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 March 31, 2009

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

For the transition period from                      to                     

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 incorporation or organization)		(I.R.S. Employer 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 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.

     Common Stock no par value, 7,525,472 as of April 15, 2009

 

 

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

PART I					3
Item 1		Condensed Consolidated Financial Statements (Unaudited)			3
Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations			13
Item 3		Quantitative and Qualitative Disclosures about Market Risk			25
Item 4		Controls and Procedures			27
PART II					28
Item 1		Legal Proceedings			28
Item 1A		Risk Factors			28
Item 2		Unregistered Sales of Equity Securities and Use of Proceeds			28
Item 6		Exhibits			28
SIGNATURES					29
EX-31.(A)
EX-31.(B)
EX-32

PART I — FINANCIAL INFORMATION

Item 1 — Condensed Consolidated Financial Statements (Unaudited)

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

		March 31				December 31
		2009				2008
ASSETS
Cash and demand deposits due from banks		$	20,310			$	23,554
Trading securities			19,179				21,775
Available-for-sale securities (amortized cost of $246,112 in 2009; $248,741 in 2008)			244,227				246,455
Mortgage loans held for sale			6,400				898
Loans
Agricultural			57,985				58,003
Commercial			327,388				324,806
Installment			32,179				33,179
Residential real estate mortgage			305,876				319,397
Total loans			723,428				735,385
Less allowance for loan losses			11,925				11,982
Net loans			711,503				723,403
Accrued interest receivable			6,523				6,322
Premises and equipment			23,757				23,231
Corporate-owned life insurance policies			16,317				16,152
Acquisition intangibles and goodwill, net			47,709				47,804
Equity securities without readily determinable fair values			17,820				17,345
Other assets			13,010				12,324
TOTAL ASSETS		$	1,126,755			$	1,139,263
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing		$	87,663			$	97,546
NOW accounts			116,965				113,973
Certificates of deposit and other savings			428,819				422,689
Certificates of deposit over $100,000			146,667				141,422
Total deposits			780,114				775,630
Borrowed funds ($22,987 carried at fair value in 2009; $23,130 in 2008)			203,260				222,350
Accrued interest and other liabilities			7,846				6,807
Total liabilities			991,220				1,004,787
Shareholders’ Equity
Common stock — no par value
15,000,000 shares authorized; outstanding —7,525,472 (including 11,856 shares to be issued) in 2009 and 7,518,856 (including 5,248 shares to be issued) in 2008			133,600				133,602
Shares to be issued for deferred compensation obligations			4,055				4,015
Retained earnings			2,853				2,428
Accumulated other comprehensive loss			(4,973	)			(5,569	)
Total shareholders’ equity			135,535				134,476
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	1,126,755			$	1,139,263

See notes to condensed consolidated financial statements.

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

																		Accumulated
		Common																Other
		Stock Shares				Common				Shares to				Retained				Comprehensive
		Outstanding				Stock				be issued				Earnings				Income (Loss)				Totals
Balances, January 1, 2008			6,364,120			$	112,547			$	3,772			$	7,027			$	(266	)		$	123,080
Cumulative effect to apply EITF 06-4, net of tax			—				—				—				(1,571	)			—				(1,571	)
Comprehensive income			—				—				—				1,927				1,644				3,571
Common stock dividends (10%)			687,599				30,254				—				(30,254	)			—				—
Regulatory Capital transfer			—				(28,000	)			—				28,000				—				—
Bank acquisition			514,809				22,652				—				—				—				22,652
Issuance of common stock			15,611				645				—				—				—				645
Common stock issued for deferred compensation obligations			19,175				272				(272	)			—				—				—
Share-based payment awards under equity compensation plan			—				—				143				—				—				143
Common stock repurchased			(107,510	)			(4,725	)			—				—				—				(4,725	)
Cash Dividends ($0.12 per share)			—				—				—				(900	)			—				(900	)
Balances, March 31, 2008			7,493,804			$	133,645			$	3,643			$	4,229			$	1,378			$	142,895
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			(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

See notes to condensed consolidated financial statements.

