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.

For the quarterly period ended September 30, 2008

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from                      to                     

Isabella Bank Corporation

 

(Exact name of registrant as specified in its charter)

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

200 East Broadway, 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 is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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.

 

 

ISABELLA BANK CORPORATION
Index to Form 10-Q

				Page Numbers
PART I FINANCIAL INFORMATION
Item 1		Condensed Consolidated Financial Statements (Unaudited)			3-16
Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations			17-33
Item 3		Quantitative and Qualitative Disclosures About Market Risk			34-35
Item 4		Controls and Procedures			36
PART II OTHER INFORMATION
Item 1		Legal Proceedings			37
Item 1A		Risk Factors			37
Item 2		Unregistered Sales of Equity Securities and Use of Proceeds			37
Item 6		Exhibits			37
Signatures					38
Exhibit 31(a)					39
Exhibit 31(b)					40
Exhibit 32					41
EXHIBIT 31.A
EXHIBIT 31.B
EXHIBIT 32

Item 1 — Condensed Consolidated Financial Statements (Unaudited)

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

		September 30				December 31
		2008				2007
ASSETS
Cash and demand deposits due from banks		$	23,831			$	25,583
Trading securities			22,628				25,064
Available-for-sale securities (amortized cost of $234,871 in 2008 and $212,285 in 2007)			231,821				213,127
Mortgage loans available for sale			706				2,214
Loans
Agricultural			60,750				47,407
Commercial			312,560				238,306
Installment			34,122				29,037
Residential real estate mortgage			323,431				297,937
Total loans			730,863				612,687
Less allowance for loan losses			8,797				7,301
Net loans			722,066				605,386
Accrued interest receivable			6,886				5,948
Premises and equipment			22,176				22,516
Corporate-owned life insurance policies			15,611				13,195
Acquisition intangibles and goodwill, net			47,903				27,010
Equity securities without readily determinable fair values			15,930				7,353
Other assets			13,737				9,886
TOTAL ASSETS		$	1,123,295			$	957,282
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing		$	96,199			$	84,846
NOW accounts			115,099				105,526
Certificates of deposit and other savings			463,228				410,782
Certificates of deposit over $100,000			144,460				132,319
Total deposits			818,986				733,473
Other borrowed funds ($22,219 carried at fair value in 2008, $7,523 in 2007)			156,991				92,887
Escrow funds payable			—				1,912
Accrued interest and other liabilities			6,798				5,930
Total liabilities			982,775				834,202
Shareholders’ Equity Common stock — no par value 15,000,000 shares authorized; outstanding— 7,481,776 in 2008 (6,364,120 in 2007)			136,718				116,319
Retained earnings			6,636				7,027
Accumulated other comprehensive loss			(2,834	)			(266	)
Total shareholders’ equity			140,520				123,080
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	1,123,295			$	957,282

See notes to condensed consolidated financial statements.

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

		Nine Months Ended
		September 30
		2008				2007
Number of Shares of Common Stock Outstanding
Balance at beginning of period			6,364,120				6,335,861
Common stock dividends			687,599				—
Shares issued in exchange for bank acquisition			514,809				—
Other issuances of common stock			63,584				43,252
Common stock repurchased			(148,336	)			(41,428	)
Balance end of period			7,481,776				6,337,685
Common Stock
Balance at beginning of period		$	116,319			$	114,785
Common stock dividends (10%)			30,256				—
Transfer			(28,000	)			—
Issuance of common stock in exchange for bank acquisition			22,652				—
Other issuances of common stock			1,610				1,470
Share-based payment awards under equity compensation plan			321				621
Common stock repurchased			(6,440	)			(1,801	)
Balance end of period			136,718				115,075
Retained Earnings
Balance at beginning of period			7,027				4,451
Adjustment to initially apply FASB Statement No. 159, net of tax			—				(1,050	)
Adjustment to initially apply EITF 06-4, net of tax			(1,571	)			—
Net income			6,142				5,662
Common stock dividends (10%)			(30,256	)			—
Transfer			28,000				—
Cash dividends ($0.36 per share in 2008 and $0.33 per share in 2007)			(2,706	)			(2,276	)
Balance end of period			6,636				6,787
Accumulated Other Comprehensive Loss
Balance at beginning of period			(266	)			(3,487	)
Adjustment to initially apply fair value provisions of FASB Statement No. 159, net of tax			—				897
Other comprehensive (loss) income			(2,568	)			1,910
Balance end of period			(2,834	)			(680	)
Total shareholders’ equity end of period		$	140,520			$	121,182

