SOUTHERN MICHIGAN BANCORP INC - Quarter Report: 2011 March (Form 10-Q)

Southern Michigan Form 10-Q - 05/13/11

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

FORM 10-Q

(Mark One)

	[X]		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2011

	[ ]		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: 000-49772

SOUTHERN MICHIGAN BANCORP, INC.
(Exact Name of Registrant as Specified in its Charter)

Michigan (State or Other Jurisdiction of Incorporation or Organization)		38-2407501 (I.R.S. Employer Identification No.)

51 West Pearl Street Coldwater, Michigan (Address of Principal Executive Offices)		49036 (Zip Code)

(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 X No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 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). 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 "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):

	Large accelerated filer	Accelerated filer ___

	Non-accelerated filer ____	Smaller reporting company X
(Do not check if a 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 No X

The number of shares outstanding of the Registrant's Common Stock, $2.50 par value, as of May 12, 2011, was 2,340,339 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 may be identified by words or phrases such as "outlook", "plan", or "strategy" that an event or trend "may", "should", "will", "is likely", or is "probable" to occur or "continue", has "begun" or "is scheduled" or "on track" or that the Company or its management "anticipates", "believes", "estimates", "plans", "forecasts", "intends", "predicts", "projects", or "expects" a particular result, or is "committed", "confident", "optimistic" or has an "opinion" that an event will occur, or other words or phrases such as "ongoing", "future", "judgment", "signs", "efforts", "tend", "exploring", "appearing", "until", "near term", "going forward", "starting" and variations of such words and similar expressions. Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, statements related to real estate valuation, future levels of non-performing loans, future asset dispositions, dividends, future growth and funding sources, future liquidity levels, the availability of sources of liquidity, future profitability levels, the effects on earnings of changes in interest rates and other revenue sources, and the effects of newly enacted laws. All statements with references to future time periods are forward-looking. Management's determination of the provision and allowance for loan losses, the appropriate carrying value of intangible assets (including goodwill and mortgage servicing rights), deferred tax assets and other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) involves judgments that are inherently forward-looking. All of the information concerning interest rate sensitivity is forward-looking. Management's assumptions regarding pension and other post retirement plans involve judgments that are inherently forward-looking. Our ability to sell other real estate at carrying value or at all, successfully implement new programs and initiatives, increase efficiencies, respond to declines in collateral values and credit quality, maintain our current level of deposits and other sources of funding, and improve profitability is not entirely within our control and is not assured. The future effect of changes in the real estate, financial and credit markets and the national and regional economy on the banking industry, generally, and Southern Michigan Bancorp, Inc., specifically, are also inherently uncertain. 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. Actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update or revise our forward-looking statements to reflect developments that occur or information obtained after the date of this report.

Risk factors include, but are not limited to, the risk factors described in "Item 1A - Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2010. 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

Item 1.

Financial Statements

SOUTHERN MICHIGAN BANCORP, INC.
UNAUDITED INTERIM FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share data)

	March 31, 2011			December 31, 2010
ASSETS
Cash and cash equivalents	$	71,941		$	78,833
Federal funds sold		249			275
Securities available for sale		81,070			59,228
Loans held for sale		267			2,637
Loans, net of allowance for loan losses of $5,576 - 2011 ($5,694 - 2010)		300,218			303,830
Premises and equipment, net		12,599			12,599
Accrued interest receivable		2,227			2,107
Net cash surrender value of life insurance		10,045			9,965
Goodwill		13,422			13,422
Other intangible assets, net		1,920			2,005
Other assets		8,452			8,979
TOTAL ASSETS	$	502,410		$	493,880

LIABILITIES
Deposits:
Non-interest bearing	$	63,291		$	59,942
Interest bearing		354,304			349,959
Total deposits		417,595			409,901

Securities sold under agreements to repurchase and overnight borrowings		16,621			15,027
Accrued expenses and other liabilities		4,114			4,476
Other borrowings		8,854			10,079
Subordinated debentures		5,155			5,155
Common stock subject to repurchase obligation in Employee
Stock Ownership Plan, shares outstanding - 108,831 in 2011
(107,627 shares in 2010)		1,306			1,399
Total liabilities		453,645			446,037

SHAREHOLDERS' EQUITY
Preferred stock, 100,000 shares authorized; none issued or outstanding		-			-
Common stock, $2.50 par value:
Authorized - 4,000,000 shares
Issued - 2,340,339 shares in 2011 (2,340,717 shares in 2010)
Outstanding (other than ESOP shares) - 2,231,508 shares in 2011 (2,233,090 shares in 2010)		5,579			5,583
Additional paid-in capital		18,165			18,033
Retained earnings		25,323			24,692
Accumulated other comprehensive loss, net		(37	)		(168	)
Unearned Employee Stock Ownership Plan shares		(265	)		(297	)
Total shareholders' equity		48,765			47,843
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	502,410		$	493,880

See accompanying notes to interim consolidated financial statements.

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

	Three Months Ended March 31,
	2011		2010
Interest income:
Loans, including fees	$	4,461	$	4,801
Securities:
Taxable		138		181
Tax-exempt		216		204
Other		51		23
Total interest income		4,866		5,209

Interest expense:
Deposits		844		1,001
Other		159		168
Total interest expense		1,003		1,169
Net interest income		3,863		4,040
Provision for loan losses		125		200
Net interest income after provision for loan losses		3,738		3,840

Non-interest income:
Service charges on deposit accounts		511		570
Trust fees		275		253
Net gains on security calls		2		-
Net gains on loan sales		317		120
Earnings on life insurance assets		80		74
Gain on life insurance proceeds		-		156
Income from automated teller machines		235		207
Other		235		244
Total non-interest income		1,655		1,624
Non-interest expense:
Salaries and employee benefits		2,538		2,501
Occupancy, net		373		381
Equipment		203		221
Printing, postage and supplies		141		145
Telecommunication expenses		99		78
Professional and outside services		221		293
Software maintenance		105		111
FDIC assessments		165		169
Amortization of other intangibles		85		87
Other		526		704
Total non-interest expense		4,456		4,690
INCOME BEFORE INCOME TAXES		937		774
Federal income tax provision		189		72
NET INCOME	$	748	$	702
Basic Earnings Per Common Share	$	0.32	$	0.30
Diluted Earnings Per Common Share	$	0.32	$	0.30
Dividends Declared Per Common Share	$	0.05	$	0.05

SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands, except number of shares and per share data)
For the Three Months Ended March 31, 2011 and 2010

	Common Stock			Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income/(Loss), Net			Unearned ESOP Shares			Total
Balance at January 1, 2010	$	5,553		$	18,363		$	22,062		$	193		$	(437	)	$	45,734
Comprehensive income:
Net income								702									702
Net change in other comprehensive
income items											22						22
Total comprehensive income																	724
Cash dividends declared - $.05 per share								(116	)								(116	)
Issuance of restricted stock (18,325 shares of common stock at $10.10 per share)		46			(46	)											-
Vesting of restricted stock					15												15
Forfeiture of restricted stock (1,018 shares)		(2	)		2												-
Change in common stock subject to
repurchase		(5	)		(192	)											(197	)
Reduction of ESOP obligation														29			29
Stock option expense					20												20
Balance at March 31, 2010	$	5,592		$	18,162		$	22,648		$	215		$	(408	)	$	46,209

Balance at January 1, 2011	$	5,583		$	18,033		$	24,692		$	(168	)	$	(297	)	$	47,843
Comprehensive income:
Net income								748									748
Net change in other comprehensive
income items											131						131
Total comprehensive income																	879
Cash dividends declared - $.05 per share								(117	)								(117	)
Vesting of restricted stock					20												20
Forfeiture of restricted stock (378 shares)		(2	)		2												-
Change in common stock subject to
repurchase		(2	)		95												93
Reduction of ESOP obligation														32			32
Stock option expense					15												15
Balance at March 31, 2011	$	5,579		$	18,165		$	25,323		$	(37	)	$	(265	)	$	48,765

See accompanying notes to interim consolidated financial statements.

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

	Three Months Ended March 31,
	2011			2010
Operating Activities
Net income	$	748		$	702
Adjustments to reconcile net income to net cash
from operating activities:
Provision for loan losses		125			200
Depreciation		222			249
Net amortization of investment securities		215			123
Loans originated for sale		(9,576	)		(6,385	)
Proceeds on loans sold		12,263			6,245
Net gains on loan sales		(317	)		(120	)
Gain on life insurance proceeds		-			(156	)
Stock option and restricted stock grant compensation expense		35			35
Net gains on security calls		(2	)		-
Net loss on other real estate owned sales		28			148
Amortization of other intangible assets		85			87
Net loss (gain) on disposal of fixed assets		(7	)		5
Net change in obligation under ESOP		32			29
Net change in:
Accrued interest receivable		(120	)		(232	)
Cash surrender value		(80	)		(74	)
Other assets		187			(63	)
Accrued expenses and other liabilities		(363	)		421
Net cash from operating activities		3,475			1,214

Investing Activities
Activity in available for sale securities:
Proceeds from maturities and calls		6,144			4,911
Purchases		(28,001	)		(362	)
Net change in federal funds sold		26			36
Loan originations and payments, net		3,409			7,827
Proceeds from life insurance		-			421
Proceeds on other real estate owned sales		323			216
Proceeds from sale of equipment		26			2
Additions to premises and equipment		(241	)		(263	)
Net cash from investing activities		(18,314	)		12,788

Financing Activities
Net change in deposits		7,694			(3,107	)
Net change in securities sold under agreements to repurchase and overnight borrowings		1,594			(986	)
Proceeds from other borrowings		-			5,000
Repayments of other borrowings		(1,225	)		(169	)
Cash dividends paid		(116	)		(116	)
Net cash from financing activities		7,947			622
Net change in cash and cash equivalents		(6,892	)		14,624
Beginning cash and cash equivalents		78,833			24,814
Ending cash and cash equivalents	$	71,941		$	39,438

Cash paid for interest	$	1,002		$	1,200
Cash paid for income taxes		50			-
Transfers from loans to other real estate owned		78			115

See accompanying notes to interim consolidated financial statements.

SOUTHERN MICHIGAN BANCORP, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The consolidated financial statements include the accounts of Southern Michigan Bancorp, Inc. (the Company) and its wholly-owned subsidiary, Southern Michigan Bank & Trust (SMB&T), after elimination of significant inter-company balances and transactions. SMB&T owns FNB Financial Services, which conducts a brokerage business and is consolidated into SMB&T's financial statements. During 2004, the Company formed a special purpose trust, Southern Michigan Bancorp Capital Trust I, for the sole purpose of issuing trust preferred securities. Under accounting principles generally accepted in the United States of America, the trust is not consolidated into the financial statements of the Company.

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 Rule 8-03 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 in order to make the financial statements not misleading have been included. Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes of the Company for December 31, 2010 included in the Company's Annual Report on Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission on March 28, 2011.

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

Adoption of New Accounting Standards: In July 2010, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (ASU) No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses which increases disclosures made about the credit quality of loans and the allowance for credit losses. The disclosures provide additional information about the nature of credit risk inherent in the Company's loans, how credit risk is analyzed and assessed, and the reasons for the change in the allowance for loan losses. The expanded disclosure requirements of ASU 2010-20 were disclosed in the Company's December 31, 2010 consolidated financial statements. Other required disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010, and are disclosed for the quarter ended March 31, 2011 in Note D.

In December 2010, the FASB issued ASU No. 2010-29 "Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations." If a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 also expands the supplementary pro forma disclosures. ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. ASU 2010-29 will only affect the Company if there are future business combinations.

In December 2010, the FASB issued ASU No. 2010-28 "Intangibles - Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." ASU 2010-28 affects all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. ASU 2010-28 is effective for fiscal years and interim periods within those years, beginning after December 15, 2010. ASU 2010-28 did not have an impact on the Company's financial condition, results of operations, or disclosures as a result of adopting for the quarter ended March 31, 2011 because the most recent Step 1 goodwill impairment test was performed as of November 30, 2010 and did not result in a negative carrying amount.

