1934 and by the Federal Reserve Board under the Bank Holding Company Act of 1956 as amended (“BHC Act”) and Financial Services Holding Company Act of 2000. A bank holding company and its subsidiaries are able to conduct only the business of commercial banking and activities closely related or incidental to commercial banking. (See “Regulation” below)

Isabella Bank is chartered by the State of Michigan and is a member of the Federal Reserve System. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The Bank is a member of the Federal Home Loan Bank of Indianapolis. The Bank is supervised and regulated by the Michigan Office of Financial and Insurance Regulation (OFIR) and the Federal Reserve Board. (See “Regulation” below)

Personnel

As of December 31, 2009, the Corporation and its subsidiaries had 335 full-time equivalent leased employees. The Corporation provides group life, health, accident, disability and other insurance programs for employees and a number of other employee benefit programs. The Corporation believes its relationship with its employees to be good.

Legal Proceedings

There are various claims and lawsuits in which the Corporation and its subsidiaries are periodically involved, such as claims to enforce liens, condemnation proceedings on making and servicing of real property loans and other issues incidental to the Corporation’s business. However, the Corporation and its subsidiaries are not involved in any material pending litigation.

AVAILABLE INFORMATION

The Corporation’s SEC filings (including the Corporation’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Definitive Proxy Statements, Current Reports on Form 8-K and amendments to those reports) are available through Isabella Bank’s website (www.isabellabank.com). The Corporation will provide paper copies of its SEC reports free of charge upon request of a shareholder.

The SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding the Corporation (CIK #0000842517) and other issuers.

REGULATION

The earnings and growth of the banking industry and therefore the earnings of the Corporation and of the Bank are affected by the credit policies of monetary authorities, including the Federal Reserve System. An important function of the Federal Reserve System is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve System to implement these objectives are open market operations in U.S. Treasury and U.S. Government Agency securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve System have had a significant effect on the operating results of commercial banks and related financial service providers in the past and are expected to continue to do so in the future. The effect of such policies upon the future business and earnings of the Corporation and the Bank cannot be predicted.

The Corporation

The Corporation, as a financial services holding company, is regulated under the BHC Act, and is subject to the supervision of the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). The Corporation is registered as a financial services holding company with the Federal Reserve Board and is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board requires. The Federal Reserve Board may also make inspections and examinations of the Corporation and its subsidiaries.

Prior to March 13, 2000, a bank holding company generally was prohibited under the BHC Act from acquiring the beneficial ownership or control of more than 5% of the voting shares or substantially all the assets of any company, including a bank, without the Federal Reserve

Board’s prior approval. Also, prior to March 13, 2000, a bank holding company generally was limited to engaging in banking and such other activities as determined by the Federal Reserve Board to be closely related to banking.

Under the Gramm-Leach-Bliley Act of 1999 (“GLB Act”), beginning March 13, 2000, an eligible bank holding company was able to elect to become a financial holding company and thereafter affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. The GLB Act defines “financial in nature” to include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; activities that the Federal Reserve Board has determined to be closely related to banking; and other activities that the Federal Reserve Board, after consultation with the Secretary of the Treasury, determines by regulation or order to be financial in nature or incidental to a financial activity. No Federal Reserve Board approval is required for a financial holding company to acquire a company, other than a bank holding company, bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as defined in the GLB Act or as determined by the Federal Reserve Board.

A bank holding company is eligible to become a financial holding company if each of its subsidiary banks and savings associations is well capitalized under the prompt corrective action provisions of the Federal Deposit Insurance Act (“FDI Act”), is well managed and has a rating under the Community Reinvestment Act (CRA) of satisfactory or better. If any bank or savings association subsidiary of a financial holding company ceases to be well capitalized or well managed, the Federal Reserve Board may require the financial holding company to divest the subsidiary. Alternatively, the financial holding company may elect to conform its activities to those permissible for bank holding companies that do not elect to become financial holding companies. If any bank or savings association subsidiary of a financial holding company receives a CRA rating of less than satisfactory, the financial holding company will be prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations.

The Corporation became a financial holding company effective March 13, 2000. It continues to maintain its status as a bank holding company for purposes of other Federal Reserve Board regulations.

Under Federal Reserve Board policy, the Corporation is expected to act as a source of financial strength to its subsidiary Bank and to commit resources to support its subsidiaries. This support may be required at times when, in the absence of such Federal Reserve Board policy, the Corporation would not otherwise be required to provide it.

Under Michigan law, if the capital of a Michigan state chartered bank (such as the Bank) has become impaired by losses or otherwise, the Commissioner of the OFIR may require that the deficiency in capital be met by assessment upon the bank’s shareholders pro rata on the amount of capital stock held by each, and if any such assessment is not paid by any shareholder within 30 days of the date of mailing of notice thereof to such shareholder, cause the sale of the stock of such shareholder to pay such assessment and the costs of sale of such stock.

Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. This priority would apply to guarantees of capital plans under the Federal Deposit Insurance Corporation Improvement Act of 1991.

The Sarbanes-Oxley Act of 2002 (“SOX”) contains important requirements for public companies in the area of financial disclosure and corporate governance. In accordance with Section 302(a) of SOX, a written certification by the Corporation’s principal executive and financial officer is required. This certification attests that the Corporation’s quarterly and annual reports filed with the SEC do not contain any untrue statement of a material fact. See the Certifications filed as Exhibits 31 (a) and (b) to this Form 10-K for such certification of the financial statements and other information for this 2009 Form 10-K. The Corporation has also implemented a program designed to comply with Section 404 of SOX, which included the identification of significant processes and accounts, documentation of the design of control effectiveness over process and entity level controls, and testing of the operating effectiveness of key controls. See Item 8A, “Controls and Procedures” for the Corporation’s evaluation of its disclosure controls and procedures.

The Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted in October, 2008. Pursuant to authority under EESA, the U.S. Treasury created the Troubled Asset Relief Program (TARP) Capital Purchase Program. After carefully reviewing the Corporation’s capital position, the cost of the federal government’s capital, the terms and conditions of participating in the TARP Capital Purchase Program, and the consequences of having the U.S. Treasury as a preferred stock shareholder, management and the Corporation’s Board of Directors decided it would not be in the best interests of the Corporation’s shareholders to participate in the program.