See notes to condensed consolidated financial statements.

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

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2008				2007				2008				2007
Interest Income
Loans, including fees		$	12,566			$	11,227			$	37,511			$	32,625
Investment securities
Taxable			1,288				967				4,023				2,609
Nontaxable			1,161				954				3,466				2,659
Trading account securities			221				389				856				1,809
Federal funds sold and other			165				257				430				523
Total interest income			15,401				13,794				46,286				40,225
Interest Expense
Deposits			4,773				5,783				15,720				17,030
Borrowings			1,536				907				4,050				2,463
Total interest expense			6,309				6,690				19,770				19,493
Net interest income			9,092				7,104				26,516				20,732
Provision for loan losses			975				268				3,775				618
Net interest income after provision for loan losses			8,117				6,836				22,741				20,114
Noninterest Income
Service charges and fees			1,507				1,223				4,185				3,572
Title insurance revenue (Note 2)			—				611				234				1,738
Trust fees			240				262				685				708
Gain on sale of mortgage loans			38				50				195				149
Net gain (loss) on trading securities			20				320				(22	)			263
Change in the fair value of other borrowings carried at fair market value			182				(74	)			304				9
Other			390				327				1,091				918
Total noninterest income			2,377				2,719				6,672				7,357
Noninterest Expenses
Compensation and benefits			4,156				3,933				12,693				11,750
Occupancy			512				440				1,533				1,329
Furniture and equipment			959				841				2,829				2,504
Other			1,803				1,781				5,272				5,049
Total noninterest expenses			7,430				6,995				22,327				20,632
Income before federal income taxes			3,064				2,560				7,086				6,839
Federal income taxes			540				464				944				1,177
NET INCOME		$	2,524			$	2,096			$	6,142			$	5,662
Earnings per share
Basic		$	0.34			$	0.30			$	0.82			$	0.81
Diluted		$	0.33			$	0.29			$	0.80			$	0.79
Cash dividends per basic share		$	0.12			$	0.11			$	0.36			$	0.33

See notes to condensed consolidated financial statements.

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

		Three months Ended								Nine Months Ended
		September 30								September 30
		2008				2007				2008				2007
Net Income		$	2,524			$	2,096			$	6,142			$	5,662
Unrealized (losses) gains on available-for-sale securities:
Unrealized holding (losses) gains arising during the period			(2,299	)			1,860				(3,877	)			(165	)
Reclassification adjustment for net realized (gains) losses included in net income			(15	)			—				(15	)			30
Net unrealized (losses) gains			(2,314	)			1,860				(3,892	)			(135	)
Tax effect			787				(632	)			1,324				46
Unrealized (losses) gains, net of tax			(1,527	)			1,228				(2,568	)			(89	)
Change in unrecognized actuarial loss of defined benefit pension plan, principally due to curtailment			—				—				—				3,029
Tax effect			—				—				—				(1,030	)
Change in unrecognized actuarial loss of defined benefit pension plan, principally due to curtailment, net of tax			—				—				—				1,999
Other comprehensive (loss) income, net of tax			(1,527	)			1,228				(2,568	)			1,910
Comprehensive income		$	997			$	3,324			$	3,574			$	7,572

See notes to condensed consolidated financial statements.

