Southern Michigan Form 10-Q

10-Q 1 smb10q_111210.htm SOUTHERN MICHIGAN FORM 10-Q Southern Michigan Form 10-Q - 11/12/10

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 September 30, 2010

	[ ]		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 Web site, 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 November 11, 2010, was 2,340,717 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", "is likely", or is "probable" 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", "optimistic" or has an "opinion" that an event will occur, or other words or phrases such as "ongoing", "future", or "judgment", "considered" 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, mortgage servicing rights and deferred tax assets) 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 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, 2009 And in "Part II, Item 1A - Risk Factors" of this report. 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)

	September 30, 2010			December 31, 2009
ASSETS
Cash and cash equivalents	$	64,411		$	24,814
Federal funds sold		221			2,540
Securities available for sale		58,057			56,948
Loans held for sale		1,115			605
Loans, net of allowance for loan losses of $5,728 - 2010 ($6,075 - 2009)		314,542			327,004
Premises and equipment, net		12,712			12,914
Accrued interest receivable		2,366			2,054
Net cash surrender value of life insurance		9,859			9,881
Goodwill		13,422			13,422
Other intangible assets, net		2,093			2,355
Other assets		8,700			9,872
TOTAL ASSETS	$	487,498		$	462,409

LIABILITIES
Deposits:
Non-interest bearing	$	56,501		$	55,250
Interest bearing		345,487			325,655
Total deposits		401,988			380,905

Securities sold under agreements to repurchase and overnight borrowings		16,876			14,799
Accrued expenses and other liabilities		4,183			4,039
Other borrowings		10,318			10,832
Subordinated debentures		5,155			5,155
Common stock subject to repurchase obligation in Employee
Stock Ownership Plan, shares outstanding - 104,514 in 2010
(101,999 shares in 2009)		1,233			945
Total liabilities		439,753			416,675

SHAREHOLDERS' EQUITY
Preferred stock, 100,000 shares authorized; none issued or outstanding		-			-
Common stock, $2.50 par value:
Authorized - 4,000,000 shares
Issued - 2,340,717 shares in 2010 (2,323,410 shares in 2009)
Outstanding (other than ESOP shares) - 2,236,203 shares in 2010 (2,221,411 shares in 2009)		5,591			5,553
Additional paid-in capital		18,152			18,363
Retained earnings		24,086			22,062
Accumulated other comprehensive income, net		243			193
Unearned Employee Stock Ownership Plan shares		(327	)		(437	)
Total shareholders' equity		47,745			45,734
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	487,498		$	462,409

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 September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Interest income:
Loans, including fees	$	4,878	$	4,966	$	14,427	$	14,881
Federal funds sold and balances with banks		42		22		99		42
Securities:
Taxable		151		228		474		895
Tax-exempt		178		231		580		684
Total interest income		5,249		5,447		15,580		16,502

Interest expense:
Deposits		928		1,128		2,863		3,561
Other		172		142		515		544
Total interest expense		1,100		1,270		3,378		4,105
Net interest income		4,149		4,177		12,202		12,397
Provision for loan losses		425		350		775		2,300

Net interest income after provision for loan losses		3,724		3,827		11,427		10,097

Non-interest income:
Service charges on deposit accounts		652		786		1,834		2,091
Trust fees		244		237		740		716
Net gains on security calls and sales		-		-		207		407
Net gains on loan sales		403		173		684		603
Earnings on life insurance assets		93		83		243		251
Gain on life insurance proceeds		-		-		156		-
Income and fees from automated teller machines		235		181		660		514
Other		211		214		652		718
Total non-interest income		1,838		1,674		5,176		5,300

Non-interest expense:
Salaries and employee benefits		2,529		2,413		7,467		7,355
Occupancy, net		324		325		1,068		1,047
Equipment		229		217		683		672
Printing, postage and supplies		146		158		437		470
Telecommunication expenses		107		88		281		263
Professional and outside services		160		339		685		999
FDIC assessments		157		157		473		676
Software maintenance		94		101		302		315
Amortization of other intangibles		87		91		262		272
Other		595		672		2,017		2,113
Total non-interest expense		4,428		4,561		13,675		14,182
INCOME BEFORE INCOME TAXES		1,134		940		2,928		1,215
Federal income tax provision (credit)		264		169		553		(36	)
NET INCOME	$	870	$	771	$	2,375	$	1,251

Basic Earnings Per Common Share	$	.38	$	.34	$	1.03	$	.55
Diluted Earnings Per Common Share		.38		.34		1.03		.55
Dividends Declared Per Common Share		.05		.05		.15		.15

See accompanying notes to interim consolidated financial statements.

SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands, except number of shares and per share data)
For the Nine Months Ended September 30, 2010 and 2009

	Common Stock			Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income, Net		Unearned ESOP Shares			Total
Balance at January 1, 2009	$	5,528		$	18,473		$	20,593		$	413	$	(591	)	$	44,416
Comprehensive income:
Net income								1,251								1,251
Net change in other comprehensive
income items											33					33
Total comprehensive income																1,284
Cash dividends declared - $.15 per share								(350	)							(350	)
Issuance of restricted stock (12,230 shares of common stock at $7.40 per share)		30			(30	)										-
Vesting of restricted stock					35											35
Change in common stock subject to
repurchase		(5	)		(138	)										(143	)
Reduction of ESOP obligation													125			125
Forfeiture of restricted stock (560 shares)		(1	)		1											-
Stock option expense					64											64
Balance at September 30, 2009	$	5,552		$	18,405		$	21,494		$	446	$	(466	)	$	45,431

Balance at January 1, 2010	$	5,553		$	18,363		$	22,062		$	193	$	(437	)	$	45,734

Comprehensive income:
Net income								2,375								2,375
Net change in other comprehensive
income items											50					50
Total comprehensive income																2,425
Cash dividends declared - $.15 per share								(351	)							(351	)
Issuance of restricted stock (18,325 shares of common stock at $10.10 per share)		46			(46	)										-
Vesting of restricted stock					58											58
Forfeiture of restricted stock (1,018 shares)		(2	)		2											-
Change in common stock subject to
repurchase		(6	)		(282	)										(288	)
Reduction of ESOP obligation													110			110
Stock option expense					57											57
Balance at September 30, 2010	$	5,591		$	18,152		$	24,086		$	243	$	(327	)	$	47,745

See accompanying notes to interim consolidated financial statements.

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

	Nine Months Ended September 30,
	2010			2009
Operating Activities
Net income	$	2,375		$	1,251
Adjustments to reconcile net income to net cash
from operating activities:
Provision for loan losses		775			2,300
Depreciation		746			788
Net amortization of investment securities		402			297
Loans originated for sale		(29,955	)		(34,800	)
Proceeds on loans sold		30,129			35,266
Net gains on loan sales		(684	)		(603	)
Gain on life insurance proceeds		(156	)		-
Stock option and restricted stock grant compensation expense		115			99
Net gains on security calls and sales		(207	)		(407	)
Net loss on other real estate owned sales		241			202
Amortization of other intangible assets		262			272
Net loss (gain) on disposal of fixed assets		(3	)		9
Net change in obligation under ESOP		110			125
Net change in:
Accrued interest receivable		(312	)		110
Cash surrender value		(243	)		(251	)
Other assets		935			445
Accrued expenses and other liabilities		144			(197	)
Net cash from operating activities		4,674			4,906

Investing Activities
Activity in available for sale securities:
Proceeds on securities sold		7,445			15,477
Proceeds from maturities and calls		32,163			23,583
Purchases		(40,836	)		(32,151	)
Net change in federal funds sold		2,319			378
Loan originations and payments, net		10,940			(5,573	)
Proceeds from life insurance		421			-
Proceeds on other real estate owned sales		717			2,057
Proceeds from sale of equipment		15			-
Additions to premises and equipment		(556	)		(404	)
Net cash from investing activities		12,628			3,367

