UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 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	38-2407501
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
51 West Pearl Street Coldwater, Michigan	49036
(Address of Principal Executive Offices)	(Zip Code)

(517) 279-5500

(Registrant’s Telephone Number, Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class	Name of Each Exchange on Which Registered
None	None

Securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934:

None

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes  ¨    No  x

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   x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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	¨  (Do not check if smaller reporting company)	Smaller reporting company	x

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 aggregate market value of the common stock held by non-affiliates of the registrant, computed by reference to the average bid and asked price of the common stock, as of June 30, 2011 was $26,272,625.

The number of shares outstanding of the registrant’s common stock, $2.50 par value, as of March 9, 2012, was 2,376,724 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”, “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”, “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 trends in our credit quality metrics, future capital levels, future charge-off levels, real estate valuation, future levels of non-performing assets and costs associated with administration and disposition of non-performing assets, the rate of asset dispositions, dividends, future growth and funding sources, future liquidity levels, future profitability levels, future FDIC assessment levels, future effects of new or changed accounting standards, the effects on earnings of changes in interest rates and the future level of other revenue sources. 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, 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), and management’s assumptions concerning pension and other postretirement benefit plans involves judgments that are inherently forward-looking. All statements with references to future time periods are forward-looking. All of the information concerning interest rate sensitivity is 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. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements.

Risk factors include, but are not limited to, the risk factors described in “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. 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.

PART I

Item 1. Business

As used in this report, the terms “Southern,” the “Company,” “we,” “our,” and “us” mean Southern Michigan Bancorp, Inc. and its subsidiaries, unless the context indicates another meaning. The terms "Southern Michigan Bank" and the "Bank" means Southern Michigan Bank & Trust.

General

Southern Michigan Bancorp, Inc. is a bank holding company registered under the Bank Holding Company Act of 1956. Southern was incorporated on March 1, 1982, as a Michigan corporation. Southern acquired all of the capital stock of Southern Michigan Bank & Trust, a Michigan state-chartered bank, in November 1982. Southern is also the parent company of Southern Michigan Bancorp Capital Trust I, a Delaware statutory trust. Southern Michigan Bank is the parent company of FNB Financial Services, Inc., a Michigan corporation.

Our business, which we conduct primarily through the Bank, is concentrated in a single industry segment—commercial banking. We offer a variety of deposit, payment, credit and other financial services to all types of customers. These services include time, savings, and demand deposits, safe deposit services, and automated teller machine services. Loans, including both commercial and consumer, are extended primarily on a secured basis to corporations, partnerships and individuals. Commercial lending covers such categories as business, industry, agricultural, construction, inventory and real estate. Consumer lending covers direct and indirect loans to purchasers of residential real property and consumer goods. We offer trust and investment services, which include investment management, trustee services, IRA rollovers and retirement plans, institutional and personal custody, estate settlement, wealth management, estate planning assistance, wealth transfer planning assistance, charitable gift planning assistance, and cash management custody. We operate 15 banking offices located in Battle Creek, Camden, Centreville, Coldwater, Constantine, Hillsdale, Marshall, Mendon, Tekonsha, Three Rivers, and Union City, Michigan.

On December 1, 2007, we completed the acquisition of FNB Financial Corporation (“FNB”) and its subsidiary bank, FNB Financial. On April 24, 2009, FNB Financial was consolidated with and into the Bank.

At December 31, 2011, on a consolidated basis, we had assets of $509.2 million, deposits of $420.5 million, a net loan portfolio of $327.4 million, trust assets under management totaling $213.6 million, and shareholders’ equity of $51.9 million. During 2011, 2010, and 2009, our interest income accounted for approximately 70%, 69% and 70%, respectively, of our operating revenues and our non-interest income accounted for 30%, 31% and 30%, respectively, of our operating revenues. Additional information about our consolidated financial condition as of December 31, 2011 and 2010 and the results of our operations for the three years ended December 31, 2011, may be found throughout this report, including in “Management's Discussion and Analysis of Financial Condition and Results of Operations” and in the consolidated financial statements and related notes, which information is here incorporated by reference.

We have no material foreign loans, assets or activities. No material part of our business is dependent on a single customer or very few customers, the loss of which would have a material adverse effect on us.