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

		Three Months Ended
		March 31
		2009				2008
Interest Income
Loans, including fees		$	11,898			$	12,525
Investment securities
Taxable			1,287				1,368
Nontaxable			1,163				1,148
Trading account securities			206				328
Federal funds sold and other			119				157
Total interest income			14,673				15,526
Interest Expense
Deposits			3,627				5,904
Borrowings			1,601				1,178
Total interest expense			5,228				7,082
Net interest income			9,445				8,444
Provision for loan losses			1,472				1,207
Net interest income after provision for loan losses			7,973				7,237
Noninterest Income
Service charges and fees			1,349				1,448
Gain on sale of mortgage loans			268				84
Net gain on trading securities			87				443
Net gain (loss) on borrowings measured at fair value			143				(117	)
Title insurance revenue			—				234
Other			510				425
Total noninterest income			2,357				2,517
Noninterest Expenses
Compensation and benefits			4,676				4,334
Occupancy			529				528
Furniture and equipment			1,016				933
FDIC insurance premiums			885				43
Other			1,938				1,718
Total noninterest expenses			9,044				7,556
Income before federal income tax (benefit) expense			1,286				2,198
Federal income tax (benefit) expense			(43	)			271
NET INCOME		$	1,329			$	1,927
Earnings per share
Basic		$	0.18			$	0.26
Diluted		$	0.17			$	0.25
Cash dividends per basic share		$	0.12			$	0.12

See notes to condensed consolidated financial statements.

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

		Three Months Ended
		March 31
		2009				2008
Net Income		$	1,329			$	1,927
Unrealized gains on available-for-sale securities:
Unrealized holding gains arising during the period			622				2,490
Reclassification adjustment for net realized gains included in net income			(221	)			—
Net unrealized gains			401				2,490
Tax effect			195				(846	)
Other comprehensive income			596				1,644
Comprehensive income		$	1,925			$	3,571

See notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands)

		Three Months Ended March 31
		2009				2008
OPERATING ACTIVITIES
Net income		$	1,329			$	1,927
Reconciliation of net income to net cash provided by operations:
Provision for loan losses			1,472				1,207
Depreciation			582				530
Amortization and impairment of mortgage servicing rights			491				111
Amortization of acquisition intangibles			95				105
Net amortization of investment securities			175				58
Realized gain on sale of available-for-sale investment securities			(221	)			—
Unrealized gains on trading securities			(87	)			(443	)
Unrealized (gains) losses on borrowings measured at fair value			(143	)			117
Increase in cash value of corporate owned life insurance policies			(165	)			(125	)
Share-based payment awards under equity compensation plan			184				143
Deferred income tax benefit			—				(212	)
Net changes in operating assets and liabilities which provided (used) cash, net in 2008 of bank acquisition and joint venture formation:
Trading securities			2,683				85
Loans held for sale			(5,502	)			231
Accrued interest receivable			(201	)			(644	)
Other assets			(1,429	)			(1,249	)
Escrow funds payable			—				(46	)
Accrued interest and other liabilities			1,039				(988	)
Net Cash Provided By Operating Activities			302				807
INVESTING ACTIVITIES
Activity in available-for-sale securities
Maturities, calls, and sales			40,906				19,568
Purchases			(38,231	)			(29,548	)
Loan principal collections (originations), net			9,913				(2,411	)
Proceeds from sales of foreclosed assets			487				260
Purchases of premises and equipment			(1,108	)			(615	)
Bank acquisition, net of cash acquired			—				(9,480	)
Cash contributed to title company joint venture formation			—				(4,542	)
Net Cash Provided By (Used In) Investing Activities			11,967				(26,768	)
FINANCING ACTIVITIES
Net increase in deposits			4,484				9,141
Net (decrease) increase in other borrowed funds			(18,947	)			23,582
Cash dividends paid on common stock			(904	)			(900	)
Proceeds from issuance of common stock			334				645
Common stock repurchased			(294	)			(4,725	)
Common stock purchased for deferred compensation obligations			(186	)			—
Net Cash (Used In) Provided By Financing Activities			(15,513	)			27,743
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS			(3,244	)			1,782
Cash and cash equivalents at beginning of period			23,554				25,583
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	20,310			$	27,365
Supplemental cash flows information:
Interest paid		$	5,286			$	6,926
Transfer of loans to foreclosed assets			515				478

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 considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. 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, 2008.