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

		Nine months ended September 30
		2008				2007
OPERATING ACTIVITIES
Net income		$	6,142			$	5,662
Reconciliation of net income to cash provided by operations:
Provision for loan losses			3,775				618
Provision for foreclosed asset losses			8				—
Depreciation			1,608				1,471
Amortization and impairment of mortgage servicing rights			167				156
Amortization of acquisition intangibles			316				213
Net amortization of investment securities			228				136
Realized (gain) loss on sale of available-for-sale investment securities			(15	)			30
Unrealized losses (gains) on trading securities			22				(263	)
Unrealized gains on borrowings measured at their fair values			(304	)			(9	)
Earnings on corporate owned life insurance policies			(385	)			(321	)
Share-based payment awards			321				621
Deferred income tax (benefit) expense			(212	)			23
Net changes in operating assets and liabilities which provided (used) cash, net in 2008 of bank acquisition and joint venture formation:
Trading securities			7,393				48,040
Loans held for sale			1,508				1,352
Accrued interest receivable			(338	)			(854	)
Other assets			(1,555	)			(3,722	)
Escrow funds payable			(46	)			1,232
Accrued interest and other liabilities			(1,459	)			420
Net Cash Provided By Operating Activities			17,174				54,805
INVESTING ACTIVITIES
Activity in available-for-sale securities
Maturities, calls, and sales			51,346				39,596
Purchases			(67,138	)			(87,269	)
Loan principal originations, net			(34,715	)			(19,753	)
Proceeds from sales of foreclosed assets			1,680				—
Purchases of premises and equipment			(1,372	)			(2,163	)
Bank acquisition, net of cash acquired			(9,465	)			—
Title company joint venture formation, net of cash exchanged			(4,542	)			—
Purchase of corporate owned life insurance policies			(1,250	)			—
Net Cash Used In Investing Activities			(65,456	)			(69,589	)
FINANCING ACTIVITIES
Net increase (decrease) in noninterest bearing deposits			1,204				(5,432	)
Net (decrease) increase in interest bearing deposits			(5,740	)			6,361
Net increase in other borrowed funds			58,602				8,630
Cash dividends paid on common stock			(2,706	)			(2,276	)
Proceeds from issuance of common stock			1,610				1,470
Common stock repurchased			(6,440	)			(1,801	)
Net Cash Provided By Financing Activities			46,530				6,952
DECREASE IN CASH AND CASH EQUIVALENTS			(1,752	)			(7,832	)
Cash and cash equivalents at beginning of period			25,583				31,359
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	23,831			$	23,527
Supplemental cash flows information:
Transfer of foreclosed loans to foreclosed assets		$	2,475			$	653

See notes to condensed consolidated financial statements.

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

NOTE 1 — BASIS OF PRESENTATION

The accompanying unaudited 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 (consisting only of normal recurring accruals with the exception of the fair value reporting election described in Note 6 and the adoption of EITF 06-4 described in Note 7) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. 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, 2007.

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

Effective January 1, 2008, the Corporation acquired Greenville Community Financial Corporation (GCFC). The condensed consolidated financial statements include the results of operations of GCFC since January 1, 2008 (see Note 2). Effective March 1, 2008, the Corporation entered into a joint venture with Corporate Title Agency, LLC. The condensed consolidated financial statements include the results of operations from this new entity since March 1, 2008 (see Note 2). Refer to Management’s Discussion and Analysis for further consideration of the impact of these transactions on the condensed consolidated financial statements.

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, 2007, with the addition of new pronouncements adopted during 2008 (see Note 7).