Our headquarters and administrative offices are located at 51 West Pearl Street, Coldwater, Michigan 49036, and our telephone number is (517) 279-5500. Our internet website address is www.smb-t.com. We make available free of charge through our website the periodic reports and amendments to those reports that we are required to file or furnish with the SEC as soon as reasonably practicable after filing or furnishing such reports with the SEC. The information on our website address is not incorporated by reference into this report, and the information on the website is not part of this report.

1

Competition

Our business is highly competitive. We face significant competition from commercial banks, saving and loan associations, credit unions, commercial and consumer finance companies, insurance companies and leasing companies. We also face competition from money market mutual funds, investment and brokerage firms and nonfinancial institutions, which provide many of the financial services we offer. Many of our non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and banks. Such non-bank competitors may, as a result, have certain advantages over us in providing some services. The principal methods of competition that we face are price (interest rates paid on deposits, interest rates charged on borrowings and fees charged for services) and service (convenience and quality of services rendered to customers).

Supervision and Regulation

We are extensively regulated and are subject to a comprehensive regulatory framework that imposes restrictions on our activities, minimum capital requirements, lending and deposit restrictions, dividend restrictions, and numerous other requirements. This system of regulation is primarily intended for the protection of depositors, federal deposit insurance funds and the banking system as a whole, rather than for the protection of shareholders and creditors of Southern. Many of these laws and regulations have undergone significant change in recent years and are likely to change in the future. Future legislative or regulatory changes, or changes in enforcement practices or court rulings, may have a significant and potentially adverse impact on our operations and financial condition. Our non-bank subsidiaries are also subject to various federal and state laws and regulations.

Recent Regulatory Developments

Dodd-Frank Act: The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act"), was signed into law by President Obama on July 21, 2010. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States, established the federal Bureau of Consumer Financial Protection ("BCFP"), and requires 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 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.

Deposit Insurance: The FDIC has finalized changes to its deposit insurance assessment base effective April 1, 2011, which uses average consolidated total assets less average tangible equity as the assessment base instead of quarterly deposits. Additional information about these changes may be found below under the heading “Southern Michigan Bank.”

On November 12, 2009, the FDIC adopted a final rule on assessment regulations to require depository institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012, on December 30, 2009. The projected assessment base for each quarter represented the September 30, 2009 assessment base increased quarterly by a 5 percent annual growth rate. This rule, and the Bank’s corresponding December 30, 2009 premium payment, resulted in a prepaid assessment for the Bank of $1.2 million and $1.6 million at December 31, 2011 and 2010, respectively.

As a result of provisions of the Dodd-Frank Act, all funds in a "noninterest-bearing transaction account" are insured in full by the FDIC from December 31, 2010, through December 31, 2012. This temporary unlimited coverage is in addition to, and separate from, the general FDIC deposit insurance coverage of up to $250,000 available to depositors. The increase in maximum deposit insurance coverage to $250,000 was made permanent under the Dodd-Frank Act.

2

Debit Card Interchange Fees and Routing: The Federal Reserve Board in June 2011 issued a rule to implement a provision in the Dodd-Frank Act that requires it to set debit-card interchange fees so they are “reasonable and proportional” to the cost of the transaction incurred by the card issuer. The rule could result in a significant reduction in banks’ debit-card interchange revenue. Though the rule technically does not apply to institutions with less than $10 billion, there is concern that the price controls will harm community banks, such as Southern Michigan Bank, which will be pressured by the marketplace to lower their own interchange rates.

Southern

Southern is subject to supervision and regulation by the Federal Reserve System. Our activities are generally limited to owning or controlling Southern Michigan Bank and engaging in such other activities as the Federal Reserve System may determine to be closely related to banking. Prior approval of the Federal Reserve System, and in some cases various other government agencies, is required for us to acquire control of any additional bank holding companies, banks or other operating subsidiaries. We are subject to periodic examination by the Federal Reserve System, and are required to file with the Federal Reserve System periodic reports of our operations and such additional information as the Federal Reserve System may require.