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. Effective March 1, 2008, the Corporation entered into a joint venture with Corporate Title Agency, LLC. The investment in the joint venture is accounted for under the equity method and is included in the line item equity securities without readily determinable fair values on the consolidated balance sheets. The results of operations since the date of the joint venture are recorded in other income on the statements of income for the results of operations.

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, 2008.

NOTE 2 — 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 the Rabbi 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. In accordance with SFAS No. 128 (as amended), Earnings Per Share, the Corporation’s obligations to issue shares of stock to participants in its deferred directors plan have been treated as outstanding shares of common stock in the diluted earnings per share calculation. 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
		March 31
		2009				2008
Average number of common shares outstanding for basic calculation*			7,521,271				7,493,804
Potential effect of shares in the Deferred Director fee plan*			190,896				182,682
Average number of common shares outstanding used to calculate diluted earnings per common share			7,712,167				7,676,486
Net income		$	1,329			$	1,927
Earnings per share
Basic		$	0.18			$	0.26
Diluted		$	0.17			$	0.25

NOTE 3 — 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, 2009 and 2008 and each of the three month periods then ended, retail banking operations represented more than 90 percent of the Corporation’s total assets and operating results. As such, no segment reporting is presented.

NOTE 4 — DEFINED BENEFIT PENSION PLAN

The Corporation has a non-contributory defined benefit pension plan, which was curtailed effective March 1, 2007. Due to 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. As a result of the curtailment, the Corporation does not anticipate contributing to the plan in the reasonably foreseeable future.

The components of net periodic benefit cost (income) for the three month periods ended March 31 are as follows:

		2009				2008
Net periodic benefit cost (income)
Interest cost on projected benefit obligation		$	126			$	126
Expected return on plan assets			(131	)			(165	)
Amortization of unrecognized actuarial net loss			43				1
Net periodic benefit cost (income)		$	38			$	(38	)

NOTE 5 — 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, derivatives and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time to time, the Corporation may be required to record at fair value other assets on a nonrecurring basis, such as loans held-for-sale, loans held for investment in foreclosed assets, 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 SFAS 157, the Corporation groups assets and liabilities 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. 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 Corporation has invested $11,000 in auction rate money market preferred and preferred stock investment security instruments, which are classified as available-for-sale securities and reflected at fair value. Due to recent events and uncertainty in credit markets, these investments have become illiquid.

Due to the current illiquidity of these securities, these assets were classified as Level 3 during the third quarter of 2008. The fair values of these securities were estimated utilizing a discounted cash flow analysis or other type of valuation adjustment methodology as of March 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, estimates of the next time the security is expected to have a successful auction, and the Corporation’s ability to hold such securities until credit markets improve.

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

		2009				2008
Level 3 inputs — January 1		$	19,391			$	12,694
Purchases			3,300				2,461
Maturities			(262	)			(338	)
Net unrealized gains on available-for-sale investment securities			988				45
Level 3 inputs — March 31		$	23,417			$	14,862

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

		March 31, 2009																December 31, 2008
Description		Total				(Level 1)				(Level 2)				(Level 3)				Total				(Level 1)				(Level 2)				(Level 3)
Recurring Items
Trading securities		$	19,179			$	7,539			$	11,640			$	—			$	21,775			$	10,175			$	11,600			$	—
Available-for-sale investment securities			244,227				74,190				146,620				23,417				246,455				89,507				137,557				19,391
Mortgage loans available for sale			6,400				—				6,400				—				898				—				898				—
Borrowed funds			22,987				22,987				—				—				23,130				23,130				—				—
Nonrecurring Items
Impaired loans			10,055				—				—				10,055				10,014				—				—				10,014
Mortgage servicing rights			1,974				—				1,974				—				2,105				—				2,105				—
Foreclosed assets			2,951				—				2,951				—				2,923				—				2,923				—
		$	307,773			$	104,716			$	169,585			$	33,472			$	307,300			$	122,812			$	155,083			$	29,405
Percent of assets and liabilities measured at fair value							34.02	%			55.10	%			10.88	%							39.96	%			50.47	%			9.57	%