Certain additional information concerning regulatory guidelines for capital adequacy and other regulatory matters is presented herein under the caption “Capital” on page 29 and in the notes to the consolidated financial statements “Note 15 — Commitments and Other Matters” and “Note 16 — Minimum Regulatory Capital Requirements”.

Subsidiary Bank

The Bank is subject to regulation and examination primarily by OFIR and is also subject to regulation and examination by the Federal Reserve Board.

The agencies and federal and state laws extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits and the safety and soundness of banking practices.

The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the Federal Deposit Insurance Corporation (“FDIC”) and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that assesses insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating.

During 2009, the FDIC assessed a 10 basis point surcharge on covered liabilities that was payable as of June 30, 2009, required the prepayment of the estimated 2010, 2011 and 2012 premiums and raised the base assessment rate by 3 basis points, effective for 2010.

The enactment of EESA temporarily raised the basic limit on federal deposit insurance coverage from $100 to $250 per depositor. The temporary increase in deposit insurance coverage became effective on October 3, 2008. EESA provides that the basic deposit insurance limit will return to $100 on January 1, 2014, except for Individual Retirement Accounts and certain other retirement accounts, which will remain at $250 per depositor.

Banking laws and regulations also restrict transactions by insured banks owned by a bank holding company, including loans to and certain purchases from the parent holding company, non-bank and bank subsidiaries of the parent holding company, principal shareholders, officers, directors and their affiliates, and investments by the subsidiary bank in the shares or securities of the parent holding company (or any of the other non-bank or bank affiliates), or acceptance of such shares or securities as collateral security for loans to any borrower.

The Bank is also subject to legal limitations on the frequency and amount of dividends that can be paid to the Corporation. For example, a Michigan state chartered bank may not declare a cash dividend or a dividend in kind except out of net profits then on hand after deducting all losses and bad debts, and then only if it will have a surplus amounting to not less than 20% of its capital after the payment of the dividend. Moreover, a Michigan state chartered bank may not declare or pay any cash dividend or dividend in kind until the cumulative dividends on its preferred stock, if any, have been paid in full. Further, if the surplus of a Michigan state chartered bank is at any time less than the amount of its capital, before the declaration of a cash dividend or dividend in kind, it must transfer to surplus not less than 10% of its net profits for the preceding half-year (in the case of quarterly or semi-annual dividends) or the preceding two consecutive half-year periods (in the case of annual dividends).

The payment of dividends by the Corporation and the Bank is also affected by various regulatory requirements and policies, such as the requirement to maintain adequate capital above regulatory guidelines. Federal laws impose further restrictions on the payment of dividends by insured banks that fail to meet specified capital levels. The FDIC may prevent an insured bank from paying dividends if the bank is in default of payment of any assessment due to the FDIC. In addition, payment of dividends by a bank may be prevented by the applicable federal regulatory authority if such payment is determined, by reason of the financial condition of such bank, to be an unsafe and unsound banking practice. The Federal Reserve Board and the FDIC have issued policy statements providing that bank holding companies and insured banks should generally pay dividends only out of current operating earnings. Additionally in 2009, the FRB Board of Governors required the Corporation to notify the FRB prior to increasing its cash dividend by more than 10% over the prior year.

The aforementioned regulations and restrictions may limit the Corporation’s ability to obtain funds from its subsidiary bank for its cash needs, including payment of dividends and operating expenses.

The activities and operations of the Bank are also subject to other federal and state laws and regulations, including usury and consumer credit laws, the Federal Truth-in-Lending Act, Truth-in-Saving and Regulation Z of the Federal Reserve Board, the Federal Bank Merger Act, and the Bank Secrecy Act.

Item 1A. Risk Factors

In the normal course of business the Corporation is exposed to various risks. These risks include credit risk, interest rate risk, liquidity risk, operational risk, compliance risk, economic risk, accounting risk, disruption of infrastructure, and increases in FDIC insurance premiums. These risks, if not managed correctly, could have a significant impact on earnings and capital of the Corporation. Management balances the Corporation’s strategic goals, including revenue and profitability objectives, with associated risks through the use of policies, systems, and procedures which have been adopted to identify, assess, control, monitor, and manage each risk area. Senior management continually reviews the adequacy and effectiveness of these policies, systems, and procedures.

Credit Risk

Credit risk is defined as the risk impacting earnings or capital due to an obligor’s failure to meet the terms of a loan or an investment, or otherwise failing to perform as agreed. Credit risk occurs any time an institution relies on another party, issuer, or borrower’s performance.

A volatile, illiquid market could require the Corporation to recognize an “other-than-temporary” impairment loss related to the investment securities held in the portfolio. Management considers many factors in determining whether other-than-temporary impairment exists including the length of time and extent to which fair value has been less than cost, the investment credit rating, the probability the issuer will be unable to pay the amount when due and the fact that the Corporation asserts that it does not intend to sell the security in an unrealized loss position and it is more likely than not it will not have to sell the securities before recovery of its cost basis. The presence of these factors could lead to impairment charges that could have a material adverse effect on net income and capital levels.

To manage the credit risk arising from lending activities, the Corporation’s most significant source of credit risk, management maintains what it believes are sound underwriting policies and procedures. Management continuously monitors asset quality in order to manage the Corporation’s credit risk to determine the appropriateness of valuation allowances. These valuation allowances take into consideration various factors including, but not limited to, local, regional, and national economic conditions.

The Corporation maintains an allowance for probable loan losses, which is a reserve established through a provision for probable loan losses charged to expense, that represents management’s best estimate of probable losses that may be incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for possible loan losses inherently involves a high degree of subjectivity and requires the Corporation to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Corporation’s control, may require an increase in the allowance for possible loan losses. In addition, bank regulatory agencies periodically review the Corporation’s allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Any increases in the allowance for possible loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Corporation’s financial condition and results of operations.

