UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		Quarterly 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 St, Mt. Pleasant, MI		48858
(Address of principal executive offices)		(Zip code)

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

N/A
(Former name, former address and former fiscal year, if changed since last report)

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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “accelerated filer”, “large accelerated filer”, and “smaller reporting company”, in Rule 12b-2 of the Exchange Act (Check One).

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

APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock no par value, 7,543,502 as of April 19, 2010

 

 

ISABELLA BANK CORPORATION
QUARTERLY REPORT ON FORM 10-Q
Table of Contents

PART I			3
Item 1 Interim Condensed Consolidated Financial Statements (Unaudited)			3
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3 Quantitative and Qualitative Disclosures about Market Risk			33
Item 4 Controls and Procedures			35
PART II			36
Item 1 Legal Proceedings			36
Item 1A Risk Factors			36
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds			36
Item 6 Exhibits			36
SIGNATURES			37
EX-31(a)
EX-31(b)
EX-32

PART I — FINANCIAL INFORMATION

Item 1 — Interim Condensed Consolidated Financial Statements (Unaudited)

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(Dollars in thousands)

		March 31				December 31
		2010				2009
ASSETS
Cash and demand deposits due from banks		$	19,038			$	22,706
Certificates of deposit held in other financial institutions			6,580				7,156
Trading securities			9,611				13,563
Investment securities available-for-sale (amortized cost of $275,309 in 2010; $258,585 in 2009)			277,094				259,066
Mortgage loans available-for-sale			482				2,281
Loans
Agricultural			65,866				64,845
Commercial			347,125				340,274
Installment			32,285				32,359
Residential real estate mortgage			280,889				285,838
Total loans			726,165				723,316
Less allowance for loan losses			12,987				12,979
Net loans			713,178				710,337
Premises and equipment			24,281				23,917
Corporate-owned life insurance policies			16,840				16,782
Accrued interest receivable			6,338				5,832
Acquisition intangibles and goodwill, net			47,343				47,429
Equity securities without readily determinable fair values			17,783				17,921
Other assets			16,970				16,954
TOTAL ASSETS		$	1,155,538			$	1,143,944
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing		$	95,440			$	96,875
NOW accounts			129,824				128,111
Certificates of deposit under $100 and other savings			408,406				389,644
Certificates of deposit over $100			185,866				188,022
Total deposits			819,536				802,652
Borrowed funds ($17,748 in 2010 and $17,804 in 2009 at fair value)			185,707				193,101
Accrued interest and other liabilities			7,825				7,388
Total liabilities			1,013,068				1,003,141
Shareholders’ equity
Common stock — no par value
15,000,000 shares authorized; outstanding —7,543,506 (including 25,880 shares to be issued) in 2010 and 7,535,193 (including 30,626 shares to be issued) in 2009			133,640				133,443
Shares to be issued for deferred compensation obligations			4,493				4,507
Retained earnings			5,641				4,972
Accumulated other comprehensive loss			(1,304	)			(2,119	)
Total shareholders’ equity			142,470				140,803
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	1,155,538			$	1,143,944
See notes to interim condensed consolidated financial statements.

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)
(Dollars in thousands except per share data)

										Shares to be
										Issued for								Accumulated
		Common								Deferred								Other
		Stock Shares				Common				Compensation				Retained				Comprehensive
		Outstanding				Stock				Obligations				Earnings				Loss				Totals
Balances, January 1, 2009			7,518,856			$	133,602			$	4,015			$	2,428			$	(5,569	)		$	134,476
Comprehensive income			—				—				—				1,329				596				1,925
Issuance of common stock			20,977				478				—				—				—				478
Common stock issued for deferred compensation obligations			10,067				274				(144	)			—				—				130
Share-based payment awards under equity compensation plan			—				—				184				—				—				184
Common stock purchased for deferred compensation obligations			—				(186	)			—				—				—				(186	)
Common stock repurchased pursuant to publicly announced repurchase plan			(24,428	)			(568	)			—				—				—				(568	)
Cash dividends ($0.12 per share)			—				—				—				(904	)			—				(904	)
Balances, March 31, 2009			7,525,472			$	133,600			$	4,055			$	2,853			$	(4,973	)		$	135,535
Balances, January 1, 2010			7,535,193			$	133,443			$	4,507			$	4,972			$	(2,119	)		$	140,803
Comprehensive income			—				—				—				2,023				815				2,838
Issuance of common stock			29,147				736				—				—				—				736
Common stock issued for deferred compensation obligations			13,331				247				(195	)			—				—				52
Share-based payment awards under equity compensation plan			—				—				181				—				—				181
Common stock purchased for deferred compensation obligations			—				(157	)			—				—				—				(157	)
Common stock repurchased pursuant to publicly announced repurchase plan			(34,165	)			(629	)			—				—				—				(629	)
Cash dividends ($0.18 per share)			—				—				—				(1,354	)			—				(1,354	)
Balances, March 31, 2010			7,543,506			$	133,640			$	4,493			$	5,641			$	(1,304	)		$	142,470

See notes to interim condensed consolidated financial statements.

