SOUTHERN MICHIGAN BANCORP INC - Quarter Report: 2007 September (Form 10-Q)

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

FORM 10-Q

(Mark One)

(517) 279-5500
(Registrant's Telephone Number, Including Area Code)

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.            Yes              No    X   

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.

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

The number of shares outstanding of the Registrant's Common Stock, $2.50 par value, as of November 16, 2007, was 1,771,988 shares.

Forward-Looking Statements

          This report contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and Southern Michigan Bancorp, Inc. Forward-looking statements are identifiable by words or phrases such as "outlook," or "strategy" that an event or trend "may," "should," "will," or "is likely" to occur or "continue" or "is scheduled" or "on track" or that Southern Michigan Bancorp, Inc. or its management "anticipates", "believes," "estimates," "plans," "forecasts," "intends," "predicts," "projects," or "expects" a particular result, or is "confident" or "optimistic" that an event will occur, and variations of such words and similar expressions. All of the information concerning interest rate sensitivity in Part I, Item 3 is forward-looking. Management's determination of the provision and allowance for loan losses involves judgments that are inherently forward-looking. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("risk factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Southern Michigan Bancorp, Inc. undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise.

          Risk factors include, but are not limited to, the risk factors described in the section entitled "Risk Factors" in Southern Michigan Bancorp, Inc.'s Amendment No. 2 to Form S-4 Registration Statement, filed with the Securities and Exchange Commission on September 28, 2007; the timing and level of asset growth; changes in banking laws and regulations; changes in tax laws; changes in prices, levies and assessments; the impact of technological advances and issues; governmental and regulatory policy changes; opportunities for acquisitions and the effective completion of acquisitions and integration of acquired entities; the possibility that anticipated cost savings and revenue enhancements from acquisitions, restructurings, reorganizations and bank consolidations may not be realized at amounts projected, at all or within expected time frames; the local and global effects of the ongoing war on terrorism and other military actions, including actions in Iraq; and current uncertainties and fluctuations in the financial markets and stocks of financial services providers due to concerns about credit availability and concerns about the Michigan economy in particular. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

Part I.  Financial Information

SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands, except share data)

See accompanying notes to consolidated financial statements.

SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)
(In thousands, except per share data)

See accompanying notes to consolidated financial statements.

SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
(In thousands, except number of shares and per share data)
For nine months ended September 30, 2007 and 2006

See accompanying notes to consolidated financial statements.

SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)

See accompanying notes to consolidated financial statements.

SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS

NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation
The consolidated financial statements include the accounts of Southern Michigan Bancorp, Inc. ("Southern") and its wholly-owned subsidiary, Southern Michigan Bank & Trust (the "Bank"), and the Bank's wholly-owned subsidiary SMB Mortgage Company. All significant inter-company transactions and balances have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes of Southern for December 31, 2006 included in Southern's Amendment No. 2 to Form S-4 Registration Statement, filed with the Securities and Exchange Commission on September 28, 2007.

Reclassifications
Some items in the prior period consolidated financial statements have been reclassified to conform to the current year presentation.

NOTE B - NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 158 (FAS 158) "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans," that requires companies to recognize the funded status of their defined benefit pension and postretirement plans as an asset or liability on the balance sheet rather than being disclosed in the notes to the financial statements. The over-funded or under-funded status (asset or liability) would be measured as the difference between the fair value of the plan assets and the projected benefit obligation for pensions and the accumulated postretirement benefit obligation for other post-retirement benefits. The requirement to recognize the funded status in the balance sheet was effective for fiscal years ending after December 15, 2006 for public entities and years ending after June 15, 2007 for non-public entities. Southern will adopt the balance sheet recognition requirement for its year ending December 31, 2007. The adoption of FAS 158 in the 2006 financial statements would have reduced accumulated other comprehensive income by $22,000.

In February 2007, the FASB issued FASB Statement No. 159 (FAS 159), "The Fair Value Option for Financial Assets and Financial Liabilities." Southern will be adopting FAS 159 as of January 1, 2008. Early adoption was allowed, effective January 1, 2007, if the election was made by April 30, 2007. FAS 159 permits, but does not require, entities to measure selected financial assets and liabilities at fair value. Changes in fair value are recorded through the income statement in subsequent periods. The statement provides for a one time opportunity to transfer existing assets and liabilities to fair value at the point of adoption with a cumulative effect adjustment recorded against equity. After adoption, the election to report assets and liabilities at fair value must be made at the point of their inception. Southern has elected not to early adopt FAS 159 and has not yet determined the impact FAS 159 may have on its consolidated financial statements upon adoption.