In April 2011, FASB issued ASU No. 2011-02 "Receivables (Topic 310) - A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring." ASU 2011-02 clarifies whether loan modifications constitute troubled debt restructuring. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 is effective for the first interim and annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The Company does not expect ASU 2011-02 will have any impact on its financial condition or results of operations, but its adoption will result in expanded disclosures.

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.

A reconciliation of the numerators and denominators of basic and diluted earnings per share for the three month periods ended March 31, 2011 and 2010 is as follows (dollars in thousands, except per share data):

	Three Months Ended March 31, 2011		Three Months Ended March 31, 2010
Basic earnings per share:
Net income	$	748	$	702
Weighted average common shares outstanding		2,340,434		2,336,727
Less unallocated ESOP shares		23,844		28,816
Weighted average common shares outstanding for basic earnings per share		2,316,590		2,307,911
Basic earnings per share	$	0.32	$	0.30

Diluted earnings per share:
Net income	$	748	$	702
Weighted average common shares outstanding for basic earnings per share		2,316,590		2,307,911
Add: Dilutive effect of assumed exercise of stock options		4,729		2,410
Weighted average common and dilutive potential common shares outstanding		2,321,319		2,310,321
Diluted earnings per share	$	0.32	$	0.30

Stock option awards that were anti-dilutive, and therefore not included in the computation of diluted earnings per share, were as follows: 196,787 and 211,730, respectively, as of March 31, 2011 and 2010.

NOTE D - ALLOWANCE FOR LOAN LOSSES

In evaluating the allowance for loan losses, loans are analyzed based on the department originating the loan which in some instances may be different than how the loans are categorized for regulatory reporting purposes. Required disclosures about activity in the allowance for loan losses for reporting periods subsequent to December 15, 2010 are provided below for the quarter ended March 31, 2011. The following is an analysis of the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of and for the quarter ended March 31, 2011 and as of December 31, 2010 as well as summary activity in the allowance for loan losses for the quarter ended March 31, 2010(in thousands):

March 31, 2011	2011
Allowance for Loan Losses:	Commercial including CRE		Consumer		Real Estate Mortgage 1^st Lien		Real Estate Mortgage Junior Lien		Total		2010
Balance at January 1	$4,239		$86		$1,211		$158		$5,694		$6,075
Provision for loan losses	(202	)	47		146		134		125		200
Loans charged off	(100	)	(35	)	(120	)	(64	)	(319	)	(385	)
Recoveries	66		3		6		1		76		54
Balance at March 31	$4,003		$101		$1,243		$229		$5,576		5,944
Ending balance individually evaluated for impairment	$842		-		$309		$15		$1,166
Ending balance collectively evaluated for impairment	$3,161		$101		$934		$214		$4,410

Total Loans:
Ending balance	$213,298		$9,012		$69,902		$13,582		$305,794
Ending balance individually evaluated for impairment	$7,509		$28		$2,667		$45		$10,249
Ending balance collectively evaluated for impairment	$205,789		$8,984		$67,235		$13,537		$295,545

Commercial loans also include demand deposit loan account charge-offs and recoveries amounting to $37,000 and $23,000, respectively, for the quarter ended March 31, 2011.

December 31, 2010
Allowance for Loan Losses:	Commercial including CRE	Consumer	Real Estate Mortgage 1^st Lien	Real Estate Mortgage Junior Lien	Total
Ending balance individually evaluated for impairment	$867	-	$300	$4	$1,171
Ending balance collectively evaluated for impairment	$3,372	$87	$911	$153	$4,523
Total	$4,239	$87	$1,211	$157	$5,694

Total Loans:
Ending balance	$216,401	$9,849	$69,437	$13,837	$309,524
Ending balance individually evaluated for impairment	$7,676	$87	$2,881	$122	$10,766
Ending balance collectively evaluated for impairment	$208,725	$9,762	$66,556	$13,715	$298,758

The following tables present loans individually evaluated for impairment by class of loans as of March 31, 2011 and December 31, 2010 (in thousands):

March 31, 2011	Unpaid Principal Balance		Allowance for Loan Losses Allocated
With no related allowance recorded:
Commercial	$	144	$	-
Real estate - commercial		2,750		-
Real estate - construction		-		-
Consumer		28		-
Real estate mortgage		1,975		-

With an allowance recorded:
Commercial		867		153
Real estate - commercial		1,917		302
Real estate - construction		581		169
Consumer		-		-
Real estate mortgage		1,987		542
Total	$	10,249	$	1,166

December 31, 2010	Unpaid Principal Balance		Allowance for Loan Losses Allocated
With no related allowance recorded:
Commercial	$	608	$	-
Real estate - commercial		2,685		-
Real estate - construction		-		-
Consumer		87		-
Real estate mortgage		2,495		-

With an allowance recorded:
Commercial		588		99
Real estate - commercial		1,823		413
Real estate - construction		583		173
Consumer		-		-
Real estate mortgage		1,897		486
Total	$	10,766	$	1,171

The following table presents the aging of the recorded investment in past due and nonaccrual loans for the year to date periods ended March 31, 2011 and December 31, 2010 by class of loans (in thousands):

March 31, 2011	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due & Non Accrual		Total Past Due &Non Accrual		Loans Not Past Due or Non Accrual		Total
Commercial	$	159	$	-	$	485	$	644	$	52,159	$	52,803
Real estate - commercial		428				2,630		3,058		136,365		139,423
Real estate - construction		263		-		774		1,037		10,625		11,662
Consumer		49				29		78		9,233		9,311
Real estate mortgage		1,919				2,257		4,176		88,419		92,595
Total	$	2,818	$		$	5,770	$	8,993	$	296,801	$	305,794