Financing Activities
Net change in deposits		21,083			(11,354	)
Net change in securities sold under agreements to repurchase and overnight borrowings		2,077			5
Proceeds from other borrowings		5,000			5,000
Repayments of other borrowings		(5,514	)		(1,541	)
Cash dividends paid		(351	)		(580	)
Net cash from financing activities		22,295			(8,470	)
Net change in cash and cash equivalents		39,597			(197	)
Beginning cash and cash equivalents		24,814			27,989
Ending cash and cash equivalents	$	64,411		$	27,792

Cash paid for interest	$	3,415		$	4,317
Cash paid for income taxes		250			-
Transfers from loans to other real estate owned		747			2,612

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. FNB Financial was a wholly-owned subsidiary of the Company until its consolidation with SMB&T in April 2009. SMB&T also owns FNB Financial Services, which conducts a brokerage business and is also 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 nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes of the Company for December 31, 2009 included in the Company's Annual Report on Form 10-K for the year ended December 31, 2009, filed with the Securities and Exchange Commission on March 26, 2010.

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: ASC 860-10 addresses accounting for transfers of financial assets. Among other requirements, the ASC removes the concept of a qualifying special-purpose entity and removes the exception from applying consolidation of variable interest entities to qualifying special-purpose entities. The objective is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor's continuing involvement, if any, in transferred financial assets. Among other things, ASC 860-10 applies to any transfer of financial assets, which for the Company primarily relates to loan participations sold. The adoption of ASC 860-10 effective January 1, 2010 has not had any impact on the Company's September 30, 2010 consolidated financial statements since SMB&T did not sell any loan participations during the nine month period.

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Disclosures, which provides amendments to ASC 820-10 and is intended to improve disclosure requirements related fair value measurements. The Update clarifies that a reporting entity should provide fair value measurement disclosures for each class of assets and liabilities measured at fair value. A class is often a subset of assets or liabilities within a line item in the statement of financial assets. Reporting entities should also provide disclosures about the valuation techniques and inputs used to measure fair value for fair value measurements falling within Level 2 or 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Information on fair value measurements is included in Note F to the consolidated financial statements.

In July 2010, the FASB issued Accounting Standards Update 2010-20, Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses which will increase disclosures made about the credit quality of loans and the allowance for credit losses. The disclosures will 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 will be effective for the Company's December 31, 2010 consolidated financial statements.

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 and nine month periods ended September 30, 2010 and 2009 is as follows (dollars in thousands, except per share data):

	Three Months Ended September 30, 2010		Three Months Ended September 30, 2009		Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009

Basic earnings per share:
Net income	$	870	$	771	$	2,375	$	1,251

Weighted average common shares outstanding		2,340,717		2,323,410		2,339,121		2,322,411

Less unallocated ESOP shares		28,799		31,333		28,604		31,033

Weighted average common shares outstanding for basic earnings per share		2,311,918		2,292,077		2,310,517		2,291,378

Basic earnings per share	$	0.38	$	0.34	$	1.03	$	0.55

Diluted earnings per share:
Net income	$	870	$	771	$	2,375	$	1,251

Weighted average common shares outstanding for basic earnings per share		2,311,918		2,292,077		2,310,517		2,291,378

Add: Dilutive effect of assumed exercise of stock options		3,986		511		3,312		-

Weighted average common and dilutive potential common shares outstanding		2,315,904		2,292,588		2,313,829		2,291,378

Diluted earnings per share	$	.38	$	.34	$	1.03	$	0.55

Stock option awards that were anti-dilutive, and therefore not included in the computation of diluted earnings per share, were as follows: 197,702 and 193,675, respectively, as of September 30, 2010 and 2009.

NOTE D - 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 September 30, 2010, there were 105,199 shares available for future issuance under the 2005 plan.