Under Federal Reserve System policy, we are expected to act as a source of financial strength to the Bank and to commit resources to support the Bank. In addition, if the Michigan Office of Financial and Insurance Regulation (“OFIR”) deems the Bank’s capital to be impaired, OFIR may require the Bank to restore its capital by a special assessment on us as the Bank’s only shareholder. If we failed to pay any assessment, our directors would be required, under Michigan law, to sell the shares of the Bank’s stock owned by us to the highest bidder at either a public or private auction and use the proceeds of the sale to restore the Bank’s capital.

Southern is a legal entity separate and distinct from the Bank. There are legal limitations on the extent to which the Bank may lend or otherwise supply funds to us, which indirectly limit our ability to pay dividends to our shareholders. Payment of dividends to us by the Bank, our principal source of funds, is subject to various state and federal regulatory limitations. Under the Michigan Banking Code of 1999, the Bank's ability to pay dividends to us is subject to the following restrictions:

• A bank may not declare or pay a dividend if a bank’s surplus would be less than 20% of its capital after payment of the dividend.

• A bank may not declare a dividend except out of net income then on hand after deducting its losses and bad debts.

• A bank may not declare or pay a dividend until cumulative dividends on preferred stock, if any, are paid in full.

• A bank may not pay a dividend from capital or surplus.

Federal law generally prohibits a bank from making any capital distribution (including payment of a dividend) or paying any management fee to its parent company if the depository institution would thereafter be undercapitalized. The FDIC may prevent an insured bank from paying dividends if the bank is in default of payment of any assessment due to the FDIC. In addition, the FDIC may prohibit the payment of dividends by a bank, if such payment is determined, by reason of the financial conditions of the bank, to be an unsafe and unsound banking practice.

3

In a policy statement, the Federal Reserve Board has expressed its view that a bank holding company should not pay cash dividends if its net income available to shareholders for the past four quarters, net of dividends paid during that period, is not sufficient to fully fund the dividends, its prospective rate of earnings retention is not consistent with capital needs and overall current and prospective financial condition, or it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve Board also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Additional information on restrictions on payment of dividends by us and the Bank may be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note Q of our consolidated financial statements, which information is here incorporated by reference.

The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other items, be denied approval to acquire or establish additional banks or non-bank businesses.

Southern Michigan Bank

Southern Michigan Bank is chartered under Michigan law and is subject to regulation by OFIR. Michigan banking laws place restrictions on various aspects of banking, including permitted activities, loan interest rates, branching, payment of dividends, and capital and surplus requirements.

The Bank’s deposits are insured by the FDIC to the extent provided by law. From time to time, the Bank is required to pay deposit insurance premiums to the Deposit Insurance Fund. The FDIC finalized changes to its deposit insurance assessment base effective April 1, 2011, which now uses average consolidated total assets less average tangible equity as the assessment base instead of quarterly deposits. Under this new calculation, most well-capitalized banks will pay 5 to 9 basis points annually, increasing to 35 basis points for banks that pose significant supervisory concerns. This base rate may be adjusted for the level of unsecured debt and brokered deposits, resulting in adjusted rates ranging from 2.5 to 9 basis points annually for most well-capitalized banks to 30 to 45 basis points for banks that pose significant supervisory concerns. As of December 31, 2011 the Bank’s annual assessment rate under these new guidelines was 7.9 basis points.

The FDIC Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, federal banking regulators have established five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, in which all institutions are placed. The FDIC has also specified by regulation the relevant capital levels for each of the categories.

The FDIC is required to take specified mandatory supervisory actions and is authorized to take other discretionary actions with respect to banks in the three undercapitalized categories. The severity of the action depends upon the capital category in which the bank is placed. Subject to a narrow exception, the FDIC must generally appoint a receiver or conservator for a bank that is critically undercapitalized. A bank in any of the undercapitalized categories is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. An undercapitalized bank is also generally prohibited from paying any dividends, increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval.

Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business. In addition, such a bank would generally not receive regulatory approval of any application that requires the consideration of capital adequacy, such as a branch or merger application, unless the bank could demonstrate a reasonable plan to meet the capital requirement within a reasonable period of time.