December 31, 2010	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due & Non Accrual		Total Past Due &Non Accrual		Loans Not Past Due or Non Accrual		Total
Commercial	$	277	$	20	$	217	$	514	$	58,249	$	58,763
Real estate - commercial		184		-		2,295		2,479		133,892		136,371
Real estate - construction		-		-		583		583		10,552		11,135
Consumer		62		-		87		149		10,004		10,153
Real estate mortgage		737		28		2,112		2,877		90,225		93,102
Total	$	1,260	$	48	$	5,294	$	6,602	$	302,922	$	309,524

Troubled Debt Restructurings:

The Company has allocated $534,000 and $379,000 of specific reserves to customers whose loan terms have been modified as of March 31, 2011 and December 31, 2010, respectively. The Company intends to lend no additional amounts to these customers.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes all loans from the commercial loan department. This analysis is performed at least annually. The Company uses the following definitions for risk ratings:

Special Mention: Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

As of March 31, 2011 and December 31, 2010, based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):

March 31, 2011	Pass		Special Mention		Substandard		Doubtful		Not Risk Rated		Total
Commercial	$	39,221	$	8,725	$	4,857	$	-	$	-	$	52,803
Real estate - commercial		119,662		13,136		5,749		368		508		139,423
Real estate - construction		608		4,955		2,503		-		3,596		11,662
Real estate - mortgage		7,723		1,761		2,942		-		80,169		92,595
Consumer		-		-		-		-		9,311		9,311
Total	$	167,214	$	28,577	$	16,051	$	368	$	93,584	$	305,794

December 31, 2010	Pass		Special Mention		Substandard		Doubtful		Not Risk Rated		Total
Commercial	$	44,819	$	12,821	$	1,123	$	-	$	-	$	58,763
Real estate - commercial		110,384		19,054		6,311		370		252		136,371
Real estate - construction		2,371		1,047		4,630		-		3,087		11,135
Real estate - mortgage		7,096		2,892		2,700		-		80,414		93,102
Consumer		-		-		-		-		10,153		10,153
Total	$	164,670	$	35,814	$	14,764	$	370	$	93,906	$	309,524

NOTE E - STOCK OPTIONS

Shareholders of the Company approved a stock option plan in April 2000 and a stock incentive plan in June 2005. The plans authorized the Company to issue up to 115,500 and 157,500 shares, respectively. In May 2008, shareholders of the Company ratified amendments to the Stock Incentive Plan of 2005, which among other things increased the authorized shares for issuance from 157,500 to 300,000. On March 20, 2010, the April 2000 plan terminated. As of March 31, 2011, there were 105,929 shares available for future issuance under the 2005 plan.

A summary of stock option activity is as follows for the three months ended March 31, 2011:

	Shares	Weighted Average Price
Outstanding at beginning of year	218,977	$ 21.29
Granted	-	-
Exercised	-	-
Forfeited	1,045	20.28
Outstanding at March 31, 2011	218,977	21.29
Options exercisable at March 31, 2011	146,207	20.75

The Company recorded compensation expense of $15,000 and $20,000, respectively, related to stock options during the three month periods ended March 31, 2011 and 2010.

Restricted Stock - Shares of restricted stock may also be granted under the Stock Incentive Plan of 2005. Compensation expense is recognized over the vesting period of the shares based on the market value of the shares on the grant date. All shares of restricted stock issued and outstanding vest 20% per year over five years. Compensation expense related to the award of shares of restricted stock was $20,000 and $15,000, respectively, during the three months ended March 31, 2011 and 2010. As of March 31, 2011, there was $229,000 of total unrecognized compensation expense related to non-vested shares of restricted stock granted under the plan which is expected to be recognized over a weighted average period of 3.3 years.


	Shares		Weighted Average Grant Date Fair Value
Nonvested at January 1, 2011	30,593		$	10.46
Granted	-			-
Vested	(6,327	)		10.35
Forfeited	(378	)		9.54
Nonvested at March 31, 2011	23,888		$	10.50

NOTE F - FAIR VALUE INFORMATION

The following methods and assumptions were used by the Company in estimating fair values for financial instruments:

Cash and cash equivalents and federal funds sold: The carrying amount reported in the balance sheet approximates fair value.

Securities available for sale: Fair values for securities available for sale are based on quoted market prices, where available. For all other securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the securities' terms and conditions, among other things.

Loans and loans held for sale, net: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are estimated using discounted cash flows analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The allowance for loan losses is considered to be a reasonable estimate of discount for credit quality concerns.

Accrued interest receivable: The carrying amount reported in the balance sheet approximates fair value.

Off-balance-sheet financial instruments: The estimated fair value of off-balance-sheet financial instruments is based on current fees or costs that would be charged to enter or terminate the arrangements. The estimated fair value is not considered to be significant for this presentation.

Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). 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 expected monthly maturities on time deposits.

Securities sold under agreements to repurchase and overnight borrowings: The carrying amount reported in the balance sheet approximates fair value.

Other borrowings: The fair value of other borrowings is estimated using discounted cash flows analysis based on the current incremental borrowing rate for similar types of borrowing arrangements.

Subordinated debentures: The carrying amount reported in the balance sheet approximates fair value of the variable-rate subordinated debentures.

Accrued interest payable: The carrying amount reported in the balance sheet approximates fair value.

While these estimates of fair value are based on management's judgment of appropriate factors, there is no assurance that if the Company had disposed of such items at March 31, 2011 or December 31, 2010, the estimated fair values would have been realized. Market values may differ depending on various circumstances not taken into consideration in this methodology. The estimated fair values at March 31, 2011 and December 31, 2010, should not be considered to apply at subsequent dates.

In addition, other assets and liabilities that are not defined as financial instruments are not included in the following disclosures, such as property and equipment. Also, non-financial instruments typically not recognized in financial statements may have value but are not included in the following disclosures. These include, among other items, the estimated earnings power of core deposit accounts, trained work force, customer goodwill and similar items.