Interest Rate Risk

Interest rate risk is the timing differences in the maturity or repricing frequency of a financial institution’s interest earning assets and its interest bearing liabilities. Management monitors the potential effects of changes in interest rates through rate shock and gap analyses. To help mitigate the effects of interest rate risk, management makes significant efforts to stagger projected cash flows and maturities of interest sensitive assets and liabilities.

Liquidity Risk

Liquidity risk is the risk to earnings or capital arising from the Bank’s inability to meet its obligations when they come due without incurring unacceptable losses. Liquidity risk includes the inability to manage unplanned decreases or changes in funding sources, or failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value. The Corporation has significant borrowing capacity through correspondent banks as well as the ability to sell investments to fund potential cash shortages.

Operational Risk

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or external events. The Corporation is exposed to operational risk which includes reputation risk and transaction risk. Reputation risk is developing and retaining marketplace confidence in handling customers’ financial transactions in an appropriate manner as well as protecting the safety and soundness of the institution. Transaction risk includes losses from fraud, error, the inability to deliver products or services, and loss or theft of information. Transaction risk also encompasses product development and delivery, transaction processing, information technology systems, and the internal control environment.

To help minimize the potential losses due to operational risks, management has established an internal audit department and has retained the services of a certified public accounting firm to assist in performing such internal audit work. The focus of these internal audit procedures is to verify the validity and appropriateness of various transactions and processes. The results of these procedures are reported to the Corporation’s Audit Committee.

Compliance Risk

Compliance risk is the risk of loss from violations of, or nonconformance with laws, rules, regulations, prescribed practices, or ethical standards. This includes new or revised tax, accounting, and other laws, regulations, rules and standards that could significantly impact strategic initiatives, results of operations, and financial condition. The financial services industry is extensively regulated and must meet regulatory standards set by the FDIC, OFIR, the Federal Reserve Board, FASB, SEC, PCAOB and other regulatory bodies. Federal and state laws and regulations are designed primarily to protect the deposit insurance funds and consumers, and not necessarily to benefit the Corporation’s shareholders. The nature, extent, and timing of the adoption of significant new laws, changes in existing laws, or repeal of existing laws may have a material impact on the Corporation’s business, results of operations, and financial condition, the effect of which is impossible to predict at this time.

The Corporation’s compliance department annually assesses the adequacy and effectiveness of the Corporation’s processes for controlling and managing its principal compliance risks.

Economic Conditions

An economic downturn within the Corporation’s local markets, as well as downturns in the state or national markets, could negatively impact household and corporate incomes. This could lead to decreased demand for both loan and deposit products and lead to an increase of customers who fail to pay interest or principal on their loans. Management continually monitors key economic indicators in an effort to anticipate the possible effects of downturns in the local, regional, and national economies.

The Corporation’s success depends primarily on the general economic conditions of the State of Michigan and the specific local markets in which the Corporation operates. Unlike larger national or other regional banks that are more geographically diversified, the Corporation provides banking and financial services to customers located primarily in the Clare, Gratiot, Isabella, Mecosta, Montcalm, and Saginaw Counties in Michigan. The local economic conditions in these areas have a significant impact on the demand for the Corporation’s products and services as well as the ability of the Corporation’s customers to repay loans, the value of the collateral securing loans and the stability of the Corporation’s deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on the Corporation’s financial condition and results of operations.

Accounting Risk

The Corporation’s consolidated financial statements conform with generally accepted accounting principles, which require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements. These estimates are based on information available to management at the time the estimates are made. Actual results could differ from those estimates. For further discussion regarding significant accounting estimates, see “Note 1- Summary of Significant Accounting Policies” in the Notes to the Consolidated Financial Statements.

Disruption of Infrastructure

The Corporation’s operations depend upon its technological and physical infrastructure, including its equipment and facilities. Extended disruption of its vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, or other events outside of the Corporation’s control, could affect the financial outcome of the Corporation or the financial services industry as a whole. The Corporation has developed disaster recovery plans, which provide detailed instructions covering all significant aspects of the Corporation’s operations.

Increases in FDIC Insurance Premiums

The Corporation is unable to control the amount of premiums that it is required to pay for FDIC insurance. If there are additional bank or financial institution failures, the Corporation may be required to pay even higher FDIC premiums than the recently increased levels. These announced increases have, and any future increases in FDIC insurance premiums will, materially adversely affect the Corporation’s results of operations, financial condition and ability to continue to pay dividends on its common shares at the current rate.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The Corporation’s executive offices are located at 401 N. Main Street, Mt. Pleasant, Michigan 48858. Isabella Bank owns 24 branches and an operations center. The Corporation’s facilities current, planned, and best use is for conducting its current activities with the exception of approximately 75% of the Corporation’s previous main office location and 25% of the building that houses the Lake Isabella office which are leased to non-related parties. Management continually monitors and assesses the need for expansion and / or improvement for all facilities. In management’s opinion, each facility has sufficient capacity and is in good condition.

Item 3. Legal Proceedings

The Corporation and its subsidiaries are not involved in any material pending legal proceedings. The Corporation, because of the nature of its business, is at times subject to numerous pending and threatened legal actions that arise out of the normal course of operating their business.

Part II

Item 4. Market for Registrant’s Common Equity, Related Shareholders’ Matters and Issuer Purchases of Equity Securities

Common Stock and Dividend Information

The Corporation’s common stock is traded in the over-the-counter market. The common stock has been quoted on the Pink Sheets Electronic Quotation Service (“Pink Sheets”) under the symbol “ISBA” since August of 2008 and under the symbol “IBTM” prior to August of 2008. Other trades in the common stock occur in privately negotiated transactions from time to time of which the Corporation may have little or no information.

Management has reviewed the information available as to the range of reported high and low bid quotations, including high and low bid information as reported by Pink Sheets and closing price information as reported by the parties to privately negotiated transactions. The following table sets forth management’s compilation of that information for the periods indicated. Price information obtained from Pink Sheets reflects inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions. Price information obtained from parties to privately negotiated transactions reflects actual closing prices that were disclosed to the Corporation, which management has not independently verified. The following compiled data is provided for information purposes only and should not be viewed as indicative of the actual or market value of the Corporation’s common stock. All of the information has been adjusted to reflect the 10% stock dividend, paid February 29, 2008.