NOTE C - EARNINGS PER SHARE

Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. ESOP shares are considered outstanding for this calculation unless unearned. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per common share are restated for all stock splits and dividends through the date of issue of the financial statements.

A reconciliation of the numerators and denominators of basic and diluted earnings per share for the three- and nine-month periods ended September 30, 2007 and 2006 is as follows (dollars in thousands, except per share data):

Stock option awards outstanding that were anti-dilutive and therefore not included in the computation of earnings per share were as follows: 130,425 and 28,560 for the three months ended September 30, 2007 and 2006, respectively, and 130,425 and 28,560 for the nine months ended September 30, 2007 and 2006, respectively.

NOTE D - STOCK OPTIONS

Shareholders of Southern approved a stock option plan in April 2000 and a stock incentive plan in June 2005. The plans were authorized to issue up to 115,500 and 157,500 shares, respectively. As of September 30, 2007, there were 45,841 shares available for future issuance under the 2000 plan and 20,502 shares available for future issuance under the 2005 plan.

A summary of stock option activity in the plans is as follows for the nine months ended September 30, 2007:

In January 2007, 2,740 shares of restricted stock were issued to employees and directors. The shares vest 20% per year over five years.

For the nine months ended September 30, 2007, compensation expense of $57,000 was recorded with respect to options granted in January and April 2007. Such expense was computed in accordance with Statement of Financial Accounting Standards No. 123R, "Share-Based Payment."

NOTE E - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchase (repurchase agreements) have original maturities of less than one year. Repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities. Securities involved with the agreements are recorded as assets of the Bank and are held in safekeeping by correspondent banks. Repurchase agreements are offered principally to certain large deposit customers as deposit equivalent investments.

NOTE F - MERGER WITH FNB FINANCIAL CORPORATION

On April 18, 2007, Southern and FNB Financial Corporation ("FNB") jointly announced that they had executed a definitive merger agreement. FNB is a bank holding company headquartered in Three Rivers, Michigan, with 8 offices located within St. Joseph and Cass Counties in Michigan. The merger is expected to be completed during the fourth quarter of 2007.

If the merger is completed, FNB will be merged with and into Southern. The surviving corporation will be Southern. The surviving corporation will own The First National Bank of Three Rivers and the Bank and all of the other assets of FNB and Southern. Subject to certain possible adjustments as provided in the plan of merger, FNB shareholders will receive either (1) 1.87 shares of Southern common stock, (2) $45.35 in cash, or (3) a combination of both for each share of FNB common stock. The approximate value of the total merger consideration to be paid by Southern is $26,000,000 (consisting of approximately $13,000,000 in cash and 536,073 shares of Southern common stock). Completion of the merger is subject to certain conditions, including, among others, that the shareholders of FNB approve the plan of merger, that necessary regulatory approvals be obtained, that no proceeding seeking to prevent the merger be pending or threatened, and that Southern and FNB obtain various ancillary certificates, opinions and agreements. At any time before the effective time of the merger, the boards of directors of Southern and FNB may, by mutual consent, abandon the merger. In addition, for certain specified reasons the board of directors of either Southern or FNB may abandon the merger.

          The following discussion provides information about the financial condition and results of operations of Southern, which supplements Southern's consolidated financial statements. The discussion should be read in conjunction with the financial statements included in this filing.

          Results of Operations

          Net income increased 5.2% or $53,000 in the third quarter of 2007 compared to the same period in 2006. For the nine-month period ended September 30, 2007 net income increased $157,000, or 5.3% over the same period in 2006. The year-to-date increase resulted from higher net interest income, non-interest income and lower non-interest expense partially offset by an increase in the provision for loan losses. The quarterly increase resulted from higher non-interest income and reduced provision for loan losses, offset by slightly lower net interest income, and higher non-interest expense during the third quarter compared to the same quarter in 2006.

          The return on average assets was 1.24% for the first nine months of 2007, which equaled the return for the same period a year ago. The return on average shareholders' equity was 13.97% for the first nine months of 2007, compared to 14.54% for the comparable 2006 period.

          Net Interest Income

          The following tables provide information regarding interest income and expense for the nine-month periods ended September 30, 2007 and 2006, respectively. Table 1 shows the year-to-date daily average balances for interest earning assets and interest bearing liabilities, interest earned or paid, and the annualized effective rate, for the nine-month periods ended September 30, 2007 and 2006. Table 2 shows the effect on interest income and expense of changes in volume and interest rates.

Table 1 - Average Balances and Tax Equivalent Interest Rates

Table 2 - Changes in Tax-Equivalent Net Interest Income

(Dollars in Thousands):