The estimated fair values of the Company's financial instruments are as follows (in thousands):

	March 31, 2011						December 31, 2010
	Carrying Amount			Fair Value			Carrying Amount			Fair Value
Financial assets:
Cash and cash equivalents	$	71,941		$	71,941		$	78,833		$	78,833
Federal funds sold		249			249			275			275
Securities available for sale		81,070			81,070			59,228			59,228
Loans held for sale		267			267			2,637			2,637
Loans, net of allowance for loan losses		300,218			303,676			303,830			307,946
Accrued interest receivable		2,227			2,227			2,107			2,107

Financial liabilities:
Deposits	$	(417,595	)	$	(420,221	)	$	(409,901	)	$	(406,143	)
Securities sold under agreements to repurchase and overnight borrowings		(16,621	)		(16,621	)		(15,027	)		(15,027	)
Other borrowings		(8,854	)		(9,016	)		(10,079	)		(9,835	)
Subordinated debentures		(5,155	)		(5,155	)		(5,155	)		(5,155	)
Accrued interest payable		(172	)		(172	)		(171	)		(171	)

The preceding table does not include net cash surrender value of life insurance and dividends payable which are also considered financial instruments. The estimated fair value of such items is considered to be their carrying amount.

The Company also has unrecognized financial instruments which include commitments to extend credit and standby letters of credit. The estimated fair value of such instruments is considered to be their contract amount.

NOTE G - FAIR VALUE MEASUREMENTS

The Fair Value Measurements Topic of ASC 820-10 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. ASC 820-10-20 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact.

ASC 820-10 requires the use of valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, ASC Topic 820-10-55 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.), or inputs that are derived principally from or corroborated by market data by correlation or other means.

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity's own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, follows. These valuation methodologies were applied to all of the Company's financial and nonfinancial assets and liabilities carried at fair value.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the company's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company's valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company's valuation methodologies 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 estimate of fair value at the reporting date.

Securities Available for Sale. Securities classified as available for sale are reported at fair value utilizing Level 1, Level 2 and Level 3 inputs. Unadjusted quoted prices in active markets for identical assets are utilized to determine fair value at the measurement date for Level 1 securities. For all other securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond's terms and conditions, among other things. When there are unobservable inputs, such securities are classified as Level 3.

Securities available for sale classified as Level 3 inputs represent non-publicly traded municipal issues with limited trading activity from entities within the Company's market area. The fair value of these investments is determined using Level 3 valuation techniques, as there is no market available to price these investments. The method used for determining the fair value for these investments includes a comparison to the fair value of other investment securities valued with Level 2 inputs with similar characteristics (credit, time to maturity, call structure, etc.) and the interest yield curve for comparable debt investments.

Impaired Loans. The Company does not record impaired loans at fair value on a recurring basis. However, periodically, a loan is considered impaired and is reported at the fair value of the underlying collateral, less estimated costs to sell, if repayment is expected solely from the collateral. Impaired loans measured at fair value typically consist of loans on nonaccrual status and loans with a portion of the allowance for loan losses allocated specific to the loan. Some loans may be included in both categories whereas other loans may only be included in one category. Collateral values are estimated using level 2 inputs, including recent appraisals, and Level 3 inputs based on customized discounting criteria. Due to the significance of the level 3 inputs, impaired loans have been classified as level 3.

Other Real Estate Owned (OREO). The Company values OREO at the fair value of the underlying collateral less expected selling costs. Collateral values are estimated primarily using appraisals and reflect a market value approach.

The following table summarizes financial and nonfinancial assets (there were no financial or nonfinancial liabilities) measured at fair value as of March 31, 2011 and December 31, 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):

March 31, 2011	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
Available for Sale Securities:
U.S. Treasury and Federal agencies	$	38,519	$	-	$	-	$	38,519
U.S. Government sponsored entities		15,243		-		-		15,243
State and political subdivisions		-		23,707		3,025		26,732
Mortgage backed securities		-		576		-		576
Total available-for-sale securities	$	53,762	$	24,283	$	3,025	$	81,070
Nonrecurring:
Impaired loans	$	-	$	-	$	9,083	$	9,083
Other real estate owned	$	-	$	-	$	983	$	983

Impaired loans are reported net of a $1,166,000 allowance for loan losses.

December 31, 2010	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
Available for Sale Securities:
U.S. Treasury and Federal agencies	$	24,106	$	-	$	-	$	24,106
U.S. Government sponsored entities		6,678		-		-		6,678
State and political subdivisions		-		22,378		2,992		25,370
Asset-backed securities		2,476		-		-		2,476
Mortgage backed securities		-		548		-		548
Total available-for-sale securities	$	33,260	$	22,976	$	2,992	$	59,228
Nonrecurring:
Impaired loans	$	-	$	-	$	9,595	$	9,595
Other real estate owned	$	-	$	-	$	1,247	$	1,247

Impaired loans are reported net of a $1,171,000 allowance for loan losses.

The following is a reconciliation of the beginning and ending balances of securities available for sale which are measured at fair value on a recurring basis using significant unobservable (Level 3) inputs during the three month period ended March 31, 2011 (in thousands):

Balance at January 1, 2011	$	2,992
Net maturities and calls		(13	)
Transfers into Level 3		-
Purchases		47
Unrealized net gains included in other comprehensive income		(1	)
Balance at March 31, 2011	$	3,025

NOTE H - SUBSEQUENT EVENTS

Management evaluated subsequent events through the date the financial statements were issued. Events or transactions occurring after March 31, 2011, but prior to when the financial statements were issued, that provided additional evidence about conditions that existed at March 31, 2011, have been recognized in the financial statements for the three month period ended March 31, 2011. Events or transactions that provided evidence about conditions that did not exist at March 31, 2011, but arose before the financial statements were issued, have not been recognized in the financial statements for the three month period ended March 31, 2011.

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion provides information about the financial condition and results of operations of the Company and its subsidiary, Southern Michigan Bank & Trust (SMB&T) for the three month periods ended March 31, 2011 and 2010.