4

As of December 31, 2011, the capital ratios of the Bank exceeded the minimum thresholds to be categorized as “well-capitalized” under applicable regulations. Note V of our consolidated financial statements provides additional information regarding our capital ratios, and is here incorporated by reference.

The Bank is a member of the Federal Home Loan Bank system. This provides certain advantages, including favorable borrowing rates for certain funds.

During 2011, the Bank paid $36,000 in Financing Corporation (“FICO”) assessments related to outstanding FICO bonds to the FDIC as collection agent. The FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings and Loan Insurance Corporation. FICO assessments will continue in the future for the Bank.

Banks are subject to a number of federal and state laws and regulations, which have a material impact on their business. These include, among others, minimum capital requirements, state usury laws, state laws relating to fiduciaries, the Dodd-Frank Act, the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Real Estate Settlement Procedures Act, the USA PATRIOT Act, the FACT Act, the Gramm-Leach-Bliley Act, the Sarbanes-Oxley Act, the Bank Secrecy Act, electronic funds transfer laws, redlining laws, predatory lending laws, antitrust laws, environmental laws, money laundering laws and privacy laws. The instruments of monetary policy of authorities, such as the Federal Reserve System, may influence the growth and distribution of bank loans, investments and deposits, and may also affect interest rates on loans and deposits. These policies may have a significant effect on the operating results of banks.

Bank holding companies may acquire banks and other bank holding companies located in any state in the United States without regard to geographic restrictions or reciprocity requirements imposed by state banking law. Banks may also establish interstate branch networks through acquisitions of and mergers with other banks. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed only if specifically authorized by state law.

Michigan banking laws do not significantly restrict interstate banking. The Michigan Banking Code of 1999 permits, in appropriate circumstances and with the approval of OFIR, (1) acquisition of Michigan banks by FDIC-insured banks, savings banks or savings and loan associations located in other states, (2) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) consolidation of Michigan banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, (4) establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (5) establishment by foreign banks of branches located in Michigan. A Michigan bank holding company may acquire a non-Michigan bank and a non-Michigan bank holding company may acquire a Michigan bank.

Environmental Regulations

We hold title, on a temporary or permanent basis, to a number of parcels of real property. These include properties owned for branch offices and other business purposes and properties taken in or in lieu of foreclosure to satisfy loans in default. Under current federal laws, present and past owners of real property are exposed to liability for the cost of cleanup of contamination on or originating from those properties, even if they are wholly innocent of the actions that caused the contamination. These liabilities can be material and can exceed the value of the contaminated property. Although management is currently aware of no such environmental liabilities attributable to us or any of our properties, any such liabilities could have a material adverse effect on our capital expenditures, earnings, or competitive position.

5

Employees

As of December 31, 2011, Southern Michigan Bank employed 179 total employees equaling 171 full-time equivalent employees. Southern’s only employees as of the same date were its three executive officers (all of whom were also employed by Southern Michigan Bank).

Statistical Information

Additional statistical information describing our business appears in the following pages and in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in our consolidated financial statements and related notes contained in this report.

Securities Portfolio

The carrying value of securities categorized by type at December 31 was as follows:

(Dollars in thousands)	2011		2010		2009
U.S. government and Federal agencies	$	51,391	$	30,784	$	30,311
States and political subdivisions		33,445		25,370		25,839
Asset-backed securities		2,476		2,476		—
Mortgage-backed securities		3,032		598		798
Total	$	90,344	$	59,228	$	56,948

At the end of 2011 and 2010, the fair value of securities issued by the State of Michigan and all its political subdivisions totaled $26,314,000 and $19,903,000, respectively. No other securities held of any other single issuer were greater than 10% of shareholders' equity. At December 31, 2011, we had no investment in securities of issuers outside of the United States.

Presented below is the fair value of securities as of December 31, 2011 and 2010, a schedule of maturities of securities as of December 31, 2011, and the weighted average yields of securities as of December 31, 2011.

