UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No.     )

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ISABELLA BANK CORPORATION

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TABLE OF CONTENTS

NOTICE OF THE ANNUAL MEETING OF SHAREHOLDERS
PROXY STATEMENT
	General Information
	Voting at the Meeting
Election of Directors
	Director Nominees for Terms Ending in 2012
	Current Directors with Terms Ending in 2010
	Current Directors with Terms Ending in 2011
Corporate Governance
	Director Independence
	Committees of the Board of Directors and Meeting Attendance
	Report of the Audit Committee
Compensation Discussion and Analysis
	Compensation Objectives
	What the Compensation Programs are Designed to Reward
	Elements of Compensation
	Why Each of the Elements of Compensation is Chosen
	How the Corporation Chose Amounts for Each Element
	How Elements Fit into Overall Compensation Objectives
Compensation and Benefits Committee Report
Executive Officers
Summary Compensation Table
2008 Pension Benefits
2008 Nonqualified Deferred Compensation
Potential Payments Upon Termination or Change in Control
	Retirement
	Death or Disability
	Change in Control
Director Compensation
Compensation and Human Resource Committee Interlocks and Insider Participation
Indebtedness of and Transactions with Management
Security Ownership of Certain Beneficial Owners and Management
Independent Registered Public Accounting Firm
	Fees for Professional Services Provided by Rehmann Robson P.C.
	Pre-approval Policies and Procedures
Shareholder Proposals
Directors’ Attendance at the Annual Meeting of Shareholders
Section 16(a) Beneficial Ownership Reporting Compliance
Other Matters
As to Other Business Which May Come Before the Meeting
SUMMARY OF SELECTED FINANCIAL DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED BALANCE SHEETS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands except per share amounts)
Management’s Discussion and Analysis of Financial Condition and Results of Opearations
COMMON STOCK AND DIVIDEND INFORMATION
SHAREHOLDERS’ INFORMATION

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ISABELLA BANK CORPORATION
401 N. Main St.
MountMt. Pleasant, Michigan 48858

 

 

NOTICE OF THE ANNUAL MEETING OF SHAREHOLDERS
To Be Held May 5, 20093, 2011

 

Notice is hereby given that the Annual Meeting of Shareholders of Isabella Bank Corporation will be held on Tuesday, May 5, 20093, 2011 at 5:00 p.m. Eastern Standard Time, at the Comfort Inn, 2424 S. Mission Street, MountMt. Pleasant, Michigan. The meeting is for the purpose of considering and acting upon the following:following items of business:

 

1. The election of fourfive directors.

 

2. SuchTo hold an advisory, non-binding vote on executive compensation of named executive officers.

3. To hold an advisory, non-binding vote on how frequently advisory votes on the executive compensation of named executive officers should be held.

4. To transact such other business as may properly come before the meeting, or any adjournment or adjournments thereof.

 

The Board of Directors has fixed April 1, 20092011 as the record date for determination of shareholders entitled to notice of, and to vote at, the meeting or any adjournments thereof.

 

Your vote is important. Even if you plan to attend the meeting, please date and sign the enclosed proxy form, indicate your choice with respect to the matters to be voted upon, and return it promptly in the enclosed envelope. Note that if stock is held in more than one name, all parties should sign the proxy form.

 

By order of the Board of Directors

 

 

Debra Campbell, Secretary

 

Dated: April 10, 20098, 2011

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ISABELLA BANK CORPORATION
401 N. Main St
MountMt. Pleasant, Michigan 48858

PROXY STATEMENT

General Information

 

This Proxy Statement is furnished in connection with the solicitation of proxies by the Board of Directors of Isabella Bank Corporation (the Corporation) a Michigan financial holding company, to be voted at the Annual Meeting of Shareholders of the Corporation to be held on Tuesday, May 5, 20093, 2011 at 5:00 p.m. at the Comfort Inn, 2424 S. Mission Street, MountMt. Pleasant, Michigan, or at any adjournment or adjournments thereof, for the purposes set forth in the accompanying Notice of Annual Meeting of Shareholders and in this Proxy Statement.

 

This Proxy Statement has been mailed on April 10, 20098, 2011 to all holders of record of common stock as of the record date. If a shareholder’s shares are held in the name of a broker, bank or other nominee, then that party should give the shareholder instructions for voting the shareholder’s shares.

 

Voting at the Meeting

 

The Board of Directors of the Corporation has fixed the close of business on April 1, 20092011 as the record date for the determination of shareholders entitled to notice of, and to vote at, the Annual Meeting of Shareholders and any adjournment thereof. The Corporation has only one class of common stock and no preferred stock. As of April 1, 2009,2011, there were 7,531,4727,546,866 shares of common stock of the Corporation outstanding. Each outstanding share entitles the holder thereof to one vote on each separate matter presented for vote at the meeting. Shareholders may vote on matters that are properly presented at the meeting by either attending the meeting and casting a vote or by signing and returning the enclosed proxy. If the enclosed proxy is executed and returned, it may be revoked at any time before it is exercised at the meeting. All shareholders are encouraged to date and sign the enclosed proxy, indicate their choice with respect to the matters to be voted upon, and return it to the Corporation.

 

The Corporation will hold the Annual Meeting of Shareholders if holders of a majority of the Corporation’s shares of common stock entitled to vote are represented in person or by proxy at the meeting. If a shareholder signs and returns the proxy, those shares will be counted to determine whether the Corporation has a quorum, even if the shareholder abstains or fails to vote on any of the proposals listed on the proxy.

 

If aA shareholder’s shares are held inbroker may not vote on the nameelection of a nominee, anddirectors, the advisory vote to approve the named executive officers’ compensation or the advisory vote on the frequency of the vote on named executive officers’ compensation if the shareholder does not tellfurnish instructions for such proposals. A shareholder should use the nominee howvoting instruction card provided by the institution that holds his or her shares to instruct the broker to vote the shares (referred to as broker non-votes), thenor else the nominee can vote them as they see fit only on matters that are determined toshareholder’s shares will be routine and not on any other proposal. considered “broker non-votes.”

Broker non-votes will be countedare shares held by brokers or nominees as present to determine if a quorum exists but willwhich voting instructions have not be counted as present andbeen received from the beneficial owners or the persons entitled to vote those shares and the broker or nominee does not have discretionary voting power under rules applicable to broker-dealers. Under these rules, proposals one, two and three are not items on any non-routine proposals.which brokerage firms may vote in their discretion on behalf of their clients if such clients have not furnished voting instructions.

 

At this year’s annual meeting, shareholders will elect five directors to serve for a term of three years. In voting on the election of directors, directora shareholder may vote in favor of the nominees, receivingvote against or withhold votes as to all nominees, or vote against or withhold votes as to specific nominees. Directors are elected by a plurality of the votes cast at the meetingannual meeting. This means that the nominees receiving the greatest number of votes will be elected directors of the Corporation.elected. Shares not voted, including broker non-votes, have no effect on the election of directors.

In voting on the advisory, nonbinding proposal to approve the executive compensation described in this proxy statement, a shareholder may vote in favor of the advisory proposal, vote against the advisory proposal or abstain from voting. A majority of the shares represented at the annual meeting and entitled to vote on this advisory proposal must be voted in favor of the proposal for it to pass. While this vote is required by law, it will neither be

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binding on the Board of Directors, nor will it create or imply any change in the fiduciary duties of, or impose any additional fiduciary duty on the Board of Directors. In counting votes on the advisory, nonbinding proposal to approve executive compensation matters, abstentions will have the same effect as a vote against the proposal and broker non-votes will have no effect on the outcome of the vote.

In voting on the advisory, nonbinding proposal on how frequently a shareholder vote on executive compensation matters should be held, a shareholder may vote in favor of holding such a vote once every year, once every two years or once every three years, or may abstain from voting. Generally, approval of any proposal presented to the Corporation’s shareholders requires the affirmative vote of a majority of the shares represented at the meeting and entitled to vote on the proposal. However, because this vote is advisory and nonbinding, if none of the vote frequency options receives the affirmative vote of a majority of the shares represented at the meeting and entitled to vote on the proposal, the vote frequency option receiving the greatest number of votes will be considered the frequency option recommended by the Corporation’s shareholders. Even though this vote will not be binding on the Board of Directors, and it will not create or imply any change in the fiduciary duties of, or impose any additional fiduciary duty on, the Board of Directors, the Board of Directors will take into account the outcome of this vote in making a determination on the frequency that advisory votes on the Corporation’s executive compensation will be included in the Corporation’s proxy statements. In counting votes on the advisory, nonbinding proposal on how frequently the shareholder vote on the Corporation’s executive compensation should be held, abstentions and broker non-votes will have no effect on the outcome of the vote.

 

ElectionProposal 1-Election of Directors

 

The Board of Directors currently consists of thirteen (13) members and is divided into three classes, with the directors in each class being elected for a term of three years. On December 31, 2010, in accordance with the Corporation’s bylaws, William J. Strickler and Theodore W. Kortes retired as members of the Corporation’s Board of Directors and the number of directors was reduced to thirteen (13). At the 2011 Annual Meeting of Shareholders fourfive directors, will be elected forDennis P. Angner, Jeffrey J. Barnes, G. Charles Hubscher, David J. Maness, and W. Joseph Manifold, whose terms ending withexpire at the annual meeting, of shareholders in 2012.have been nominated for election through 2014 for the reasons described below.

 

Except as otherwise specified in the proxy, proxies will be voted for election of the four nominees named below.five nominees. If a nominee becomes unable or unwilling to serve, proxies will be voted for such other person, if any, as shall be designated by the Board of Directors. However, the Corporation’s management now knows of no reason to anticipate that this will occur. The fourfive nominees for election as directors who receive the greatest number of votes cast will be elected directors. Each of the nominees has agreed to serve as a director if elected.

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Nominees for election and current directors are listed below. Also shown for each nominee and each current director is his or her principal occupation for the last five or more years, age and length of service as a director of the Corporation.

 

The Board of Directors unanimously recommends that shareholders vote FOR the election of each of the fourfive director nominees nominated by the Board of Directors.

Director’s Qualifications

The members of the Corporation’s Board of Directors (the Board) are all well qualified to serve on the Board and represent our shareholders’ best interest. As described below, under the caption “Nominating and Corporate Governance Committee” the Board and Nominating and Corporate Governance Committee (the “Nominating Committee”) select nominees to the Board to establish a Board that is comprised of members who:

	•	Have extensive business leadership
	•	Bring a diverse perspective and experience
	•	Are independent and collegial
	•	Have high ethical standards and have demonstrated sound business judgment
	•	Are willing and able to commit the significant time and effort to effectively fulfill their responsibilities
	•	Are active in and knowledgeable of their respective communities

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Each director nominee along with the other directors brings these qualifications to the Board. They provide a diverse complement of specific business skills, experience, and knowledge including extensive financial and accounting experience, knowledge of banking, small business operating experience, and specific knowledge of customer market segments, including agriculture, oil and gas, health care, food and beverage, manufacturing, and retail.

The following describes the key qualifications each director brings to the Board, in addition to the general qualifications described above and the information included in the biographical summaries provided below.

Bank

Professionals

Expertise

Audit

Leadership

Diversity

Business

Standing

in Financial

Committee

Civic and

and Team

by Race,

Geo-

Entre-

Segment

in Chosen

or Related

Financial

Community

Building

Gender, or

graphical

Tech-

Market-

Govern-

preneurial

Human

Represent-

Director

Field

Field

Expert

Involvement

Skills

Cultural

Diversity

Finance

nology

ing

ance

Skills

Resources

ation

David J. Maness

X

X

X

X

X

X

Dennis P. Angner

X

X

X

X

X

X

X

Jeffrey J. Barnes

X

X

X

X

X

X

Richard J. Barz

X

X

X

X

X

X

X

Sandra L. Caul

X

X

X

X

X

X

James C. Fabiano

X

X

X

X

X

X

X

G. Charles Hubscher

X

X

X

X

X

X

Thomas L. Kleinhardt

X

X

X

X

X

X

X

Joseph LaFramboise

X

X

X

X

X

W. Joseph Manifold

X

X

X

X

X

X

X

W. Michael McGuire

X

X

X

X

X

X

X

X

X

Dianne C. Morey

X

X

X

X

X

X

X

Dale D. Weburg

X

X

X

X

X

X

The following table identifies the individual members of our Board serving on each of these standing committees:

Nominating

Compensation

and Corporate

and Human

Director

Audit

Governance

Resource

David J. Maness

X

o

X

o

X

c,o

Dennis P. Angner

Jeffrey J. Barnes

X

X

Richard J. Barz

Sandra L. Caul

X

X

James C. Fabiano

X

X

G. Charles Hubscher

X

X

Thomas L. Kleinhardt

X

Joseph LaFramboise

X

X

W. Joseph Manifold

X

c

X

X

W. Michael McGuire

X

X

X

Dianne C. Morey

X

Dale D. Weburg

X

c

X

C — Chairperson

O — Ex-Officio

 

Director Nominees for Terms Ending in 20122014

 

Dennis P. Angner (age 53)55) has been a director of the Corporation and Isabella Bank (the Bank) since 2000. He also serves as an ex-officio member of all of the Corporation’s subsidiary Boards of Directors and the Finance and Planning Committee. Mr. Angner also serves on the Board of Financial Group Information Services. Mr. Angner has been Presidentprincipally employed by the Corporation since 1984 and CEOhas served as President of the Corporation since December 30, 2001. Prior to his appointment as President2001 and CEO, heCFO since January 1, 2010. Mr. Angner served as Chief Executive Vice PresidentOfficer of the Corporation. Mr. AngnerCorporation from December 30, 2001 through December 31, 2009. He is the past Chair of the Michigan Bankers Association and is currently serving as vice chairman of its taxation committee, is a member of

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the American Bankers Association Government Relations Council, and has served on the Central Michigan American Red Cross board for over 20 years.

 

DavidDr. Jeffrey J. ManessBarnes(age 55)48) has been a director of the CorporationBank since September 2007 and was appointed to the Corporation’s Board of Directors effective January 1, 2010. Dr. Barnes is a physician and co-owner of Central Eye Consultants. He is a former member of the Central Michigan Community Hospital Board of Directors.

G. Charles Hubscher(age 57) has been a director of the Bank since May 2004 and serves onwas appointed to the Audit Committee,Corporation’s Board of Directors effective January 1, 2010. Mr. Hubscher is the CompensationPresident of Hubscher and Human Resource CommitteeSon, Inc., a sand and gravel producer. He is currently Chairperson ona director of the FinanceNational Stone and Planning Committee. He alsoGravel Association, the Michigan Aggregates Association, serves on the Board of Directors of Isabella BankTrustees for the Mt. Pleasant Area Community Foundation, and is Chairpersona member of Financial Group Information Services.the Zoning Board of Appeals for Deerfield Township.

David J. Maness(age 57) has been a director of the Bank since 2003 and of the Corporation since 2004. Mr. Maness was elected chairman of the board for the Corporation and the Bank in 2010. He is President of Maness Petroleum, a geological and geophysical consulting services company. Mr. Maness servedis currently serving as a school board memberdirector for the Michigan Oil & Gas Association, and he previously served on the Mt. Pleasant Public Schools Board of the Mount Pleasant School board.Education.

 

W. Joseph Manifold(age 57)59) has been a director of the Corporation since 2003 and serves on the Nominating and Corporate Governance Committee, the Compensation and Human Resource Committee, and serves as Chairperson of the Audit Committee.Bank since January 1, 2010. Mr. Manifold is a Certified Public Accountant and CFO of Federal Broach Holdings LLC, a holding company which operates several manufacturing company.companies. Previously, he was a senior auditormanager with Ernst & Young Certified Public Accounting firm working principally on external bank audits and was CFO of the Delfield Corporation.Company. Prior to joining Isabella Bank Corporationthe Board, Mr. Manifold also served on the Isabella Community Credit Union Board and was ChairChairman of the MountMt. Pleasant School board.

William J. Strickler(age 68) has been a directorPublic Schools Board of the Corporation since 2002, and serves on the Nominating and Corporate Governance Committee, the Finance and Planning Committee, and the Compensation and Human Resource Committee. He has been a director of Isabella Bank since 1995 and is currently serving as Chairperson. Mr. Strickler is President of Michiwest Energy, an oil and gas producer. Prior to joining the Corporation and the Bank Board he served as a director of the National City Community Bank Board.

Education.

 

Current Directors with Terms Ending in 2010

James C. Fabiano(age 65) has been a director of Isabella Bank since 1979 and of the Corporation since 1988, of which he is currently serving as Chairperson and is an ex-officio member of all corporate committees. He also serves as an ex-officio member of all subsidiary Boards of Directors of the Corporation and serves as Chairperson of the Compensation and Human Resource Committee. Mr. Fabiano is Chairman and CEO of Fabiano Brothers, Inc., a wholesale beverage distributor operating in several counties throughout Michigan. Mr. Fabiano is a past recipient of the Mount Pleasant Area Chamber of Commerce Citizen of the year award. He is also a past Chairman of Central Michigan University board of trustees.

Dale D. Weburg(age 65) has served on the Board of the Corporation since 2000 and is a member of the Financial Group Information Services Board of Directors. He also serves as the Chairperson for the Nominating and Corporate Governance Committee, serves on the Audit Committee, and the Compensation and Human Resource Committee. He has been a director of the Breckenridge division of Isabella Bank since 1987, of which he is currently serving as Chairperson. Mr. Weburg is President of Weburg Farms, a cash crop farm operation. Mr. Weburg also serves as a trustee of the Board of Directors of Gratiot Health System.

Theodore W. Kortes(age 68) was appointed director of the Corporation on January 1, 2008, and serves on the Finance and Planning Committee and the Compensation and Human Resource Committee. He is a director and Chairperson of the Greenville division of Isabella Bank. Mr. Kortes was President and CEO of Greenville Community Bank and Greenville Community Financial Corporation since its founding in 1998, until his retirement in 2007.

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Current Directors with Terms Ending in 20112012

 

Richard J. Barz(age 60)62) has been a director of the Bank since 2000 and of the Corporation since 2002. He has been a director of Isabella Bank since 2000. Mr. Barz also serves on the Board of Financial Group Information Services and is a member of the Finance and Planning Committee. Mr. Barz has been employed by the Corporation since 1972 and has been Chief Executive Officer of the Corporation since January 1, 2010 and President and CEO of Isabellathe Bank since December 30, 2001. Prior to his appointment as President and CEO, he served as Executive Vice President of Isabellathe Bank. Mr. Barz has been very active in community organizations and events. He is the past chairman of the Central Michigan Community Hospital Board of Directors, is the current chairman of the Middle Michigan Development Corporation Board of Directors, and serves on several boards and committees for Central Michigan University and various volunteer organizations throughout mid-Michigan.

 

Sandra L. Caul(age 65)67) has been a director of the Bank since 1994 and of the Corporation since 2005. She currently serves as director of Isabella Bank, and serves on the Audit Committee, the Nominating and Corporate Governance Committee, and the Compensation and Human Resource Committee. Ms. Caul is Vice ChairChairperson of the Central Michigan Community Hospital Board of Directors, Chairperson of the Mid Michigan Community College Advisory Board and is Chairpersonboard member for Central Michigan Community Mental Health Facilities. She also sits on the board of the Central Michigan American Red Cross. Ms. Caul retired in January 2005 as a state representative of the Michigan State House of Representatives. Ms. Caul is a registered nurse.

 

W. Michael McGuire(age 59)61) has been a director of the Corporation since 2007 and serves onof the Audit Committee, Finance and Planning Committee, and the Compensation and Human Resource Committee.Bank since January 1, 2010. He is a director of the Farwell divisionDivision of Isabellathe Bank. Mr. McGuire is currently an attorney and the Director of the Office of the Corporate Secretary and Assistant Secretary of The Dow Chemical Company, a manufacturer of chemicals, plastics and agricultural products.products, headquartered in Midland, Michigan.

Dianne C. Morey(age 64) has been a director of the Bank since December 2000 and was appointed to the Corporation’s Board of Directors effective January 1, 2010. Mrs. Morey is an owner of Bandit Industries, Inc., a forestry equipment manufacturer. She serves as a Trustee for the Mt. Pleasant Area Community Foundation.

Current Directors with Terms Ending in 2013

James C. Fabiano(age 67) has been a director of the Bank since 1979 and of the Corporation since 1988. He served as the Corporations’ chair from 2004 to 2010. Mr. Fabiano is Chairman and CEO of Fabiano Brothers, Inc., a wholesale beverage distributor operating in several counties throughout Michigan. Mr. Fabiano is a past recipient of

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the Mt. Pleasant Area Chamber of Commerce Citizen of the Year award. He is also a past Chairman of the Central Michigan University Board of Trustees.

Thomas L. Kleinhardt(age 56) has been a director of the Bank since October 1998 and was appointed to the Corporation’s Board of Directors effective January 1, 2010. Mr. Kleinhardt is President of McGuire Chevrolet, is active in the Clare Kiwanis Club, and coaches girls Junior Varsity Basketball team at Clare High School.

Joseph LaFramboise(age 61) has been a director of the Bank since September 2007, and was appointed to the Corporation’s Board of Directors effective January 1, 2010. He is a retired Sales and Marketing Executive of Ford Motor Company. Mr. LaFramboise is Ambassador of Eagle Village in Evart, Michigan.

Dale D. Weburg(age 67) has served as a director of the Breckenridge Division of the Bank since 1987 and of the Bank and Corporation since 2000. Mr. Weburg is President of Weburg Farms, a cash crop farm operation. Mr. Weburg also serves as a trustee of the Board of Directors of Gratiot Health System.

 

Each of the directors has been engaged in their stated professions for more than five years. The principal occupation of Dennis P. Angner is with the Corporation, and he has been employed by Isabella Bank

and/or the Corporation since 1984. Other executive officers of the Corporation include: Richard J. Barz, President of Isabella Bank, an employee of Isabella Bankand/orNamed Executive Officers the Corporation since 1972;

Timothy M. Miller (age 58)(age 60), President of the Breckenridge divisionDivision of Isabellathe Bank and a member of its Board of Directors, has been an employee of Breckenridge divisionand/orthe Corporation since 1985; Peggy L. Wheeler1985. Steven D. Pung (age 49)61), Chief Operations Officer of the Bank and a member of the Board of Directors of Financial Group Information Services (a wholly owned subsidiary of the Corporation) has been employed by the Corporation since 1978. David J. Reetz (age 50), Senior Vice President and ControllerChief Lending Officer of the Corporation,Bank, has been employed by Isabella Bankand/or the Corporation since 1977; and Steven D. Pung (age 59), Chief Operations Officer of Isabella Bank, employed by Isabella Bankand/or the Corporation since 1978. 1987.

All officers of the Corporation serve at the pleasure of the Corporation’s Board of Directors.

Proposal 2-Advisory Vote On Executive Compensation

 

The compensation of the Corporation’s principal executive officer, principal financial officer, and three other most highly compensated executive officers (named executive officers) is described below under the headings “Compensation Discussion and Analysis” and “Executive Officers”. Shareholders are urged to read these sections of this proxy statement, which discusses the Corporation’s compensation policies and procedures with respect to its named executive officers.

In accordance with recently adopted changes to Section 14A of the Securities Exchange Act of 1934 (the Exchange Act), shareholders will be asked at the annual meeting to provide their support with respect to the compensation of the Corporation’s named executive officers by voting on the following advisory, non-binding resolution:

RESOLVED, that the shareholders of Isabella Bank Corporation approve, on an advisory basis, the compensation paid to the Corporation’s named executive officers, as disclosed pursuant to the compensation disclosure rules of the Securities and Exchange Commission, “SEC” including the Compensation Discussion and Analysis, compensation tables and narrative discussion, for purposes of Section 14A (a) of the Securities Exchange Act of 1934.

This advisory vote, commonly referred to as asay-on-pay advisory vote, is non-binding on the Board of Directors. Although non-binding, the Board of Directors and the Compensation and Human Resource Committee value constructive dialogue on executive compensation and other important governance topics with the Corporation’s shareholders and encourage all shareholders to vote their shares on this matter. The Board of Directors and the Compensation and Human Resource Committee will review the voting results and take them into consideration when making future decisions regarding executive compensation programs. The Board believes shareholders should consider the following in determining whether to approve this proposal:

	•	The Corporation is not required to provide any severance or termination pay or benefits to any named executive officer;

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	•	Each member of the Compensation and Human Resource Committee is independent under the applicable standards of the NASDAQ Marketplace Rules;
	•	The Compensation and Human Resource Committee continually monitors the Corporation’s performance and adjusts compensation practices accordingly; and
	•	The Compensation and Human Resource Committee with the assistance of an independent compensation consulting firm regularly assesses the Corporation’s individual and total compensation programs against peer companies, the general marketplace and other industry data points.

Unless otherwise instructed, validly executed proxies will be voted “FOR” this resolution.

The Board of Directors unanimously recommends that shareholders vote FOR the nonbinding advisory resolution approving the executive compensation of the Corporation’s named executive officers.

Proposal 3-Frequency of Advisory Votes On Executive Compensation

In accordance with recently adopted changes to Section 14A of the Exchange Act, the Corporation is providing a shareholder advisory vote to approve the compensation of our named executive officers (thesay-on-pay advisory vote in Proposal 2 above) this year and will do so at least once every three years thereafter. Pursuant to recently adopted changes to Section 14A of the Exchange Act, at the 2011Annual Meeting, the Corporation is also asking shareholders to vote on whether futuresay-on-pay advisory votes on executive compensation should occur every year, every two years or every three years.

After careful consideration, the Board of Directors recommends that future shareholdersay-on-pay advisory votes on executive compensation be conducted every three years. Although the Board of Directors recommends asay-on-pay vote every three years, shareholders will be able to specify one of four choices for this proposal on the proxy card: one year, two years, three years or abstain. Shareholders are not voting to approve or disapprove the Board of Directors’ recommendation.

Although this advisory vote regarding the frequency ofsay-on-pay votes is non-binding on the Board of Directors, the Board of Directors and the Compensation and Human Resource Committee will review the voting results and take them into consideration when deciding how often to conduct futuresay-on-pay shareholder advisory votes.

Unless otherwise instructed, validly executed proxies will be voted “FOR” the Three Year frequency option.

The Board of Directors unanimously recommends that shareholders vote FOR the Three Year frequency option.

Corporate Governance

 

Director Independence

 

The Corporation has adopted the director independence standards as defined inunder Rule 5605(a)(2) of the NASDAQ Marketplace Rule 4200(a)(15).Rules. The Board has determined that James C. Fabiano, Dale D. Weburg, David J. Maness, W. Joseph Manifold, William J. Strickler, Sandra L. Caul, W. Michael McGuire, Thomas L. Kleinhardt, Joseph LaFramboise, Jeffrey J. Barnes, Dianne C. Morey, and Ted W. KortesG. Charles Hubscher are independent directors. Dennis P. Angner is not independent as he is employed as President and Chief ExecutiveFinancial Officer of the Corporation. Richard J. Barz is not independent as he is employed as PresidentChief Executive Officer of the Corporation.

Board Leadership Structure and Risk Oversight

The Corporation’s Governance policy provides that only directors who are deemed to be independent as set forth by NASDAQ and SEC rules are eligible to hold the office of Chairman of the Board. Additionally, the chairpersons of Board established committees must also be independent directors. It is the Board’s belief that

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having a separate Chairman and Chief Executive Officer best serves the interest of the shareholders. The Board of Directors elects its chairperson at the first Board meeting following the annual meeting. Independent members of the Board of Directors meet without insider directors at least twice per year.

Management is responsible for the Corporation’s day to day risk management and the Board’s role is to engage in informed oversight. The Board utilizes committees to oversee risks associated with compensation, financial, and governance. Financial Group Information Services, the Corporation’s information processing subsidiary is responsible for overseeing risks associated with information technology. The Isabella Bank.Bank Board of Directors is responsible for overseeing credit, investment, interest rate, and trust risks. The chairpersons of the respective boards or committees report on their activities on a regular basis.

The Audit Committee is responsible for the integrity of the consolidated financial statements of the Corporation; the independent auditors’ qualifications and independence; the performance of the Corporation’s, and its subsidiaries’ internal audit function and independent auditors; the Corporation’s system of internal controls; the Corporation’s financial reporting and system of disclosure controls; and the compliance by the Corporation with legal and regulatory requirements and with the Corporation’s Code of Business Conduct and Ethics.

 

Committees of the Board of Directors and Meeting Attendance

 

The Board of Directors of the Corporation met 14 times during 2008.2010. All incumbent directors attended 75% or more of the meetings held in 2008.2010. The Board of Directors has an Audit Committee, a Nominating and Corporate Governance Committee, and a Compensation and Human Resource Committee, and a Finance and Planning Committee.

 

Audit Committee

 

The Audit Committee is composed of independent directors who meet the requirements for independence as defined in Rule 5605(a)(2) of the NASDAQ Marketplace Rule 4200(a)(15).Rules. Information regarding the functions performed by the Committee, its membership, and the number of meetings held during the year, is set forth in the “Report of the Audit Committee” included elsewhere in this annual proxy statement. The Audit Committee is governed by a written charter approved by the Board of Directors and was included as Appendix A toBoard. The Audit Committee Charter is available on the Corporation’s proxy statement forBank’s website, www.isabellabank.com, under the 2008 Annual Shareholder’s Meeting.Investor Relations tab.

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In accordance with the provisions of the Sarbanes — Oxley Act of 2002, Directordirectors Manifold meetsand McGuire meet the requirements of Audit Committee Financial Expert and hashave been so designated by the Board of Directors.Board. The committeeCommittee also consists of directors Caul, Fabiano, Maness, McGuireBarnes, Hubscher, LaFramboise, and Weburg.Maness.

 

Nominating and Corporate Governance Committee

 

The Corporation has a standing Nominating and Corporate Governance Committee consisting of independent directors who meet the requirements for independence as defined in Rule 5605(a)(2) of NASDAQ Marketplace Rule 4200(a) (15).Rules. The Committee consists of directors Caul, Fabiano, Maness, Manifold, StricklerMcGuire, and Weburg. The Nominating and Corporate Governance Committee met as a full board and held two meetingsone meeting in 2008, and2010, with all directors attended 75% or more of the meetings in 2008.meeting. The Board of Directors has approved a Nominating and Corporate Governance Committee Charter and it was included as Appendix B towhich is available on the Corporation’s proxy statement forBank’s website www.isabellabank.com under the 2008 Annual Shareholder’s Meeting. Investor Relations tab.

The Nominating and Corporate Governance Committee is responsible for evaluating and recommending individuals for nomination to the Board of Directors for approval. In making its selectionsThe Committee in evaluating nominees, including incumbent directors and recommendations,any nominees put forth by shareholders, considers business experience, skills, character, judgment, leadership experience, and their knowledge of the Nominatinggeographical markets, business segments or other criteria the Committee deems relevant and Corporate Governanceappropriate based on the current composition of the Board. The Committee considers a varietydiversity in identifying members with respect to geographical markets served by the Corporation and the business experience of factors, which generally include the candidate’s personal and professional integrity, independence, business judgment, and communication skills.nominee.

 

The Nominating and Corporate Governance Committee will consider as potential nominees, persons recommended by shareholders. Recommendations should be submitted in writing to the Secretary of the Corporation, 401 N. Main St., MountMt. Pleasant, Michigan 48858 and include the shareholder’s name, address and number of shares of the Corporation owned by the shareholder. The recommendation should also include the name, age, address and

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qualifications of the recommended candidate for nomination. Recommendations for the 20102012 Annual Meeting of Shareholders should be delivered no later than December 11, 2009.9, 2011. The Nominating and Corporate Governance Committee does not evaluate potential nominees for director differently based on whether they are recommended to the Nominating and Corporate Governance Committee by a shareholder or otherwise.

 

Compensation and Human Resource Committee

 

The Compensation and Human Resource Committee of the Corporation is responsible for reviewing and recommending to the Corporation’s Board of Directors the compensation of the PresidentChief Executive Officer and other executive officers of the Corporation, benefit plans and the overall percentage increase in salaries. The committee consists of all independent directors, who meet the requirements for independence as defined in Rule 5605(a) (2) of the NASDAQ Marketplace Rules. The Committee consists of directors Maness, Barnes, Caul, Fabiano, Caul, Kortes,Hubscher, Kleinhardt, LaFramboise, Manifold, McGuire, Maness, Manifold, Strickler,Morey, and Weburg. The Committee held one meeting during 20082010 with all directors attending the meeting. This committeeCommittee is governed by a written charter approved by the Board of Directors that was attached as Appendix A tois available on the Corporation’s proxy statement forBank’s website www.isabellabank.com under the 2007 Annual Shareholder’s Meeting.

Finance and Planning Committee

The Finance and Planning Committee evaluates new business opportunities and business acquisitions, assists management in establishing financial goals, reviews all strategic plans of subsidiaries to assure consistency with overall corporate goals, and reviews interest rate risks, credit risks and insurance coverage. The committee consists of directors Maness, Angner, Barz, Fabiano, Kortes, McGuire, and Strickler.Investor Relations tab.

 

Communications with the Board

 

Shareholders may communicate with the Corporation’s Board of Directors by sending written communications to the Corporation’s Secretary, Isabella Bank Corporation, 401 N. Main St., MountMt. Pleasant, Michigan 48858. Communications will be forwarded to the Board of Directors or the appropriate committee, as soon as practicable.

 

Code of Ethics

 

The Corporation has adopted a Code of Business Conduct and Ethics that is applicable to the Corporation’s principal executive officerChief Executive Officer and the principal financial officer and controller.Chief Financial Officer. The Corporation’s Code of Business Conduct and Ethics may be obtained free of charge by sending a request to Debra Campbell, Secretary, Isabella Bank Corporation, 401 N. Main St., Mount Pleasant, Michigan 48858.is available on the Bank’s website www.isabellabank.com under the Investor Relations tab.

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Report of the Audit Committee

 

The Audit Committee oversees the Corporation’s financial reporting process on behalf of the Board of Directors.Board. The 2010 Committee consistsconsisted of directors Fabiano, Caul,Barnes, Hubscher, LaFramboise, Maness, Manifold McGuire, and Weburg.McGuire.

 

The Audit Committee is responsible for pre-approving all auditing services and permitted non-audit services over $5,000 for the Corporation by its independent auditors or any other auditing or accounting firm if those fees are reasonably expected to exceed 5.0% of the current year agreed upon fee for independent audit services, except as noted below. The Audit Committee has established general guidelines for the permissible scope and nature of any permitted non-audit services in connection with its annual review of the audit plan and reviews the guidelines with the Board of Directors.

 

Management has the primary responsibility for the consolidated financial statements and the reporting process including the systems of internal controls. In fulfilling its oversight responsibilities, the Audit Committee reviewed the audited consolidated financial statements in the Annual Report with management including a discussion of the quality, not just the acceptability, of the accounting principles, the reasonableness of significant judgments, and the clarity of disclosures in the consolidated financial statements. The Audit Committee also reviewed with management and the independent auditors, management’s assertion on the design and effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2008.2010.

 

The Audit Committee reviewed with the Corporation’s independent auditors, who are responsible for expressing an opinion on the conformity of those audited consolidated financial statements with accounting principles generally accepted in the United States of America, their judgments as to the quality, not just the acceptability, of the Corporation’s accounting principles and such other matters as are required to be discussed with the Audit Committee by the standards of the Public Company Accounting Oversight Board (United States), including those described in AU Section 380 “Communication with Audit Committees”, as may be modified or supplemented. In addition, the Audit Committee has received the written disclosures and the letter from the independent accountants required by PCAOB Rule 3526, Communication with Audit Committees Concerning Independence, as may be modified or supplemented, and has discussed with the independent accountant the independent accountants’ independence.

 

The Audit Committee discussed with the Corporation’s internal and independent auditors the overall scope and plans for their respective audits. The Audit Committee meets with the internal and external independent auditors, with and without management present, to discuss the results of their examinations, their evaluations of the Corporation’s internal controls and the overall quality of the Corporation’s financial reporting process. The Audit Committee held foursix meetings during 2008,2010, and all directorscommittee members attended 75% or more of the meetings held in 2008.meetings.

 

In reliance on the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors (and the Board has approved) that the audited consolidated financial statements be included in the Annual Report onForm 10-K for the year ended December 31, 20082010 for filing with the Securities and Exchange Commission. The Audit Committee has appointed Rehmann Robson as the independent auditors for the 20092011 audit.

 

Respectfully submitted,

 

W. Joseph Manifold, Audit Committee Chairperson

James C. FabianoJeffrey J. Barnes

G. Charles Hubscher

Joseph LaFramboise

David J. Maness

Sandra L. Caul

W. Michael McGuire

Dale D. Weburg

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Compensation Discussion and Analysis

 

The Compensation and Human Resource Committee (the “Committee”) is responsible for the compensation and benefits for the Chief Executive Officer, President, and executive officers of the Corporation. The Committee evaluates and approves the executive officer and senior management compensation plans, policies and programs of the Corporation and its affiliates. The Committee also evaluates and establishes the compensation of the President and Chief Executive Officer, of the Corporation. The President and Chief Executive Officer, Dennis P. Angner,Richard J. Barz, conducts annual performance reviews for all Named Executive Officers, excluding himself. Mr. AngnerBarz recommends an appropriate salary increase to the Committee based on the performance review and the officer’s years of service along with competitive market data.

Compensation Objectives

 

The Committee considers asset growth with the safety and soundness objectives and earnings per share to be the primary ratios in measuring financial performance. The Corporation’s philosophy is to maximize long-term return to shareholders consistent with safe and sound banking practices, while maintaining the commitment to superior customer and community service. The Corporation believes that the performance of our executive officers in managing ourthe business should be the basis for determining overall compensation. Consideration is also given to overall economic conditions and current competitive forces in the market place. The objectives of the Committee are to effectively balance salaries and potential compensation to an officer’s individual management responsibilities and encourage them to realize their potential for future contributions to the Corporation. The objectives are designed to attract and retain high performing executive officers who will lead the Corporation while attaining the Corporation’s earnings and performance goals.

 

What the Compensation Programs are Designed to Reward

 

The Corporation’s compensation programs are designed to reward dedicated and conscientious employment with the Corporation, loyalty in terms of continued employment, attainment of job related goals and overall profitability of the Corporation. In measuring an executive officer’s contributions to the Corporation, the Committee considers numerous factors including, among other things, the Corporation’s growth in terms of asset size and increase in earnings per share. In rewarding loyalty and long-term service, the Corporation provides attractive retirement benefits.

Review of Risks Associated with Compensation Plans

Based on an analysis conducted by management and reviewed by the Committee, management does not believe that the Corporation’s compensation programs for employees are reasonably likely to have a material short or long term adverse effect on the Corporation’s Results of Operation.

Use of Consultants

In 2010, the Committee directly engaged the services of Blanchard Chase, an outside compensation consulting firm, to assist with a total compensation review for the top two executive officers of the Corporation (CEO and President). Blanchard Chase is an independent consulting firm and does not perform any additional services for the Corporation or senior management. In addition, Blanchard Chase does not have any other personal or business relationships with any Board member or any officer of the Corporation. The Committee is continuing to work with Blanchard Chase on proxy support in 2011. During 2009, the Committee did not employ any services of outside compensation or benefit consultants to assist it in compensation-related initiatives.

 

Elements of Compensation

 

The Corporation’s executive compensation program has consisted primarily of base salary and benefits, annual cash bonus incentives, stock awards,director fees for insider directors, and participation in the Corporation’s retirement plans.

 

Why Each of the Elements of Compensation is Chosen

 

Base Salary and Benefitsare set to provide competitive levels of compensation to attract and retain officers with strong motivated leadership. Each officer’s performance, current compensation, and responsibilities within the Corporation are considered by the Committee when establishing base salaries. The Corporation also believes it is best to pay sufficient base salary because it believes an over-reliance on equity incentive compensation could

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potentially skew incentives toward short-term maximization of shareholder value as opposed to building long-term shareholder value. Base salary encourages management to operate the Corporation in a safe and sound manner even when incentive goals may prove unattainable.

 

Annual Performance Incentivesare used to reward executive officers for the Corporation’s overall financial performance. This element of the Corporation’s compensation programs is included in the overall compensation in order to reward employees above and beyond their base salaries when the Corporation’s performance and profitability exceed established annual targets. The inclusion of a modest incentive compensation encourages management to be more creative, diligent and exhaustive in managing the Corporation to achieve specifiedspecific financial goals.goals without incurring inordinate risks.

 

Stock Awardsare also provided as stock awards arePerformance incentives paid under the element of compensationExecutive Incentive Plan in 2010 were determined by reference to seven performance measures that is most effectiverelated to services performed in aligning2009. The maximum award that may be granted under the financial interests of management with those of shareholders and because stock awards are a traditional

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and well-proven element of compensation among community banks and bank holding companies. These stock awards are granted pursuantExecutive Incentive Plan to the Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors (“Directors’ Plan”), under whicheach eligible executive officers elect to defer their director fees, which deferred fees are then converted, on a quarterly basis, into sharesemployee equals 10% of the Corporation’s common stock.employee’s base salary (the “Maximum Award”). The Corporation has established a Trust to fund the Directors’ Plan. The directorspayment of 35% of the CorporationMaximum Award was conditioned on the eligible employee accomplishing personal performance goals that were established by such employee’s supervisor as part of the employee’s annual performance review. Each of the employees who were eligible to participate in the Executive Incentive Plan in 2009 accomplished his or her personal performance goals and its subsidiaries are requiredwas accordingly paid 35% of the 2009 Maximum Award. The payment of the remaining 65% of the Maximum Award was conditioned on the achievement of Corporation-wide targets in the following six categories: (1) earnings per share (weighted 40%); (2) net operating expenses to defer at least 25%average assets (weighted 15%); (3) Fully Taxable Equivalent “FTE” net interest margin, excluding loan fees (weighted 15%); (4) in-market deposit growth (weighted 10%); (5) loan growth (weighted 10%); and (6) exceeding peer group return on average assets (weighted 10%). The following chart provides the 2009 target for each of their earned board fees into the Directors’ Plan.foregoing targets that were used to determine bonus awards that were paid in 2010, as well as the performance obtained for each target.

Executive Incentive Plan

		2009 Targets																2009
Target		25.00%				50.00%				75.00%				100.00%				Performance
Earning per share		$	0.90			$	0.93			$	0.96			$	0.99			$	1.04
Net operating expenses to
average assets			1.66	%			1.65	%			1.64	%			1.63	%			1.71	%
FTE Net Interest Margin			3.71	%			3.73	%			3.75	%			3.77	%			3.86	%
In market deposit growth			4.50	%			5.00	%			5.50	%			6.00	%			1.87	%
Loan growth			5.50	%			6.00	%			6.50	%			7.00	%			8.28	%
Exceeding peer group return
on average assets			−0.26	%			−0.25	%			−0.25	%			−0.24	%			0.91	%

 

Retirement Plans.  The Corporation’s retirement plans are designed to assist executives in providing themselves with a financially secure retirement. OurThe retirement plans include: a frozen defined benefit pension plan,plan; a 401(k) plan,plan; and a non-leveraged employee stock ownership plan (ESOP), which is frozen to new participants,participants; and a retirement bonus plan.

 

How the Corporation Chose Amounts for Each Element

 

The Committee’s approach to determining the annual base salary of executive officers is to offer competitive salaries in comparison with other comparable financial institutions. The Committee utilizedutilizes both an independent compensation consultant, to performBlanchard Chase and a compensation survey prepared by the Michigan Bankers Association of similar sized Michigan based institutions. The independent compensation consultant established a benchmark peer group of 20 mid-west financial institutions for 2007in non urban areas whose average assets size, number of branch locations, return on average assets and nonperforming assets that were comparable to Isabella Bank Corporation. The Michigan Bankers Association 2010 compensation survey was based on the compensation information provided by the Michigan Bankers Associationthese organizations for banks in the State of Michigan with assets over $500 million to provide salary ranges for its executive officers.2009. Specific factors used to decide where an executive officer’s salary should be within the established range include the historical financial performance, financial performance outlook, years of service, and job performance.

