UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2013

or

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

For the transition period from to

Commission File Number: 0-18415

Isabella Bank Corporation

(Exact name of registrant as specified in its charter)

Michigan	38-2830092
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer identification No.)
401 N. Main St, Mt. Pleasant, MI	48858
(Address of principal executive offices)	(Zip code)

(989) 772-9471

(Registrant’s telephone number, including area code)

N/A

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ý  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ý  Yes    ¨  No

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     ¨  Yes    ý  No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock no par value, 7,711,460 as of 7/25/2013

ISABELLA BANK CORPORATION

QUARTERLY REPORT ON FORM 10-Q

Table of Contents

PART I FINANCIAL INFORMATION	4
Item 1 Financial Statements	4
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations	38
Item 3 Quantitative and Qualitative Disclosures about Market Risk	58
Item 4 Controls and Procedures	58
PART II OTHER INFORMATION	59
Item 1 Legal Proceedings	59
Item 1A Risk Factors	59
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds	59
Item 6 Exhibits	60
SIGNATURES

2

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. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and is included in 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, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Our 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 include, but are not limited to, changes in: interest rates, general economic conditions, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the FRB, the quality or composition of the loan or investment portfolios, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, demand for financial services in our 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 Isabella Bank Corporation and its business, including additional factors that could materially affect our financial results, is included in our filings with the SEC.

The acronyms and abbreviations identified below may be used throughout this 10-Q, or in our other filings. You may find it helpful to refer back to this page while reading this report.

AFS: Available-for-sale	GLB Act: Gramm-Leach-Bliley Act of 1999
ALLL: Allowance for loan and lease losses	IFRS: International Financial Reporting Standards
AOCI: Accumulated other comprehensive income (loss)	IRR: Interest Rate Risk
ASC: FASB Accounting Standards Codification	JOBS Act: Jumpstart our Business Startups Act
ASU: FASB Accounting Standards Update	LIBOR: London Interbank Offered Rate
ATM: Automated Teller Machine	Moody’s: Moody’s Investors Service, Inc
BHC Act: Bank Holding Company Act of 1956	N/A: Not applicable
CFPB: Consumer Financial Protection Bureau	N/M: Not meaningful
CRA: Community Reinvestment Act	NASDAQ: NASDAQ Stock Market Index
DIF: Deposit Insurance Fund	NASDAQ Banks: NASDAQ Bank Stock Index
DIFS: Department of Insurance and Financial Services	NAV: Net asset value
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors	NOW: Negotiable order of withdrawal
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan	NSF: Non-sufficient funds
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010	OCI: Other comprehensive income (loss)
ESOP: Employee stock ownership plan	OMSRs: Originated mortgage servicing rights
Exchange Act: Securities Exchange Act of 1934	OREO: Other real estate owned
FASB: Financial Accounting Standards Board	OTC: Over-the-Counter
FDI Act: Federal Deposit Insurance Act	OTTI: Other-than-temporary impairment
FDIC: Federal Deposit Insurance Corporation	PBO: Projected Benefit Obligation
FFIEC: Federal Financial Institutions Examinations Council	PCAOB: Public Company Accounting Oversight Board
Fitch: Fitch Ratings	Rabbi Trust: A trust established to fund the Directors Plan
FRB: Federal Reserve Bank	SEC: U.S. Securities & Exchange Commission
FHLB: Federal Home Loan Bank	SOX: Sarbanes-Oxley Act of 2002
Freddie Mac: Federal Home Loan Mortgage Corporation	S&P: Standard & Poor
FTE: Fully taxable equivalent	TDR: Troubled debt restructuring
GAAP: U.S. generally accepted accounting principles	XBRL: eXtensible Business Reporting Language

3

PART I – FINANCIAL INFORMATION

Item 1 – Interim Condensed Consolidated Financial Statements (Unaudited)

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

	June 30 2013			December 31 2012
ASSETS
Cash and cash equivalents
Cash and demand deposits due from banks	$	21,289		$	22,634
Interest bearing balances due from banks	77			2,286
Total cash and cash equivalents	21,366			24,920
Certificates of deposit held in other financial institutions	1,810			4,465
Trading securities	950			1,573
AFS securities (amortized cost of $499,891 in 2013 and $490,420 in 2012)	499,424			504,010
Mortgage loans AFS	743			3,633
Loans
Commercial	389,044			371,505
Agricultural	87,516			83,606
Residential real estate	293,158			284,148
Consumer	33,734			33,494
Total loans	803,452			772,753
Less allowance for loan and lease losses	11,700			11,936
Net loans	791,752			760,817
Premises and equipment	25,852			25,787
Corporate owned life insurance policies	24,101			22,773
Accrued interest receivable	5,232			5,227
Equity securities without readily determinable fair values	18,242			18,118
Goodwill and other intangible assets	46,418			46,532
Other assets	15,525			12,784
TOTAL ASSETS	$	1,451,415		$	1,430,639
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing	$	139,942		$	143,735
NOW accounts	173,184			181,259
Certificates of deposit under $100 and other savings	468,094			455,546
Certificates of deposit over $100	240,204			237,127
Total deposits	1,021,424			1,017,667
Borrowed funds	262,460			241,001
Accrued interest payable and other liabilities	8,243			7,482
Total liabilities	1,292,127			1,266,150
Shareholders’ equity
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,703,589 shares (including 4,742 shares held in the Rabbi Trust) in 2013 and 7,671,846 shares (including 5,130 shares held in the Rabbi Trust) in 2012	137,321			136,580
Shares to be issued for deferred compensation obligations	3,871			3,734
Retained earnings	22,244			19,168
Accumulated other comprehensive income (loss)	(4,148		)	5,007
Total shareholders’ equity	159,288			164,489
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,451,415		$	1,430,639

See notes to interim condensed consolidated financial statements.

4

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands except per share amounts)

	Three Months Ended   June 30				Six Months Ended   June 30
	2013		2012		2013		2012
Interest income
Loans, including fees	$	10,280	$	10,849	$	20,610	$	21,789
AFS securities
Taxable	1,798		1,988		3,632		3,877
Nontaxable	1,244		1,216		2,478		2,420
Trading securities	9		22		23		64
Federal funds sold and other	109		113		225		242
Total interest income	13,440		14,188		26,968		28,392
Interest expense
Deposits	1,822		2,368		3,696		4,880
Borrowings	959		1,061		1,906		2,253
Total interest expense	2,781		3,429		5,602		7,133
Net interest income	10,659		10,759		21,366		21,259
Provision for loan losses	215		439		515		900
Net interest income after provision for loan losses	10,444		10,320		20,851		20,359
Noninterest income
Service charges and fees	1,747		1,628		3,291		3,257
Gain (loss) on sale of mortgage loans	249		279		607		658
Earnings on corporate owned life insurance policies	190		177		359		348
Gain (loss) on sale of AFS securities	—		—		99		1,003
Other	550		460		827		819
Total noninterest income	2,736		2,544		5,183		6,085
Noninterest expenses
Compensation and benefits	5,236		5,232		10,681		10,533
Furniture and equipment	1,192		1,170		2,381		2,260
Occupancy	641		599		1,306		1,240
AFS security impairment loss
Total other-than-temporary impairment loss	—		—		—		486
Portion of loss reported in other comprehensive income (loss)	—		—		—		(204		)
Net AFS security impairment loss	—		—		—		282
Other	2,255		2,187		4,147		4,446
Total noninterest expenses	9,324		9,188		18,515		18,761
Income before federal income tax expense	3,856		3,676		7,519		7,683
Federal income tax expense	643		672		1,219		1,445
NET INCOME	$	3,213	$	3,004	$	6,300	$	6,238
Earnings per share
Basic	$	0.42	$	0.40	$	0.82	$	0.82
Diluted	$	0.41	$	0.39	$	0.80	$	0.80
Cash dividends per basic share	$	0.21	$	0.20	$	0.42	$	0.40

See notes to interim condensed consolidated financial statements.

5

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

	Three Months Ended   June 30						Six Months Ended   June 30
	2013			2012			2013			2012
Net income	$	3,213		$	3,004		$	6,300		$	6,238
Unrealized gains (losses) on AFS securities:
Unrealized gains (losses) arising during the period	(11,997		)	1,420			(13,958		)	2,219
Reclassification adjustment for net realized (gains) losses included in net income	—			—			(99		)	(1,003		)
Reclassification adjustment for impairment loss included in net income	—			—			—			282
Net unrealized gains (losses)	(11,997		)	1,420			(14,057		)	1,498
Tax effect (1)	3,979			(546		)	4,902			(27		)
Other comprehensive income (loss)	(8,018		)	874			(9,155		)	1,471
Comprehensive income (loss)	$	(4,805	)	$	3,878		$	(2,855	)	$	7,709

(1) See “Note 10 – Federal Income Taxes” for tax effect reconciliation.

See notes to interim condensed consolidated financial statements.

6

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands except per share amounts)

	Common Stock  Shares Outstanding		Common Stock			Shares to be Issued for Deferred Compensation Obligations			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Totals
Balance, January 1, 2012	7,589,226		$	134,734		$	4,524		$	13,036		$	2,489		$	154,783
Comprehensive income (loss)	—		—			—			6,238			1,471			7,709
Issuance of common stock	54,900		1,322			—			—			—			1,322
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations	—		95			(95		)	—			—			—
Share-based payment awards under equity compensation plan	—		—			295			—			—			295
Common stock purchased for deferred compensation obligations	—		(225		)	—			—			—			(225		)
Common stock repurchased pursuant to publicly announced repurchase plan	(41,581	)	(995		)	—			—			—			(995		)
Cash dividends ($0.40 per share)	—		—			—			(3,034		)	—			(3,034		)
Balance, June 30, 2012	7,602,545		$	134,931		$	4,724		$	16,240		$	3,960		$	159,855
Balance, January 1, 2013	7,671,846		$	136,580		$	3,734		$	19,168		$	5,007		$	164,489
Comprehensive income (loss)	—		—			—			6,300			(9,155		)	(2,855		)
Issuance of common stock	77,568		1,900			—			—			—			1,900
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations	—		121			(121		)	—			—			—
Share-based payment awards under equity compensation plan	—		—			258			—			—			258
Common stock purchased for deferred compensation obligations	—		(166		)	—			—			—			(166		)
Common stock repurchased pursuant to publicly announced repurchase plan	(45,825	)	(1,114		)	—			—			—			(1,114		)
Cash dividends ($0.42 per share)	—		—			—			(3,224		)	—			(3,224		)
Balance, June 30, 2013	7,703,589		$	137,321		$	3,871		$	22,244		$	(4,148	)	$	159,288

See notes to interim condensed consolidated financial statements.

7

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

	Six Months Ended   June 30
	2013			2012
OPERATING ACTIVITIES
Net income	$	6,300		$	6,238
Reconciliation of net income to net cash provided by operations:
Provision for loan losses	515			900
Impairment of foreclosed assets	92			17
Depreciation	1,249			1,195
Amortization and impairment of OMSRs	210			287
Amortization of acquisition intangibles	114			133
Net amortization of AFS securities	1,131			1,076
AFS security impairment loss	—			282
(Gain) loss on sale of AFS securities	(99		)	(1,003		)
Net unrealized (gains) losses on trading securities	18			32
Net gain on sale of mortgage loans	(607		)	(658		)
Net unrealized (gains) losses on borrowings measured at fair value	—			(33		)
Increase in cash value of corporate owned life insurance policies	(359		)	(348		)
Share-based payment awards under equity compensation plan	258			295
Origination of loans held-for-sale	(35,014		)	(46,386		)
Proceeds from loan sales	38,511			47,902
Net changes in operating assets and liabilities which provided (used) cash:
Trading securities	605			2,680
Accrued interest receivable	(5		)	631
Other assets	914			(1,132		)
Accrued interest payable and other liabilities	761			(161		)
Net cash provided by (used in) operating activities	14,594			11,947
INVESTING ACTIVITIES
Net change in certificates of deposit held in other financial institutions	2,655			2,044
Activity in AFS securities
Sales	9,857			24,241
Maturities and calls	46,780			37,922
Purchases	(67,140		)	(112,835		)
Loan principal originations, net	(32,185		)	(6,768		)
Proceeds from sales of foreclosed assets	1,556			647
Purchases of premises and equipment	(1,314		)	(1,298		)
Purchases of corporate owned life insurance policies	(1,092		)	—
Proceeds from redemption of corporate owned life insurance policies	123			—
Net cash provided by (used in) investing activities	(40,760		)	(56,047		)

8

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Dollars in thousands)

	Six Months Ended   June 30
	2013			2012
FINANCING ACTIVITIES
Acceptances and withdrawals of deposits, net	3,757			20,664
Increase (decrease) in borrowed funds	21,459			18,029
Cash dividends paid on common stock	(3,224		)	(3,034		)
Proceeds from issuance of common stock	1,900			1,322
Common stock repurchased	(1,114		)	(995		)
Common stock purchased for deferred compensation obligations	(166		)	(225		)
Net cash provided by (used in) financing activities	22,612			35,761
Increase (decrease) in cash and cash equivalents	(3,554		)	(8,339		)
Cash and cash equivalents at beginning of period	24,920			28,590
Cash and cash equivalents at end of period	$	21,366		$	20,251
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid	$	5,667		$	7,291
Federal income taxes paid	702			836
SUPPLEMENTAL NONCASH INVESTING AND FINANCING INFORMATION:
Transfers of loans to foreclosed assets	$	735		$	1,150

See notes to interim condensed consolidated financial statements.

9

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands except per share amounts)

Note 1 – Basis of Presentation

As used in these notes as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to “Isabella,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiaries. Isabella Bank Corporation refers solely to the parent holding company, and Isabella Bank refers to Isabella Bank Corporation’s subsidiary, Isabella Bank.

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. For further information, refer to the consolidated financial statements and footnotes thereto included in our annual report for the year ended December 31, 2012.