(Dollars in thousands)	Securities maturing within:
									Fair Value		Fair Value
	Less than		1 Year -		5 Years -		More than		at Dec. 31,		at Dec. 31,
	1 Year		5 Years		10 Years		10 Years		2011		2010
U.S. government and
Federal agencies	$	13,254	$	38,137	$	—	$	—	$	51,391	$	30,784
States and political subdivisions		3,345		12,312		13,742		4,046		33,445		25,370
Asset-backed securities		2,476		—		—		—		2,476		2,476
Mortgage-backed securities		—		29		129		2,874		3,032		598
Total securities	$	19,075	$	50,478	$	13,871	$	6,920	$	90,344	$	59,228

	Weighted average yields(1)
U.S. government and
Federal agency		0.63	%	0.78	%	—	%	—	%
States and political subdivisions		2.72		3.24		3.43		4.11
Asset-backed securities		2.63		—		—		—
Mortgage-backed securities		—		4.92		3.53		0.88

(1) Yields are not presented on a tax-equivalent basis. The weighted average yields are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount.

6

Loan Portfolio

Our combined loan portfolio, categorized by loan type (excluding loans held for sale) as of December 31 is presented below.

(Dollars in thousands)	2011		2010		2009		2008		2007
Commercial and agricultural	$	70,056	$	58,763	$	61,855	$	74,446	$	84,937
Real estate—commercial		150,829		136,371		148,806		131,180		129,065
Real estate—construction		12,479		11,135		10,522		10,446		11,686
Real estate—residential		91,273		93,102		100,007		104,321		94,560
Consumer		8,167		10,153		11,889		14,917		15,730
Total loans, gross	$	332,804	$	309,524	$	333,079	$	335,310	$	335,978

We have no foreign loans.

Maturities and Sensitivities of Loans to Changes in Interest Rates

The following schedule presents the maturities of loans (excluding residential real estate and consumer loans) as of December 31, 2011. All loans over one year in maturity (excluding residential real estate and consumer loans) are also presented classified according to the sensitivity to changes in interest rates as of December 31, 2011.

(Dollars in thousands)	Less than		1 Year -		More than
Loan Type	1 Year		5 Years		5 Years		Total
Commercial, agricultural, and real estate—commercial	$	77,057	$	134,044	$	9,784	$	220,885
Real estate—construction		8,508		3,312		659		12,479
Totals	$	85,565	$	137,356	$	10,443	$	233,364

	1 Year -		More than
Loan Sensitivity to Changes in Interest Rates	5 Years		5 Years		Total
Loans with fixed interest rates	$	136,441	$	10,443	$	146,884
Loans with floating or adjustable interest rates		915		—		915
Totals	$	137,356	$	10,443	$	147,799

Risk Elements

The objective of our credit risk strategy is to quantify and manage credit risk on an aggregate portfolio basis, and to limit the risk of loss resulting from an individual customer default. This strategy has not changed over the past five years and is based on three core principles: conservatism, diversification and monitoring. We believe that effective credit risk management begins with conservative lending practices. These practices include conservative underwriting, documentation, monitoring and collection standards. Our credit risk strategy also emphasizes diversification on an industry and customer level, regular credit examinations, and monthly management reviews of large credit exposures and credits experiencing deterioration of credit quality. Lending activities are centralized, with lending officers delegated specific authority amounts. We have annual independent reviews of the quality of our underwriting and documentation and the accuracy of risk grades.

Our credit review process and overall assessment of required allowances are based on ongoing quarterly assessments of the probable estimated losses inherent in our loan portfolio. We use these assessments in an effort to promptly identify potential problem loans within the portfolio, maintain an allowance for losses we believe to be adequate and take any necessary charge-offs. In addition to the individual review of larger commercial loans that exhibit probable or observed credit weaknesses, the commercial credit review includes the use of a risk grading system.

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Loan originations are developed from a number of sources, including continuing business with depositors, borrowers and real estate developers, advertisements, solicitations by lending staff, walk-in customers, director referrals, and loan participations purchased from other financial institutions.

Commercial and agricultural loans. We make loans for commercial purposes to sole proprietorships, partnerships, corporations and other business enterprises. We make agricultural loans for the purpose of financing agricultural production, including all costs associated with growing crops or raising livestock. Commercial and agricultural loans may be secured, other than by real estate, or unsecured, requiring one single payment or on an installment repayment schedule. Commercial and agricultural loans generally have final maturities of five years or less and are made with either fixed interest rates or rates that adjust based upon the national prime rate in effect at the time of the rate change.