		Number of				Sale Price
Period		Shares				Low				High
2009
First Quarter			61,987			$	14.99			$	25.51
Second Quarter			91,184				15.85				20.75
Third Quarter			66,399				17.50				19.50
Fourth Quarter			76,985				14.00				19.25
			296,555
2008
First Quarter			107,920				32.73				44.00
Second Quarter			50,600				39.00				44.00
Third Quarter			29,303				33.00				40.00
Fourth Quarter			71,855				22.50				36.50
			259,678

The following table sets forth the cash dividends paid for the following quarters, adjusted for the 10% stock dividend paid on February 29, 2008.

		Per Share
		2009				2008
First Quarter		$	0.12			$	0.12
Second Quarter			0.13				0.12
Third Quarter			0.13				0.12
Fourth Quarter			0.32				0.29
Total		$	0.70			$	0.65

Isabella Bank Corporation’s authorized common stock consists of 15,000,000 shares, of which 7,535,193 shares are issued and outstanding as of December 31, 2009. As of that date, there were 3,004 shareholders of record.

The Board of Directors has adopted a common stock repurchase plan. On October 29, 2009, the Board of Directors amended the plan to allow for the repurchase of an additional 100,000 shares of the Corporation’s common stock. The maximum number of shares which may be repurchased pursuant to this plan was 78,432 shares as of December 31, 2009. These authorizations do not have expiration dates. As shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued shares. The following table provides information for the three month period ended December 31, 2009, with respect to this plan:

										Total Number of
										Shares Purchased				Maximum Number of
		Shares Repurchased								as Part of Publicly				Shares That May Yet Be
						Average Price				Announced Plan				Purchased Under the
		Number				Per Share				or Program				Plans or Programs
Balance, September 30, 2009															6,636
October 1 - 28, 2009			3,689			$	17.45				3,689				2,947
Additional authorization			—				—				—				102,947
October 29 - 31, 2009			—				—				—				102,947
November 1 - 30, 2009			11,152				17.06				11,152				91,795
December 1 - 31, 2009			13,363				18.12				13,363				78,432
Balance, December 31, 2009			28,204			$	17.61				28,204				78,432

Information concerning Securities Authorized for Issuance Under Equity Compensation Plans appears under “Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters” included elsewhere in this annual report on Form 10-K.

Stock Performance

The following graph compares the cumulative total shareholder return on Corporation common stock for the last five years with the cumulative total return on (1) the NASDAQ Stock Market Index, which is comprised of all United States common shares traded on the NASDAQ and (2) the NASDAQ Bank Stock Index, which is comprised of bank and bank holding company common shares traded on the NASDAQ over the same period. The graph assumes the value of an investment in the Corporation and each index was $100 at December 31, 2004 and all dividends are reinvested.

The dollar values for total shareholder return plotted in the graph above are shown in the table below:

Comparison of Five Year Cumulative
Among Isabella Bank Corporation, NASDAQ Stock Market,
and NASDAQ Bank Stock

		Isabella
		Bank								NASDAQ
Year		Corporation				NASDAQ				Banks
12/31/2004			100.0				100.0				100.0
12/31/2005			106.4				102.1				98.0
12/31/2006			118.7				112.6				111.4
12/31/2007			120.6				124.6				89.5
12/31/2008			78.5				75.0				70.5
12/31/2009			60.5				108.8				59.0

Item 5. Selected Financial Data

RESULTS OF OPERATIONS

Two key measures of earnings performance commonly used in the banking industry are return on average assets and return on average shareholders’ equity. Return on average assets measures the ability of a corporation to profitably and efficiently employ its resources. Return on average equity indicates how effectively the Corporation is able to generate earnings on shareholder invested capital.

SUMMARY OF SELECTED FINANCIAL DATA
(Dollars in thousands except per share data)

		2009				2008				2007				2006				2005
INCOME STATEMENT DATA
Total interest income		$	58,105			$	61,385			$	53,972			$	44,709			$	36,882
Net interest income			38,266				35,779				28,013				24,977				23,909
Provision for loan losses			6,093				9,500				1,211				682				777
Net income			7,800				4,101				7,930				7,001				6,776
BALANCE SHEET DATA
End of year assets		$	1,143,944			$	1,139,263			$	957,282			$	910,127			$	741,654
Daily average assets			1,127,634				1,113,102				925,631				800,174				700,624
Daily average deposits			786,714				817,041				727,762				639,046				576,091
Daily average loans/net			712,965				708,434				596,739				515,539				459,310
Daily average equity			139,810				143,626				119,246				91,964				74,682
PER SHARE DATA (1)
Earnings per share
Basic		$	1.04			$	0.55			$	1.14			$	1.12			$	1.14
Diluted			1.01				0.53				1.11				1.09				1.14
Cash dividends			0.70				0.65				0.62				0.58				0.55
Book value (at year end)			18.69				17.89				17.58				16.61				13.44
FINANCIAL RATIOS
Shareholders’ equity to assets (at year end)			12.31	%			11.80	%			12.86	%			12.72	%			10.91	%
Return on average equity			5.58				2.86				6.65				7.61				9.07
Return on average tangible equity			8.54				4.41				8.54				8.31				9.12
Cash dividend payout to net income			67.40				118.82				54.27				53.92				48.02
Return on average assets			0.69				0.37				0.86				0.87				0.97