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The annual performance incentive is based on the achievement of goals set on individual performance and recognition of individual performance. A subjectivefor each individual. An analysis is conducted by the Chief Executive Officer. The Chief Executive Officer makes a recommendation to the Committee for the appropriate amount for each individual executive officer. The Committee reviews, modifies if necessary, and approves the recommendations of the Chief Executive Officer. The Committee reviews the performance of the Chief Executive Officer. The Committee uses the following factors as quantitative measures of corporate performance in determining annual cash bonus amounts to be paid.paid:

 

	•	peerPeer group financial performance compensation;compensation
	•	1 and 5 year shareholder returns;returns
	•	earningsEarnings per share and earnings per share growth;growth
	•	budgetedBudgeted as compared to actual annual operating performance;performance
	•	communityCommunity and industry involvement;involvement
	•	resultsResults of audit and regulatory exams; andexams
	•	otherOther strategic goals as established by the board of directors

 

While no particular weight is given to any specific factor, the Committee gives at least equal weight to the subjective analyses as described above.

 

Stock awards are granted pursuant to the Director’s Plan, under which participants elect to defer their director fees, which director fees are then converted, on a quarterly basis, into shares of the Corporation’s common stock based on the fair market value of a share of the Corporation’s common stock at that time. Shares of stock credited to a participant’s account under the Directors’ Plan are eligible for stock and cash dividends as payable.

Total compensation in 20082010 was based on the committeeCommittee targeting its executive officer’sChief Executive Officer’s and President & Chief Financial Officer’s compensation to approximate the median of the rangesrange provided by the independent consultants andcompensation consultant. Compensation for other named executive officers was based on the ranges provide by the Michigan Bankers Association surveys.

 

Retirement plans.  In December 2006, the Board of Directors voted to curtail the defined benefit plan effective March 1, 2007. The effect of the curtailment was recognized in the first quarter of 2007 and the current participants’ accrued benefits were frozen as of March 1, 2007. Participation in the plan was limited to eligible employees as of December 31, 2006.

The Corporation has a 401(k) plan in which substantially all employees are eligible to participate. Employees may contribute up to 100%50% of their compensation subject to certain limits based on federal tax laws. As a result of the curtailment of the defined benefit plan noted above,below, the Corporation increased the contributions to the 401(k)

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plan effective January 1, 2007. The enhancement includesCorporation makes a discretionaryannual 3.0% safe harbor contribution for all eligible employees and matching contributions equal to 50% of the first 4.0% of an employee’s compensation contributed to the Plan during the year. Employees are 100% vested in the safe harbor contributions and are 0% vested through their first two years of employment and are 100% vested after 6 years through a laddered vesting schedule of service for matching contributions.

 

The Corporation maintains a non-leveraged employee stock ownership plan (ESOP) which covers substantially all of its employees. The plan was frozen effective December 31, 2006 to new participants. Contributions’Contributions to the plan are discretionary and approved by the Board of Directors.

The Corporation maintains a plan for officers to provide death benefits to each participant. Insurance policies, designed primarily to fund death benefits, have been purchased on the life of each participant with the Corporation as the sole owner and beneficiary of the policies.

 

The retirement bonus plan is a nonqualified plan of deferred compensation benefits for eligible employees effective January 1, 2007. An initial amount has been credited for each eligible employee as of January 1, 2007. Subsequent amounts will be credited on each allocation date thereafter as defined in the plan. The amount of the initial allocation and the annual allocation will beare determined pursuant to the payment schedule adopted at the sole and exclusive discretion of the Board of Directors, as set forth in the plan.

In December 2006, the Board of Directors voted to curtail the defined benefit plan effective March 1, 2007. The effect of the curtailment was recognized in the first quarter of 2007 and the current participants’ accrued benefits were frozen as of March 1, 2007. Participation in the plan was limited to eligible employees as of December 31, 2006.

 

Other Benefits and Perquisites.  Executive officers are eligible for all of the benefits made available to full-time employees of the Corporation (such as the 401(k) plan, employee stock purchase plan, health insurance, group term life insurance and disability insurance) on the same basis as other full-time employees and are subject to the same sick leave and other employee policies. The Corporation also provides its executive officers with certain additional benefits and perquisites, which it believes are appropriate in order to attract and retain the proper quality of talent for these positions and to recognize that similar executive benefits and perquisites are commonly offered by comparable financial institutions.

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A description and the cost to the Corporation of these perquisites are included in footnote two in the “Summary Compensation Table” appearing on page 14.

The Corporation believes that benefits and perquisites provided to its executive officers in 2010 represented a reasonable percentage of each executive’s total compensation package and was not inconsistent, in the aggregate, with perquisites provided to executive officers of comparable competing financial institutions.

The Corporation maintains a plan for qualified officers to provide death benefits to each participant. Insurance policies, designed primarily to fund death benefits, have been purchased on the life of each participant with the Corporation as the sole owner and beneficiary of the policies.

How Elements Fit into Overall Compensation Objectives

 

The elements of the Corporation’s compensation are structured to reward past and current performance, continued service and motivate its leaders to excel in the future. The Corporation’s salary compensation has generally been used to retain and attract motivated leadership. The Corporation intends to continually ensure salaries are sufficient to attract and retain exceptional officers. The Corporation’s cash bonus incentive rewards current performance based upon personal and corporate goals and targets. The Corporation makes stock awardsoffers the Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors (the “Directors’ Plan”) to motivate its eligible officers to enhance value for shareholders by aligning the interests of management with those of its shareholders.

 

As part of its goal of attracting and retaining quality team members, the Corporation has developed competitive employee benefit plans that make it stand out from the rest of the competition.plans. Management feels that the combination of all of the plans listed above makes the Corporation’s total compensation packages attractive.

 

Compensation and BenefitsHuman Resource Committee Report

 

The following Report of the Compensation and Human Resource Committee does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Corporation filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Corporation specifically incorporates this Report by reference therein.

 

The Compensation and Human Resource Committee, which includes all of the independent directors of the board,Board, has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of SECRegulation S-K with management, and based on such review and discussion, the Compensation and Human Resource Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Proxy Statement and the Annual Report onForm 10-K.

 

Submitted by the Compensation and Human Resource Committee of Isabella Bank Corporation’s Board of Directors:

 

James C. Fabiano,David J. Maness, Chairperson

Jeffrey J. Barnes

Sandra L. Caul

Ted W. KortesJames C. Fabiano

David J. ManessG. Charles Hubscher

Thomas L. Kleinhardt

Joseph LaFramboise

W. Joseph Manifold

W. Michael McGuire

William J. StricklerDianne C, Morey

Dale D. Weburg

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Executive Officers

 

Executive Officers of the Corporation are compensated in accordance with their employment with the applicable entity. The following table shows information on compensation earned from the Corporation or its subsidiaries for each of the last three fiscal years ended December 31, 2008, by2010, for the President and Chief Executive Officer, the PrincipalChief Financial Officer, and the corporation’sCorporation’s three other most highly compensated executive officers.

 

Summary Compensation Table

 

																		Change in Pension
																		Value and
																		Non-Qualified
																		Deferred
																		Compensation				All Other
						Salary				Bonus				Stock Awards				Earnings				Compensation				Total
Name and principal position		Year				($)(1)				($)(1)				($)				($)(2)				($)(3)				($)
Dennis P. Angner			2008			$	294,670			$	9,450			$	41,425			$	28,089			$	18,453			$	392,087
President and CEO			2007				288,101				8,225				26,280				(7,000	)			18,715				334,321
of Isabella Bank Corporation			2006				255,237				10,000				16,228				70,646				8,233				360,344
Peggy L. Wheeler			2008				105,000				3,500				—				13,000				2,216				123,716
Principal Financial Officer,			2007				100,000				3,000				—				(3,000	)			2,023				102,023
Sr. Vice President and Controller of Isabella Bank Corporation			2006				88,500				—				—				14,339				685				103,524
Richard J. Barz			2008				300,785				9,100				32,490				72,622				22,697				437,694
Executive Vice President of			2007				274,706				7,875				18,125				—				23,226				323,932
Isabella Bank Corporation President and CEO Isabella Bank			2006				237,175				14,400				15,100				134,235				10,948				411,858
Timothy M. Miller			2008				160,145				3,200				6,715				3,411				14,127				187,598
Vice President of			2007				155,171				—				7,880				(1,000	)			14,167				176,218
Isabella Bank Corporation President of the Breckenridge division of Isabella Bank			2006				149,117				3,567				7,223				17,030				5,778				182,715
Steven D. Pung(4)			2008				117,100				3,785				1,125				45,884				13,169				181,063
Sr. Vice President and COO Isabella Bank			2007				108,100				3,625				1,800				—				14,194				127,719

														Change in pension
														Value and
														Non-Qualified
														Deferred
														Compensation				All Other
						Salary				Bonus				Earnings				Compensation				Total
Name and principal position		Year				($)(1)				($)				($)(2)				($)(3)				($)
Richard J. Barz			2010			$	357,600			$	24,706			$	116,364			$	34,856			$	533,526
CEO Isabella Bank Corporation			2009				354,250				9,625				90,184				30,568				484,627
President and CEO Isabella Bank			2008				333,275				9,100				110,559				22,697				475,631
Dennis P. Angner			2010			$	352,600			$	24,706			$	103,340			$	27,922			$	508,568
President and CFO			2009				359,425				9,800				79,623				25,252				474,100
Isabella Bank Corporation			2008				336,095				9,450				83,957				18,453				447,955
Timothy M. Miller			2010			$	161,220			$	12,370			$	9,000			$	32,798			$	215,388
President of the Breckenridge			2009				174,600				7,319				6,000				17,323				205,242
Division of Isabella Bank			2008				166,860				3,200				11,000				14,127				195,187
Steven D. Pung			2010			$	143,632			$	10,572			$	62,288			$	32,886			$	249,378
Sr. Vice President and COO			2009				127,100				6,003				48,518				18,468				200,089
Isabella Bank			2008				118,225				3,785				65,111				13,169				200,290
David J. Reetz(4)			2010			$	123,910			$	9,165			$	36,429			$	13,694			$	183,198
Sr. Vice President and CLO
Isabella Bank

 

 

(1)		Includes compensation voluntarily deferred under the Corporation’s 401(k) plan. Directors fees paid in cash are also included, for calendar years 2008, 20072010, 2009 and 20062008 respectively as follows: Richard J. Barz $52,600, $59,250, and $58,275; Dennis P. Angner $14,670, $23,870$52,600, $59,425, and $20,237; Richard J. Barz $25,785, $20,475 and $12,175; and$56,095; Timothy M. Miller $17,445, $20,940$11,300, $26,900, and $18,117.$24,160; and Steven D. Pung $900, $900, and $1,125.
(2)		For 2006, approximately 75% ofRepresents the aggregate change in the actuarial present value of the definednoted executive’s accumulated benefit is related to prior service, a decrease inunder the assumed discount rate,Isabella Bank Corporation Pension Plan and a change in the actuarial mortality table. Amounts were determined using assumptions consistent with those used in the Corporation’s consolidated financial statements. The Board of Directors approved a curtailment of this plan in December 2006 effective March 1, 2007. Assumptions were consistent with those that were presented in the consolidated financial statements.Isabella Bank Corporation Retirement Bonus Plan.
(3)		For all noted executives all other compensation includes 401(k) matching contributions. For Richard J. Barz, and Steven D. Pung, and David J. Reetz this also includes club dues and auto allowance. For Dennis P. Angner and Timothy M. Miller, this also includes auto allowance.
(4)		Not a named executive officer prior to 2007.2010.

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20082010 Pension Benefits

 

The following table indicates the present value of accumulated benefits as of December 31, 20082010 for each named executive in the summary compensation table.

 

				Number of														Number of
				Years of				Present										Years of				Present
				Credited				Value of										Vesting				Value of
				Service as				Accumulated				Payments						Service as of				Accumulated				Payments
				of 01/01/09				Benefit				During Last						01/01/11				Benefit				During Last
Name		Plan Name		(#)				($)				Fiscal Year				Plan name		(#)				($)				Fiscal Year
Richard J. Barz																Isabella Bank Corporation Pension Plan			39			$	762,000			$	—
																Isabella Bank Corporation Retirement Bonus Plan			39				270,931				—
Dennis P. Angner		Isabella Bank Corporation Pension Plan			23			$	297,000			$	—			Isabella Bank Corporation Pension Plan			27				382,000				—
		Isabella Bank Corporation Retirement Bonus Plan			23				177,570				—			Isabella Bank Corporation Retirement Bonus Plan			27				275,533				—
Peggy L. Wheeler		Isabella Bank Corporation Pension Plan			28				79,000				—
Timothy M. Miller																Isabella Bank Corporation Pension Plan			10				79,000				—
		Isabella Bank Corporation Retirement Bonus Plan			28				46,134				—														—
Richard J. Barz		Isabella Bank Corporation Pension Plan			35				625,000				—
		Isabella Bank Corporation Retirement Bonus Plan			35				201,383				—
Timothy M. Miller		Isabella Bank Corporation Pension Plan			6				64,000				—
Steven D. Pung		Isabella Bank Corporation Pension Plan			28				313,000				—			Isabella Bank Corporation Pension Plan			32				384,000				—
		Isabella Bank Corporation Retirement Bonus Plan			28				105,824				—			Isabella Bank Corporation Retirement Bonus Plan			32				145,630
David J. Reetz																Isabella Bank Corporation Pension Plan			24				119,000				—
																Isabella Bank Corporation Retirement Bonus Plan			24				90,378				—

 

Defined benefit pension plan.  The Corporation sponsors the Isabella Bank Corporation Pension Plan, a frozen 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, froze the current participant’s accrued benefits as of March 1, 2007 and limited participation in the plan to eligible employees as of December 31, 2006. Due to the curtailment of the plan, the number of years of credited service was frozen. As such, the years of credited service for the plan may differ from the participant’s actual years of service with the Corporation.

 

Annual contributions are made to the plan as required by accepted actuarial principles, applicable federal tax law,laws, and expenses of operating and maintaining the plan. The amount of contributions on behalf of any one participant cannot be separately or individually computed.

 

Pension 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, effective through December 31, 2006.

 

A participant may earn a benefit for up to 35 years of accredited service. Earned benefits are 100 percent vested after five years of service. Benefit payments normally start when a participant reaches age 65. A participant with more than five years of service may elect to take early retirement benefits anytime after reaching age 55. Benefits payable under early retirement are reduced actuarially for each month prior to age 65 in which benefits begin.

 

Dennis P. Angner, Richard J. Barz, Timothy M. Miller, and Steven D. Pung are eligible for early retirement under the Isabella Bank Corporation Pension Plan. Under the provisions of the Plan, participants are eligible for early retirement after reaching the age of 55 with at least 5 years of service. The early retirement benefit amount is the accrued benefit payable at normal retirement date reduced by5/9% 5/9% for each of the first 60 months and5/18% 5/18% for each of the next 60 months that the benefit commencement date precedes the normal retirement date.

 

Retirement bonus plan.  The Corporation sponsors the Isabella Bank Corporation Retirement Bonus Plan. The retirement bonus planRetirement Bonus Plan is a nonqualified plan of deferred compensation benefits for eligible employees effective January 1, 2007. This plan is intended to provide eligible employees with additional retirement benefits. To be eligible, the employee needed to be employed by the Corporation on January 1, 2007, and be a participant in the Corporation’s frozen Executive Supplemental Income Agreement. Participants must also be an officer of the Corporation with at least 10 years of service as of December 31, 2006. The Corporation has sole and exclusive discretion to add new participants to the plan by authorizing such participation pursuant to action of the Corporation’s Board of Directors.

 

An initial amount has been credited for each eligible employee as of January 1, 2007. Subsequent amounts shall be credited on each allocation date thereafter as defined in the plan.Plan. The amount of the initial allocation and the

1015

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annual allocation shall be determined pursuant to the payment schedule adopted by the sole and exclusive discretion of the Board, of Directors, as set forth in the plan.Plan.

 

Dennis P. Angner, Richard J. Barz, Timothy M. Miller, and Steven D. Pung are eligible for early retirement under the Isabella Bank Corporation Retirement Bonus Plan. Under the provisions of the Plan,plan, participants are eligible for early retirement upon attaining 55 years of age. There is no difference between the calculation of benefits payable upon early retirement and normal retirement.

 

20082010 Nonqualified Deferred Compensation

 

		Executive				Aggregate				Aggregate				Executive				Aggregate				Aggregate
		Contributions in				Earnings in				Balance at				Contributions in				Earnings in				Balance at
		Last FY				Last FY				Last FYE				Last FY				Last FY				Last FYE
Name		($)				($)				($)				($)				($)				($)
Richard J. Barz														$	30,650			$	3,501			$	97,379
Dennis P. Angner		$	41,425			$	1,269			$	85,930				44,400				4,836				134,713
Peggy L. Wheeler			—				—				—
Richard J. Barz			32,490				987				67,306
Timothy M. Miller			6,715				352				22,465				3,500				839				21,990
Steven D. Pung			1,125				98				6,042				900				181				4,799
David J. Reetz															N/A				N/A				N/A

 

The directors of the Corporation and its subsidiaries are required to defer at least 25% of their earned board fees into the Directors’ Plan and may defer up to 100% of their earned fees based on their annual election. These amounts are reflected in the 20082010 nonqualified deferred compensation table above. Under the Directors’ Plan, these deferred fees are converted on a quarterly basis into shares of the Corporation’s common stock based on the fair market value of shares of the Corporation’s common stock at that time. Shares credited to a participant’s account are eligible for stock and cash dividends as payable.

 

Distribution from the Directors’ Plan occurs when the participant retires from the board,Board, attains age 70 or upon the occurrence of certain other events. Distributions must take the form of shares of the Corporation’s common stock. Any Corporation common stock issued under the Directors’ Plan will be considered restricted stock under the Securities Act of 1933, as amended.

 

Potential Payments Upon Termination or Change in Control

 

The estimated pay outspayments payable to each named executive officer upon severance from employment, retirement, termination upon death or disability or termination following a change in control of the Corporation are described below. For all termination scenarios, the amounts assume such termination took place as of December 31, 2008.2010.

 

Any Severance of Employment

 

Regardless of the manner in which a named executive officer’s employment terminates, he or she is entitled to receive amounts earned during his or her term of employment. Such amounts include:

 

	•	Amounts accrued and vested through the Defined Benefit Pension Plan.
	•	Amounts accrued and vested through the Retirement Bonus Plan.
	•	Amounts deferred in the Directors’ Plan.
	•	Unused vacation pay.

 

Retirement

 

In the event of the retirement of an executive officer, the officer would receive the benefits identified above.

As of December 31, 2008,2010, the named executive officers listed had no unused vacation days.

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Death or Disability

 

In the event of death or disability of an executive officer, in addition to the benefits listed above, the executive officer will also receive payments under the Corporation’s life insurance plan or benefits under the Corporation’s disability plan as appropriate.

 

In addition to potential payments upon termination available to all employees, the estates for the executive officers listed below would receive the following payments upon death:

 

		While an												While an
		Active				Subsequent to								Active				Subsequent to
Name		Employee				Retirement								Employee				Retirement
Richard J. Barz														$	610,000			$	305,000
Dennis P. Angner		$	560,000			$	140,000								600,000				300,000
Peggy L. Wheeler			210,000				105,000
Richard J. Barz			550,000				275,000
Timothy M. Miller			285,400				142,700								299,800				149,900
Steven D. Pung			234,200				117,100								285,400				142,700
David J. Reetz															247,800				123,900

 

Change in Control

 

The Corporation currently does not have a change in control agreement with any of the executive officers; provided, however, pursuant to the Retirement Bonus Plan each participant would become 100% vested in their benefit under the plan if, following a change in control, they voluntarily terminate employment or are terminated without just cause.

 

Director Compensation

 

The following table summarizes the Compensation of each non-employee director who served on the Board of Directors during 2008.2010.

 

										Change in
										Pension Value
										and Non-
		Fees								Qualified
		Earned or								Deferred
		Paid in				Stock				Compensation
		Cash				Awards				Earnings				Total
Name		($)				($)				($)				($)
Sandra Caul		$	—			$	37,450			$	(174,451	)		$	(137,001	)
James Fabiano			—				47,750				(482,948	)			(435,198	)
Ted Kortes			18,737				12,038				(3,429	)			27,346
David Maness			—				40,325				(79,544	)			(39,219	)
W. Joseph Manifold			—				25,350				(55,389	)			(30,039	)
W. Michael McGuire			—				30,275				(34,439	)			(4,164	)
William Strickler			—				51,499				(215,151	)			(163,652	)
Dale Weburg			—				32,435				(111,175	)			(78,740	)

		Fees
		Earned or
		Paid in
		Cash				Total
Name		($)				($)
Jeffrey J. Barnes			21,000				21,000
Sandra L. Caul			35,800				35,800
James Fabiano			40,915				40,915
G. Charles Hubscher			25,950				25,950
Thomas L. Kleinhardt			29,450				29,450
Ted W. Kortes			31,100				31,100
Joseph LaFramboise			27,900				27,900
David J. Maness			52,300				52,300
W. Joseph Manifold			29,146				29,146
W. Michael McGuire			31,800				31,800
Dianne C. Morey			18,850				18,850
William J. Strickler			39,085				39,085
Dale D. Weburg			36,400				36,400

 

The Corporation paid a $6,000$14,000 retainer plus $950$1,350 per board meeting to itsexternal directors and a $6,000 retainer plus $1,350 per board meeting to inside directors during 2008 and $2252010. Members of the audit committee were paid $350 per audit committee meeting attended.

 

The Corporation sponsors a nonqualified deferred compensation plan for directors (the “Directors’ Plan”), pursuantPursuant to whichthe Directors’ Plan the directors of the Corporation and its subsidiaries are required to defer at least 25% of their earned board fees. Under the Directors’ Plan, deferred directors’ fees are converted on a quarterly basis into shares of the Corporation’s common stock, based on the fair market value of a share of the Corporation’s

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common stock at that time. Shares of stock credited to a participant’s account are eligible for cash and stock dividends as payable. ParticipantsDirectors of the Corporation deferred $483,405$419,696 under the Directors’ Plan in 2008.2010.

 

Upon a participant’s attainment of age 70, retirement from the board,Board, or the occurrence of certain other events, the participant is eligible to receive a lump-sum, in-kind distribution of all of the stock that is then credited to his or

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her account. The plan does not allow for cash settlement. Stock issued under the Directors’ Plan is restricted stock under the Securities Act of 1933, as amended.

 

The Corporation established a Trust effective as of January 1, 2008 to fund the Directors’ Plan. The Trust is an irrevocable grantor trust to which the Corporation may contribute assets for the limited purpose of funding a nonqualified deferred compensation plan. Although the Corporation may not reach the assets of the Trust for any purpose other than meeting its obligations under the Directors’ Plan, the assets of the Trust remain subject to the claims of the Corporation’s creditors. The Corporation may contribute cash or common stock to the Trust from time to time for the sole purpose of funding the Directors’ Plan. The Trust will use any cash that the Corporation may contribute to it to purchase shares of the Corporation’s common stock on the open market through the Corporation’s brokerage services department.

 

The Corporation transferred $248,693$492,958 to the Rabbi Trust in 2008,2010, which held 5,24832,686 shares of the Corporation’s common stock for settlement as of December 31, 2008.2010. As of December 31, 2008,2010, there were 186,766191,977 shares of stock credited to participants’ accounts, as adjusted for the 10% stock dividend paid on February 29, 2008, which credits are unfunded as of such date to the extent that they are in excess of the stock and cash that has been credited to the Trust. All amounts are unsecured claims against the Corporation’s general assets. The net cost of this benefit to the Corporation was $119,616$165,353 in 2008.2010.

 

The following table displays the number of equity shares grantedcredited pursuant to the terms of the Directors’ Plan as of December 31, 2008:2010:

 

		# of Shares
		of Stock
Name		GrantedStock Credited
Dennis P Angner			2,3687,787
Jeffrey J. Barnes			31,280
Richard JJ. Barz			1,8455,629
Sandra L. Caul			13,074287,411
James Fabiano			35,657756,559
G. Charles Hubscher			71,357
Thomas L. Kleinhardt			165,741
Ted W. Kortes			33815,636
Joseph LaFramboise			36,348
David J. Maness			6,186166,134
W. Joseph Manifold			4,142108,959
W. Michael McGuire			2,81384,660
Dianne C. Morey			103,849
William JJ. Strickler			16,191368,446
Dale D. Weburg			8,382200,490

 

Compensation and Human Resource Committee Interlocks and Insider Participation

 

The Compensation and Human Resource Committee of the Corporation is responsible for reviewing and recommending to the Corporation’s Board of Directors the compensation of the PresidentChief Executive Officer and other executive officers of the Corporation, benefit plans and the overall percentage increase in salaries. The committee consists of directors Maness, Barnes, Caul, Fabiano, Caul, Kortes,Hubscher, Kleinhardt, LaFramboise, Manifold, McGuire, Maness, Manifold, Strickler,Morey, and Weburg.

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Indebtedness of and Transactions with Management

 

Certain directors and officers of the Corporation and members of their families were loan customers of Isabella Bank, or have been directors or officers of corporations, or partners of partnerships which have had transactions with the subsidiary Bank. In management’s opinion, all such transactions arewere made in the ordinary course of business and arewere substantially on the same terms, including collateral and interest rates, as those prevailing at the same time for comparable transactions with customers not related to the Bank. These transactions do not involve more than normal risk of collectability or present other unfavorable features. Total loans to these customers were approximately $4,011,000$4,347,000 as of December 31, 2008.2010. The Corporation addresses transactions with related parties in its’Code‘Code of Business Conduct and Ethics’policy.policy. Conflicts of interest are prohibited as a matter of Corporation policy, except under guidelines approved by the Board of Directors or committees of the Board.

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Security Ownership of Certain Beneficial Owners and Management

 

As of April 1, 20092011 the Corporation does not have any person who is known to the Corporation to be the beneficial owner of more than 5% of the common stock of the Corporation.

 

The following table sets forth certain information as of April 1, 20092011 as to the common stock of the Corporation owned beneficially by each director and director nominee, by each named executive officer, and by all directors, director nominees and executive officers of the Corporation as a group. The shares to be granted from stock awardscredited under the Directors’ Plan are not included in the table below.

 

		Amount and Nature of Beneficial Ownership																Amount and Nature of Beneficial Ownership
		Sole Voting				Shared Voting				Total				Percentage of				Sole Voting				Shared Voting				Total				Percentage of
		and Investment				and Investment				Beneficial				Common Stock				and Investment				or Investment				Beneficial				Common Stock
Name of Owner		Powers				Powers				Ownership				Outstanding				Powers				Powers				Ownership				Outstanding
Dennis P. Angner*			20,946				—				20,946				0.28	%			18,100				—				18,100				0.24	%
Richard J Barz*			23,915				—				23,915				0.32	%
Jeffrey J. Barnes																			—				5,669				5,669				0.08	%
Richard J. Barz*																			20,325				—				20,325				0.27	%
Sandra L. Caul			—				10,242				10,242				0.14	%			—				10,609				10,609				0.14	%
James C. Fabiano			250,930				6,059				256,989				3.42	%			264,871				6,579				271,450				3.60	%
Theodore W. Kortes			—				15,115				15,115				0.20	%
G. Charles Hubscher																			28,031				3,548				31,579				0.42	%
Thomas L. Kleinhardt																			—				31,179				31,179				0.41	%
Joseph LaFramboise																			—				910				910				0.01	%
David J. Maness																			466				1,135				1,601				0.02	%
W. Joseph Manifold			543				—				543				0.01	%			2,089				—				2,089				0.03	%
W. Michael McGuire			6,177				—				6,177				0.08	%			56,531				—				56,531				0.75	%
David J. Maness			429				951				1,381				0.02	%
William J. Strickler			78,126				13,029				91,154				1.21	%
Dianne C. Morey																			—				40,283				40,283				0.53	%
Dale D. Weburg			25,642				29,969				55,611				0.74	%			27,842				31,683				59,525				0.79	%
Timothy M. Miller			77				2,946				3,024				0.04	%			215				3,330				3,545				0.05	%
Steven D. Pung			12,752				7,160				19,912				0.26	%			9,422				8,236				17,658				0.23	%
Peggy L. Wheeler			5,730				2,256				7,986				0.11	%
David J. Reetz																			8,468				175				8,643				0.11	%
All Directors, nominees and Executive Officers as a Group (13 persons)			425,268				87,727				512,995				6.83	%
All Directors, nominees and Executive
Officers as a Group (16 persons)																			436,360				143,336				579,696				7.68	%

 

 

*		Trustees of the ESOP who vote ESOP stock.

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Independent Registered Public Accounting Firm

 

The Audit Committee has appointed Rehmann Robson as the independent auditors of the Corporation for the year ending December 31, 2009.2011.

 

A representative of Rehmann Robson is expected to be present at the Annual Meeting of Shareholders to respond to appropriate questions from shareholders and to make any comments they believeRehmann believes is appropriate.

 

Fees for Professional Services Provided by Rehmann Robson P.C.

 

The following table shows the aggregate fees billed by Rehmann Robson for the audit and other services provided to the Corporation for 20082010 and 2007.2009.

 

		2008				2007
Audit Fees		$	238,275			$	371,860
Audit Related Fees			52,415				31,365
Tax Fees			65,257				28,750
Other Professional Services Fees			15,098				16,450
Total		$	371,045			$	448,425

		2010				2009
Audit fees		$	252,163			$	291,497
Audit related fees			39,089				40,135
Tax fees			24,730				39,784
Other professional services fees			—				—
Total		$	315,982			$	371,416

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The audit fees were for performing the integrated audit of the Corporation’s consolidated annual financial statements and the audit of internal control over financial reporting related to the Federal Deposit Insurance Corporation Improvement Act, review of interim quarterly financial statements included in the Corporation’sForms 10-Q, auditing of the Corporation’s employee benefit plans and services that are normally provided by Rehmann Robson in connection with statutory and regulatory filings or engagements. The decline in audit fees have steadily declined over the past few years as a result of the centralization of corporate processes and diligently working on improving efficienciesfrom 2009 to 2010 is primarily related to Sarbanes Oxley (SOX) compliance.the Corporations’ continued improvement in financial reporting and SOX 404 processes.

 

The audit related fees for 2008 and 2007 were for regulatory filings and procedures related to the acquisition of Greenville Community Financial Corporation andare typically for various discussions related to the adoption and interpretation of new accounting pronouncements. Also included are fees for auditing of the Corporation’s employee benefit plans.

 

The tax fees were for the preparation of the CorporationCorporation’s and its subsidiaries’ state and federal tax returns and for consultation with the Corporation on various tax matters. The increase in the 2008During 2009 tax fees is primarily related to tax consulting for an audit conducted by the State of Michigan for Single Business Tax (SBT), the 2007 Greenville Community Financial Corporation final tax return preparation, and taxalso included consulting related to the joint venture with CT/IBT Title (refer to Note 2then new State of the Corporation’s consolidated financial statement)Michigan Business Tax (MBT).

 

The Audit Committee has considered whether the services provided by Rehmann Robson, P.C. other than the audit fees, are compatible with maintaining Rehmann Robson’sRobson, P.C.’s independence and believes that the other services provided are compatible.

 

Pre-approvalPre-Approval Policies and Procedures

 

All audit and non-audit services over $5,000 to be performed by Rehmann Robson must be approved in advance by the Audit Committee.Committee if those fees are reasonably expected to exceed 5.0% of the current year agreed upon fee for independent audit services. As permitted by the SEC’s rules, the Audit Committee has authorized its Chairperson to pre-approve audit, audit-related, tax and non-audit services, provided that such approved service is reported to the full Audit Committee at its next meeting.

 

As early as practicable in each calendar year, the independent auditor provides to the Audit Committee a schedule of the audit and other services that the independent auditor expects to provide or may provide during the next twelve months. The schedule will be specific as to the nature of the proposed services, the proposed fees, timing, and other details that the Audit Committee may request. The Audit Committee will by resolution authorize or decline the proposed services. Upon approval, this schedule will serve as the budget for fees by specific activity or service for the next twelve months.

 

A schedule of additional services proposed to be provided by the independent auditor, or proposed revisions to services already approved, along with associated proposed fees, may be presented to the Audit Committee for their consideration and approval at any time. The schedule will be specific as to the nature of the proposed service, the

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proposed fee, and other details that the Audit Committee may request. The Audit Committee will by resolution authorize or decline authorization for each proposed new service.

 

Applicable SEC rules and regulations permit waiver of the pre-approval requirements for services other than audit, review or attest services if certain conditions are met. Out of the services characterized above as Audit-Related, Taxaudit-related, tax and Professional Services,professional services, none were billed pursuant to these provisions in 20082010 and 20072009 without pre-approval.

pre-approval as required under the Corporation’s policies.

 

Shareholder Proposals

 

Any proposals which shareholders of the Corporation intend to present at the next annual meeting of the Corporation must be received before December 11, 20099, 2011 to be considered for inclusion in the Corporation’s proxy statement and proxy for that meeting. Proposals should be made in accordance with Securities and Exchange CommissionRule 14a-8.

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Directors’ Attendance at the Annual Meeting of Shareholders

 

The Corporation’s directors are encouraged to attend the annual meeting of shareholders. At the 20082010 annual meeting, all directors were in attendance.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934 requires the Corporation’s directors and certain officers and persons who own more than ten percent of the Corporation’s common stock, to file with the SEC initial reports of ownership and reports of changes in ownership of the Corporation’s common stock. These officers, directors, and greater than ten percent shareholders are required by SEC regulation to furnish the Corporation with copies of these reports.

 

To the Corporation’s knowledge, based solely on review of the copies of such reports furnished to the Corporation, during the year ended December 31, 20082010 all Section 16(a) filing requirements were satisfied, with respect to the applicable officers, directors, and greater than 10 percent beneficial owners.

 

Other Matters

 

The cost of soliciting proxies will be borne by the Corporation. In addition to solicitation by mail, officers and other employees of the Corporation may solicit proxies by telephone or in person, without compensation other than their regular compensation.

 

As to Other Business Which May Come Before the Meeting

 

Management of the Corporation does not intend to bring any other business before the meeting for action. However, if any other business should be presented for action, it is the intention of the persons named in the enclosed form of proxy to vote in accordance with their judgment on such business.

 

By order of the Board of Directors

 

Debra Campbell, Secretary

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Isabella Bank Corporation

 

Financial Information Index

 

Page				Description
18	23			Summary of Selected Financial Data
	1924			Report of Independent Registered Public Accounting Firm
	21 - 25			Consolidated Financial Statements
	26 - 6430			Notes to Consolidated Financial Statements
	65 - 9172			Management’s Discussion and Analysis of Financial Condition and Results of Operations
	9295			Common Stock and Dividend Information
	9598			Shareholders’ Information

1722

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SUMMARY OF SELECTED FINANCIAL DATA

 

		2008				2007				2006				2005				2004
		(Dollars in thousands except per share data)
INCOME STATEMENT DATA
Total interest income		$	61,385			$	53,972			$	44,709			$	36,882			$	33,821
Net interest income			35,779				28,013				24,977				23,909				23,364
Provision for loan losses			9,500				1,211				682				777				735
Net income			4,101				7,930				7,001				6,776				6,645
BALANCE SHEET DATA
End of year assets		$	1,139,263			$	957,282			$	910,127			$	741,654			$	678,034
Daily average assets			1,113,102				925,631				800,174				700,624				675,157
Daily average deposits			817,041				727,762				639,046				576,091				567,145
Daily average loans/net			708,434				596,739				515,539				459,310				430,854
Daily average equity			143,626				119,246				91,964				74,682				70,787
PER SHARE DATA(1)
Earnings per share
Basic		$	0.55			$	1.14			$	1.12			$	1.14			$	1.13
Diluted			0.53				1.11				1.09				1.14				1.13
Cash dividends			0.65				0.62				0.58				0.55				0.52
Book value (at year end)			17.89				17.58				16.61				13.44				12.25
FINANCIAL RATIOS
Shareholders’ equity to assets (at year end)			11.80	%			12.86	%			12.72	%			10.91	%			10.71	%
Return on average equity			2.86				6.65				7.61				9.07				9.39
Return on average tangible equity			4.41				8.54				8.31				9.12				10.01
Cash dividend payout to net income			118.82				54.27				53.92				48.02				46.20
Return on average assets			0.37				0.86				0.87				0.97				0.98

		2010				2009				2008				2007				2006
		(Dollars in thousands except per share data)
INCOME STATEMENT DATA
Total interest income		$	57,217			$	58,105			$	61,385			$	53,972			$	44,709
Net interest income			40,013				38,266				35,779				28,013				24,977
Provision for loan losses			4,857				6,093				9,500				1,211				682
Net income			9,045				7,800				4,101				7,930				7,001
BALANCE SHEET DATA
End of year assets		$	1,225,810			$	1,143,944			$	1,139,263			$	957,282			$	910,127
Daily average assets			1,182,930				1,127,634				1,113,102				925,631				800,174
Daily average deposits			840,392				786,714				817,041				727,762				639,046
Daily average loans/net			712,272				712,965				708,434				596,739				515,539
Daily average equity			139,855				139,810				143,626				119,246				91,964
PER SHARE DATA(1)
Earnings per share
Basic		$	1.20			$	1.04			$	0.55			$	1.14			$	1.12
Diluted			1.17				1.01				0.53				1.11				1.09
Cash dividends			0.72				0.70				0.65				0.62				0.58
Book value (at year end)			19.23				18.69				17.89				17.58				16.61
FINANCIAL RATIOS
Shareholders’ equity to assets (at year end)			11.84	%			12.31	%			11.80	%			12.86	%			12.72	%
Return on average equity			6.47				5.58				2.86				6.65				7.61
Return on average tangible equity			9.55				8.53				4.41				8.54				8.31
Cash dividend payout to net income			59.93				67.40				118.82				54.27				53.92
Return on average assets			0.76				0.69				0.37				0.86				0.87

 

		2008																2007																2010																2009
		4th				3rd				2nd				1st				4th				3rd				2nd				1st				4th				3rd				2nd				1st				4th				3rd				2nd				1st
Quarterly Operating Results:
Total interest income		$	15,099			$	15,401			$	15,359			$	15,526			$	13,747			$	13,794			$	13,539			$	12,892			$	14,540			$	14,306			$	14,272			$	14,099			$	14,411			$	14,516			$	14,505			$	14,673
Interest expense			5,836				6,309				6,379				7,082				6,466				6,690				6,554				6,249				4,217				4,296				4,291				4,400				4,657				4,928				5,026				5,228
Net interest income			9,263				9,092				8,980				8,444				7,281				7,104				6,985				6,643				10,323				10,010				9,981				9,699				9,754				9,588				9,479				9,445
Provision for loan losses			5,725				975				1,593				1,207				593				268				224				126				1,626				968				1,056				1,207				1,544				1,542				1,535				1,472
Noninterest income			1,130				2,377				1,778				2,517				2,605				2,719				2,227				2,411				2,629				2,634				1,870				2,167				2,102				2,566				3,131				2,357
Noninterest expenses			8,377				7,430				7,341				7,556				6,597				6,995				6,833				6,804				8,558				8,620				8,275				8,354				8,176				7,995				8,468				9,044
Net (loss) income			(2,041	)			2,524				1,691				1,927				2,268				2,096				1,756				1,810
Per Share of Common Stock:(1)
Earnings (loss) per share
Net income																																			2,318				2,553				2,151				2,023				2,073				2,197				2,201				1,329
Per Share of Common Stock:
Earnings per share
Basic		$	(0.28	)		$	0.34			$	0.23			$	0.26			$	0.33			$	0.30			$	0.25			$	0.26			$	0.30			$	0.34			$	0.29			$	0.27			$	0.28			$	0.29			$	0.29			$	0.18
Diluted			(0.27	)			0.33				0.22				0.25				0.32				0.29				0.25				0.25				0.30				0.33				0.28				0.26				0.27				0.28				0.29				0.17
Cash dividends			0.29				0.12				0.12				0.12				0.29				0.11				0.11				0.11				0.18				0.18				0.18				0.18				0.32				0.13				0.13				0.12
Book value (at quarter end)			17.89				18.78				18.75				19.07				17.58				17.38				17.04				16.77				19.23				19.59				19.39				18.89				18.69				18.97				18.06				18.01

 

 

(1)		Retroactively restated for the 10% stock dividend, paid on February 29, 2008.

1823

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Shareholders and Board of Directors

Isabella Bank Corporation

Mt.Mount Pleasant, Michigan

 

We have audited the accompanying consolidated balance sheets ofIsabella Bank Corporationas of December 31, 20082010 and 2007,2009, and the related consolidated statements of changes in shareholders’ equity, income, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2008.2010. We also have auditedIsabella Bank Corporation’sinternal control over financial reporting as of December 31, 2008,2010, based on criteria established in theInternal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Isabella Bank Corporation’smanagement is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the effectiveness of theIsabella Bank Corporation’sinternal control over financial reporting, based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material misstatement exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. We believe that our audits provide a reasonable basis for our opinion.

 

A corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A corporation’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the corporation; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the corporation are being made only in accordance with authorizations of management and directors of the corporation; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the corporation’s assets that could have a material effect on the consolidated financial statements.

 

As discussed in Note 1 to the consolidated financial statements, effective January 1, 2008, the Corporation adopted ASC Topic 715,Compensation — Retirement Benefits.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

As described in Note 1 to the consolidated financial statements, effective January 1, 2008 the Corporation adopted EITF IssueNo. 06-4,Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. Also, as described in Notes 17 and 20 to the consolidated financial statements, effective January 1, 2007 the Corporation elected the early adoption of Statements of Financial Accounting Standards (SFAS) No.’s 159,The Fair Value Option for Financial Assets and Financial Liabilities,and 157,Fair Value Measurements,and effective December 31, 2006 changed its method of accounting for defined benefit pension and other postretirement plans in accordance with SFAS No. 158,Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans.

19

---

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position ofIsabella Bank Corporationas of December 31, 20082010 and 2007,2009, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 20082010 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinionIsabella Bank Corporationmaintained, in all material respects, effective internal control over financial reporting as of December 31, 2008,2010, based on the criteria established in theInternal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission.

 

 

Rehmann Robson, P.C.

 

Saginaw, Michigan

March 6, 2009

20

---

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

		December 31
		2008				2007
		(Dollars in thousands)
ASSETS
Cash and demand deposits due from banks		$	23,554			$	25,583
Trading securities			21,775				25,064
Investment securities available for sale (amortized cost of $248,741 in 2008 and $212,285 in 2007)			246,455				213,127
Mortgage loans available for sale			898				2,214
Net loans
Loans			735,385				612,687
Less allowance for loan losses			11,982				7,301
Total net loans			723,403				605,386
Premises and equipment			23,231				22,516
Corporate-owned life insurance policies			16,152				13,195
Accrued interest receivable			6,322				5,948
Acquisition intangibles and goodwill, net			47,804				27,010
Equity securities without readily determinable fair values			17,345				7,353
Other assets			12,324				9,886
Total assets		$	1,139,263			$	957,282
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing		$	97,546			$	84,846
NOW accounts			113,973				105,526
Certificates of deposit and other savings			422,689				410,782
Certificates of deposit over $100,000			141,422				132,319
Total deposits			775,630				733,473
Other borrowed funds ($23,130 in 2008 and 7,523 in 2007 at fair value)			222,350				92,887
Escrow funds payable			—				1,912
Accrued interest and other liabilities			6,807				5,930
Total liabilities			1,004,787				834,202
Shareholders’ Equity
Common stock — no par value 15,000,000 shares authorized; outstanding — 7,518,856 (including 5,248 shares to be issued) in 2008 and 6,364,120 in 2007			133,602				112,547
Shares to be issued for deferred compensation obligations			4,015				3,772
Retained earnings			2,428				7,027
Accumulated other comprehensive loss			(5,569	)			(266	)
Total shareholders’ equity			134,476				123,080
Total liabilities and shareholders’ equity		$	1,139,263			$	957,282

The accompanying notes are an integral part of these consolidated financial statements.