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 impairment was recognized in the three month periods ended March 31, 2009 and 2008, are summarized as follows:

		Three Months Ended March 31
		2009												2008
		Trading												Trading
		Gains and				Other Gains								Gains and				Other Gains
Description		(Losses)				and (Losses)				Total				(Losses)				and (Losses)				Total
Recurring Items
Trading securities		$	87			$	—			$	87			$	443			$	—			$	443
Borrowed funds			—				143				143				—				(117	)			(117	)
Nonrecurring Items
Mortgage servicing rights			—				(213	)			(213	)			—				(30	)			(30	)
										$	17											$	296

The net gains on trading securities represents mark-to-market adjustments. Included in the net trading gains of $87 during 2009, was $94 of net trading gains on securities that were held in the Corporation’s trading portfolio as of March 31, 2009.

As a result of declines in the rates offered on new residential mortgage loans, the Corporation recorded impairment charges 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.

The activity in the trading portfolio of investment securities was as follows for the three month periods ended March 31, 2009 and 2008:

		Three Months Ended March 31
		2009				2008
Purchases		$	—			$	7,674
Sales, calls, and maturities			(2,683	)			(2,082	)
Total		$	(2,683	)		$	5,592

During the first three months of 2009 and 2008, there were no changes in the level of borrowings measured at fair value, only recurring fair value adjustments.

NOTE 6 — FEDERAL INCOME TAXES

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

		2009				2008
Income taxes at 34% statutory rate		$	437			$	747
Effect of nontaxable income			(491	)			(501	)
Effect of nondeductible expenses			11				25
Federal income tax (benefit) expense		$	(43	)		$	271

NOTE 7 — RECENT ACCOUNTING PRONOUNCEMENTS

On April 1, 2009 the FASB staff issued Staff Position No. FSP 141R-1 Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies. This FASB Staff Position (FSP) amends and clarifies FASB Statement No. 141 (revised 2007), Business Combinations, to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. This FSP is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. FSP 141R-1 is expected to impact accounting by the Corporation of future business combinations.

On April 9, 2009 the FASB staff issued Staff Position No. FSP 157-4 Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FSP 157-4 provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. FSP 157-4, also includes guidance on identifying circumstances that indicate a market is distressed or not orderly. The Corporation expects to adopt this statement for the quarterly reporting period ending June 30, 2009, and is currently evaluating the potential impact the adoption of this standard will have on the Corporation’s consolidated financial statements.

On April 9, 2009 the FASB staff issued Staff Position No. FSP 115-2 Recognition and Presentation of Other-Than-Temporary Impairments. The objective of an other-than-temporary impairment analysis under existing U.S. generally accepted accounting principles (GAAP) is to determine whether the holder of an investment in a debt or equity security for which changes in fair value are not regularly recognized in earnings (such as securities classified as held-to-maturity or available-for-sale) should recognize a loss in earnings when the investment is impaired. An investment is impaired if the fair value of the investment is less than its amortized cost basis. FSP 115-2 amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The Corporation expects to adopt this statement for the quarterly reporting period ending June 30, 2009, and is currently evaluating the potential impact the adoption of this standard will have on the Corporation’s consolidated financial statements.

On April 9, 2009 the FASB staff issued Staff Position FSP No. 107-1 and APB 28-1 Interim Disclosures about Fair Value of Financial Instruments. This FASB Staff Position (FSP) amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. The Corporation expects to adopt this statement for the quarterly reporting period ending June 30, 2009, and is currently evaluating the potential impact the adoption of this standard will have on the Corporation’s consolidated financial statements.

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 2008 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, 2008. 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 2008 Annual Report and herein.

United States 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 which 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 considered to be other than temporary are reflected as realized losses in the consolidated statements of income. 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 month periods ended March 31, 2009 and 2008. 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.