Executive Summary

Net income for the three month period ended March 31, 2011 was $748,000 compared to $702,000 for the same period in 2010. Earnings per share was $0.32 for the three month period ended March 31, 2011, compared to $0.30 for the same period in 2010. Return on average assets for both three month periods ended March 31, 2011 and 2010 was 0.60%. Return on average shareholders' equity was 6.19% for the first quarter of 2011 compared to 6.08% for the same period in 2010.

The increase in net income for the three months ended March 31, 2011, over the first three months of 2010, was primarily the result of a decrease in the provision for loan losses. Details of the changes in various components of net income are discussed below.

Total consolidated assets at March 31, 2011 were $502.4 million compared to $493.9 million at December 31, 2010.

Results of Operations

Net Interest Income

The Company derives the greatest portion of its income from net interest income. Net interest margin for the three month period ended March 31, 2011 was 3.57% compared to 4.07% for the same period of 2010, a decrease of 50 basis points. Average loan balances for the first three months of 2011 declined $19.6 million, while the average balance in the lower yielding category federal funds sold and other increased $39.3 million. This overall increase in lower yielding assets resulted in a 73 basis point reduction in total interest earning asset yield. This reduction was partially offset as the Company was able to lower its cost of funds by 26 basis points during the first quarter of 2011 compared to the same three month period of 2010.

The following tables provide information regarding interest income and expense for the three-month periods ended March 31, 2011 and 2010, 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. Table 2 shows the effect on interest income and expense of changes in volume and interest rates on a tax equivalent basis.

Table 1 - Average Balances and Tax Equivalent Interest Rates

(Dollars in Thousands):

	March 31, 2011							March 31, 2010
	Average Balance			Interest		Yield/ Rate		Average Balance			Interest		Yield/ Rate
ASSETS
Interest earning assets:
Loans(1)(2)(3)	$	309,173		$	4,465	5.78	%	$	328,780		$	4,828	5.87	%
Federal funds sold and other(6)		65,116			51	.31			25,775			23	.36
Taxable investment securities(4)		46,966			138	1.18			33,726			181	2.15
Tax-exempt investment securities(1)		23,962			327	5.46			21,962			309	5.63
Total interest earning assets		445,217			4,981	4.48			410,243			5,341	5.21
Non-interest earning assets:
Cash and due from banks		12,407							10,085
Other assets(5)		48,446							50,520
Less allowance for loan losses		(5,584	)						(6,024	)
Total assets	$	500,486						$	464,824

Interest bearing liabilities:
Demand deposits	$	167,862			123	.29	%	$	144,700			131	.36	%
Savings deposits		50,141			12	.10			46,465			22	.19
Time deposits		136,530			709	2.08			133,285			848	2.54
Securities sold under agreements to repurchase and federal funds purchased		16,588			12	.29			15,571			10	.26
Other borrowings		9,892			109	4.41			14,207			120	3.38
Subordinated debentures		5,155			38	2.95			5,155			38	2.95
Total interest bearing liabilities		386,168			1,003	1.04			359,383			1,169	1.30

Non-interest bearing liabilities:
Demand deposits		61,209							54,417
Other		3,383							3,817
Common stock subject to repurchase obligation		1,353							1,043
Shareholders' equity		48,373							46,164
Total liabilities and shareholders' equity	$	500,486						$	464,824
Net interest income				$	3,978						$	4,172
Interest rate spread						3.44	%						3.91	%
Net yield on interest earning assets						3.57	%						4.07	%

(1)	Includes tax equivalent adjustment of interest (assuming a 34% tax rate) for securities and loans of $111,000 and $4,000, respectively, for 2011 and $105,000 and $27,000, respectively, for 2010.
(2)	Average balance includes average non-accrual loan balances of $5,617,000 in 2011 and $7,227,000 in 2010.
(3)	Interest income includes loan fees of $127,000 in 2011 and $99,000 in 2010.
(4)	Average balance includes average unrealized gain of $170,000 in 2011 and $636,000 in 2010 on available for sale securities.
(5)	Includes $15,394,000 in 2011 and $15,743,000 in 2010 relating to goodwill and other intangible assets.
(6)	Includes $61,851,000 in 2011 and $19,997,000 in 2010 of federal reserve deposit accounts.

Table 2 - Changes in Tax-Equivalent Net Interest Income

(Dollars in Thousands)

	Three Months Ended March 31 2011 Over 2010 Increase (Decrease) Due To									Three Months Ended March 31 2010 Over 2009 Increase (Decrease) Due To
Interest income on:	Rate			Volume			Net			Rate			Volume			Net
Loans	$	(79	)	$	(284	)	$	(363	)	$	(50	)	$	(95	)	$	(145	)
Taxable investment securities		(99	)		56			(43	)		(147	)		(61	)		(208	)
Tax-exempt investment securities		(10	)		28			18			(17	)		(22	)		(39	)
Federal funds sold		(3	)		31			28			11			3			14
Total interest earning assets	$	(191	)	$	(169	)	$	(360	)	$	(203	)	$	(175	)	$	(378	)
Interest expense on:
Demand deposits	$	(27	)	$	19		$	(8	)	$	(65	)	$	(9	)	$	(74	)
Savings deposits		(12	)		2			(10	)		(6	)		(3	)		(9	)
Time deposits		(158	)		20			(138	)		(211	)		7			(204	)
Securities sold under agreements to repurchase and federal funds purchased		1			1			2			(3	)		1			(2	)
Other borrowings		30			(42	)		(12	)		(36	)		19			(17	)
Subordinated debentures		-			-			-			(8	)		-			(8	)
Total interest bearing liabilities	$	(166	)	$	-		$	(166	)	$	(329	)	$	15		$	(314	)
Net interest income	$	(25	)	$	(169	)	$	(194	)	$	126		$	(190	)	$	(64	)

Tax equivalent net interest income decreased $194,000, or 4.7%, in the first three months of 2011 compared to the same period in 2010. The primary component was a $169,000 net decrease due to volume changes comparing the first three months of 2011 with the first three months of 2010 on a tax equivalent basis. The decrease was a result of lower effective rates for essentially all interest-bearing asset and liability categories in 2011 as compared to 2010.