21

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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

		Year Ended December 31
		2008				2007				2006
		(Dollars in thousands)
Number of Shares of Common Stock Outstanding
Balance at beginning of year			6,364,120				6,335,861				4,974,715
Common stock dividends			687,599				—				497,299
Shares issued in exchange for bank acquisition			514,809				—				797,475
Other issuances of common stock			100,664				71,479				66,372
Common stock repurchased			(148,336	)			(43,220	)			—
Balance end of year			7,518,856				6,364,120				6,335,861
Common Stock
Balance at beginning of year		$	112,547			$	111,648			$	69,592
Common stock dividends (10)%			30,256				—				20,887
Regulatory capital transfer			(28,000	)			—				(12,000	)
Issuances of common stock in exchange for bank acquisition			22,652				—				30,448
Issuance of common stock			2,836				2,780				2,721
Common stock purchased for deferred compensation obligations			(249	)			—				—
Common stock repurchased			(6,440	)			(1,881	)			—
Balance end of year			133,602				112,547				111,648
Shares to be issued for deferred compensation obligations
Balance at beginning of year			3,772				3,137				2,704
Share-based payment awards under equity compensation plan			603				758				470
Issuance of common stock			(360	)			(123	)			(37	)
Balance end of year			4,015				3,772				3,137
Retained Earnings
Balance at beginning of year			7,027				4,451				10,112
Adjustment to initially apply FASB Statement No. 159, net of tax			—				(1,050	)			—
Adjustment to initially apply EITF06-4, net of tax			(1,571	)			—				—
Net income			4,101				7,930				7,001
Common stock dividends (10)%			(30,256	)			—				(20,887	)
Regulatory capital transfer			28,000				—				12,000
Cash dividends ($0.65 per share in 2008, $0.62 per share in 2007, $0.58 per share in 2006)			(4,873	)			(4,304	)			(3,775	)
Balance end of year			2,428				7,027				4,451
Accumulated Other Comprehensive Loss
Balance at beginning of year			(266	)			(3,487	)			(1,506	)
Cumulative adjustment to initially apply the fair value option of FASB Statement No. 159, net of tax			—				827
Cumulative adjustment to initially apply FASB Statement No. 158, net of tax			—				—				(2,728	)
Other comprehensive (loss) income			(5,303	)			2,324				747
Balance end of year			(5,569	)			(266	)			(3,487	)
Total shareholders’ equity end of year		$	134,476			$	123,080			$	115,749

The accompanying notes are an integral part of these consolidated financial statements.

22

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CONSOLIDATED STATEMENTS OF INCOME

		Year Ended December 31
		2008				2007				2006
		(Dollars in thousands
		except per share data)
Interest Income
Loans, including fees		$	49,674			$	43,808			$	36,575
Investment securities
Taxable			5,433				3,751				4,948
Nontaxable			4,642				3,657				2,797
Trading account securities			1,093				2,097				—
Federal funds sold and other			543				659				389
Total interest income			61,385				53,972				44,709
Interest Expense
Deposits			19,873				22,605				17,164
Borrowings			5,733				3,354				2,568
Total interest expense			25,606				25,959				19,732
Net interest income			35,779				28,013				24,977
Provision for loan losses			9,500				1,211				682
Net interest income after provision for loan losses			26,279				26,802				24,295
Noninterest Income
Service charges and fees			6,370				5,894				5,490
Title insurance revenue (Note 2)			234				2,192				2,389
Gain on sale of mortgage loans			249				209				207
Net gain on trading securities			245				460				—
Other			704				1,207				1,012
Total noninterest income			7,802				9,962				9,098
Noninterest Expenses
Compensation and benefits			16,992				15,618				13,869
Occupancy			2,035				1,766				1,730
Furniture and equipment			3,849				3,297				2,868
Other			7,828				6,548				6,006
Total noninterest expenses			30,704				27,229				24,473
Income before federal income tax (benefit) expense			3,377				9,535				8,920
Federal income tax (benefit) expense			(724	)			1,605				1,919
Net income		$	4,101			$	7,930			$	7,001
Earnings per share
Basic		$	0.55			$	1.14			$	1.12
Diluted		$	0.53			$	1.11			$	1.09

The accompanying notes are an integral part of these consolidated financial statements.

23

---

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

		Year Ended December 31
		2008				2007				2006
		(Dollars in thousands)
Net income		$	4,101			$	7,930			$	7,001
Unrealized holding gains on available-for-sale securities:
Unrealized (losses) gains arising during the year			(3,104	)			614				1,020
Reclassification adjustment for net realized (gains) losses included in net income			(24	)			19				112
Net unrealized (losses) gains			(3,128	)			633				1,132
Tax effect			(643	)			(216	)			(385	)
Unrealized (losses) gains, net of tax			(3,771	)			417				747
(Increase) reduction of unrecognized pension cost			(2,320	)			2,890				—
Tax effect			788				(983	)			—
Net unrealized (loss) gain on defined benefit pension plan			(1,532	)			1,907				—
Other comprehensive (loss) income, net of tax			(5,303	)			2,324				747
Comprehensive income		$	(1,202	)		$	10,254			$	7,748

The accompanying notes are an integral part of these consolidated financial statements.8, 2011

24

---

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)BALANCE SHEETS

 

		Year Ended December 31
		2008				2007				2006
		(Dollars in thousands)
Operating activities
Net income		$	4,101			$	7,930			$	7,001
Reconciliation of net income to cash provided by (used in) operations:
Provision for loan losses			9,500				1,211				682
Provision for foreclosed asset losses			231				109				—
Depreciation			2,171				1,960				1,852
Amortization and impairment of mortgage servicing rights			346				201				184
Amortization of acquisition intangibles			415				278				160
Net amortization of investment securities			356				216				705
Realized (gain) loss on sale of available-for-sale investment securities			(24	)			19				112
Unrealized gains on trading securities			(245	)			(460	)			—
Unrealized losses on borrowings measured at fair value			641				66				—
Earnings on corporate owned life insurance policies			(616	)			(432	)			(404	)
Share-based payment awards under equity compensation plan			603				758				470
Deferred income tax (benefit) expense			(1,812	)			301				274
Net changes in operating assets and liabilities which provided (used) cash, net in 2008 and 2006 of bank acquisitions and of the 2008 joint venture formation:
Trading securities			8,513				53,235				—
Loans held for sale			1,316				520				(1,990	)
Accrued interest receivable			226				(183	)			(626	)
Other assets			(3,565	)			(4,667	)			(1,424	)
Escrow funds payable			(46	)			(504	)			(7,407	)
Accrued interest and other liabilities			(1,450	)			(171	)			(1,378	)
Net cash provided by (used in) operating activities			20,661				60,387				(1,789	)
Investing activities
Activity in available-for-sale securities
Maturities, calls, and sales			66,387				54,997				57,577
Purchases			(96,168	)			(132,115	)			(70,140	)
Loan principal originations, net			(42,700	)			(24,455	)			(44,805	)
Proceeds from sales of foreclosed assets			2,310				662				524
Purchases of premises and equipment			(2,990	)			(3,722	)			(2,467	)
Bank acquisition, net of cash acquired			(9,465	)			—				(2,713	)
Cash contributed to title company joint venture formation			(4,542	)			—				—
Purchase of corporate owned life insurance policies			(1,560	)			—				(499	)
Net cash used in investing activities			(88,728	)			(104,633	)			(62,523	)
Financing activities
Net (decrease) increase in deposits			(47,892	)			7,633				60,024
Net increase in other borrowed funds			123,016				34,365				6,138
Cash dividends paid on common stock			(4,873	)			(4,304	)			(3,775	)
Proceeds from issuance of common stock			2,476				2,657				2,459
Common stock repurchased			(6,440	)			(1,881	)			—
Common stock purchased for deferred compensation obligations			(249	)			—				—
Net cash provided by (used in) financing activities			66,038				38,470				64,846
(Decrease) increase in cash and cash equivalents			(2,029	)			(5,776	)			534
Cash and cash equivalents at beginning of year			25,583				31,359				30,825
Cash and cash equivalents at end of year		$	23,554			$	25,583			$	31,359
Supplemental cash flows information:
Interest paid		$	25,556			$	25,872			$	19,392
Federal income taxes paid			1,155				1,776				1,516
Transfer of loans to foreclosed assets			3,398				1,295				433

		December 31
		2010				2009
		(Dollars in thousands)
ASSETS
Cash and cash equivalents
Cash and demand deposits due from banks		$	16,978			$	17,342
Interest bearing balances due from banks			1,131				7,140
Total cash and cash equivalents			18,109				24,482
Certificates of deposit held in other financial institutions			15,808				5,380
Trading securities			5,837				13,563
Available-for-sale investment securities (amortized cost of $329,435 in 2010 and $258,585 in 2009)			330,724				259,066
Mortgage loansavailable-for-sale			1,182				2,281
Loans
Agricultural			71,446				64,845
Commercial			348,852				340,274
Installment			30,977				32,359
Residential real estate mortgage			284,029				285,838
Total loans			735,304				723,316
Less allowance for loan losses			12,373				12,979
Net loans			722,931				710,337
Premises and equipment			24,627				23,917
Corporate owned life insurance			17,466				16,782
Accrued interest receivable			5,456				5,832
Equity securities without readily determinable fair values			17,564				17,921
Goodwill and other intangible assets			47,091				47,429
Other assets			19,015				16,954
Total Assets		$	1,225,810			$	1,143,944
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing		$	104,902			$	96,875
NOW accounts			142,259				128,111
Certificates of deposit under $100 and other savings			425,981				389,644
Certificates of deposit over $100			204,197				188,022
Total deposits			877,339				802,652
Borrowed funds ($10,423 in 2010 and $17,804 in 2009 at fair value)			194,917				193,101
Accrued interest and other liabilities			8,393				7,388
Total liabilities			1,080,649				1,003,141
Shareholders’ equity
Common stock — no par value 15,000,000 shares authorized; issued and outstanding — 7,550,074 (including 32,686 shares to be issued) in 2010 and 7,535,193 (including 30,626 shares to be issued) in 2009			133,592				133,443
Shares to be issued for deferred compensation obligations			4,682				4,507
Retained earnings			8,596				4,972
Accumulated other comprehensive loss			(1,709	)			(2,119	)
Total shareholders’ equity			145,161				140,803
Total liabilities and shareholders’ equity		$	1,225,810			$	1,143,944

 

The accompanying notes are an integral part of these consolidated financial statements.

25

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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

 

										Shares to be
										Issued for
		Common Stock								Deferred								Accumulated Other
		Shares				Common				Compensation				Retained				Comprehensive
		Outstanding				Stock				Obligations				Earnings				Loss				Totals
		(Dollars in thousands except per share data)
Balance, January 1, 2008			6,364,120			$	112,547			$	3,772			$	7,027			$	(266	)		$	123,080
Cumulative effect to apply ASC Topic 715, net of tax			—				—				—				(1,571	)			—				(1,571	)
Comprehensive loss			—				—				—				4,101				(5,303	)			(1,202	)
Common stock dividends (10)%			687,599				30,256				—				(30,256	)			—				—
Regulatory capital transfer			—				(28,000	)			—				28,000				—				—
Bank acquisition			514,809				22,652				—				—				—				22,652
Issuance of common stock			73,660				2,476				—				—				—				2,476
Common stock issued for deferred compensation obligations			27,004				360				(360	)			—				—				—
Share-based payment awards under equity compensation plan			—				—				603				—				—				603
Common stock purchased for deferred compensation obligations			—				(249	)			—												(249	)
Common stock repurchased pursuant to publicly announced repurchase plan			(148,336	)			(6,440	)			—				—				—				(6,440	)
Cash dividends ($0.65 per share)			—				—				—				(4,873	)			—				(4,873	)
Balance, December 31, 2008			7,518,856				133,602				4,015				2,428				(5,569	)			134,476
Comprehensive income			—				—				—				7,800				3,450				11,250
Issuance of common stock			126,059				2,664				—				—				—				2,664
Common stock issued for deferred compensation obligations			12,890				331				(185	)			—				—				146
Share-based payment awards under equity compensation plan			—				—				677				—				—				677
Common stock purchased for deferred compensation obligations			—				(767	)			—												(767	)
Common stock repurchased pursuant to publicly announced repurchase plan			(122,612	)			(2,387	)							—				—				(2,387	)
Cash dividends ($0.70 per share)			—				—				—				(5,256	)			—				(5,256	)
Balance, December 31, 2009			7,535,193				133,443				4,507				4,972				(2,119	)			140,803
Comprehensive income			—				—				—				9,045				410				9,455
Issuance of common stock			124,953				2,683				—				—				—				2,683
Common stock issued for deferred compensation obligations			28,898				537				(475	)			—				—				62
Share-based payment awards under equity compensation plan			—				—				650				—				—				650
Common stock purchased for deferred compensation obligations			—				(514	)			—				—				—				(514	)
Common stock repurchased pursuant to publicly announced repurchase plan			(138,970	)			(2,557	)							—				—				(2,557	)
Cash dividends ($0.72 per share)			—				—				—				(5,421	)			—				(5,421	)
Balance, December 31, 2010			7,550,074			$	133,592			$	4,682			$	8,596			$	(1,709	)		$	145,161

The accompanying notes are an integral part of these consolidated financial statements.

26

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CONSOLIDATED STATEMENTS OF INCOME

		Year Ended December 31
		2010				2009				2008
		(Dollars in thousands
		except per share data)
Interest income
Loans, including fees		$	46,794			$	47,706			$	49,674
Investment securities
Taxable			5,271				4,712				5,433
Nontaxable			4,367				4,623				4,642
Trading account securities			306				687				1,093
Federal funds sold and other			479				377				543
Total interest income			57,217				58,105				61,385
Interest expense
Deposits			11,530				13,588				19,873
Borrowings			5,674				6,251				5,733
Total interest expense			17,204				19,839				25,606
Net interest income			40,013				38,266				35,779
Provision for loan losses			4,857				6,093				9,500
Net interest income after provision for loan losses			35,156				32,173				26,279
Noninterest income
Service charges and fees			6,480				6,913				6,370
Gain on sale of mortgage loans			610				886				249
Net (loss) gain on trading securities			(94	)			80				245
Net gain (loss) on borrowings measured at fair value			227				289				(641	)
Gain on sale ofavailable-for-sale investment securities			348				648				24
Other			1,729				1,340				1,555
Total noninterest income			9,300				10,156				7,802
Noninterest expenses
Compensation and benefits			18,552				18,258				16,992
Occupancy			2,351				2,170				2,035
Furniture and equipment			4,344				4,146				3,849
FDIC insurance premiums			1,254				1,730				313
Other			7,306				7,379				7,515
Total noninterest expenses			33,807				33,683				30,704
Income before federal income tax expense (benefit)			10,649				8,646				3,377
Federal income tax expense (benefit)			1,604				846				(724	)
Net income		$	9,045			$	7,800			$	4,101
Earnings per share
Basic		$	1.20			$	1.04			$	0.55
Diluted		$	1.17			$	1.01			$	0.53
Cash dividends per basic share		$	0.72			$	0.70			$	0.65

The accompanying notes are an integral part of these consolidated financial statements.

27

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

		Year Ended December 31
		2010				2009				2008
		(Dollars in thousands)
Net income		$	9,045			$	7,800			$	4,101
Unrealized holding gains (losses) onavailable-for-sale securities:
Unrealized gains (losses) arising during the year			1,156				3,415				(3,104	)
Reclassification adjustment for net realized gains
included in net income			(348	)			(648	)			(24	)
Net unrealized gains (losses)			808				2,767				(3,128	)
Tax effect			(351	)			436				(643	)
Unrealized gains (losses), net of tax			457				3,203				(3,771	)
(Increase) reduction of unrecognized pension costs			(72	)			374				(2,320	)
Tax effect			25				(127	)			788
Net unrealized (loss) gain on defined benefit pension plan			(47	)			247				(1,532	)
Other comprehensive income (loss), net of tax			410				3,450				(5,303	)
Comprehensive income (loss)		$	9,455			$	11,250			$	(1,202	)

The accompanying notes are an integral part of these consolidated financial statements.

28

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CONSOLIDATED STATEMENTS OF CASH FLOWS

		Year Ended December 31
		2010				2009				2008
		(Dollars in thousands)
		(Unaudited)
Operating activities
Net income		$	9,045			$	7,800			$	4,101
Reconciliation of net income to net cash provided by operations:
Provision for loan losses			4,857				6,093				9,500
Impairment of foreclosed assets			180				157				231
Depreciation			2,522				2,349				2,171
Amortization and impairment of originated mortgage servicing rights			543				683				346
Amortization of acquisition intangibles			338				375				415
Net amortization ofavailable-for-sale investment securities			1,153				741				356
Realized gain on sale ofavailable-for-sale investment securities			(348	)			(648	)			(24	)
Net unrealized losses (gains) on trading securities			94				(80	)			(245	)
Net gain on sale of mortgage loans			(610	)			(886	)			(249	)
Net unrealized (gains) losses on borrowings measured at fair value			(227	)			(289	)			641
Increase in cash value of corporate owned life insurance			(642	)			(641	)			(616	)
Realized gain on redemption of corporate owned life insurance			(21	)			—				—
Share-based payment awards under equity compensation plan			650				677				603
Deferred income tax expense (benefit)			179				(641	)			(1,812	)
Origination of loans held for sale			(72,106	)			(153,388	)			(33,353	)
Proceeds from loan sales			73,815				152,891				34,918
Net changes in operating assets and liabilities which provided (used) cash:
Trading securities			7,632				8,292				8,513
Accrued interest receivable			376				490				226
Other assets			(1,914	)			(6,331	)			(3,565	)
Accrued interest and other liabilities			1,005				581				(1,496	)
Net cash provided by operating activities			26,521				18,225				20,661
Investing activities
Net change in certificates of deposit held in other financial institutions			(10,428	)			(4,805	)			882
Activity inavailable-for-sale securities
Maturities, calls, and sales			85,273				130,580				66,387
Purchases			(156,928	)			(140,517	)			(96,168	)
Loan principal (originations) collections, net			(21,319	)			4,437				(42,700	)
Proceeds from sales of foreclosed assets			2,778				4,145				2,310
Purchases of premises and equipment			(3,232	)			(3,035	)			(2,990	)
Bank acquisition, net of cash acquired			—				—				(9,465	)
Cash contributed to title company joint venture formation			—				—				(4,542	)
Purchases of corporate owned life insurance			(175	)			—				(1,560	)
Proceeds from the redemption of corporate owned life insurance			154				11				—
Net cash used in investing activities			(103,877	)			(9,184	)			(87,846	)
Financing activities
Acceptances and withdrawals of deposits, net			74,687				27,022				(47,892	)
Advances (repayments) of borrowed funds			2,043				(28,960	)			123,016
Cash dividends paid on common stock			(5,421	)			(5,256	)			(4,873	)
Proceeds from issuance of common stock			2,208				2,479				2,476
Common stock repurchased			(2,020	)			(2,056	)			(6,440	)
Common stock purchased for deferred compensation obligations			(514	)			(767	)			(249	)
Net cash provided by (used in) financing activities			70,983				(7,538	)			66,038
(Decrease) increase in cash and cash equivalents			(6,373	)			1,503				(1,147	)
Cash and cash equivalents at beginning of year			24,482				22,979				24,126
Cash and cash equivalents at end of year		$	18,109			$	24,482			$	22,979
Supplemental cash flows information:
Interest paid		$	17,344			$	20,030			$	25,556
Federal income taxes paid			1,261				2,237				1,155
Supplemental noncash information:
Transfers of loans to foreclosed assets		$	3,868			$	2,536			$	3,398
Common stock issued for deferred compenstion obligations			475				185				360
Common stock repurchased from an associated grantor trust (Rabbi Trust)			(537	)			(331	)			(360	)

The accompanying notes are an integral part of these consolidated financial statements.

29

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share amounts)

 

Note 1 — Nature of Operations and Summary of Significant Accounting Policies

NOTE 1 —	Nature of Operations and Summary of Significant Accounting Policies

 

Basis of Presentation and Consolidation:

 

The consolidated financial statements include the accounts of Isabella Bank Corporation (the “Corporation”), a financial services holding company, and its wholly owned subsidiaries, Isabella Bank (the “Bank”), Financial Group Information Services, and IB&T Employee Leasing, LLC. All intercompany balances and accounts have been eliminated in consolidation.

 

Nature of Operations:

 

Isabella Bank Corporation is a financial services holding company offering a wide array of financial products and services in mid-Michigan.several mid-Michigan counties. Its banking subsidiary, Isabella Bank, offers banking services through 25 locations, 24 locations,24-hourhour banking services locally and nationally through shared automatic teller machines, 24-24 hour online banking, and direct deposits to businesses, institutions, and individuals. Lending services offered include commercial real estate loans, and lines of credit, agricultural loans, residential real estate loans, consumer loans, student loans, and credit cards. Deposit services include interest and noninterest bearing checking accounts, savings accounts, money market accounts, and certificates of deposit. Other related financial products include trust and investment services, safe deposit box rentals, and credit life insurance. Active competition, principally from other commercial banks, savings banks and credit unions, exists in all of the Bank’sCorporation’s principal markets. The Corporation’s results of operations can be significantly affected by changes in interest rates or changes in the local economic environment.

In April 2007, the Corporation consolidated the charters of FSB Bank and Isabella Bank. The consolidation into a single charter helped to further reduce operating expenses through the elimination of duplications in memberships, licensing, service contracts, compliance, computer platforms, and computer processing. The legal reorganization had no effect on the Corporation’s consolidated financial statements (See “Note 23 — Operating Segments”).

On January 1, 2008, the 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 the Bank (see Note 2 — “Business Combinations and 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 joint venture is accounted for as an equity investment. 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 (see Note 2 — “Business Combinations and Joint Venture Formation”).

 

Financial Group Information Services provides information technology services to Isabella Bank Corporation and its subsidiaries.

 

IB&T Employee Leasing provides payroll services, benefit administration, and other human resource services to Isabella Bank Corporation and its subsidiaries.

 

Use of Estimates:

 

In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting year. Actual results could differ from those estimates.

 

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the fair value of certainavailable-for-saleinvestment securities, the valuation of real estate

26

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

acquired in connection with foreclosures or in satisfaction of loans, valuation of goodwill and other intangible assets, and determinations of assumptions in accounting for the defined benefit pension plan, and other post-retirement liabilities.plan. In connection with the determination of the allowance for loan losses and the carrying value of foreclosed real estate, management obtains independent appraisals for significant properties.

Fair Value Measurements:

Fair value refers to the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants in the market in which the reporting entity transacts such sales or transfers based on the assumptions market participants would use when pricing an asset or liability. Assumptions are developed based on prioritizing information within a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, such as the reporting entity’s own data. The Corporation may choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value measurement option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with certain exceptions, allowing the Corporation to record identical financial assets and liabilities at fair value or by another

30

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

measurement basis permitted under generally accepted accounting principles, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments.

For assets and liabilities recorded at fair value, it is the Corporation’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements for those financial instruments for which there is an active market. In cases where the market for a financial asset or liability is not active, the Corporation includes appropriate risk adjustments that market participants would make for nonperformance and liquidity risks when developing fair value measurements. Fair value measurements for assets and liabilities for which limited or no observable market data exists are accordingly based primarily upon estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values.

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

Fair Value Hierarchy

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

Level 1:  Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2:  Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model based valuation techniques for which all significant assumptions are observable in the market.

Level 3:  Valuation is generated from model based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.

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

For a further discussion of fair value considerations, refer to Notes 19 to the consolidated financial statements.

 

Significant Group Concentrations of Credit Risk:

 

Most of the Corporation’s activities conducted are with customers located within the central Michigan area. A significant amount of its outstanding loans are secured by commercial and residential real estate or are made to finance agricultural production.estate. Other than these types of loans, there is no significant concentration to any other industry or any one customer.

 

Cash and Cash Equivalents:

 

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from banks, federal funds sold, and other deposit accounts, all of which have original maturity dates within ninety days.accounts. Generally, federal funds sold are for a one day

31

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

period. The Corporation maintains deposit accounts in various financial institutions which generally exceed federally insured limits or are not insured. Management does not believe the Company is exposed to any significant interest, credit or other financial risk as a result of these deposits.

Certificates of Deposit Held in Other Financial Institutions:

Certificates of deposits held in other financial institutions consist of interest bearing certificates of deposit that mature within 3 years and are carried at cost.

 

Trading Securities:

 

Effective January 1, 2007, in conjunction with the early adoption of the fair value option of SFAS No. 159 (see Note 20), theThe Corporation engages in trading activities forof its own account.accounts. Securities that are held principally for resale in the near term are recorded in the trading assets account at fair value with unrealized changes in fair value recorded in noninterest income. Interest and dividends areincome is included in net interest income.

 

Available-For-Sale Investment Securities:

 

All purchases of investment securities are generally classified asavailable-for-sale. However, classification of investment securities as either held to maturity or trading may be elected by management of the Corporation. Securities classified as “available-for-sale”, other than money market preferred securities,available-for-sale are recorded at fair value, with unrealized gains and losses, net of the effect of deferred income taxes, excluded from earnings and reported in other comprehensive income. Available — for-saleAuction rate money market preferred securities and preferred stocks are considered equity securities for federal income tax purposes, as such, no estimated federal income tax impact is expected or recorded. Auction rate money market preferred securities and preferred stock are recorded at fair value, with unrealized gains and losses, considered notother-than-temporary, excluded from earnings and reported in other comprehensive income.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines inRealized gains and losses on the fair valuesale ofavailable-for-sale investment securities below their cost that are deemed to be other than temporarydetermined using the specific identification method.

Investment securities are reflected in earnings as realized losses.reviewed quarterly for possibleother-than-temporary impairment (OTTI). In determining whether another-than-temporary impairment (OTTI) losses exist,exists for debt securities, management must assert that: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. If these conditions are not met, the Corporation must recognize another-than-temporary impairment charge through earnings for the difference between the debt security’s amortized cost basis and its fair value, and such amount is included in noninterest income. For debt securities that do not meet the above criteria, and the Corporation does not expect to recover the security’s amortized cost basis, the security is consideredother-than-temporarily impaired. For these debt securities, the Corporation separates the total impairment into the credit risk loss component and the amount of the loss related to market and other risk factors. In order to determine the amount of the credit loss for a debt security, the Corporation calculates the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows management expects to recover. The amount of the totalother-than-temporary impairment related to the credit risk is recognized in earnings and is included in noninterest income. The amount of the totalother-than-temporary impairment related to other risk factors is recognized as a component of other comprehensive income. For debt securities that have recognized another-than-temporary impairment through earnings, if through subsequent evaluation there is a significant increase in the cash flow expected, the difference between the amortized cost basis and the cash flows expected to be collected is accreted as interest income.

Available-for-sale equity securities are reviewed forother-than-temporary impairment at each reporting date. This evaluation considers (1)a number of factors including, but not limited to, the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-termnear term prospects of the issuer, and (3)management’s ability and intent to hold the positivesecurities until fair value recovers. If it is determined that management does not have the ability and intent to hold the securities until recovery or that there are conditions that indicate that a security may

32

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

not recover in value then the difference between the fair value and abilitythe cost of the Corporation to retain its investmentsecurity is recognized in the issuer for a period of time sufficient to allow for any anticipated recoveryearnings and is included in fair value (see Note 4). Realized gains andnoninterest income. No such losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.were recognized in 2010, 2009, or 2008.

 

Loans:

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balance adjusted for any charge offs,charge-offs, the allowance for loans losses, and any deferred fees or costs on originated loans. Interest income on loans is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the constant yield method.

 

The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Credit card loans and other personal loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

27

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

For loans that are placed on non-accrual status or charged-off,charged off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected is charged against the allowance for loan losses. The interest on these loans is accounted for on the cash-basis, or cost-recovery method, until qualifying for return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. For impaired loans not classified as nonaccrual, interest income continues to be accrued over the term of the loan based on the principal amount outstanding.

 

Allowance for Loan Losses:

 

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention.deemed to be impaired. For such loans that are also classified as impaired,analyzed for specific allowance allocations, an allowance is established when the discounted cash flows (oror collateral value or observable market price)price of the impaired loan is lower than the carrying value of that loan. The general component covers non-classifiednon classified loans and is based on historical loss experience. An unallocated component is maintained to cover uncertainties that management believes affect its estimate of probable losses based on qualitative factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

 

ALoans may be classified as impaired if they meet one or more of the following criteria:

1. There has been a chargeoff of its principal balance;

2. The loan has been classified as a troubled debt restructuring; or

3. The loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on anonaccrual status.

33

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case-by-caseNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued) basis, taking into consideration all of the circumstance surrounding the loan and the borrower, including the length of the delay, the reason for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan by loan basis for commercial and commercial real estate loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent.

 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment allocations and related disclosures.

 

Loans Held for Sale:

 

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value as determined by aggregating outstanding commitments from investors or current investor yield requirements. Net unrealized losses, if any, are recognized through a valuation allowance by charges toof which the provision is accounted for in other noninterest expenses in the consolidated statements of income.

 

Mortgage loans held for sale can beare sold with the mortgage servicing rights retained by the Bank or sold to the investor.Corporation. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold.

28

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Transfers of Financial Assets:

 

Transfers of financial assets, including sold mortgage loans and mortgage loans held for sale, mortgage loans, as described above, and participation loans are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is determined to be surrendered when 1) the assets have been legally isolated from the Bank,Corporation, 2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets and 3) the BankCorporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Other than servicing, as disclosed in Note 5, the Corporation has no substantive continuing involvement related to these loans. Servicing fee earned on such loans was $760, $724, and $627 for 2010, 2009, and 2008, respectively, and is included in other noninterest income.

 

Servicing:

 

Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. The Corporation has no purchased servicing rights. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.

 

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate, loan type, and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranche. If the Corporation later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the valuation allowance may be recorded as an increase to income. Capitalized servicing rights are reported in other assets and are amortized into non-interestnoninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

34

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Servicing fee income is recorded for fees earned for servicing loans for others. The fees are based on a contractual percentage of the outstanding principal; or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income, a component of noninterest income.

 

Loans Acquired Through Transfer:

 

American Institute of Certified Public Accountants’ Statement of Position (SOP)03-3Authoritative accounting guidance related to acquired loans requires that a valuation allowance for loans acquired in a transfer, including in a business combination, reflect only losses incurred after acquisition, and should not be recorded at acquisition. ItThis standard applies to any loan acquired in a transfer that shows evidence of credit quality deterioration since it was originated. The effect on results of operations and financial position of the Corporation’s acquisition of the allowance for loan losses carried over from Farwell State Savings Bank (“Farwell”) (see Note 2) was not material in 2006 due to the limited number of troubled loans held by Farwell. Included in the fair value adjustments of nonintangible net assets acquired from Greenville Community Financial Corporation (GCFC), was a reduction in the allowance for loan losses of $437. The $437 represented the identified impairments in GCFC’s loan portfolio as of December 31, 2007 (see Note 2).

 

Foreclosed Assets:

 

Assets acquired through, or in lieu, of loan foreclosure are held for sale and are initially recorded at the lower of the Bank’sCorporation’s carrying amount or fair value less estimated selling costs at the date of transfer, establishing a new cost basis. Any write-downswrite downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, property held for sale is carried at the lower of the new cost basis or fair value less costs to sell. Impairment losses on property to be held and used are measured at the amount by which the carrying amount of property exceeds its fair value. Costs relating to holding these assets are expensed as incurred. Valuations are

29

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

periodically performed by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the lower of the Bank’sCorporation’s carrying amount or fair value less costs to sell. Foreclosed assets of $2,923$2,067 and $1,376$1,157 are included in Other Assets on the accompanying consolidated balance sheets at December 31, 2008 and 2007, respectively.

Off-Balance-Sheet Credit Related Financial Instruments:

In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under credit card arrangements, home equity lines of credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded only when funded.sheets.

 

Premises and Equipment:

 

Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation. Depreciationdepreciation which is computed principally by the straight linestraight-line method based upon the estimated useful lives of the related assets, which range from 3 to 40 years. Major improvements are capitalized and appropriately amortized based upon the useful lives of the related assets which generally range from 5 to 30 years.or the expected terms of the leases, if shorter, using the straight-line method. Maintenance, repairs and minor alterations are charged to current operations as expenditures occuroccur. Management annually reviews these assets to determine whether carrying values have been impaired.

Fdic Insurance Premium:

In 2009, the Corporation was required to prepay quarterly FDIC risk-based assessments for the fourth quarter of 2009 and major improvements are capitalized.each of the quarters in the years ending December 31, 2010, 2011 and 2012. The assessments for 2010 through 2012, which had a carrying balance of $3,586 and $4,737 as of December 31, 2010 and 2009, respectively, have been recorded as a prepaid asset in the accompanying consolidated balance sheets in Other Assets, and will be expensed on a ratable basis quarterly through December 31, 2012.

 

Equity Securities Without Readily Determinable Fair Values:

 

Included in equity securities without readily determinable fair values are restricted securities, of $9,340 in 2008 and $6,253 in 2007. Restricted securities include stock of the Federal Reserve Bank and the Federal Home Loan Bank, which are carried at cost, and have no contractual maturity. Also includedinvestments in nonconsolidated entities accounted for under the equity method of accounting.

35

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Equity securities without readily determinable fair values consist of the following as of December 31, 2008 is the Corporation’s investment in CT/IBT Title Agency, LLC, which was $6,905 at that date (see Note 2 — “Business Combinations and Joint Venture Formation”).31:

		2010				2009
Federal Home Loan Bank Stock		$	7,596			$	7,960
Investment in Corporate Settlement Solutions			6,793				6,782
Federal Reserve Bank Stock			1,879				1,879
Investment in Valley Financial Corporation			1,000				1,000
Other			296				300
Total		$	17,564			$	17,921

 

Stock Compensation Plans:

 

In accordanceAt December 31, 2010, the Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors (the “Directors Plan”) had 224,663 shares to be issued to participants, for which an associated grantor trust (Rabbi Trust) held 32,686 shares. The Corporation had 216,905 shares to be issued in 2009, with Statement of Financial Accounting Standard (SFAS) No. 123(revised 2004),Share-Based Payment, compensation30,626 shares held in the Rabbi Trust. Compensation costs relating to share-basedshare based payment transactions are recognized in the consolidated financial statements and the cost is measured based on the fair value of the equity or liability instruments issued. SFAS No. 123(R) covers a wide range of share-basedThe Corporation has no other share based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Compensation expense is based on the fair value of the awards, which is generally the market price of the stock on the measurement date and is recognized ratably over the service period of the award, which is usually the vesting period.

SFAS 123(R) applies to new awards and awards modified, repurchased, or cancelled after January 1, 2006. Compensation cost related to the non-vested portion of the awards outstanding as of December 31, 2005 was based on the grant date fair value of those awards as calculated under the original provisions of SFAS No. 123; that is, the Corporation was not required to re-measure the grant date fair value estimate of the unvested portion of awards granted prior to the effective date of SFAS No. 123(R).

 

Corporate Owned Life Insurance:

 

The Corporation has purchased life insurance policies on key members of management. In the event of death of one of these individuals, the Corporation would receive a specified cash payment equal to the face value of the policy. Such policies are recorded at their cash surrender value, or the amount that can be realized on the balance sheet dates. Increases in cash surrender value in excess of single premiums paid are reported as other noninterest income.Other Noninterest Income.

 

Emerging Issues Task Force (“EITF”) IssueNo. 06-4,Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements,ratified byASC Topic 715 was amended to require that the FASB in September, 2006, requires that policyholdersCorporation recognize a liability for any postretirementpost retirement benefits provided through

30

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

by the Corporation’s program.Corporation, beginning January 1, 2008. As a result of the adoption of the new authoritative guidance, the Corporation recognized a liability of $1,571 as of January 1, 2008. As of December 31, 2008,2010 and 2009, the present value of the nature and amount of post retirement benefits promised by the Corporation to the covered employees iswas estimated to be $2,460.$2,573 and $2,505, respectively, and is included in Accrued Interest and Other Liabilities on the consolidated balance sheets. The periodic policy maintenance costs were $85$68 and $45 for 2008.2010 and 2009, respectively.

 

Acquisition Intangibles and Goodwill:

 

Isabella BankThe Corporation previously acquired branch facilities and related deposits in business combinations accounted for as a purchase. During October 2006, Isabella Bank Corporation acquired Farwell State Savings Bank (“Farwell”) resulting in identified core deposit intangibles and goodwill (see Note 2). On January 1, 2008, Isabella Bank acquired Greenville Community Financial Corporation (“GCFC”) resulting in identified core deposit intangibles and goodwill (see Note 2). The acquisition of the branchesacquisitions included amounts related to the valuation of customer deposit relationships (core deposit intangibles). Such core deposit intangibles are included in other assets and are being amortized on the straight line basis over nine years. Core deposit intangibles arising from the acquisition of Farwellacquisitions are included in Other Assets and are being amortized on a 10 year sum-of-year’s digits amortization schedule. Core deposit intangibles arising from the acquisition of GCFC are being amortized on a 15 year sum-of-year’s digits amortization schedule.over their estimated lives. Goodwill, which is included in otherOther Assets, represents the excess of purchase price over identifiable assets, and is not amortized but is evaluated for impairment at least annually, or on an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below the carrying value.

Off Balance Sheet Credit Related Financial Instruments:

In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under credit card arrangements, home equity lines of credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded only when funded.

36

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Federal Income Taxes:

 

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax assets or liability is determined based on the tax effects of the temporary differences between the book and tax bases on the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Valuations allowances are established, where necessary, to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the year plus or minus the change during the year in deferred tax assets and liabilities.

The Corporation analyzes its filing positions in the jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The Corporation has also elected to retain its existing accounting policy with respect to the treatment of interest and penalties attributable to income taxes, and continues to reflect any charges for such, to the extent they arise, as a component of its noninterest expenses

 

AdvertisingMarketing Costs:

 

AdvertisingMarketing costs are expensed as incurred (see Note 11)10).

 

Computation of Earnings Per Share:

 

Basic earnings per share represents income available to common stockholders divided by the weighted-averageweighted — average number of common shares issued during the period, which includes shares held in the Rabbi Trust controlled by the Corporation (see Note 17).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 planDirectors Plan (see Note 17)16).

 

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

 

		2008				2007				2006				2010				2009				2008
Average number of common shares issued*			7,492,677				6,973,508				6,269,465
Effect of shares in the Deferred Director fee plan*			184,473				197,055				181,280
Average number of common shares outstanding for basic calculation															7,541,676				7,517,276				7,492,677
Average potential effect of shares in the Deferred Director fee plan(1)															187,744				181,319				184,473
Average number of common shares outstanding used to calculate diluted earnings per common share			7,677,150				7,170,563				6,450,745				7,729,420				7,698,595				7,677,150
Net Income		$	4,101			$	7,930			$	7,001
Net income														$	9,045			$	7,800			$	4,101
Earnings per share
Basic		$	0.55			$	1.14			$	1.12			$	1.20			$	1.04			$	0.55
Diluted		$	0.53			$	1.11			$	1.09			$	1.17			$	1.01			$	0.53

 

 

*(1)		As adjusted forExclusive of shares held in the 10% stock dividend paid February 29, 2008Rabbi Trust

31

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Reclassifications:

 

Certain amounts reported in the 20072009 and 20062008 consolidated financial statements have been reclassified to conform with the 20082010 presentation.

 

Recent Accounting Pronouncements:

 

FASB ASC Topic 310, “Receivables.”In September of 2006, EITF IssueNo. 06-4,Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements,April 2010, ASC Topic 310 was ratifiedamended by the Financial Accounting Standards Board (“FASB”Update (ASU)No. 2010-18, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset — (a consensus of the FASB Emerging Issues Task”), to clarify that individual loans accounted for

37

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

within pools are not to be removed from the pool solely as a result of modifications to the loan (including troubled debt restructurings). The EITF reachednew guidance was effective for interim and annual periods ending on or after July 15, 2010 and did not have a consensussignificant impact on the Corporation’s consolidated financial statements.

In July 2010, ASC Topic 310 was amended by ASUNo. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”to provide financial statement users greater transparency about the Corporation’s allowance for loan losses and the credit quality of its financing receivables. Existing disclosures are amended that required the Corporation to provide the following disclosure about its loan portfolio on a disaggregated basis: (1) a rollforward schedule of the allowance for an endorsement split-dollar life insurance arrangementloan losses from the beginning of the reporting period to the end of a reporting period on a portfolio segment basis, with the ending balance further disaggregated on the basis of the impairment method, (2) for each disaggregated ending balance in item (1), the related recorded investment in loans, (3) the nonaccrual status of loans by class of loans, and (4) impaired loans by class of loans.

The amendments in this update required the Corporation to provide the following additional disclosures about its loans: (1) credit quality indicators of financing receivables at the end of the reporting period by class of loans, (2) the aging of past due loans at the end of the reporting period by class of loans, (3) the nature and extent of troubled debt restructurings that occurred during the period by class of loans and their effect on the allowance for loan losses, (4) the nature and extent of financing receivables modified within the scopeprevious 12 months that defaulted during the period by class 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 assetfinancing receivables and their effect on the consolidated balance sheets. These life insurance policies are generally subject to endorsement split-dollar life insurance arrangements. These arrangements were designed to provide a pre-and postretirement benefitallowance for senior officersloan losses and (5) significant purchases and sales of loans during the period disaggregated by portfolio segment. The new disclosures as of the Corporation.end of a reporting period were effective for interim and annual reporting periods ending on or after December 15, 2010, with the exception of the new disclosures related to troubled debt restructurings which are not required to be reported until the second quarter of 2011. The Corporation adopted EITF Issuenew disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The new guidance has significantly expanded the Corporation’s consolidated financial statement disclosures. (See Note 4)

FASB ASC Topic 350, “Intangibles — Goodwill and Other.” In December 2010, ASC Topic 350 was amended by ASUNo. 06-42010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force)”, to address questions related to the testing for goodwill impairments for entities with goodwill with zero or negative carrying amounts. The new guidance is effective for interim and annual periods beginning after December 15, 2010 and is not anticipated to have any impact on the Corporation’s consolidated financial statements.

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

FASB ASC Topic 805, “Business Combinations.” In December 2010, ASC Topic 805 was amended by ASUNo. 2010-29,“Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force”, to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The new guidance is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period on or after December 15, 2010 and is not anticipated to impact the Corporation’s consolidated financial statements.

FASB ASC Topic 810, “Consolidation.” New authoritative accounting guidance under ASC Topic 810 amends prior guidance to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other factors, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The new authoritative accounting guidance requires additional disclosures about the reporting entity’s involvement with

38

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

variable interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entity’s financial statements. The new authoritative accounting guidance under ASC Topic 810 was effective January 1, 20082010 and as a result recorded an initial liability of $2,375. To establish this liability,had no impact on the Corporation recorded a one time charge of $1,571, net of tax, directly to retained earnings at that date.Corporation’s consolidated financial statements.

 

On March 19, 2008,FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” In January 2010, ASC Topic 820 was amended by ASUNo. 2010-06, to add new disclosures for: (1) significant transfers in and out of Level 1 and Level 2 fair value measurements and the FASB issued Statementreasons for the transfers and (2) presenting separately information about purchases, sales, issuances and settlements for Level 3 fair value instruments (as opposed to reporting activity as net).

ASUNo. 2010-06 also clarifies existing disclosures by requiring reporting entities to provide fair value measurement disclosures for each class of Financial Accounting Standards No. 161 (SFAS No. 161)Disclosures about Derivative Instrumentsassets and Hedging Activities.The objective of SFAS No. 161 isliabilities and to enhanceprovide disclosures about an entity’s derivativethe valuation techniques and hedging activitiesinputs used to measure fair value for both recurring and thereby improve the transparency of financial reporting. SFAS No. 161 isnonrecurring fair value measurements.

The new authoritative guidance was effective for financial statements issued for fiscal yearsinterim and interimannual reporting periods beginning after November 15, 2008January 1, 2010 except for the disclosures about purchases, sales, issuances and settlements in the rollforward of activity in Level 3 fair value measurements, which will be effective January 1, 2011. The new guidance did not, and is not expectedanticipated to, have a significant impact on the Corporation’s consolidated financial statements.

 

In May 2008, the 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 isASC Topic 860, “Transfers and Servicing.” New authoritative accounting guidance under ASC Topic 860 amends prior accounting guidance to identify the sources of accounting principles and the framework for selecting the principles to be used in the preparationenhance reporting about transfers of financial statementsassets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. The new authoritative accounting guidance eliminates the concept of nongovernmental entities that are presented in conformitya “qualifying special purpose entity” and changes the requirements for derecognizing financial assets. The new authoritative accounting guidance also requires additional disclosures about all continuing involvements with generally acceptedtransferred financial assets including information about gains and losses resulting from transfers during the period. The new authoritative accounting principles (GAAP) in the United States (the GAAP hierarchy). SFAS No. 162 isguidance under ASC Topic 860 was 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 PrinciplesJanuary 1, 2010 and is not expected to have ahad no significant impact on the Corporation’s consolidated financial statements.

 

In October 2008, the FASB staff issued Staff PositionNo. 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, 2007, in cases where a market is not active. The Corporation has considered the guidance provided byFSP 157-3, which was effective on October 10, 2008, in its determination of estimated fair values as of December 31, 2008.