Commercial and agricultural lending involves certain risks relating to changes in local and national economic conditions and the resulting effect on commercial or agricultural borrowers. Such loans are subject to greater risk of default during periods of adverse economic conditions. Because such loans may be secured by equipment, inventory, accounts receivable and other non-real estate assets, the collateral may not be sufficient to ensure full payment of the loan in the event of a default. To reduce such risk, we may obtain the personal guarantees of one or more of the principals of the borrowers.

Real estate – commercial loans. We make non-residential real estate loans secured by first mortgages and/or junior mortgages on non-residential real estate, including retail stores, office buildings, warehouses, apartment buildings, and other commercial properties. These loans typically have a higher degree of risk than residential lending. The increased risk is due primarily to the dependence of the borrower on the cash flow from the property or the business operated on the property to service the loan and larger individual loan amounts.

Real estate – residential loans. We make residential real estate loans secured by first mortgages on one-to four family residences, with a majority being single family residences. These loans are typically limited in relationship to the appraised value of the real estate and improvements at the time of origination of the loan.

Real estate – construction. Construction loans are made to finance land development before erecting new structures and to finance the construction of new buildings or additions to existing buildings. Many of the construction loans we make are to owner occupants for the construction of single family homes. Other loans we make are to builders and developers for various projects.

Consumer loans. We make a variety of consumer loans to individuals for family, household and other personal purposes. We make these loans for the purpose of financing the purchase of vehicles or furniture, educational expenses, medical expenses or vacation expenses, and other consumer purposes. Consumer loans may be secured, other than by real estate, or unsecured, generally requiring repayment on an installment repayment schedule.

The following were classified as non-accrual, past due and restructured loans as of December 31:

(Dollars in thousands)	2011		2010		2009		2008		2007
Loans accounted for on a non-accrual basis	$	5,703	$	5,293	$	7,585	$	8,715	$	4,405
Accruing loans which are contractually past due 90 days or more as to principal or interest payments		6		1		14		437		429
Restructured loans		3,540		3,297		702		—		—
Totals	$	9,249	$	8,591	$	8,301	$	9,152	$	4,834

8

A loan is placed on nonaccrual status at the point in time at which the collectability of principal or interest is considered in doubt, typically when payments are past due over 90 days, unless the loan is both well-secured and in the process of collection. The table below illustrates interest forgone and interest recorded on nonperforming loans for the years presented.

(Dollars in thousands)	2011		2010		2009		2008		2007
Interest on non-performing loans which would have been earned had the loans been in an accrual or performing status	$	342	$	354	$	463	$	598		$	278
Interest on non-performing loans that was actually recorded when received	$	234	$	228	$	38	$	34		$	21

Potential Problem Loans

At December 31, 2011, there were $37.7 million of loans not disclosed above pursuant to Item III.C.1. of Industry Guide 3 where known information about possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms. We have allocated $984,000 in the aggregate for specific loan losses for impaired loans as of December 31, 2011. However, our entire allowance for loan losses is available for potential problem loans.

Loan Concentrations

As of December 31, 2011, there was no concentration of loans exceeding 10% of total loans which are not otherwise disclosed as a category of loans pursuant to Item III.A. of Industry Guide 3.

Other Interest Bearing Assets

As of December 31, 2011, we had no interest bearing assets that would be required to be disclosed pursuant to Item III.C.1. or 2. of Industry Guide 3 if such assets were loans.

9

Summary of Loan Loss Experience

The following schedule presents a summary of activity in the allowance for loan losses for the periods shown and the percentage of net charge-offs during each period to average gross loans outstanding during the period.