NOTE 2 — BUSINESS COMBINATION AND JOINT VENTURE FORMATION

Bank Acquisition

On the opening of business on January 1, 2008, Isabella Bank Corporation acquired 100 percent of Greenville Community Financial Corporation (GCFC). As a result of this acquisition, Greenville Community Bank, a wholly owned subsidiary of GCFC, merged with and into Isabella Bank (the “Bank”). Under the terms of the merger agreement, each share of GCFC common stock was automatically converted into the right to receive 0.6659 shares of Isabella Bank Corporation common stock and $14.70 per share in cash. Exclusive of the effects of the 10% stock dividend paid February 29, 2008, the Corporation issued 514,809 shares of Isabella Bank Corporation common stock valued at $22,652 and paid a total of $11,365 in cash to GCFC shareholders. The total consideration exchanged including the value of the common stock issued, cash paid to shareholders, plus cash paid for $564 in transaction costs resulted in a total purchase price of $34,581. The purchase price was determined using the latest Isabella Bank Corporation stock transaction price known to management as of November 27, 2007, the date of the merger agreement. The acquisition of Greenville has increased the overall market share for Isabella Bank Corporation in furtherance of the Bank’s strategic plan to pursue certain acquisitions.

The following table summarizes the estimate of the total purchase price of the transaction as well as adjustments to allocate the purchase price based on the preliminary estimates of fair values of the assets and liabilities of GCFC.

						Fair Value
						Adjustments of
						Nonintangible				Fair Value
		Greenville				Net Assets				of Net Assets
		January 1, 2008				Acquired				Acquired
ASSETS
Cash and cash equivalents		$	2,339			$	—			$	2,339
Federal funds sold			125				—				125
Trading securities			4,979				—				4,979
Securities available for sale			7,007				—				7,007
Loans, net			88,613				(398	)			88,215
Bank premises and equipment			2,054				194				2,248
Other assets			2,870				—				2,870
Total assets acquired			107,987				(204	)			107,783
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits			90,151				(102	)			90,049
Other borrowed funds			5,625				181				5,806
Accrued interest and other liabilities			146				—				146
Total liabilities assumed			95,922				79				96,001
Net assets acquired		$	12,065			$	(283	)			11,782
Core deposit intangible											1,480
Goodwill											21,319
Total consideration paid										$	34,581

The fair value adjustments of tangible net assets acquired are being amortized over two years using the straight line amortization method. The core deposit intangible is being amortized using a 15 year sum-of-the-years’ digits amortization schedule. Goodwill, which is not amortized, is tested for impairment at least annually. As the acquisition was considered a stock transaction, goodwill is not deductible for federal income tax purposes.

The 2008 interim consolidated statements of income include operating results of GCFC since the date of acquisition.

The unaudited pro forma information presented in the following table has been prepared based on Isabella Bank Corporation’s historical results combined with GCFC. The information has been combined to present the results of operations as if the acquisition had occurred at the beginning of the earliest period presented. The pro forma results are not necessarily indicative of the results which would have actually been attained if the acquisition had been consummated in the past or what may be attained in the future (as adjusted for the 10% stock dividend paid February 29, 2008):

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2008				2007				2008				2007
Net interest income		$	9,092			$	8,013			$	26,516			$	23,402
Net income		$	2,524			$	2,311			$	6,142			$	6,358
Basic earnings per share		$	0.34			$	0.30			$	0.82			$	0.81

Title Joint Venture Formation

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 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. As the Corporation is a 50 percent owner of this new entity, revenues and expenses will now be recorded under the equity method, and as such net income from the joint venture will be included in other income. As of September 30, 2008, the Corporation had a recorded investment of $7,064 in the new entity, which is included in equity securities without readily determinable fair values. The following table summarizes the balance sheet of IBT Title as of March 1, 2008. These amounts were excluded from the balance sheet detail of the Corporation and are now included in investment in equity securities without readily determinable fair values.