The presentation of net interest income on a tax equivalent basis is not in accordance with generally accepted accounting principles ("GAAP"), but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income on a tax equivalent basis were $115,000 and $132,000, respectively, for the three months ended March 31, 2011 and 2010. These adjustments were computed using a 34% federal income tax rate.

Provision for Loan Losses

The provision for loan losses is based on an analysis of the required additions to the allowance for loan losses. The provision is charged to income to bring the allowance for loan losses to a level believed adequate by management to absorb probable incurred losses in the loan portfolio. Some factors considered by management in determining the level at which the allowance is maintained include specific credit reviews, historical loan loss experience, current economic conditions and trends, results of examinations by regulatory agencies and the volume, growth and composition of the loan portfolio. The provision is adjusted quarterly, if necessary, to reflect changes in the factors above, as well as actual charge-off experience and any known losses.

The provision for loan losses for the three month period ended March 31, 2011 was $125,000 compared to a provision for loan losses for the same period of 2010 of $200,000.

The allowance for loan losses was 1.82% of total loans at March 31, 2011 compared to 1.84% at December 31, 2010 and 1.83% at March 31, 2010.

Charge-offs and recoveries for respective loan categories for the three months ended March 31, 2011 and 2010 were as follows:

(Dollars in Thousands)

	March 31, 2011				March 31, 2010
	Charge-offs		Recoveries		Charge-offs		Recoveries
Commercial	$	62	$	43	$	82	$	18
Residential real estate		184		7		212		3
Consumer		73		26		91		33
Total	$	319	$	76	$	385	$	54

Net charge-offs in the quarter of 2011 were $243,000, or 0.32%, of loans on an annualized basis. Net charge-offs in the first three months of 2010 were $331,000, or 0.41%, of loans on an annualized basis.

Non-interest income

Non-interest income for the three month periods ended March 31, 2011 and 2010 was $1,655,000 and $1,624,000, respectively.

Service charges on deposit accounts decreased $159,000 (10.4%) in the first quarter of 2011 as compared to the first quarter of 2010. Reduced non-sufficient fund activity was the primary cause of the decline.

Net gains on loan sales increased 164.2%, or $197,000, in the first quarter of 2011 compared to the first quarter of 2010. Fixed rate long term residential mortgages are generally sold in the secondary market, while adjustable rate mortgages are retained in the loan portfolio. An increase in mortgage lending staff during the second half of 2010 resulted in higher production volumes in the first quarter of 2011 as compared to the same quarter of 2010.

During the first quarter of 2010, the Company recorded a $156,000 gain from life insurance proceeds.

Non-interest expense

Non-interest expense for the three month period ended March 31, 2011 was $4,456,000 compared to $4,690,000 for the same period in 2010, a decrease of $234,000 (5.0%).

Professional and outside services decreased $72,000, or 24.6%, in the first quarter of 2011 compared to the same period of 2010. Collection related legal fees decreased $43,000 as foreclosure activity and collection activity involving litigation slowed during the first quarter of 2011. Other non-interest expense also decreased $120,000 as the loss on sale of other real estate owned decreased from $148,000 for the first quarter of 2010 to $28,000 for the first quarter of 2011.

Federal income taxes

The Company had an income tax provision of $189,000 for the three months ended March 31, 2011 compared to $72,000 for the comparable period of 2010. The $156,000 gain on life insurance proceeds was a non-taxable event which, along with tax-exempt income from securities and loans, reduced the effective tax rate at March 31, 2010 to 9.3%. The effective tax rate for the period ended March 31, 2011 was 20.2%. Tax-exempt income continues to have a major impact on the Company's tax provision. The benefit offsetting lower coupon rates on municipal instruments is the nontaxable feature of the income earned on such investments. This resulted in a lower effective tax rate and reduced the federal income tax provision.

Financial Condition

Assets

Total assets at March 31, 2011 were $502.4 million, an increase of $8.5 million compared to December 31, 2010.

Investment securities increased $21.8 million at March 31, 2011 compared to December 31, 2010, primarily due to continued deposit growth and reduced loan balances.

Gross loans decreased $3.7 million, or 1.2%, as of March 31, 2011 compared to December 31, 2010. The decrease occurred primarily in the commercial portfolio and resulted from payoffs in the portfolio. The Company began to see renewed demand from credit worthy commercial borrowers toward the end of the first quarter of 2011 and is optimistic this will result in future loan growth in 2011.

Nonperforming assets

Nonperforming assets include non-accrual loans, accruing loans past due 90 days or more, and other real estate owned, which includes real estate acquired through foreclosure and deeds in lieu of foreclosure.

A loan generally is classified as nonaccrual when full collectibility of principal or interest is doubtful or a loan becomes 90 days past due as to principal or interest, unless management determines that the estimated net realizable value of the collateral is sufficient to cover the principal balance and accrued interest. When interest accruals are discontinued, unpaid interest is reversed. Nonperforming loans are returned to performing status when the loan is brought current and has performed in accordance with contract terms for a period of time.

The following table sets forth the aggregate amount of nonperforming assets in each of the following categories:

(Dollars in thousands)

	3/31/11			12/31/10			3/31/10
Nonaccrual loans:
Commercial and commercial real estate	$	4,180		$	3,755		$	4,368
Real estate mortgage		1,562			1,451			1,800
Consumer		28			87			106
		5,770			5,293			6,274
Loans contractually past due 90 days or more and still on accrual:
Commercial and commercial real estate		372			1			119
Real estate mortgage		-			-			-
Consumer		-			-			-
		372			1			119
Total nonperforming loans		6,142			5,294			6,393
Other real estate		983			1,247			950
Total nonperforming assets	$	7,125		$	6,541		$	7,343
Nonperforming loans to total loans		2.01	%		1.71	%		1.97	%
Nonperforming assets to total assets		1.42	%		1.32	%		1.58	%

Nonperforming loans are subject to continuous monitoring by management and estimated losses are specifically allocated for in the allowance for loan losses where appropriate. At March 31, 2011, December 31, 2010 and March 31, 2010 the Company had loans of $10.2 million, $10.8 million and $7.7, respectively, which were considered impaired.