In December 2008 the FASB issued FSP No. 132(R)-1Employers’ Disclosures about Postretirement Benefit Plan Assets. FSP 132(R)-1 provides guidance related to an employer’s disclosures about plan assets of defined benefit pension or other post- retirement benefit plans. Under FSP 132(R)-1, disclosures should provide users of financial statements with an understanding of how investment allocation decisions are made, the factors that are pertinent to an understanding of investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets. The disclosures required by FSP 132(R)-1 will be included in the Corporation’s financial statements beginning with the financial statements for the year-ended December 31, 2009.

On January 12, 2009 EITF Issue99-20-1,Amendments to the Impairment Guidance of EIFT IssueNo. 99-20 Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to be Held by a Transferor in Securitized Financial Assets was ratified by the FASB. The FSP retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure

32

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

requirements in FASB Statement No. 115,Accounting for Certain Investments in Debt and Equity Securities,and other related guidance. EITF Issue99-20-1 is not expected to have a significant impact on the Corporation’s consolidated financial statements.

The FASB Issued EITFNo. 03-6-1,Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securitiesin June 2008. FSPEITF 03-6-1 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSPEITF 03-6-1 will be effective on January 1, 2009. All previously reported earnings per share data will be retrospectively adjusted to conform with the provisions of FSPEITF 03-6-1. FSPEITF 03-6-1 is not expected to have a significant impact on the Corporation’s consolidated financial statements.

Note 2 — Business Combinations and Joint Venture Formation

Farwell State Savings Bank

On October 3, 2006, Isabella Bank (the “Bank”) acquired 100 percent of Farwell State Savings Bank (Farwell). As a result of this acquisition, Farwell merged with and into the Bank. Under the terms of the merger agreement, each share of Farwell common stock was automatically converted into the right to receive 3.0382 shares of Isabella Bank Corporation common stock and $29.00 in cash. As a result of this acquisition, the Corporation issued 797,475 shares of Isabella Bank Corporation common stock valued at $30,448 and paid a total of $7,612 in cash to Farwell shareholders. Included in the purchase price was $382 of transaction costs. The total consideration exchanged including the value of the common stock issued, cash paid to shareholders, plus cash paid for transaction costs resulted in a total purchase cost of $38,442. The acquisition of Farwell has increased the overall market share for Isabella Bank Corporation in furtherance of the Bank’s strategic plan.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition.

						Fair Value
						Adjustments of
		Farwell				Nonintangible				Fair Value
		October 3,				Net Assets				of Net Assets
		2006				Acquired				Acquired
ASSETS
Cash and cash equivelants		$	5,281			$	—			$	5,281
Securities available for sale			17,166				—				17,166
Loans, net			63,874				(470	)			63,404
Bank premises and equipment			307				600				907
Other assets			2,416				15				2,431
Total assets acquired			89,044				145				89,189
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits			73,731				(393	)			73,338
Accrued interest and other liabilities			1,114				—				1,114
Total liabilities assumed			74,845				(393	)			74,452
Net assets acquired		$	14,199			$	538				14,737
Core deposit intangible											1,442
Goodwill											22,263
Total consideration paid										$	38,442

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The fair value adjustments are being amortized over two years using the straight line amortization method. The core deposit intangible is being amortized using a 10 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 consolidated statements of income include operating results of Farwell 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 Farwell. The information has been combined to present the results of operations as if the acquisition had occurred at the beginning of the periods 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 and have not been adjusted for the 10% stock dividend paid February 29, 2008:

		Year Ended
		December 31
		2006
Net interest income		$	27,499
Net income		$	8,023
Basic earnings per share		$	1.41

Greenville Community Financial Corporation

Effective 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 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.

34

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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
		Greenville				Nonintangible				Fair Value
		January 1,				Net Assets				of Net Assets
		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 consolidated statements of income include the operating results of GCFC for the entire year.

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:

		Year Ended December 31
		2007				2006
Net interest income		$	31,579			$	28,817
Net income		$	8,631			$	7,992
Basic earnings per share*		$	1.10			$	1.12

*NOTE 2 —		As adjusted for the 10% stock dividend paid February 29, 2008.Trading Securities

35

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Title Company 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 is 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, our share of the net income or loss from the joint venture will be included in other noninterest income. As of December 31, 2008, the Corporation had a recorded investment of $6,905 in the new entity, which is included in equity securities without readily determinable fair values. The following table summarizes the condensed 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, including intangibles of $1,590			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

The assets of the joint venture as of December 31, 2008 were $12,834. The total liabilities of the joint venture were $1,287 and the equity was $11,547 as of December 31, 2008. The Corporation’s share of the joint venture’s operating results for the ten-months ended December 31, 2008 was not significant.

Note 3 — Trading Securities

 

Trading securities, at fair value, consist of the following investments at December 31:

 

		2008				2007
Government-sponsored enterprises		$	4,014			$	4,024
States and political subdivisions			11,556				10,324
Corporate obligations			160				1,004
Mortgage-backed			6,045				9,712
Total trading securities		$	21,775			$	25,064

		2010				2009
States and political subdivisions		$	5,837			$	9,962
Mortgage-backed			—				3,601
Total		$	5,837			$	13,563

Included in the net trading losses of $94 during 2010, were $74 of net trading losses on securities that relate to the Corporation’s trading portfolio as of December 31, 2010. Included in net trading gains of $80 during 2009, were $38 of net trading gains on securities that relate to the Corporation’s trading portfolio as of December 31, 2009.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 4 — INVESTMENT SECURITIES

NOTE 3 —	Available-for-Sale Investment Securities

 

The amortized cost and fair value ofavailable-for-sale investment securities, available for sale, with gross unrealized gains and losses, are as follows as of December 31:

 

		2008
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Securities Available-for-Sale
U.S. Government and federal agencies		$	3,999			$	84			$	—			$	4,083
Government-sponsored enterprises			61,919				1,070				1				62,988
States and political subdivisions			148,186				1,808				671				149,323
Corporate			7,145				—				—				7,145
Money market preferred			11,000				—				5,021				5,979
Mortgage-backed			16,492				445				—				16,937
Total		$	248,741			$	3,407			$	5,693			$	246,455

		2010
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Government sponsored enterprises		$	5,394			$	10			$	—			$	5,404
States and political subdivisions			167,328				3,349				960				169,717
Auction rate money market preferred			3,200				—				335				2,865
Preferred stocks			7,800				—				864				6,936
Mortgage-backed			101,096				1,633				514				102,215
Collateralized mortgage obligations			44,617				103				1,133				43,587
Total		$	329,435			$	5,095			$	3,806			$	330,724

 

		2007
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Securities Available-for-Sale
U.S. Government and federal agencies		$	3,983			$	75			$	—			$	4,058
Government-sponsored enterprises			49,631				556				6				50,181
States and political subdivisions			130,772				611				427				130,956
Corporate			12,000				—				—				12,000
Money market preferred			12,300				—				—				12,300
Mortgage-backed			3,599				33				—				3,632
Total		$	212,285			$	1,275			$	433			$	213,127

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

 

The Corporation had pledged investmentsavailable-for-sale and trading securities in the following amounts as of December 31:

 

		2008				2007				2010				2009
Pledged for public deposits and for other purposes necessary or requried by law		$	18,000			$	26,289
Pledged to secure borrowed funds										$	86,788			$	41,612
Pledged to secure repurchase agreements			64,876				16,072				86,381				74,605
Pledged for public deposits and for other purposes necessary or required by law											14,626				20,054
Total		$	82,876			$	42,361			$	187,795			$	136,271

While borrowed funds increased $1,816 since December 31, 2009, the Corporation increased the level of securities pledged to secure other borrowed funds and repurchase agreements by $51,524 in the same period. The additional pledging has enhanced the Corporation’s liquidity position as it allows for an increased availability of borrowed funds.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The amortized cost and fair value ofavailable-for-sale securities by contractual maturity at December 31, 20082010 are as follows:

 

		Available for Sale
		Amortized				Fair
		Cost				Value
Within 1 year		$	32,057			$	27,163
Over 1 year through 5 years			73,531				74,888
After 5 years through 10 years			79,159				80,158
Over 10 years			47,502				47,309
			232,249				229,518
Mortgage-backed securities			16,492				16,937
		$	248,741			$	246,455

		Maturing																Securities
						After One				After Five								With
		Due in				Year But				Years But								Variable
		One Year				Within				Within				After				Monthly
		or Less				Five Years				Ten Years				Ten Years				Payments				Total
Government sponsored enterprises		$	—			$	5,000			$	394			$	—			$	—			$	5,394
States and political subdivisions			14,061				33,702				85,757				33,808				—				167,328
Auction rate money market preferred			—				—				—				—				3,200				3,200
Preferred stocks			—				—				—				—				7,800				7,800
Mortgage-backed			—				—				—				—				101,096				101,096
Collateralized mortgage obligations			—				—				—				—				44,617				44,617
Total amortized cost		$	14,061			$	38,702			$	86,151			$	33,808			$	156,713			$	329,435
Fair value		$	14,132			$	39,844			$	87,660			$	43,286			$	145,802			$	330,724

 

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

 

Because of their variable monthly payments, auction rate money market preferreds, preferred stocks, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group.

 

A summary of the activity related to the sale ofavailable-for-sale debt securities is as follows during the years ended December 31:

 

		2008				2007				2006				2010				2009				2008
Proceeds from sales of securities		$	6,096			$	5,396			$	15,257			$	18,303			$	32,204			$	6,096
Gross realized gains		$	24			$	12			$	—			$	351			$	648			$	24
Gross realized losses			—				(31	)			(112	)			(3	)			—				—
Net realized gains (losses)		$	24			$	(19	)		$	(112	)
Net realized gains														$	348			$	648			$	24
Applicable income tax (expense) benefit		$	(8	)		$	6			$	38
Applicable income tax expense														$	118			$	220			$	8

The cost basis used to determine the realized gains or losses of securities sold was the amortized cost of the individual investment security as of the trade date.

41

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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

 

		December 31, 2008
		Less Than Twelve Months								Over Twelve Months
		Gross								Gross								Total
		Unrealized				Fair				Unrealized				Fair				Unrealized
		Losses				Value				Losses				Value				Losses
Securities Available-for-Sale
Government-sponsored enterprises		$	1			$	999			$	—			$	—			$	1
States and political subdivisions			620				27,015				51				2,705				671
Money market preferred			5,021				5,979				—				—				5,021
Total securities available-for-sale		$	5,642			$	33,993			$	51			$	2,705			$	5,693

		December 31, 2010
		Less Than Twelve Months								Over Twelve Months
		Gross								Gross								Total
		Unrealized				Fair				Unrealized				Fair				Unrealized
		Losses				Value				Losses				Value				Losses
States and political subdivisions		$	960			$	29,409			$	—			$	—			$	960
Auction rate money market preferred			—				—				335				2,865				335
Preferred stock			—				—				864				2,936				864
Mortgage-backed			514				38,734				—				—				514
Collateralized mortgage obligations			1,133				33,880				—				—				1,133
Total		$	2,607			$	102,023			$	1,199			$	5,801			$	3,806
Number of securities in an unrealized loss position:							82								4				86

 

38

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

		December 31, 2007
		Less Than Twelve Months								Over Twelve Months
		Gross								Gross								Total
		Unrealized				Fair				Unrealized				Fair				Unrealized
		Losses				Value				Losses				Value				Losses
Securities Available-for-Sale
Government-sponsored enterprises		$	6			$	994			$	—			$	—			$	6
States and political subdivisions			276				32,309				151				17,065				427
Total securities available-for-sale		$	282			$	33,303			$	151			$	17,065			$	433

		December 31, 2009
		Less Than Twelve Months								Over Twelve Months
		Gross								Gross								Total
		Unrealized				Fair				Unrealized				Fair				Unrealized
		Losses				Value				Losses				Value				Losses
Government sponsored enterprises		$	42			$	7,960			$	—			$	—			$	42
States and political subdivisions			2,536				11,459				54				2,267				2,590
Auction rate money market preferred			—				—				227				2,973				227
Preferred stocks			—				—				746				3,054				746
Mortgage-backed			119				25,395				—				—				119
Collateralized mortgage obligations			192				10,104				—				—				192
Total		$	2,889			$	54,918			$	1,027			$	8,294			$	3,916
Number of securities in an unrealized loss position:							39								8				47

 

The unrealized losses in the Corporation’s municipal bond portfolio are largely due to the downgrading of the two largest bond insurers from AAA to AA in June 2008. These downgrades caused the market to demand higher returns on insured bonds, which has resulted in declines in the value of the Corporation’s municipal bond portfolio, as the majority of the portfolio is insured. Despite the significant declines in interest rates observed during the fourth quarter of 2008, the municipal bond portfolio has struggled to increase in value.

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

 

Due to the current illiquiditylimited trading activity of these securities, the fair values were estimated utilizing a discounted cash flow analysis or other type of valuation adjustment methodology as of December 31, 2008.2010 and December 31, 2009. These analyses consider, among other factors, the collateral underlying the security investments, theconsidered creditworthiness of the counterparty, the timing of expected future cash flows, estimatesand the current volume of trading activity. As of December 31, 2010, the Corporation held an auction rate money market preferred security and preferred stock which declined in fair value as a result of the next timesecurities interest rates, they are currently lower than the security is expected to have a successful auction, and the Corporation’s positive intent and ability to hold such securities until credit markets improve. These securities were also compared, when possible, to otheroffering rates of securities with similar characteristics. Despite the limited trading of these securities, management has determined that any declines in the fair value of these securities are the result of changes in interest rates and not risks related to the underlying credit quality of the security. Additionally, none of these securities are deemed to be below investment grade, and management does not intend to sell the securities in an unrealized loss position, and it is more likely than not that the Corporation will not have to sell the securities before recovery of their cost basis. As a result, the Corporation has not recognized another-than-temporary impairment related to these declines in fair value.

42

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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

 

	•	Has the value of the investment declined more than 20%what is deemed to be reasonable 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?
	•	DoesIs it more likely than not that the Corporation will not have the ability and positive intent to holdsell the security until maturity?before recovery of its cost basis?
	•	Has the duration of the investment been extended by more than 7 years?extended?

 

Based on the Corporation’s analysis using the above criteria, and the fact that management has asserted that it does not have the intent to sell these securities in an unrealized loss position, and that it is more likely than not the Corporation haswill not have to sell the positive intent and ability to hold debt securities for the reasonably foreseeable future,before recovery of their cost basis, management does not believe that the values of these or any other securities areother-than-temporarily impaired as of December 31, 20082010 or 2007.

39

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)2009.

 

Note 5 — Loans

NOTE 4 —	Loans and Allowance for Loan Losses

 

The BankCorporation grants commercial, agricultural, consumer and residential loans to customers situated primarily in Isabella, Gratiot, Mecosta, Southwestern Midland, Western Saginaw, Montcalm and Southern Clare counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, light manufacturing, retail, gaming and tourism, higher education, and general economic conditions of this region. Substantially all of the consumer and residential mortgage loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees; a portion of loans are unsecured.

 

A summary of the major classifications of loans is as follows:follows as of December 31:

 

		December 31
		2008				2007				2010				2009
Mortgage loans on real estate
Residential 1-4 family		$	231,705			$	227,304			$	207,749			$	207,560
Commercial			200,398				158,982				239,810				224,176
Agricultural			31,656				19,951				44,246				38,236
Construction and land development			16,571				15,060				12,250				13,268
Second mortgages			46,103				36,393				26,712				34,255
Equity lines of credit			25,018				19,180				37,318				30,755
Total mortgage loans			551,451				476,870				568,085				548,250
Commercial and agricultural loans
Commercial			124,408				79,324				109,042				116,098
Agricultural production			26,347				27,456				27,200				26,609
Total commercial and agricultural loans			150,755				106,780				136,242				142,707
Consumer installment loans			33,179				29,037				30,977				32,359
Total loans			735,385				612,687				735,304				723,316
Less: allowance for loan losses			11,982				7,301				12,373				12,979
Loans, net		$	723,403			$	605,386
Net loans										$	722,931			$	710,337

43

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

A summary of changes in the allowance for loan losses by loan segments follows:

 

		Year Ended December 31
		2008				2007				2006
Balance at beginning of year		$	7,301			$	7,605			$	6,899
Allowance of acquired bank			822				—				726
Loans charged off			(6,325	)			(2,146	)			(1,149	)
Recoveries			684				631				447
Provision charged to income			9,500				1,211				682
Balance at end of year		$	11,982			$	7,301			$	7,605

Allowance for Credit Losses and Recorded Investment in Financing Receivables
For the Year Ended December 31, 2010

										Residential
		Commercial				Agricultural				Real Estate				Consumer				Unallocated				Total
Allowance for loan losses
January 1, 2010		$	5,531			$	731			$	3,590			$	626			$	2,501			$	12,979
Loans charged off			(3,731	)			—				(2,524	)			(596	)			—				(6,851	)
Recoveries			452				1				638				297				—				1,388
Provision for loan losses			3,796				301				1,494				278				(1,012	)			4,857
December 31, 2010		$	6,048			$	1,033			$	3,198			$	605			$	1,489			$	12,373
Allowance for loan losses as of December 31, 2010
Individually evaluated for impairment		$	490			$	558			$	732			$	—			$	—			$	1,780
Collectively evaluated for impairment			5,558				475				2,466				605				1,489				10,593
Total		$	6,048			$	1,033			$	3,198			$	605			$	1,489			$	12,373
Loans as of December 31, 2010
Individually evaluated for impairment		$	4,890			$	2,629			$	4,866			$	—							$	12,385
Collectively evaluated for impairment			343,962				68,817				279,163				30,977								722,919
Total		$	348,852			$	71,446			$	284,029			$	30,977							$	735,304

Following is a summary of changes in the allowance for loan losses for the years ended December 31:

		2009				2008
Balance at beginning of year		$	11,982			$	7,301
Allowance of acquired bank			—				822
Loans charged off			(6,642	)			(6,325	)
Recoveries			1,546				684
Provision charged to income			6,093				9,500
Balance at end of year		$	12,979			$	11,982

The primary factors behind the determination of the level of the allowance for loan losses (ALLL) are specific allocations for impaired loans, historical loss percentages, as well as current economic conditions. Specific allocations for impaired loans are primarily determined based on the difference between the net realizable value of the loan’s underlying collateral or the net present value of the projected payment stream and its recorded investment. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio over the preceding three years.

Commercial loans include loans for commercial real estate, farmland and agricultural production, state and political subdivisions, and commercial operating loans. The largest concentration of commercial loans is

4044

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

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

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

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

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

45

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Credit Quality Indicators
As of December 31, 2010

Commercial and Agricultural Credit Exposure

Credit Risk Profile by Internally Assigned Credit Rating

		Commercial												Agricultural
		Real Estate				Other				Total				Real Estate				Other				Total
Rating
2 — High quality		$	10,995			$	13,525			$	24,520			$	3,792			$	1,134			$	4,926
3 — High satisfactory			74,912				30,322				105,234				11,247				3,235				14,482
4 — Low satisfactory			119,912				57,403				177,315				22,384				14,862				37,246
5 — Special mention			19,560				6,507				26,067				4,169				3,356				7,525
6 — Substandard			10,234				1,104				11,338				2,654				4,613				7,267
7 — Vulnerable			3,339				54				3,393				—				—				—
8 — Doubtful			858				127				985				—				—				—
Total		$	239,810			$	109,042			$	348,852			$	44,246			$	27,200			$	71,446

Internally assigned risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned risk ratings for commercial and agricultural loans are as follows:

1.	EXCELLENT — Substantially Risk Free

Loans to borrowers with a strong financial condition and solid earnings history, characterized by:

	•	High liquidity, strong cash flow, low leverage.
	•	Unquestioned ability to meet all obligations when due.
	•	Experienced management, with management succession in place.
	•	Secured by cash.

2.	HIGH QUALITY — Limited Risk

Loans to borrowers with a sound financial condition and positive trend in earnings supplemented by:

	•	Favorable liquidity and leverage ratios.
	•	Ability to meet all obligations when due.
	•	Management with successful track record.
	•	Steady and satisfactory earnings history.
	•	If loan is secured, collateral is of high quality and readily marketable.
	•	Access to alternative financing.
	•	Well defined primary and secondary source of repayment.
	•	If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.

46

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

3.	HIGH SATISFACTORY — Reasonable Risk

Loans to borrowers with a satisfactory financial condition and further characterized by:

	•	Working capital adequate to support operations.
	•	Cash flow sufficient to pay debts as scheduled.
	•	Management experience and depth appear favorable.
	•	Loan performing according to terms.
	•	If loan is secured, collateral is acceptable and loan is fully protected.

4.	LOW SATISFACTORY — Acceptable Risk

Loans to borrowers which are considered Bankable risks, although some signs of weaknesses are shown:

	•	Would include moststart-up businesses.
	•	Occasional instances of trade slowness or repayment delinquency — may have been10-30 days slow within the past year.
	•	Management abilities apparent yet unproven.
	•	Weakness in primary source of repayment with adequate secondary source of repayment.
	•	Loan structure generally in accordance with policy.
	•	If secured, loan collateral coverage is marginal.
	•	Adequate cash flow to service debt, but coverage is low.

To be classified as less than satisfactory, only one of the following criteria must be met.

5.	SPECIAL MENTION- Criticized

These borrowers constitute an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan:

	•	Downward trend in sales, profit levels and margins.
	•	Impaired working capital position.
	•	Cash flow is strained in order to meet debt repayment.
	•	Loan delinquency(30-60 days) and overdrafts may occur.
	•	Shrinking equity cushion.
	•	Diminishing primary source of repayment and questionable secondary source.
	•	Management abilities are questionable.
	•	Weak industry conditions.
	•	Litigation pending against the borrower.
	•	Loan may need to be restructured to improve collateral position or reduce payments.
	•	Collateral / guaranty offers limited protection.
	•	Negative debt service coverage however well collateralized and payments current.

47

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

6.	SUBSTANDARD — Classified

A substandard loan is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged. There is a distinct possibility that the Corporation will implement collection procedures if the loan deficiencies are not corrected. In addition, the following characteristics may apply:

	•	Sustained losses have severely eroded the equity and cash flow.
	•	Deteriorating liquidity.
	•	Serious management problems or internal fraud.
	•	Original repayment terms liberalized.
	•	Likelihood of bankruptcy.
	•	Inability to access other funding sources.
	•	Reliance on secondary source of repayment.
	•	Litigation filed against borrower.
	•	Collateral provides little or no value.
	•	Requires excessive attention of the loan officer.
	•	Borrower is uncooperative with loan officer.

7.	VULNERABLE — Classified

This classification includes substandard loans that warrant placing on nonaccrual. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply:

	•	Insufficient cash flow to service debt.
	•	Minimal or no payments being received.
	•	Limited options available to avoid the collection process.
	•	Transition status, expect action will take place to collect loan without immediate progress being made.

8.	DOUBTFUL — Workout

A doubtful loan has all the weaknesses inherent in a substandard loan with the added characteristic that collectionand/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply:

	•	Normal operations are severely diminished or have ceased.
	•	Seriously impaired cash flow.
	•	Original repayment terms materially altered.
	•	Secondary source of repayment is inadequate.
	•	Survivability as a “going concern” is impossible.
	•	Collection process has begun.
	•	Bankruptcy petition has been filed.
	•	Judgments have been filed
	•	Portion of the loan balance has been charged-off.

48

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

9.	LOSS — Charge off

Loans classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification is for charged off loans but does not mean that the asset has absolutely no recovery or salvage value. These loans are further characterized by:

	•	Liquidation or reorganization under Bankruptcy, with poor prospects of collection.
	•	Fraudulently overstated assetsand/or earnings.
	•	Collateral has marginal or no value.
	•	Debtor cannot be located.
	•	Over 120 days delinquent.

The Corporation’s primary credit quality indicators for residential real estate and consumer loans is the individual loan’s past due aging.

Age Analysis of Past Due Loans
As of December 31, 2010

		Accruing Interest												Total
		and Past Due:												Past Due
		30-89				90 Days								and
		Days				or More				Nonaccrual				Nonaccrual				Current				Total
Commercial
Commercial real estate		$	4,814			$	125			$	4,001			$	8,940			$	230,870			$	239,810
Commercial other			381				—				139				520				108,522				109,042
Total commercial			5,195				125				4,140				9,460				339,392				348,852
Agricultural
Agricultural real estate			92				—				—				92				44,154				44,246
Agricultural other			4				50				—				54				27,146				27,200
Total agricultural			96				50				—				146				71,300				71,446
Residential mortgage
Senior liens			5,265				310				1,421				6,996				213,003				219,999
Junior liens			476				—				49				525				26,187				26,712
Home equity lines of credit			598				—				—				598				36,720				37,318
Total residential mortgage			6,339				310				1,470				8,119				275,910				284,029
Consumer
Secured			298				—				—				298				24,781				25,079
Unsecured			10				1				—				11				5,887				5,898
Total consumer			308				1				—				309				30,668				30,977
Total		$	11,938			$	486			$	5,610			$	18,034			$	717,270			$	735,304
																		��
December 31, 2009		$	10,305			$	768			$	8,522			$	19,595			$	703,721			$	723,316
December 31, 2008		$	14,906			$	1,251			$	11,175			$	27,332			$	708,053			$	735,385

49

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following is a summary of information pertaining to impaired loans atas of, and for the year, ended December 31, 2010:

		December 31, 2010												2010 Year to Date
						Unpaid								Average				Interest
		Outstanding				Principal				Valuation				Outstanding				Income
		Balance				Balance				Allowance				Balance				Recognized
Impaired loans with a valuation allowance
Commercial real estate		$	3,010			$	4,110			$	472			$	2,482			$	90
Commercial other			18				18				18				259				1
Agricultural other			2,196				2,196				558				1,098				143
Residential mortgage senior liens			4,292				5,236				698				5,045				187
Residential mortgage junior liens			172				250				34				205				7
Consumer			—				—				—				12				—
Total impaired loans with a valuation allowance		$	9,688			$	11,810			$	1,780			$	9,101			$	428
Impaired loans without a valuation allowance
Commercial real estate		$	1,742			$	2,669							$	2,738			$	147
Commercial other			169				269								145				20
Agricultural real estate			—				—								106				—
Residential mortgage senior liens			401				501								201				26
Home equity lines of credit			—				—								8				—
Consumer secured			48				85								55				5
Total impaired loans without a valuation allowance		$	2,360			$	3,524							$	3,253			$	198
Impaired loans
Commercial		$	4,939			$	7,066			$	490			$	5,624			$	258
Agricultural			2,196				2,196				558				1,204				143
Residential mortgage			4,865				5,987				732				5,459				220
Consumer			48				85				—				67				5
Total impaired loans		$	12,048			$	15,334			$	1,780			$	12,354			$	626

The following is a summary of information pertaining to impaired loans as of, and for the years ended, December 31:

 

		2008				2007
Impaired loans with a valuation allowance		$	9,603			$	3,779
Impaired loans without a valuation allowance		$	411			$	—
Total impaired loans accruing interest		$	2,796			$	1,292
Valuation allowance related to impaired loans		$	2,065			$	703
Total nonaccrual loans		$	11,175			$	4,156
Accruing loans past due 90 days or more		$	1,251			$	1,727
Average investment in impaired loans		$	6,636			$	3,768
Total restructured loans		$	4,550			$	685

		2009				2008
Impaired loans with a valuation allowance		$	3,757			$	7,378
Impaired loans without a valuation allowance			8,897				6,465
Total impaired loans		$	12,654			$	13,843
Valuation allowance related to impaired loans		$	612			$	1,413
Year to date average outstanding balance of impaired loans		$	13,249			$	9,342
Year to date interest income recognized on impaired loans		$	340			$	171

50

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following is a summary of restructured loans as of December 31:

		2010				2009				2008
Total restructured loans			5,763			$	4,977			$	4,550

 

Interest income recognized on impaired loans was not significant during any of the three years ended December 31, 2008. No additional funds are committed to be advanced in connection with impaired loans, which includes restructured loans.

 

Note 6 — ServicingInterest income is recognized on impaired loans in nonaccrual status on the cash basis, but only after all principal has been collected. For impaired loans not in nonaccrual status, interest income is recognized daily as it’s earned according to the terms of the loan agreement.

NOTE 5 —	Servicing

 

Residential mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balancesbalance of mortgages serviced for others was $254,495, $255,839,$309,882 and $255,577$307,656 at December 31, 2008, 2007,2010 and 2006 respectively; such loans are not included in the accompanying consolidated balance sheets.2009, respectively. The fair value of servicing rights was determined using a discount rate of 8.1%rates ranging from 7.50% to 9.00%, prepayment speeds ranging from 6.0%6.00% to 25.8%48.72%, depending upon the stratification of the specific right and a weighted average default rate of 0.0%0.4%. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and taxing authorities, and foreclosure processing.

 

The following table summarizes the changes in each year of the carrying value and changes therein of mortgage servicing rights included in other assetsOther Assets as of December 31:

 

		2008				2007				2006				2010				2009				2008
Balance at beginning of year		$	2,198			$	2,155			$	2,125			$	2,620			$	2,105			$	2,198
Mortgage servicing rights capitalized			3,079				2,869				2,655				4,445				4,370				3,079
Accumulated amortization			(3,016	)			(2,785	)			(2,589	)			(4,250	)			(3,706	)			(3,016	)
Impairment valuation allowance			(156	)			(41	)			(36	)			(148	)			(149	)			(156	)
Balance at end of year		$	2,105			$	2,198			$	2,155			$	2,667			$	2,620			$	2,105
Impairment losses recognized		$	115			$	5			$	24
Impairment losses (reversed) recognized														$	(1	)		$	(7	)		$	115

 

Note 7 — PremisesThe Corporation recorded servicing fee revenue of $760, $724, and Equipment$627 related to residential mortgage loans serviced for others during the years ended December 31, 2010, 2009, and 2008, respectively.

NOTE 6 —	Premises and Equipment

 

A summary of premises and equipment at December 31 follows:

 

		2008				2007				2010				2009
Land		$	4,665			$	3,997			$	4,694			$	4,614
Buildings and improvements			18,653				16,067				21,502				20,478
Furniture and equipment			23,043				23,226				25,822				24,284
Total			46,361				43,290				52,018				49,376
Less: Accumulated depreciation			23,130				20,774
Less: accumulated depreciation											27,391				25,459
Premises and equipment, net		$	23,231			$	22,516			$	24,627			$	23,917

 

Depreciation expense amounted to $2,522, $2,349 and $2,171 $1,960in 2010, 2009, and $1,852 in 2008, 2007, and 2006, respectively.

4151

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 8��— Goodwill and Other Intangible Assets

NOTE 7 —	Goodwill and Other Intangible Assets

 

The change in the carrying amount of goodwill for the year is as follows:

		2008				2007
Balance January 1		$	25,889			$	25,889
Goodwill identified in GCFC acquisition (See Note 2)			21,319				—
Reclassificaiton for goodwill contributed to CT/IBT Title Agency, LLC joint venture (See Note 2)			(1,590	)			—
Balance at December 31		$	45,618			$	25,889

was $45,618 at December 31, 2010 and 2009.

 

Identifiable intangible assets at year end were as follows:

 

		2008
		Gross								Net
		Intangible				Accumulated				Intangible
		Assets				Amortization				Assets
Amortizable intangible assets:
Core deposit premium resulting from the Greenville acquisition in 2008		$	1,480			$	185			$	1,295
Core deposit premium resulting from the Farwell acquisition in 2006			1,442				551				891
Core deposit premium resulting from previous acquisitions			2,451				2,451				—
Total		$	5,373			$	3,187			$	2,186

		2010
		Gross								Net		��
		Intangible				Accumulated				Intangible
		Assets				Amortization				Assets
Core deposit premium resulting from acquisitions			5,373				3,900				1,473
Total		$	5,373			$	3,900			$	1,473

 

		2007
		Gross								Net
		Intangible				Accumulated				Intangible
		Assets				Amortization				Assets
Amortizable intangible assets:
Core deposit premium resulting from the Farwell acquisition in 2006		$	1,442			$	321			$	1,121
Core deposit premium resulting from previous acquisitions			2,451				2,451				—
Total		$	3,893			$	2,772			$	1,121

		2009
		Gross								Net
		Intangible				Accumulated				Intangible
		Assets				Amortization				Assets
Core deposit premium resulting from acquisitions			5,373				3,562				1,811
Total		$	5,373			$	3,562			$	1,811

 

Amortization expense associated with identifiable intangible assets was $338, $375, and $415 $278,in 2010, 2009, and $160 in 2008, 2007, and 2006, respectively.

 

Estimated amortization expense associated with identifiable intangibles for each of the next five years succeeding December 31, 2010, and thereafter is as follows:

 

Year		Amount				Amount
2009		$	376
2010			337
2011			299			$	299
2012			261				260
2013			221				221
2014							183
2015							145
Thereafter			692				365
		$	2,186			$	1,473

42

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 9 — Deposits

NOTE 8 —	Deposits

 

Scheduled maturities of time deposits for the next five years, succeeding December 31, 2008and thereafter, are as follows:

 

Year		Amount				Amount
2009		$	240,339
2010			63,464
2011			29,771			$	216,927
2012			21,565				113,999
2013			24,860				44,269
2014							31,414
2015							39,474
Thereafter			1,589				6,278
		$	381,588			$	452,361

 

Interest expense on time deposits greater than $100 was $4,427 in 2010, $5,246 in 2009, and $6,525 in 2008, $6,649 in 2007, and $5,195 in 2006.2008.

52

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 10 — Borrowed Funds

NOTE 9 —	Borrowed Funds

 

Borrowed funds consist of the following obligations at December 31:

 

		2008				2007
Federal Home Loan Bank advances		$	150,220			$	66,023
Federal Funds purchased			9,700				15,883
Securities sold under agreements to repurchase without stated maturity dates			42,430				981
Securities sold under agreements to repurchase with stated maturity dates			20,000				10,000
		$	222,350			$	92,887

		2010								2009
		Amount				Rate				Amount				Rate
Federal Home Loan Bank advances		$	113,423				3.64	%		$	127,804				4.11	%
Securities sold under agreements to repurchase
without stated maturity dates			45,871				0.25	%			37,797				0.30	%
Securities sold under agreements to repurchase
with stated maturity dates			19,623				3.01	%			20,000				3.72	%
Federal funds purchased			16,000				0.60	%			—				—
Federal Reserve Bank discount window advance			—				—				7,500				0.75	%
Total		$	194,917				2.53	%		$	193,101				3.19	%

 

The Federal Home Loan Bank borrowings are collateralized by a blanket lien on all qualified 1-to-4 family whole mortgage loans and U.S. government and federal agency securities. Advances are also secured by FHLB stock owned by the Bank.Corporation.

The Corporation had the ability to borrow up to an additional $122,960, based on the assets currently pledged as collateral. The Corporation has pledged eligible mortgage loans and investment securities as collateral for any such borrowings.

 

The maturity and weighted average interest rates of FHLB advances are as follows as of December 31:

		2010								2009
		Amount				Rate				Amount				Rate
Fixed rate advances due 2010		$	—				—			$	28,320				4.52	%
One year putable advances due 2010			—				—				6,000				5.31	%
Fixed rate advances due 2011			10,086				3.96	%			10,206				3.96	%
One year putable advances due 2011			1,000				4.75	%			1,000				4.75	%
Fixed rate advances due 2012			17,000				2.97	%			17,000				2.97	%
One year putable advances due 2012			15,000				4.10	%			15,000				4.10	%
Fixed rate advances due 2013			5,337				4.14	%			5,278				4.14	%
One year putable advances due 2013			5,000				3.15	%			5,000				3.15	%
Fixed rate advances due 2014			25,000				3.16	%			15,000				3.63	%
Fixed rate advances due 2015			25,000				4.63	%			25,000				4.63	%
Fixed rate advances due 2017			10,000				2.35	%			—				—
Total		$	113,423				3.64	%		$	127,804				4.11	%

53

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The maturity and weighted average interest rates of securities sold under agreements to repurchase with stated maturity dates are as follows at December 31:

 

		2008								2007
		Amount				Rate				Amount				Rate
Fixed rate advances due 2008		$	—				—			$	6,131				4.79	%
Fixed rate advances due 2009			42,215				1.89	%			11,500				4.95	%
Fixed rate advances due 2010			29,516				4.58	%			18,392				5.08	%
Fixed rate advances due 2011			10,225				3.96	%			—				—
One year putable advances due 2010			5,000				5.18	%			3,000				4.98	%
One year putable advances due 2011			1,000				4.75	%			—				—
One year putable advances due 2012			5,000				4.07	%			15,000				4.10	%
Fixed rate advances due 2012			17,000				4.19	%			2,000				4.90	%
One year putable advances due 2013			10,264				3.66	%			—				—
Fixed rate advances due 2014			5,000				4.38	%			—				—
Fixed rate advances due 2015			25,000				4.63	%			10,000				4.84	%
		$	150,220				3.68	%		$	66,023				4.76	%

		2010								2009
		Amount				Rate				Amount				Rate
Repurchase agreements due 2010		$	—				—			$	5,000				4.00	%
Repurchase agreements due 2011			858				1.51	%			—				—
Repurchase agreements due 2012			1,013				2.21	%			—				—
Repurchase agreements due 2013			5,127				4.45	%			5,000				4.51	%
Repurchase agreements due 2014			12,087				3.00	%			10,000				3.19	%
Repurchase agreements due 2015			538				3.25	%			—				—
Total		$	19,623				3.01	%		$	20,000				3.72	%

 

Securities sold under agreements to repurchase are classified as secured borrowings. Securities sold under agreements to repurchase without stated maturity dates generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in

43

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

connection with the transaction. The U.S. government agency securities underlying the agreements have a carrying value and a fair value of $64,876$86,381 and $16,072$74,605 at December 31, 20082010 and 2007,2009, respectively. Such securities remain under the control of the Corporation. The Corporation may be required to provide additional collateral based on the fair value of underlying securities.

 

The maturity and weighted average interest rates of securitiesSecurities sold under repurchase agreements to repurchase withwithout stated maturity dates, are as follows atfederal funds purchased, and Federal Reserve Bank discount window advances generally mature within one to four days from the transaction date. The following table provides a summary of short term borrowings for the years ended December 31:

 

		2008								2007
		Amount				Rate				Amount				Rate
Repurchase agreements due 2010		$	5,000				4.00	%		$	5,000				4.00	%
Repurchase agreements due 2013			5,000				4.51	%			5,000				4.51	%
Repurchase agreements due 2014			10,000				3.19	%			—				—
		$	20,000				3.72	%		$	10,000				4.26	%

		2010												2009
		Maximum				YTD				Weighted Average				Maximum				YTD				Weighted Average
		Month-End				Average				Interest Rate				Month-End				Average				Interest Rate
		Balance				Balance				During the Year				Balance				Balance				During the Year
Securities sold under agreements to repurchase witout stated maturity dates		$	56,410			$	44,974				0.29	%		$	51,269			$	38,590				0.32	%
Federal funds purchased			16,000				333				0.60	%			13,200				1,635				0.50	%
Federal Reserve Bank discount window advance			7,500				103				0.75				7,500				41				0.75

54

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 11 — Other Noninterest Expenses

NOTE 10 —	Other Noninterest Expenses

 

A summary of expenses included in Other Noninterest Expenses are as follows for the year ended December 31:

 

		2008				2007				2006
Director fees		$	867			$	796			$	584
Marketing and advertising			691				642				697
Audit and SOX compliance fees			565				583				1,010
Other, not individually significant			5,705				4,527				3,715
		$	7,828			$	6,548			$	6,006

		2010				2009				2008
Marketing and community relations		$	1,093			$	894			$	921
Foreclosed asset and collection			710				546				565
Directors fees			887				923				867
Audit and SOX compliance fees			916				831				698
Education and travel			499				395				491
Printing and supplies			420				529				508
Postage and freight			382				415				419
Legal fees			338				375				415
Amortization of deposit premium			395				472				523
Consulting fees			167				201				298
All other			1,499				1,798				1,810
Total other		$	7,306			$	7,379			$	7,515

 

Note 12 — Federal Income Taxes

NOTE 11 —	Federal Income Taxes

 

Components of the consolidated provision (benefit) for income taxes are as follows for the year ended December 31:

 

		2008				2007				2006
Currently payable		$	1,088			$	1,304			$	1,645
Deferred (benefit) expense			(1,812	)			301				274
Federal income tax (benefit) expense		$	(724	)		$	1,605			$	1,919

		2010				2009				2008
Currently payable		$	1,425			$	1,487			$	1,088
Deferred expense (benefit)			179				(641	)			(1,812	)
Income tax expense (benefit)		$	1,604			$	846			$	(724	)

 

The reconciliation of the provision (benefit) for federal income taxes and the amount computed at the federal statutory tax rate of 34% of income before federal income tax (benefit) expensetaxes is as follows for the yearyears ended December 31:

 

		2008				2007				2006				2010				2009				2008
Income taxes at 34% statutory rate		$	1,148			$	3,242			$	3,033			$	3,621			$	2,940			$	1,148
Effect of nontaxable income			(2,088	)			(1,782	)			(1,239	)
Interest income on tax exempt municipal bonds															(1,565	)			(1,680	)			(1,713	)
Earnings on corporate owned life insurance															(225	)			(218	)			(106	)
Other															(395	)			(383	)			(269	)
Total effect of nontaxable income															(2,185	)			(2,281	)			(2,088	)
Effect of nondeductible expenses			216				145				125				168				187				216
Federal income tax (benefit) expense		$	(724	)		$	1,605			$	1,919
Income tax expense (benefit)														$	1,604			$	846			$	(724	)

44

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for federal income tax purposes.

55

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Significant components of the Corporation’s deferred tax assets and liabilities, included in other assets in the accompanying consolidated balance sheets, are as follows as of December 31:

 

		2008				2007				2010				2009
Deferred tax assets
Allowance for loan losses		$	3,145			$	1,658			$	3,270			$	3,482
Deferred directors’ fees			1,930				1,803				2,364				2,251
Employee benefit plans			80				33				122				132
Core deposit premium and acquisition expenses			252				116				694				310
Net unrealized losses on trading securities			32				119				400				23
Net unrecognized actuarial loss on pension plan			1,211				424				1,109				1,084
Life insurance death benefit payable			804				—				804				804
Alternative minimum tax											686				619
Other			860				209				219				504
Total deferred tax assets			8,314				4,362				9,668				9,209
Deferred tax liabilities
Prepaid pension cost			951				899				851				900
Premises and equipment			620				606				902				665
Accretion on securities			45				47				36				54
Core deposit premium and acquisition expenses			506				315				1,000				642
Net unrealized gains on available-for-sale securities			930				286				847				494
Other			193				194				518				435
Total deferred tax liabilities			3,245				2,347				4,154				3,190
Net deferred tax assets		$	5,069			$	2,015			$	5,514			$	6,019

In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes(FIN No. 48), an interpretation of Statement of Financial Accounting Standards (SFAS) No. 109,Accounting for Income Taxes. FIN No. 48 seeks to reduce the significant diversity in practice associated with financial statement recognition and measurement in accounting for income taxes and prescribes a recognition threshold and measurement attribute for disclosure of tax positions taken or expected to be taken on an income tax return, in order for those tax provisions to be recognized in the Corporation’s financial statements. During 2007, the Corporation adopted the provisions of FIN No. 48. The adoption had no effect on the Corporation’s financial statements.

 

The Corporation and its subsidiaries are subject to U.S. federal income tax. The Corporation is no longer subject to examination by taxing authorities for years before 2005.2007. There are no material uncertain tax positions requiring recognition in the Company’s consolidated financial statements. The Corporation does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.

 

The Corporation recognizes interestand/or penalties related to income tax matters in income tax expense. The Corporation does not have any amounts accrued for interest and penalties at December 31, 20082010 and is not aware of any claims for such amounts by federal income tax authorities.

45

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Included in other comprehensive income for the years ended December 31, 2010 and 2009 are the changes in unrealized losses of $226 and unrealized gains of $4,048, respectively, related to auction rate money market securities and preferred stock. For federal income tax purposes, these securities are considered equity investments for which no federal deferred income taxes are expected or recorded.

NOTE 12 —	Off-Balance-Sheet Activities

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 13 — Off-Balance-Sheet Activities

Credit-Related Financial Instruments

 

The Corporation is party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of its customers. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement the Corporation has in a particular class of financial instrument.