A summary of stock option activity is as follows for the nine months ended September 30, 2010:

	Shares	Weighted Average Price

Outstanding at beginning of year	225,270	$ 21.83
Granted	8,075	10.10
Exercised	-	-
Forfeited	14,368	23.45
Outstanding at September 30, 2010	218,977	21.29

Options exercisable at September 30, 2010	133,702	22.10

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the weighted average assumptions noted in the following table. The expected volatility and life assumptions are based on historical experience. The interest rate is based on the U.S. Treasury yield curve and the dividend assumption is based on the Company's history and expected dividend payouts. Following are the assumptions used in calculating the fair value of the options issued during the nine months ended September 30, 2010:

	Dividend yield	3.29%
	Expected life	8 years
	Expected volatility	23.64%
	Risk-free interest rate	0.96%
	Weighted average fair value of options granted during 2010	$1.53

The Company recorded compensation expense of $57,000 and $64,000, respectively, related to the stock options during the nine month periods ended September 30, 2010 and 2009.

Restricted Stock - Shares of restricted stock may also be granted under the Stock Incentive Plan of 2005 described above. 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 of $58,000 was recorded during the nine months ended September 30, 2010. As of September 30, 2010, there was $271,000 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 3.2 years.


	Shares		Weighted Average Grant Date Fair Value

Nonvested at January 1, 2010	17,062		$	11.26
Granted	18,325			10.10
Vested	(3,776	)		12.29
Forfeited	(1,018	)		10.64
Nonvested at September 30, 2010	30,593		$	10.46

NOTE E - 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, 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 September 30, 2010 or December 31, 2009, 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 September 30, 2010 and December 31, 2009, 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):

	September 30, 2010						December 31, 2009
	Carrying Amount			Fair Value			Carrying Amount			Fair Value
Financial assets:
Cash and cash equivalents	$	64,411		$	64,411		$	24,814		$	24,814
Federal funds sold		221			221			2,540			2,540
Securities available for sale		58,057			58,057			56,948			56,948
Loans held for sale		1,115			1,115			605			605
Loans, net of allowance for loan losses		314,542			316,597			327,004			329,961
Accrued interest receivable		2,366			2,366			2,054			2,054

Financial liabilities:
Deposits	$	(401,988	)	$	(404,446	)	$	(380,905	)	$	(382,166	)
Securities sold under agreements to repurchase and overnight borrowings		(16,876	)		(16,876	)		(14,799	)		(14,799	)
Other borrowings		(10,318	)		(10,550	)		(10,832	)		(10,983	)
Subordinated debentures		(5,155	)		(5,155	)		(5,155	)		(5,155	)
Accrued interest payable		(190	)		(190	)		(228	)		(228	)

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 F - 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 presents the fair value measurements of assets recognized in the accompanying consolidated balance sheet measured at fair value on a recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at September 30, 2010 (in thousands):

	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value

Available for Sale Securities:
U.S. Treasury and Federal agencies	$	29,032	$	-	$	-	$	29,032
U.S. Government sponsored entities		6,155		-		-		6,155
State and political subdivisions		-		19,133		3,124		22,257
Mortgage backed securities		-		613		-		613
Total available-for-sale securities	$	35,187	$	19,746	$	3,124	$	58,057

The following table presents the fair value measurements of assets recognized in the accompanying consolidated balance sheet measured at fair value on a non recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at September 30, 2010 (in thousands):

	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value

Impaired loans	$	-	$	-	$	7,915	$	7,915
Other real estate owned	$	-	$	-	$	1,042	$	1,042

Impaired loans are reported net of a $1,113,000 allowance for loan losses.

The following table summarizes financial and nonfinancial assets (there were no financial or nonfinancial liabilities) measured at fair value as of December 31, 2009, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):

	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value

Recurring:
Securities available for sale	$	31,109	$	22,740	$	3,099	$	56,948

Nonrecurring:
Impaired loans	$	-	$	-	$	9,585	$	9,585

Other real estate owned	$	-	$	-	$	1,187	$	1,187

Impaired loans are reported net of a $1,550,000 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 nine month period ended September 30, 2010 (in thousands):

Balance at January 1, 2010	$	3,099
Net maturities and calls		(791	)
Transfers into Level 3		829
Unrealized net gains included in other comprehensive income		(13	)

Balance at September 30, 2010	$	3,124

NOTE G - SUBSEQUENT EVENTS

Management evaluated subsequent events through the date the financial statements were issued. Events or transactions occurring after September 30, 2010, but prior to when the financial statements were issued, that provided additional evidence about conditions that existed at September 30, 2010, have been recognized in the financial statements for the nine month period ended September 30, 2010. Events or transactions that provided evidence about conditions that did not exist at September 30, 2010, but arose before the financial statements were issued, have not been recognized in the financial statements for the nine month period ended September 30, 2010.