In management's evaluation of the loan portfolio risks, any significant future increases in nonperforming loans is dependent to a large extent on the economic environment. In a deteriorating or uncertain economy, management applies more conservative assumptions when assessing the future prospects of borrowers and when estimating collateral values.

Liabilities

Deposits increased $7.7 million, or 1.9%, from December 31, 2010 to March 31, 2011. The majority of deposits are derived from core client sources, relating to long term relationships with local individuals, businesses and public clients. A small amount of brokered deposits are maintained, but are not used to support growth.

Shareholders' equity

Total shareholders' equity at March 31, 2011 increased $922,000 from December 31, 2010. The increase was primarily attributable to the net income for the period less dividends to shareholders as well as a reduction in the obligation to repurchase common stock.

The following table summarizes the Company's regulatory capital ratios as of March 31, 2011 and December 31, 2010:

	March 31, 2011		December 31, 2010		Minimum Required for Capital Adequacy Purposes
Total risk-based capital ratio	13.8	%	13.7	%	8.0	%
Tier I capital ratio	12.5	%	12.4	%	4.0	%
Leverage ratio	8.3	%	8.2	%	4.0	%

Liquidity

Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. SMB&T maintains certain levels of liquid assets (the most liquid of which are cash and cash equivalents, federal funds sold and investment securities) in order to meet these demands. Maturing loans and investment securities are the principal sources of asset liquidity. Liquidity is monitored and closely managed by the Asset/Liability Management Committee (ALCO), whose members are comprised of senior management.

SMB&T maintains correspondent accounts with other banks for various purposes. At times, SMB&T is a participant in the federal funds market, either as a borrower or a seller. SMB&T has a $3 million federal funds line available from a correspondent bank. In addition, SMB&T has the ability to borrow $39.6 million from the Federal Home Loan Bank based on collateral pledged, and also has the ability to borrow at the discount window of the Federal Reserve Bank as an additional short term funding source.

The Company's balances in federal funds sold and short term interest bearing balances with banks were $61.8 million at March 31, 2011, compared to $68.4 million at December 31, 2010 and $32.1 million at March 31, 2010. The Company continues to maintain high levels of liquidity, with investments, federal funds and cash equivalents held to improve the liquidity of the balance sheet during this period of economic uncertainty. The Company expects to maintain higher than normal levels of liquidity until economic conditions improve and more attractive investment opportunities emerge.

The Company's principal source of funds to pay cash dividends is the earnings and dividends paid by SMB&T.

Impact of Inflation and Changing Prices

The majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Another significant effect of inflation is on other expenses, which tend to rise during periods of general inflation.

Item 4.

Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 15d - 15(e) under the Exchange Act) as of March 31, 2011. Based on and as of the time of that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that as of the end of the period covered by this report the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms and is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There was no change in the Company's internal control over financial reporting that occurred during the three months ended March 31, 2011 that has materially affected, or that is reasonably likely to materially affect, the Company's internal control over financial reporting.

Part II. Other Information

Item 6.

Exhibits

Exhibits. The following exhibits are filed as part of this report on Form 10-Q:

	Exhibit Number		Document

	3.1		Articles of Incorporation of Southern Michigan Bancorp, Inc., as amended. Previously filed with the Commission on July 13, 2007 in Southern Michigan Bancorp Inc.'s Form S-4 Registration Statement, Exhibit 3.1. Here incorporated by reference.

	3.2		Amended and Restated Bylaws of Southern Michigan Bancorp, Inc., as amended. Previously filed with the Commission on July 13, 2007 in Southern Michigan Bancorp Inc.'s Form S-4 Registration Statement, Exhibit 3.2. Here incorporated by reference.

	4.1		Articles of Incorporation of Southern Michigan Bancorp, Inc., as amended. Exhibit 3.1 is here incorporated by reference.

	4.2		Amended and Restated Bylaws of Southern Michigan Bancorp, Inc., as amended. Exhibit 3.2 is here incorporated by reference.

	4.3		Long-Term Debt. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the Securities and Exchange Commission upon request.

	31.1		Certification of Chairman of the Board and Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2		Certification of Senior Vice President, Chief Financial Officer, Secretary and Treasurer under Section 302 of the Sarbanes-Oxley Act of 2002.

	32		Certification pursuant to 18 U.S.C. § 1350.

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.

	SOUTHERN MICHIGAN BANCORP, INC.


Date: May 13, 2011	By: /s/ John H. Castle
	John H. Castle Chairman of the Board and Chief Executive Officer (Principal Executive Officer)


Date: May 13, 2011	By: /s/ Danice L. Chartrand
	Danice L. Chartrand Senior Vice President, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer)

Exhibit Index

	Exhibit Number		Document

	3.1		Articles of Incorporation of Southern Michigan Bancorp, Inc., as amended. Previously filed with the Commission on July 13, 2007 in Southern Michigan Bancorp Inc.'s Form S-4 Registration Statement, Exhibit 3.1. Here incorporated by reference.

	3.2		Amended and Restated Bylaws of Southern Michigan Bancorp, Inc., as amended. Previously filed with the Commission on July 13, 2007 in Southern Michigan Bancorp Inc.'s Form S-4 Registration Statement, Exhibit 3.2. Here incorporated by reference.

	4.1		Articles of Incorporation of Southern Michigan Bancorp, Inc., as amended. Exhibit 3.1 is here incorporated by reference.

	4.2		Amended and Restated Bylaws of Southern Michigan Bancorp, Inc., as amended. Exhibit 3.2 is here incorporated by reference.

	4.3		Long-Term Debt. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the Securities and Exchange Commission upon request.

	31.1		Certification of Chairman of the Board and Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2		Certification of Senior Vice President, Chief Financial Officer, Secretary and Treasurer under Section 302 of the Sarbanes-Oxley Act of 2002.

	32		Certification pursuant to 18 U.S.C. § 1350.