 

		Contract Amount
		2008				2007
Unfunded commitments under lines of credit		$	106,861			$	87,969
Commercial and standby letters of credit			6,429				4,405
Commitments to grant loans			10,228				1,069

56

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

		Contract Amount
		2010				2009
Unfunded commitments under lines of credit		$	110,201			$	111,711
Commercial and standby letters of credit			4,881				6,509
Commitments to grant loans			13,382				9,645

 

Unfunded commitments under commercial lines-of-credit,lines of credit, revolving credit home equity lines of credit and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. The commitments for equity lines of credit may expire without being drawn upon. These lines-of-creditlines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the BankCorporation is committed. A majority of such commitments are at fixed rates of interest; a portion is unsecured.

 

StandbyCommercial and standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions.

 

The Corporation considers standby letters of credit to be guarantees. These commitments to extend credit and letters of credit mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. The Corporation evaluates each customer’s credit worthiness on acase-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon the extension of credit, is based on management’s credit evaluation of the borrower. While the Corporation considers standby letters of credit to be guarantees, the amount of the liability related to such guarantees on the commitment date is not significant and a liability related to such guarantees is not recorded on the consolidated balance sheets.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank,Corporation, is based on management’s credit evaluation of the customer.

 

The Corporation’s exposure to credit-related loss in the event of nonperformance by the counter parties to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Corporation uses the same credit policies in deciding to make these commitments as it does for extending loans to customers. No significant losses are anticipated as a result of these commitments.

 

Note 14NOTE 13 —	On-Balance Sheet Activities

 

Derivative Loan Commitments

 

Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding. The Corporation enters into commitments to fund residential mortgage loans at specific times in the future, with the intention that these loans will subsequently be sold in the secondary market. A mortgage loan commitment binds the Corporation to lend funds to a potential borrower at a specified interest rate within a specified period of time, generally up to 60 days after inception of the rate lock.

46

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Outstanding derivative loan commitments expose the Corporation to the risk that the price of the loans arising from the exercise of the loan commitment might decline from the inception of the rate lock to funding of the loan due to increases in mortgage interest rates. If interest rates increase, the value of these loan commitments decreases. Conversely, if interest rates decrease, the value of these loan commitments increases. The notional amount of undesignated interest rate lock commitments was $334$547 and $311$760 at December 31, 20082010 and 2007,2009, respectively.

57

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Forward Loan Sale Commitments

 

To protect against the price risk inherent in derivative loan commitments, the Corporation utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to mitigate the risk of potential decreases in the values of loan that would result from the exercise of the derivative loan commitments.

 

With a “mandatory delivery” contract, the Corporation commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. If the Corporation fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay a “pair-off” fee, based on then current market prices, to the investor to compensate the investor for the shortfall.

 

With a “best efforts” contract, the Corporation commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. Generally, the price the investor will pay the seller for an individual loan is specified prior to the loan being funded (e.g. on the same day the lender commits to lend funds to a potential borrower).

 

The Corporation expects that these forward loan sale commitments will experience changes in fair value opposite to the change in fair value of derivatederivative loan commitments. The notional amount of undesignated forward loan sale commitments was $1,232$1,729 and $2,525$3,041 at December 31, 20082010 and 2007,2009, respectively.

 

The fair values of the rate lock loan commitments related to the origination of mortgage loans that will be held for sale and the forward loan sale commitments are deemed insignificant by management and, accordingly, are not recorded in the accompanying consolidated financial statements.

 

Note 15NOTE 14 —	Commitments and otherOther Matters

 

Banking regulations require banksthe Bank to maintain cash reserve balances in currency or as deposits with the Federal Reserve Bank. At December 31, 20082010 and 2007,2009, the reserve balances amounted to $700$470 and $370, respectively.

Isabella Bank sponsors the IBT Foundation (the “Foundation”), which is a nonprofit entity formed for the purpose of distributing charitable donations to recipient organizations generally located in the communities serviced by Isabella Bank. The Bank periodically makes charitable contributions in the form of cash transfers to the Foundation. The Foundation is administered by members of the Isabella Bank Board of Directors. The assets and transactions of the Foundation are not included in the consolidated financial statements of Isabella Bank Corporation. During 2008, 2007, and 2006, the Corporation contributed $78 ,$0, and $0 respectively to the Foundation. The assets of the Foundation as of December 31, 2008 and 2007 were $953 and $1,069,$687, respectively.

 

Banking regulations limit the transfer of assets in the form of dividends, loans, or advances from the Bank to the Corporation. At December 31, 2008,2010, substantially all of the Bank’s assets were restricted from transfer to the Corporation in the form of loans or advances. Consequently, bank dividends are the principal source of funds for the Corporation. Payment of dividends without regulatory approval is limited to the current years retained net income plus retained net income for the preceding two years, less any required transfers to common stock. At January 1, 2009,2011, the amount available for dividends without regulatory approval was approximately $7,831.

The Bank has obtained approval to borrow up to $200,000 from the Federal Home Loan Bank (FHLB) of Indianapolis. Under the terms of the agreement, the Bank may obtain advances at the stated rate at the time of the borrowings. The Bank has agreed to pledge eligible mortgage loans and U.S. Treasury and governmental agencies as collateral for any such borrowings.

47

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)$8,435.

 

Note 1615 —	Minimum Regulatory Capital Requirements

 

The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the Federal Reserve Bank and the Federal Deposit Insurance Corporation (The Regulators). Failure to meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by The Regulators that if undertaken, could have a material effect on the Corporation’s and Bank’s financial statements. Under The Regulators’regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that include quantitative measures of their assets, liabilities, capital, and certain off-balance-sheet items, as calculated under regulatory accounting standards. The Bank’s capital amounts and classifications are also subject to qualitative judgments by The Regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

 

Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and Tier 1 capital to average assets (as defined).

58

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Management believes, as of December 31, 20082010 and 2007,2009, that the Corporation and the Bank meetmet all capital adequacy requirements to which they are subject.

 

As of December 31, 2008,2010, the most recent notifications from The Regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notifications that management believes has changed the Bank’s categories. The Corporation’s and eachthe Bank’s actual capital amounts (in thousands) and ratios are also presented in the table.

 

																		Minimum to be																						Minimum to be
																		Well Capitalized																						Well Capitalized
										Minimum								Under Prompt														Minimum								Under Prompt
										Capital								Corrective Action														Capital								Corrective Action
		Actual								Requirement								Provisions						Actual								Requirement								Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio		Amount				Ratio				Amount				Ratio				Amount				Ratio
December 31, 2008
December 31, 2010
Total capital to risk weighted assets
Isabella Bank		$	89,192				12.4	%		$	57,666				8.0	%		$	72,082			10.0%		$	98,566				12.8	%		$	61,642				8.0	%		$	77,053				10.0	%
Consolidated			98,867				13.5				58,485				8.0				N/A			N/A			106,826				13.7				62,423				8.0				N/A				N/A
Tier 1 capital to risk weighted assets
Isabella Bank			80,145				11.1				28,833				4.0				43,249			6.0			88,901				11.5				30,821				4.0				46,232				6.0
Consolidated			89,694				12.3				29,242				4.0				N/A			N/A			97,040				12.4				31,212				4.0				N/A				N/A
Tier 1 capital to average assets
Isabella Bank			80,145				7.4				43,069				4.0				53,836			5.0			88,901				7.6				46,653				4.0				58,316				5.0
Consolidated			89,694				8.4				42,603				4.0				N/A			N/A			97,040				8.2				47,116				4.0				N/A				N/A
December 31, 2007
Total capital to risk weighted assets
Isabella Bank		$	75,769				12.7	%		$	47,705				8.0	%		$	59,632			10.0%
Consolidated			103,436				17.0				48,636				8.0				N/A			N/A
Tier 1 capital to risk weighted assets
Isabella Bank			68,468				11.5				23,853				4.0				35,779			6.0
Consolidated			96,135				15.8				24,318				4.0				N/A			N/A
Tier 1 capital to average assets
Isabella Bank			68,468				7.7				35,723				4.0				44,654			5.0
Consolidated			96,135				10.7				35,936				4.0				N/A			N/A

																		Minimum to be
																		Well Capitalized
										Minimum								Under Prompt
										Capital								Corrective Action
		Actual								Requirement								Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
December 31, 2009
Total capital to risk weighted assets
Isabella Bank		$	93,079				12.9	%		$	57,713				8.0	%		$	72,141				10.0	%
Consolidated			102,285				14.1				58,213				8.0				N/A				N/A
Tier 1 capital to risk weighted assets
Isabella Bank			84,012				11.6				28,856				4.0				43,285				6.0
Consolidated			93,141				12.8				29,106				4.0				N/A				N/A
Tier 1 capital to average assets
Isabella Bank			84,012				7.8				42,813				4.0				53,516				5.0
Consolidated			93,141				8.6				43,326				4.0				N/A				N/A

Note 16 —	Benefit Plans

401(k) Plan

The Corporation has a 401(k) plan in which substantially all employees are eligible to participate. Employees may contribute up to 50% of their compensation subject to certain limits based on federal tax laws. The Corporation makes a 3.0% safe harbor contribution for all eligible employees and matching contributions equal to 50% of the first 4.0% of an employee’s compensation contributed to the Plan during the year. Employees are 100% vested in the safe harbor contributions and are 0% vested through their first two years of employment and are 100% vested after

4859

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 17 —	Employee Benefit Plans

6 years of service for matching contributions. For the year ended December 31, 2010, 2009 and 2008, expenses attributable to the Plan were $625, $617, and $543 respectively.

 

Defined Benefit Pension Plan

 

The Corporation has a non-contributory defined benefit pension plan covering substantially all of its employees. 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 recognizedcurtailed in the first quarter of 2007, suspended the current participant’s accrued benefits as of March 1, 2007 and limited participation in the plan to eligible employees as of December 31, 2006.2007. Due to the curtailment, future salary increases will not be considered and the benefits are based on years of service and the employees’ five highest consecutive years of compensation out of the last ten years of service rendered through March 1, 2007. As a result of the curtailment, the Corporation does not anticipate contributing to the plan in the near future.

The curtailment resulted in a reduction in 2007 of $2,939 in the projected benefit obligation, which served to reduce unrecognized net actuarial loss of $2,939, a component of accumulated other comprehensive loss.

Subsequent to the decision to curtail the defined benefit plan, the Corporation decided to increase the contributions to the Corporation’s 401(k) plan effective January 1, 2007 (see “Other Employee Benefit Plans” on page 52).

 

Changes in the projected benefit obligation and plan assets during each year, the funded status of the plan, and the net amount recognized on the Corporation’s consolidated balance sheets using an actuarial measurement date of December 31, are summarized as follows during the years ended December 31:

 

		2008				2007				2010				2009
Change in benefit obligation
Benefit obligation, January 1		$	8,206			$	10,996			$	8,897			$	8,436
Service cost			—				109
Interest cost			503				489				531				504
Actuarial loss			356				51				679				392
Benefits paid, including plan expenses			(629	)			(500	)			(447	)			(435	)
Plan curtailment			—				(2,939	)
Benefit obligation, December 31			8,436				8,206				9,660				8,897
Change in plan assets
Fair value of plan assets, January 1			9,607				9,199				8,355				7,669
Investment (loss) return			(1,309	)			558
Corporation contribution			—				350
Investment return											945				1,121
Contributions											47				—
Benefits paid, including plan expenses			(629	)			(500	)			(447	)			(435	)
Fair value of plan assets, December 31			7,669				9,607				8,900				8,355
(Deficiency in) funded status at December 31		$	(767	)		$	1,401
Deficiency in funded status at December 31, included on the consolidated balance sheets in accrued interest and other liabilities										$	(760	)		$	(542	)
Change in accrued pension benefit costs
Accrued benefit cost at January 1										$	(542	)		$	(767	)
Contributions											47				—
Net periodic cost for the year											(193	)			(149	)
Net change in unrecognized actuarial loss and prior service cost											(72	)			374
Accrued pension benefit cost at December 31										$	(760	)		$	(542	)

 

		2008				2007
Change in (accrued) prepaid pension benefit costs
Prepaid (accrued) benefit cost at January 1		$	1,401			$	(1,797	)
Contributions to the plan			—				350
Net periodic benefit income (cost) for the year			152				(2	)
Plan curtailment loss			—				(40	)
Net change in unrecognized actuarial loss and prior service cost			(2,320	)			2,890
(Accrued) prepaid pension benefit cost at December 31		$	(767	)		$	1,401

Amounts recognized as a component of other comprehensive loss consist of the following amounts during the years ended December 31 :

		2010				2009				2008
Change in unrecognized pension cost		$	(72	)		$	374			$	(2,320	)
Tax effect			25				(127	)			788
Net		$	(47	)		$	247			$	(1,532	)

The accumulated benefit obligation was $9,660 and $8,897 at December 31, 2010 and 2009, respectively.

The Company has recorded the funded status of the Plan in its consolidated balance sheets. The Company adjusts the underfunded status in a liability account to reflect the current funded status of the plan. Any gains or

4960

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

During 2006, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans(“SFAS No. 158”) and in accordance therewith reflected the under funded status of the plan on its consolidated balance sheet at December 31, 2006. Prospectively, the Corporation adjusts the liability to reflect the current funded status of the plan. Any gains or losses that arise during the yearperiod but are not recognized as components of net periodic benefit cost are nowwill be recognized as a component of other comprehensive income (loss).

The adoption of SFAS No. 158 had no effect on the Corporation’s consolidated statement of operations for the year ended December 31, 2006, and it will not affect the Corporation’s operating results in future periods.

The incremental effects of applying FASB Statement No. 158 on individual line items on the consolidated statement of financial position as of the December 31, 2006 implementation date are as follows:

		Before				SFAS No. 158				After
		Application of				Application				Application of
		SFAS No. 158				Adjustments				SFAS No. 158
(Prepaid) accrued liability for pension benefits		$	(2,337	)		$	4,134			$	1,797
Deferred income tax assets			2,030				1,406				3,436
Total liabilities			792,581				1,797				794,378
Accumulated other comprehensive loss			(759	)			(2,728	)			(3,487	)
Total shareholders’ equity			118,477				(2,728	)			115,749

Amounts recognized as a component of accumulated other comprehensive loss consist of:

		December 31
		2008				2007				2006
(Increase) reduction of unrecognized pension cost		$	(2,320	)		$	2,890			$	—
Tax effect			788				(983	)			—
Net of tax amount			(1,532	)			1,907				—
Adjustment to initially apply FASB Statement No. 158			—				—				(4,134	)
Tax effect			—				—				1,406
Net of tax amount			—				—				(2,728	)
Total		$	(1,532	)		$	1,907			$	(2,728	)

The accumulated benefit obligation was $8,436 and $8,206 at December 31, 2008 and 2007, respectively. The $4,134 adjustment to initially apply SFAS No. 158 in 2006 consisted primarily of previously unrecognized net actuarial losses.

The components of net periodic benefit cost and other pension related amounts recognized in other comprehensive income (loss) are as follows for the years ended December 31:

 

		2008				2007				2006
Net periodic benefit (income) cost
Service cost on benefits earned for services rendered during the year		$	—			$	109			$	637
Interest cost on projected benefit obligation			503				489				607
Expected return on plan assets			(659	)			(628	)			(555	)
Amortization of unrecognized prior service cost			—				—				18
Amortization of unrecognized actuarial net loss			4				32				232
Net periodic benefit (income) cost		$	(152	)		$	2			$	939

		2010				2009				2008
Net periodic benefit cost (income)
Interest cost on projected benefit obligation		$	531			$	504			$	503
Expected return on plan assets			(491	)			(524	)			(659	)
Amortization of unrecognized actuarial net loss			153				169				4
Net periodic benefit cost (income)		$	193			$	149			$	(152	)

50

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Accumulated other comprehensive loss at December 31, 20082010 includes net unrecognized actuarial losses before income taxes of $3,564,$3,262, of which $170$138 is expected to be amortized into benefit cost during 2009.2011.

 

ActuarialThe actuarial assumptions used in determining the projected benefit obligation are as follows forand the year ended December 31:

		2008				2007				2006
Weighted average discount rate			6.10	%			6.44	%			6.00	%
Rate of increase in future compensation			N/A				N/A				4.50	%
Expected long-term rate of return			7.00	%			7.00	%			7.50	%

The actual weighted average assumptions used in determining the net periodic pension costs are as follows for the year ended December 31:

 

		2008				2007				2006
Discount rate			6.10	%			6.44	%			6.00	%
Rate of compensation increase			N/A				N/A				4.50	%
Expected long-term return on plan assets			7.00	%			7.00	%			7.00	%

		2010				2009				2008
Discount rate			6.10	%			5.87	%			6.10	%
Expected long-term rate of return			6.00	%			6.00	%			7.00	%

As a result of the curtailment of the Plan, there is no rate of compensation increase considered in the above assumptions.

 

The expected long term rate of return is an estimate of anticipated future long term rates of return on the Corporation’s plan assets as measured on a market value basis. Factors considered in arriving at this assumption include:

 

	•	Historical longer term rates of return for broad asset classes.
	•	Actual past rates of return achieved by the plan.
	•	The general mix of assets held by the plan.
	•	The stated investment policy for the plan.

 

The selected rate of return is net of anticipated investment related expenses.

 

The Corporation’s actual pension plan weighted-average asset allocations by asset category are as follows at December 31:

Asset Category		2008				2007
Money market			2.5	%			4.0	%
Equity securities			52.8	%			38.0	%
Debt securities			44.7	%			58.0	%
Total			100.00	%			100.00	%

Plan Assets

 

AsThe Corporation’s overall investment strategy is to moderately grow the portfolio by investing 50% of December 31, 2008, the plan held $188 (2.5%portfolio in equity securities and 50% in fixed income securities. This strategy is designed to generate a long term rate of total plan assets)return of funds in8.7%. Equity securities primarily consist of the S&P 500 Index with a money market account. The remaining fundssmaller allocation to the Small Cap and International Index. Fixed income securities are invested in two mutual funds managed by the plan’s investment advisors. These funds had $4,050Bond Market Index. The Plan has appropriate assets invested in equityshort term investments and $3,431 in debt securities as of December 31, 2008.to meet near-term benefit payments.

 

The asset mix and the sector weighting of equitythe investments and debt issues to hold are based ondetermined by the pension committee, which is comprised of members of management of the Corporation. Consultations are held with a third party investment advisor retained by the Corporation to manage the plan.Plan. The Corporation reviews the performance of the advisor no less than annually.

The Corporation does not expect to make contributions to the pension plan in 2009.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The fair values of the Corporation’s pension plan assets by asset category were as follows as of December 31:

		2010								2009
Description		Total				(Level 2)				Total				(Level 2)
Asset Category
Short-term investments		$	108			$	108			$	70			$	70
Common collective trusts
Fixed income			4,470				4,470				4,826				4,826
Equity investments			4,322				4,322				3,459				3,459
		$	8,900			$	8,900			$	8,355			$	8,355

The following is a description of the valuation methodologies used for assets measured at fair value. There have been no changes in the methodologies used at December 31, 2010 and 2009:

	•	Short-term investments:  Shares of a money market portfolio, which is valued using amortized cost, which approximates fair value.
	•	Common collective trusts:  These investments are public investment securities valued using the net asset value (“NAV”) provided by a third party investment advisor. The NAV is quoted on a private market that is not active; however, the unit price is based on underlying investments which are traded on an active market.

The Corporation does not anticipate making any contributions to the plan in 2011.

 

Estimated future benefit payments are as follows for the next ten years:

 

Year		Amount				Amount
2009		$	363
2010			379
2011			381			$	393
2012			400				406
2013			399				404
Years 2014 – 2018 (total)			2,753
2014							497
2015							542
Years 2016 — 2020							3,038

Other Employee Benefit Plans

 

The Corporation maintains a nonqualified supplementary employee retirement plan (SERP)components of projected net periodic benefit cost are as follows for qualified officers to provide supplemental retirement benefits to each participant. Expenses related to this program for 2008, 2007, and 2006 were $206, $202, and $97, respectively, and are being recognized over the participants’ expected years of service. As a result of curtailing Isabella Bank Corporation’s defined benefit plan in March 2007, the Corporation established an additional SERP to maintain the benefit levels for all employees that were at least forty years old and had at least 15 years of service. The cost to provide this benefit was $128 and $120 for 2008 and 2007, respectively.

The Corporation maintains a non-leveraged employee stock ownership plan (ESOP) and a profit sharing plan which cover substantially all of its employees. Effective December 31, 2006, the ESOP plan was frozen to new participants. Contributions to the plans are discretionary and are approved by the Board of Directors and recorded as compensation expense. Expenses related to the plans for 2008, 2007, and 2006 were $0, $115, and $13, respectively. Total allocated shares outstanding related to the ESOP at December 31, 2008, 2007, and 2006 were 271,520, 149,154, and 161,762, respectively, were included in the computation of dividends and earnings per share in each of the respective years and have not been adjusted for the 10% stock dividend paid February 29, 2008.

The Corporation maintains a self-funded medical plan under which the Corporation is responsible for the first $50 per year of claims made by a covered family. Medical claims are subject to a lifetime maximum of $5,000 per covered individual. Expenses are accrued based on estimates of the aggregate liability for claims incurred and the Corporation’s experience. Expenses were $2,110 in 2008, $1,804 in 2007 and $1,316 in 2006.

The Corporation offers dividend reinvestment, and employee and director stock purchase plans. The dividend reinvestment plan allows shareholders to purchase previously unissued Isabella Bank Corporation common shares. The stock purchase plan allows employees and directors to purchase Isabella Bank Corporation common stock through payroll deduction. The number of shares reserved for issuance under these plans are 635,000, with 314,856 shares unissued at December 31, 2008, as adjusted for the 10% stock dividend paid February 29, 2008. During 2008, 2007 and 2006, 78,994 shares were issued for $2,879, 63,233 shares were issued for $2,657 and 61,258 shares were issued for $2,459, respectively, in cash pursuant to these plans, exclusive of the effects of the 10% stock dividend paid February 29, 2008.

401(k) Plan

The Corporation has a 401(k) plan in which substantially all employees are eligible to participate. Employees may contribute up to 100% of their compensation subject to certain limits based on federal tax laws. The Corporation began making matching contributions equal to 25% of the first 3% of an employee’s compensation contributed to the plan in 2005. Employees are 0% vested through their first two years of employment and are 100% vested after 6 years of service.

As a result of the curtailment of the defined benefit plan noted above, the Corporation decided to increase the contributions to the Corporation’s 401(k) plan effective January 1, 2007. The enhancement includes an automatic 3.0% contribution for all eligible employees and matching contributions equal to 50% of the first 4.0% of an

52

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

employee’s compensation contributed to the Plan during the year. For the year ended December 31, 2008 and 2007, expenses attributable to the Plan were $543 and $439, respectively.31:

		2011
Interest cost on projected benefit obligation			507
Expected return on plan assets			(522	)
Amortization of unrecognized actuarial net loss			153
Net periodic benefit cost		$	138

 

Equity Compensation Plan

 

Pursuant to the terms of the Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors (the “Directors Plan”), directors of the Corporation and its subsidiaries are required to defer at least 25% of their earned board fees tointo the Directors Plan. The fees are converted toon a quarterly basis into the Corporation’s common stock units based on the fair market value of a share of common stock as of the relevant valuation date. Stock credited to a participant’s account is eligible for stock and cash dividends as declared. Upon retirement from the board or the occurrence of certain other events, the participant is eligible to receive a lump-sum, in-kind, distribution of all of the stock that is then in his or her account, and any unconverted cash will be converted to and rounded up to whole shares of stock and distributed, as well. The Directors Plan as modified does not allow for cash settlement, and therefore, such share-basedshare based payment awards qualify for classification as equity. All authorized but unissued

62

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

shares of common stock are eligible for issuance under thisthe Directors Plan. The Corporation may also purchase shares of common stock fromon the open market to meet its obligations under the Plan. Under the Plan, the Corporation was to issue $3,766 in dollar value of common stock or 186,766 shares and $3,772 or 198,939 shares as of December 31, 2008 and 2007, respectively as adjusted for the 10% stock dividend paid on February 29, 2008, pursuant to the antidilution provision required by theDirectors Plan.

 

On December 17,In 2008, the Corporation established a Rabbi Trust effective as of July 1, 2008, to fund the Directors Plan. A Rabbi Trust is an irrevocable grantor trust to which the Corporation may contribute assets for the limited purpose of funding a nonqualified deferred compensation plan. Although the Corporation may not reach the assets of the Rabbi Trust (“Trust”) for any purpose other than meeting its obligations under the plan,Directors Plan, the assets of the trustTrust remain subject to the claims of the Corporation’s creditors and are included in the consolidated financial statements. The Corporation may contribute cash or common stock to the trustTrust from time to time for the sole purpose of funding the Directors Plan. The trustTrust will use any cash that the Corporation contributed to purchase shares of the Corporation’s common stock on the open market through the Corporation’s brokerage services department.

 

Since July 1,The components of shares eligible to be issued under the Directors Plan were as follows as of December 31:

		2010								2009
		Eligible				Market				Eligible				Market
		Shares				Value				Shares				Value
Unissued			191,977			$	3,321				186,279			$	3,530
Shares held in Rabbi Trust			32,686				565				30,626				580
Total			224,663			$	3,886				216,905			$	4,110

Other Employee Benefit Plans

The Corporation maintains a nonqualified supplementary employee retirement plan (“SERP”) for qualified officers to provide supplemental retirement benefits to each participant. Expenses related to this program for 2010, 2009, and 2008 were $218, $219, and $206, respectively, and are being recognized over the participants’ expected years of service. As a result of curtailing the Corporation’s defined benefit plan, the Corporation has transferred $249established an additional SERP to maintain the benefit levels for all employees that were at least forty years old and had at least 15 years of cashservice. The cost to provide this benefit was $145, $124 and $128 for 2010, 2009 and 2008, respectively.

The Corporation maintains a non leveraged employee stock ownership plan (ESOP) and a profit sharing plan which cover substantially all of its employees. Effective December 31, 2006, the ESOP was frozen to new participants. Contributions to the Rabbi Trust. Asplans are discretionary and are approved by the Board of Directors and recorded as compensation expense. During 2009, the Board of Directors approved a contribution of $50 to the plan. Expenses related to the plans for 2010, 2009, and 2008 were $0, $50, and $0, respectively. Total allocated shares outstanding related to the ESOP at December 31, 2010, 2009, and 2008 were 246,419, 271,421, and 271,520, respectively. Such shares are included in the Trustcomputation of dividends and earnings per share in each of the respective years.

The Corporation maintains a self funded medical plan under which the Corporation is responsible for the first $50 per year of claims made by a covered family. Medical claims are subject to a lifetime maximum of $5,000 per covered individual. Expenses are accrued based on estimates of the aggregate liability for claims incurred and the Corporation’s experience. Expenses were $2,101 in 2010, $2,155 in 2009 and $2,110 in 2008.

The Corporation maintains the Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan (the “Dividend Reinvestment Plan”). The dividend reinvestment feature of the Dividend Reinvestment Plan allows shareholders to purchase previously unissued Isabella Bank Corporation common shares using dividends paid on shares held 5,248in the plan. The employee stock purchase feature of the Dividend Reinvestment Plan allows employees and directors to purchase Isabella Bank Corporation common stock through payroll deduction. The shareholder stock purchase feature of the Dividend Reinvestment Plan enables existing shareholders to purchase additional shares of the Corporation’s common stock directly from the Corporation. The number of shares reserved for settlement.issuance under this plan are 885,000, with 313,078 shares unissued at December 31, 2010. During 2010, 2009 and 2008, 124,904 shares were issued for $2,203, 126,874 shares were issued for $2,396 and 78,994 shares were issued for $2,879, respectively, in cash pursuant to these plans.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 1817 —	Accumulated Other Comprehensive Income (Loss)Loss

 

Comprehensive income (loss)loss includes net income as well as unrealized gains and losses, net of tax, onavailable-for-sale investment securities owned and changes in the funded status of the Corporation’s defined benefit pension plan, which are excluded from net income. Unrealized investment securities gains and losses and changes in the funded status of the pension plan, net of tax, are excluded from net income, and are reflected as a direct charge or credit to shareholders’ equity. Comprehensive income (loss) and the related components are disclosed in the accompanying consolidated statements of comprehensive income for each of the years ended December 31, 2008, 2007,2010, 2009, and 2006.2008.

 

The following is a summary of the components comprising the balance of accumulated other comprehensive loss reported on the consolidated balance sheets as of December 31 (presented net of tax):

 

		2008				2007				2010				2009
Unrealized gains on available-for-sale investment securities		$	(3,216	)		$	555
Unrealized gains (losses) onavailable-for-sale investment securities										$	444			$	(13	)
Unrecognized pension costs			(2,353	)			(821	)			(2,153	)			(2,106	)
Accumulated other comprehensive loss		$	(5,569	)		$	(266	)		$	(1,709	)		$	(2,119	)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 1918 —	Related Party Transactions

 

In the ordinary course of business, the BankCorporation grants loans to principal officers and directors and their affiliates (including their families and companies in which they have 10% or more ownership). Annual activity during the years ended December 31 consisted of the following:

 

		2008				2007				2010				2009
Beginning balance		$	10,461			$	10,749
Balance, beginning of year										$	4,142			$	4,011
New loans			3,488				8,720				3,038				5,033
Repayments			(9,938	)			(9,008	)			(2,833	)			(4,902	)
Ending Balance		$	4,011			$	10,461
Balance, ending of year										$	4,347			$	4,142

 

Total deposits of these principal officers and directors and their affiliates amounted to $8,317$11,556 and $10,526$7,090 at December 31, 20082010 and 2007,2009, respectively. In addition, Isabella Bank Corporation’s Employee Stock Ownership Plan (Note 17) held deposits with the Bank aggregating $370$254 and $928,$219, respectively, at December 31, 20082010 and 2007.2009.

 

Note 2019 —	Financial Instruments Recorded at Fair Value

 

In February 2007, the FASB issued SFAS No. 159,TheEstimated Fair Values of Financial Instruments Not Recorded at Fair Value Option for Financial Assets and Financial Liabilitiesin their Entirety on a Recurring Basis(“SFAS No. 159”). SFAS No. 159 expands

Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of fair value accounting but doesestimates. In cases where quoted market values in an active market are not affect existing standards which require assets or liabilities to be carried at fair value. Under SFAS No. 159,available, the Corporation may electuses present value techniques and other valuation methods to measure manyestimate the fair values of its financial instrumentsinstruments. These valuation methods require considerable judgment and certain other assets and liabilities at fair value (“fair value option” — FVO). The fair value measurement option is not allowable for deposit or withdrawable on demand liabilities. If the useresulting estimates of fair value is elected, any upfront costscan be significantly affected by the assumptions made and fees related to the instrument must be recognized in earnings and cannot be deferred, e.g., debt issue costs. The fair value election is irrevocable and is generally made on aninstrument-by-instrument basis, even if the Corporation has similar instruments that it elects not to measure based on fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings as of January 1, 2007. Subsequent to the adoption of SFAS No. 159, changes in fair value are recognized in earnings. Although SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 and would have been required to be adopted by Isabella Bank Corporation in the first quarter of fiscal 2008, Isabella Bank Corporation elected to early adopt SFAS No. 159 effective January 1, 2007, the impact of which is detailed in the table below.

As shown in the following table, the Corporation elected to transfer $77,839 of its $213,450 available-for-sale securities investment portfolio to trading status to facilitate more active trading of these securities. In determining which available-for-sale securities to transfer, the Corporation considered interest rates, duration, marketability, and balance sheet management strategies. The securities transferred included obligations of US Government Agencies, variable rate Federal National Mortgage Association and Federal Home Loan Mortgage Corporation mortgage backed securities, taxable municipal bonds, and a limited number of tax exempt bonds.methods used.

5464

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Corporation also elected to report $7,256 of long-term, relatively high interest rate, Federal Home Loan Bank advances at theircarrying amount and estimated fair value upon the early adoption of SFAS No. 159 to provide a hedge against significant movement in interest rates.

		Balance Sheet				Net Gain/				Balance Sheet
		1/1/2007 Prior to				(Loss ) Upon				1/1/2007 After
		Adoption of FVO				Adoption of FVO				Adoption of FVO
Investment securities		$	79,198			$	(1,359	)		$	77,839
FHLB borrowings included in other borrowed funds			(7,256	)			(232	)			(7,488	)
Pretax cumulative loss effect of adoption of the fair value option							(1,591	)
Increase in deferred tax asset							541
Cumulative loss effect of adoption of the fair value option (charged as a reduction to retained earnings as of January 1, 2007)						$	(1,050	)

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 arefinancial instruments not recorded at fair value in their entirety on a recurring basis. Additionally, from time to time,basis on the Corporation may be required to record at fair value other assets on a nonrecurring basis, suchCorporation’s consolidated balance sheets are 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 applicationfollows as of lower of cost or market accounting or write-downs of individual assets.December 31:

		2010								2009
		Estimated				Carrying				Estimated				Carrying
		Fair Value				Value				Fair Value				Value
ASSETS
Cash and demand deposits due from banks		$	18,109			$	18,109			$	24,482			$	24,482
Certicates of deposit held in other financial institutions			15,908				15,808				5,380				5,380
Mortgage loansavailable-for-sale			1,182				1,182				2,294				2,281
Net loans			734,634				722,931				719,604				710,337
Accrued interest receivable			5,456				5,456				5,832				5,832
Equity securities without readily determinable fair values			17,564				17,564				17,921				17,921
Originated mortgage servicing rights			2,673				2,667				2,620				2,620
LIABILITIES
Deposits with no stated maturities			424,978				424,978				382,006				382,006
Deposits with stated maturities			454,332				452,361				424,048				420,646
Borrowed funds			190,180				184,494				177,375				175,297
Accrued interest payable			1,003				1,003				1,143				1,143

 

Financial Instruments Recorded at Fair Value Hierarchy

 

Under SFAS 157,The table below presents the Corporation groupsrecorded amount of assets and liabilities measured at fair value into three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:December 31:

 

	•	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.

		2010												2009
Description		Total				(Level 2)				(Level 3)				Total				(Level 2)				(Level 3)
Recurring items
Trading securities
States and political subdivisions		$	5,837			$	5,837			$	—			$	9,962			$	9,962			$	—
Mortgage-backed			—				—				—				3,601				3,601				—
Total trading securities			5,837				5,837				—				13,563				13,563				—
Available-for-sale investment securities
Government-sponsored enterprises			5,404				5,404				—				19,471				19,471				—
States and political subdivisions			169,717				169,717				—				151,730				151,730				—
Auction rate money market preferred			2,865				—				2,865				2,973				—				2,973
Preferred stock			6,936				—				6,936				7,054				—				7,054
Mortgage-backed			102,215				102,215				—				67,734				67,734				—
Collateralized mortgage obligations			43,587				43,587				—				10,104				10,104				—
Totalavailable-for-sale investment securities			330,724				320,923				9,801				259,066				249,039				10,027
Borrowed funds			10,423				10,423				—				17,804				17,804				—
Nonrecurring items
Mortgage loansavailable-for-sale			1,182				1,182				—				2,281				2,281				—
Impaired loans			12,048				—				12,048				12,654				—				12,654
Originated mortgage servicing rights			2,667				2,667				—				2,620				2,620				—
Foreclosed assets			2,067				2,067				—				1,157				1,157				—
		$	364,948			$	343,099			$	21,849			$	309,145			$	286,464			$	22,681
Percent of assets and liabilities measured at fair value							94.01	%			5.99	%							92.66	%			7.34	%

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

 

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

Cash and demand deposits due from banks:

The carrying amounts of cash and short term investments, including Federal funds sold, approximate fair values.

Certificates of deposit held in other financial institutions:

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

 

Investment Securities:securities:

 

Investment securities are recorded at fair value on a recurring basis. FairLevel 2 fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-basedmodel based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets, mortgage-backed securities issued by government-sponsored entities and money market funds. Level 2 securities include municipal bonds issued by government sponsored enterprises, states and corporate debtpolitical subdivisions, mortgage-backed securities, in active markets. and collateralized mortgage obligations issued by government sponsored enterprises.

Securities classified as Level 3 include securities in less liquid markets

55

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

including illiquid markets in some instances, and include certain municipal securities and money market preferred auction rate securities.

The Corporation has invested $11,000 in auction rate money market preferred investment security instruments, which are classified as available-for-sale securities and reflected at fair value. Due to recent events and uncertainty in credit markets, these investments have become illiquid.

preferred stocks. Due to the current illiquiditylimited trading activity of these securities, these assets were classified as Level 3 during 2008. Thethe fair values of these securities were estimated utilizing a discounted cash flow analysis or other type of valuation adjustment methodology as of December 31, 2008.2010 and 2009. These analyses consider, among other factors, the collateral underlying the security investments, theconsidered creditworthiness of the counterparty, the investment grade, the timing of expected future cash flows, estimatesand the current volume of trading activity. The discount rates used were determined by using the interest rates of similarly rated financial institutions debt based on the weighted average of a range of terms for corporate bond interest rates, which were obtained from published sources. All securities have call dates within the next timeyear. The Corporation calculated the security is expected to havepresent value assuming a successful auction,30 year nonamortizing balloon using weighted average discount rates between 3.88% and the Corporation’s positive intent and ability to hold such securities until credit markets improve,6.87% as described in Note 4.of December 31, 2010.

 

Loans Available-for-Sale:Mortgage loansavailable-for-sale:

 

Loans available for saleMortgage loansavailable-for-sale are carried at the lower of cost or market value. The fair value of mortgage loans held-for-sale isavailable-for-sale are based on what price secondary markets are currently offering for portfolios with similar characteristics. As such, the CompanyCorporation classifies loans subjected to nonrecurring fair value adjustments as Level 2.

 

Loans:

For variable rate loans with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated.

66

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Corporation does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and ana specific allowance for loan losses ismay be established. Loans for which it is probable that payment of interest and principal will not be made in accordance withsignificantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114,Accounting by Creditors for Impairment of a Loan, (SFAS 114).the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value, andor discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2008,

The Corporation reviews the net realizable values of the underlying collateral for collateral dependent impaired loans were evaluated based on at least a quarterly basis for all loan types. To determine the faircollateral value, management utilizes independent appraisals, broker price opinions, or internal evaluations. These valuations are reviewed to determine whether an additional discount should be applied given the age of market information that may have been considered as well as other factors such as costs to carry and sell an asset if it is determined that the collateral will be liquidated in connection with the ultimate settlement of the loan. The Corporation uses this valuation to determine if any charge offs or specific reserves are necessary. The Corporation may obtain new valuations in certain circumstances, including when there has been significant deterioration in the condition of the collateral, if the foreclosure process has begun, or based onif the net present value of their expected cash flows. existing valuation is deemed to be outdated.

Impaired loans where an allowance is established based on the fairnet realizable value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraisal value, the Corporation records the loan as nonrecurring Level 2. When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value, and there is no observable market price, or the impairment is determined using the net present value of the expected cash flows, the Corporation classifiesrecords the impaired loanloans as nonrecurring Level 3.

 

Foreclosed Assets:

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

Equity Securities Without Readily Determinable Fair Values:Accrued interest:

 

The Corporation has investments in equity securities without readily determinablecarrying amounts of accrued interest approximate fair values as well as an investment in a joint venture. The assets are individually reviewed for impairment on an annual basis by comparing the carrying value to the estimated fair value. The lack of an independent source to validate fair value estimates, including the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. The Corporation classifies nonmarketable equity securities and its investment in a joint venture subjected to nonrecurring fair value adjustments as Level 3. During 2008 and 2007, there were no impairments recorded on equity securities without readily determinable fair values.

56

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Mortgage Servicing Rights:

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

 

Goodwill and Other Intangible Assets:other intangible assets:

 

GoodwillAcquisition intangibles and identified intangible assetsgoodwill are subject to impairment testing. A projected cash flow valuation method is used in the completion of impairment testing. This valuation method requires a significant degree of management judgment. In the event the projected undiscounted net operating cash flows are less than the carrying value, the asset is recorded at fair value as determined by the valuation model. If the testing resulted in impairment, the Corporation would classify goodwill and other intangible assetsacquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 20082010 and 2007,2009, there were no impairments recorded on goodwill and other intangible assets.acquisition intangibles.

 

Other Borrowed Funds:Equity securities without readily determinable fair values:

 

The Corporation has electedinvestments in equity securities without readily determinable fair values as well as investments in joint ventures. The assets are individually reviewed for impairment on an annual basis by comparing the carrying value to measure a portion of other borrowed funds at theirthe estimated fair value. These borrowings are recorded atThe lack of an independent source to validate fair value on a recurring basis, withestimates, including the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. The Corporation classifies nonmarketable equity securities and its investments in joint ventures subjected to nonrecurring fair value measurement being based upon quoted prices. Changes in the fair value of these borrowings are included in noninterest income. As such, the Corporation classifies other borrowed fundsadjustments as Level 1.

The table below represents the activity in Level 3 inputs measured3. During 2010 and 2009, there were no impairments recorded on a recurring basis for the year ended December 31:

		2008				2007
Level 3 inputs — January 1		$	12,694			$	13,723
Purchases			2,307				—
Maturities			(1,255	)			(1,029	)
Transfers of securities into level 3 due to changes in the observability of significant inputs (illiquid markets)			11,000				—
Net unrealized losses on available-for-sale investment securities			(5,355	)			—
Level 3 inputs — December 31		$	19,391			$	12,694

The tables below present the recorded amount of assets and liabilities measured atequity securities without readily determinable fair value on December 31:

		2008
Description		Total				(Level 1)				(Level 2)				(Level 3)
Recurring Items
Trading securities		$	21,775			$	10,175			$	11,600			$	—
Investment securities available for sale			246,455				89,507				137,557				19,391
Mortgage loans available for sale			898				—				898				—
Other borrowed funds			23,130				23,130				—				—
Nonrecurring Items
Impaired loans			10,014				—				—				10,014
Mortgage servicing rights			2,105				—				2,105				—
Foreclosed assets			2,923				—				2,923				—

values.

5767

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

		2007
Description		Total				(Level 1)				(Level 2)				(Level 3)
Recurring Items
Trading securities		$	25,064			$	14,741			$	10,323			$	—
Investment securities available for sale			213,127				57,871				142,562				12,694
Mortgage loans available for sale			2,214				—				2,214				—
Other borrowed funds			7,523				7,523				—				—
Nonrecurring Items
Impaired loans			3,779				—				—				3,779
Mortgage servicing rights			2,198				—				2,198				—
Foreclosed assets			1,376				—				1,376				—

The Corporation had 10.8% and 6.5% of Level 3 assets as a percentage of total assets and liabilities measured at fair value as of December 31, 2008 and 2007, respectively.

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 years ended December 31, 2008 and 2007, are summarized as follows:

		Year Ended December 31
		2008												2007
		Trading				Other								Trading				Other
		Gains and				Gains and								Gains and				Gains and
Description		(Losses)				(Losses)				Total				(Losses)				(Losses)				Total
Recurring Items
Trading securities		$	245			$	—			$	245			$	460			$	—			$	460
Other borrowed funds			—				(641	)			(641	)			—				(66	)			(66	)
Nonrecurring Items
Impaired loans			—				(71	)			(71	)			—				—				—
Mortgage servicing rights			—				(115	)			(115	)			—				(5	)			(5	)
Foreclosed assets			—				(231	)			(231	)			—				(109	)			(109	)
										$	(813	)										$	280

During 2008, primarily as a result of declines in the rates offered on new residential mortgage loans, the Corporation recorded impairment charges of $115 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 impairment charges to foreclosed assets were the result of the real estate held declining in value subsequent to the properties being transferred to other real estate.

The activity in the trading portfolio of investment securities was as follows for the years ended December 31, 2008 and 2007:

		2008				2007
Purchases		$	11,010			$	7,654
Sales, calls, and maturities			(14,544	)			(62,248	)
Total		$	(3,534	)		$	(54,594	)

58

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The net loss on trading securities represents mark-to-market adjustments. Included in the net trading losses of $245 during 2008, was $262 of net trading gains on securities that were held in the Corporation’s trading portfolio as of December 31, 2008.

The activity in borrowings carried at fair value was as follows for years ended December 31, 2008 and 2007:

		2008				2007
Issuances		$	15,000			$	—
Sales, calls, and maturities			(34	)			(31	)
Total		$	14,966			$	(31	)

Note 21 —	Fair Values of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the estimated amounts provided herein do not necessarily indicate amounts which could be realized in a current exchange. Furthermore, as the Corporation typically holds the majority of its financial instruments until maturity, it does not expect to realize all of the estimated amounts disclosed. The disclosures also do not include estimated fair value amounts for items which are not defined as financial instruments, but which have significant value. These include such items as core deposit intangibles, the future earnings of significant customer relationships and the value of other fee generating businesses. The Corporation believes the imprecision of an estimate could be significant.