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(Dollars in thousands except per share data)

		Three Months Ended
		March 31
		2010				2009
Interest income
Loans, including fees		$	11,517			$	11,898
Investment securities
Taxable			1,279				1,287
Nontaxable			1,094				1,163
Trading account securities			105				206
Federal funds sold and other			104				119
Total interest income			14,099				14,673
Interest expense
Deposits			2,883				3,627
Borrowings			1,517				1,601
Total interest expense			4,400				5,228
Net interest income			9,699				9,445
Provision for loan losses			1,207				1,472
Net interest income after provision for loan losses			8,492				7,973
Noninterest income
Service charges and fees			1,628				1,349
Gain on sale of mortgage loans			93				268
Net (loss) gain on trading securities			(1	)			87
Net gain on borrowings measured at fair value			56				143
Gain on sale of available-for-sale investment securities			56				221
Other			335				289
Total noninterest income			2,167				2,357
Noninterest Expenses
Compensation and benefits			4,595				4,676
Occupancy			562				529
Furniture and equipment			1,031				1,016
FDIC insurance premiums			306				885
Other			1,860				1,938
Total noninterest expenses			8,354				9,044
Income before federal income tax expense (benefit)			2,305				1,286
Federal income tax expense (benefit)			282				(43	)
NET INCOME		$	2,023			$	1,329
Earnings per share
Basic		$	0.27			$	0.18
Diluted		$	0.26			$	0.17
Cash dividends per basic share		$	0.18			$	0.12

See notes to interim condensed consolidated financial statements.

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(Dollars in thousands)

		Three Months Ended
		March 31
		2010				2009
Net income		$	2,023			$	1,329
Unrealized gains on available-for-sale securities:
Unrealized holding gains arising during the period			1,360				622
Reclassification adjustment for net realized gains included in net income			(56	)			(221	)
Net unrealized gains			1,304				401
Tax effect			(489	)			195
Other comprehensive income, net of tax			815				596
COMPREHENSIVE INCOME		$	2,838			$	1,925

See notes to interim condensed consolidated financial statements.

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Dollars in thousands)

		Three Months Ended
		March 31
		2010				2009
OPERATING ACTIVITIES
Net income		$	2,023			$	1,329
Reconciliation of net income to net cash provided by operations:
Provision for loan losses			1,207				1,472
Impairment of foreclosed assets			77				—
Depreciation			598				582
Amortization and impairment of originated mortgage servicing rights			39				491
Amortization of acquisition intangibles			86				95
Net amortization of available-for-sale investment securities			203				175
Realized gain on sale of available-for-sale investment securities			(56	)			(221	)
Unrealized losses (gains) on trading securities			1				(87	)
Unrealized gains on borrowings measured at fair value			(56	)			(143	)
Increase in cash value of corporate owned life insurance policies			(148	)			(165	)
Realized gain on redemption of corporate owned life insurance policies			(21	)			—
Share-based payment awards under equity compensation plan			181				184
Net changes in operating assets and liabilities which provided (used) cash:
Trading securities			3,951				2,683
Mortgage loans available-for-sale			1,799				(5,502	)
Accrued interest receivable			(506	)			(201	)
Other assets			(399	)			(1,429	)
Accrued interest and other liabilities			437				1,039
Net cash provided by operating activities			9,416				302
INVESTING ACTIVITIES
Net change in certificates of deposit held in other financial institutions			576				(4,673	)
Activity in available-for-sale securities
Maturities, calls, and sales			20,051				40,906
Purchases			(36,922	)			(38,231	)
Loan principal (originations) collections, net			(5,018	)			9,913
Proceeds from sales of foreclosed assets			886				487
Purchases of premises and equipment			(962	)			(1,108	)
Proceeds from redemption of corporate owned life insurance policies			111				—
Net cash (used in) provided by investing activities			(21,278	)			7,294
FINANCING ACTIVITIES
Net increase in deposits			16,884				4,484
Net decrease in other borrowed funds			(7,338	)			(18,947	)
Cash dividends paid on common stock			(1,354	)			(904	)
Proceeds from issuance of common stock			541				334
Common stock repurchased			(382	)			(294	)
Common stock purchased for deferred compensation obligations			(157	)			(186	)
Net cash provided by (used in) financing activities			8,194				(15,513	)
DECREASE IN CASH AND CASH EQUIVALENTS			(3,668	)			(7,917	)
Cash and cash equivalents at beginning of period			22,706				22,979
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	19,038			$	15,062
Supplemental cash flows information:
Interest paid		$	4,428			$	5,286
Transfer of loans to foreclosed assets			970				515

See notes to interim condensed consolidated financial statements.