		2009																2008
		4th				3rd				2nd				1st				4th				3rd				2nd				1st
Quarterly Operating Results:
Total interest income		$	14,411			$	14,516			$	14,505			$	14,673			$	15,099			$	15,401			$	15,359			$	15,526
Interest expense			4,657				4,928				5,026				5,228				5,836				6,309				6,379				7,082
Net interest income			9,754				9,588				9,479				9,445				9,263				9,092				8,980				8,444
Provision for loan losses			1,544				1,542				1,535				1,472				5,725				975				1,593				1,207
Noninterest income			2,102				2,566				3,131				2,357				1,130				2,377				1,778				2,517
Noninterest expenses			8,176				7,995				8,468				9,044				8,377				7,430				7,341				7,556
Net income (loss)			2,073				2,197				2,201				1,329				(2,041	)			2,524				1,691				1,927
Per Share of Common Stock: (1)
Earnings (loss) per share
Basic		$	0.28			$	0.29			$	0.29			$	0.18			$	(0.28	)		$	0.34			$	0.23			$	0.26
Diluted			0.27				0.28				0.29				0.17				(0.27	)			0.33				0.22				0.25
Cash dividends			0.32				0.13				0.13				0.12				0.29				0.12				0.12				0.12
Book value (at quarter end)			18.69				18.97				18.06				18.01				17.89				18.78				18.75				19.07

Item 6. Management’s Discussion and Analysis of Financial Condition and Results of Operations

ISABELLA BANK CORPORATION FINANCIAL REVIEW
(All dollars in thousands)

The following is management’s discussion and analysis of the financial condition and results of operations for Isabella Bank Corporation (the “Corporation”). This discussion and analysis is intended to provide a better understanding of the consolidated financial statements and statistical data included elsewhere in the Annual Report. The Corporation’s acquisition of Greenville Community Financial Corporation in January 2008 was accounted for as a purchase transaction, and as such, the related results of operations are included from the date of acquisition. See “Note 2 — Business Combinations and Joint Venture Formation” in the accompanying Notes to Consolidated Financial Statements included elsewhere in the report.

The current recession, which began in 2008, continued to negatively impact the Corporation’s overall profitability throughout 2009 as historically high delinquencies and nonaccrual loans have translated into high levels of net loans charged off and foreclosed asset and collection related expenses. Although nonperforming loans remain at historically high levels, they have declined $3,136 from last year. This improvement, coupled with a decline in net loans charged off, enabled the Corporation to reduce its provision for loan losses in 2009. The reduction in the provision for loan losses along with an increased net yield on interest earning assets (on a fully tax equivalent basis) resulted in net income of $7,800 for 2009, as compared to $4,101 for 2008. For further detailed discussion and analysis, see below.

The Corporation has not received any notices of regulatory actions as of December 31, 2009.

CRITICAL ACCOUNTING POLICIES: The Corporation’s significant accounting policies are set forth in Note 1 of the Consolidated Financial Statements. Of these significant accounting policies, the Corporation considers its policies regarding the allowance for loan losses, acquisition intangibles, and the determination of the fair value of investment securities to be its most critical accounting policies.

The allowance for loan losses requires management’s most subjective and complex judgment. Changes in economic conditions can have a significant impact on the allowance for loan losses and, therefore, the provision for loan losses and results of operations. The Corporation has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Corporation’s assessments may be impacted in future periods by changes in economic conditions, and the discovery of information with respect to borrowers which is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Corporation’s allowance for loan losses and related matters, see the Provision for Loan Losses discussion below.

United States generally accepted accounting principles require that the Corporation determine the fair value of the assets and liabilities of an acquired entity, and record their fair value on the date of acquisition. The Corporation employs a variety of measures in the determination of the fair value, including the use of discounted cash flow analysis, market appraisals, and projected future revenue streams. For certain items that management believes it has the appropriate expertise to determine the fair value, management may choose to use its own calculations of the value. In other cases, where the value is not easily determined, the Corporation consults with outside parties to determine the fair value of the identified asset or liability. Once valuations have been adjusted, the net difference between the price paid for the acquired entity and the value of its balance sheet, including identifiable intangibles, is recorded as goodwill. This goodwill is not amortized, but is tested for impairment on at least an annual basis.

The Corporation currently has both available-for-sale and trading investment securities that are carried at fair value. Changes in the fair value of available-for-sale investment securities are included as a component of other comprehensive income, while declines in the fair value of these securities below their cost that are other than temporary are reflected as realized losses. The change in value of trading investment securities is included in current earnings. Management evaluates securities for indications of losses that are considered other-than-temporary, if any, on a regular basis.

The market values for available-for-sale and trading investment securities are typically obtained from outside sources and applied to individual securities within the portfolio. The fair values of investment securities with illiquid markets are estimated by management utilizing a discounted cash flow analysis or other type of valuation adjustment methodology. These securities are also compared, when possible, to other securities with similar characteristics.

DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS’ EQUITY

INTEREST RATE AND INTEREST DIFFERENTIAL

The following schedules present the daily average amount outstanding for each major category of interest earning assets, nonearning assets, interest bearing liabilities, and noninterest bearing liabilities for the last three years. This schedule also presents an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a fully taxable equivalent (FTE) basis using a 34% federal income tax rate. Nonaccruing loans, for the purpose of the following computations, are included in the average loan amounts outstanding. Federal Reserve and Federal Home Loan Bank Equity holdings which are restricted are included in Other Assets.

														Year Ended
		December 31, 2009												December 31, 2008												December 31, 2007
						Tax				Average								Tax				Average								Tax				Average
		Average				Equivalent				Yield /				Average				Equivalent				Yield /				Average				Equivalent				Yield /
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
INTEREST EARNING ASSETS:
Loans		$	725,299			$	47,706				6.58	%		$	717,040			$	49,674				6.93	%		$	604,342			$	43,808				7.25	%
Taxable investment securities			119,063				4,712				3.96	%			108,919				5,433				4.99	%			68,398				3,751				5.48	%
Nontaxable investment securities			121,676				7,217				5.93	%			121,220				7,218				5.95	%			96,789				5,726				5.92	%
Trading account securities			17,279				856				4.95	%			26,618				1,305				4.90	%			50,904				2,298				4.51	%
Federal funds sold			842				1				0.12	%			5,198				110				2.12	%			6,758				342				5.06	%
Other			27,433				376				1.37	%			17,600				433				2.46	%			7,143				317				4.44	%
Total earning assets			1,011,592				60,868				6.02	%			996,595				64,173				6.44	%			834,334				56,242				6.74	%
NON EARNING ASSETS:
Allowance for loan losses			(12,334	)											(8,606	)											(7,603	)
Cash and due from banks			18,190												18,582												20,588
Premises and equipment			23,810												22,905												21,507
Accrued income and other assets			86,376												83,626												56,805
Total assets		$	1,127,634											$	1,113,102											$	925,631
INTEREST BEARING LIABILITIES:
Interest bearing demand deposits		$	116,412				146				0.13	%		$	114,889				813				0.71	%		$	109,370				1,880				1.72	%
Savings deposits			177,538				399				0.22	%			213,410				2,439				1.14	%			188,323				4,232				2.25	%
Time deposits			398,356				13,043				3.27	%			393,190				16,621				4.23	%			349,941				16,493				4.71	%
Borrowed funds			193,922				6,251				3.22	%			145,802				5,733				3.93	%			68,586				3,354				4.89	%
Total interest bearing liabilities			886,228				19,839				2.24	%			867,291				25,606				2.95	%			716,220				25,959				3.62	%
NONINTEREST BEARING LIABILITIES:
Demand deposits			94,408												95,552												80,128
Other			7,188												6,633												10,037
Shareholders’ equity			139,810												143,626												119,246
Total liabilities and equity		$	1,127,634											$	1,113,102											$	925,631
Net interest income (FTE)						$	41,029											$	38,567											$	30,283
Net yield on interest earning assets (FTE)											4.06	%											3.87	%											3.63	%