		IBT Title
		March 1, 2008
ASSETS
Cash and cash equivalents		$	4,542
Premises and equipment			2,352
Other assets			2,339
Total assets			9,233
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Escrow funds		$	1,866
Other liabilities			194
Total liabilities			2,060
Total equity			7,173
Total liabilities & equity		$	9,233

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. 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 amounts:

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2008				2007				2008				2007
Average number of common shares outstanding for basic calculation*			7,477,290				6,971,829				7,492,152				6,970,965
Potential effect of shares in the Deferred Director fee plan*			184,667				198,326				183,891				196,896
Average number of common shares outstanding used to calculate diluted earnings per common share			7,661,957				7,170,155				7,676,043				7,167,861
Net Income		$	2,524			$	2,096			$	6,142			$	5,662
Earnings per share
Basic		$	0.34			$	0.30			$	0.82			$	0.81
Diluted		$	0.33			$	0.29			$	0.80			$	0.79

NOTE 4 — OPERATING SEGMENTS

The Corporation’s reportable segments are based on legal entities that account for at least 10 percent of net operating results. In April 2007, the individual bank charters of Isabella Bank and Trust and FSB Bank were consolidated into one bank charter as a part of the Corporation’s strategy to increase efficiencies. As of September 30, 2008 and 2007 and the nine month periods then ended, retail banking operations represent more than 90 percent of the Corporation’s total assets and operating results. As such, no segment reporting is presented.

NOTE 5 — DEFINED BENEFIT PENSION PLAN

The Corporation has a non-contributory defined benefit pension plan. In December 2006, the Board of Directors voted to curtail the defined benefit plan effective March 1, 2007. The effect of the curtailment, which was recognized in the first quarter of 2007, suspended the current participants’ accrued benefits as of March 1, 2007 and limited participation in the plan to eligible employees as of December 31, 2006. As a result of the curtailment, the Corporation recognized a loss of $37 in the first quarter of 2007 in accordance with SFAS No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits. Due to the curtailment, future salary increases will not be considered and the 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. As a result of the curtailment, the Corporation does not anticipate contributing to the plan in the future.

The components of net periodic benefit (income) cost for the three and nine month periods ended September 30 are as follows:

		Pension Benefits
		Three months ended								Nine Months Ended
		September 30								September 30
		2008				2007				2008				2007
Net periodic benefit (income) cost
Service cost on benefits earned for services rendered during the period		$	—			$	27			$	—			$	82
Interest cost on projected benefit obligation			125				126				377				379
Expected return on plan assets			(165	)			(158	)			(495	)			(476	)
Amortization of unrecognized prior service cost			—				—				—				2
Amortization of unrecognized actuarial net loss			1				10				3				32
Net periodic benefit (income) cost			(39	)			5				(115	)			19
Loss on plan curtailment			—				—				—				37
Total net periodic benefit (income) cost		$	(39	)		$	5			$	(115	)		$	56

NOTE 6 — FINANCIAL INSTRUMENTS RECORDED AT FAIR VALUE

Fair value is the price that would be expected to be received upon the sale of an asset or transfer of a liability in an orderly transaction between market participants at the measurement date. To increase consistency and comparability in fair value measurements and related disclosures, the fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The level in the fair value hierarchy within which the fair value measurement in its entirety falls shall be determined based on the lowest level input that is significant to the fair value measurement in its entirety. The fair value hierarchy levels are summarized below.

	•		Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
	•		Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
	•		Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

SFAS 157 states that inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability and characterizes the inputs as observable or unobservable.

	•		Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity.
	•		Unobservable inputs are inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

The Corporation has invested in $11,000 of auction rate money market preferred investment security instruments, which are classified as available for sale securities and reflected at fair value. Due to recent events in credit markets these investments have become illiquid. As such, the fair values of these securities were estimated utilizing a discounted cash flow analysis or other type of valuation adjustment methodology as of September 30, 2008; previously the fair value of these investments was based on observable market data (Level 2). These analyses consider, among other items, the collateral underlying the security investments, the creditworthiness of the counterparty, the timing of expected future cash flows, estimates of the next time the security is expected to have a successful

auction, and the Corporation’s intent and ability to hold such securities until credit markets improve. These securities were also compared, when possible, to other securities with similar characteristics.