ISABELLA BANK CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1 — BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s annual report for the year ended December 31, 2009.

All amounts except share and per share amounts have been rounded to the nearest thousand ($000) in this report.

The accounting policies are the same as those discussed in Note 1 to the Consolidated Financial Statements included in the Corporation’s annual report for the year ended December 31, 2009.

NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS

FASB ASC Topic 715, “Compensation – Retirement Benefits.” In January 2010, ASC Topic 715 was amended by Accounting Standards Update (ASU) No. 2010-06, “Improving Disclosures about Fair Value Measurements”, to change the terminology for major categories of assets to classes of assets to correspond with the amendments to ASC Topic 820 (see below). The new guidance was effective for interim and annual periods after January 1, 2010 and had no impact on the Corporation’s consolidated interim financial statements.

FASB ASC Topic 810, “Consolidation.” New authoritative accounting guidance under ASC Topic 810 amends prior guidance to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other factors, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The new authoritative accounting guidance requires additional disclosures about the reporting entity’s involvement with variable-interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entity’s financial statements. The new authoritative accounting guidance under ASC Topic 810 was effective January 1, 2010 and had no impact on the Corporation’s consolidated interim financial statements.

FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” In January 2010, ASC Topic 820 was amended by ASU No. 2010-6, to add new disclosures for: (1) Significant transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for the transfers and (2) Presenting separately information about purchases, sales, issuances and settlements for Level 3 fair value instruments (as opposed to reporting activity as net).

ASU No. 2010-6 also clarifies existing disclosures by requiring reporting entities to provide fair value measurement disclosures for each class of assets and liabilities and to provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

The new authoritative guidance was effective for interim and annual reporting periods beginning January 1, 2010 except for the disclosures about purchases, sales, issuances and settlements in the rollforward of activity in Level 3 fair value measurements, which will be effective January 1, 2011. The new guidance did not, and is not anticipated to, have a significant impact on the Corporation’s consolidated financial statements.

FASB ASC Topic 860, “Transfers and Servicing.” New authoritative accounting guidance under ASC Topic 860 amends prior accounting guidance to enhance reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. The new authoritative accounting guidance eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. The new authoritative accounting guidance also requires additional disclosures about all continuing involvements with transferred financial

assets including information about gains and losses resulting from transfers during the period. The new authoritative accounting guidance under ASC Topic 860 was effective January 1, 2010 and had no impact on the Corporation’s consolidated interim financial statements.

NOTE 3 — COMPUTATION OF EARNINGS PER SHARE

Basic earnings per share represents income available to common stockholders divided by the weighted–average number of common shares outstanding during the period, which includes shares held in a Trust controlled by the Corporation. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding shares in the Corporation’s Deferred Director Fee Plan.

Earnings per common share have been computed based on the following:

		Three Months Ended
		March 31
		2010				2009
Average number of common shares outstanding for basic calculation			7,540,735				7,521,271
Potential effect of shares in the Deferred Director Fee Plan (1)			182,386				190,896
Average number of common shares outstanding used to calculate diluted earnings per common share			7,723,121				7,712,167
Net income		$	2,023			$	1,329
Earnings per share
Basic		$	0.27			$	0.18
Diluted		$	0.26			$	0.17

NOTE 4 — TRADING SECURITIES

Trading securities, at fair value, consist of the following investments at:

		March 31				December 31
		2010				2009
States and political subdivisions		$	9,611			$	9,962
Mortgage-backed			—				3,601
Total		$	9,611			$	13,563

NOTE 5 — INVESTMENT SECURITIES

The amortized cost and fair value of investment securities available for sale, with gross unrealized gains and losses, are as follows at:

		March 31, 2010
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Government-sponsored enterprises		$	19,377			$	108			$	37			$	19,448
States and political subdivisions			146,745				4,247				2,593				148,399
Auction rate money market preferred			3,200				—				451				2,749
Preferred stocks			7,800				—				655				7,145
Mortgage-backed			77,818				1,267				121				78,964
Collateralized mortgage obligations			20,369				96				76				20,389
Total		$	275,309			$	5,718			$	3,933			$	277,094