Our accounting policies are materially the same as those discussed in Note 1 to the Consolidated Financial Statements included in our annual report for the year ended December 31, 2012.

Note 2 – Computation of Earnings Per Share

Basic earnings per share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan.

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

	Three Months Ended   June 30				Six Months Ended   June 30
	2013		2012		2013		2012
Average number of common shares outstanding for basic calculation	7,701,042		7,592,668		7,689,092		7,593,462
Average potential effect of shares in the Directors Plan (1)	168,323		203,603		166,800		201,743
Average number of common shares outstanding used to calculate diluted earnings per common share	7,869,365		7,796,271		7,855,892		7,795,205
Net income	$	3,213	$	3,004	$	6,300	$	6,238
Earnings per share
Basic	$	0.42	$	0.40	$	0.82	$	0.82
Diluted	$	0.41	$	0.39	$	0.80	$	0.80

⁽¹⁾  Exclusive of shares held in the Rabbi Trust

Note 3 – Recently Adopted Accounting Standards Update

ASU No. 2013-02: “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”

In February 2013, ASU No. 2013-02 amended ASC Topic 220, “Comprehensive Income” to require disclosures related to reclassifications out of AOCI in one place. The ASU also requires the disclosure of reclassifications out of AOCI by component. The new authoritative guidance was effective for interim and annual periods beginning after December 15, 2012 and did not have a financial impact on the Corporation, but increased the level of disclosures related to AOCI (see "Note 13 – Accumulated Other Comprehensive Income (Loss)").

10

Note 4 – Trading Securities

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

	June 30 2013		December 31 2012
States and political subdivisions	$	950	$	1,573

Included in net trading losses of $18 during the first six months of 2013 were $4 of net unrealized trading losses on securities that were held in our trading portfolio as of June 30, 2013. Included in net trading losses of $32 during the first six months of 2012 were $10 of net unrealized trading losses on securities that were held in our trading portfolio as of June 30, 2012.

Note 5 – AFS Securities

The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:

	June 30, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Government sponsored enterprises	$	25,184	$	16	$	951	$	24,249
States and political subdivisions	184,157		5,567		2,422		187,302
Auction rate money market preferred	3,200		—		257		2,943
Preferred stocks	6,800		66		307		6,559
Mortgage-backed securities	151,530		862		2,985		149,407
Collateralized mortgage obligations	129,020		1,445		1,501		128,964
Total	$	499,891	$	7,956	$	8,423	$	499,424

	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Government sponsored enterprises	$	25,668	$	108	$	—	$	25,776
States and political subdivisions	174,118		9,190		565		182,743
Auction rate money market preferred	3,200		—		422		2,778
Preferred stocks	6,800		—		437		6,363
Mortgage-backed securities	152,256		3,199		110		155,345
Collateralized mortgage obligations	128,378		2,627		—		131,005
Total	$	490,420	$	15,124	$	1,534	$	504,010

11

The amortized cost and fair value of AFS securities by contractual maturity at June 30, 2013 are as follows:

	Maturing								Securities with Variable Monthly Payments or Noncontractual Maturities
	Due in One Year or Less		After One Year But Within Five Years		After Five Years But Within Ten Years		After Ten Years				Total
Government sponsored enterprises	$	—	$	72	$	25,112	$	—	$	—	$	25,184
States and political subdivisions	9,925		35,019		92,688		46,525		—		184,157
Auction rate money market preferred	—		—		—		—		3,200		3,200
Preferred stocks	—		—		—		—		6,800		6,800
Mortgage-backed securities	—		—		—		—		151,530		151,530
Collateralized mortgage obligations	—		—		—		—		129,020		129,020
Total amortized cost	$	9,925	$	35,091	$	117,800	$	46,525	$	290,550	$	499,891
Fair value	$	9,998	$	36,221	$	119,783	$	45,549	$	287,873	$	499,424

Expected maturities for government sponsored enterprises and states and political subdivisions may differ from contractual maturities because issuers may have the right to call or prepay obligations.

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

A summary of the activity related to sales of AFS securities was as follows for the three and six month periods ended:

	Three Months Ended   June 30				Six Months Ended   June 30
	2013		2012		2013		2012
Proceeds from sales of AFS securities	$	—	$	—	$	9,857	$	24,241
Gross realized gains (losses)	$	—	$	—	$	99	$	1,003
Applicable income tax expense (benefit)	$	—	$	—	$	34	$	341

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.

Information pertaining to AFS securities with gross unrealized losses at June 30, 2013 and December 31, 2012 aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

	June 30, 2013
	Less Than Twelve Months				Twelve Months or More
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Total Unrealized Losses
Government sponsored enterprises	$	951	$	23,043	$	—	$	—	$	951
States and political subdivisions	1,901		39,297		521		2,090		2,422
Auction rate money market preferred	—		—		257		2,943		257
Preferred stocks	—		—		307		3,493		307
Mortgage-backed securities	2,985		93,842		—		—		2,985
Collateralized mortgage obligations	1,501		54,368		—		—		1,501
Total	$	7,338	$	210,550	$	1,085	$	8,526	$	8,423
Number of securities in an unrealized loss position:			155				6		161

12

	December 31, 2012
	Less Than Twelve Months				Twelve Months or More
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Total Unrealized Losses
States and political subdivisions	$	80	$	5,019	$	485	$	2,352	$	565
Auction rate money market preferred	—		—		422		2,778		422
Preferred stocks	—		—		437		3,363		437
Mortgage-backed securities	110		25,499		—		—		110
Total	$	190	$	30,518	$	1,344	$	8,493	$	1,534
Number of securities in an unrealized loss position:			15				6		21

As of June 30, 2013 and December 31, 2012, we conducted an analysis to determine whether any securities currently in an unrealized loss position should be other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:

• Has the value of the investment declined more than 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 the issuer will be unable to pay the amount when due?

• Is it more likely than not that we will not have to sell the security before recovery of its cost basis?

• Has the duration of the investment been extended?

During the three month period ended March 31, 2012, we had one state issued student loan auction rate AFS investment security (which is included in states and political subdivisions) that was downgraded by Moody’s from A3 to Caa3. As a result of this downgrade, we engaged the services of an independent investment valuation firm to estimate the amount of credit losses (if any) related to this particular issue as of March 31, 2012. The evaluation calculated a range of estimated credit losses utilizing two different bifurcation methods:

1) Discounted Cash Flow Method.

2) Credit Yield Analysis Method.

The two methods were then weighted, with a higher weighting applied to the Discounted Cash Flow Method, to determine the estimated credit related impairment. As a result of this analysis we recognized an OTTI of $282 in earnings in the quarter ended March 31, 2012.

A summary of key valuation assumptions used in the aforementioned analysis as of March 31, 2012, follows:

	Discounted Cash Flow Method
Ratings
Fitch	Not Rated
Moody’s	Caa3
S&P	A
Seniority	Senior
Discount rate	LIBOR + 6.35%
	Credit Yield Analysis Method
Credit discount rate	LIBOR + 4.00%
Average observed discounts based on closed transactions	14.00%

To test for additional impairment of this security during the three and six months ended June 30, 2013, we obtained another investment valuation (from the same firm engaged to perform the initial valuation as of March 31, 2012) as of June 30, 2013. Based on our analysis, no additional OTTI was indicated as of June 30, 2013.

13

The following table provides a roll-forward of credit related impairment recognized in earnings for the:

	Three Months Ended June 30				Six Months Ended June 30
	2013		2012		2013		2012
Balance at beginning of period	$	282	$	282	$	282	$	—
Additions to credit losses for which no previous OTTI was recognized	—		—		—		282
Balance at end of period	$	282	$	282	$	282	$	282

Based on our analysis using the above criteria, the fact that we have asserted that we do not have the intent to sell these securities in an unrealized loss position, and considering it is unlikely that we will have to sell the securities before recovery of their cost basis, we do not believe that the values of any other securities are other-than-temporarily impaired as of June 30, 2013, or December 31, 2012.

Note 6 – Loans and ALLL

We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw 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, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate 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.

Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs. 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 level yield method.

The accrual of interest on commercial, agricultural, and residential real estate loans is typically 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. Consumer 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.

For loans that are placed on nonaccrual status or 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 ALLL. The interest on these loans is accounted for on the cash basis, until qualifying for return to accrual status. Loans are typically returned to accrual status after six months of continuous performance. 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.

Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, farmland and agricultural production, and states and political subdivisions. Repayment of these loans is often dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of credit exposure 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. Commercial and agricultural real estate loans generally require loan-to-value limits of less than 80%. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports as deemed necessary.

We offer adjustable rate mortgages, fixed rate balloon mortgages, construction loans, 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 Freddie Mac. Fixed rate residential real estate loans with an amortization of 15 years or less may be held in our portfolio, held for future sale, or sold upon origination. We consider the direction of interest rates, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell these loans to Freddie Mac.

Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans 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,

14

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 and reviewed internally. All mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market automated underwriting system; loans in excess of $400 require the approval of our Internal Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.

Consumer loans include automobile loans, secured and unsecured personal 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 perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.

The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.

The ALLL is evaluated on a regular basis and is based upon a periodic review of the collectability 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 primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. 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 our recorded investment. Historical loss allocations were calculated at the loan class and segment levels based on a migration analysis of the loan portfolio over the preceding five years. An unallocated component is maintained to cover uncertainties that we believe affect our 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.

A summary of changes in the ALLL and the recorded investment in loans by segments follows:

	Allowance for Loan Losses
	Three Months Ended June 30, 2013
	Commercial			Agricultural		Residential Real Estate			Consumer			Unallocated		Total
April 1, 2013	$	6,897		$	321	$	3,634		$	732		$	325	$	11,909
Loans charged-off	(234		)	—		(397		)	(88		)	—		(719		)
Recoveries	166			—		61			68			—		295
Provision for loan losses	(357		)	14		378			(65		)	245		215
June 30, 2013	$	6,472		$	335	$	3,676		$	647		$	570	$	11,700

	Allowance for Loan Losses
	Six Months Ended June 30, 2013
	Commercial			Agricultural			Residential Real Estate			Consumer			Unallocated		Total
January 1, 2013	$	6,862		$	407		$	3,627		$	666		$	374	$	11,936
Loans charged-off	(445		)	—			(587		)	(209		)	—		(1,241		)
Recoveries	223			—			114			153			—		490
Provision for loan losses	(168		)	(72		)	522			37			196		515
June 30, 2013	$	6,472		$	335		$	3,676		$	647		$	570	$	11,700

15

	Allowance for Loan Losses and Recorded Investment in Loans
	June 30, 2013
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	1,642	$	31	$	1,744	$	—	$	—	$	3,417
Collectively evaluated for impairment	4,830		304		1,932		647		570		8,283
Total	$	6,472	$	335	$	3,676	$	647	$	570	$	11,700
Loans
Individually evaluated for impairment	$	13,639	$	576	$	10,720	$	54			$	24,989
Collectively evaluated for impairment	375,405		86,940		282,438		33,680				778,463
Total	$	389,044	$	87,516	$	293,158	$	33,734			$	803,452

	Allowance for Loan Losses
	Three Months Ended June 30, 2012
	Commercial			Agricultural			Residential Real Estate			Consumer			Unallocated		Total
April 1, 2012	$	5,728		$	859		$	3,702		$	625		$	1,461	$	12,375
Loans charged-off	(237		)	—			(238		)	(146		)	—		(621		)
Recoveries	42			—			20			63			—		125
Provision for loan losses	475			(426		)	185			125			80		439
June 30, 2012	$	6,008		$	433		$	3,669		$	667		$	1,541	$	12,318

	Allowance for Loan Losses
	Six Months Ended June 30, 2012
	Commercial			Agricultural			Residential Real Estate			Consumer			Unallocated		Total
January 1, 2012	$	6,284		$	1,003		$	2,980		$	633		$	1,475	$	12,375
Loans charged-off	(686		)	—			(353		)	(237		)	—		(1,276		)
Recoveries	128			—			61			130			—		319
Provision for loan losses	282			(570		)	981			141			66		900
June 30, 2012	$	6,008		$	433		$	3,669		$	667		$	1,541	$	12,318

	Allowance for Loan Losses and Recorded Investment in Loans
	December 31, 2012
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	2,050	$	91	$	1,796	$	—	$	—	$	3,937
Collectively evaluated for impairment	4,812		316		1,831		666		374		7,999
Total	$	6,862	$	407	$	3,627	$	666	$	374	$	11,936
Loans
Individually evaluated for impairment	$	14,456	$	723	$	10,704	$	75			$	25,958
Collectively evaluated for impairment	357,049		82,883		273,444		33,419				746,795
Total	$	371,505	$	83,606	$	284,148	$	33,494			$	772,753

16

The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit ratings as of:

	June 30, 2013
	Commercial						Agricultural
	Real Estate		Other		Total		Real Estate		Other		Total
Rating
2 - High quality	$	21,836	$	16,358	$	38,194	$	3,523	$	3,273	$	6,796
3 - High satisfactory	94,390		40,835		135,225		24,305		14,758		39,063
4 - Low satisfactory	133,379		44,636		178,015		24,782		13,248		38,030
5 - Special mention	14,315		1,314		15,629		803		201		1,004
6 - Substandard	17,350		2,138		19,488		958		1,268		2,226
7 - Vulnerable	1,068		78		1,146		—		248		248
8 - Doubtful	1,327		20		1,347		—		149		149
Total	$	283,665	$	105,379	$	389,044	$	54,371	$	33,145	$	87,516

	December 31, 2012
	Commercial						Agricultural
	Real Estate		Other		Total		Real Estate		Other		Total
Rating
2 - High quality	$	25,209	$	15,536	$	40,745	$	2,955	$	2,313	$	5,268
3 - High satisfactory	83,805		28,974		112,779		16,972		11,886		28,858
4 - Low satisfactory	127,423		45,143		172,566		27,291		15,437		42,728
5 - Special mention	16,046		1,692		17,738		1,008		3,191		4,199
6 - Substandard	20,029		2,224		22,253		1,167		1,217		2,384
7 - Vulnerable	1,512		2,294		3,806		—		—		—
8 - Doubtful	1,596		22		1,618		—		169		169
Total	$	275,620	$	95,885	$	371,505	$	49,393	$	34,213	$	83,606

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

Credit has 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

Credit with sound financial condition and has a 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.