Due to the lack of marketability of these instruments at this time, management conducted an analysis to determine whether these investments should be considered other than temporarily impaired (OTTI). Such analyses included 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 the Corporation have the ability and intent to hold the security until maturity?
	•		Has the duration of the investment been extended by more than 7 years?

Based on the Corporation’s analysis using the above criteria, management does not believe that the values of these or any other securities are other than temporarily impaired. The Corporation had no assets classified as Level 3 as of September 30, 2007.

The table below represents the activity in Level 3 inputs for the nine month period ended September 30, 2008:

Level 3 inputs — January 1		$	—
Transfers into level 3 due to changes in the observability of significant inputs			11,000
Unrealized losses on available-for-sale investment securities			(762	)
Level 3 inputs — September 30		$	10,238

						Fair Value Measurements																Fair Value Measurements
						at September 30, 2008 Using																at September 30, 2007 Using
										Significant																Significant
						Quoted Prices in				Other				Significant								Quoted Prices in				Other
		Fair Value				Active Markets for				Observable				Unobservable				Fair Value				Active Markets for				Observable
		Measurements				Identical Assets				Inputs				Inputs				Measurements				Identical Assets				Inputs
Description		9/30/2008				(Level 1)				(Level 2)				(Level 3)				9/30/2007				(Level 1)				(Level 2)
Recurring Items
Trading securities		$	22,628			$	—			$	22,628			$	—			$	30,062			$	—			$	30,062
Investment securities available for sale			231,821				4,014				217,569				10,238				182,983				3,981				179,002
Mortgage loans available for sale			706				—				706				—				1,382				—				1,382
Other borrowed funds			22,219				—				22,219				—				7,479				—				7,479
Nonrecurring Items
Mortgage servicing rights			2,224				—				2,224				—				2,192				—				2,192
Foreclosed assets			2,853				—				2,853				—				755				—				755

		Changes in Fair Value for the 3-month Period Ended September 30, 2008												Changes in Fair Value for the 9-month Period Ended September 30, 2008
		for Items Measured at Fair Value Pursuant to Election of the Fair Value Option												for Items Measured at Fair Value Pursuant to Election of the Fair Value Option
										Total Changes in												Total Changes in
										Fair Values												Fair Values
		Trading Gains and				Other Gains and				Included in Current				Trading Gains and				Other Gains and				Included in Current
Description		(Losses)				(Losses)				Period Earnings				(Losses)				(Losses)				Period Earnings
Recurring Items
Trading securities		$	20			$	—			$	20			$	(22	)		$	—			$	(22	)
Other borrowed funds			—				182				182				—				304				304
Nonrecurring Items
Mortgage servicing rights			—				8				8				—				8				8
Foreclosed assets			—				—				—				—				(8	)			(8	)
										$	210											$	282

During the first quarter of 2008, primarily as a result of declines in the rates offered on new residential mortgage loans, the Corporation recorded impairment charges of $30 related to the carrying value of its mortgage servicing rights, in accordance with the provisions of SFAS No. 156. This decline in offering rates decreased the expected lives of the loans serviced and in turn decreased the value of the serving rights. However, in the second and third quarters of 2008, the Corporation reduced the recorded impairment on mortgage servicing rights by $30 and $8, respectively, as offering rates increased. As such, the net effect of changes in the fair value of the mortgage servicing rights was a reduction in the recorded impairment of $8 for the nine month period ended September 30, 2008.

The impairment charges to other real estate owned of $38 for the three month and $64 for the nine month period ended September 30, 2008 were the result of the real estate held declining in value subsequent to the properties being transferred to other real estate.