		December 31, 2009
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Government-sponsored enterprises		$	19,386			$	127			$	42			$	19,471
States and political subdivisions			150,688				3,632				2,590				151,730
Auction rate money market preferred			3,200				—				227				2,973
Preferred stocks			7,800				—				746				7,054
Mortgage-backed			67,215				638				119				67,734
Collateralized mortgage obligations			10,296				—				192				10,104
Total		$	258,585			$	4,397			$	3,916			$	259,066

The Corporation had pledged investments in the following amounts at:

		March 31				December 31
		2010				2009
Pledged to secure other borrowed funds		$	102,819				41,612
Pledged to secure repurchase agreements			72,157				74,605
Pledged for public deposits and for other purposes necessary or required by law			23,805				20,054
Total		$	198,781			$	136,271

Despite a decline in borrowed funds of $7,394 since December 31, 2009, the Corporation increased the level of securities pledged to secure other borrowed funds and repurchase agreements by $58,759 since December 31, 2009. This additional pledging has enhanced the Corporation’s liquidity position as it allows for an increased availability of borrowed funds.

The amortized cost and fair value of available-for-sale securities by contractual maturity at March 31, 2010 are as follows:

		Amortized				Fair
		Cost				Value
Within 1 year		$	10,914			$	11,088
Over 1 year through 5 years			48,816				50,443
After 5 years through 10 years			74,281				75,990
Over 10 years			43,111				40,220
			177,122				177,741
Mortgage-backed securities			77,818				78,964
Collateralized mortgage obligations			20,369				20,389
		$	275,309			$	277,094

Expected maturities may differ from contractual maturities because issuers have the right to call or prepay obligations.

Because of their variable payments, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group.

A summary of the activity related to the sale of available-for-sale debt securities is as follows during the three month periods ended:

		March 31
		2010				2009
Proceeds from sales of securities		$	3,632			$	7,690
Gross realized gains		$	59			$	221
Gross realized losses			(3	)			—
Net realized gains (losses)		$	56			$	221
Applicable income tax (expense) benefit		$	(19	)		$	(75	)

Information pertaining to available-for-sale securities with gross unrealized losses at March 31, 2010 and December 31, 2009 aggregated by investment category and length of time that individual securities have been in continuous loss position, follows:

		March 31, 2010
		Less Than Twelve Months								Over Twelve Months
		Gross								Gross								Total
		Unrealized				Fair				Unrealized				Fair				Unrealized
		Losses				Value				Losses				Value				Losses
Government-sponsored enterprises		$	37			$	4,961			$	—			$	—			$	37
States and political subdivisions			2,531				9,574				62				2,665				2,593
Auction rate money market preferred			—				—				451				2,749				451
Preferred stocks			—				—				655				1,145				655
Mortgage-backed			121				15,005				—				—				121
Collateralized mortgage obligations			76				15,241				—				—				76
Total		$	2,765			$	44,781			$	1,168			$	6,559			$	3,933

		December 31, 2009
		Less Than Twelve Months								Over Twelve Months
		Gross								Gross								Total
		Unrealized				Fair				Unrealized				Fair				Unrealized
		Losses				Value				Losses				Value				Losses
Government-sponsored enterprises		$	42			$	7,960			$	—			$	—			$	42
States and political subdivisions			2,536				11,459				54				2,267				2,590
Auction rate money market preferred			—				—				227				2,973				227
Preferred stocks			—				—				746				3,054				746
Mortgage-backed			119				25,395				—				—				119
Collateralized mortgage obligations			192				10,104				—				—				192
Total		$	2,889			$	54,918			$	1,027			$	8,294			$	3,916

The Corporation has invested $11,000 in auction rate money market preferred investment security instruments, which are classified as available-for-sale securities and reflected at estimated fair value. Due to market concentrations and general uncertainty in credit markets, the trading for these securities has been limited. As a result of the limited trading of these securities, $7,800 converted to preferred stock with debt like characteristics in 2009.

Due to the limited trading activity of these securities, the fair values were estimated utilizing a discounted cash flow analysis or other type of valuation adjustment methodology as of March 31, 2010 and December 31, 2009. These analyses consider, among other factors, the collateral underlying the security investments, the creditworthiness of the counterparty, the timing of expected future cash flows and estimates of the next time the security is expected to have a successful auction. As of March 31, 2010, the Corporation had a preferred stock security with a decline in fair market value resulting from the security’s interest rate, as it is significantly lower than the offering rates of securities with similar characteristics. Despite the limited trading of these securities, management has determined that any declines in the fair market value of these securities are the result of interest rates and not the underlying credit quality of the security, it does not intend to sell the securities in an unrealized loss position, and it is more likely than not that the Corporation will not have to sell the securities before recovery of its cost basis.