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 and nine month periods ended September 30, 2010 and 2009.

Executive Summary

Net income for the three and nine month periods ended September 30, 2010 was $870,000 and $2,375,000 respectively, compared to $771,000 and $1,251,000 respectively, for the same periods in 2009. Diluted earnings per share was $0.38 and $1.03, respectively, for the three and nine month periods ended September 30, 2010, compared to $0.34 and $0.55, respectively, for the same periods in 2009. Return on average assets was 0.67% for the first nine months of 2010 compared to 0.36% for the first nine months of 2009. Return on average shareholders' equity was 6.76% for the first nine months of 2010 compared to 3.70% for the same period in 2009.

The increase in net income for the nine months ended September 30, 2010, over the first nine months of 2009, 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 September 30, 2010 were $487.5 million compared to $462.4 million at December 31, 2009. Cash balances remained elevated as of September 30, 2010, as compared to December 31, 2009, due to increased deposits and reductions in the loan portfolio.

Results of Operations

Net Interest Income

The Company derives the greatest portion of its income from net interest income. Declining interest rates over the past two years have reduced the Company's yield on earning assets, as well as reduced its cost of funds. During the nine month period ended September 30, 2010, the Company was able to lower its cost of funds by 27 basis points compared to the same nine month period of 2009. Tax equivalent yields on average interest earning assets for the same comparable periods declined 37 basis points. This resulted in a slight reduction in both the interest rate spread and the tax equivalent net interest margin.

The following tables provide information regarding interest income and expense for the nine-month periods ended September 30, 2010 and 2009, 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, 2010 and 2009. 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):

	September 30, 2010							September 30, 2009
	Average Balance			Interest		Yield/ Rate		Average Balance			Interest		Yield/ Rate
ASSETS
Interest earning assets:
Loans(1)(2)(3)	$	325,105		$	14,487	5.94	%	$	334,189		$	14,967	5.97	%
Federal funds sold and other(6)		39,090			99	.34			17,246			42	0.32
Taxable investment securities(4)		31,523			474	2.00			38,833			895	3.07
Tax-exempt investment securities(1)		20,925			878	5.59			23,209			1,047	6.01
Total interest earning assets		416,643			15,938	5.10			413,477			16,951	5.47

Non-interest earning assets:
Cash and due from banks		11,257							10,666
Other assets(5)		49,877							48,845
Less allowance for loan losses		(5,813	)						(6,578	)

Total assets	$	471,964						$	466,410


Interest bearing liabilities:
Demand deposits	$	145,878			386	.35	%	$	141,568			478	0.45	%
Savings deposits		47,756			58	.16			53,257			86	0.22
Time deposits		135,417			2,419	2.38			135,295			2,997	2.95
Securities sold under agreements to repurchase and federal funds purchased		16,051			35	.29			14,698			31	0.28
Other borrowings		12,770			362	3.78			12,155			354	3.88
Subordinated debentures		5,155			118	3.05			5,155			159	4.11
Total interest bearing liabilities		363,027			3,378	1.24			362,128			4,105	1.51

Non-interest bearing liabilities:
Demand deposits		56,968							55,737
Other		4,006							2,721
Common stock subject to repurchase obligation		1,089							800
Shareholders' equity		46,874							45,024
Total liabilities and shareholders' equity	$	471,964						$	466,410
Net interest income				$	12,560						$	12,846
Interest rate spread						3.86	%						3.96	%
Net yield on interest earning assets						4.02	%						4.14	%

(1)	Includes tax equivalent adjustment of interest (assuming a 34% tax rate) for securities and loans of $298,000 and $60,000, respectively, for 2010 and $363,000 and $86,000, respectively, for 2009.
(2)	Average balance includes average non-accrual loan balances of $7,473,000 in 2010 and $8,162,000 in 2009.
(3)	Interest income includes loan fees of $360,000 in 2010 and $259,000 in 2009.
(4)	Average balance includes average unrealized gain of $626,000 in 2010 and $982,000 in 2009 on available for sale securities.
(5)	Includes $15,656,000 in 2010 and $16,012,000 in 2009 relating to goodwill and other intangible assets.
(6)	Includes $34,271,000 in 2010 and $14,730,000 in 2009 of federal reserve deposit accounts.