The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments.

Cash and cash equivalents:

The carrying amounts of cash and short-term instruments approximate fair values.

Investment securities:

Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are unavailable, fair values are based on quoted market prices of comparable instruments or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions.

Mortgage loans available for sale:

Fair values of mortgage loans available for sale are based on commitments on hand from investors or prevailing market prices.

Loans receivable:

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

59

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

MortgageForeclosed assets:

Upon transfer from the loan portfolio, foreclosed assets are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral and as such, the Corporation classifies foreclosed assets as a nonrecurring Level 2. When management determines that the net realizable value of the collateral is further impaired below the appraised value but there is no observable market price, the Corporation records the foreclosed asset as nonrecurring Level 3.

Originated mortgage servicing rights:

 

Fair value is determined using prices for similar assets with similar characteristics when applicable, or based uponOriginated mortgage servicing rights are subject to impairment testing. A valuation model, which utilizes a discounted cash flow analyses.analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and a discount rate determined by management, is used for impairment testing. If the valuation model reflects a value less than the carrying value, originated mortgage servicing rights are adjusted to fair value through a valuation allowance as determined by the model. As such, the Corporation classifies loan servicing rights subject to nonrecurring fair value adjustments as Level 2.

 

Deposit liabilities:Deposits:

 

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

 

Short-term borrowings:Borrowed funds:

 

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

Borrowings:

 

The Corporation has elected to measure a portion of borrowed funds at fair values of the Corporation’s long-termvalue. These borrowings are recorded at fair value on a recurring basis, with the fair value measurement estimated using discounted cash flow analysesanalysis based on the Corporation’s current incremental borrowing arrangements. The carrying amounts of federal funds purchased and borrowings under repurchase agreements approximate their fair value. The fair values of other borrowings are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements. Changes in the fair value of these borrowings are included in noninterest income. As such, the Corporation classifies other borrowed funds as Level 2.

 

Accrued interest:

The carrying amountsCommitments to extend credit, standby letters of accrued interest approximate fair value.

Derivative financial instruments:credit and undisbursed loans:

 

Fair values for derivative loan commitments and forward loan sale commitments are based on fair values of the underlying mortgage loans and the probability of such commitments being exercised.

Off-balance-sheet credit-related instruments:

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

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

6068

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following sets forthtable below represents the estimated fair value and recorded carrying values ofactivity inavailable-for-sale investment securities measured with Level 3 inputs on a recurring basis for the Corporation’s financial instruments as ofyears ended December 31:

 

		2008								2007
		Estimated				Carrying				Estimated				Carrying
		Fair Value				Value				Fair Value				Value
ASSETS
Cash and demand deposits due from banks		$	23,554			$	23,554			$	25,583			$	25,583
Trading securities			21,775				21,775				25,064				25,064
Investment securities available for sale			246,455				246,455				213,127				213,127
Mortgage loans available for sale			905				898				2,228				2,214
Net loans			743,110				723,403				606,840				605,386
Accrued interest receivable			6,322				6,322				5,948				5,948
Mortgage servicing rights			2,105				2,105				2,198				2,198
LIABILITIES
Deposits with no stated maturities			394,042				394,042				387,054				387,054
Deposits with stated maturities			387,291				381,588				348,488				346,419
Borrowed funds			230,130				222,350				91,897				92,887
Accrued interest payable			1,334				1,334				1,284				1,284

		2010				2009
Level 3 inputs — January 1		$	10,027			$	5,979
Net unrealized (losses) gains onavailable-for-sale investment securities			(226	)			4,048
Level 3 inputs — December 31		$	9,801			$	10,027

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

		Year Ended December 31
		2010												2009
		Trading												Trading
		Gains and				Other Gains								Gains and				Other Gains
Description		(Losses)				and (Losses)				Total				(Losses)				and (Losses)				Total
Recurring items
Trading securities		$	(94	)		$	—			$	(94	)		$	80			$	—			$	80
Borrowed funds			—				227				227				—				289				289
Nonrecurring items
Foreclosed assets			—				(180	)			(180	)			—				(157	)			(157	)
Originated mortgage servicing rights			—				1				1				—				7				7
Total		$	(94	)		$	48			$	(46	)		$	80			$	139			$	219

The activity in borrowings which the Corporation has elected to carry at fair value was as follows for the years ended December 31:

		2010				2009
Borrowings carried at fair value — January 1		$	17,804			$	23,130
Paydowns and maturities			(7,154	)			(5,037	)
Net change in fair value			(227	)			(289	)
Borrowings carried at fair value — December 31		$	10,423			$	17,804
Unpaid principal balance — December 31		$	10,000			$	17,154

69

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 2220 —	Parent Company Only Financial Information (Unaudited)

 

Condensed Balance Sheets

 

		December 31								December 31
		2008				2007				2010				2009
ASSETS	ASSETS								ASSETS
Cash on deposit at subsidiary Bank		$	1,144			$	14,265			$	301			$	172
Securities available for sale			2,140				2,210				1,929				2,073
Investments in subsidiaries			82,673				77,486				94,668				89,405
Premises and equipment			2,043				3,637				1,952				2,346
Other assets			52,096				26,309				53,481				53,644
Total Assets		$	140,096			$	123,907			$	152,331			$	147,640
																	LIABILITIES AND SHAREHOLDERS’ EQUITY
Other liabilities		$	5,620			$	827			$	7,170			$	6,837
Shareholders’ equity			134,476				123,080				145,161				140,803
Total Liabilities and Shareholders’ Equity		$	140,096			$	123,907
Total Liabilities And Shareholders’ Equity										$	152,331			$	147,640

61

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Statements of Income

 

						Year Ended December 31												Year Ended December 31
						2008				2007				2006				2010				2009				2008
Income
Dividends from subsidiaries						$	5,800			$	15,975			$	4,025			$	6,250			$	6,100			$	5,800
Interest income							88				177				305				72				77				88
Management fee and other							1,011				1,517				1,280				1,340				993				1,011
Total income							6,899				17,669				5,610				7,662				7,170				6,899
Expenses							3,989				3,890				3,872
Salaries and benefits																			2,286				2,112				1,819
Occupancy and equipment																			356				430				435
Audit and SOX compliance fees																			476				291				376
Other																			932				1,074				1,359
Total expenses																			4,050				3,907				3,989
Income before income tax benefit and equity in undistributed earnings of subsidiaries							2,910				13,779				1,738				3,612				3,263				2,910
Federal income tax benefit							905				773				825				896				976				905
							3,815				14,552				2,563				4,508				4,239				3,815
Undistributed earnings (distributions in excess of earnings) of subsidiaries							286				(6,622	)			4,438
Undistributed earnings of subsidiaries																			4,537				3,561				286
Net income						$	4,101			$	7,930			$	7,001			$	9,045			$	7,800			$	4,101

6270

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Statements of Cash Flows

		Year Ended December 31
		2008				2007				2006
Operating Activities
Net income		$	4,101			$	7,930			$	7,001
Adjustments to reconcile net income to cash provided by operations
Undistributed earnings of subsidiaries			(286	)			6,622				(4,438	)
Share based payment awards			603				758				470
Depreciation			294				592				591
Net amortization of investment securities			5				4				21
Realized loss on sale of investment securities			—				—				8
Deferred income taxes (benefit)			162				(165	)			128
Changes in operating assets and liabilities which provided (used) cash Interest receivable			1				(2	)			29
Other assets			(817	)			(776	)			(522	)
Accrued interest and other expenses			583				(389	)			138
Net Cash Provided by Operating Activities			4,646				14,574				3,426
Investing Activities
Activity in available-for-sale securities
Maturities, calls, and sales			110				595				6,650
Purchases			—				(266	)			(4,380	)
Sales (purchases) of equipment and premises			1,300				(1,135	)			(660	)
Advances to subsidiaries			(11,927	)			(50	)			(8,394	)
Net Cash Used in Investing Activities			(10,517	)			(856	)			(6,784	)
Financing Activities
Net increase in other borrowed funds			1,836				—				—
Cash dividends paid on common stock			(4,873	)			(4,304	)			(3,775	)
Proceeds from the issuance of common stock			2,476				2,657				2,459
Common stock repurchased			(6,440	)			(1,881	)			—
Common stock purchased for deferred compensation obligations			(249	)			—				—
Net Cash Used in Financing Activities			(7,250	)			(3,528	)			(1,316	)
(Decrease) Increase in Cash and Cash Equivalents			(13,121	)			10,190				(4,674	)
Cash and cash equivelants at beginning of year			14,265				4,075				8,749
Cash and Cash Equivalents at End of Year		$	1,144			$	14,265			$	4,075

63

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		Year Ended December 31
		2010				2009				2008
Operating Activities
Net income		$	9,045			$	7,800			$	4,101
Adjustments to reconcile net income to cash provided by operations
Undistributed earnings of subsidiaries			(4,537	)			(3,561	)			(286	)
Share based payment awards			650				677				603
Depreciation			147				163				294
Net amortization of investment securities			5				6				5
Deferred income tax (benefit) expense			(172	)			(570	)			162
Changes in operating assets and liabilities which provided (used) cash
Other assets			298				(748	)			(816	)
Accrued interest and other liabilities			1,883				517				583
Net Cash Provided by Operating Activities			7,319				4,284				4,646
Investing Activities
Activity inavailable-for-sale securities
Maturities, calls, and sales			110				110				110
Sales (purchases) of equipment and premises			247				(466	)			1,300
Advances to subsidiaries			(250	)			—				(11,927	)
Net Cash Provided by (Used in) Investing Activities			107				(356	)			(10,517	)
Financing Activities
Net (decrease) increase in other borrowed funds			(1,550	)			700				1,836
Cash dividends paid on common stock			(5,421	)			(5,256	)			(4,873	)
Proceeds from the issuance of common stock			2,208				2,479				2,476
Common stock repurchased			(2,020	)			(2,056	)			(6,440	)
Common stock purchased for deferred compensation obligations			(514	)			(767	)			(249	)
Net Cash Used in Financing Activities			(7,297	)			(4,900	)			(7,250	)
Increase (Decrease) in Cash and Cash Equivalents			129				(972	)			(13,121	)
Cash and cash equivelants at beginning of year			172				1,144				14,265
Cash And Cash Equivalents at End of Year		$	301			$	172			$	1,144

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 2321 —	Operating Segments

 

In prior years, theThe Corporation’s reportable segments wereare based on legal entities that account for at least 10%10 percent of net operating results. In April 2007, the individual bank charters of Isabella Bank and FSB Bank were consolidated into one bank charter as a part of the Corporation’s strategy to increase efficiencies. Retail banking operations for 2008, 2007,2010, 2009, and 20062008 represent approximately 90% or greater of the Corporation’s total assets and operating results. As such, no additional segment information is presented.

Note 24 —	Adjustments Affecting Fourth Quarter Results of Operations

In the fourth quarter of 2008, due to the increased deterioration of the overall credit quality of the Corporation’s loan portfolio as well as the increased uncertainty related to the overall stability of the economy, the Corporation recorded a provision for loan losses in the amount of $5,725, which contributed to a net operating loss of $2,041 for the three months ended December 31, 2008. Management does not believe this adjustment is attributable to conditions that were apparent in previous quarters. The aggregate effect of the $5,725 provision for loan losses ($3,779 net of tax) was to reduce net income per share by $0.50.

6471

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Management’s Discussion and Analysis of Financial Condition and Results of OpearationsOperations

 

ISABELLA BANK CORPORATION FINANCIAL REVIEW

(All dollars in thousands)

 

The following is management’s discussion and analysis of the financial condition and results of operations for Isabella Bank Corporation (the “Corporation”).Corporation. This discussion and analysis is intended to provide a better understanding of the consolidated financial statements and statistical data included elsewhere in the Annual Report. The Corporation’s significant acquisitions of Greenville Community Financial

Executive Summary

Isabella Bank Corporation, as well as all other financial institutions in January 2008Michigan and Farwell State Savings Bank in October 2006 were accounted for as purchase transactions, and as such,across the related results ofentire country, continues to experience the negative impacts on its operations are included from the dates of acquisition. See “Note 2 — Business Combinationsrecent economic recession and Joint Venture Formation”the subsequent recovery. This recession, which began in the accompanying Notes to Consolidated Financial Statements included elsewherefourth quarter of 2008, has resulted in the report.

During 2008, as a resulthistorically high levels of a significant downturn in economy, the Corporation experienced significant increases in past dueloan delinquencies and nonaccrual loans. This increase in delinquencies has led to dramaticloans, which have translated into increases in net loans charged off as well asand foreclosed asset and collection expenses. For further discussion and analysis, see below.Additionally, there have been announcements by several large banks stating that they have halted foreclosures due to a failure to properly prepare the documents to complete the foreclosure process. Isabella Bank Corporation has, to its knowledge, materially complied with all laws governing foreclosures.

 

Despite the recent economic downturn, the Corporation continues to be profitable, with net income of $9,045 for the year ended December 31, 2010. The Corporation’s nonperforming loans represented 0.83% of total loans as of December 31, 2010 which declined from 1.28% as of December 31, 2009. The ratio of nonperforming loans to total loans for all banks in the Corporation’s peer group was 3.71% as of September 30, 2010 (December 31, 2010 peer group ratios are not yet available). The Corporation’s interest margins also continue to be strong, as the net yield on interest earning assets (on a fully tax equivalent basis) was 4.04% for the year ended December 31, 2010.

New Branch Office

As part of the Corporation’s effort to expand its market area, the Corporation opened a new branch in Midland, Michigan in the third quarter of 2010. The new full service office will expand the Corporation’s presence in the Midland area as a source for both commercial and consumer loans and deposits.

Recent Legislation

The recently passed Health Care and Education Act of 2010 and the Patient Protection and Affordable Care Act could have a significant impact on the Corporation’s operating results in future periods. Aside from the potential increases in the Corporation’s health care costs, the implementation of the new rules and requirements is likely to require a substantial commitment from the Corporation’s management.

The recently enacted Dodd-Frank Act is very broad and complex legislation that puts in place a sweeping new financial services framework that is likely to have significant regulatory and legal consequences and will likely impact the Corporation’s future operating results. Implementation of the Act will require compliance with numerous new regulations, which will increase compliance and documentation costs. For more information, see the summary of the Dodd-Frank Act under the heading “Regulation” in Item 1, included in the Corporation’s 2010 annual report onForm 10-K.

In September 2010, Congress passed and the President signed into law the Small Business Lending Bill which includes access to capital for community banks. The Corporation continues to be well capitalized and profitable and is not expecting to participate in the program.

Shareholder Stock Purchase Program

The Corporation recently amended its Dividend Reinvestment and Employee Stock Purchase Plan to allow for any current shareholders to purchase additional shares of the Corporation’s stock directly from the Corporation beginning in the fourth quarter of 2010. For more information regarding that amendment, see theForm S-3D that the Corporation filed with the SEC on October 1, 2010.

Other

The Corporation has not received any notices of regulatory actions as of February 28, 2011.

72

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Critical Accounting Policies:

 

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

 

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

 

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

 

The Corporation currently has bothavailable-for-sale and trading investment securities that are carried at their fair value. Changes in the fair value ofavailable-for-sale investment securities are included inas a component of other comprehensive income, while declines in the fair value of these securities below their cost that are other than temporaryother-than-temporary are reflected as realized losses.losses in the consolidated statements of income. The change in value of trading investment securities is included in current earnings.

Management evaluates securities for indications of losses that are consideredother-than-temporary, if any, on a regular basis. The market values foravailable-for-sale and trading investment securities are typically obtained from outside sources and applied to individual securities within the portfolio.

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

Due to the limited trading activity of these securities, the fair values of investment securities with illiquid markets arewere estimated utilizing a discounted cash flow analysis or other typeas of valuation adjustment methodology.December 31, 2010 and December 31, 2009. These analyses considered creditworthiness of the counterparty, the timing of expected future cash flows, and the current volume of trading activity. The discount rates used were determined by using the interest rates of similarly rated financial institutions debt based on the weighted average of a range of terms for corporate bond interest rates, which were obtained from published sources. All securities have call dates within the next year. The Corporation calculated the present value assuming a 30 year nonamortizing balloon using weighted average discount rates between 3.88% and 6.87% as of December 31, 2010.

As of December 31, 2010, the Corporation held an auction rate money market preferred security and preferred stock which declined in fair value as a result of the securities’ interest rates, as they are also compared, when possible, to othercurrently lower than the offering rates of securities with similar characteristics. Despite the limited trading of these securities, management has determined that any declines in the fair value of these securities are the result of changes in interest rates and not risks related to the underlying credit quality of the security. Additionally, none of these securities are deemed to be below investment grade, and management does not intend to sell the securities in an unrealized loss position, and it is more likely than not that the Corporation will not have to sell the securities before recovery of their cost basis. As

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a result, the Corporation has not recognized another-than-temporary impairment related to these declines in fair value.

DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS’ EQUITY
INTEREST RATE AND INTEREST DIFFERENTIAL

 

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

 

		2008												2007												2006												Year Ended
						Tax				Average								Tax				Average								Tax				Average				December 31, 2010												December 31, 2009												December 31, 2008
		Average				Equivalent				Yield/				Average				Equivalent				Yield/				Average				Equivalent				Yield/								Tax				Average								Tax				Average								Tax				Average
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate				Average				Equivalent				Yield/				Average				Equivalent				Yield/				Average				Equivalent				Yield/
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
INTEREST EARNING ASSETS:
INTEREST EARNING ASSETS
Loans		$	717,040			$	49,674				6.93	%		$	604,342			$	43,808				7.25	%		$	522,726			$	36,575				7.00	%		$	725,534			$	46,794				6.45	%		$	725,299			$	47,706				6.58	%		$	717,040			$	49,674				6.93	%
Taxable investment securities			108,919				5,433				4.99	%			68,398				3,751				5.48	%			123,316				4,948				4.01	%			160,514				5,271				3.28	%			119,063				4,712				3.96	%			108,919				5,433				4.99	%
Nontaxable investment securities			121,220				7,218				5.95	%			96,789				5,726				5.92	%			75,712				4,423				5.84	%			120,999				7,095				5.86	%			121,676				7,217				5.93	%			121,220				7,218				5.95	%
Trading account securities			26,618				1,305				4.90	%			50,904				2,298				4.51	%			—				—				—				8,097				436				5.38	%			17,279				856				4.95	%			26,618				1,305				4.90	%
Federal funds sold			5,198				110				2.12	%			6,758				342				5.06	%			2,762				139				5.03	%			—				—				—				842				1				0.12	%			5,198				110				2.12	%
Other			17,600				433				2.46	%			7,143				317				4.44	%			5,012				250				4.99	%			45,509				479				1.05	%			27,433				376				1.37	%			17,600				433				2.46	%
Total earning assets			996,595				64,173				6.44	%			834,334				56,242				6.74	%			729,528				46,335				6.35	%			1,060,653				60,075				5.66	%			1,011,592				60,868				6.02	%			996,595				64,173				6.44	%
NON EARNING ASSETS:
NON EARNING ASSETS
Allowance for loan losses			(8,606	)											(7,603	)											(7,187	)											(13,262	)											(12,334	)											(8,606	)
Cash and due from banks			18,582												20,588												24,351
Cash and demand deposits due from banks																																							18,070												18,190												18,582
Premises and equipment			22,905												21,507												17,690												24,624												23,810												22,905
Accrued income and other assets			83,626												56,805												35,792												92,845												86,376												83,626
Total assets		$	1,113,102											$	925,631											$	800,174											$	1,182,930											$	1,127,634											$	1,113,102
INTEREST BEARING LIABILITIES:
INTEREST BEARING LIABILITIES
Interest bearing demand deposits		$	114,889				813				0.71	%		$	109,370				1,880				1.72	%		$	105,476				1,664				1.58	%		$	137,109				151				0.11	%		$	116,412				146				0.13	%		$	114,889				813				0.71	%
Savings deposits			213,410				2,439				1.14	%			188,323				4,232				2.25	%			158,327				2,675				1.69	%			169,579				391				0.23	%			177,538				399				0.22	%			213,410				2,439				1.14	%
Time deposits			393,190				16,621				4.23	%			349,941				16,493				4.71	%			301,593				12,825				4.25	%			430,892				10,988				2.55	%			398,356				13,043				3.27	%			393,190				16,621				4.23	%
Other borrowed funds			145,802				5,733				3.93	%			68,586				3,354				4.89	%			53,256				2,568				4.82	%
Borrowed funds																																							188,512				5,674				3.01	%			193,922				6,251				3.22	%			145,802				5,733				3.93	%
Total interest bearing liabilities			867,291				25,606				2.95	%			716,220				25,959				3.62	%			618,652				19,732				3.19	%			926,092				17,204				1.86	%			886,228				19,839				2.24	%			867,291				25,606				2.95	%
NONINTEREST BEARING LIABILITIES:
NONINTEREST BEARING LIABILITIES
Demand deposits			95,552												80,128												73,650												102,812												94,408												95,552
Other			6,633												10,037												15,908												14,171												7,188												6,633
Shareholders’ equity			143,626												119,246												91,964												139,855												139,810												143,626
Total liabilities and equity		$	1,113,102											$	925,631											$	800,174
Total liabilities and shareholders’ equity																																						$	1,182,930											$	1,127,634											$	1,113,102
Net interest income (FTE)						$	38,567											$	30,283											$	26,603											$	42,871											$	41,029											$	38,567
Net yield on interest earning assets (FTE)											3.87	%											3.63	%											3.65	%											4.04	%											4.06	%											3.87	%

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Net Interest Income

 

The Corporation derives the majority of its gross income from interest earned on loans and investments, while its most significant expense is the interest cost incurred for funds used. Net interest income is the amount by which interest income on earning assets exceeds the interest cost of deposits and borrowings. Net interest income is influenced by changes in the balance and mix of assets and liabilities and market interest rates. Management exerts

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some control over these factors; however, Federal Reserve monetary policy and competition have a significant impact. Interest income includes loan fees of $2,196, in 2010, $1,963 in 2009, and $1,808 in 2008, $1,330 in 2007, and $1,172 in 2006.2008. For analytical purposes, net interest income is adjusted to a “taxable equivalent” basis by adding the income tax savings from interest on tax-exempttax exempt loans and securities, thus making year-to-yearyear to year comparisons more meaningful.

 

VOLUME AND RATE VARIANCE ANALYSIS

 

The following table details the dollar amount of changes in FTE net interest income for each major category of interest earning assets and interest bearing liabilities and the amount of change attributable to changes in average balances (volume) or average rates. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

 

		2008 Compared to 2007												2007 Compared to 2006												2010 Compared to 2009												2009 Compared to 2008
		Increase (Decrease) Due to												Increase (Decrease) Due to												Increase (Decrease) Due to												Increase (Decrease) Due to
		Volume				Rate				Net				Volume				Rate				Net				Volume				Rate				Net				Volume				Rate				Net
CHANGES IN INTEREST INCOME:
Loans		$	7,877			$	(2,011	)		$	5,866			$	5,878			$	1,355			$	7,233			$	15			$	(927	)		$	(912	)		$	567			$	(2,535	)		$	(1,968	)
Taxable investment securities			2,048				(366	)			1,682				(2,647	)			1,450				(1,197	)			1,453				(894	)			559				474				(1,195	)			(721	)
Nontaxable investment securities			1,454				38				1,492				1,246				57				1,303				(40	)			(82	)			(122	)			27				(28	)			(1	)
Trading account securities			(1,176	)			183				(993	)			2,298				—				2,298				(489	)			69				(420	)			(463	)			14				(449	)
Federal funds sold			(66	)			(166	)			(232	)			202				1				203				(1	)			—				(1	)			(51	)			(58	)			(109	)
Other			306				(190	)			116				97				(30	)			67				205				(102	)			103				182				(239	)			(57	)
Total changes in interest income			10,443				(2,512	)			7,931				7,074				2,833				9,907				1,143				(1,936	)			(793	)			736				(4,041	)			(3,305	)
CHANGES IN INTEREST EXPENSE:
Interest bearing demand deposits			90				(1,157	)			(1,067	)			63				153				216				24				(19	)			5				11				(678	)			(667	)
Savings deposits			505				(2,298	)			(1,793	)			568				989				1,557				(18	)			10				(8	)			(353	)			(1,687	)			(2,040	)
Time deposits			1,924				(1,796	)			128				2,189				1,479				3,668				1,002				(3,057	)			(2,055	)			216				(3,794	)			(3,578	)
Other borrowings			3,146				(767	)			2,379				749				37				786
Borrowed funds																											(171	)			(406	)			(577	)			1,672				(1,154	)			518
Total changes in interest expense			5,665				(6,018	)			(353	)			3,569				2,658				6,227				837				(3,472	)			(2,635	)			1,546				(7,313	)			(5,767	)
Net change in interest margin (FTE)		$	4,778			$	3,506			$	8,284			$	3,505			$	175			$	3,680			$	306			$	1,536			$	1,842			$	(810	)		$	3,272			$	2,462

 

Despite a $49,061 increase in interest earning assets in 2010, the $1,842 increase in FTE net interest income was primarily the result of interest rates on interest bearing liabilities decreasing faster than rates earned on interest earning assets. The Corporation as well as all other financial institutions, has experienced dramatic changes in interest rates in the last two years. Since September of 2007, the Federal Reserve Bank (“The Fed”) has lowered its target Fed Funds rate from 5.25% to its current level of 0.00% - 0.25%. The Fed’s actions are a result of significant weakening of the Nation’s economy.

The Corporation’s balance sheet was well positioned to protect interest margins in this decreasing rate environment and provided stronganticipates that net interest margin growth in 2008. Interest margins are likely to decrease in 2009yield will decline slightly during 2011 due to the following three factors:

 

	•	While the Corporation’s liability sensitive balance sheet has allowed it to benefit from decreases in interest rates, it also makes the Corporation sensitive to increases in deposit and borrowing rates. As part of the Corporation’s goal to minimize the potential negative impacts of possible increases in future interest rates, management is actively working to lengthen the terms of its interest bearing liabilities. This lengthening has increased the Corporation’s cost of funding, reducing net interest income in the short term.
	•	Based on the current economic conditions, management does not anticipate any changes in the target Fed Funds during 2009.funds rate in the foreseeable future. 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, due to securities which may be called or will mature in 2011, as securities with call dates during 2009these funds will most likely be called and the Corporation will be reinvesting those proceedsreinvested at significantly lower rates.

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	•	The recent substantialInterest rates on residential mortgage loans remain at or near historical lows. This rate environment has led to strong consumer demand for fixed rate mortgage products which are generally sold to the secondary market. As a result, there has been a significant decline in residential mortgage rates will also result in movement of the Corporation’s customers from its three and five year balloon mortgages, to fixed rate products thatwhich are soldheld on the secondary market. The reinvestmentCorporation’s balance sheet. As these balloon mortgages have paid off, the proceeds from these loans have been reinvested (typically in the form of these proceedsavailable-for-sale investment securities) at lower interest rates willwhich has adversely impactimpacted interest income.
	•	The Corporation experiencedLoan growth has been minimal during 2010. As a significant increase in non-accrualresult, funds were reinvested from higher yielding loans in the fourth quarter of 2008. 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. Theinto lower yielding investments.

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	•	increase in non-accrualThe interest rates on many types of loans will decrease 2009including home equity lines of credit, residential balloon mortgages, variable rate commercial lines of credit, and investment securities with acceptable credit and interest rate risks are currently priced at or below the Corporation’s current net yield on interest earning assets. In order to earn additional net interest income, as thesethe Corporation is continuing to extend loans and purchase investments that will no longer be accruingincrease net income but decrease net interest income.margin yield.

 

Net yield on interest earning assets increased by 0.24% when 2008 is compared to 2007. The primary reason for this increase was that in early 2007, the Corporation, as part of a balance sheet management strategy, extended the maturities of interest earning assets, which as interest rates declined in the latter half of 2007, had a positive impact on interest margins as the cost of funding sources decreased more rapidly than the rates earned on interest earning assets. Another contributing factor for the increase in margins was a result of the loan growth, primarily in higher yielding commercial loans.

The above mentioned balance sheet reorganization strategy was accelerated by the Corporation’s election to early adopt Statement of Financial Accounting Standards (“SFAS”) No. 159,The Fair Value Option for Financial Assets and Financial Liabilities, and SFAS No. 157,Fair Value Measurements, effective January 1, 2007. The purpose of the early adoption of these standards was to not only provide the Corporation with an opportunity to accelerate the restructuring of its balance sheet, but also to better manage interest rate risk now and in the future.

Overall FTE net interest margin increased by $8,284 for the year ended December 31, 2008 as compared to the same period in 2007. Changes in volume provided an additional $4,778 of net interest margin, while changes in interest rates, both earned and paid, provided an additional $3,506 of net interest margin. During 2008, the rates paid on interest bearing liabilities decreased by 0.67% while those earned on interest earning assets declined by only 0.30%.

Net FTE interest income increased $3,680 for the year ended December 31, 2007 when compared to the same period in 2006. The net increase from the change in volume of interest earning assets and interest bearing liabilities was $3,505 in 2007. Net interest income increased $175 as a result of interest rate changes. During 2007, the rates paid on interest bearing liabilities increased 0.43%, while those earned on interest earning assets increased 0.39%. The decline in interest rate spread is a direct result of the continued use of high cost funding sources such as certificates of deposit and other borrowed funds. The increase in the cost of these deposits in relation to other sources is a result of continued competition for retail deposits.

Provision for Loan LossesALLOWANCE FOR LOAN LOSSES

 

The provision for loan losses representsviability of any financial institution is ultimately determined by its management of credit risk. Loans outstanding represent the current period loan cost associated with maintaining an appropriateCorporation’s single largest concentration of risk. The allowance for loan losses as determined by management. Periodic fluctuations(“ALLL”) is management’s estimation of losses in the provision for loan losses result from management’s best estimates as to the adequacy of the allowance for loan losses to absorb probable losses within the existing loan portfolio. The provision for loan losses for each period is further dependent upon many factors, including loan growth, net charge-offs, changes in the composition ofFactors used to evaluate the loan portfolio, delinquencies, assessment by management, third parties and banking regulatorsthus to determine the current charge to expense, include recent loan loss history, financial condition of the qualityborrowers, amount of the loan portfolio, the value of the underlying collateral on problemnonperforming and impaired loans, and the generaloverall economic conditions, in our market areas.and other factors.

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

 

		Year Ended December 31,																				Year Ended December 31
		2008				2007				2006				2005				2004				2010				2009				2008				2007				2006
Allowance for loan losses — January 1		$	7,301			$	7,605			$	6,899			$	6,444			$	6,204			$	12,979			$	11,982			$	7,301			$	7,605			$	6,899
Allowance of acquired bank			822				—				726				—				—				—				—				822				—				726
Loans charged off
Commercial and agricultural			2,137				905				368				101				561				3,731				3,081				2,137				905				368
Real estate mortgage			3,334				659				252				166				—				2,524				2,627				3,334				659				252
Consumer			854				582				529				376				374				596				934				854				582				529
Total loans charged off			6,325				2,146				1,149				643				935				6,851				6,642				6,325				2,146				1,149
Recoveries
Commercial and agricultural			160				297				136				105				191				453				623				160				297				136
Real estate mortgage			240				49				53				—				62				638				546				240				49				53
Consumer			284				285				258				216				187				297				377				284				285				258
Total recoveries			684				631				447				321				440				1,388				1,546				684				631				447
Net loans charged off			5,641				1,515				702				322				495				5,463				5,096				5,641				1,515				702
Provision charged to income			9,500				1,211				682				777				735				4,857				6,093				9,500				1,211				682
Allowance for loan losses — December 31		$	11,982			$	7,301			$	7,605			$	6,899			$	6,444			$	12,373			$	12,979			$	11,982			$	7,301			$	7,605
Year to date average loans		$	717,040			$	604,342			$	522,726			$	466,001			$	437,438			$	725,534			$	725,299			$	717,040			$	604,342			$	522,726
Net loans charged off to average loans outstanding			0.79	%			0.25	%			0.13	%			0.07	%			0.11	%			0.75	%			0.70	%			0.79	%			0.25	%			0.13	%
Total amount of loans outstanding		$	735,385			$	612,687			$	591,042			$	483,242			$	452,895			$	735,304			$	723,316			$	735,385			$	612,687			$	591,042
Allowance for loan losses as a % of loans			1.63	%			1.19	%			1.29	%			1.43	%			1.42	%			1.68	%			1.79	%			1.63	%			1.19	%			1.29	%

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During 2008, the Corporation experienced a significant increase in total loans charged off, primarily in the form of residential real estate mortgages; total loans charged off increased by $4,179 to $6,325. As a result of the increasesrecent economic recession, residential real estate values in loans charged off, as well as local and regional economic uncertainties of the Corporation’s loan portfolio,market areas have declined. These declines are the Corporation recorded a provision for loan loss in the amountresult of $5,725 in the fourth quarter of 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. This increased inventory is partially the result of the inability of potential home buyers to obtain financing due to the tightening of loan underwriting criteria by many financial institutions, brokers and government sponsored agencies and uncertainties associated with industry wide concerns over the foreclosure process. While the Corporation has maintained traditional lending standards, the decline in real estate values has had an adverse impact on customers who are experiencing financial difficulties. Historically, customers who experienced difficulties were able to sell their properties for more than the loan balance owed. The inventory of unsold homessteep decline in real estate values has not reached these levels since the 1991 recession. The combination of all of these factors is expecteddiminished homeowner equity and led borrowers who are experiencing financial difficulties to further reduce average home values and thus homeowner’s equitydefault on a national level.their mortgage loans.

 

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

 

With increasesAs shown in the preceding table, when comparing 2010 to 2009, net loans charged off increased by $367. This increase is primarily related to average loans and nonperforming loans asone loan, for which a percentagecharge off of total loans,$1,000 was recorded in the Corporation increasedfourth quarter of 2010. Despite the provision charged to income in 2008. This additional provision increased the

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allowance for loans losses as a percentage of loans by 0.44% to 1.63%. The increase in net loans charged off, the allowance as a percentage of loans is the result of increases in charge offs in the current year, an increase in nonperforming loans, and the declinesoverall improvement in the credit quality of the Corporation’s loan portfolio. Management will continueportfolio has allowed the Corporation to closely monitorreduce its overallprovision for loan losses in 2010 when compared to 2009.

The Corporation allocates the allowance throughout its loan portfolio based on management’s assessment of the underlying risks associated with each loan segment. Management’s assessments include allocations based on specific impairment allocations, historical loss histories, internally assigned credit quality during 2009 to ensure thatratings, and past due and nonaccrual balances. A portion of the allowance for loan losses remains adequate.is not allocated to any one loan segment, but is instead a reflection of other qualitative risks within the Corporation’s loan portfolio.

 

BasedFor further discussion on management’s analysis,the allocation of the allowance for loan losses, of $11,982 is considered adequate as of December 31, 2008.see “Note 4 — Loans and Allowance for Loan Losses” to the Corporation’s consolidated financial statements.

 

Allocation of the Allowance for Loan LossesLoans Past Due and Loans in Nonaccrual Status

 

Increases in past due and nonaccrual loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, management analyzes its historical loss trends on loans past due30-89 days, 90 days or more, and nonaccrual loans.

The allowance for loan losses has been allocated according tofollowing tables summarize the amount deemed to be reasonably necessary to reflect for the probability of losses being incurred within the following categoriesCorporation’s past due and nonaccrual loans as of December 31:

 

		2008								2007								2006								2005								2004
						% of Each								% of Each								% of Each								% of Each								% of Each
						Category								Category								Category								Category								Category
		Allowance				to Total				Allowance				to Total				Allowance				to Total				Allowance				to Total				Allowance				to Total
		Amount				Loans				Amount				Loans				Amount				Loans				Amount				Loans				Amount				Loans
Commercial and agricultural		$	3,632				50.7	%		$	2,458				46.0	%		$	2,687				43.3	%		$	2,771				46.9	%		$	2,634				42.3	%
Real estate mortgage			3,832				43.4	%			1,341				48.6	%			1,367				50.9	%			1,192				46.8	%			1,463				50.5	%
Consumer installment			1,736				4.5	%			2,195				4.8	%			2,434				5.1	%			2,286				5.8	%			1,606				6.6	%
Impaired loans			2,065				1.4	%			703				0.6	%			594				0.7	%			184				0.5	%			304				0.6	%
Unallocated			717				0.0	%			604				0.0	%			523				0.0	%			466				0.0	%			437				0.0	%
Total		$	11,982				100.0	%		$	7,301				100.0	%		$	7,605				100.0	%		$	6,899				100.0	%		$	6,444				100.0	%

		Total Past Due and Nonaccrual
		2010				2009				2008				2007				2006
Commercial and agricultural		$	9,606			$	8,839			$	13,958			$	8,746			$	7,213
Residential mortgage			8,119				10,296				12,418				8,357				4,631
Consumer installment			309				460				956				617				360
		$	18,034			$	19,595			$	27,332			$	17,720			$	12,204

		2010
		Accruing Loans Past Due												Total
						Greater								Past Due
						Than								and
		30-89 Days				90 Days				Nonaccrual				Nonaccrual
Commercial and agricultural			5,291				175				4,140			$	9,606
Residential mortgage			6,339				310				1,470				8,119
Consumer installment			308				1				—				309
		$	11,938			$	486			$	5,610			$	18,034

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		2009
		Accruing Loans Past Due												Total
						Greater								Past Due
						Than								and
		30-89 Days				90 Days				Nonaccrual				Nonaccrual
Commercial and agricultural			2,567				462				5,810			$	8,839
Residential mortgage			7,352				287				2,657				10,296
Consumer installment			386				19				55				460
		$	10,305			$	768			$	8,522			$	19,595

 

ManagementRestructured Loans

The following table summarizes the Corporation’s restructured loans as of December 31:

		2010												2009												2008												2007				2006
		Accruing				Non-								Accruing				Non-								Accruing				Non-								Accruing				Accruing
		Interest				accrual				Total				Interest				accrual				Total				Interest				accrual				Total				Interest				Interest
Current		$	4,798			$	499			$	5,297			$	2,754			$	786			$	3,540			$	2,297			$	1,355			$	3,652			$	517			$	640
Past due30-89 days			277				26				303				107				904				1,011				268				—				268				115				57
Past due 90 days or more			—				163				163				—				426				426				—				630				630				53				—
Total		$	5,075			$	688			$	5,763			$	2,861			$	2,116			$	4,977			$	2,565			$	1,985			$	4,550			$	685			$	697

The Corporation had no restructured loans in nonaccrual status as of December 31, 2007 or 2006.

The Corporation has evaluated impairedtaken aggressive actions to avoid foreclosures on borrowers who are willing to work with the Corporation in modifying their loans, and believesthus making them more affordable. These loan restructurings have allowed borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure. Restructured loans that have been placed in nonaccrual status may be placed back on accrual status after six months of continuous performance.

To be classified as a restructured loan, the valuation allowanceconcessions granted to a customer who is experiencing financial difficulty must meet one of the following criteria:

1. Reduction of the stated interest rate related to thesethe sole purpose of providing payment and relief for the remaining original life of the debt.

2. Extension of the amortization period beyond typical lending guidelines.

3. Forbearance of principal.

4. Forbearance of accrued interest.

The following table displays the results of the Corporation’s efforts related to loans restructured since December 31, 2008:

		Successful								Unsuccessful								Total
		Number of				Amount of				Number of				Amount of				Number of				Amount of
		Loans				Loans				Loans				Loans				Loans				Loans
Reduction in interest rate			2			$	275				1			$	132				3			$	407
Extension of amortization			29				6,235				2				68				31				6,303
Reduction in interest rate and
extension of amortization			33				4,196				—				—				33				4,196
			64			$	10,706				3			$	200				67			$	10,906

Since December 31, 2008, the Corporation has not restructured any loans as a result of a forbearance of principal or accrued interest.

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The Corporation has restructured $10,906 of loans since December 31, 2008 and had $5,763 of loans classified as restructured as of December 31, 2010. While the number of loans restructured has increased in 2010, it is a reflection of the Corporation’s efforts to be adequate.work with customers to modify the terms of their loan agreements and an indicator that the local economy remains under stress.

 

Nonperforming Assets

 

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

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The following table presentssummarizes the Corporation’s nonperforming assets for the past five years:as of December 31:

 

Nonperforming Assets

		Year Ended December 31,
		2008				2007				2006				2005				2004				2010				2009				2008				2007				2006
Nonaccrual loans		$	11,175			$	4,156			$	3,444			$	1,375			$	1,900			$	5,610			$	8,522			$	11,175			$	4,156			$	3,444
Accruing loans past due 90 days or more			1,251				1,727				1,185				1,058				702				486				768				1,251				1,727				1,185
Restructured loans			4,550				685				697				725				686
Total nonperforming loans			16,976				6,568				5,326				3,158				3,288				6,096				9,290				12,426				5,883				4,629
Other real estate owned			2,770				1,376				562				122				40				2,039				1,141				2,770				1,376				562
Repossessed assets			153				—				—				—				—				28				16				153				—				—
Total nonperperforming assets		$	19,899			$	7,944			$	5,888			$	3,280			$	3,328
Total nonperforming assets																						$	8,163			$	10,447			$	15,349			$	7,259			$	5,191
Nonperforming loans as a% of total loans			2.31	%			1.07	%			0.90	%			0.65	%			0.73	%
Nonperforming loans as a % of total loans																							0.83	%			1.28	%			1.69	%			0.96	%			0.78	%
Nonperforming assets as a % of total assets			1.75	%			0.83	%			0.65	%			0.44	%			0.49	%			0.67	%			0.91	%			1.35	%			0.76	%			0.57	%

 

Due to the aforementioned residential real estate market difficulties inherent in the market, the Corporation has increased its efforts to identify potential problem loans. Residential real estate loansLoans are placed in nonaccrual status when the foreclosure process has begun, generally after a loan is 90 days past due, unless theresuch loan is well secured and in the process of collection. Upon transferring the loans to nonaccrual status, an abundance of collateral. Additionally, these loans are charged downevaluation to their estimateddetermine the net realizable value when placed on nonaccrual. Historically, residential real estate loans were placed in nonaccrual status upon reaching the beginning of the legally mandated borrower redemption period, whichunderlying collateral is typicallyperformed. This evaluation is used to help determine if any charge downs are necessary. Loans may be placed back on accrual status after six months. Chargeoffsmonths of any expected deficiency were recognized at the end of the six month redemption period. These efforts have had a significant impact on the increase in loans classified as nonaccrual as well as the increase in gross chargeoffs in 2008.continued performance.

 

The increasefollowing table summarizes the Corporation’s nonaccrual loan balances by type as of December 31:

		2010				2009				2008				2007				2006
Commercial and agricultural		$	4,140			$	5,810			$	8,059			$	1,959			$	2,887
Residential mortgage			1,470				2,657				3,092				2,185				557
Consumer installment			—				55				24				12				—
		$	5,610			$	8,522			$	11,175			$	4,156			$	3,444

Included in nonaccrual commercial and agricultural loans was one credit with a balance of $2,679 as of December 31, 2010. This credit is secured by unsold condominiums and undeveloped commercial real estate for which there has been a specific allocation established in the Corporation’s nonperformingamount of $345. Commercial and agricultural nonaccrual loans is primarily relatedincluded one credit with a balance of $1,800 as of December 31, 2009 which was subsequently transferred 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 the Bank’s carrying amount or fair value less costs to sell, as necessary. Management expects the balance of OREO to continue to increase throughout 2009 both as the result of increases in foreclosures as well as increases in the marketing time for home sales.third quarter of 2010. There were no other individually significant credits included in nonaccrual loans as of December 31, 2010, 2009, 2008, 2007, or 2006.

 

ManagementIncluded in the nonaccrual loan balances above were credits currently classified as restructured loans as of December 31:

		2010				2009				2008
Commercial and agricultural		$	115			$	1,692			$	1,985
Residential mortgage			573				424				—
		$	688			$	2,116			$	1,985

The Corporation had no restructured loans in nonaccrual status as of December 31, 2007 or 2006.

The Corporation has devoted considerable attention to identifying impaired loans for which losses are possible and adjusting the net carrying value of these loans to their current net realizable values.values through the establishment of a specific reserve or

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the recording of a charge off. 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.

 

AsBased on management’s analysis, the allowance for loan losses is considered appropriate as of December 31, 2008, there were no other interest bearing assets which required classification.2010. Management is not aware of any recommendations by regulatory agencieswill continue to closely monitor its overall credit quality during 2011 to ensure that if implemented, would have a material impact on the Corporation’s liquidity, capital, or operations.allowance for loan losses remains appropriate.