As of March 31, 2010 and December 31, 2009, management conducted an analysis to determine whether all securities currently in an unrealized loss position, including auction rate money market preferred securities and preferred stocks, should be considered other-than-temporarily-impaired (OTTI). Such analyses considered, among other factors, the following criteria:

	•		Has the value of the investment declined more than 20% based on a risk and maturity adjusted discount rate?
	•		Is the investment credit rating below investment grade?
	•		Is it probable that the issuer will be unable to pay the amount when due?
	•		Does management assert that it does not intend to sell and will not have to sell the security until recovery of its cost basis?
	•		Has the duration of the investment been extended by more than 7 years?

Based on the Corporation’s analysis using the above criteria, and the fact that management has asserted that it does not have the intent to sell these securities in an unrealized loss position and that it is more likely than not the Corporation will not have sell the securities before recovery of its cost basis, management does not believe that the values of any securities are other-than-temporarily impaired as of March 31, 2010 or December 31, 2009.

NOTE 6 — OTHER NONINTEREST EXPENSES

A summary of expenses included in Other Noninterest Expenses are as follows for the three month periods ended March 31:

		2010				2009
Marketing and community relations		$	372			$	184
Audit and SOX compliance fees			245				187
Directors fees			209				221
Foreclosed asset and collection			199				164
Education and travel			114				78
Printing and supplies			96				220
Amortization of deposit premium			86				95
Postage and freight			83				127
Legal			83				117
Consulting			46				50
All other			327				495
Total other			1,860				1,938

NOTE 7 — FEDERAL INCOME TAXES

The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of 34% of income before federal income tax expense is as follows for the three month periods ended March 31:

		2010				2009
Income taxes at 34% statutory rate		$	784			$	437
Effect of nontaxable income			(506	)			(491	)
Effect of nondeductible expenses			4				11
Federal income tax expense (benefit)		$	282			$	(43	)

Included in other comprehensive income for the three month periods ended March 31, 2010 and 2009 are unrealized losses of $133 and gains of $971, respectively, related to auction rate preferred stock investment securities and preferred stocks. For federal income tax purposes, these securities are considered equity investments for which no deferred federal income taxes are expected or recorded.

NOTE 8 — DEFINED BENEFIT PENSION PLAN

The Corporation has a non-contributory defined benefit pension plan, which was curtailed effective March 1, 2007. As a result of the curtailment, future salary increases are no longer considered and plan benefits are based on years of service and the employees’ five highest consecutive years of compensation out of the last ten years of service through March 1, 2007. The Corporation expects to contribute $47 to the pension plan in 2010.

Following are the components of net periodic benefit cost for the three month periods ended March 31:

		2010				2009
Interest cost on projected benefit obligation		$	133			$	126
Expected return on plan assets			(123	)			(131	)
Amortization of unrecognized actuarial net loss			38				43
Net periodic benefit cost		$	48			$	38

NOTE 9 —FAIR VALUE

Financial Instruments Recorded at Fair Value

The Corporation utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale, trading securities, mortgage loans available-for-sale and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time to time, the Corporation may be required to record other assets at fair value on a nonrecurring basis, such as loans held-for-sale, impaired loans, foreclosed assets, originated mortgage servicing rights and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy

Under fair value measurement and disclosure authoritative guidance, the Corporation groups assets and liabilities measured at fair value into three levels, based on the markets in which the assets and liabilities are traded, and the reliability of the assumptions used to determine fair value, based on the prioritization of inputs in the valuation techniques. These levels are:

	Level 1:		Valuation is based upon quoted prices for identical instruments traded in active markets.
	Level 2:		Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
	Level 3:		Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.

The assets or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs

The tables below present the recorded amount of assets and liabilities measured at fair value on:

		March 31, 2010												December 31, 2009
Description		Total				(Level 2)				(Level 3)				Total				(Level 2)				(Level 3)
Recurring items
Trading securities States and political subdivisions		$	9,611			$	9,611			$	—			$	9,962			$	9,962			$	—
Mortgage-backed			—				—				—				3,601				3,601				—
Total trading securities			9,611				9,611				—				13,563				13,563				—
Available-for-sale investment securities
Government-sponsored enterprises			19,448				19,448				—				19,471				19,471				—
States and political subdivisions			148,399				148,399				—				151,730				151,730				—
Auction rate money market preferred			2,749				—				2,749				2,973				—				2,973
Preferred stock			7,145				—				7,145				7,054				—				7,054
Mortgage-backed			78,964				78,964				—				67,734				67,734				—
Collateralized mortgage obligations			20,389				20,389				—				10,104				10,104				—
Total available-for-sale investment securities			277,094				267,200				9,894				259,066				249,039				10,027
Borrowed funds			17,748				17,748				—				17,804				17,804				—
Nonrecurring items
Impaired loans			13,321				—				13,321				12,654				—				12,654
Foreclosed assets			1,164				1,164				—				1,157				1,157				—
Originated mortgage servicing rights			1,991				1,991				—				2,620				2,620				—
		$	320,929			$	297,714			$	23,215			$	306,864			$	284,183			$	22,681
Percent of assets and liabilities measured at fair value							92.77	%			7.23	%							92.61	%			7.39	%