SUMMARY OF SELECTED FINANCIAL DATA

		Three Months Ended
		March 31
		2009				2008
INCOME STATEMENT DATA
Net interest income		$	9,445			$	8,444
Provision for loan losses			1,472				1,207
Net income			1,329				1,927
PER SHARE DATA
Earnings per share:
Basic		$	0.18			$	0.26
Diluted			0.17				0.25
Cash dividends per common share			0.12				0.12
Book value (at end of period)			18.01				19.07
RATIOS
Average primary capital to average assets			13.07	%			14.15	%
Net income to average assets			0.47				0.71
Net income to average equity			3.83				5.26
Net income to average tangible equity			5.91				8.18

Despite an increase of $1,001 in net interest income, net income in the first quarter of 2009 declined by $598 or 31.0% from 2008. Outweighing the improvement in net interest margin was an $842 increase in FDIC insurance premiums and an increase of $265 in the provision for loan losses.

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 $450 for the three month period ended March 31, 2009, as compared to $411 during the same period in 2008. 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 16)

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 March 31, 2009 and March 31, 2008 are as follows:

		Three Months Ended
		March 31, 2009												March 31, 2008
						Tax				Average								Tax				Average
		Average				Equivalent				Yield /				Average				Equivalent				Yield /
		Balance				Interest				Rate				Balance				Interest				Rate
INTEREST EARNING ASSETS:
Loans		$	729,011			$	11,898				6.53	%		$	700,002			$	12,525				7.16	%
Taxable investment securities			122,868				1,287				4.19	%			97,193				1,368				5.63	%
Nontaxable investment securities			121,594				1,808				5.95	%			119,623				1,785				5.97	%
Trading account securities			20,601				252				4.89	%			32,214				386				4.79	%
Federal funds sold			3,260				1				0.12	%			6,232				49				3.15	%
Other			24,195				118				1.95	%			13,329				108				3.24	%
Total earning assets			1,021,529				15,364				6.02	%			968,593				16,221				6.70	%
NON EARNING ASSETS:
Allowance for loan losses			(12,068	)											(8,699	)
Cash and due from banks			19,639												20,708
Premises and equipment			23,648												23,800
Accrued income and other assets			89,559												84,105
Total assets		$	1,142,307											$	1,088,507
INTEREST BEARING LIABILITIES:
Interest bearing demand deposits		$	118,989				33				0.11	%		$	123,805				378				1.22	%
Savings deposits			179,330				102				0.23	%			208,439				863				1.66	%
Time deposits			387,184				3,492				3.61	%			404,340				4,663				4.61	%
Borrowed funds			217,749				1,601				2.94	%			107,005				1,178				4.40	%
Total interest bearing liabilities			903,252				5,228				2.32	%			843,589				7,082				3.36	%
NONINTEREST BEARING LIABILITIES:
Demand deposits			93,479												90,878
Other			6,807												7,487
Shareholders’ equity			138,769												146,553
Total liabilities and equity		$	1,142,307											$	1,088,507
Net interest income (FTE)						$	10,136											$	9,139
Net yield on interest earning assets (FTE)											3.97	%											3.77	%

VOLUME AND RATE VARIANCE ANALYSIS

The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows:

Volume Variance — change in volume multiplied by the previous year’s rate.

Rate Variance — change in the fully taxable equivalent (FTE) rate multiplied by the prior year’s volume.

The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

		Three Months Ended
		March 31, 2009 compared to
		March 31, 2008
		Increase (Decrease) Due to
		Volume				Rate				Net
CHANGES IN INTEREST INCOME:
Loans		$	504			$	(1,131	)		$	(627	)
Taxable investment securities			314				(395	)			(81	)
Nontaxable investment securities			29				(6	)			23
Trading account securities			(142	)			8				(134	)
Federal funds sold			(16	)			(32	)			(48	)
Other			64				(54	)			10
Total changes in interest income			753				(1,610	)			(857	)
CHANGES IN INTEREST EXPENSE:
Interest bearing demand deposits			(14	)			(331	)			(345	)
Savings deposits			(106	)			(655	)			(761	)
Time deposits			(191	)			(980	)			(1,171	)
Borrowed funds			913				(490	)			423
Total changes in interest expense			602				(2,456	)			(1,854	)
Net change in interest margin (FTE)		$	151			$	846			$	997