17

3. HIGH SATISFACTORY – Reasonable Risk

Credit with 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

Credit with bankable risks, although some signs of weaknesses are shown:

• Would include most start-up businesses.

• Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.

• Management’s abilities are 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

Credit constitutes 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.

• Collateral or guaranty offers limited protection.

• Negative debt service coverage, however the credit is well collateralized and payments are current.

6. SUBSTANDARD – Classified

Credit where the borrower’s current net worth, paying capacity, and value of the collateral pledged is inadequate. There is a distinct possibility that we 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.

18

7. VULNERABLE – Classified

Credit is considered “Substandard” and warrants 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

Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/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.

Our primary credit quality indicators for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans as of:

	June 30, 2013
	Accruing Interest and Past Due:								Total Past Due and Nonaccrual
	30-59 Days		60-89 Days		90 Days or More		Nonaccrual				Current		Total
Commercial
Commercial real estate	$	1,224	$	490	$	—	$	1,806	$	3,520	$	280,145	$	283,665
Commercial other	403		113		192		78		786		104,593		105,379
Total commercial	1,627		603		192		1,884		4,306		384,738		389,044
Agricultural
Agricultural real estate	377		19		—		—		396		53,975		54,371
Agricultural other	—		12		—		248		260		32,885		33,145
Total agricultural	377		31		—		248		656		86,860		87,516
Residential real estate
Senior liens	2,461		462		316		1,427		4,666		234,597		239,263
Junior liens	199		29		—		71		299		14,220		14,519
Home equity lines of credit	90		25		—		—		115		39,261		39,376
Total residential real estate	2,750		516		316		1,498		5,080		288,078		293,158
Consumer
Secured	46		—		12		21		79		28,984		29,063
Unsecured	19		6		—		—		25		4,646		4,671
Total consumer	65		6		12		21		104		33,630		33,734
Total	$	4,819	$	1,156	$	520	$	3,651	$	10,146	$	793,306	$	803,452

19

	December 31, 2012
	Accruing Interest and Past Due:								Total Past Due and Nonaccrual
	30-59 Days		60-89 Days		90 Days or More		Nonaccrual				Current		Total
Commercial
Commercial real estate	$	1,304	$	161	$	63	$	2,544	$	4,072	$	271,548	$	275,620
Commercial other	606		—		40		2,294		2,940		92,945		95,885
Total commercial	1,910		161		103		4,838		7,012		364,493		371,505
Agricultural
Agricultural real estate	—		—		—		—		—		49,393		49,393
Agricultural other	90		—		—		169		259		33,954		34,213
Total agricultural	90		—		—		169		259		83,347		83,606
Residential real estate
Senior liens	2,000		346		320		2,064		4,730		223,532		228,262
Junior liens	232		—		—		50		282		16,207		16,489
Home equity lines of credit	237		—		—		182		419		38,978		39,397
Total residential real estate	2,469		346		320		2,296		5,431		278,717		284,148
Consumer
Secured	127		33		4		—		164		28,118		28,282
Unsecured	31		3		1		—		35		5,177		5,212
Total consumer	158		36		5		—		199		33,295		33,494
Total	$	4,627	$	543	$	428	$	7,303	$	12,901	$	759,852	$	772,753

Impaired Loans

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

1. There has been a charge-off of its principal balance (in whole or in part),

2. The loan has been classified as a TDR, or

3. The loan is in nonaccrual status.

Impairment is measured on a loan-by-loan basis for commercial and agricultural loans by comparing the loan’s outstanding balance to 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. Impairment is measured on a loan-by-loan basis for residential real estate and consumer loans by comparing the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate.

20

We do not recognize interest income on impaired loans in nonaccrual status. For impaired loans not in nonaccrual status, interest income is recognized daily, as earned, according to the terms of the loan agreement. The following is a summary of information pertaining to impaired loans as of, and for the periods ended:

	June 30, 2013						December 31, 2012
	Outstanding Balance		Unpaid Principal Balance		Valuation Allowance		Outstanding Balance		Unpaid Principal Balance		Valuation Allowance
Impaired loans with a valuation allowance
Commercial real estate	$	6,919	$	7,420	$	1,578	$	7,295	$	7,536	$	1,653
Commercial other	1,468		1,468		64		2,140		2,140		397
Agricultural real estate	91		91		31		91		91		32
Agricultural other	—		—		—		420		420		59
Residential real estate senior liens	10,475		11,675		1,731		10,450		11,672		1,783
Residential real estate junior liens	71		109		13		72		118		13
Total impaired loans with a valuation allowance	$	19,024	$	20,763	$	3,417	$	20,468	$	21,977	$	3,937
Impaired loans without a valuation allowance
Commercial real estate	$	4,405	$	5,139			$	3,749	$	4,408
Commercial other	847		958				1,272		1,433
Agricultural real estate	132		132				—		—
Agricultural other	353		473				212		332
Home equity lines of credit	174		474				182		482
Consumer secured	54		54				75		84
Total impaired loans without a valuation allowance	$	5,965	$	7,230			$	5,490	$	6,739
Impaired loans
Commercial	$	13,639	$	14,985	$	1,642	$	14,456	$	15,517	$	2,050
Agricultural	576		696		31		723		843		91
Residential real estate	10,720		12,258		1,744		10,704		12,272		1,796
Consumer	54		54		—		75		84		—
Total impaired loans	$	24,989	$	27,993	$	3,417	$	25,958	$	28,716	$	3,937

21

	Three Months Ended   June 30, 2013					Six Months Ended   June 30, 2013
	Average Outstanding Balance		Interest Income Recognized			Average Outstanding Balance		Interest Income Recognized
Impaired loans with a valuation allowance
Commercial real estate	$	7,990	$	102		$	8,084	$	221
Commercial other	764		37			932		38
Agricultural real estate	91		1			124		4
Agricultural other	—		—			105		—
Residential real estate senior liens	10,466		110			10,460		209
Residential real estate junior liens	85		1			85		1
Total impaired loans with a valuation allowance	$	19,396	$	251		$	19,790	$	473
Impaired loans without a valuation allowance
Commercial real estate	$	3,954	$	85		$	3,790	$	158
Commercial other	1,020		19			1,126		59
Agricultural real estate	133		2			67		2
Agricultural other	458		(11		)	423		(4		)
Home equity lines of credit	179		5			181		9
Consumer secured	63		1			68		2
Total impaired loans without a valuation allowance	$	5,807	$	101		$	5,655	$	226
Impaired loans
Commercial	$	13,728	$	243		$	13,932	$	476
Agricultural	682		(8		)	719		2
Residential real estate	10,730		116			10,726		219
Consumer	63		1			68		2
Total impaired loans	$	25,203	$	352		$	25,445	$	699

22

	Three Months Ended   June 30, 2012				Six Months Ended   June 30, 2012
	Average Outstanding Balance		Interest Income Recognized		Average Outstanding Balance		Interest Income Recognized
Impaired loans with a valuation allowance
Commercial real estate	$	6,444	$	83	$	6,165	$	181
Commercial other	829		16		777		28
Agricultural real estate	—		—		—		—
Agricultural other	2,145		36		2,306		73
Residential real estate senior liens	7,862		92		7,706		175
Residential real estate junior liens	175		2		183		4
Total impaired loans with a valuation allowance	$	17,455	$	229	$	17,137	$	461
Impaired loans without a valuation allowance
Commercial real estate	$	6,789	$	112	$	7,299	$	179
Commercial other	2,249		34		1,777		65
Agricultural real estate	274		—		232		—
Agricultural other	607		3		595		7
Home equity lines of credit	195		4		197		8
Consumer secured	89		1		95		3
Total impaired loans without a valuation allowance	$	10,203	$	154	$	10,195	$	262
Impaired loans
Commercial	$	16,311	$	245	$	16,018	$	453
Agricultural	3,026		39		3,133		80
Residential real estate	8,232		98		8,086		187
Consumer	89		1		95		3
Total impaired loans	$	27,658	$	383	$	27,332	$	723

As of June 30, 2013 and December 31, 2012, we had committed to advance $61 and $9, respectively, in connection with impaired loans, which include TDRs.

Troubled Debt Restructurings

Loan modifications are considered to be TDRs when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties.

Typical concessions granted include, but are not limited to:

1. Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics.

2. Extending the amortization period beyond typical lending guidelines for debt with similar risk characteristics.

3. Forbearance of principal.

4. Forbearance of accrued interest.

To determine if a borrower is experiencing financial difficulties, we consider if:

1. The borrower is currently in default on any of their debt.

2. The borrower would likely default on any of their debt if the concession was not granted.

3. The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted.

4. The borrower has declared, or is in the process of declaring, bankruptcy.

5. The borrower is unlikely to continue as a going concern (if the entity is a business).

23

The following is a summary of information pertaining to TDRs granted in the periods ended:

	Three Months Ended June 30, 2013					Six Months Ended June 30, 2013
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial other	7	$	3,153	$	2,957	7	$	3,153	$	2,957
Agricultural other	—	—		—		1	134		134
Residential real estate senior liens	7	635		635		15	1,435		1,418
Total	14	$	3,788	$	3,592	23	$	4,722	$	4,509

	Three Months Ended June 30, 2012					Six Months Ended June 30, 2012
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial other	5	$	305	$	305	26	$	4,891	$	4,891
Agricultural other	—	—		—		6	561		561
Residential real estate senior liens	7	684		684		12	1,405		1,405
Total	12	$	989	$	989	44	$	6,857	$	6,857

	Three Months Ended June 30, 2013						Six Months Ended June 30, 2013
	Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period			Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period
	Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment
Commercial other	3	$	1,357	4	$	1,796	3	$	1,357	4	$	1,796
Agricultural other	—	—		—	—		1	134		—	—
Residential real estate senior liens	4	414		3	221		7	625		8	810
Total	7	$	1,771	7	$	2,017	11	$	2,116	12	$	2,606

	Three Months Ended June 30, 2012						Six Months Ended June 30, 2012
	Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period			Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period
	Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment
Commercial other	3	$	160	2	$	145	24	$	4,746	2	$	145
Agricultural other	—	—		—	—		6	561		—	—
Residential real estate senior liens	4	324		3	360		4	324		8	1,081
Total	7	$	484	5	$	505	34	$	5,631	10	$	1,226

We did not restructure any loans through the forbearance of principal or accrued interest in the three and six month periods ended June 30, 2013 or 2012.

Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs, including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment.

We had no loans that defaulted in the three and six month periods ended June 30, 2013, which were modified within 12 months prior to the default date.

24

Following is a summary of loans that defaulted in the three and six month periods ended June 30, 2012, which were modified within 12 months prior to the default date:

	Three Months Ended June 30, 2012							Six Months Ended June 30, 2012
	Number of Loans	Pre- Default Recorded Investment		Charge-Off Recorded Upon Default		Post- Default Recorded Investment		Number of Loans	Pre- Default Recorded Investment		Charge-Off Recorded Upon Default		Post- Default Recorded Investment
Commercial other	2	$	50	$	25	$	25	3	$	132	$	67	$	65
Residential real estate senior liens	—	—		—		—		1	47		43		4
Consumer secured	1	8		8		—		1	8		8		—
Total	3	$	58	$	33	$	25	5	$	187	$	118	$	69

The following is a summary of TDR loan balances as of:

	June 30 2013		December 31 2012
TDRs	$	20,857	$	19,355

Note 7 – 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 unconsolidated entities accounted for under the equity method of accounting.

Equity securities without readily determinable fair values consist of the following as of:

	June 30 2013		December 31 2012
FHLB Stock	$	8,100	$	7,850
Corporate Settlement Solutions, LLC	6,919		7,040
FRB Stock	1,879		1,879
Valley Financial Corporation	1,000		1,000
Other	344		349
Total	$	18,242	$	18,118

Note 8 – Borrowed Funds

Borrowed funds consist of the following obligations as of:

	June 30 2013		December 31 2012
FHLB advances	$	162,000	$	152,000
Securities sold under agreements to repurchase without stated maturity dates	71,668		66,147
Securities sold under agreements to repurchase with stated maturity dates	16,292		16,284
Federal funds purchased	12,500		6,570
Total	$	262,460	$	241,001

The FHLB advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans and certain mortgage-backed securities and collateralized mortgage obligations. Advances are also secured by our holdings of FHLB stock. As of June 30, 2013, we had the ability to borrow up to an additional $91,951, based on assets pledged as collateral. During the first quarter of 2013 and 2012, we reduced funding costs by modifying the term of $30,000 and $60,000, respectively, of FHLB advances.

25

The following table lists the maturity and weighted average interest rates of FHLB advances as of:

	June 30, 2013				December 31, 2012
	Amount		Rate		Amount		Rate
Fixed rate advances due 2013	$	10,000	0.33	%	$	—	—	%
Fixed rate advances due 2014	10,000		0.48	%	10,000		0.48	%
Fixed rate advances due 2015	32,000		0.84	%	42,000		1.12	%
Fixed rate advances due 2016	10,000		2.15	%	10,000		2.15	%
Fixed rate advances due 2017	30,000		1.95	%	40,000		2.15	%
Fixed rate advances due 2018	30,000		2.49	%	20,000		2.86	%
Fixed rate advances due 2019	20,000		3.11	%	20,000		3.73	%
Fixed rate advances due 2020	10,000		1.98	%	10,000		1.98	%
Fixed rate advances due 2023	10,000		3.90	%	—		—	%
Total	$	162,000	1.92	%	$	152,000	2.05	%

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 connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $122,362 and $143,322 at June 30, 2013 and December 31, 2012, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.