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Noninterest Income

 

The following table shows the changes in noninterest income between the years ended December 31, 2008, 2007,2010, 2009, and 20062008 respectively.

 

		Year Ended December 31																												Year Ended December 31
										Change												Change																Change												Change
		2008				2007				$				%				2006				$				%				2010				2009				$				%				2008				$				%
Service charges and fee income
Service charges and fees
NSF and overdraft fees		$	3,413			$	2,961			$	452				15.3	%		$	2,950			$	11				0.4	%		$	2,809			$	3,187			$	(378	)			−11.9	%		$	3,413			$	(226	)			−6.6	%
ATM and debit card fees																															1,492				1,218				274				22.5	%			1,029				189				18.4	%
Trust fees			886				1,035				(149	)			−14.4	%			866				169				19.5	%			896				814				82				10.1	%			886				(72	)			−8.1	%
Freddie Mac servicing fee			627				635				(8	)			−1.3	%			635				—				0.0	%			760				724				36				5.0	%			627				97				15.5	%
ATM and debit card fees			1,029				737				292				39.6	%			545				192				35.2	%
Service charges on deposit accounts			372				328				44				13.4	%			315				13				4.1	%			333				344				(11	)			−3.2	%			372				(28	)			−7.5	%
Net OMSR (loss) income			(92	)			43				(135	)			N/M				30				13				43.3	%
Net originated mortgage servicing
rights income (loss)																															47				514				(467	)			−90.9	%			(92	)			606				N/M
All other			135				155				(20	)			−12.9	%			149				6				4.0	%			143				112				31				27.7	%			135				(23	)			−17.0	%
Total service charges and fees			6,370				5,894				476				8.1	%			5,490				404				7.4	%			6,480				6,913				(433	)			−6.3	%			6,370				543				8.5	%
Title insurance revenue			234				2,192				(1,958	)			−89.3	%			2,389				(197	)			−8.2	%
Gain on sale of mortgage loans			249				209				40				19.1	%			207				2				1.0	%			610				886				(276	)			−31.2	%			249				637				N/M
Net gain on trading securities			245				460				(215	)			−46.7	%			—				460				N/M
Net (loss) gain on trading securities																															(94	)			80				(174	)			N/M				245				(165	)			−67.3	%
Net gain (loss) on borrowings measured at fair value																															227				289				(62	)			−21.5	%			(641	)			930				N/M
Gain on sale ofavailable-for-sale investment securities																															348				648				(300	)			−46.3	%			24				624				N/M
Other
Increase in cash value of corporate owned life insurance policies			616				432				184				42.6	%			404				28				6.9	%
Earnings on corporate owned life insurance policies																															663				641				22				3.4	%			616				25				4.1	%
Brokerage and advisory fees			480				276				204				73.9	%			213				63				29.6	%			573				521				52				10.0	%			480				41				8.5	%
Gain (loss) on sale of investment securities			24				(19	)			43				N/M				(112	)			93				83.0	%
Net loss on borrowings measured at fair value			(641	)			(66	)			(575	)			N/M				—				(66	)			N/M
All other			225				584				(359	)			−61.5	%			507				77				15.2	%			493				178				315				177.0	%			459				(281	)			−61.2	%
Total other			704				1,207				(503	)			−41.7	%			1,012				195				19.3	%			1,729				1,340				389				29.0	%			1,555				(215	)			−13.8	%
Total noninterest income		$	7,802			$	9,962			$	(2,160	)			−21.7	%		$	9,098			$	864				9.5	%		$	9,300			$	10,156			$	(856	)			−8.4	%		$	7,802			$	2,354				30.2	%

Significant changes in noninterest income are detailed below:

	•	Management continuously analyzes various fees related to deposit accounts including: service charges and NSF and overdraft 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. NSF and overdraft fees have been declining over the past two years, and declined further in the third quarter and fourth quarters of 2010 as a result of new regulatory rules issued by the Federal Reserve Bank being implemented related to NSF and overdraft fees. The Corporation anticipates that NSF and overdraft fees will decline further in 2011 as a result of this recent rule making.

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Noninterest Income (excluding the activity of GCFC since January 1, 2008 to make year to year comparisons more meaningful)

		Year Ended December 31
										Change												Change
		2008				2007				$				%				2006				$				%
Service charges and fee income
NSF and overdraft fees		$	3,094			$	2,961			$	133				4.5	%		$	2,950			$	11				0.4	%
Trust fees			886				1,035				(149	)			−14.4	%			866				169				19.5	%
Freddie Mac servicing fee			626				635				(9	)			−1.4	%			635				—				0.0	%
ATM and debit card fees			995				737				258				35.0	%			545				192				35.2	%
Service charges on deposit accounts			330				328				2				0.6	%			315				13				4.1	%
Net OMSR (loss) income			(92	)			43				(135	)			N/M				30				13				43.3	%
All other			118				155				(37	)			−23.9	%			149				6				4.0	%
Total service charges and fees			5,957				5,894				63				1.1	%			5,490				404				7.4	%
Title insurance revenue			234				2,192				(1,958	)			−89.3	%			2,389				(197	)			−8.2	%
Gain on sale of mortgage loans			207				209				(2	)			−1.0	%			207				2				1.0	%
Net gain on trading securities			236				460				(224	)			−48.7	%			—				460				N/M
Other
Increase in cash value of corporate owned life insurance policies			604				432				172				39.8	%			404				28				6.9	%
Brokerage and advisory fees			430				276				154				55.8	%			213				63				29.6	%
Gain (loss) on sale of investment securities			24				(19	)			43				N/M				(112	)			93				83.0	%
Net loss on borrowings measured at fair value			(641	)			(66	)			(575	)			N/M				—				(66	)			N/M
All other			229				584				(355	)			−60.8	%			507				77				15.2	%
Total other			646				1,207				(561	)			−46.5	%			1,012				195				19.3	%
Total noninterest income		$	7,280			$	9,962			$	(2,682	)			−26.9	%		$	9,098			$	864				9.5	%

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 OMSR (originated mortgage servicing rights) income was primarily due to an increase in amortization expense. The increase in amortization was the result of the estimated lives on the mortgage loans serviced decreasing, which was driven by decreases in the rates offered on new loans in December 2008. Typically as the rates on mortgages decline, there is an increase in consumer refinancing, which results in an increase in amortization of OMSR and eventually an increase in the gain on sale of mortgage loans. As the large declines in interest rates occurred so close to year end, the Corporation had not observed any large increases in the gain on sale

	•	The increases in ATM and debit card fees are primarily the result of the increased usage of debit cards by 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.
	•	As a result of lower than normal residential mortgage rates, the Corporation experienced increases in the volume of loans sold to Freddie Mac beginning in the fourth quarter of 2008. This high volume led to increases in gains from the sale of mortgage loans in 2009. The volume of new mortgage activity has returned to more normal levels in 2010, leading to a decline in the gain on sale of mortgage loans. Despite the increase in the balance of serviced loans, the Corporation recorded only modest increases in the value of its originated mortgage servicing rights (“OMSR”) portfolio in 2010 as rates remained at historically low levels. As interest rates are expected to increase, the Corporation anticipates that Freddie Mac servicing fees and net OMSR income will increase in 2011, while the gains from the sale of mortgage loans will likely decline.
	•	Fluctuations in the gains and losses related to trading securities and borrowings carried at fair value are caused by interest rate variances. Management does not anticipate any significant fluctuations in net trading activities in 2011 as significant interest rate changes are not expected.
	•	The Corporation does not anticipate any significant sales ofavailable-for-sale investment securities in 2011.
	•	Fees generated from brokerage and advisory services have been steadily increasing for the past few years. This has been the result of staff additions as well as a conscious effort by management to expand the Corporation’s presence in its local market. Management anticipates brokerage and advisory fees to increase further in 2011.
	•	The fluctuation in all other income in 2010 is due partially to a $133 increase in earnings from the Corporation’s investment in Corporate Settlement Solutions. The remainder of the difference is spread throughout the various categories, none of which are individually significant.

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of mortgage loans. However, the Corporation does anticipate significant increases in gains from the sales from mortgage loans in 2009.

Title insurance fees have decreased as a result of a joint venture between IBT Title and Insurance Agency and Corporate Title on March 1, 2008 (see Note 2 — “Business Combinations and Joint Venture Formation” of Notes to Consolidated Financial Statements).

Net gains from trading activities have declined significantly from last year. Exclusive of the effects of the merger with GCFC, net gains on trading securities have declined by 48.7% to $236. Significant losses on trading securities were incurred in the second quarter, primarily related to municipal investment securities. The reason for the large declines in value in this sector was related to the downgrading of the two largest bond insurers from AAA to AA in June 2008. These downgrades caused the market to demand higher returns on insured bonds, which has resulted in declines in the value of the Corporation’s municipal bond portfolio, as the majority of the portfolio is insured. Despite the significant declines in interest rates observed during the fourth quarter of 2008, the trading portfolio has struggled to increase in value. 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.

Income related to the value of Corporate owned life insurance has increased as a result of the purchase of additional policies as well as transferring the management of the policies to a new investment advisor.

The year ended December 31, 2008 was a good year for brokerage and advisory services income, and one of the most productive years in the Corporation’s history. These results are due to an increase in customer base and a conscious effort by management to expand the Bank’s presence in the local market. The Corporation anticipates this trend to continue throughout 2009.

The increase in total noninterest income from 2006 to 2007 was partially the result of the acquisition of Farwell State Savings Bank in October 2006. Exclusive of the effects of the acquisition, total noninterest income increased 6.29%. There were no individually significant changes other than those noted above between 2007 and 2006.

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Noninterest Expenses

 

The following table shows the changes in noninterest expenses between the years ended December 31, 2008, 2007,2010, 2009, and 20062008 respectively.

 

		Year Ended December 31																												Year Ended December 31
										Change												Change																Change												Change
		2008				2007				$				%				2006				$				%				2010				2009				$				%				2008				$				%
Compensation
Compensation and benefits
Leased employee salaries		$	12,232			$	11,362				870				7.7	%		$	10,105			$	1,257				12.4	%		$	13,697			$	13,494			$	203				1.5	%		$	12,465			$	1,029				8.3	%
Leased employee benefits			4,502				4,096				406				9.9	%			3,608				488				13.5	%			4,837				4,745				92				1.9	%			4,502				243				5.4	%
All other			258				160				98				61.3	%			156				4				2.6	%			18				19				(1	)			−5.3	%			25				(6	)			−24.0	%
Total compensation			16,992				15,618				1,374				8.8	%			13,869				1,749				12.6	%
Total compensation and benefits																															18,552				18,258				294				1.6	%			16,992				1,266				7.5	%
Occupancy
Depreciation			508				448				60				13.4	%			412				36				8.7	%			584				546				38				7.0	%			508				38				7.5	%
Outside services			492				332				160				48.2	%			334				(2	)			−0.6	%			524				433				91				21.0	%			492				(59	)			−12.0	%
Property taxes			411				384				27				7.0	%			322				62				19.3	%			505				439				66				15.0	%			411				28				6.8	%
Utilities			366				344				22				6.4	%			320				24				7.5	%			423				393				30				7.6	%			366				27				7.4	%
Building rent			3				72				(69	)			−95.8	%			163				(91	)			−55.8	%
Building repairs			202				147				55				37.4	%			129				18				14.0	%			243				288				(45	)			−15.6	%			202				86				42.6	%
All other			53				39				14				35.9	%			50				(11	)			−22.0	%			72				71				1				1.4	%			56				15				26.8	%
Total occupancy			2,035				1,766				269				15.2	%			1,730				36				2.1	%			2,351				2,170				181				8.3	%			2,035				135				6.6	%
Furniture and equipment
Depreciation			1,663				1,512				151				10.0	%			1,440				72				5.0	%			1,938				1,803				135				7.5	%			1,663				140				8.4	%
Computer/service contracts			1,526				1,254				272				21.7	%			1,101				153				13.9	%			1,779				1,676				103				6.1	%			1,565				111				7.1	%
ATM and debit card fees			570				433				137				31.6	%			263				170				64.6	%			595				621				(26	)			−4.2	%			570				51				8.9	%
All other			90				98				(8	)			−8.2	%			64				34				53.1	%			32				46				(14	)			−30.4	%			51				(5	)			−9.8	%
Total furniture and equipment			3,849				3,297				552				16.7	%			2,868				429				15.0	%			4,344				4,146				198				4.8	%			3,849				297				7.7	%
FDIC insurance premiums																															1,254				1,730				(476	)			−27.5	%			313				1,417				N/M
Other
Marketing and community relations																															1,093				894				199				22.3	%			921				(27	)			−2.9	%
Foreclosed asset and collection																															710				546				164				30.0	%			565				(19	)			−3.4	%
Directors fees																															887				923				(36	)			−3.9	%			867				56				6.5	%
Audit and SOX compliance fees			565				583				(18	)			−3.1	%			1,010				(427	)			−42.3	%			916				831				85				10.2	%			698				133				19.1	%
Marketing			691				642				49				7.6	%			697				(55	)			−7.9	%
Directors fees			867				796				71				8.9	%			584				212				36.3	%
Education and travel																															499				395				104				26.3	%			491				(96	)			−19.6	%
Printing and supplies			508				462				46				10.0	%			377				85				22.5	%			420				529				(109	)			−20.6	%			508				21				4.1	%
Education and travel			446				412				34				8.3	%			360				52				14.4	%
Postage and freight			523				459				64				13.9	%			445				14				3.1	%			382				415				(33	)			−8.0	%			419				(4	)			−1.0	%
Legal			419				296				123				41.6	%			229				67				29.3	%
Legal fees																															338				375				(37	)			−9.9	%			415				(40	)			−9.6	%
Amortization of deposit premium			415				278				137				49.3	%			160				118				73.8	%			395				472				(77	)			−16.3	%			523				(51	)			−9.8	%
Foreclosed assets			419				157				262				166.9	%			41				116				N/M
Collection			279				112				167				149.1	%			31				81				N/M
Brokerage and advisory			205				92				113				122.8	%			31				61				196.8	%
FDIC Insurance			313				95				218				N/M				87				8				9.2	%
Consulting			298				176				122				69.3	%			208				(32	)			−15.4	%
Consulting fees																															167				201				(34	)			−16.9	%			298				(97	)			−32.6	%
All other			1,880				1,988				(108	)			−5.4	%			1,746				242				13.9	%			1,499				1,798				(299	)			−16.6	%			1,810				(12	)			−0.7	%
Total other			7,828				6,548				1,280				19.5	%			6,006				542				9.0	%			7,306				7,379				(73	)			−1.0	%			7,515				(136	)			−1.8	%
Total noninterest expenses		$	30,704			$	27,229			$	3,475				12.8	%		$	24,473			$	2,756				11.3	%		$	33,807			$	33,683			$	124				0.4	%		$	30,704			$	2,979				9.7	%

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Noninterest Expenses (excluding the activity of GCFC since January 1, 2008 to make year-to-year comparisons more meaningful)Significant changes in noninterest expenses are detailed below:

 

		Year Ended December 31
										Change												Change
		2008				2007				$				%				2006				$				%
Compensation
Leased employee salaries		$	11,152			$	11,362			$	(210	)			−1.8	%		$	10,105			$	1,257				12.4	%
Leased employee benefits			4,144				4,096				48				1.2	%			3,608				488				13.5	%
All other			241				160				81				50.6	%			156				4				2.6	%
Total compensation			15,537				15,618				(81	)			−0.5	%			13,869				1,749				12.6	%
Occupancy
Depreciation			445				448				(3	)			−0.7	%			412				36				8.7	%
Outside services			404				332				72				21.7	%			334				(2	)			−0.6	%
Property taxes			388				384				4				1.0	%			322				62				19.3	%
Utilities			340				344				(4	)			−1.2	%			320				24				7.5	%
Building rent			3				72				(69	)			−95.8	%			163				(91	)			−55.8	%
Building repairs			185				147				38				25.9	%			129				18				14.0	%
All other			49				39				10				25.6	%			50				(11	)			−22.0	%
Total occupancy			1,814				1,766				48				2.7	%			1,730				36				2.1	%
Furniture and equipment
Depreciation			1,557				1,512				45				3.0	%			1,440				72				5.0	%
Computer/service contracts			1,322				1,254				68				5.4	%			1,101				153				13.9	%
ATM and debit card fees			553				433				120				27.7	%			263				170				64.6	%
All other			80				98				(18	)			−18.4	%			64				34				53.1	%
Total furniture and equipment			3,512				3,297				215				6.5	%			2,868				429				15.0	%
Other
Audit and SOX compliance fees			557				583				(26	)			−4.5	%			1,010				(427	)			−42.3	%
Marketing			636				642				(6	)			−0.9	%			697				(55	)			−7.9	%
Directors fees			771				796				(25	)			−3.1	%			584				212				36.3	%
Printing and supplies			479				462				17				3.7	%			377				85				22.5	%
Education and travel			401				412				(11	)			−2.7	%			360				52				14.4	%
Postage and freight			495				459				36				7.8	%			445				14				3.1	%
Legal			411				296				115				38.9	%			229				67				29.3	%
Amortization of deposit premium			415				278				137				49.3	%			160				118				73.8	%
Foreclosed assets			390				157				233				148.4	%			41				116				N/M
Collection			158				112				46				41.1	%			31				81				N/M
Brokerage and advisory			205				92				113				122.8	%			31				61				196.8	%
FDIC Insurance			275				95				180				189.5	%			87				8				9.2	%
Consulting			269				176				93				52.8	%			208				(32	)			−15.4	%
All other			1,531				1,988				(457	)			−23.0	%			1,746				242				13.9	%
Total other			6,993				6,548				445				6.8	%			6,006				542				9.0	%
Total noninterest expenses		$	27,856			$	27,229			$	627				2.3	%		$	24,473			$	2,756				11.3	%

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Leased employee salaries expenses have decreased as a result of the new joint venture entered into during the first quarter of 2008 (see “Note 2 — Business Combinations and Joint Venture Formation” of Notes to Consolidated Financial Statements). Exclusive of the effects of this joint venture, leased employee salaries expenses have increased due to annual merit increases and the continued growth of the Corporation. Despite the reduction in salaries as a result of the above mentioned joint venture, leased employee benefits increased as a result of continued increases in health care costs.

A significant portion of the increase in occupancy and equipment is related to additional expenses incurred for snowplowing during the fourth quarter of 2008. This increase was offset by a decline in building rent, due to the new joint venture.

The increase in furniture and equipment expense in 2008 was primarily the result of increases in ATM and debit card expenses. These increases were the result of increased usage of debit cards by the Bank’s customers, as the Bank incurs a fee each time a card is used.

Management has been diligently working to decrease audit and Sarbanes Oxley (SOX) compliance fees through improved efficiencies. These fees have steadily declined over the past few years as a result of the centralization of corporate processes.

The increases in director fees in 2007 were the result of additional meetings related to ongoing strategic planning, which was partially related to the acquisition of Greenville Community Financial Corporation and the joint venture with Corporate Title, LLC (see “Note 2 — Business Combinations and Joint Venture Formation” of Notes to Consolidated Financial Statements).

The Corporation places a strong emphasis on continuing education. These educational programs help provide team members with a competitive edge in the market place. Over the past three years, the Corporation offered structured leadership training to its employees. This program is designed to help develop and optimize the communication skills of its participants. Management feels that this investment in its employees today will pay dividends for years to come.

The increase in the amortization of deposit premium is related to the January 2008 acquisition of GCFC.

As a result of the recent increases in delinquencies and foreclosures, the Corporation has experienced significant increases in legal, foreclosed asset, and collection expenses. These expenses are expected to continue to increase throughout 2009 as management anticipates that delinquency rates and foreclosures will increase.

FDIC insurance expense has increased not only as a result of growth of the Corporation, but primarily as a result of increases in the premium rates charged by the Federal Deposit Insurance Corporation. These expenses are expected to significantly increase in 2009 as a result of further premium increases.

Consulting fees increased in 2008 primarily as a result of a potential new branch location study that was performed.

All other expenses include title insurance expenses as well as other miscellaneous expenses. All other expenses decreased by $222 as a result of the new joint venture (see “Note 2 — Business Combinations and Joint Venture Formation” of Notes to Consolidated Financial Statements). The main reasons for the increase in this line item in 2007 were related to expenses of approximately $130 incurred to convert the Farwell Division to Isabella Bank’s core banking platform in August of 2007. The remaining changes in other expenses are individually not significant.

The increase in total noninterest expenses from 2006 to 2007 was partially the result of the acquisition of Farwell State Savings Bank in October 2006. Exclusive of the effects of the acquisition, total noninterest expenses increased 4.9%, with no individually significant changes when comparing 2007 to 2006.

	•	Leased employee salaries have remained essentially unchanged from 2009. During 2009, the Corporation incurred increased overtime costs related to the large volume of mortgage refinancing activity. While the demand for mortgage refinancing has reduced, the reduction in overtime has been offset by annual merit increases and the continued growth of the Corporation. Leased employee benefits fluctuate from period to period primarily as a result of changes in health care related expenses. The Corporation does not anticipate any significant changes in leased employee salaries or benefit expenses in 2011.
	•	FDIC insurance premium expense decreased primarily when the year ended December 31, 2010 is compared to the same period in 2009 as a result of an FDIC special assessment of $479, which was paid in September 2009. Management expects FDIC insurance premiums to approximate current levels for 2011.
	•	The increase in marketing and community relations expenses in 2010 is primarily related to the Corporation making a contribution of $250 to the IBT Foundation, compared to $140 in 2009 and $0 in 2008.
	•	Audit and SOX compliance fees fluctuate due to the timing of the performance of recurring audit procedures.
	•	Director fees declined in 2010 due to Corporation implementing a policy whereby the membership on the Isabella Bank and Isabella Bank Corporation’s board of directors is identical; no significant change is expected in 2011.
	•	Printing and supplies expenses were historically high in the first three months of 2009 as a result of the Corporation increasing inventories of various supplies. Printing and supplies expenses are expected to approximate current levels in 2011.
	•	The Corporation places a strong emphasis on customer service. In February 2010, all of the Corporation’s employees attended a special customer service seminar. This seminar coupled with increases in expenditures for executive leadership training led to increases in education expenses during 2010. Management expects that education related expenses may decline slightly in 2011.
	•	Postage and freight expenses have declined, and are expected to continue to decline, as a result of fewer special mailings as well as an increase in the Corporation’s customers usage of electronic statements.
	•	The Corporation’s legal expenses can fluctuate from period to period based on the volume of foreclosures as well as expenses related to the Corporation’s ongoing operations, including regulatory compliance. At this time, the Corporation is not aware of any significant legal matters, and as such expects that legal expenses should approximate current levels in 2011.
	•	The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.

 

Federal Income Taxes

 

Federal income tax expense (benefit) expense for 20082010 was ($724)$1,604 or (21.4%)15.1% of pre-tax income compared to $1,605$846 or 16.8%9.8% of pre-tax income in 20072009 and $1,919($724) or 21.5%(21.4%) in 2006.2008. The primary factor behind the reduction in the effective rate in 2008 and 2007 is related to the increase in tax exempt income as a percentage of net income. A

77

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reconcilement of actual federal income tax expense reported and the amount computed at the federal statutory rate of 34% is found in Note 12,11, “Federal Income Taxes”, of Notes to Consolidated Financial Statements.

83

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ANALYSIS OF CHANGES IN FINANCIAL CONDITION

 

		December 31
		2010				2009				$ Change				% Change
ASSETS
Cash and cash equivalents		$	18,109			$	24,482			$	(6,373	)			−26.03	%
Certificates of deposit held in other financial institutions			15,808				5,380				10,428				193.83	%
Trading securities			5,837				13,563				(7,726	)			−56.96	%
Available-for-sale investment securities			330,724				259,066				71,658				27.66	%
Mortgage loansavailable-for-sale			1,182				2,281				(1,099	)			−48.18	%
Loans			735,304				723,316				11,988				1.66	%
Allowance for loan losses			(12,373	)			(12,979	)			606				−4.67	%
Premises and equipment			24,627				23,917				710				2.97	%
Goodwill and other intangible assets			47,091				47,429				(338	)			−0.71	%
Equity securities without readily determinable fair values			17,564				17,921				(357	)			−1.99	%
Other assets			41,937				39,568				2,369				5.99	%
Total Assets		$	1,225,810			$	1,143,944			$	81,866				7.16	%
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits		$	877,339			$	802,652			$	74,687				9.31	%
Borrowed funds			194,917				193,101				1,816				0.94	%
Accrued interest and other liabilities			8,393				7,388				1,005				13.60	%
Total liabilities			1,080,649				1,003,141				77,508				7.73	%
Shareholders’ equity			145,161				140,803				4,358				3.10	%
Total liabilities and shareholders’ equity		$	1,225,810			$	1,143,944			$	81,866				7.16	%

As shown in the following tables,above, the Corporation experienced another yearhas intentionally increased its balance sheet through the acquisition of solid assetavailable-for-sale investment securities and certificates of deposit held in other financial institutions, which is consistent with its plan to increase net interest income. These purchases were funded primarily with retail deposit growth. This growth has been the result of the Corporation’s continued growth strategies, including the GCFC acquisition. See below for further discussion.

		December 31
		2008				2007				$ Change				% Change
ASSETS
Cash and cash equivalents		$	23,554			$	25,583			$	(2,029	)			−7.93	%
Trading account securities			21,775				25,064				(3,289	)			−13.12	%
Securities available for sale			246,455				213,127				33,328				15.64	%
Mortgage loans available for sale			898				2,214				(1,316	)			−59.44	%
Loans			735,385				612,687				122,698				20.03	%
Allowance for loan losses			(11,982	)			(7,301	)			(4,681	)			64.11	%
Bank premises and equipment			23,231				22,516				715				3.18	%
Acquisition intangibles, net			47,804				27,010				20,794				76.99	%
Equity securities without readily determinable fair values			17,345				7,353				9,992				135.89	%
Other assets			34,798				29,029				5,769				19.87	%
Total assets		$	1,139,263			$	957,282			$	181,981				19.01	%
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits		$	775,630			$	733,473			$	42,157				5.75	%
Other borrowed funds			222,350				92,887				129,463				139.38	%
Escrow funds payable			—				1,912				(1,912	)			−100.00	%
Accrued interest and other liabilities			6,807				5,930				877				14.79	%
Total liabilities			1,004,787				834,202				170,585				20.45	%
Shareholders’ equity			134,476				123,080				11,396				9.26	%
Total liabilities and shareholders’ equity		$	1,139,263			$	957,282			$	181,981				19.01	%

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Analysis ofAvailable-for-sale investment securities are expected to continue to increase in 2011. Overall changes in financial condition (excludingdeposit accounts and demand for loans are the effects ofprimary reasons for fluctuations in cash and cash equivalents. As the acquisition of GCFC on January 1, 2008 to make the year-to-year comparisons more useful)

		December 31
		2008				2007				$ Change				% Change
ASSETS
Cash and cash equivalents		$	21,090			$	25,583			$	(4,493	)			−17.56	%
Trading account securities			16,796				25,064				(8,268	)			−32.99	%
Securities available for sale			239,448				213,127				26,321				12.35	%
Mortgage loans available for sale			898				2,214				(1,316	)			−59.44	%
Loans			646,772				612,687				34,085				5.56	%
Allowance for loan losses			(11,982	)			(7,301	)			(4,681	)			64.11	%
Bank premises and equipment			21,177				22,516				(1,339	)			−5.95	%
Acquisition intangibles, net			47,804				27,010				20,794				76.99	%
Equity securities without readily determinable fair values			16,937				7,353				9,584				130.34	%
Other assets			32,336				29,029				3,307				11.39	%
Total assets		$	1,031,276			$	957,282			$	73,994				7.73	%
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits		$	685,479			$	733,473			$	(47,994	)			−6.54	%
Other borrowed funds			216,725				92,887				123,838				133.32	%
Escrow funds payable			—				1,912				(1,912	)			−100.00	%
Accrued interest and other liabilities			6,661				5,930				731				12.33	%
Total liabilities			908,865				834,202				74,663				8.95	%
Shareholders’ equity			122,411				123,080				(669	)			−0.54	%
Total liabilities and shareholders’ equity		$	1,031,276			$	957,282			$	73,994				7.73	%

Corporation has increased its investment securities, it has reduced its interest bearing balances, which is included in cash and cash equivalents.

 

A discussion of changes in balance sheet amounts by major categories follows:

 

Trading account securities

 

As previously mentioned, the Corporation commenced a balance sheet reorganization strategy in 2007 which resulted in a transfer of available-for-saleTrading securities to trading securities.are carried at fair value. The Corporation’s overall intent wasis to maintain a trading portfolio to enhance the ongoing restructuring of assets and liabilities as part of our interest rate risk management objectives (See Note 32 “Trading Securities” of the Consolidated Financial Statements). Due to the current interest rate environment, the Corporation has allowed this balance to decline.

7984

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The following is a schedule of the carrying value of trading securities as of December 31:

		2010				2009				2008
Government sponsored enterprises		$	—			$	—			$	4,014
States and political subdivisions			5,837				9,962				11,556
Corporate			—				—				160
Mortgage-backed			—				3,601				6,045
Total		$	5,837			$	13,563			$	21,775

Available-for-sale Investment Securities investment securities

 

The primary objective of the Corporation’s investing activities is to provide for safety of the principal invested. Secondary considerations include the need for earnings, liquidity, and the Corporation’s overall exposure to changes in interest rates. Securities are currently classified asavailable-for-sale or trading and are stated at fair value.

 

The following is a schedule of the carrying value of investment securities available-for-sale:available-for-sale as of December 31:

 

		December 31
		2008				2007				2006
Available-for-sale
U.S. Government and federal agencies		$	67,071			$	54,239			$	69,020
States and political subdivisions			149,323				130,956				112,754
Corporate			7,145				12,000				11,053
Money market preferred securities			5,979				12,300				—
Mortgage-backed			16,937				3,632				20,623
Total		$	246,455			$	213,127			$	213,450

The following is a schedule of the carrying value of trading securities:

		December 31								2010				2009				2008
		2008				2007
Trading Securities
U.S. Government and federal agencies		$	4,014			$	4,024			$	—			$	—			$	4,083
Government sponsored enterprises											5,404				19,471				62,988
States and political subdivisions			11,556				10,324				169,717				151,730				149,323
Corporate			160				1,004				—				—				7,145
Auction rate money market preferred											2,865				2,973				5,979
Preferred stocks											6,936				7,054				—
Mortgage-backed			6,045				9,712				102,215				67,734				16,937
Collateralized mortgage obligations											43,587				10,104				—
Total		$	21,775			$	25,064			$	330,724			$	259,066			$	246,455

 

Excluding those holdings in government sponsored enterprises and municipalities within the state of the investment portfolio in U.S. Government and federal agencies,Michigan, there were no investments in securities of any one issuer that exceeded 10% of shareholders’ equity. The Corporation has a policy prohibiting investments in securities that it deems are unsuitable due to their inherent credit or market risks. Prohibited investments include stripped mortgage backed securities, zero coupon bonds, nongovernment agency asset backed securities, and structured notes. The Corporation’s holdings in mortgage-backed securities and collateralized mortgage obligations include only government agencies and government sponsored agencies as the Corporation holds no investments in private label mortgage-backed securities or collateralized mortgage obligations.

 

The Corporation has invested $11,000 in auction rate money market preferred investment security instruments, which are classified as available-for-sale securities and reflected at fair value. Due to recent events, the credit markets for these investments have become illiquid.

Due to the current illiquidity of these securities, the fair values were estimated utilizing a discounted cash flow analysis or other type of valuation adjustment methodology as of December 31, 2008. 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 positive intent and ability to hold such securities until credit markets improve. These securities were also compared, when possible, to other securities with similar characteristics (see Note 4 of Notes to Consolidated Financial Statements).

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The following is a schedule of maturities of available for saleavailable-for-sale investment securities (at carrying value) and their weighted average yield as of December 31, 2008.2010. Weighted average yields have been computed on a fully taxable-equivalent basis using a tax rate of 34%. Mortgage-backed securities and collateralized mortgage obligations are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Trading securities have been excluded as they are not expected to be held to maturity. Included in the contractual maturity distribution in the following table are auction rate money market preferred securities and preferred stock. Auction rate debt and auction rate preferred securities are long term floating rate instruments for which interest rates are set at periodic auctions. At each successful auction, the Corporation has the option to sell the security at par value. Additionally,

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the issuers of auction rate securities generally have the right to redeem or refinance the debt. As a result, the expected life of auction rate securities may differ significantly from the contractual term.

 

		Maturing
										After One Year But								After Five Years But
		Within One Year								Within Five Years								Within Ten Years								After Ten Years
		Amount				Yield (%)				Amount				Yield (%)				Amount				Yield (%)				Amount				Yield (%)
Available-for-sale
U.S. Government and federal agencies		$	4,083				3.29			$	37,324				4.40			$	25,664				4.82			$	—				—
States and political subdivisions			9,956				5.14				37,564				5.59				54,494				5.70				47,309				4.92
Mortgage-backed			25				2.79				361				5.33				2,459				5.34				14,092				4.86
Money market preferred securities			5,979				4.12				—				—				—				—				—				—
Corporate			7,145				5.67				—				—				—				—				—				—
Total		$	27,188				4.76			$	75,249				5.00			$	82,617				5.41			$	61,401				4.90

		Maturing
										After One								After Five
										Year But								Years But
		Within								Within								Within								After								Securities with
		One Year								Five Years								Ten Years								Ten Years								Variable Payments
		Amount				Yield (%)				Amount				Yield (%)				Amount				Yield (%)				Amount				Yield (%)				Amount				Yield (%)
Government sponsored enterprises		$	—				—			$	5,007				2.02			$	397				7.91			$	—				—			$	—				—
States and political subdivisions			14,132				3.51				34,837				3.73				87,263				3.74				33,485				2.09				—				—
Mortgage-backed			—				—				—				—				53,738				2.54				48,477				2.66				—				—
Collateralized mortgage obligations			—				—				—				—				—				—				—				—				43,587				2.59
Auction rate money market preferred			—				—				—				—				—				—				—				—				2,865				4.86
Preferred stocks			—				—				—				—				—				—				—				—				6,936				4.60
Total		$	14,132				3.51			$	39,844				3.53			$	141,398				3.29			$	81,962				2.43			$	53,388				2.98

 

Loans

 

The largest component of earning assets is loans. The proper management of credit and market risk inherent in the loan portfolio is critical to the financial well-beingwell being of the Corporation. To control these risks, the Corporation has adopted strict underwriting standards. TheThese standards include specific criteria against lending outside the Corporation’s defined market areas, lending limits to a single borrower, and strict loan to collateral value limits. The Corporation also monitors and limits loan concentrations extended to volatiledistressed industries. The Corporation has no foreign loans and there were no concentrations greater than 10% of total loans that are not disclosed as a separate category in the following table.

 

The following table presents the composition of the loan portfolio for the years ended December 31:

 

		2008				2007				2006				2005				2004				2010				2009				2008				2007				2006
Commercial		$	324,806			$	238,306			$	212,701			$	179,541			$	146,152			$	348,852			$	340,274			$	324,806			$	238,306			$	212,701
Agricultural			58,003				47,407				47,302				49,424				49,179				71,446				64,845				58,003				47,407				47,302
Residential real estate mortgage			319,397				297,937				300,650				226,251				227,421				284,029				285,838				319,397				297,937				300,650
Installment			33,179				29,037				30,389				28,026				30,143				30,977				32,359				33,179				29,037				30,389
		$	735,385			$	612,687			$	591,042			$	483,242			$	452,895			$	735,304			$	723,316			$	735,385			$	612,687			$	591,042

 

The following table presents the change in the loan categories for the years ended December 31:

 

		2008								2007								2006
		$ Change				% Change				$ Change				% Change				$ Change				% Change
Commercial		$	86,500				36.3	%		$	25,605				12.0	%		$	33,160				18.5	%
Agricultural			10,596				22.4	%			105				0.2	%			(2,122	)			−4.3	%
Residential real estate mortgage			21,460				7.2	%			(2,713	)			−0.9	%			74,399				32.9	%
Installment			4,142				14.3	%			(1,352	)			−4.4	%			2,363				8.4	%
		$	122,698				20.0	%		$	21,645				3.7	%		$	107,800				22.3	%

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The following table presents the change in loan categories between December 31, 2008 and December 31, 2007, excluding the loans acquired from GCFC:

						Less
						loans				Adjusted
		Consolidated				Acquired				Consolidated				Consolidated																2010								2009								2008
		12/31/08				from GCFC				12/31/08				12/31/07				$ Change				% Change								$ Change				% Change				$ Change				% Change				$ Change				% Change
Commercial		$	324,806			$	44,605			$	280,201			$	238,306			$	41,895				17.6	%						$	8,578				2.5	%		$	15,468				4.8	%		$	86,500				36.3	%
Agricultural			58,003				—				58,003				47,407				10,596				22.4	%							6,601				10.2	%			6,842				11.8	%			10,596				22.4	%
Residential real estate mortgage			319,397				37,142				282,255				297,937				(15,682	)			−5.3	%							(1,809	)			−0.6	%			(33,559	)			−10.5	%			21,460				7.2	%
Installment			33,179				6,866				26,313				29,037				(2,724	)			−9.4	%							(1,382	)			−4.3	%			(820	)			−2.5	%			4,142				14.3	%
		$	735,385			$	88,613			$	646,772			$	612,687			$	34,085				5.6	%						$	11,988				1.7	%		$	(12,069	)			−1.6	%		$	122,698				20.0	%

 

The growth in commercial and agricultural loans is a result of the Corporation’s efforts to increase these segments of the commercial loan portfolio as a percentage of total loans. A significant portion of this growth has been driven by the Corporation’s new business development team.

 

ExcludingAs rates in 2010 on residential mortgages were comparable to the effectsrates in 2009, residential mortgage refinancing activity stabilized which resulted in a decrease in loans sold to the secondary market. As a result of this decline in loans sold, the Greenville acquisition,residential real estate portfolio remained stable in 2010 as compared to the significant

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declines noted in 2009. Refinancing activity resulted in a net increase of $2,226 in the balance of residential mortgage loans declined during 2008 as a result of a shift in demand from balloon mortgages to long term fixed rate (typically 30 year) mortgage products. This triggered a decrease in residential mortgage loans as loans with maturity dates greater than 15 years are typically sold to the Federal Home Loan Mortgage Corporation (Freddie Mac). Installment loans have been steadily decreasing over the past few years. This issecondary market in 2010 compared to a resultnet increase of the increased competition from credit unions and financing offered from other non traditional financial institutions. Management expects both residential mortgages and installment loans to decrease during$53,161 in 2009.

 

A substantial portion of the increase in total loans whenas of December 31, 2006 is2008 compared to 2005, most notably the increase in residential real estate mortgages,December 31, 2007 was thea result of the acquisition of the Farwell State Savings BankGreenville Financial Corporation in October 2006.January 2008. Pursuant to the acquisition, the Corporation purchased gross loans totaling $64,600.

Bank Premises and Equipment

Exclusive of the effects of the GCFC acquisition, Bank premises and equipment and escrow funds payable have declined as a result of the merger of assets and liabilities between IBT Title and Insurance Agency and Corporate Title Agency, LLC through a joint venture transaction (see “Note 2 — Business Combinations and Joint Venture Formation” of Notes to Consolidated Financial Statements), resulting in a reduction in such assets and liabilities.$88,613.

 

Equity securities without readily determinable fair values

 

Included in equity securities without readily determinable fair values are restricted securities, which are carried at cost, and investments in nonconsolidated entities accounted for under the equity method of accounting.

Equity securities without readily determinable fair values includes Federal Home Loan Bank Stock and Federal Reserve Bank Stock. The Corporation has purchased additional shares of stock in 2008 as a resultconsist of the consolidationfollowing as of the Bank’s charter as well as to fulfill stock requirements to borrow additional funds from the Federal Home Loan Bank. Also included in the increase is the Corporation’s investment in the joint venture between IBT Title and Insurance Agency and Corporate Title Agency, LLC, which is accounted for under the equity method of accounting (see “Note 2 — Business Combinations and Joint Venture Formation” of Notes to Consolidated Financial Statements).December 31:

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		2010				2009
Federal Home Loan Bank Stock		$	7,596			$	7,960
Investment in Corporate Settlement Solutions			6,793				6,782
Federal Reserve Bank Stock			1,879				1,879
Investment in Valley Financial Corporation			1,000				1,000
Other			296				300
Total		$	17,564			$	17,921

Deposits

 

The main source of funds for the Corporation is deposits. The deposit portfolio represents various types of non transaction accounts as well as savings accounts and time deposits.

The following table presents the composition of ourthe deposit portfolio as of December 31:

 

		2008				2007				2006				2005				2004				2010				2009				2008				2007				2006
Noninterest bearing demand deposits		$	97,546			$	84,846			$	83,902			$	73,839			$	65,736
Noninterest bearing deposits																						$	104,902			$	96,875			$	97,546			$	84,846			$	83,902
Interest bearing demand deposits			113,973				105,526				111,406				104,251				101,362				142,259				128,111				113,973				105,526				111,406
Savings deposits			182,523				196,682				178,001				153,397				162,516				177,817				157,020				182,523				196,682				178,001
Certificates of deposit			340,976				311,976				320,226				250,246				234,262				386,435				356,594				340,976				311,976				320,226
Brokered certificates of deposit			28,185				28,197				27,446				7,076				—				53,748				50,933				28,185				28,197				27,446
Internet certificates of deposit			12,427				6,246				4,859				3,669				—				12,178				13,119				12,427				6,246				4,859
Total		$	775,630			$	733,473			$	725,840			$	592,478			$	563,876			$	877,339			$	802,652			$	775,630			$	733,473			$	725,840

 

The following table presents the change in the deposit categories for the years ended December 31:

 

		2008								2007								2006
		$ Change				% Change				$ Change				% Change				$ Change				% Change
Noninterest bearing demand deposits		$	12,700				15.0	%		$	944				1.1	%		$	10,063				13.6	%
Interest bearing demand deposits			8,447				8.0	%			(5,880	)			−5.3	%			7,155				6.9	%
Savings deposits			(14,159	)			−7.2	%			18,681				10.5	%			24,604				16.0	%
Certificates of deposit			29,000				9.3	%			(8,250	)			−2.6	%			69,980				28.0	%
Brokered certificates of deposit			(12	)			0.0	%			751				2.7	%			20,370				100.0	%
Internet certificates of deposit			6,181				99.0	%			1,387				28.5	%			1,190				100.0	%
Total		$	42,157				5.7	%		$	7,633				1.1	%		$	133,362				22.5	%

The following table presents the change in deposit categories between December 31, 2008 and 2007, excluding the deposits acquired from GCFC:

						Less																				2010								2009								2008
						Deposits				Adjusted																$ Change				% Change				$ Change				% Change				$ Change				% Change
		Consolidated				Acquired				Consolidated				Consolidated
		12/31/08				from GCFC				12/31/08				12/31/07				$ Change				% Change
Noninterest bearing demand deposits		$	97,546			$	10,251			$	87,295			$	84,846			$	2,449				2.9	%
Noninterest bearing deposits																										$	8,027				8.3	%		$	(671	)			−0.7	%		$	12,700				15.0	%
Interest bearing demand deposits			113,973				12,236				101,737				105,526				(3,789	)			−3.6	%			14,148				11.0	%			14,138				12.4	%			8,447				8.0	%
Savings deposits			182,523				10,735				171,788				196,682				(24,894	)			−12.7	%			20,797				13.2	%			(25,503	)			−14.0	%			(14,159	)			−7.2	%
Certificates of deposit			340,976				39,911				301,065				311,976				(10,911	)			−3.5	%			29,841				8.4	%			15,618				4.6	%			29,000				9.3	%
Brokered certificates of deposit			28,185				8,976				19,209				28,197				(8,988	)			−31.9	%			2,815				5.5	%			22,748				80.7	%			(12	)			0.0	%
Internet certificates of deposit			12,427				8,042				4,385				6,246				(1,861	)			−29.8	%			(941	)			−7.2	%			692				5.6	%			6,181				99.0	%
Total		$	775,630			$	90,151			$	685,479			$	733,473			$	(47,994	)			−6.5	%		$	74,687				9.3	%		$	27,022				3.5	%		$	42,157				5.7	%

 

As shown in the preceding table, exclusivethe Corporation has enjoyed strong deposit growth during 2010. This growth was the result of the effectsCorporation offering products with competitive rates and terms, as well as focused marketing efforts to increase deposit market share in the communities served. Management anticipates that deposits will continue to grow in 2011.