Table 2 - Changes in Tax-Equivalent Net Interest Income

(Dollars in Thousands)

	Nine Months Ended September 30, 2010 Over 2009 Increase (Decrease) Due To									Nine Months Ended September 30, 2009 Over 2008 Increase (Decrease) Due To
Interest income on:	Rate			Volume			Net			Rate			Volume			Net

Loans	$	(75	)	$	(405	)	$	(480	)	$	(2,377	)	$	(60	)	$	(2,437	)
Taxable investment securities		(273	)		(148	)		(421	)		(523	)		(172	)		(695	)
Tax-exempt investment securities		(70	)		(99	)		(169	)		23			(61	)		(38	)
Federal funds sold		2			55			57			(257	)		(40	)		(297	)

Total interest earning assets	$	(416	)	$	(597	)	$	(1,013	)	$	(3,134	)	$	(333	)	$	(3,467	)

Interest expense on:

Demand deposits	$	(115	)	$	23		$	(92	)	$	(1,067	)	$	(194	)	$	(1,261	)
Savings deposits		(20	)		(8	)		(28	)		(219	)		(6	)		(225	)
Time deposits		(582	)		4			(578	)		(598	)		192			(406	)
Securities sold under agreements to repurchase and federal funds purchased		1			3			4			(151	)		44			(107	)
Other borrowings		(14	)		22			8			(149	)		(44	)		(193	)
Subordinated debentures		(41	)		-			(41	)		(65	)		-			(65	)

Total interest bearing liabilities	$	(771	)	$	44		$	(727	)	$	(2,249	)	$	(8	)	$	(2,257	)

Net interest income	$	355		$	(641	)	$	(286	)	$	(885	)	$	(325	)	$	(1,210	)

Tax equivalent net interest income decreased $286,000, or 2.2%, in the first nine months of 2010 compared to the same period in 2009. Net interest income decreased $641,000 due to volume changes comparing the first nine months of 2010 with the first nine months of 2009 on a tax equivalent basis. The decrease was offset by an increase due to interest rate changes of $355,000.

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 $358,000 and $449,000, respectively, for the nine months ended September 30, 2010 and 2009.. 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 appropriate by management. The allowance for loan losses is maintained at 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 and nine month periods ended September 30, 2010 was $425,000 and $775,000, respectively, compared to a provision for loan losses for the same periods of 2009 of $350,000 and $2,300,000, respectively. Net charge-offs of $423,000 were recorded for the third quarter of 2010, compared to

$254,000 for the same quarter a year ago. Net charge-offs of $1,122,000 have been recorded during the first nine months of 2010, compared to $2,684,000 during the same period of 2009. In addition, specific reserves decreased 28.2% at September 30, 2010 compared to December 31, 2009.

The allowance for loan losses was 1.79% of total loans at September 30, 2010 compared to 1.82% at December 31, 2009 and 2.00% at September 30, 2009.

Charge-offs and recoveries for respective loan categories for the nine months ended September 30, 2010 and 2009 were as follows:

(Dollars in Thousands)

	September 30, 2010				September 30, 2009
	Charge-offs		Recoveries		Charge-offs		Recoveries

Commercial	$	361	$	29	$	1,566	$	51
Residential real estate		687		28		953		3
Consumer		213		82		302		83
Total	$	1,261	$	139	$	2,821	$	137

Net charge-offs in the first nine months of 2010 were $1,122,000, or 0.47%, of loans on an annualized basis. Net charge-offs in the first nine months of 2009 were $2,684,000, or 1.07%, of loans on an annualized basis.