The following table provides a summary of short-term borrowings for the three and six month periods ended:

	Three Months Ended June 30, 2013						Three Months Ended June 30, 2012
	Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period		Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates	$	71,668	$	69,692	0.15	%	$	58,584	$	58,045	0.20	%
Federal funds purchased	13,700		6,022		0.57	%	17,900		7,025		0.47	%

	Six Months Ended June 30, 2013						Six Months Ended June 30, 2012
	Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period		Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates	$	71,668	$	65,363	0.15	%	$	58,584	$	55,436	0.11	%
Federal funds purchased	13,700		3,646		0.56	%	17,900		3,552		0.23	%

We had pledged certificates of deposit held in other financial institutions, trading securities, AFS securities, and 1-4 family residential real estate loans in the following amounts at:

	June 30 2013		December 31 2012
Pledged to secure borrowed funds	$	307,647	$	308,628
Pledged to secure repurchase agreements	122,362		143,322
Pledged for public deposits and for other purposes necessary or required by law	22,331		22,955
Total	$	452,340	$	474,905

We had no investment securities that are restricted to be pledged for specific purposes.

26

Note 9 – Other Noninterest Expenses

A summary of expenses included in other noninterest expenses are as follows for the:

	Three Months Ended   June 30				Six Months Ended   June 30
	2013		2012		2013		2012
Marketing and community relations	$	432	$	535	$	674	$	1,029
FDIC insurance premiums	273		213		545		428
Directors fees	205		209		404		419
Audit and related fees	162		154		301		330
Education and travel	116		139		238		266
Postage and freight	94		94		193		195
Printing and supplies	99		110		185		219
Legal fees	120		81		180		143
Consulting fees	83		71		155		258
Other	671		581		1,272		1,159
Total other	$	2,255	$	2,187	$	4,147	$	4,446

Note 10 – Federal Income Taxes

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

	Three Months Ended   June 30						Six Months Ended   June 30
	2013			2012			2013			2012
Income taxes at 34% statutory rate	$	1,311		$	1,250		$	2,556		$	2,612
Effect of nontaxable income
Interest income on tax exempt municipal securities	(400		)	(388		)	(801		)	(779		)
Earnings on corporate owned life insurance policies	(65		)	(60		)	(122		)	(118		)
Other	(222		)	(141		)	(450		)	(292		)
Total effect of nontaxable income	(687		)	(589		)	(1,373		)	(1,189		)
Effect of nondeductible expenses	19			11			36			22
Federal income tax expense	$	643		$	672		$	1,219		$	1,445

Included in OCI for the three and six month periods ended June 30, 2013 and 2012 are changes in unrealized holding gains and losses related to auction rate money market preferred and preferred stocks. For federal income tax purposes, these securities are considered equity investments. As such, no deferred federal income taxes related to unrealized holding gains or losses are expected or recorded.

27

A summary of OCI follows for the:

	Three Months Ended June 30
	2013									2012
	Auction Rate Money Market Preferred and Preferred Stocks			All Other AFS Securities			Total			Auction Rate Money Market Preferred and Preferred Stocks			All Other AFS Securities			Total
Unrealized gains (losses) arising during the period	$	(363	)	$	(11,634	)	$	(11,997	)	$	(185	)	$	1,605		$	1,420
Reclassification adjustment for net realized (gains) losses included in net income	—			—			—			—			—			—
Reclassification adjustment for impairment loss included in net income	—			—			—			—			—			—
Net unrealized gains (losses)	(363		)	(11,634		)	(11,997		)	(185		)	1,605			1,420
Tax effect	—			3,979			3,979			—			(546		)	(546		)
Unrealized gains (losses), net of tax	$	(363	)	$	(7,655	)	$	(8,018	)	$	(185	)	$	1,059		$	874

	Six Months Ended June 30
	2013								2012
	Auction Rate Money Market Preferred and Preferred Stocks		All Other AFS Securities			Total			Auction Rate Money Market Preferred and Preferred Stocks		All Other AFS Securities			Total
Unrealized gains (losses) arising during the period	$	295	$	(14,253	)	$	(13,958	)	$	1,419	$	800		$	2,219
Reclassification adjustment for net realized (gains) losses included in net income	—		(99		)	(99		)	—		(1,003		)	(1,003		)
Reclassification adjustment for impairment loss included in net income	—		—			—			—		282			282
Net unrealized gains (losses)	295		(14,352		)	(14,057		)	1,419		79			1,498
Tax effect	—		4,902			4,902			—		(27		)	(27		)
Unrealized gains (losses), net of tax	$	295	$	(9,450	)	$	(9,155	)	$	1,419	$	52		$	1,471

Note 11 – Defined Benefit Pension Plan

We maintain a noncontributory defined benefit pension plan, which was curtailed effective March 1, 2007. As a result of the curtailment, future salary increases are no longer considered and plan benefits are based on years of service and the individual employee’s five highest consecutive years of compensation out of the last ten years of service through March 1, 2007. We contributed $215 and $709 to the plan during the six month periods ended June 30, 2013 and 2012, respectively. We do not anticipate any further contributions to the plan in 2013.

28

Following are the components of net periodic benefit cost for the three and six month periods ended:

	Three Months Ended   June 30						Six Months Ended   June 30
	2013			2012			2013			2012
Interest cost on PBO	$	112		$	117		$	225		$	235
Expected return on plan assets	(144		)	(127		)	(287		)	(254		)
Amortization of unrecognized actuarial net loss	82			73			165			146
Net periodic benefit cost	$	50		$	63		$	103		$	127

Note 12 – Fair Value

Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.

Cash and cash equivalents: The carrying amounts of cash and short term investments, including Federal funds sold, approximate fair values. As such, we classify cash and demand deposits due from banks as Level 1.

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. As such, we classify certificates of deposits held in other financial institutions as Level 2.

AFS and trading securities: AFS and trading securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. 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. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources.

Mortgage loans AFS:Mortgage loans AFS are carried at the lower of cost or fair value. The fair value of Mortgage loans AFS are based on what price secondary markets are currently offering for portfolios with similar characteristics. As such, we classify Mortgage loans AFS subject 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. As such, we classify loans as Level 3 assets.

We do not record loans at fair value on a recurring basis. However, from time-to-time, loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure 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, or 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.

We review the net realizable values of the underlying collateral for collateral dependent impaired loans on at least a quarterly basis for all loan types. To determine the collateral value, we utilize independent appraisals, broker price opinions, or internal evaluations. We review these valuations 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. We use these valuations to determine if any charge-offs or specific reserves are necessary. We 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 if the existing valuation is deemed to be outdated. Due to the inherent level of estimation in the valuation process, we record impaired loans as nonrecurring Level 3.

29

The table below lists the quantitative information about impaired loans measured utilizing Level 3 fair value measurements as of:

	June 30, 2013
Valuation Techniques	Fair Value	Unobservable Input	Range
Discounted cash flow	$8,802	Duration of cash flows:	8-120 Months
		Reduction in interest rate from original loan terms:	5.00% - 6.63%
		Discount applied to collateral appraisal:
		Real Estate	20% - 30%
		Equipment	50%
Discounted appraisal value	$12,770	Livestock	50%
		Cash crop inventory	50%
		Other inventory	75%
		Accounts receivable	75%

	December 31, 2012
Valuation Techniques	Fair Value	Unobservable Input	Range
Discounted cash flow	$8,726	Duration of cash flows:	14-120 Months
		Reduction in interest rate from original loan terms:	5.00% - 6.25%
		Discount applied to collateral appraisal:
		Real Estate	20% - 30%
		Equipment	50%
Discounted appraisal value	$13,295	Livestock	50%
		Cash crop inventory	50%
		Other inventory	75%
		Accounts receivable	75%

Accrued interest receivable: The carrying amounts of accrued interest receivable approximate fair value. As such, we classify accrued interest receivable as Level 1.

Equity securities without readily determinable fair values: Included in equity securities without readily determinable fair values are FHLB Stock and FRB Stock as well as our ownership interests in Corporate Settlement Solutions, LLC and Valley Financial Corporation. The investment in Corporate Settlement Solutions, LLC, a title insurance company, was made in the first quarter 2007. We are not the managing entity of Corporate Settlement Solutions, LLC, and therefore, we account for our investment under the equity method of accounting. Valley Financial Corporation is the parent company of 1st State Bank in Saginaw, Michigan, which is a de novo bank that opened in 2005. We made investments in Valley Financial Corporation in 2004 and in 2007.

The lack of an active market, or other independent sources to validate fair value estimates coupled with the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. As the fair values of these investments are not readily determinable, they are not disclosed under a specific fair value hierarchy; however, they are reviewed quarterly for impairment. If we were to record an impairment adjustment related to these securities, it would be classified as a nonrecurring Level 3 fair value adjustment. During 2013 and 2012, there were no impairments recorded on equity securities without readily determinable fair values.

Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets (which are included in other 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. Due to the inherent level of estimation in the valuation process, we record foreclosed assets as nonrecurring Level 3.

30

The table below lists the quantitative information related to foreclosed assets measured utilizing Level 3 fair value measurements as of:

	June 30, 2013
Valuation Techniques	Fair Value		Unobservable Input	Range
			Discount applied to collateral appraisal:
Discounted appraisal value	$	1,105	Real Estate	20% - 30%

	December 31, 2012
Valuation Techniques	Fair Value		Unobservable Input	Range
			Discount applied to collateral appraisal:
Discounted appraisal value	$	2,018	Real Estate	20% - 30%

Goodwill and other intangible assets: Acquisition intangibles and goodwill are evaluated for potential impairment on at least an annual basis. Acquisition intangibles and goodwill are typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance of acquisition intangibles or goodwill is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the potential impairment. If the testing resulted in impairment, we would classify goodwill and other acquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 2013 and 2012, there were no impairments recorded on goodwill and other acquisition intangibles.

OMSRs:OMSRs (which are included in other assets) are subject to impairment testing. To test for impairment, we utilize a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and discount rates. If the valuation model reflects a value less than the carrying value, OMSRs are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSRs subject to nonrecurring fair value adjustments as Level 2.

Deposits: The fair value of 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), and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their recorded carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, fixed rate certificates of deposit are classified as Level 2.

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. The fair values of other borrowed funds are estimated using discounted cash flow analyses based on current incremental borrowing arrangements. As such, borrowed funds are classified as Level 2.

Accrued interest payable: The carrying amounts of accrued interest payable approximate fair value. As such, we classify accrued interest payable as Level 1.

Commitments to extend credit, standby letters of credit, and undisbursed loans: Our commitments to extend credit, standby letters of credit, and undisbursed funds have no carrying amount and are estimated to have no realizable fair value. Historically, a majority of the unused commitments to extend credit have not been drawn upon and, generally, we do not receive fees in connection with these commitments other than standby letter of credit fees, which are not significant.

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. Although we believe our 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.

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

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

31

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

	June 30, 2013
	Carrying Value			Estimated Fair Value			(Level 1)		(Level 2)		(Level 3)
ASSETS
Cash and cash equivalents	$	21,366		$	21,366		$	21,366	$	—	$	—
Certificates of deposit held in other financial institutions	1,810			1,813			—		1,813		—
Mortgage loans AFS	743			768			—		768		—
Total loans	803,452			808,902			—		—		808,902
Less allowance for loan and lease losses	(11,700		)	(11,700		)	—		—		(11,700		)
Net loans	791,752			797,202			—		—		797,202
Accrued interest receivable	5,232			5,232			5,232		—		—
Equity securities without readily determinable fair values (1)	18,242			18,242			—		—		—
OMSRs	2,381			2,381			—		2,381		—
LIABILITIES
Deposits without stated maturities	561,224			561,224			561,224		—		—
Deposits with stated maturities	460,200			464,148			—		464,148		—
Borrowed funds	262,460			266,633			—		266,633		—
Accrued interest payable	686			686			686		—		—

	December 31, 2012
	Carrying Value			Estimated Fair Value			(Level 1)		(Level 2)		(Level 3)
ASSETS
Cash and cash equivalents	$	24,920		$	24,920		$	24,920	$	—	$	—
Certificates of deposit held in other financial institutions	4,465			4,475			—		4,475		—
Mortgage loans AFS	3,633			3,680			—		3,680		—
Total loans	772,753			784,964			—		—		784,964
Less allowance for loan and lease losses	(11,936		)	(11,936		)	—		—		(11,936		)
Net loans	760,817			773,028			—		—		773,028
Accrued interest receivable	5,227			5,227			5,227		—		—
Equity securities without readily determinable fair values (1)	18,118			18,118			—		—		—
OMSRs	2,285			2,285			—		2,285		—
LIABILITIES
Deposits without stated maturities	553,332			553,332			553,332		—		—
Deposits with stated maturities	464,335			472,630			—		472,630		—
Borrowed funds	241,001			248,822			—		248,822		—
Accrued interest payable	751			751			751		—		—

⁽¹⁾  Due to the characteristics of equity securities without readily determinable fair values, they are not disclosed under a specific fair value hierarchy. If we were to record an impairment adjustment related to these securities, such amount would be classified as a nonrecurring Level 3 fair value adjustment.