Interest rates paid on interest bearing liabilities decreased faster than those earned on interest earning assets, resulting in a 0.20% increase in net interest margins on a tax equivalent basis when the first three months of 2009 are compared to the same period in 2008. Despite this increase over last year’s results and the expectation that borrowing rates will remain historically low, the Corporation anticipates that net interest margin yield will decline during 2009 due to the followings factors:

	•		Based on the current economic conditions, management does not anticipate any changes in the target Fed Funds rate during 2009. As such, the Corporation does not anticipate significant, if any, changes in market rates. However, there is the potential for declines in rates earned on interest earning assets. Most of the potential declines would arise out of the Corporation’s investment portfolio, as securities with call dates during 2009 will most likely be called and the Corporation will be reinvesting those proceeds at significantly lower rates.
	•		The recent substantial decline in residential mortgage rates will continue to lead to increases in the demand of fixed rate mortgage products resulting in the Corporation’s customers refinancing three and five year balloon mortgages into fixed rate products that are sold on the secondary market. The reinvestment of these proceeds at lower interest rates will adversely impact interest income.
	•		The Corporation has experienced a significant increase in non-accrual loans. The increase is a direct result of a decline in residential housing market values, the inability of residential and commercial developers to sell and or lease property, and a significant increase in unemployment rates, and overall economic uncertainty. The increase in non-accrual loans will decrease 2009 interest income as these loans will no longer be accruing interest income.

Allowance for Loan Losses

The viability of any financial institution is ultimately determined by its management of credit risk. Total loans outstanding represent 64.2% of the Corporation’s total assets and is the Corporation’s single largest concentration of risk. The allowance for loan losses is management’s estimation of potential future losses inherent in the existing loan portfolio. Factors used to evaluate the loan portfolio, and thus to determine the current charge to expense, include recent loan loss history, financial condition of borrowers, amount of nonperforming and impaired loans, overall economic conditions, and other factors. The following table summarizes the Corporation’s charge off and recovery activity for the three month periods ended March 31, 2009 and 2008.

		Three Months Ended
		March 31
		2009				2008
Allowance for loan losses — January 1		$	11,982			$	7,301
Allowance of acquired bank			—				908
Loans charged off
Commercial and agricultural			1,372				422
Real estate mortgage			246				658
Consumer			220				158
Total loans charged off			1,838				1,238
Recoveries
Commercial and agricultural			147				27
Real estate mortgage			63				45
Consumer			99				83
Total recoveries			309				155
Net loans charged off			1,529				1,083
Provision charged to income			1,472				1,207
Allowance for loan losses — March 31		$	11,925			$	8,333
Year to date average loans		$	729,011			$	700,002
Net loans charged off to average loans outstanding			0.21	%			0.15	%
Total amount of loans outstanding		$	723,428			$	702,660
Allowance for loan losses as a % of loans			1.65	%			1.19	%

     With increases in the net loans charged off to average loans and nonperforming loans as a percentage of total loans, and the declines in the credit quality of the loan portfolio, the Corporation significantly increased the provision charged to income in the second half of 2008 and into 2009. This additional provision increased the allowance for loans losses as a percentage of loans to 1.63% as of December 31, 2008 and 1.65% as of March 31, 2009.

     The Corporation has also experienced an increase in foreclosed loans and an increase in loans charged off due mainly to the downturn in the residential real estate mortgage market, which has also resulted in an increase in other real estate owned. Of the $1,372 of total commercial and agricultural loans charged off in the first quarter of 2009, $1,125 related to one loan, of which $1,000 was a specific impairment allocation as of December 31, 2008.

     The nationwide increase in residential mortgage loans past due and in foreclosures has received considerable attention by the Federal Government, the media, banking regulators, and industry trade groups. Based on information provided by The Mortgage Bankers Association, a substantial portion of the nationwide increases in both past dues and foreclosures are related to fixed and adjustable rate sub-prime mortgages. While the Corporation does not hold sub-prime mortgage loans, the difficulties experienced in the sub-prime market have adversely impacted the entire market, and thus the overall credit quality of the Corporation’s residential mortgage portfolio. The increase in troubled residential mortgage loans and a tightening of underwriting standards will most likely result in a continued increase in the inventory of unsold homes. The inventory of unsold homes has not reached these levels since the 1991 recession. The combination of all of these factors is expected to further reduce average home values and thus homeowner’s equity on a national level.