As of March 31, 2010 and December 31, 2009, the Corporation had no assets or liabilities measured utilizing Level 1 valuation techniques.

Following is a description of the valuation methodologies and key inputs used to measure financial assets and liabilities recorded at fair value, as well as a description of the methods and significant assumptions used to estimate fair value disclosures for financial instruments not recorded at fair value in their entirety on a recurring basis. For financial assets and liabilities recorded at fair value, the description includes an indication of the level of the fair value hierarchy in which the assets or liabilities are classified

Cash and demand deposits due from banks: The carrying amounts of cash and short-term investments, including Federal funds sold approximate fair values.

Certificates of deposit held in other financial institutions: Interest bearing balances held in other financial institutions include certificates of deposit and other short term interest bearing balances that mature within 3 years. Fair value is determined using prices for similar assets with similar characteristics.

Investment Securities: Investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. Level 2 securities include U.S. Treasury securities, mortgage-backed securities issued by government-sponsored entities, municipal bonds and corporate debt securities in active markets. Securities classified as Level 3 include securities in less liquid markets and include auction rate money market preferred securities and preferred stocks.

As discussed above, the Corporation invested $11,000 in auction rate money market preferred investment security instruments, which are classified as available-for-sale securities and reflected at fair value. Due to continuing uncertainty in credit markets, the trading for these investments has been limited, and as such, these investments have been classified as Level 3 since the third quarter of 2008.

Mortgage Loans Available-for-Sale: Loans available for sale are carried at the lower of cost or market value. The fair value of loans held-for-sale is based on what price secondary markets are currently offering for portfolios with similar characteristics. As such, the Corporation classifies loans subjected to nonrecurring fair value adjustments as Level 2 valuation.

Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans (e.g.: real estate mortgage, agricultural, commercial, and installment) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated.

The Corporation does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and a specific allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. Impaired loans, where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, or the impairment is determined using the net present value of the expected cash flows, the Corporation classifies the impaired loan as nonrecurring Level 3 valuation.

Accrued interest: The carrying amounts of accrued interest approximate fair value.

Acquisition Intangibles and Goodwill: Intangible assets are subject to impairment testing. A projected cash flow valuation method is used in the completion of impairment testing. This valuation method requires a significant degree of management judgment. In the event the projected undiscounted net operating cash flows are less than the carrying value, the asset is recorded at fair value as determined by the valuation model. If the testing resulted in impairment, the Corporation would classify goodwill and other intangible assets subjected to nonrecurring fair value adjustments as Level 3 valuation. During 2010 and 2009, there were no impairments recorded on goodwill and other acquisition intangible assets.

Equity Securities Without Readily Determinable Fair Values: The Corporation has investments in equity securities without readily determinable fair values as well as an investment in a joint venture. The assets are individually reviewed for impairment on an annual basis by comparing the carrying value to the estimated fair value. The lack of an independent source to validate fair value estimates, including the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. The Corporation classifies nonmarketable equity securities and its investment in a joint venture subjected to nonrecurring fair value adjustments as Level 3 valuation. During 2010 and 2009, there were no impairments recorded on equity securities without readily determinable fair values.

Foreclosed Assets: Upon transfer from the loan portfolio, foreclosed assets are adjusted to and subsequently carried at the lower of carrying value or fair value less estimated costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral and as such, the Corporation classifies foreclosed assets as nonrecurring Level 2 valuation. When a current appraisal is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the foreclosed asset as nonrecurring Level 3 valuation.

Originated Mortgage Servicing Rights: Loan servicing rights are subject to impairment testing. A valuation model, which utilizes a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and a discount rate determined by management, is used for impairment testing. If the valuation model reflects a value less than the carrying value, mortgage servicing rights are adjusted to fair value through a valuation allowance as determined by the model. As such, the Corporation classifies loan servicing rights subjected to nonrecurring fair value adjustments as Level 2 valuation.