32

Financial Instruments Recorded at Fair Value

The table below presents the recorded amount of assets and liabilities measured at fair value on:

	June 30, 2013											December 31, 2012
	Total		(Level 1)			(Level 2)			(Level 3)			Total		(Level 1)			(Level 2)			(Level 3)
Recurring items
Trading securities
States and political subdivisions	$	950	$	—		$	950		$	—		$	1,573	$	—		$	1,573		$	—
AFS Securities
Government-sponsored enterprises	24,249		—			24,249			—			25,776		—			25,776			—
States and political subdivisions	187,302		—			187,302			—			182,743		—			182,743			—
Auction rate money market preferred	2,943		—			2,943			—			2,778		—			2,778			—
Preferred stocks	6,559		6,559			—			—			6,363		6,363			—			—
Mortgage-backed securities	149,407		—			149,407			—			155,345		—			155,345			—
Collateralized mortgage obligations	128,964		—			128,964			—			131,005		—			131,005			—
Total AFS Securities	499,424		6,559			492,865			—			504,010		6,363			497,647			—
Nonrecurring items
Impaired loans (net of the ALLL)	21,572		—			—			21,572			22,021		—			—			22,021
OMSRs	2,381		—			2,381			—			2,285		—			2,285			—
Foreclosed assets	1,105		—			—			1,105			2,018		—			—			2,018
	$	525,432	$	6,559		$	496,196		$	22,677		$	531,907	$	6,363		$	501,505		$	24,039
Percent of assets and liabilities measured at fair value			1.25		%	94.44		%	4.31		%			1.20		%	94.28		%	4.52		%

The following table provides a summary of the changes in fair value of assets and liabilities recorded at fair value through earnings on a recurring basis and changes in assets and liabilities recorded at fair value on a nonrecurring basis, for which an impairment, or reduction of an impairment, was recognized in the three and six month periods ended:

	Three Months Ended June 30
	2013									2012
	Trading Losses			Other Gains (Losses)			Total			Trading Losses			Other Gains (Losses)			Total
Recurring items
Trading securities	$	(8	)	$	—		$	(8	)	$	(16	)	$	—		$	(16	)
Borrowed funds	—			—			—			—			—			—
Nonrecurring items							—									—
Foreclosed assets	—			(68		)	(68		)	—			—			—
OMSRs	—			135			135			—			(32		)	(32		)
Total	$	(8	)	$	67		$	59		$	(16	)	$	(32	)	$	(48	)

33

	Six Months Ended June 30
	2013									2012
	Trading Losses			Other Gains (Losses)			Total			Trading Losses			Other Gains (Losses)			Total
Recurring items
Trading securities	$	(18	)	$	—		$	(18	)	$	(32	)	$	—		$	(32	)
Borrowed funds	—			—			—			—			33			33
Nonrecurring items																—
Foreclosed assets	—			(92		)	(92		)	—			(17		)	(17		)
OMSRs	—			152			152			—			42			(16		)
Total	$	(18	)	$	60		$	42		$	(32	)	$	58		$	(32	)

Note 13 – Accumulated Other Comprehensive Income (Loss)

The following table summarizes the changes in AOCI by component for the:

	Three Months Ended June 30
	2013									2012
	Unrealized Holding Gains (Losses) on AFS Securities			Defined Benefit Pension Plan			Total			Unrealized Holding Gains (Losses) on AFS Securities			Defined Benefit Pension Plan			Total
April 1, 2013	$	7,541		$	(3,671	)	$	3,870		$	6,539		$	(3,453	)	$	3,086
OCI before reclassifications	(11,997		)	—			(11,997		)	1,420			—			1,420
Amounts reclassified from AOCI	—			—			—			—			—			—
Subtotal	(11,997		)	—			(11,997		)	1,420			—			1,420
Tax effect	3,979			—			3,979			(546		)	—			(546		)
OCI, net of tax	(8,018		)	—			(8,018		)	874			—			874
June 30, 2013	$	(477	)	$	(3,671	)	$	(4,148	)	$	7,413		$	(3,453	)	$	3,960

	Six Months Ended June 30
	2013									2012
	Unrealized Holding Gains (Losses) on AFS Securities			Defined Benefit Pension Plan			Total			Unrealized Holding Gains (Losses) on AFS Securities			Defined Benefit Pension Plan			Total
January 1, 2013	$	8,678		$	(3,671	)	$	5,007		$	5,942		$	(3,453	)	$	2,489
OCI before reclassifications	(13,958		)	—			(13,958		)	2,219			—			2,219
Amounts reclassified from AOCI	(99		)	—			(99		)	(721		)	—			(721		)
Subtotal	(14,057		)	—			(14,057		)	1,498			—			1,498
Tax effect	4,902			—			4,902			(27		)	—			(27		)
OCI, net of tax	(9,155		)	—			(9,155		)	1,471			—			1,471
June 30, 2013	$	(477	)	$	(3,671	)	$	(4,148	)	$	7,413		$	(3,453	)	$	3,960

34

The following table details reclassification adjustments and the related affected line items on our interim condensed consolidated statements of income for the noted periods:

Details about AOCI components	Amount Reclassified from AOCI									Affected Line Item in the Interim Condensed Consolidated Statements of Income
	Three Months Ended June 30				Six Months Ended June 30
	2013		2012		2013		2012
Unrealized holding gains (losses) on AFS securities
	$	—	$	—	$	99	$	1,003		Gain (loss) on sale of AFS securities
	—		—		—		(282		)	Net AFS impairment loss
	—		—		99		721			Income before federal income tax expense
	—		—		34		245			Federal income tax expense
	$	—	$	—	$	65	$	476		Net income

Note 14 – Parent Company Only Financial Information

Interim Condensed Balance Sheets

	June 30 2013		December 31 2012
ASSETS
Cash on deposit at the Bank	$	812	$	332
AFS Securities	3,595		3,939
Investments in subsidiaries	110,500		115,781
Premises and equipment	2,091		2,041
Other assets	52,303		52,398
TOTAL ASSETS	$	169,301	$	174,491
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other liabilities	$	10,013	$	10,002
Shareholders' equity	159,288		164,489
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	169,301	$	174,491

35

Interim Condensed Statements of Income

	Three Months Ended   June 30				Six Months Ended   June 30
	2013		2012		2013		2012
Income
Dividends from subsidiaries	$	1,500	$	1,500	$	3,000	$	3,125
Interest income	41		43		84		89
Management fee and other	559		551		1,067		966
Total income	2,100		2,094		4,151		4,180
Expenses
Compensation and benefits	669		604		1,381		1,214
Occupancy and equipment	119		97		230		182
Audit and related fees	93		81		158		175
Other	297		265		501		497
Total expenses	1,178		1,047		2,270		2,068
Income before income tax benefit and equity in undistributed earnings of subsidiaries	922		1,047		1,881		2,112
Federal income tax benefit	199		160		388		357
	1,121		1,207		2,269		2,469
Undistributed earnings of subsidiaries	2,092		1,797		4,031		3,769
Net income	$	3,213	$	3,004	$	6,300	$	6,238

36

Interim Condensed Statements of Cash Flows

	Six Months Ended   June 30
	2013			2012
OPERATING ACTIVITIES
Net income	$	6,300		$	6,238
Adjustments to reconcile net income to cash provided by operations
Undistributed earnings of subsidiaries	(4,031		)	(3,769		)
Undistributed earnings of equity securities without readily determinable fair values	125			—
Share-based payment awards	258			295
Depreciation	77			54
Net amortization of AFS securities	1			2
Changes in operating assets and liabilities which used cash
Other assets	(26		)	(278		)
Accrued interest and other liabilities	211			(69		)
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES	2,915			2,473
INVESTING ACTIVITIES
Maturities, calls, and sales of AFS securities	395			370
Purchases of equipment and premises	(127		)	(81		)
Repayment of advances to subsidiaries	101			—
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES	369			289
FINANCING ACTIVITIES
Net increase (decrease) in borrowed funds	(200		)	(597		)
Cash dividends paid on common stock	(3,224		)	(3,034		)
Proceeds from the issuance of common stock	1,900			1,322
Common stock repurchased	(1,114		)	(995		)
Common stock purchased for deferred compensation obligations	(166		)	(225		)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES	(2,804		)	(3,529		)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	480			(767		)
Cash and cash equivalents at beginning of period	332			1,474
Cash and cash equivalents at end of period	$	812		$	707

Note 15 – Operating Segments

Our reportable segments are based on legal entities that account for at least 10% of net operating results. The operations of the Bank as of June 30, 2013 and 2012 and each of the three and six month periods then ended, represented 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

37

Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations

ISABELLA BANK CORPORATION FINANCIAL REVIEW

(Dollars in thousands except per share amounts)

This section reviews our financial condition and results of our operations for the three and six month periods ended June 30, 2013 and 2012. This analysis should be read in conjunction with our 2012 annual report and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.

Executive Summary

Despite compressed margins, we surpassed 2012 earnings on a quarterly and year-to-date basis due to continued improvement in credit quality, a reduction in the provisionfor loan losses, and loan growth of $30.70 million in the first six months of 2013. Our continued success throughout these challenging times is a direct result of our unwavering focus on community banking principles, prudent underwriting standards, and long term sustainable growth. This focus has enabled us to continue to meet the needs of the communities we serve, which translates into increased shareholder value.

As we continue to provide superior customer service, we are excited to see the construction progress on our latest branch located in Big Rapids, Michigan, which is expected to open in the third quarter. The new location will complement our existing Big Rapids office and provide additional shareholder value for years to come.

Recent Legislation

The Health Care and Education Act of 2010, the Patient Protection and Affordable Care Act, the Dodd-Frank Act, and the JOBS Act, have already had, and are expected to continue to have, a significant negative impact on our operating results. Of these three acts, the Dodd-Frank Act has had, and is likely to have, the most significant impact, along with its establishment of the Consumer Financial Protection Bureau. This particular act made sweeping changes in the regulation of financial institutions aimed at strengthening the oversight of the federal government over the operation of the financial services sector and increasing the protection of consumers within the financial services sector. As a result of the implementation of some of the provisions, we have had increases in compensation costs and this trend is expected to continue.

The CFPB has begun to issue substantial proposed and final rules regarding consumer lending, including residential mortgage lending. These rules will likely further increase our compensation and outside advisor costs to ensure our compliance with the new regulations.

On July 3 , 2013, the FRB published revised BASEL III Capital standards for Banks. The rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital cushion buffer. The rules take effect for us on January 1, 2015 and are not expected to have a material impact on the Corporation. 

38

RESULTS OF OPERATIONS

Selected Financial Data

The following table outlines our quarterly results of operations and provides certain performance measures for:

	Three Months Ended   June 30						Six Months Ended   June 30
	2013			2012			2013			2012
INCOME STATEMENT DATA
Interest income	$	13,440		$	14,188		$	26,968		$	28,392
Interest expense	2,781			3,429			5,602			7,133
Net interest income	10,659			10,759			21,366			21,259
Provision for loan losses	215			439			515			900
Noninterest income	2,736			2,544			5,183			6,085
Noninterest expenses	9,324			9,188			18,515			18,761
Federal income tax expense	643			672			1,219			1,445
Net Income	$	3,213		$	3,004		$	6,300		$	6,238
PER SHARE
Basic earnings	0.42			0.40			0.82			0.82
Diluted earnings	0.41			0.39			0.80			0.80
Dividends	0.21			0.20			0.42			0.40
Market value*	24.75			24.85			24.75			24.85
Tangible book value*	15.19			14.37			15.19			14.37
BALANCE SHEET DATA
At end of period
Loans	$	803,452		$	754,952		$	803,452		$	754,952
Total assets	1,451,415			1,381,496			1,451,415			1,381,496
Deposits	1,021,424			978,828			1,021,424			978,828
Shareholders' equity	159,288			159,855			159,288			159,855
Average balance
Loans	$	780,909		$	748,223		$	773,825		$	746,072
Total assets	1,440,370			1,369,240			1,436,287			1,362,675
Deposits	1,022,153			972,953			1,024,924			975,835
Shareholders’ equity	165,710			154,627			165,112			155,374
PERFORMANCE RATIOS
Return on average total assets (annualized)	0.89		%	0.88		%	0.88		%	0.92		%
Return on average shareholders' equity (annualized)	7.76		%	7.77		%	7.63		%	8.03		%
Return on average tangible equity (annualized)	11.10		%	11.11		%	10.98		%	11.66		%
Net interest margin yield (FTE annualized)	3.50		%	3.73		%	3.52		%	3.71		%
Loan to deposit*	78.66		%	77.13		%	78.66		%	77.13		%
Nonperforming loans to total loans*	0.52		%	0.86		%	0.52		%	0.86		%
Nonperforming assets to total assets*	0.36		%	0.64		%	0.36		%	0.64		%
ALLL to nonperforming loans*	280.51		%	188.67		%	280.51		%	188.67		%
CAPITAL RATIOS
Shareholders' equity to assets*	10.97		%	11.57		%	10.97		%	11.57		%
Tier 1 capital to average assets*	8.38		%	8.24		%	8.38		%	8.24		%
Tier 1 risk-based capital*	13.59		%	13.19		%	13.59		%	13.19		%
Total risk-based capital*	14.84		%	14.44		%	14.84		%	14.44		%

* At end of period

39

AVERAGE BALANCES, INTEREST RATE, AND NET INTEREST INCOME

The following schedules present the daily average amount outstanding for each major category of interest earning assets, nonearning assets, interest bearing liabilities, and noninterest bearing liabilities. This schedule also presents an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a 34% tax rate. Nonaccruing loans, for the purpose of the following computations, are included in the average loan amounts outstanding. FRB and FHLB restricted equity holdings are included in accrued income and other assets.