Net Interest Income

The Corporation derives the majority of its gross income from interest earned on loans and investments, while its most significant expense is the interest cost incurred for funds used. Net interest income is the amount by which interest income on earning assets exceeds the interest cost of deposits and borrowings. Net interest income is influenced by changes in the balance and mix of assets and liabilities and market interest rates. Management exerts some control over these factors; however, Federal Reserve monetary policy and competition have a significant impact. Interest income includes loan fees of $1,963, in 2009, $1,808 in 2008, and $1,330 in 2007. For analytical purposes, net interest income is adjusted to a “taxable equivalent” basis by adding the income tax savings from interest on tax-exempt loans and securities, thus making year-to-year comparisons more meaningful.

VOLUME AND RATE VARIANCE ANALYSIS

The following table details the dollar amount of changes in FTE net interest income for each major category of interest earning assets and interest bearing liabilities and the amount of change attributable to changes in average balances (volume) or average rates. 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.

		2009 Compared to 2008												2008 Compared to 2007
		Increase (Decrease) Due to												Increase (Decrease) Due to
		Volume				Rate				Net				Volume				Rate				Net
CHANGES IN INTEREST INCOME:
Loans		$	567			$	(2,535	)		$	(1,968	)		$	7,877			$	(2,011	)		$	5,866
Taxable investment securities			474				(1,195	)			(721	)			2,048				(366	)			1,682
Nontaxable investment securities			27				(28	)			(1	)			1,454				38				1,492
Trading account securities			(463	)			14				(449	)			(1,176	)			183				(993	)
Federal funds sold			(51	)			(58	)			(109	)			(66	)			(166	)			(232	)
Other			182				(239	)			(57	)			306				(190	)			116
Total changes in interest income			736				(4,041	)			(3,305	)			10,443				(2,512	)			7,931
CHANGES IN INTEREST EXPENSE:
Interest bearing demand deposits			11				(678	)			(667	)			90				(1,157	)			(1,067	)
Savings deposits			(353	)			(1,687	)			(2,040	)			505				(2,298	)			(1,793	)
Time deposits			216				(3,794	)			(3,578	)			1,924				(1,796	)			128
Borrowed funds			1,672				(1,154	)			518				3,146				(767	)			2,379
Total changes in interest expense			1,546				(7,313	)			(5,767	)			5,665				(6,018	)			(353	)
Net change in interest margin (FTE)		$	(810	)		$	3,272			$	2,462			$	4,778			$	3,506			$	8,284

The Corporation, as well as all other financial institutions, has experienced dramatic changes in interest rates in the last three years. The Federal Reserve Bank (“The Fed”) lowered its target Fed Funds rate to 0.00% — 0.25% in December 2008. The Fed’s actions were the result of a significant weakening of the Nation’s economy to an extent not seen since the Great Depression. As the Corporation’s balance sheet is liability sensitive, net interest margins increased as the interest rates paid on interest bearing liabilities decreased faster than those earned on interest earning assets.

Management does anticipate, however, that net interest margins will decline throughout 2010 due to the following factors:

	•		Based on the current economic conditions, management does not anticipate any changes in the target Fed funds rate during much of 2010. As such, the Corporation does not anticipate significant, if any, changes in market rates. However, there is the potential for declines in rates earned on interest earning assets. Most of the potential declines would arise out of the Corporation’s investment portfolio, as securities with call dates will most likely be called and the Corporation will be reinvesting those proceeds at significantly lower rates.
	•		Long term residential mortgage rates continue to be at historically low levels. This rate environment has led to strong consumer demand for fixed rate mortgage products which are sold to the secondary market. As a result of the majority of loans being sold to the secondary market, there has been a significant decline in balloon mortgages, which are held on the Corporation’s balance sheet. As these balloon mortgages have been paid off, the proceeds from these loans have been reinvested at lower interest rates, which has, and will continue to, adversely impact interest income.
	•		While the Corporation’s liability sensitive balance sheet has allowed it to benefit from decreases in interest rates, it also makes the Corporation extremely sensitive to increases in deposit and borrowing rates. As part of the Corporation’s goal to minimize the potential negative impacts of possible increases in future interest rates, management will actively work to lengthen its interest bearing liabilities. This lengthening will increase the Corporation’s cost of funding, potentially reducing net interest income in the short term.
	•		In an effort to reduce the potential long term negative impact of increases in rates paid on interest bearing liabilities, the Corporation anticipates growing the balance sheet through the acquisition of investment securities in 2010. These investments will be funded through deposit growth and wholesale borrowings. The net interest margin generated by the purchase of these investments is anticipated to be less than 2.0%, but will provide additional net interest income.