Non-interest income

Non-interest income for the three month periods ended September 30, 2010 and 2009 was $1,838,000 and $1,674,000, respectively. Non-interest income for the nine month periods ended September 30, 2010 and 2009 was $5,176,000 and $5,300,000, respectively.

Service charges on deposit accounts declined 17.0% in the third quarter of 2010 as compared to the third quarter of 2009, and declined12.3% for the first nine months of 2010 compared to the same nine month period of 2009. Reduced non-sufficient fund activity was the primary cause of the declines.

Net gains on loan sales increased 132.9%, or $230,000, in the third quarter of 2010 compared to the third quarter of 2009. Net gains on loan sales increased 13.4%, or $81,000, in the first nine months of 2010 compared to the same period of 2009. Fixed rate long term residential mortgages are generally sold in the secondary market, while adjustable rate mortgages are retained in the loan portfolio. Lower mortgage rates, as well as an increase in mortgage lending staff, resulted in higher production volumes in the third quarter of 2010 as compared to the same quarter of 2009.

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

Income and fees from automated teller machines (ATMs) increased $54,000, or 29.8%, in the third quarter of 2010 compared to the third quarter of 2009. Income and fees from ATMs increased $146,000 or 28.4% in the first nine months of 2010 compared to the same period in 2009. During the fourth quarter of 2009, the Company converted all of its ATMs to a new processor and network resulting in increased fees.

Non-interest expense

Non-interest expense for the three month periods ended September 30, 2010 and 2009 was $4,428,000 and $4,561,000, respectively. Non-interest expense for the nine month periods ended September 30, 2010 and 2009 was $13,675,000 and $14,182,000, respectively.

Professional and outside services decreased $179,000, or 52.8%, and $314,000, or 31.4%, respectively, in the third quarter and first nine months of 2010 compared to the same periods of 2009. In April 2009, FNB Financial

was consolidated into SMB&T. The process of consolidating the two systems occurred over a period of several months with final conversion in July of 2009 resulting in increased professional fees in 2009.

FDIC assessments were flat in the third quarter of 2010 compared to the same period of 2009. For the first nine months of 2010, FDIC assessments decreased $203,000, or 30.0%, compared to the first nine months of 2009. FDIC assessments in the second quarter of 2009 included a one-time special assessment.

Federal income taxes

The Company had an income tax provision of $553,000 for the nine months ended September 30, 2010 compared to a credit of $36,000 for the comparable period of 2009. 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 September 30, 2010 to 18.9%. Because of the decline in 2009 income before taxes, a federal income tax credit resulted after consideration of tax-exempt interest income and other normal tax reconciling items. Tax-exempt income continues to have a major impact on the Company's tax provision or credit. 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 or credit.

Financial Condition

Assets

Total assets at September 30, 2010 were $487,498,000, an increase of $25.1 million compared to December 31, 2009. Cash and cash equivalents increased $39.6 million at September 30, 2010 compared to December 31, 2009, primarily due to increased deposits and reductions in the loan portfolio.

Gross loans decreased $12.8 million, or 3.8%, as of September 30, 2010 compared to December 31, 2009. The decrease occurred throughout the portfolio and primarily resulted from slower loan demand during 2010.

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)

	9/30/10			12/31/09			9/30/09
Nonaccrual loans:
Commercial, financial and agricultural	$	4,470		$	5,576		$	5,610
Real estate mortgage		2,277			1,933			2,445
Installment		83			76			81
		6,830			7,585			8,136
Loans contractually past due 90 days or
more and still on accrual:
Commercial, financial and agricultural		39			14			-
Real estate mortgage		-			-			-
Installment		-			-			15
		39			14			15

Total nonperforming loans		6,869			7,599			8,151
Other real estate owned		1,042			1,187			1,516

Total nonperforming assets	$	7,911		$	8,786		$	9,667
Nonperforming loans to total loans		2.14	%		2.28	%		2.43	%
Nonperforming assets to total assets		1.62	%		1.90	%		2.07	%

Nonperforming loans are subject to continuous monitoring by management and estimated losses are specifically allocated for in the allowance for loan losses where appropriate.