The following table displays the results for the three month periods ended June 30:

	2013							2012
	Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate
INTEREST EARNING ASSETS
Loans	$	780,909		$	10,280	5.27	%	$	748,223		$	10,849	5.80	%
Taxable investment securities	341,232			1,798		2.11	%	316,237			1,988		2.51	%
Nontaxable investment securities	162,626			2,024		4.98	%	144,492			1,983		5.49	%
Trading account securities	1,156			14		4.84	%	2,496			33		5.29	%
Other	23,533			109		1.85	%	25,911			113		1.74	%
Total earning assets	1,309,456			14,225		4.35	%	1,237,359			14,966		4.84	%
NONEARNING ASSETS
ALLL	(11,889		)					(12,586		)
Cash and demand deposits due from banks	17,157							18,572
Premises and equipment	25,917							24,948
Accrued income and other assets	99,729							100,947
Total assets	$	1,440,370						$	1,369,240
INTEREST BEARING LIABILITIES
Interest bearing demand deposits	$	181,044		40		0.09	%	$	167,399		50		0.12	%
Savings deposits	242,247			90		0.15	%	210,872			109		0.21	%
Time deposits	460,379			1,692		1.47	%	475,996			2,209		1.86	%
Borrowed funds	243,936			959		1.57	%	227,360			1,061		1.87	%
Total interest bearing liabilities	1,127,606			2,781		0.99	%	1,081,627			3,429		1.27	%
NONINTEREST BEARING LIABILITIES
Demand deposits	138,483							118,686
Other	8,571							14,300
Shareholders’ equity	165,710							154,627
Total liabilities and shareholders’ equity	$	1,440,370						$	1,369,240
Net interest income (FTE)				$	11,444						$	11,537
Net yield on interest earning assets (FTE)						3.50	%						3.73	%

40

The following table displays the results for the six month periods ended June 30:

	2013							2012
	Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate
INTEREST EARNING ASSETS
Loans	$	773,825		$	20,610	5.33	%	$	746,072		$	21,789	5.84	%
Taxable investment securities	342,375			3,632		2.12	%	300,689			3,877		2.58	%
Nontaxable investment securities	159,147			4,035		5.07	%	141,560			3,948		5.58	%
Trading account securities	1,363			35		5.14	%	3,457			97		5.61	%
Other	26,955			225		1.67	%	37,246			242		1.30	%
Total earning assets	1,303,665			28,537		4.38	%	1,229,024			29,953		4.87	%
NONEARNING ASSETS
ALLL	(11,987		)					(12,597		)
Cash and demand deposits due from banks	17,909							19,442
Premises and equipment	25,927							24,974
Accrued income and other assets	100,773							101,832
Total assets	$	1,436,287						$	1,362,675
INTEREST BEARING LIABILITIES
Interest bearing demand deposits	$	183,921		81		0.09	%	$	170,153		104		0.12	%
Savings deposits	241,824			181		0.15	%	209,047			231		0.22	%
Time deposits	460,958			3,434		1.49	%	477,843			4,545		1.90	%
Borrowed funds	237,863			1,906		1.60	%	219,386			2,253		2.05	%
Total interest bearing liabilities	1,124,566			5,602		1.00	%	1,076,429			7,133		1.33	%
NONINTEREST BEARING LIABILITIES
Demand deposits	138,221							118,792
Other	8,388							12,080
Shareholders’ equity	165,112							155,374
Total liabilities and shareholders’ equity	$	1,436,287						$	1,362,675
Net interest income (FTE)				$	22,935						$	22,820
Net yield on interest earning assets (FTE)						3.52	%						3.71	%

Net Interest Income

Net interest income is our primary source of income. Interest income includes loan fees of $862 and $1,683 for the three and six month periods ended June 30, 2013, respectively, as compared to $809 and $1,456 during the same periods in 2012. For analytical purposes, net interest income is adjusted to an FTE basis by adding the income tax savings from interest on tax exempt loans and securities, thus making year to year comparisons more meaningful.

41

VOLUME AND RATE VARIANCE ANALYSIS

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

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

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

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

	Three Months Ended   June 30, 2013 Compared to   June 30, 2012   Increase (Decrease) Due to									Six Months Ended   June 30, 2013 Compared to   June 30, 2012   Increase (Decrease) Due to
	Volume			Rate			Net			Volume			Rate			Net
CHANGES IN INTEREST INCOME
Loans	$	460		$	(1,029	)	$	(569	)	$	789		$	(1,968	)	$	(1,179	)
Taxable AFS securities	149			(339		)	(190		)	496			(741		)	(245		)
Nontaxable AFS securities	236			(195		)	41			465			(378		)	87
Trading securities	(16		)	(3		)	(19		)	(54		)	(8		)	(62		)
Other	(11		)	7			(4		)	(76		)	59			(17		)
Total changes in interest income	818			(1,559		)	(741		)	1,620			(3,036		)	(1,416		)
CHANGES IN INTEREST EXPENSE
Interest bearing demand deposits	4			(14		)	(10		)	8			(31		)	(23		)
Savings deposits	15			(34		)	(19		)	32			(82		)	(50		)
Time deposits	(70		)	(447		)	(517		)	(156		)	(955		)	(1,111		)
Borrowed funds	73			(175		)	(102		)	178			(525		)	(347		)
Total changes in interest expense	22			(670		)	(648		)	62			(1,593		)	(1,531		)
Net change in interest margin (FTE)	$	796		$	(889	)	$	(93	)	$	1,558		$	(1,443	)	$	115

As shown in the following table, we continue to experience downward pressure on our net yield on interest earning assets. This pressure is a direct result of FRB monetary policy which has reduced yields on interest earning assets more than rates on interest bearing liabilities. The persistent low interest rate environment coupled with an increase in the concentration of AFS securities and trading securities as a percentage of earnings assets has also placed downward pressure on net interest margin yield.

	Average Yield / Rate For The Three Month Periods Ended:
	June 30 2013		March 31 2013		December 31 2012		September 30 2012		June 30 2012
Total earning assets	4.35	%	4.41	%	4.61	%	4.76	%	4.84	%
Total interest bearing liabilities	0.99	%	1.01	%	1.12	%	1.18	%	1.27	%
Net yield on interest earning assets (FTE)	3.50	%	3.54	%	3.65	%	3.73	%	3.73	%

While there have recently been noticeable increases in long term interest rates, short and medium term rates continue to be at historically low levels, and therefore the net yield on interest earning assets is not likely to increase in the near future. We anticipate that the continued reduction in rates earned on loans without a proportionate decline in funding rate will continue to cause downward pressure in net interest margin yield.

42

Allowance for Loan and Lease Losses

The viability of any financial institution is ultimately determined by its management of credit risk. Loans outstanding represent our single largest concentration of risk. The ALLL is our estimation of probable losses inherent in the existing loan portfolio. We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated with each loan segment. Our assessments include allocations based on specific impairment allocations, historical charge-offs, internally assigned credit ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a reflection of other qualitative risks within the loan portfolio.

The following tables summarize our charge-off and recovery activity for the:

	Three Months Ended   June 30						Six Months Ended   June 30
	2013			2012			2013			2012
ALLL at beginning of period	$	11,909		$	12,375		$	11,936		$	12,375
Loans charged-off
Commercial and agricultural	234			237			445			686
Residential real estate	397			238			587			353
Consumer	88			146			209			237
Total Loans charged-off	719			621			1,241			1,276
Recoveries
Commercial and agricultural	166			42			223			128
Residential real estate	61			20			114			61
Consumer	68			63			153			130
Total Recoveries	295			125			490			319
Provision for loan losses	215			439			515			900
ALLL at end of period	$	11,700		$	12,318		$	11,700		$	12,318
Net loans charged-off	$	424		$	496		$	751		$	957
Year-to-date average loans outstanding	780,909			748,223			773,825			746,072
Net loans charged-off to average loans outstanding	0.05		%	0.07		%	0.10		%	0.13		%
Total loans at end of period	$	803,452		$	754,952		$	803,452		$	754,952
ALLL as a% of loans at end of period	1.46		%	1.63		%	1.46		%	1.63		%

As shown in the preceding table, the level of net charge-offs continues to decline. This trend has allowed us to reduce the provision for loan losses, leading to a decline in the ALLL in both amount and as a percentage of loans. We do not expect any significant increases in net loans charged-off throughout the remainder of 2013 and, as such, we anticipate the provision for loan losses to approximate current levels. For further discussion of the allocation of the ALLL, see “Note 6 – Loans and ALLL” of the interim condensed consolidated financial statements.

Loans 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, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual loans. We monitor all loans that are past due and in nonaccrual status for indicators of additional deterioration.

	Total Past Due and Nonaccrual
	June 30 2013		March 31 2013		December 31 2012		September 30 2012		June 30 2012
Commercial and agricultural	$	4,962	$	8,713	$	7,271	$	11,004	$	9,459
Residential real estate	5,080		4,077		5,431		4,879		4,496
Consumer	104		212		199		284		179
Total	$	10,146	$	13,002	$	12,901	$	16,167	$	14,134

43

A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual loans by type, is included in “Note 6 – Loans and ALLL” of our interim condensed consolidated financial statements.

Troubled Debt Restructurings

We have taken a proactive approach to avoid foreclosures on borrowers who are willing to work with us in modifying their loans, thus making them more affordable. While this approach has allowed certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure, it has contributed to a significant increase in the level of loans classified as TDRs. The implementation of ASU No. 2011-02 “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” has also contributed to the increased level of TDRs. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. At the time of the TDR, the loan is reviewed to determine whether or not to classify the loan as accrual or nonaccrual. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed in nonaccrual status may be placed back on accrual status after six months of continued performance.

We restructure debt with borrowers who due to temporary financial difficulties are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, forgive principal, or a combination of these modifications. Typically, the modifications are for a period of five years or less. There were no TDRs that were Government sponsored as of June 30, 2013 or December 31, 2012.

Losses associated with TDRs, if any, are included in the estimation of the ALLL in the quarter in which a loan is identified as a TDR, and we review the ALLL estimation each reporting period to ensure its continued appropriateness.

The following tables provide a roll-forward of TDRs for the:

	Three Months Ended June 30, 2013
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
April 1, 2013	119		$	16,900		19		$	2,502		138		$	19,402
New modifications	14		3,592			—		—			14		3,592
Principal payments	—		(198		)	—		(206		)	—		(404		)
Loans paid-off	(7	)	(1,089		)	(4	)	(497		)	(11	)	(1,586		)
Partial charge-off	—		—			—		—			—		—
Balances charged-off	(3	)	(147		)	—		—			(3	)	(147		)
Transfers to OREO	—		—			—		—			—		—
Transfers to accrual status	1		105			(1	)	(105		)	—		—
Transfers to nonaccrual status	(1	)	(29		)	1		29			—		—
June 30, 2013	123		$	19,134		15		$	1,723		138		$	20,857

44

	Six Months Ended June 30, 2013
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
January 1, 2013	115		$	16,531		19		$	2,824		134		$	19,355
New modifications	22		4,411			1		98			23		4,509
Principal payments	—		(463		)	—		(243		)	—		(706		)
Loans paid-off	(10	)	(1,219		)	(5	)	(697		)	(15	)	(1,916		)
Partial charge-off	—		(15		)	—		(211		)	—		(226		)
Balances charged-off	(3	)	(147		)	—		—			(3	)	(147		)
Transfers to OREO	—		—			(1	)	(12		)	(1	)	(12		)
Transfers to accrual status	1		105			(1	)	(105		)	—		—
Transfers to nonaccrual status	(2	)	(69		)	2		69			—		—
June 30, 2013	123		$	19,134		15		$	1,723		138		$	20,857

	Three Months Ended June 30, 2012
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
April 1, 2012	127		$	20,964		17		$	2,138		144		$	23,102
New modifications	12		989			1		—			13		989
Principal payments	—		(423		)	—		(30		)	—		(453		)
Loans paid-off	(5	)	(550		)	—		—			(5	)	(550		)
Partial charge-off	—		(152		)	—		—			—		(152		)
Balances charged-off	(1	)	(8		)	(1	)	(25		)	(2	)	(33		)
Transfers to OREO	—		—			(4	)	(360		)	(4	)	(360		)
Transfers to accrual status	—		—			—		—			—		—
Transfers to nonaccrual status	(7	)	(1,186		)	7		1,186			—		—
June 30, 2012	126		$	19,634		20		$	2,909		146		$	22,543

	Six Months Ended June 30, 2012
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
January 1, 2012	112		$	17,738		12		$	1,018		124		$	18,756
New modifications	36		5,640			9		1,217			45		6,857
Principal payments	—		(778		)	—		(91		)	—		(869		)
Loans paid-off	(14	)	(1,591		)	—		—			(14	)	(1,591		)
Partial charge-off	—		(152		)	—		—			—		(152		)
Balances charged-off	(1	)	(8		)	(4	)	(90		)	(5	)	(98		)
Transfers to OREO	—		—			(4	)	(360		)	(4	)	(360		)
Transfers to accrual status	1		21			(1	)	(21		)	—		—
Transfers to nonaccrual status	(8	)	(1,236		)	8		1,236			—		—
June 30, 2012	126		$	19,634		20		$	2,909		146		$	22,543

45

The following table summarizes our TDRs as of:

	June 30, 2013						December 31, 2012
	Accruing Interest		Nonaccrual		Total		Accruing Interest		Nonaccrual		Total		Total Change
Current	$	18,264	$	874	$	19,138	$	16,301	$	941	$	17,242	$	1,896
Past due 30-59 days	870		34		904		158		561		719		185
Past due 60-89 days	—		—		—		72		41		113		(113		)
Past due 90 days or more	—		815		815		—		1,281		1,281		(466		)
Total	$	19,134	$	1,723	$	20,857	$	16,531	$	2,824	$	19,355	$	1,502

Additional disclosures about TDRs are included in “Note 6 – Loans and ALLL” of our interim condensed consolidated financial statements.

Impaired Loans

The following is a summary of information pertaining to impaired loans as of:

	June 30, 2013						December 31, 2012
	Outstanding Balance		Unpaid Principal Balance		Valuation Allowance		Outstanding Balance		Unpaid Principal Balance		Valuation Allowance
TDRs
Commercial real estate	$	9,411	$	10,085	$	1,269	$	9,227	$	9,640	$	1,333
Commercial other	2,286		2,316		64		1,167		1,197		38
Agricultural real estate	223		223		31		91		91		32
Agricultural other	105		225		—		569		689		59
Residential real estate senior liens	8,798		9,197		1,489		8,224		8,670		1,429
Residential real estate junior liens	—		—		—		21		57		4
Consumer secured	34		34		—		56		56		—
Total TDRs	20,857		22,080		2,853		19,355		20,400		2,895
Other impaired loans
Commercial real estate	1,913		2,474		309		1,817		2,304		320
Commercial other	29		110		—		2,245		2,376		359
Agricultural other	248		248		—		63		63		—
Residential real estate senior liens	1,677		2,478		242		2,226		3,002		354
Residential real estate junior liens	71		109		13		51		61		9
Home equity lines of credit	174		474		—		182		482		—
Consumer secured	20		20		—		19		28		—
Total other impaired loans	4,132		5,913		564		6,603		8,316		1,042
Total impaired loans	$	24,989	$	27,993	$	3,417	$	25,958	$	28,716	$	3,937

Additional disclosure related to impaired loans is included in “Note 6 – Loans and ALLL” of our interim condensed consolidated financial statements.