LOAN QUALITY

Provision for Loan Losses

The provision for loan losses represents the current period loan cost associated with maintaining an appropriate allowance for loan losses as determined by management. Periodic fluctuations in the provision for loan losses result from management’s best estimates as to the adequacy of the allowance for loan losses to absorb probable losses within the existing loan portfolio. The provision for loan losses for each period is further dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, assessment by management, third parties and banking regulators of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in the market areas.

In the past two years, residential real estate values in the Bank’s market areas have declined 20% to 40%. These declines are the result of increases in the inventory of unsold homes. This increased inventory is partially the result of the inability of potential home buyers to obtain financing due to the tightening of loan underwriting criteria by many of the financial institutions, brokers and government sponsored agencies. While Isabella Bank has maintained traditional lending standards, the decline in real estate values has had an adverse impact on customers who are experiencing financial difficulties. Historically, customers who experienced difficulties were able to sell their properties for more than the loan balance owed. The steep decline in real estate values has diminished homeowner equity and led borrowers who are experiencing financial difficulties to default on their mortgage loans.

While the Bank has elected not to participate in the U.S. Treasury’s “Making Home Affordable Program”, it has taken aggressive actions to avoid foreclosures on borrowers who are willing to work with the Bank in modifying their loans, thus making them more affordable. Actions taken include extensions of amortizations, temporary reductions in interest rates and, when necessary, a reduction in the principal balance owed. To date, the Bank has modified 94 loans with outstanding balances totaling $7,562.

The following schedule shows the composition of the provision for loan losses and the allowance for loan losses.

		Year Ended December 31
		2009				2008				2007				2006				2005
Allowance for loan losses — January 1		$	11,982			$	7,301			$	7,605			$	6,899			$	6,444
Allowance of acquired bank			—				822				—				726				—
Loans charged off
Commercial and agricultural			3,081				2,137				905				368				101
Real estate mortgage			2,627				3,334				659				252				166
Consumer			934				854				582				529				376
Total loans charged off			6,642				6,325				2,146				1,149				643
Recoveries
Commercial and agricultural			623				160				297				136				105
Real estate mortgage			546				240				49				53				—
Consumer			377				284				285				258				216
Total recoveries			1,546				684				631				447				321
Net loans charged off			5,096				5,641				1,515				702				322
Provision charged to income			6,093				9,500				1,211				682				777
Allowance for loan losses — December 31		$	12,979			$	11,982			$	7,301			$	7,605			$	6,899
Year to date average loans		$	725,299			$	717,040			$	604,342			$	522,726			$	466,001
Net loans charged off to average loans outstanding			0.70	%			0.79	%			0.25	%			0.13	%			0.07	%
Total amount of loans outstanding		$	723,316			$	735,385			$	612,687			$	591,042			$	483,242
Allowance for loan losses as a % of loans			1.79	%			1.63	%			1.19	%			1.29	%			1.43	%

As shown in the preceding table, the Corporation’s gross chargeoffs increased $317 to $6,642 in 2009, while recoveries increased by $862 resulting in a $545 reduction in net chargeoffs compared with 2008. Management believes the increase in recoveries, in both dollars and as a percentage of chargeoffs, is a direct result of management conservatively valuing collateral that it has repossessed from defaulted credits.

As discussed above, the Corporation experienced a decline in credit quality in 2008 resulting in a dramatic increase in total loans charged off. These chargeoffs were a direct result of the significant downturn in the national and local economy which has led to increases in unemployment coupled with significant property devaluation. As a result of the significant increases in loans charged off, local and regional economic uncertainties of the Corporation’s loan portfolio and increases in foreclosed loans during 2008 and 2009, the Corporation significantly increased its provision for loan losses in these years. This increased provision has resulted in an allowance for loan losses as a percentage of gross loans of 1.79% as of December 31, 2009.

The Corporation has also experienced an increase in foreclosed loans and an increase in loans charged off due mainly to the downturn in the commercial real estate mortgage market. Of the $3,081 commercial and agricultural loans charged off in 2009, $1,325 was related to one loan, for which a $1,000 specific allocation was recorded as of December 31, 2008.

The nationwide increase in residential mortgage loans past due and in foreclosures has received considerable attention by the Federal Government, the media, banking regulators, and industry trade groups. Based on information provided by The Mortgage Bankers Association, a substantial portion of the nationwide increase in both past dues and foreclosures are related to option adjustable rate mortgages and Alternative-A sub-prime mortgage products. While the Corporation has not originated or held alternative mortgage loan products, the difficulties experienced in these markets have adversely impacted the entire market, and thus the overall credit quality of the Corporation’s residential mortgage portfolio. The increase in troubled residential mortgage loans and a tightening of underwriting standards will most likely result in an increase in residential mortgage loans in foreclosure and possibly the inventory of unsold homes. The combination of all of these factors is expected to further reduce average home values and thus homeowner’s equity on a national level.

The Corporation originates and sells fixed rate residential real estate mortgages to the Federal Home Loan Mortgage Corporation. The Corporation has not originated loans for either trading or its own portfolio that would be classified as sub prime, nor has it originated adjustable rate mortgages or financed loans for more than 80% of market value unless insured by private third party insurance.

Based on management’s analysis, the allowance for loan losses of $12,979 is considered adequate as of December 31, 2009.

Allocation of the Allowance for Loan Losses

The allowance for loan losses has been allocated according to the amount deemed to be reasonably necessary to reflect for the probability of losses being incurred within the following categories as of December 31:

		2009								2008								2007								2006								2005
						% of Each								% of Each								% of Each								% of Each								% of Each
						Category								Category								Category								Category								Category
		Allowance				to Total				Allowance				to Total				Allowance				to Total				Allowance				to Total				Allowance				to Total
		Amount				Loans				Amount				Loans				Amount				Loans				Amount				Loans				Amount				Loans
Commercial and agricultural		$	3,565				53.1	%		$	3,632				50.7	%		$	2,458				46.0	%		$	2,687				43.3	%		$	2,771				46.9	%
Real estate mortgage			3,809				39.5	%			3,832				43.4	%			1,341				48.6	%			1,367				50.9	%			1,192				46.8	%
Consumer installment			1,308				4.5	%			1,736				4.5	%			2,195				4.8	%			2,434				5.1	%			2,286				5.8	%
Specific allocations			3,572				2.9	%			2,065				1.4	%			703				0.6	%			594				0.7	%			184				0.5	%
Unallocated			725				N/A				717				N/A				604				N/A				523				N/A				466				N/A
Total		$	12,979				100.0	%		$	11,982				100.0	%		$	7,301				100.0	%		$	7,605				100.0	%		$	6,899				100.0	%

Management has evaluated all specific allocations and believes the valuation allowance related to these loans to be adequate.