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A substantial portion of the increase in total deposits as of December 31, 2008 compared to December 31, 2007 was a result of the acquisition of Greenville Community Financial Corporation (GCFC) in January 2008. Pursuant to the acquisition, the Corporation purchased deposits totaling $90,151. Exclusive of the GCFC acquisition, the Corporation has observed a decline in deposits during 2008.decreased $47,994 when December 31, 2008 is compared to December 31, 2007. This decline has beenwas the result of increased competition with other depository institutions as well as declines in brokered certificates of deposit and internet certificates of deposit. Deposits also declined due to well publicized bank failures, the collapse of the investment banking industry, and uncertainty of the public in the financial condition of banks in general.

The decrease in savings accounts is the result of large deposit customers looking for a secure investment that is fully insured. As a result, the Corporation expanded its repurchase sweep products to meet customers needs. Since December 31, 2007, these repurchase agreements have increased by $41,449; due to the nature of these accounts, they are classified as borrowings. The

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following table shows the average balances and corresponding interest rates paid on deposit accounts as of December 31:

 

		2008								2007								2006								2010								2009								2008
		Amount				Rate				Amount				Rate				Amount				Rate				Amount				Rate				Amount				Rate				Amount				Rate
Noninterest bearing demand deposits		$	95,552							$	80,128							$	73,650							$	102,812				—			$	94,408				—			$	95,552				—
Interest bearing demand deposits			114,889				0.71	%			109,370				1.72	%			105,476				1.58	%			137,109				0.11	%			116,412				0.13	%			114,889				0.71	%
Savings deposits			213,410				1.14	%			188,323				2.25	%			158,327				1.69	%			169,579				0.23	%			177,538				0.22	%			213,410				1.14	%
Time deposits			393,190				4.23	%			349,941				4.71	%			301,593				4.25	%			430,892				2.55	%			398,356				3.27	%			393,190				4.23	%
Total		$	817,041							$	727,762							$	639,046							$	840,392							$	786,714							$	817,041

 

The time remaining until maturity of time certificates and other time deposits of $100 or more atas of December 31, 20082010 was as follows:

 

Maturity
Within 3 months		$	36,650			$	35,935
Within 3 to 6 months			15,550				20,695
Within 6 to 12 months			37,207				49,207
Over 12 months			52,015				98,360
Total		$	141,422			$	204,197

 

Borrowed Funds

 

As a resultThe following table summarizes the Corporation’s borrowings as of December 31:

		2010								2009
		Amount				Rate				Amount				Rate
Federal Home Loan Bank advances		$	113,423				3.64	%		$	127,804				4.11	%
Securities sold under agreements to repurchase
without stated maturity dates			45,871				0.25	%			37,797				0.30	%
Securities sold under agreements to repurchase
with stated maturity dates			19,623				3.01	%			20,000				3.72	%
Federal funds purchased			16,000				0.60	%			—				—
Federal Reserve Bank discount window advance			—				—				7,500				0.75	%
Total		$	194,917				2.53	%		$	193,101				3.19	%

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The maturity and weighted average interest rates of FHLB advances are as follows as of December 31:

		2010								2009
		Amount				Rate				Amount				Rate
Fixed rate advances due 2010		$	—				—			$	28,320				4.52	%
One year putable advances due 2010			—				—				6,000				5.31	%
Fixed rate advances due 2011			10,086				3.96	%			10,206				3.96	%
One year putable advances due 2011			1,000				4.75	%			1,000				4.75	%
Fixed rate advances due 2012			17,000				2.97	%			17,000				2.97	%
One year putable advances due 2012			15,000				4.10	%			15,000				4.10	%
Fixed rate advances due 2013			5,337				4.14	%			5,278				4.14	%
One year putable advances due 2013			5,000				3.15	%			5,000				3.15	%
Fixed rate advances due 2014			25,000				3.16	%			15,000				3.63	%
Fixed rate advances due 2015			25,000				4.63	%			25,000				4.63	%
Fixed rate advances due 2017			10,000				2.35	%			—				—
Total		$	113,423				3.64	%		$	127,804				4.11	%

The maturity and weighted average interest rates of securities sold under agreements to repurchase with stated maturity dates are as follows at December 31:

		2010								2009
		Amount				Rate				Amount				Rate
Repurchase agreements due 2010		$	—				—			$	5,000				4.00	%
Repurchase agreements due 2011			858				1.51	%			—				—
Repurchase agreements due 2012			1,013				2.21	%			—				—
Repurchase agreements due 2013			5,127				4.45	%			5,000				4.51	%
Repurchase agreements due 2014			12,087				3.00	%			10,000				3.19	%
Repurchase agreements due 2015			538				3.25	%			—				—
Total		$	19,623				3.01	%		$	20,000				3.72	%

Contractual Obligations and Loan Commitments

The Corporation has various financial obligations, including contractual obligations and commitments, which may require future cash payments. The following schedule summarizes the Corporation’s non cancelable obligations and future minimum payments as of December 31, 2010:

		Minimum Payments Due by Period
						After One				After Three
		Due in				Year But				Year But
		One Year				Within				Within				After
		or Less				Three Years				Five Years				Five Years				Total
Deposits with no stated maturity		$	424,978			$	—			$	—			$	—			$	424,978
Certificates of deposit with stated maturities			216,927				158,268				70,888				6,278				452,361
Borrowed funds
Short term borrowings			61,871				—				—				—				61,871
Long term borrowings			11,944				48,477				62,625				10,000				133,046
Total borrowed funds			73,815				48,477				62,625				10,000				194,917
Total contractual obligations		$	715,720			$	206,745			$	133,513			$	16,278			$	1,072,256

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The Corporation also has loan commitments that may impact liquidity. The following schedule summarizes the Corporation’s loan commitments and expiration dates by period as of December 31, 2010. Since many of these commitments historically have expired without being drawn upon, the total amount of these commitments does not necessarily represent future cash requirements of the Corporation’s recent loan growth, the desire to increase its investment in high quality tax exempt municipal bonds, and the increased level of competition for deposits, the Corporation has increased its other borrowings significantly over the past year. Included in the increase in other borrowed funds is an increase of $41,449 in repurchase agreements (see deposit discussion above). Management does anticipate that the Corporation will continue to increase its borrowings throughout 2009 (See Note 10 of Notes to Consolidated Financial Statements).Corporation.

		Expiration Dates by Period
						After One				After Three
		Due in				Year But				Year But
		One Year				Within				Within				After
		or Less				Three Years				Five Years				Five Years				Total
Unused commitments to extend credit		$	65,717			$	24,364			$	14,847			$	5,273			$	110,201
Undisbursed loans			13,382				—				—				—				13,382
Standby letters of credit			4,881				—				—				—				4,881
Total loan commitments		$	83,980			$	24,364			$	14,847			$	5,273			$	128,464

 

Capital

 

The capital of the Corporation consists solelyprimarily of common stock, including shares to be issued, retained earnings, and accumulated other comprehensive income / (loss).loss. The Corporation offers dividend reinvestment and employee, director, and directorshareholder stock purchase plans. Under the provisions of these Plans,plans, the Corporation issued 78,994122,113 shares of common stock generating $2,879$2,164 of capital during 2008,2010, and 63,233126,874 shares of common stock generating $2,657$2,396 of capital in 2007.2009. The Corporation also offers share-based payment awardsgenerates capital through the Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors (the “Directors Plan”), its equity compensation plan (See Note 1716 “Benefit Plans” of Notes to Consolidated Financial Statements). Pursuant to this plan, the Corporation generated $603$650 and $758$677 of capital in 20082010 and 2007,2009, respectively.

 

In October 2002, theThe Board of Directors authorized managementhas adopted a common stock repurchase plan. This plan was approved to repurchase upenable the Corporation to $2,000 in dollar value ofrepurchase the Corporation’s common stock. In March 2007,stock for reissuance to the Board ofdividend reinvestment plan, the employee stock purchase plan and for distributions from the Directors amended this plan which allowed for the repurchase of up to 150,000 of additional shares. In MayPlan. During 2010 and July 2008 they further amended the plan to allow for the repurchase of an additional 25,000 and 5,000 shares, respectively. During 2008 and 2007,2009 the Corporation repurchased 148,336138,970 shares of common stock at an average price of $43.41$18.40 and 43,220122,612 shares of common stock at an average price of $43.51,$19.47, respectively. There were no shares repurchased in 2006.

 

Accumulated other comprehensive loss increased $5,303decreased $410 in 20082010 and consists of a $3,771 increase in$457 of unrealized lossgains onavailable-for-sale investment securities andwhich was offset by a $1,532$47 increase in unrecognized pension cost of the defined benefit pension plan.cost. These amounts are net of tax.

 

The Federal Reserve Board’s current recommended minimum primary capital to assets requirement is 6.0%. The Corporation’s primary capital to average assets ratio, which consists of shareholders’ equity plus the allowance

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for loan losses less acquisition intangibles, was 9.26%8.24% at year end 2008.2010. There are no commitments for significant capital expenditures.

 

The Federal Reserve Board has established a minimum risk based capital standard. Under this standard, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. The minimum standard is 8%, of which at least 4% must consist of equity capital net of goodwill. The following table sets forth the percentages required under the Risk Based Capital guidelines and the Corporation’s values at December 31, 2008:at:

 

Percentage of Capital to Risk Adjusted Assets:

		Isabella Bank Corporation
		December 31, 2008								December 31
		Required				Actual				2010				2009				Required
Equity Capital			4.00	%			12.27	%			12.44	%			12.80	%			4.00	%
Secondary Capital			4.00	%			1.25	%			1.25	%			1.25	%			4.00	%
Total Capital			8.00	%			13.52	%			13.69	%			14.05	%			8.00	%

 

Isabella Bank Corporation’s secondary capital includes only the allowance for loan losses. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources.

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The Federal Reserve Board also prescribes minimum capital requirements for the Corporation’s subsidiary Bank. At December 31, 2008,2010, the Bank exceeded these minimums. For further information regarding the Bank’s capital requirements, refer to Note 16 of the Consolidated Financial Statements,15 “Minimum Regulatory Capital Requirements”. of the Notes to Consolidated Financial Statements,

 

Fair Value

 

The Corporation utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securitiesavailable-for-sale, trading securities, 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 loansheld-for-sale, loans held for investment in foreclosed assets, originated mortgage servicing rights, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.

 

Fair Value Hierarchy

Under SFAS 157,The table below represents the Corporation groups assets and liabilities at fair value into three levels, based on the marketsactivity 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.

Following is a description of the valuation methodologies used for assets and liabilities recorded at fair value.

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Investment Securities:

Investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets, mortgage-backed securities issued by government-sponsored entities and money market funds. Level 2 securities include municipal bonds and corporate debt securities in active markets. Securities classified as Level 3 include securities in less liquid markets, including illiquid markets in some instances, and include certain municipal securities and money market preferred auction rate securities.

The Corporation has invested $11,000 in auction rate money market preferred investment security instruments, which are classified as available-for-sale securities and reflected at 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 2008. The fair values of these securities were estimated utilizing a discounted cash flow analysis or other type of valuation adjustment methodology as of December 31, 2008. 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 positive intent and ability to hold such securities until credit markets improve, as further described in Note 4 of Notes to Consolidated Financial Statements.

Loans Available-for-Sale:

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

Loans:

The Corporation does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114,Accounting by Creditors for Impairment of a Loan, (SFAS 114). The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2008, impaired loans were evaluated based on the fair value of the collateral or based on the net present value of their expected cash flows. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, or the impairment is determined using the net present value of the expected cash flows, the Corporation classifies the impaired loan as nonrecurring Level 3.

Foreclosed Assets:

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

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Equity Securities Without Readily Determinable Fair Values:

The Corporation has investments in equity securities without readily determinable fair values as well as an investment in a joint venture. The assets are individually reviewed for impairment on an annual basis by comparing the carrying value to the estimated fair value. The lack of an independent source to validate fair value estimates, including the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. The Corporation classifies nonmarketable equity securities and its investment in a joint venture subjected to nonrecurring fair value adjustments as Level 3. During 2008 and 2007, there were no impairments recorded on equity securities without readily determinable fair values.

Mortgage Servicing Rights:

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

Goodwill and Other Intangible Assets:

Goodwill and identified intangible assets are subject to impairment testing. A projected cash flow valuation method is used in the completion of impairment testing. This valuation method requires a significant degree of management judgment. In the event the projected undiscounted net operating cash flows are less than the carrying value, the asset is recorded at fair value as determined by the valuation model. If the testing resulted in impairment, the Corporation would classify goodwill and other intangible assets subjected to nonrecurring fair value adjustments as Level 3. During 2008 and 2007, there were no impairments recorded on goodwill and other intangible assets.

Other Borrowed Funds:

The Corporation has elected to measure a portion of other borrowed funds at their fair value. These borrowings are recorded at fair valueinputs measured on a recurring basis withfor the year ended December 31:

		2010				2009
Level 3 inputs — January 1		$	10,027			$	5,979
Net unrealized (losses) gains onavailable-for-sale investment securities			(226	)			4,048
Level 3 inputs — December 31		$	9,801			$	10,027

For further information regarding fair value measurement being based upon quoted prices. Changes in the fair valuemeasurements see Note 1, “Nature of these borrowings are included in noninterest income. As such, the Corporation classifies other borrowed funds as Level 2.

During 2008, primarily as a resultOperations and Summary of declines in the rates offered on new residential mortgage loans, the Corporation recorded impairment charges of $115 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 livesSignificant Accounting Policies” and Note 19, “Fair Value” of the loans serviced and in turn decreased the value of the serving rights.

The impairment charges to foreclosed assets were the result of the real estate held declining in value subsequent to the properties being transferred to other real estate.

Liquidity

The primary sources of the Corporation’s liquidity are cash and cash equivalents, trading securities, and available-for-sale investment securities, excluding money market preferred securities in 2008 due to their illiquidity as of December 31, 2008. These categories totaled $285,805 or 25.0% of assets as of December 31, 2008 as compared to $263,774 or 27.6% in 2007. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests and various other commitments discussed in the accompanying notes to consolidated financial statements. Liquidity varies significantly daily, based on customer activity.

Operating activities provided $20,661 of cash in 2008 as compared to $60,387 in 2007. The reduction in net cash provided by operating activities was the result of the Corporation reducing its trading portfolio by $8,513 in 2008 as compared to $53,235 in 2007. Net cash provided by financing activities equaled $66,038 in 2008 and

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$38,470 in 2007, and was primarily the result of increases in other borrowed funds during 2008. The Corporation’s investing activities used cash amounting to $88,728 in 2008 and $104,633 in 2007. The accumulated effect of the Corporation’s operating, investing, and financing activities used $2,029 and $5,776 of cash in 2008 and 2007, respectively.

The primary source of funds for the Bank is deposits. The Bank emphasizes interest-bearing time deposits as part of their funding strategy. The Bank also seeks noninterest bearing deposits, or checking accounts, which reduce the Bank’s cost of funds in an effort to expand the customer base.

In recent periods, the Corporation has experienced some competitive challenges in obtaining additional deposits to fuel growth. As depositors continue to have wider access to the Internet and other real-time interest rate monitoring resources, deposit sourcing and pricing has become more competitive. Deposit growth is achievable, but at a competitive price. As a result of this increased competition, the Corporation (as discussed above) has begun to rely more and more on brokered, internet deposits, and other borrowed funds as a key funding source.

In addition to these primary sources of liquidity, the Corporation has the ability to borrow from the Federal Home Loan Bank, the Federal Reserve Bank, and through various correspondent banks as fed funds. As of December 31, 2008, the Corporation had the capacity to borrow up to $50,809 from the Federal Home Loan Bank based upon the current Board of Director approved limits.. The Corporation’s liquidity is considered adequate by the management of the Corporation.Consolidated Financial Statements.

 

Interest Rate Sensitivity

 

Interest rate sensitivity is determined by the amount of earning assets and interest bearing liabilities repricing within a specific time period, and their relative sensitivity to a change in interest rates. Management also strives to achieve reasonable stability in the net interest margin through periods of changing interest rates. One tool used by management to measure interest rate sensitivity is gap analysis. As shown in the following table, the gap analysis depicts the Corporation’s position for specific time periods and the cumulative gap as a percentage of total assets.

 

InvestmentTrading securities and other investmentsare included in the 0 to 3 month time frame due to their repricing characteristics. Fixed interest rate investment securities are scheduled according to their contractual maturity. Fixed rate loans are included in the appropriate time frame based on their scheduled amortization. Variable rate loans , which totaled $143,572 as of December 31, 2010, are included in the time frame of their earliest repricing. Of the $735,385 in total loans, $156,389 are variable rate loans. Time deposit liabilities are scheduled based on their contractual maturity except for variable rate time deposits in the amount of $1,813$1,940 that are included in the 0 to 3 month time frame.

 

Savings, NOW accounts, and money market accounts have no contractual maturity date and are believed to be predominantly noninterest rate sensitive by management. These accounts have been classified in the gap table according to their estimated withdrawal rates based upon management’s analysis of deposit runoff over the past five years. Management believes this runoff experience is consistent with its expectation for the future. As of December 31, 2008,2010, the Corporation had $69,230 more liabilities than assets maturinga negative cumulative gap within one year. A negative gap position results when more liabilities, within a specified time frame, mature or reprice than assets.

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Interest Rate Sensitivity

 

The following table shows the time periods and the amount of assets and liabilities available for interest rate repricing as of December 31, 2008.2010. The interest rate sensitivity information for investment securities is based on the

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expected prepayments and call dates versus stated maturities. For purposes of this analysis, nonaccrual loans and the allowance for loan losses are excluded.

 

		0 to 3				4 to 12				1 to 5				Over 5				0 to 3				4 to 12				1 to 5				Over 5
		Months				Months				Years				Years				Months				Months				Years				Years
Interest Sensitive Assets
Trading securities		$	21,775			$	—			$	—			$	—			$	5,837			$	—			$	—			$	—
Investment securities			32,312				50,540				57,075				106,528				17,405				47,247				129,688				136,384
Loans			187,926				94,142				384,450				57,692				168,790				94,739				401,106				65,059
Total		$	242,013			$	144,682			$	441,525			$	164,220			$	192,032			$	141,986			$	530,794			$	201,443
Interest Sensitive Liabilities
Borrowed funds		$	55,659			$	39,500			$	97,191			$	30,000			$	63,421			$	10,730			$	110,766			$	10,000
Time deposits			79,488				161,477				139,034				1,589				67,036				150,552				228,495				6,278
Savings			36,670				35,706				110,147				—				10,770				33,671				107,557				25,819
Interest bearing demand			28,114				19,311				66,548				—				7,432				22,405				79,827				32,595
Total		$	199,931			$	255,994			$	412,920			$	31,589			$	148,659			$	217,358			$	526,645			$	74,692
Cumulative gap (deficiency)		$	42,082			$	(69,230	)		$	(40,625	)		$	92,006			$	43,373			$	(31,999	)		$	(27,850	)		$	98,901
Cumulative gap (deficiency) as a % of assets			3.69	%			(6.08	)%			(3.57	)%			8.08	%			3.54	%			(2.61	)%			(2.27	) %			8.07	%

 

The following table shows the maturity of commercial and agricultural loans outstanding at December 31, 2008.2010. Also provided are the amounts due after one year, classified according to the sensitivity to changes in interest rates.

 

		Due in
		1 Year				1 to 5				Over 5								1 Year				1 to 5				Over 5
		or Less				Years				Years				Total				or Less				Years				Years				Total
Commercial and agricultural		$	95,292			$	262,546			$	24,971			$	382,809			$	102,027			$	296,042			$	22,229			$	420,298
Interest Sensitivity
Loans maturing after one year that have:
Fixed interest rates						$	223,957			$	23,425											$	253,106			$	20,346
Variable interest rates							38,589				1,546												42,936				1,883
Total						$	262,546			$	24,971											$	296,042			$	22,229

Liquidity

Liquidity is monitored regularly by the Corporation’s Market Risk Committee, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.

The primary sources of the Corporation’s liquidity are cash and cash equivalents, trading securities, andavailable-for-sale investment securities, excluding auction rate money market preferred securities and preferred stock due to their illiquidity. These categories totaled $360,677 or 29.4% of assets as of December 31, 2010 as compared to $292,464 or 25.6% in 2009. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments discussed in the accompanying notes to consolidated financial statements. Liquidity varies significantly daily, based on customer activity.

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The following table summarizes the Corporation’s sources and uses of cash for the years ended December 31:

		2010				2009				$ Variance
Net cash provided by operating activities		$	26,521			$	18,225			$	8,296
Net cash used in investing activities			(103,877	)			(9,184	)			(94,693	)
Net cash provided by (used in) financing activities			70,983				(7,538	)			78,521
(Decrease) Increase in cash and cash equivalents			(6,373	)			1,503				(7,876	)
Cash and cash equivalents January 1			24,482				22,979				1,503
Cash and cash equivalents December 31		$	18,109			$	24,482			$	(6,373	)

The primary source of funds for the Corporation is deposits. The Corporation emphasizes interest bearing time deposits as part of its funding strategy. The Corporation also seeks noninterest bearing deposits, or checking accounts, to expand its customer base, while reducing the Corporation’s cost of funds.

The Corporation has the ability to borrow from the Federal Home Loan Bank, the Federal Reserve Bank, and through various correspondent banks as federal funds. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including Federal Home Loan Bank Advances, Federal Reserve Bank Discount Window Advances, and repurchase agreements, require the Corporation to pledge assets, typically in the form of investment securities or loans, as collateral.

The Corporation had the ability to borrow up to an additional $122,960, based on the assets currently pledged as collateral. The Corporation has pledged eligible mortgage loans and investment securities as collateral for any such borrowings.

 

Quantitative and Qualitative Disclosures about Market Risk

 

The Corporation’s primary market risks are interest rate risk and liquidity risk. The Corporation has no significant foreign exchange risk, holds limited loans outstanding, to oil and gas concerns, and does not utilize interest rate swaps or derivatives, except for interest rate locks and forward loan commitments, in the management of its interest rate risk. Any changes in foreign exchange rates or commodity prices would have an insignificant impact if any, on the Corporation’s interest income and cash flows. The Corporation does have a significant amount of loans extended to borrowers in agricultural production. The cash flow of such borrowers and ability to service debt is largely dependent on the commodity prices for corn, soybeans, sugar beets, milk, beef, and a variety of dry beans.prices. The Corporation mitigates these risks by using conservative price and production yields when calculating a borrower’s available cash flow to service their debt.

 

Interest rate risk (“IRR”) is the exposure of the Corporation’s net interest income, its primary source of income, to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution’s interest earning assets and its interest bearing liabilities. IRR is the fundamental method in which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to the Corporation’s earnings and capital.

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The Federal Reserve Board, the Corporation’s primary Federal regulator, has adopted a policy requiring the Board of Directors and senior management to effectively manage the various risks that can have a material impact on the safety and soundness of the Corporation. The risks include credit, interest rate, liquidity, operational, and reputational. The Corporation has policies, procedures and internal controls for measuring and managing these risks. Specifically, the IRR policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long term assets, limiting the mismatch in repricing opportunity of assets and liabilities, and the frequency of measuring and reporting to the Board of Directors.

 

The Corporation uses several techniques to manage IRR. The first method is gap analysis. Gap analysis measures the cash flowsand/or the earliest repricing of the Corporation’s interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the imbedded repricing options contained in assets and liabilities. A substantial portion of the Corporation’s assets are invested in loans and investment securities with issuer call options. LoansResidential real estate and other consumer loans have imbedded options that allow the borrower to repay

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the balance prior to maturity without penalty.penalty, while commercial and agricultural loans have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current interest rate for residential mortgages, the level of sales of used homes, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in the Corporation’s cash flows from these assets. A significant portion of the Corporation’s securities are callable.callable or subject to prepayment. The call option is more likely to be exercised in a period of decreasing interest rates. Investment securities, other than those that are callable, do not have any significant imbedded options. Savings and checking deposits may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Time deposits have penalties that discourage early withdrawals.

 

The second technique used in the management of IRR is to combine the projected cash flows and repricing characteristics generated by the gap analysis and the interest rates associated with those cash flows to project future interest income. By changing the amount and timing of the cash flows and the repricing interest rates of those cash flows, the Corporation can project the effect of changing interest rates on its interest income. Based on the projections prepared for the year ended December 31, 2008,2010, the Corporation’s net interest income would increasedecrease during a period of decreasingincreasing interest rates.

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The following tables provide information about the Corporation’s assets and liabilities that are sensitive to changes in interest rates as of December 31, 20082010 and 2007.2009. The Corporation has no interest rate swaps, futures contracts, or other derivative financial options. The principal amounts of assets and time deposits maturing were calculated based on the contractual maturity dates. Savings and NOW accounts are based on management’s estimate of their future cash flows.

 

		December 31, 2008																												Fair Value				December 31, 2010																												Fair Value
		2009				2010				2011				2012				2013				Thereafter				Total				12/31/08				2011				2012				2013				2014				2015				Thereafter				Total				12/31/10
		(Dollars in thousands)																																(Dollars in thousands)
Rate sensitive assets
Other interest bearing assets		$	575			$	—			$	—			$	—			$	—			$	—			$	575			$	575			$	10,550			$	5,429			$	960			$	—			$	—			$	—			$	16,939			$	17,039
Average interest rates			0.21	%			—				—				—				—				—				0.21	%							0.96	%			1.82	%			2.16	%			—				—				—				1.30	%
Trading securities		$	7,867			$	4,902			$	3,181			$	2,937			$	1,089			$	1,799			$	21,775			$	21,775			$	1,918			$	2,366			$	1,031			$	522			$	—			$	—			$	5,837			$	5,837
Average interest rates			3.89	%			3.57	%			3.47	%			2.74	%			2.90	%			3.11	%			3.49	%							3.46	%			2.31	%			2.42	%			2.47	%			—				—				2.72	%
Fixed interest rate securities		$	82,852			$	13,043			$	12,494			$	11,247			$	20,291			$	106,528			$	246,455			$	246,455			$	64,652			$	42,984			$	32,871			$	29,395			$	24,438			$	136,384			$	330,724			$	330,724
Average interest rates			4.68	%			4.78	%			4.25	%			4.20	%			3.74	%			3.69	%			4.15	%							3.68	%			3.42	%			3.30	%			3.33	%			3.28	%			3.13	%			3.32	%
Fixed interest rate loans		$	136,854			$	105,529			$	110,218			$	80,163			$	88,540			$	57,692			$	578,996			$	598,703			$	128,277			$	121,434			$	140,019			$	67,423			$	68,569			$	66,010			$	591,732			$	603,435
Average interest rates			6.73	%			6.78	%			6.90	%			7.20	%			6.86	%			6.34	%			6.82	%							6.80	%			6.63	%			6.26	%			6.47	%			6.08	%			5.83	%			6.41	%
Variable interest rate loans		$	61,795			$	25,166			$	16,524			$	8,049			$	27,505			$	17,350			$	156,389			$	156,389			$	59,536			$	17,306			$	22,523			$	15,118			$	18,830			$	10,259			$	143,572			$	143,572
Average interest rates			5.32	%			4.75	%			5.27	%			5.34	%			4.45	%			5.90	%			5.14	%							4.94	%			4.76	%			4.27	%			3.78	%			3.69	%			5.21	%			4.55	%
Rate sensitive liabilities
Borrowed funds		$	95,159			$	39,191			$	21,000			$	22,000			$	15,000			$	30,000			$	222,350			$	230,130			$	74,151			$	33,013			$	15,127			$	37,087			$	25,539			$	10,000			$	194,917			$	200,603
Average interest rates			1.11	%			4.57	%			3.63	%			4.17	%			3.93	%			4.59	%			2.92	%							0.62	%			3.46	%			2.55	%			3.11	%			4.60	%			2.35	%			2.33	%
Savings and NOW accounts		$	119,801			$	79,465			$	63,274			$	25,140			$	8,816			$	—			$	296,496			$	296,496			$	74,278			$	73,818			$	53,174			$	35,872			$	24,520			$	58,414			$	320,076			$	320,076
Average interest rates			0.12	%			0.27	%			0.26	%			0.20	%			0.34	%			—				0.20	%							0.21	%			0.21	%			0.20	%			0.19	%			0.18	%			0.15	%			0.19	%
Fixed interest rate time deposits		$	239,152			$	62,838			$	29,771			$	21,565			$	24,860			$	1,589			$	379,775			$	385,478			$	215,648			$	113,338			$	44,269			$	31,414			$	39,474			$	6,278			$	450,421			$	452,392
Average interest rates			3.47	%			4.29	%			4.55	%			4.61	%			4.18	%			4.57	%			3.81	%							1.79	%			2.67	%			3.35	%			2.86	%			2.97	%			3.26	%			2.36	%
Variable interest rate time deposits		$	1,187			$	626			$	—			$	—			$	—			$	—			$	1,813			$	1,813			$	1,279			$	661			$	—			$	—			$	—			$	—			$	1,940			$	1,940
Average interest rates			1.90	%			1.67	%			—				—				—				—				1.82	%							1.21	%			1.06	%			—				—				—				—				1.16	%

 

		December 31, 2007																												Fair Value
		2008				2009				2010				2011				2012				Thereafter				Total				12/31/07
Rate sensitive assets
Other interest bearing assets		$	1,457			$	—			$	—			$	—			$	—			$	—			$	1,457			$	1,457
Average interest rates			3.21	%			—				—				—				—				—				3.21	%
Trading securities		$	9,342			$	2,213			$	3,269			$	2,750			$	2,820			$	4,670			$	25,064			$	25,064
Average interest rates			4.86	%			4.86	%			4.20	%			4.34	%			3.50	%			6.98	%			4.96	%
Fixed interest rate securities		$	74,950			$	24,122			$	8,450			$	8,082			$	2,826			$	94,697			$	213,127			$	213,127
Average interest rates			5.54	%			4.98	%			4.57	%			3.99	%			4.13	%			3.94	%			4.65	%
Fixed interest rate loans		$	124,447			$	99,132			$	98,275			$	78,152			$	63,957			$	58,037			$	522,000			$	523,454
Average interest rates			6.72	%			6.65	%			6.87	%			7.25	%			7.28	%			6.50	%			6.86	%
Variable interest rate loans		$	41,596			$	14,613			$	18,792			$	4,796			$	6,435			$	4,455			$	90,687			$	90,687
Average interest rates			7.94	%			7.67	%			7.66	%			7.52	%			7.31	%			7.56	%			7.75	%
Rate sensitive liabilities
Borrowed funds		$	30,387			$	6,500			$	24,000			$	—			$	17,000			$	15,000			$	92,887			$	91,897
Average interest rates			4.77	%			4.34	%			4.69	%			—				4.19	%			4.73	%			4.61	%
Savings and NOW accounts		$	132,008			$	71,320			$	69,183			$	23,972			$	5,725			$	—			$	302,208			$	302,208
Average interest rates			2.61	%			1.15	%			0.62	%			0.59	%			0.86	%			—				1.62	%
Fixed interest rate time deposits		$	226,090			$	33,477			$	42,835			$	23,067			$	18,853			$	137			$	344,459			$	346,528
Average interest rates			4.61	%			4.42	%			4.53	%			4.81	%			4.63	%			4.40	%			4.60	%
Variable interest rate time deposits		$	1,375			$	585			$	—			$	—			$	—			$	—			$	1,960			$	1,960
Average interest rates			4.09	%			4.10	%			—				—				—				—				4.09	%

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		December 31, 2009																												Fair Value
		2010				2011				2012				2013				2014				Thereafter				Total				12/31/09
Rate sensitive assets
Other interest bearing assets		$	10,360			$	960			$	1,200			$	—			$	—			$	—			$	12,520			$	12,520
Average interest rates			1.13	%			2.29	%			2.64	%			—				—				—				1.36	%
Trading securities		$	7,139			$	2,043			$	2,546			$	1,094			$	570			$	171			$	13,563			$	13,563
Average interest rates			2.84	%			2.42	%			2.28	%			2.53	%			2.66	%			4.86	%			2.66	%
Fixed interest rate securities		$	68,078			$	35,401			$	21,540			$	20,369			$	20,431			$	93,247			$	259,066			$	259,066
Average interest rates			3.53	%			3.51	%			3.59	%			3.65	%			3.63	%			3.58	%			3.57	%
Fixed interest rate loans		$	133,703			$	111,981			$	118,749			$	109,754			$	62,280			$	48,764			$	585,231			$	594,498
Average interest rates			6.64	%			6.85	%			6.72	%			6.50	%			6.61	%			6.01	%			6.61	%
Variable interest rate loans		$	60,727			$	17,695			$	13,799			$	16,357			$	16,940			$	12,567			$	138,085			$	138,085
Average interest rates			5.00	%			4.69	%			4.79	%			3.83	%			3.74	%			5.35	%			4.68	%
Rate sensitive liabilities
Borrowed funds		$	85,101			$	11,000			$	32,000			$	15,000			$	5,000			$	45,000			$	193,101			$	195,179
Average interest rates			2.28	%			4.04	%			3.50	%			3.93	%			4.38	%			4.01	%			3.17	%
Savings and NOW accounts		$	78,383			$	65,107			$	44,439			$	30,095			$	20,609			$	46,498			$	285,131			$	285,131
Average interest rates			0.15	%			0.15	%			0.15	%			0.14	%			0.15	%			0.13	%			0.15	%
Fixed interest rate time deposits		$	268,005			$	46,484			$	53,054			$	32,959			$	16,273			$	2,050			$	418,825			$	422,227
Average interest rates			2.26	%			3.59	%			3.47	%			3.83	%			3.09	%			3.35	%			2.72	%
Variable interest rate time deposits		$	1,252			$	569			$	—			$	—			$	—			$	—			$	1,821			$	1,821
Average interest rates			1.56	%			1.40	%			—				—				—				—				1.51	%

Forward Looking Statements

 

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Corporation intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Corporation, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. The Corporation’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Corporation and the subsidiaries include, but are not limited to, changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government including policies of the U.S. Treasury, and the Federal Reserve Board, the Federal Deposit Insurance Corporation, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Corporation’s market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Corporation and its business, including additional factors that could materially affect the Corporation’s financial results, is included in the Corporation’s filings with the Securities and Exchange Commission.

 

COMMON STOCK AND DIVIDEND INFORMATION

 

The Corporation’s common stock is traded in the over-the-counterover the counter (“OTC”) market. The common stock has been quoted on the OTC Pink Sheets Electronic Quotation Service (“Pinkmarket tier of the OTC Markets Group, Inc’s electronic quotation system (the “Pink Sheets”) under the symbol “ISBA” since August of 2008 and under the symbol IBTM“IBTM” prior to August of 2008. Other trades in the common stock occur in privately negotiated transactions from time to time of which the Corporation may have little or may not be aware.no information.

 

Management has reviewed the information available to it as to the range of reported high and low bid quotations, including high and low bid information as reported by Pink Sheets and closing price information as reported by the parties to privately negotiated transactions. The following table sets forth management’s compilation of that information for the periods indicated. Price information obtained from Pink Sheets reflects inter-dealerinter dealer prices, without retailmark-up, mark-down mark up, mark down or commissions and may not necessarily represent actual transactions. Price information obtained from parties to privately negotiated transactions reflects actual closing prices that were

95

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disclosed to the Corporation, which management has not independently verified. The following compiled data is provided for information purposes only and should not be viewed as indicative of the actual or market value of the Corporation’s common stock. All of the information has been adjusted to reflect the 10% stock dividend, paid February 29, 2008.

 

		Number of				Number of				Sale Price								Number of				Sale Price
Period		Sales				Shares				Low				High				Shares				Low				High
2008
2010
First Quarter			109				107,920			$	32.73			$	44.00				45,695			$	16.75			$	19.00
Second Quarter			89				50,600				39.00				44.00				64,290				17.00				18.50
Third Quarter			50				29,303				33.00				40.00				53,897				16.05				17.99
Fourth Quarter			80				71,855				22.50				36.50				56,534				16.57				18.30
			328				259,678												220,416
2007
2009
First Quarter			61				65,506				38.18				40.91				61,987				14.99				25.51
Second Quarter			78				42,227				38.50				40.91				91,184				15.85				20.75
Third Quarter			66				59,752				38.41				40.45				66,399				17.50				19.50
Fourth Quarter			65				24,597				38.18				40.00				76,985				14.00				19.25
			270				192,082												296,555

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

 

		Per Share								Per Share
		2008				2007				2010				2009
First Quarter		$	0.12			$	0.11			$	0.18			$	0.12
Second Quarter			0.12				0.11				0.18				0.13
Third Quarter			0.12				0.11				0.18				0.13
Fourth Quarter			0.29				0.29				0.18				0.32
Total		$	0.65			$	0.62			$	0.72			$	0.70

 

Isabella Bank Corporation’s authorized common stock consists of 15,000,000 shares, of which 7,518,8567,550,074 shares are issued and outstanding as of December 31, 2008.2010. As of that date, there were 2,9793,011 shareholders of record.

 

The Board of Directors has adopted a common stock repurchase plan. On March 22, 2007,June 23, 2010, the Board of Directors adopted a repurchaseamended the plan which allows for the repurchase of up to 150,000 shares of the Corporation’s issued and outstanding common stock. This plan was amended in May 2008 to allow for the repurchase of an additional 25,000 shares. The plan was further amended to allow for an additional 5,000100,000 shares to be repurchased in July 2008.of the Corporation’s common stock. These authorizations do not have expiration dates. As shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued shares. This authorization does not have an expiration date.

The following table provides information as offor the three month period ended December 31, 2008,2010, with respect to this plan:

 

										Total Number of
										Shares Purchased				Maximum Number of
		Shares Repurchased								as Part of Publicly				Shares That May Yet Be
						Average Price				Announced Plan				Purchased Under the
		Number				Per Share				or Program				Plans or Programs
Balance, September 30, 2008															1,044
October 1 — 31, 2008			—			$	—				—				1,044
November 1 — 30, 2008			—				—				—				1,044
December 1 — 31, 2008			—				—				—				1,044
Balance, December 31, 2008			—			$	—				—				1,044

										Total Number of
										Shares Purchased				Maximum Number of
		Shares Repurchased								as Part of Publicly				Shares That May Yet Be
						Average Price				Announced Plan				Purchased Under the
		Number				Per Share				or Program				Plans or Programs
Balance, September 30, 2010															59,131
October 1 - 31, 2010			5,224			$	17.23				5,224				53,907
November 1 - 30, 2010			7,773				17.37				7,773				46,134
December 1 - 31, 2010			6,697				16.87				6,697				39,437
Balance, December 31, 2010			19,694			$	17.16				19,694				39,437

 

Information concerning Securities Authorized for Issuance Under Equity Compensation Plans appears under “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters” included elsewhere in thisthe Corporation’s 2010 annual report onForm 10-K.

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Stock Performance

 

The following graph compares the cumulative total shareholder return on Corporation common stock for the last five years with the cumulative total return on (1) the NASDAQ Stock Market Index, which is comprised of all United States common shares traded on the NASDAQ and (2) the NASDAQ Bank Stock Index, which is comprised of bank and bank holding company common shares traded on the NASDAQ over the same period. The graph assumes the value of an investment in the Corporation and each index was $100 at December 31, 20032005 and all dividends are reinvested.

 

Stock Performance

Five-Year Total Return

 

 

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

 

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

 

		Isabella Bank								NASDAQ				Isabella Bank								NASDAQ
Year		Corporation				NASDAQ				Banks				Corporation				NASDAQ				Banks
12/31/2003			100.0				100.0				100.0
12/31/2004			117.2				109.1				113.4
12/31/2005			124.7				111.4				111.2				100.0				100.0				100.0
12/31/2006			139.2				122.9				126.4				111.6				110.3				113.6
12/31/2007			141.4				136.0				101.6				113.3				122.1				91.4
12/31/2008			92.1				81.6				80.0				73.8				73.5				72.0
12/31/2009															56.9				106.6				60.2
12/31/2010															54.2				125.8				68.6

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SHAREHOLDERS’ INFORMATION

 

Annual Meeting

 

The Annual Meeting of Shareholders will be held at 5:00 p.m., Tuesday, May 5, 2009,3, 2011, Comfort Inn, 2424 S. Mission Street, Mt. Pleasant, Michigan.

 

Financial Information andForm 10-K

 

Copies of the 20082010 Annual Report, Isabella Bank CorporationForm 10-K, and other financial information not contained herein are available on the Bank’s website (www.isabellabank.com) under the Investor Relations tab, or may be obtained, without charge, by writing to:

 

	Debra Campbell

Debra Campbell
Secretary

Isabella Bank Corporation

401 N. Main St.

Mt. Pleasant, Michigan 48858

 

Mission Statement

The mission of Isabella Bank Corporation shall be:

 

To create an operating environment that will provide shareholders with sustained growth in their investment while maintaining our independence and subsidiaries’ autonomy.

 

Equal Employment Opportunity

 

The equal employment opportunity clauses in Section 202 of the Executive Order 11246, as amended; 38 USC 2012, Vietnam Era Veterans Readjustment Act of 1974; Section 503 of the Rehabilitation Act of 1973, as amended; relative to equal employment opportunity and implementing rules and regulations of the Secretary of Labor are adhered to and supported by Isabella Bank Corporation, and its subsidiaries.

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ISABELLA BANK CORPORATION PROXY
401 North Main Street
Mt. Pleasant, MI 48858 CARD

THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS

The undersigned hereby appoints Sandra L. Caul, Theodore W. Kortes,James C. Fabiano, and Dale D. WeburgJoseph LaFramboise as proxies, each with the power to appoint his/her substitute, and hereby authorizes them to represent and to vote as designated below, all the shares of Common Stock of Isabellalsabella Bank Corporation held of record bythat the undersigned onis eligible to vote as of April 1, 20092011 at the annual meeting of shareholders to be held on May 5, 20093,2011 or any adjournments thereof.

PROPOSAL 1--ELECTION OF DIRECTORS: Proposal to elect the following five (5) persons as directors. Please mark the appropriate box for each director-nominee.

FOR

AGAINST

WITHHOLD AUTHORITY

Dennis P. Angner

Jeffrey J. Barnes

G. Charles Hubscher

David J. Maness

W. Joseph Manifold

PROPOSAL 2--ADVISORY VOTE ON EXECUTIVE COMPENSATION: Proposal to adopt an advisory (non-binding) resolution regarding named executive officer compensation.

1) FOR		ELECTION OF DIRECTORS:AGAINST		WITHHOLD AUTHORITY
o		o		o

PROPOSAL 3:--FREQUENCY OF ADVISORY VOTE ON EXECUTIVE COMPENSATION: Proposal to adopt an advisory (non- binding) resolution on the frequency of shareholder votes regarding named executive officer compensation.

ONE		TWO		THREE
YEAR		FOR ALL NOMINEES LISTED BELOWqYEARS		WITHHOLD AUTHORITY TO VOTEq
YEARS		EXCEPT AS MARKED TO THEWITHHOLD AUTHORITY
o		FOR ALL NOMINEES LISTED
o		CONTRARY BELOWo		o

(INSTRUCTION: To withhold authority to voteThe Board of Directors Recommends a Vote“FOR” Proposals 1 and 2, and for any individual nominee, circle the nominee’s name in the list below.)

Dennis P. AngnerDavid J. ManessW. Joseph ManifoldWilliam J. Strickler

(continued and to be signed3-year frequency on other side)Proposal 3.

This proxy, when properly executed, will be voted in the manner directed herein by the undersigned shareholder. IF NO DIRECTION IS MADE, THIS PROXY WILL BE VOTED TO ELECT ALL NOMINEES.“FOR” PROPOSALS 1 AND 2, AND FOR THE 3-YEAR FREQUENCY ON PROPOSAL 3. The shares represented by this proxy will be voted in the discretion of the proxies on any other matters which may come before the meeting.

Please sign below as your name appears on the label. When shares are held by joint tenants, both should sign. When signing as attorney, executor, administrator, trustee or guardian, please give full title as such. If a corporation, please sign full corporate name by the President or other authorized officer. If a partnership, please sign in partnership name by authorized person.

Dated: ______________________________, 2009		___________________________________________________
Dated:				, 2011
Please mark, sign, date and return Proxy card promptly using the enclosed envelope.								Signature
Proxy card promptly using the enclosed						___________________________________________________
Envelope.
								Signature (if held jointly)

ISABELLA BANK CORPORATION  401 N Main St, Mount Pleasant, Ml 48858    www.isabellabank.com