46

Nonperforming Assets

The following table summarizes our nonperforming assets as of:

	June 30 2013			December 31 2012
Nonaccrual loans	$	3,651		$	7,303
Accruing loans past due 90 days or more	520			428
Total nonperforming loans	4,171			7,731
Foreclosed assets	1,105			2,018
Total nonperforming assets	$	5,276		$	9,749
Nonperforming loans as a % of total loans	0.52		%	1.00		%
Nonperforming assets as a % of total assets	0.36		%	0.68		%

Loans are placed in nonaccrual status when the foreclosure process has begun, generally after a loan is 90 days past due, unless they are well secured. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Loans may be placed back on accrual status after six months of continued performance.

Included in the nonaccrual loan balances above were loans currently classified as TDRs as of:

	June 30 2013		December 31 2012
Commercial and agricultural	$	1,317	$	2,325
Residential real estate	406		499
Total	$	1,723	$	2,824

The following table lists individually significant commercial and agricultural loan relationships in nonaccrual status as of June 30, 2013 and December 31, 2012. To be classified as individually significant, the recorded investment in nonaccrual loans to each borrower must have exceeded $1,000 as of the end of either period.

	June 30, 2013				December 31, 2012
	Oustanding Balance		Specific Allocation		Oustanding Balance		Specific Allocation
Borrower 1	$	—	$	—	$	2,077	$	359
Others not individually significant	3,651				5,226
Total	$	3,651			$	7,303

The reduction in the outstanding balance for Borrower 1 was the result of the loan being placed back on accrual status due to continued performance. There were no other individually significant credits included in nonaccrual loans as of June 30, 2013 or December 31, 2012.

Additional disclosures about nonaccrual loans are included in “Note 6 – Loans and ALLL” of our interim condensed consolidated financial statements.

We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off. We believe that all loans deemed to be impaired have been identified.

We believe that the level of the ALLL is appropriate as of June 30, 2013 and we will continue to closely monitor overall credit quality and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains appropriate.

47

NONINTEREST INCOME AND EXPENSES

Noninterest Income

Noninterest income consists of service charges and fee income, gains from the sale of mortgage loans, gains and losses on trading securities and borrowings measured at fair value, gains from the sale of investment securities, and other. Significant account balances are highlighted in the accompanying tables with additional descriptions of significant fluctuations:

	Three Months Ended June 30
						Change
	2013		2012			$			%
Service charges and fees
NSF and overdraft fees	$	558	$	597		$	(39	)	(6.53	)%
ATM and debit card fees	489		477			12			2.52	%
Trust fees	302		266			36			13.53	%
Freddie Mac servicing fee	187		187			—			—	%
Service charges on deposit accounts	95		84			11			13.10	%
Net OMSRs income (loss)	88		(13		)	101			N/M
All other	28		30			(2		)	(6.67	)%
Total service charges and fees	1,747		1,628			119			7.31	%
Gain on sale of mortgage loans	249		279			(30		)	(10.75	)%
Earnings on corporate owned life insurance policies	190		177			13			7.34	%
Gain (loss) on sale of AFS securities	—		—			—			—	%
Other
Brokerage and advisory fees	181		137			44			32.12	%
Other	369		323			46			14.24	%
Total other	550		460			90			19.57	%
Total noninterest income	$	2,736	$	2,544		$	192		7.55	%

48

	Six Months Ended June 30
					Change
	2013		2012		$			%
Service charges and fees
NSF and overdraft fees	$	1,074	$	1,155	$	(81	)	(7.01	)%
ATM and debit card fees	944		934		10			1.07	%
Trust fees	565		516		49			9.50	%
Freddie Mac servicing fee	371		378		(7		)	(1.85	)%
Service charges on deposit accounts	185		158		27			17.09	%
Net OMSRs income (loss)	96		50		46			92.00	%
All other	56		66		(10		)	(15.15	)%
Total service charges and fees	3,291		3,257		34			1.04	%
Gain on sale of mortgage loans	607		658		(51		)	(7.75	)%
Earnings on corporate owned life insurance policies	359		348		11			3.16	%
Gain (loss) on sale of AFS securities	99		1,003		(904		)	(90.13	)%
Other
Brokerage and advisory fees	328		267		61			22.85	%
Other	499		552		(53		)	(9.60	)%
Total other	827		819		8			0.98	%
Total noninterest income	$	5,183	$	6,085	$	(902	)	(14.82	)%

Significant changes in noninterest income are detailed below:

• We continuously analyze various fees related to deposit accounts including service charges and NSF and overdraft fees. Based on these analyses, we make any necessary adjustments to ensure that our fee structure is within the range of our competitors, while at the same time making sure that the fees remain fair to deposit customers. NSF and overdraft fees represent the largest single component of service charges and fees. While we have experienced significant increases in deposit accounts, NSF and overdraft fees continue to decline. This decline has been the result of reduced overdraft activity by our customers. We expect this trend to continue.

• In recent periods, we have invested considerable efforts to increase our market share in trust and brokerage and advisory services. These efforts have translated into increases in trust fees and brokerage and advisory fees. We expect this trend to continue.

• Residential loan refinancing activity declined in 2013, resulting in a decline in the gain on sale of mortgage loans. The decline in refinancing activity was the result of a decline in demand as well as an increase in offering rates. Offsetting the decline in the gain on sale of mortgage loans was an increase in net OMSRs income. We expect mortgage origination volumes and the related income to continue to decline when compared to 2012.

• We are continually analyzing our AFS securities for potential sale opportunities. These analyses identified several mortgage-backed securities pools in 2013 and 2012 that made economic sense to sell. We do not anticipate any significant investment sales during the remainder of 2013.

• The fluctuations in all other income is spread throughout various categories, none of which are individually significant. We do not anticipate any significant fluctuations from current levels for the remainder of 2013.

49

Noninterest Expenses

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

	Three Months Ended June 30
					Change
	2013		2012		$			%
Compensation and benefits
Employee salaries	$	3,844	$	3,820	$	24		0.63	%
Employee benefits	1,392		1,412		(20		)	(1.42	)%
Total compensation and benefits	5,236		5,232		4			0.08	%
Furniture and equipment
Service contracts	534		534		—			—	%
Depreciation	459		443		16			3.61	%
ATM and debit card fees	185		179		6			3.35	%
All other	14		14		—			—	%
Total furniture and equipment	1,192		1,170		22			1.88	%
Occupancy
Depreciation	165		155		10			6.45	%
Outside services	151		153		(2		)	(1.31	)%
Property taxes	134		130		4			3.08	%
Utilities	119		98		21			21.43	%
All other	72		63		9			14.29	%
Total occupancy	641		599		42			7.01	%
Net AFS security impairment loss	—		—		—			N/M
Other
Marketing and community relations	432		535		(103		)	(19.25	)%
FDIC insurance premiums	273		213		60			28.17	%
Directors fees	205		209		(4		)	(1.91	)%
Audit and related fees	162		154		8			5.19	%
Education and travel	116		139		(23		)	(16.55	)%
Postage and freight	94		94		—			—	%
Printing and supplies	99		110		(11		)	(10.00	)%
Legal fees	120		81		39			48.15	%
Consulting fees	83		71		12			16.90	%
Other	671		581		90			15.49	%
Total other	2,255		2,187		68			3.11	%
Total noninterest expenses	$	9,324	$	9,188	$	136		1.48	%

50

	Six Months Ended June 30
					Change
	2013		2012		$			%
Compensation and benefits
Employee salaries	$	7,720	$	7,648	$	72		0.94	%
Employee benefits	2,961		2,885		76			2.63	%
Total compensation and benefits	10,681		10,533		148			1.41	%
Furniture and equipment
Service contracts	1,070		1,014		56			5.52	%
Depreciation	923		886		37			4.18	%
ATM and debit card fees	353		330		23			6.97	%
All other	35		30		5			16.67	%
Total furniture and equipment	2,381		2,260		121			5.35	%
Occupancy
Depreciation	326		309		17			5.50	%
Outside services	321		300		21			7.00	%
Property taxes	269		259		10			3.86	%
Utilities	255		224		31			13.84	%
All other	135		148		(13		)	(8.78	)%
Total occupancy	1,306		1,240		66			5.32	%
Net AFS security impairment loss	—		282		(282		)	N/M
Other
Marketing and community relations	674		1,029		(355		)	(34.50	)%
FDIC insurance premiums	545		428		117			27.34	%
Directors fees	404		419		(15		)	(3.58	)%
Audit and related fees	301		330		(29		)	(8.79	)%
Education and travel	238		266		(28		)	(10.53	)%
Postage and freight	193		195		(2		)	(1.03	)%
Printing and supplies	185		219		(34		)	(15.53	)%
Legal fees	180		143		37			25.87	%
Consulting fees	155		258		(103		)	(39.92	)%
Other	1,272		1,159		113			9.75	%
Total other	4,147		4,446		(299		)	(6.73	)%
Total noninterest expenses	$	18,515	$	18,761	$	(246	)	(1.31	)%

To help offset our current declining net interest margin yields, we have made a conscious effort to limit increases, or reduce, noninterest expenses. These efforts translated into a decline of 1.31% in total noninterest expenses when the first six months of 2013 are compared to the same period in 2012.

Significant changes in noninterest expenses are detailed below:

• During the first quarter of 2012, we recorded a credit impairment on an AFS security through earnings due to a bond being downgraded below investment grade. We continuously monitor the AFS security portfolio for other potential OTTI. For further discussion, see “Note 5 – AFS Securities” of our notes to interim condensed consolidated financial statements.

• We have consistently been a strong supporter of the various communities, schools, and charities in the markets we serve. We sponsor a foundation, which we established in 1996, that is generally funded from non-recurring, or extraordinary, revenue sources. The foundation provides centralized oversight for donations to organizations that benefit our communities. Included in marketing and community relations were discretionary donations to the foundation of $200 and $200 for the three and six month periods ended June 30, 2013, respectively, as compared to $250 and $500 during the same periods in 2012.

51

• Audit and related fees fluctuate from period to period based on the timing of services performed. Audit and related fees are expected to approximate current levels throughout the remainder of 2013.

• Education and travel expenses were higher in 2012 as a result of a company-wide customer service seminar which occurred in the second quarter of 2012. Our 2013 company-wide customer service seminar is scheduled for the fourth quarter of 2013.

• Legal fees increased in 2013 as a result of higher costs associated with filing documents with the SEC, primarily those associated with XBRL tagging. We expect legal fees to approximate current levels for the remainder of 2013.

• Printing and supplies expenses declined in 2013 as a result of increased utilization of paperless office opportunities.

• During the first quarter of 2012, we incurred consulting fees to review our FHLB advances for potential restructuring options. They were also elevated in 2012 due to the engagement of consultants to review our loan prepayment and deposit decay assumptions and various information technology projects. Consulting fees are anticipated to approximate current levels for the remainder of 2013.

• The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.

ANALYSIS OF CHANGES IN FINANCIAL CONDITION

	June 30, 2013			December 31, 2012			$ Change			% Change (unannualized)
ASSETS
Cash and cash equivalents	$	21,366		$	24,920		$	(3,554	)	(14.26	)%
Certificates of deposit held in other financial institutions	1,810			4,465			(2,655		)	(59.46	)%
Trading securities	950			1,573			(623		)	(39.61	)%
AFS securities	499,424			504,010			(4,586		)	(0.91	)%
Mortgage loans AFS	743			3,633			(2,890		)	(79.55	)%
Loans	803,452			772,753			30,699			3.97	%
ALLL	(11,700		)	(11,936		)	236			N/M
Premises and equipment	25,852			25,787			65			0.25	%
Corporate owned life insurance policies	24,101			22,773			1,328			5.83	%
Accrued interest receivable	5,232			5,227			5			0.10	%
Equity securities without readily determinable fair values	18,242			18,118			124			0.68	%
Goodwill and other intangible assets	46,418			46,532			(114		)	(0.24	)%
Other assets	15,525			12,784			2,741			21.44	%
TOTAL ASSETS	$	1,451,415		$	1,430,639		$	20,776		1.45	%
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits	$	1,021,424		$	1,017,667		$	3,757		0.37	%
Borrowed funds	262,460			241,001			21,459			8.90	%
Accrued interest payable and other liabilities	8,243			7,482			761			10.17	%
Total liabilities	1,292,127			1,266,150			25,977			2.05	%
Shareholders’ equity	159,288			164,489			(5,201		)	(3.16	)%
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,451,415		$	1,430,639		$	20,776		1.45	%

As shown above, total assets have increased since December 31, 2012. In the first six months of 2013, loans grew by $30,699. This loan growth was primary funded by increases in borrowed funds. We expect that loans will continue to grow throughout the rest of the year.

52

The following table outlines the changes in loans:

	June 30, 2013		December 31, 2012		$ Change		% Change (unannualized)
Commercial	$	389,044	$	371,505	$	17,539	4.72	%
Agricultural	87,516		83,606		3,910		4.68	%
Residential real estate	293,158		284,148		9,010		3.17	%
Consumer	33,734		33,494		240		0.72	%
Total	$	803,452	$	772,753	$	30,699	3.97	%

The following table outlines the changes in deposits:

	June 30, 2013		December 31, 2012		$ Change			% Change (unannualized)
Noninterest bearing demand deposits	$	139,942	$	143,735	$	(3,793	)	(2.64	)%
Interest bearing demand deposits	173,184		181,259		(8,075		)	(4.45	)%
Savings deposits	248,098		228,338		19,760			8.65	%
Certificates of deposit	368,713		376,790		(8,077		)	(2.14	)%
Brokered certificates of deposit	57,701		55,348		2,353			4.25	%
Internet certificates of deposit	33,786		32,197		1,589			4.94	%
Total	$	1,021,424	$	1,017,667	$	3,757		0.37	%

Capital

Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are currently authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to theses authorizations, we issued 77,568 shares or $1,900 of common stock during the first six months of 2013, as compared to 54,900 shares or $1,322 of common stock during the same period in 2012. We also offer the Directors Plan which allows participants to purchase stock units, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $258 and $295 during the six month periods ended June 30, 2013 and 2012, respectively.