Nonperforming Assets

Loans are generally placed on nonaccrual status when they become 90 days past due, unless they are well secured and in the process of collection. When a loan is placed on nonaccrual status, any interest previously accrued and not collected is reversed from income or charged off against the allowance for loan losses. Loans are charged off when management determines that collection has become unlikely. Restructured loans are those where a concession has been granted on either principal or interest paid due to financial difficulties of the borrower. Other real estate owned consists of real property acquired through foreclosure on the related collateral underlying defaulted loans.

The following table presents nonperforming assets for the past five years:

NONPERFORMING ASSETS

		Year Ended December 31
		2009				2008				2007				2006				2005
Nonaccrual loans		$	8,522			$	11,175			$	4,156			$	3,444			$	1,375
Accruing loans past due 90 days or more			768				1,251				1,727				1,185				1,058
Total nonperforming loans			9,290				12,426				5,883				4,629				2,433
Other real estate owned			1,141				2,770				1,376				562				122
Repossessed assets			16				153				—				—				—
Total nonperforming assets		$	10,447			$	15,349			$	7,259			$	5,191			$	2,555
Nonperforming loans as a % of total loans			1.28	%			1.69	%			0.96	%			0.78	%			0.50	%
Nonperforming assets as a % of total assets			0.91	%			1.35	%			0.76	%			0.57	%			0.34	%

RESTRUCTURED LOANS

		December 31
		2009				2008				2007				2006				2005
Complying with modified terms		$	2,754			$	2,565			$	517			$	640			$	62
Past due 30-89 days			107				—				115				57				663
Past due 90 days or more			—				—				53				—				—
Nonaccrual			2,116				1,985				—				—				—
Total restructured loans		$	4,977			$	4,550			$	685			$	697			$	725

Since December 31, 2008, the Corporation’s nonperforming loans have declined $3,136. Of this decline, $1,325 is related to the charge off of one specific loan as noted previously. The remainder of the decline is related to loans being removed from nonaccrual status as a result of improvements in creditworthiness, loans being paid off, loans being charged off, or transfers to other real estate owned. The majority of the restructured loans are the result of the Corporation working with borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure or repossession of collateral.

Of the $1,629 decline in other real estate owned, $670 related to the sale of one property. Management has evaluated the properties held as other real estate owned and has adjusted the carrying value of each property to the lower of the carrying amount or fair value less costs to sell, as necessary. Management anticipates the balance of other real estate owned to remain at historically high levels throughout 2010.

Management established a credit risk management committee in 2008. This committee consists of management from lending, accounting, collection and auditing. This committee reviews various reports covering credit quality to help identify potential problem credits and their potential impact on the Corporation’s consolidated financial statements. Management believes that as of December 31, 2009 all significant loans for which inherent losses are probable have been identified and that the carrying amounts of the loans have been adjusted to reflect the collateral’s net realizable values. To management’s knowledge, there are no other loans which cause management to have serious doubts as to the ability of a borrower to comply with their loan repayment terms. A continued decline in real estate values may require further write downs of loans in foreclosure and other real estate owned and could potentially have an adverse impact on the Corporation’s financial performance.

As of December 31, 2009, there were no other interest bearing assets which required classification. Management is not aware of any recommendations by regulatory agencies that, if implemented, would have a material impact on the Corporation’s liquidity, capital, or operations.

As a result of the new State of Michigan foreclosure laws, which went into effect on July 5, 2009, the time required to complete a residential mortgage foreclosure has increased. Despite the increased timeline to complete the foreclosure process, the new law did not have a significant impact on the Corporation’s ability to initiate and complete foreclosure proceedings.

Noninterest Income

The following table shows the changes in noninterest income between the years ended December 31, 2009, 2008, and 2007 respectively.

		Year Ended December 31
										Change												Change
		2009				2008				$				%				2007				$				%
Service charges and fee income
NSF and overdraft fees		$	3,187			$	3,413			$	(226	)			-6.6	%		$	2,961			$	452				15.3	%
Trust fees			814				886				(72	)			-8.1	%			1,035				(149	)			-14.4	%
Freddie Mac servicing fee			724				627				97				15.5	%			635				(8	)			-1.3	%
ATM and debit card fees			1,218				1,029				189				18.4	%			737				292				39.6	%
Service charges on deposit accounts			344				372				(28	)			-7.5	%			328				44				13.4	%
Net originated mortgage servicing rights income (loss)			514				(92	)			606				N/M				43				(135	)			N/M
All other			112				135				(23	)			-17.0	%			155				(20	)			-12.9	%
Total service charges and fees			6,913				6,370				543				8.5	%			5,894				476				8.1	%
Gain on sale of mortgage loans			886				249				637				N/M				209				40				19.1	%
Net gain (loss) on trading securities			80				245				(165	)			-67.3	%			460				(215	)			-46.7	%
Net gain (loss) on borrowings measured at fair value			289				(641	)			930				N/M				(66	)			(575	)			N/M
Gain (loss) on sale of investment securities			648				24				624				N/M				(19	)			43				N/M
Title insurance revenue			—				234				(234	)			-100.0	%			2,192				(1,958	)			-89.3	%
Other
Increase in cash value of corporate owned life insurance policies			641				616				25				4.1	%			432				184				42.6	%
Brokerage and advisory fees			521				480				41				8.5	%			276				204				73.9	%
All other			178				225				(47	)			-20.9	%			584				(359	)			-61.5	%
Total other			1,340				1,321				19				1.4	%			1,292				29				2.2	%
Total noninterest income		$	10,156			$	7,802			$	2,354				30.2	%		$	9,962			$	(2,160	)			-21.7	%