Deposits: Demand, savings, and money market deposits are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for variable rate certificates of deposit approximate their recorded carrying value. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Borrowed Funds: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. The fair values of the Corporation’s other borrowings are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing arrangements.

The Corporation has elected to measure a portion of other borrowed funds at their fair value. These borrowings are recorded at fair value on a recurring basis, with the fair value measurement estimated using discounted cash flow analysis based on the Corporation’s current incremental borrowings rates for similar types of borrowing arrangements. Changes in the fair value of these borrowings are included in noninterest income. As such, the Corporation classifies other borrowed funds as Level 2 valuation.

Commitments to extend credit, standby letters of credit and undisbursed loans: Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into consideration the remaining terms of the agreements and the counterparties’ credit standings. The Corporation does not charge fees for lending commitments; thus it is not practicable to estimate the fair value of these instruments.

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

The table below represents the activity in investment securities available-for-sale measured with Level 3 inputs on a recurring basis for the three month periods ended March 31:

		2010				2009
Level 3 inputs — January 1		$	10,027			$	5,021
Net unrealized (losses) gains			(133	)			1,929
Level 3 inputs — March 31		$	9,894			$	6,950

The changes in fair value of assets and liabilities recorded at fair value through earnings on a recurring basis and changes in assets and liabilities recorded at fair value on a nonrecurring basis, for which an impairment, or reduction of an impairment, was recognized in the three month periods ended March 31, 2010 and 2009, are summarized as follows:

		Three Months Ended March 31
		2010												2009
		Trading Gains				Other Gains								Trading Gains				Other Gains
Description		and (Losses)				and (Losses)				Total				and (Losses)				and (Losses)				Total
Recurring items
Trading securities		$	(1	)		$	—			$	(1	)		$	87			$	—			$	87
Borrowed funds			—				56				56				—				143				143
Nonrecurring items
Foreclosed assets			—				(77	)			(77	)			—				—				—
Originated mortgage servicing rights			—				36				36				—				(213	)			(213	)
Total		$	(1	)		$	15			$	14			$	87			$	(70	)		$	17

The activity in the trading portfolio of investment securities was as follows for the three month periods ended March 31:

		2010				2009
Trading securities — January 1		$	13,563			$	21,775
Sales, calls and maturities			(3,951	)			(2,683	)
Trading (losses) gains			(1	)			87
Trading securities — March 31		$	9,611			$	19,179

The activity in borrowings carried at fair value was as follows for the three month periods ended March 31:

		2010				2009
Borrowings carried at fair value — January 1		$	17,804			$	23,130
Net change in fair value			(56	)			(143	)
Borrowings carried at fair value — March 31		$	17,748			$	22,987

Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis

Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values in an active market are not available, the Company uses present value techniques and other valuation methods to estimate the fair values of its financial instruments. These valuation methods require considerable judgment and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used.

The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis on the Corporation’s consolidated balance sheets are as follows:

		March 31, 2010								December 31, 2009
		Estimated				Carrying				Estimated				Carrying
		Fair Value				Value				Fair Value				Value
ASSETS
Cash and demand deposits due from banks		$	19,038			$	19,038			$	22,706			$	22,706
Certicates of deposit held in other financial institutions			6,683				6,580				7,156				7,156
Trading securities			9,611				9,611				13,563				13,563
Investment securities available-for-sale			277,094				277,094				259,066				259,066
Mortgage loans available-for-sale			488				482				2,294				2,281
Net loans			732,027				713,178				719,604				710,337
Accrued interest receivable			6,338				6,338				5,832				5,832
Equity securities without readily determinable fair values			17,783				17,783				17,921				17,921
Originated mortgage servicing rights			2,773				2,695				2,620				2,620
LIABILITIES
Deposits with no stated maturities			398,233				398,233				382,006				382,006
Deposits with stated maturities			423,254				421,303				424,048				420,646
Borrowed funds			190,238				185,707				195,179				193,101
Accrued interest payable			1,115				1,115				1,143				1,143

NOTE 10 — OPERATING SEGMENTS

The Corporation’s reportable segments are based on legal entities that account for at least 10 percent of net operating results. As of March 31, 2010 and 2009 and each of the three month periods then ended, the operations of Isabella Bank (the “Bank”) represented 90% or more of the Corporation’s total assets and operating results. Therefore, the Corporation has only one operating segment and no segment reporting is required.

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion and analysis of the major factors that influenced Isabella Bank Corporation’s financial performance. This analysis should be read in conjunction with the Corporation’s 2009 annual report and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 3 of this report.