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

Based on management’s analysis, the allowance for loan losses of $11,925 is considered adequate as of March 31, 2009. Management will continue to closely monitor its overall credit quality during 2009 to ensure that the allowance for loan losses remains adequate.

NONPERFORMING ASSETS

		March 31				December 31
		2009				2008
Nonaccrual loans		$	11,076			$	11,175
Accruing loans past due 90 days or more			879				1,251
Total nonperforming loans			11,955				12,426
Other real estate owned (OREO)			2,859				2,770
Repossessed assets			92				153
Total nonperforming assets		$	14,906			$	15,349
Nonperforming loans as a % of total loans			1.65	%			1.69	%
Nonperforming assets as a % of total assets			1.32	%			1.35	%

RESTRUCTURED LOANS

		March 31				December 31
		2009				2008
Complying with modified terms		$	1,006			$	2,565
Nonaccrual			2,109				1,985
Total restructured loans		$	3,115			$	4,550

Residential real estate loans are placed in nonaccrual status when the foreclosure process has begun, generally after a loan is 90 days past due, unless there is an abundance of collateral. Upon transferring the loans to nonaccrual status, an evaluation to determine the net realizable value of the underlying collateral is performed. This evaluation is used to help determine if any charge downs are necessary.

The increase in the Corporation’s nonperforming loans is primarily related to the current market difficulties previously discussed related to real estate loans. These market difficulties have also resulted in a substantial increase in restructured loans. The majority of the increase in restructured loans is the result of the Corporation working with borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure.

The increase in OREO is also related to the downturn in the residential real estate market. Management has evaluated the properties held as other real estate owned and has adjusted the carrying value of each property to the lower of Isabella Bank’s (the “Bank”) carrying amount or fair value less costs to sell, as necessary. Management expects the balance of OREO to continue to increase throughout 2009 as foreclosures increase due to the extended marketing time for home sales.

Management has devoted considerable attention to identifying loans for which losses are possible and adjusting the value of these loans to their current net realizable values. To management’s knowledge, there are no other loans which cause management to have serious doubts as to the ability of a borrower to comply with their loan repayment terms. A continued decline in residential real estate values may require further write downs of loans in foreclosure and other real estate owned and could potentially have an adverse impact on the Corporation’s financial performance.

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

NONINTEREST INCOME AND EXPENSES

Noninterest Income

Noninterest income consists of trust fees, deposit service charges, fees for other financial services, gains on the sale of mortgage loans, and other. Significant account balances are highlighted in the accompanying tables with additional descriptions of significant fluctuations:

		Three Months Ended March 31
										Change
		2009				2008				$				%
Service charges and fee income
NSF and overdraft fees		$	729			$	775			$	(46	)			-5.9	%
Trust fees			197				218				(21	)			-9.6	%
Freddie Mac servicing fee			164				156				8				5.1	%
ATM and debit card fees			275				212				63				29.7	%
Service charges on deposit accounts			75				81				(6	)			-7.4	%
Net OMSR loss			(132	)			(42	)			(90	)			-214.3	%
All other			41				48				(7	)			-14.6	%
Total service charges and fees			1,349				1,448				(99	)			-6.8	%
Title insurance revenue			—				234				(234	)			-100.0	%
Gain on sale of mortgage loans			268				84				184				219.0	%
Net gain on trading securities			87				443				(356	)			-80.4	%
Net gain (loss) on borrowings measured at fair value			143				(117	)			260				N/M
Other
Earnings on corporate owned life insurance policies			176				125				51				40.8	%
Brokerage and advisory fees			101				129				(28	)			-21.7	%
Gain on sale of investment securities			221				—				221				N/M
Net gain (loss) on borrowings measured at fair value			143				(117	)			260				N/M
All other			(131	)			288				(419	)			-145.5	%
Total other			510				425				85				20.0	%
Total noninterest income		$	2,357			$	2,517			$	(160	)			-6.4	%

Management continuously analyzes various fees related to deposit accounts, including service charges, NSF and overdraft fees, and ATM and debit card fees. Based on these analyses, the Corporation makes any necessary adjustments to ensure that its fee structure is within the range of its competitors, while at the same time making sure that the fees remain fair to deposit customers. Management does not expect significant changes to its deposit fee structure in 2009.