		Changes in Fair Value for the 3-month Period Ended September 30, 2007												Changes in Fair Value for the 9-month Period Ended September 30, 2007
		for Items Measured at Fair Value Pursuant to Election of the Fair Value Option												for Items Measured at Fair Value Pursuant to Election of the Fair Value Option
										Total Changes in												Total Changes in
										Fair Values												Fair Values
		Trading Gains and				Other Gains and				Included in Current				Trading Gains and				Other Gains and				Included in Current
Description		(Losses)				(Losses)				Period Earnings				(Losses)				(Losses)				Period Earnings
Recurring Items
Trading securities		$	320			$	—			$	320			$	263			$	—			$	263
Other borrowed funds			—				(74	)			(74	)			—				9				9
Nonrecurring Items
Mortgage servicing rights			—				—				—				—				—				—
Foreclosed assets			—				(38	)			(38	)			—				(64	)			(64	)
										$	208											$	208

The activity in the trading portfolio of investment securities for the three and nine month periods ended September 30, 2008 and 2007 was as follows:

		Three Months Ended September 30								Nine Months Ended September 30
		2008				2007				2008				2007
Purchases		$	—			$	—			$	9,052			$	3,337
Sales, calls, and maturities			(2,484	)			(12,035	)			(11,466	)			(51,377	)
Total		$	(2,484	)		$	(12,035	)		$	(2,414	)		$	(48,040	)

The net loss on trading securities represents mark-to-market adjustments. Included in the net trading losses of $22 during the nine month period ended September 30, 2008, was $10 of net trading gains on securities that were held in the Corporation’s trading portfolio as of September 30, 2008.

The activity in borrowings carried at fair market value for the three and nine month periods ended September 30, 2008 and 2007 was as follows:

		Three Months Ended September 30								Nine Months Ended September 30
		2008				2007				2008				2007
Issuances		$	5,000			$	—			$	15,000			$	—

NOTE 7 — RECENT ACCOUNTING PRONOUNCEMENTS

In September of 2006, EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangement, was ratified by the FASB. The EITF reached a consensus that for an endorsement split-dollar life insurance arrangement within the scope of this Issue, an employer should recognize a liability for future benefits. The Corporation has purchased corporation-owned life insurance on certain of its employees. The cash surrender value of these policies is carried as an asset on the condensed consolidated balance sheets. The carrying value was $13,195 at December 31, 2007. These life insurance policies are generally subject to endorsement split-dollar life insurance arrangements. These arrangements were designed to provide a pre-and postretirement benefit for senior officers of the Corporation. The Corporation adopted EITF Issue No. 06-4 effective January 1, 2008 and as a result recorded an initial liability of $2,375. To establish this liability, the Corporation recorded a one time charge of $1,571, net of tax, directly to retained earnings at that date. The periodic policy maintenance costs were $18 and $53 for the three and nine month periods ended September 30, 2008, respectively.

On March 19, 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 161 (SFAS No.161) Disclosures about Derivative Instruments and Hedging Activities. The objective of SFAS No. 161 is to enhance disclosures about an entity’s derivative and hedging activities and thereby improve the transparency of financial reporting. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 and is not expected to have a significant impact on the Corporation’s consolidated financial statements.

In May 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 163 (SFAS No.163) Accounting for Financial Guarantee Insurance Contracts-an Interpretation of FASB Statement No.60. The objective of SFAS No. 163 is to clarify how Statement No. 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. This statement also requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. SFAS No. 163 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008 and will not have an impact on the Corporation’s consolidated financial statements.

In May 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 162 (SFAS No.162) The Hierarchy of Generally Accepted Accounting Principles. The objective of SFAS No. 162 is to identify the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles and is not expected to have a significant impact on the Corporation’s consolidated financial statements.

In October 2008, the Financial Accounting Standards Board (“FASB”) staff issued Staff Position No. FSP 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active. FSP 157-3 clarifies the application of SFAS 157, which the Corporation adopted as of January 1, 2008, in cases where a market is not active. The Corporation has considered the guidance provided by FSP 157-3, which was effective on October 10, 2008, in its determination of estimated fair values as of September 30, 2008, and the impact was not material.