CRITICAL ACCOUNTING POLICIES

A summary of the Corporation’s significant accounting policies is set forth in Note 1 of the Consolidated Financial Statements included in the Corporation’s Annual Report for the year ended December 31, 2009. Of these significant accounting policies, the Corporation considers its policies regarding the allowance for loan losses, acquisition intangibles (including goodwill), 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 appropriateness 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 Corporation’s 2009 Annual Report and the following discussion herein.

Accounting principles generally accepted in the United States of America 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 would be 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.

RESULTS OF OPERATIONS

The following table outlines the results of operations for the three month periods ended March 31, 2010 and 2009.

		Three Months Ended
		March 31
		2010				2009
INCOME STATEMENT DATA
Net interest income		$	9,699			$	9,445
Provision for loan losses			1,207				1,472
Net income			2,023				1,329
PER SHARE DATA
Earnings per share:
Basic		$	0.27			$	0.18
Diluted			0.26				0.17
Cash dividends per common share			0.18				0.12
Book value (at end of period)			18.89				18.01
RATIOS
Average primary capital to average assets			13.42	%			13.07	%
Net income to average assets (annualized)			0.71				0.47
Net income to average equity (annualized)			5.68				3.83
Net income to average tangible equity (annualized)			8.66				5.91

Isabella Bank Corporation, as well as all other financial institutions in Michigan and across the entire country, has felt the negative impacts of the current economic recession. This recession, which began in 2008, has resulted in historically high levels of loan delinquencies and nonaccrual loans, which have translated into increases in net loans charged off and foreclosed asset and collection expenses. Despite the current economic downturn, the Corporation continues to be profitable, with net income of $2,023 for the three month period ended March 31, 2010. The Corporation’s nonperforming loans represented 1.21% of total loans as of March 31, 2010 which declined from 1.28% as of December 31, 2009. The ratio of nonperforming loans to total loans for all banks in the state of Michigan was 4.43% as of December 31, 2009 (March 31, 2010 state of Michigan ratios are not yet available). The Corporation’s interest margins also continue to be strong, as the net yield on interest earning assets (on a fully tax equivalent basis) improved to 4.04% for the three months ended March 31, 2010 compared to 3.97% for the same period in 2009. For further detailed discussion and analysis, see below.

Net Interest Income

Net interest income equals interest income less interest expense and is the primary source of income for the Corporation. Interest income includes loan fees of $403 for the three month period March 31, 2010, as compared to $450 during the same period in 2009. 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.

(Continued on page 22)

AVERAGE BALANCES, INTEREST RATE, AND NET INTEREST INCOME

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. 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% tax rate. Non accruing loans, for the purpose of the following computations, are included in the average loan amounts outstanding. Federal Reserve and Federal Home Loan Bank restricted equity holdings are included in other.

The following table displays the results for the three month periods ended March 31:

		2010												2009
						Tax				Average								Tax				Average
		Average				Equivalent				Yield /				Average				Equivalent				Yield /
		Balance				Interest				Rate				Balance				Interest				Rate
INTEREST EARNING ASSETS:
Loans		$	724,194			$	11,517				6.36	%		$	729,011			$	11,898				6.53	%
Taxable investment securities			142,075				1,279				3.60	%			122,868				1,287				4.19	%
Nontaxable investment securities			118,767				1,756				5.91	%			121,594				1,808				5.95	%
Trading account securities			11,022				141				5.12	%			20,601				252				4.89	%
Federal funds sold			—				—				—				3,260				1				0.12	%
Other			33,739				104				1.23	%			24,195				118				1.95	%
Total earning assets			1,029,797				14,797				5.75	%			1,021,529				15,364				6.02	%
NON EARNING ASSETS:
Allowance for loan losses			(13,395	)											(12,068	)
Cash and due from banks			16,110												19,639
Premises and equipment			24,323												23,648
Accrued income and other assets			90,423												89,559
Total assets		$	1,147,258											$	1,142,307
INTEREST BEARING LIABILITIES:
Interest bearing demand deposits		$	133,839				35				0.10	%		$	118,989				33				0.11	%
Savings deposits			165,901				89				0.21	%			179,330				102				0.23	%
Time deposits			417,030				2,759				2.65	%			387,184				3,492				3.61	%
Borrowed funds			186,079				1,517				3.26	%			217,749				1,601				2.94	%
Total interest bearing liabilities			902,849				4,400				1.95	%			903,252				5,228				2.32	%
NONINTEREST BEARING LIABILITIES:
Demand deposits			93,560												93,479
Other			8,444												6,807
Shareholders’ equity			142,405												138,769
Total liabilities and shareholders’ equity		$1,147,258												$	1,142,307
Net interest income (FTE)						$	10,397											$	10,136
Net yield on interest earning assets (FTE)											4.04	%											3.97	%