Trust fees fluctuate from period to period based on various factors including changes in mix of their customers’ portfolios and the closing of client estates (as much of their estate fees are non-recurring in nature and are based on the assets of the estate).

The increases in ATM and debit card fees are primarily the result of the increased usage of debit cards by the Bank’s customers. As management does not anticipate any significant changes to the ATM and debit card fee structures, these fees are expected to continue to increase as the usage of debit cards increases.

The decline in net originated mortgage servicing rights (OMSR) income was primarily due to the decline in residential mortgage rates. The decline in rates significantly reduced the estimated lives on the mortgage loans serviced as the potential for consumers to refinance existing loans dramatically increases the probability of refinancing activity. This refinancing has led to a decline in the carrying value of OMSR, but also an increase in gains on sale of mortgage loans, as there is an inverse relationship between the two line items. The Corporation does anticipate that mortgage rates will remain at historic lows for the foreseeable future, which will result in continued mortgage refinancing.

Title insurance fees have decreased as a result of a joint venture between IBT Title and Insurance Agency and Corporate Title which was formed on March 1, 2008 (see Note 1 of Notes to Condensed Consolidated Financial Statements).

Net gains from trading activities have declined significantly from last year. These declines are a result of overall market declines, which have led to decreases in market interest rates. Typically, as market rates decline, the value of these securities will increase,

while the value of borrowings carried at fair market value will decrease. However, the increases in the value of trading securities have not increased as much as the values of borrowings carried at fair market value have decreased.

This declining rate environment has enabled the Corporation to take advantage of several selling opportunities from its available for sale investment portfolio which resulted in gains on the sales of these securities of $221.

Noninterest Expenses

Noninterest expenses include compensation, occupancy, furniture and equipment, and other expenses. Significant account balances are highlighted in the accompanying tables with additional descriptions of significant fluctuations:

		Three Months Ended March 31
										Change
		2009				2008				$				%
Compensation and benefits
Leased employee salaries		$	3,194			$	3,151			$	43				1.4	%
Leased employee benefits			1,391				1,122				269				24.0	%
All other			91				61				30				49.2	%
Total compensation and benefits			4,676				4,334				342				7.9	%
Occupancy
Depreciation			132				128				4				3.1	%
Outside services			103				119				(16	)			-13.4	%
Property taxes			114				118				(4	)			-3.4	%
Utilities			122				105				17				16.2	%
Building rent			1				8				(7	)			-87.5	%
Building repairs			41				38				3				7.9	%
All other			16				12				4				33.3	%
Total occupancy			529				528				1				0.2	%
Furniture and equipment
Depreciation			450				402				48				11.9	%
Computer / service contracts			399				382				17				4.5	%
ATM and debit card fees			144				120				24				20.0	%
All other			23				29				(6	)			-20.7	%
Total furniture and equipment			1,016				933				83				8.9	%
FDIC insurance premiums			885				43				842				N/M
Other
Audit and SOX compliance fees			187				164				23				14.0	%
Marketing			127				233				(106	)			-45.5	%
Directors fees			221				225				(4	)			-1.8	%
Printing and supplies			220				116				104				89.7	%
Education and travel			74				79				(5	)			-6.3	%
Postage and freight			127				115				12				10.4	%
Legal			117				87				30				34.5	%
Amortization of deposit premium			95				105				(10	)			-9.5	%
Foreclosed assets			121				11				110				N/M
Collection			43				17				26				152.9	%
Brokerage and advisory			37				51				(14	)			-27.5	%
Consulting			50				77				(27	)			-35.1	%
All other			519				438				81				18.5	%
Total other			1,938				1,718				220				12.8	%
Total noninterest expenses		$	9,044			$	7,556			$	1,488				19.7	%