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 $21.1 million, or 5.5%, from December 31, 2009 to September 30, 2010. 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 September 30, 2010 increased $2,011,000 from the year ended December 31, 2009. The increase was primarily attributable to the current year's net income less dividends to shareholders.

The following table summarizes the Company's regulatory capital ratios as of September 30, 2010 and December 31, 2009:

	September 30, 2010		December 31, 2009		Minimum Required for Capital Adequacy Purposes
Total risk-based capital ratio	13.1	%	11.9	%	8.0	%
Tier I capital ratio	11.8	%	10.7	%	4.0	%
Leverage ratio	8.5	%	8.1	%	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 $42.9 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 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 September 30, 2010. 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 September 30, 2010 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 1A.

Risk Factors

Information concerning other risk factors is contained in the section entitled "Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2009, filed with the Securities and Exchange Commission on March 26, 2010. Except as set forth below, as of the date of this report, management does not believe that there has been a material change in the nature or categories of the Company's risk factors, as compared to the information disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2009.

We may face increasing pressure from historical purchasers of our residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans.

We generally sell the fixed rate long-term residential mortgage loans we originate on the secondary market. In response to the financial crisis, we believe that purchasers of residential mortgage loans, such as government sponsored entities, are increasing their efforts to seek to require sellers of residential mortgage loans to either repurchase loans previously sold or reimburse purchasers for losses related to loans previously sold when losses are incurred on a loan previously sold due to actual or alleged failure to strictly conform to the purchaser's purchase criteria. As a result, we may face increasing pressure from historical purchasers of our residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans and we may face increasing expenses to defend against such claims. If we are required in the future to repurchase loans previously sold, reimburse purchasers for losses related to loans previously sold, or if we incur increasing expenses to defend against such claims, our financial condition and results of operations would be negatively affected.

The recently enacted Dodd-Frank Act may adversely impact the Company's results of operations, financial condition or liquidity.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"), was signed into law by President Obama. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States, establishes the new federal Bureau of Consumer Financial Protection (the "BCFP"), and will require the BCFP and other federal agencies to implement many new and significant rules and regulations. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting rules and regulations will impact the Company's and the Bank's business. Compliance with these new laws and regulations will likely result in additional costs, which could be significant and could adversely impact the Company's results of operations, financial condition or liquidity.

Item 6.

Exhibits

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

	Exhibit Number		Document

	2.1		Agreement and Plan of Merger between Southern Michigan Bancorp, Inc. and FNB Financial Corporation, dated April 17, 2007. Previously filed with the Commission on September 28, 2007 in Southern Michigan Bancorp Inc.'s Amendment No. 2 to Form S-4 Registration Statement, Exhibit 2. Here incorporated by reference.

	2.2		Agreement of Consolidation between Southern Michigan Bank & Trust and FNB Financial. Previously filed with the Commission on March 26, 2010 in Southern Michigan Bancorp Inc.'s Annual Report on Form 10-K for the year ended December 31, 2009., Exhibit 2.2. Here incorporated by reference.

	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 3.1is 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: November 12, 2010	By: /s/ John H. Castle
	John H. Castle Chairman of the Board and Chief Executive Officer (Principal Executive Officer)


Date: November 12, 2010	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

	2.1		Agreement and Plan of Merger between Southern Michigan Bancorp, Inc. and FNB Financial Corporation, dated April 17, 2007. Previously filed with the Commission on September 28, 2007 in Southern Michigan Bancorp Inc.'s Amendment No. 2 to Form S-4 Registration Statement, Exhibit 2. Here incorporated by reference.

	2.2		Agreement of Consolidation between Southern Michigan Bank & Trust and FNB Financial. Previously filed with the Commission on March 26, 2010 in Southern Michigan Bancorp Inc.'s Annual Report on Form 10-K for the year ended December 31, 2009., Exhibit 2.2. Here incorporated by reference.

	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 3.1is 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.