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 2007 annual report and with the unaudited interim condensed consolidated financial statements and notes, as set forth on pages 3 through 15 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, 2007. 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 Provision for Loan Losses and Allowance for Loan Losses in the Corporation’s 2007 Annual Report and herein.

Generally accepted accounting principles require the Corporation to determine the fair value of all 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 means in determination of the fair value, including the use of discounted cash flow analysis, market comparisons, 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 and are carried at their fair value. Changes in the fair value of available-for-sale investment securities are included in 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.

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 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 and nine month periods ended September 30, 2008 and 2007. Return on average assets measures the ability of the 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.

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2008				2007				2008				2007
INCOME STATEMENT DATA
Net interest income		$	9,092			$	7,104			$	26,516			$	20,732
Provision for loan losses			975				268				3,775				618
Net income			2,524				2,096				6,142				5,662
PER SHARE DATA
Earnings per share:
Basic		$	0.34			$	0.30			$	0.82			$	0.81
Diluted			0.33				0.29				0.80				0.79
Cash dividends per common share			0.12				0.11				0.36				0.33
Book value (at end of period)			18.78				17.38				18.78				17.38
RATIOS
Average primary capital to average assets			13.29	%			13.71	%			13.71	%			13.52	%
Net income to average assets			0.90				0.91				0.74				0.82
Net income to average equity			7.14				6.98				5.69				6.39
Net income to average tangible equity			10.81				8.89				8.60				8.14

Net Interest Income

Net interest income equals interest income less interest expense and is the primary source of income for Isabella Bank Corporation. Interest income includes loan fees of $428 and $1,390 for the three and nine month periods ended September 30, 2008, respectively, as compared to $381 and $957 during the same periods 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.

     (Continued on page 20)

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. Nonaccruing 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.

Results for the three month periods ended September 30, 2008 and September 30, 2007 are as follows:

		Three Months Ended
		September 30, 2008												September 30, 2007
						Tax				Average								Tax				Average
		Average				Equivalent				Yield\				Average				Equivalent				Yield\
		Balance				Interest				Rate				Balance				Interest				Rate
INTEREST EARNING ASSETS:
Loans		$	723,038			$	12,566				6.95	%		$	608,033			$	11,227				7.39	%
Taxable investment securities			105,163				1,288				4.90	%			71,461				967				5.41	%
Nontaxable investment securities			121,231				1,805				5.96	%			100,295				1,491				5.95	%
Trading account securities			24,095				271				4.50	%			35,694				445				4.99	%
Federal funds sold			11,863				55				1.85	%			13,953				172				4.93	%
Other			18,377				110				2.39	%			7,892				85				4.31	%
Total earning assets			1,003,767				16,095				6.41	%			837,328				14,387				6.87	%
NON EARNING ASSETS:
Allowance for loan losses			(8,512	)											(7,627	)
Cash and due from banks			19,330												21,299
Premises and equipment			22,390												21,468
Accrued income and other assets			82,743												55,186
Total assets		$	1,119,718											$	927,654
INTEREST BEARING LIABILITIES:
Interest-bearing demand deposits		$	111,346				171				0.61	%		$	105,670				411				1.56	%
Savings deposits			219,103				614				1.12	%			194,843				1,200				2.46	%
Time deposits			391,037				3,988				4.08	%			348,807				4,172				4.78	%
Other borrowed funds			151,331				1,536				4.06	%			70,168				907				5.17	%
Total interest bearing liabilities			872,817				6,309				2.89	%			719,488				6,690				3.72	%
NONINTEREST BEARING LIABILITIES:
Demand deposits			99,220												78,984
Other			6,286												9,058
Shareholders’ equity			141,395												120,124
Total liabilities and equity		$	1,119,718											$	927,654
Net interest income (FTE)						$	9,786											$	7,697
Net yield on interest earning assets (FTE)											3.90	%											3.68	%