We have approved a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 45,825 shares or $1,114 of common stock compared to 41,581 shares for $995 during the first six months of 2013 and 2012, respectively. As of June 30, 2013, we were authorized to repurchase up to an additional 39,585 shares of common stock.

There are no significant regulatory constraints placed on our capital. The FRB’s current recommended minimum primary capital to assets requirement is 6.0%. Our primary capital to adjusted average assets, which consists of shareholders' equity plus the allowance for loan losses less acquisition intangibles, was 8.38% as of June 30, 2013.

The FRB 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 our values as of:

	June 30 2013		December 31 2012		Required
Equity Capital	13.59	%	13.23	%	4.00	%
Secondary Capital	1.25	%	1.25	%	4.00	%
Total Capital	14.84	%	14.48	%	8.00	%

Secondary capital includes only the ALLL. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources.

The FRB and FDIC also prescribe minimum capital requirements for Isabella Bank. At June 30, 2013, the Bank exceeded these minimum capital requirements. On July 3 , 2013, the FRB published revised BASEL III Capital standards for Banks. The rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet

53

assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital cushion buffer. The rules take effect for us on January 1, 2015 and are not expected to have a material impact on the Corporation. 

Contractual Obligations and Loan Commitments

We are 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 our customers. These financial instruments 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 we have in a particular class of financial instrument.

The following table summarizes our credit related financial instruments with off-balance-sheet risk as of:

	June 30 2013		December 31 2012
Unfunded commitments under lines of credit	$	121,516	$	115,233
Commercial and standby letters of credit	3,058		3,935
Commitments to grant loans	25,571		40,507

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These commitments may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements.

Commercial and standby letters of credit are conditional commitments issued 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. These commitments to extend credit and letters of credit generally mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on a credit evaluation of the borrower. While we consider 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 grant loans 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 amount of collateral obtained, if it is deemed necessary, is based on management’s credit evaluation of the customer. Commitments to grant loans include loans committed to be sold to the secondary market.

Our 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 could be up to the contractual notional amount of those instruments. We use the same credit policies as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments.

Fair Value

We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Trading securities, AFS securities, and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time-to-time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, foreclosed assets, OMSRs, 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.

For further information regarding fair value measurements see “Note 12 – Fair Value” of our notes to the interim condensed consolidated financial statements.

54

Liquidity

Liquidity is monitored regularly by our 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.

Our primary sources of liquidity are cash and cash equivalents, certificates of deposit held in other financial institutions, trading securities, and AFS securities. These categories totaled $523,550 or 36.1% of assets as of June 30, 2013 as compared to $534,968 or 37.4% as of December 31, 2012. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Liquidity varies significantly daily, based on customer activity.

Our primary source of funds is deposit accounts. We also have the ability to borrow from the FHLB, the FRB, and through various correspondent banks in the form of federal funds purchased. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including FHLB Advances, FRB Discount Window Advances, and repurchase agreements, require us to pledge assets, typically in the form of certificates of deposits held in other financial institutions, trading securities, AFS securities, or loans as collateral. As of June 30, 2013, we had available lines of credit of $91,951.

The following table summarizes our sources and uses of cash for the six month periods ended June 30:

	2013			2012			$ Variance
Net cash provided by (used in) operating activities	$	14,594		$	11,947		$	2,647
Net cash provided by (used in) investing activities	(40,760		)	(56,047		)	15,287
Net cash provided by (used in) financing activities	22,612			35,761			(13,149		)
Increase (decrease) in cash and cash equivalents	(3,554		)	(8,339		)	4,785
Cash and cash equivalents January 1	24,920			28,590			(3,670		)
Cash and cash equivalents June 30	$	21,366		$	20,251		$	1,115

Market Risk

Our primary market risks are interest rate risk and liquidity risk. We have no significant foreign exchange risk and do not utilize interest rate swaps or derivatives, except for interest rate locks and forward loan commitments, in the management of IRR. Any changes in foreign exchange rates or commodity prices would have an insignificant impact on our interest income and cash flows.

IRR is the exposure of our net interest 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 by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.

The FRB has adopted a policy requiring us to effectively manage the various risks that can have a material impact on our safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our Funds Management 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 our Board.

The primary technique to measure interest rate risk is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, and loan prepayments. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies.

55

Our interest rate sensitivity is estimated by first forecasting the next twelve months of net interest income under an assumed environment of a constant balance sheet and constant market interest rates (base case). We then compare the results of various simulation analyses to the base case. At June 30, 2013, we projected the change in net interest income during the next twelve months assuming market interest rates were to immediately decrease by 100 basis points and increase by 100, 200, 300, and 400 basis points in a parallel fashion over the entire yield curve during the same time period. We did not project scenarios showing decreases in interest rates beyond 100 basis points as this is considered extremely unlikely given current interest rate levels. These projections were based on our assets and liabilities remaining static over the next twelve months, while factoring in probable calls and prepayments of certain investment securities and real estate residential and consumer loans. While it is extremely unlikely that interest rates would immediately increase to these levels, we feel that these extreme scenarios help us identify potential gaps and mismatches in the repricing characteristics of assets and liabilities. We regularly monitor our forecasted net interest income sensitivity to ensure that it remains within established limits.

The following table summarizes our interest rate sensitivity as of:

	June 30, 2013
Immediate basis point change assumption (short-term rates)	(100)		0	100		200		300		400
Percent change in net income vs. constant rates	(2.86	)%	—	0.42	%	0.69	%	0.65	%	0.50	%

	December 31, 2012
Immediate basis point change assumption (short-term rates)	(100)		0	100		200		300		400
Percent change in net income vs. constant rates	(1.61	)%	—	0.49	%	(1.58	)%	(1.74	)%	(2.16	)%

The secondary method to measure IRR is gap analysis. Gap analysis measures the cash flows and/or the earliest repricing of our 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 embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without 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 offering rates, 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 cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals.

The following tables provide information about assets and liabilities that are sensitive to changes in interest rates as of June 30, 2013 and December 31, 2012. 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. During the first quarter of 2012, we engaged the services of a third party to analyze our historical loan prepayment speeds and non-contractual deposit decay rates. We have reviewed the results of the analyses in detail and feel that it reasonably reflects the prepayment speeds and decay rates of our loan and deposit portfolios.

56

	June 30, 2013
	2014			2015			2016			2017			2018			Thereafter			Total			Fair Value
Rate sensitive assets
Other interest bearing assets	$	1,647		$	240		$	—		$	—		$	—		$	—		$	1,887		$	1,890
Average interest rates	0.86		%	1.25		%	—			—			—			—			0.91		%
Trading securities	$	950		$	—		$	—		$	—		$	—		$	—		$	950		$	950
Average interest rates	2.83		%	—			—			—			—			—			2.83		%
AFS securities	$	168,609		$	90,752		$	53,417		$	38,028		$	24,252		$	124,366		$	499,424		$	499,424
Average interest rates	1.58		%	1.62		%	1.94		%	2.64		%	2.75		%	2.70		%	2.04		%
Fixed interest rate loans (1)	$	116,839		$	100,362		$	92,019		$	100,014		$	97,363		$	117,502		$	624,099		$	629,549
Average interest rates	5.43		%	5.42		%	5.13		%	4.64		%	4.42		%	4.37		%	4.90		%
Variable interest rate loans (1)	$	82,141		$	30,652		$	19,690		$	17,726		$	18,250		$	10,894		$	179,353		$	179,353
Average interest rates	4.63		%	3.88		%	4.11		%	3.32		%	3.35		%	3.64		%	3.64		%
Rate sensitive liabilities
Borrowed funds	$	109,412		$	33,048		$	10,000		$	30,000		$	40,000		$	40,000		$	262,460		$	266,633
Average interest rates	0.69		%	0.68		%	1.23		%	1.88		%	2.46		%	3.02		%	1.47		%
Savings and NOW accounts	$	38,098		$	34,415		$	30,886		$	27,749		$	24,952		$	265,182		$	421,282		$	421,282
Average interest rates	0.13		%	0.12		%	0.12		%	0.12		%	0.12		%	0.11		%	0.12		%
Fixed interest rate certificates of deposit	$	199,979		$	80,929		$	64,216		$	48,369		$	49,574		$	16,006		$	459,073		$	463,021
Average interest rates	0.95		%	1.71		%	2.11		%	1.87		%	1.41		%	1.64		%	1.42		%
Variable interest rate certificates of deposit	$	637		$	490		$	—		$	—		$	—		$	—		$	1,127		$	1,127
Average interest rates	0.42		%	0.42		%	—			—			—			—			0.42		%

	December 31, 2012
	2013			2014			2015			2016			2017			Thereafter			Total			Fair Value
Rate sensitive assets
Other interest bearing assets	$	6,411		$	100		$	240		$	—		$	—		$	—		$	6,751		$	6,761
Average interest rates	0.86		%	0.35		%	1.25		%	—			—			—			0.86		%
Trading securities	$	1,051		$	522		$	—		$	—		$	—		$	—		$	1,573		$	1,573
Average interest rates	2.68		%	2.54		%	—			—			—			—			2.63		%
AFS securities	$	124,452		$	83,606		$	49,419		$	42,655		$	35,504		$	168,374		$	504,010		$	504,010
Average interest rates	2.42		%	2.30		%	2.53		%	2.82		%	2.89		%	2.48		%	2.50		%
Fixed interest rate loans (1)	$	138,840		$	96,013		$	91,353		$	85,095		$	109,057		$	89,760		$	610,118		$	622,329
Average interest rates	5.74		%	5.62		%	5.57		%	5.21		%	4.60		%	4.63		%	5.26		%
Variable interest rate loans (1)	$	64,482		$	28,076		$	24,669		$	12,650		$	22,061		$	10,697		$	162,635		$	162,635
Average interest rates	4.90		%	3.77		%	3.96		%	3.89		%	3.36		%	3.90		%	4.21		%
Rate sensitive liabilities
Borrowed funds	$	77,865		$	10,814		$	42,322		$	20,000		$	40,000		$	50,000		$	241,001		$	248,822
Average interest rates	0.46		%	0.65		%	1.14		%	2.67		%	2.15		%	3.03		%	1.59		%
Savings and NOW accounts	$	35,796		$	32,794		$	29,476		$	26,520		$	23,885		$	261,126		$	409,597		$	409,597
Average interest rates	0.13		%	0.13		%	0.12		%	0.12		%	0.12		%	0.11		%	0.12		%
Fixed interest rate certificates of deposit	$	204,972		$	76,373		$	71,685		$	51,232		$	40,523		$	18,399		$	463,184		$	471,479
Average interest rates	1.13		%	1.69		%	2.10		%	2.14		%	1.72		%	1.67		%	1.55		%
Variable interest rate certificates of deposit	$	782		$	369		$	—		$	—		$	—		$	—		$	1,151		$	1,151
Average interest rates	0.46		%	0.45		%	—			—			—			—			0.46		%

⁽¹⁾ The fair value reported is exclusive of the allocation of the ALLL.

We do not believe that there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. As of the date of this report, we do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term. As of the date of this report, we

57

do not expect to make material changes in those methods in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques.

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

The information presented in the “Market Risk” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.

Item 4 – Controls and Procedures

DISCLOSURE CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation of the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934 ) as of June 30, 2013, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of June 30, 2013, were effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

During the most recent fiscal quarter, no change occurred in our internal control over financial reporting that materially affected, or is likely to materially effect, our internal control over financial reporting.

58

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

We are not involved in any material legal proceedings. We are involved in ordinary, routine litigation incidental to our business; however, no such routine proceedings are expected to result in any material adverse effect on operations, earnings, or financial condition, or cash flows.

Item 1A – Risk Factors

There have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2012.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

(A) None

(B) None

(C) Repurchases of Common Stock

We have adopted and publically announced a common stock repurchase plan. The plan was last amended on April 26, 2012, to allow for the repurchase of an additional 150,000 shares of 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.

The following table provides information for the three month period ended June 30, 2013, with respect to this plan:

	Shares Repurchased			Total Number of Shares Purchased as Part of Publicly Announced Plan or Program	Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs
	Number	Average Price Per Share
Balance, March 31, 2013					64,901
April 1 - 30, 2013	7,811	$	25.48	7,811	57,090
May 1 - 31, 2013	7,805	24.98		7,805	49,285
June 1 - 30, 2013	9,700	24.95		9,700	39,585
Total	25,316	$	25.12	25,316	39,585

59

Item 6 - Exhibits

(a)	Exhibits
31(a)	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer
31(b)	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer
32	Section 1350 Certification of Principal Executive Officer and Principal Financial Officer
101.1*	101.INS (XBRL Instance Document)
	101.SCH (XBRL Taxonomy Extension Schema Document)
	101.CAL (XBRL Calculation Linkbase Document)
	101.LAB (XBRL Taxonomy Label Linkbase Document)
	101.DEF (XBRL Taxonomy Linkbase Document)
	101.PRE (XBRL Taxonomy Presentation Linkbase Document)

• In accordance with Rule 406T of Regulations S-T, the XBRL related information shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

60

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		Isabella Bank Corporation
Date:	July 29, 2013		/s/ Richard J. Barz
			Richard J. Barz
			Chief Executive Officer
			(Principal Executive Officer)
Date:	July 29, 2013		/s/ Dennis P. Angner
			Dennis P. Angner
			President, Chief Financial Officer
			(Principal Financial Officer, Principal Accounting Officer)

61