(Dollars in thousands)	2011			2010			2009			2008			2007
Balance at January 1	$	5,694		$	6,075		$	7,104		$	5,156		$	3,302
Charge-offs:
Commercial and agricultural		63			278			1,350			1,943			81
Real estate – commercial		184			374			60			229			78
Real estate – construction		365			95			51			98			32
Real estate – residential		710			971			2,058			703			106
Consumer		239			313			407			370			228
Total charge-offs		1,561			2,031			3,926			3,343			525
Recoveries:
Commercial and agricultural		61			133			53			39			61
Real estate – commercial		2			6			2			10			10
Real estate – construction		43			—			—			55			—
Real estate – residential		12			108			4			9			—
Consumer		111			28			113			98			105
Total recoveries		229			275			172			211			176
Net charge-offs		1,332			1,756			3,754			3,132			349
Additions resulting from FNB acquisition		—			—			—			—			1,458
Additions charged to operations(1)		1,050			1,375			2,725			5,080			745
Balance at December 31	$	5,412		$	5,694		$	6,075		$	7,104		$	5,156
Ratio of net charge-offs during the period to average loans outstanding during the period		.43	%		.55	%		1.13	%		0.94	%		0.13	%

(1) The allowance for loan losses is maintained at a level which, in management’s judgment, is believed to be adequate to absorb probable incurred loan losses in the portfolio. In assessing the adequacy of the allowance, management reviews the characteristics of the loan portfolio in order to determine overall quality and risk profiles. Some factors management considers in determining the level at which the allowance is maintained include a continuing evaluation of those loans identified as being subject to possible problems in collection, results of examination by regulatory agencies, current economic conditions, historical loan loss experience, loan volume, portfolio mix, concentrations of credit and lending policies, procedures, and personnel.

During 2011 management added $1.1 million to the allowance, during 2010 management added $1.4 million to the allowance and during 2009 management added $2.7 million to the allowance. The provision reflects net charge off experience and the changes in the Michigan economy and the local real estate market, as well as other changes in the dynamics of the loan portfolio, including the level of non-accrual and potential problem loans.

10

The following schedule presents an allocation of the allowance for loan losses to the various loan categories as of December 31 of each year presented.

(Dollars in thousands)	2011		2010		2009		2008		2007
Commercial (including agricultural,
real estate and construction)	$	4,039	$	4,239	$	4,641	$	5,327	$	4,605
Real estate – residential (including first and junior lien holders)		1,305		1,368		1,162		1,614		396
Consumer		68		87		272		163		155
Total allowance	$	5,412	$	5,694	$	6,075	$	7,104	$	5,156

The Securities and Exchange Commission’s Industry Guide 3 provides for a break down of the allowance for loan losses into major loan categories. We allocate the allowance among the various categories through an analysis of the loan portfolio composition, prior loan loss experience, evaluation of those loans identified as being probable problems in collection, results of examination by regulatory agencies and current economic conditions. The entire allowance is available to absorb any losses without regard to the category or categories in which the charged off loans are classified.

The following schedule presents the stratification of the loan portfolio by category, based on the amount of loans outstanding as a percentage of total loans for the respective years ended December 31.

	2011			2010			2009			2008			2007
Commercial and agricultural		21.1	%		19.0	%		18.6	%		22.2	%		25.3	%
Real estate – commercial		45.3			44.0			44.6			39.1			38.4
Real estate – construction		3.7			3.6			3.2			3.1			3.5
Real estate – residential		27.4			30.1			30.0			31.1			28.1
Consumer		2.5			3.3			3.6			4.5			4.7
Total		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%

Deposits

The following schedule presents the average deposit balances by category and the average rates paid thereon for the respective years.

(Dollars in thousands)	2011				2010				2009
Noninterest-bearing demand	$	64,760			$	58,298			$	55,934
Interest-bearing demand		173,888	0.30	%		148,968	0.35	%		142,931	0.43	%
Savings		50,789	0.09	%		47,937	0.15	%		51,450	0.21	%
Certificates of deposit		127,675	2.02	%		136,369	2.34	%		135,781	2.91	%
Total	$	417,112			$	391,572			$	386,096

The following table illustrates the maturities of time deposits issued in denominations of $100,000 or more as of December 31, 2011.

(Dollars in thousands)
Maturing in less than 3 months	$	10,770
Maturing in 3 to 6 months		6,803
Maturing in 6 to 12 months		7,738
Maturing in more than 12 months		20,447
Total	$	45,758

We have no foreign deposits.

11

Return on Equity and Assets

The following schedule presents ratios for the years ended December 31:

	2011			2010			2009
Return on assets (net income divided by average total assets)		0.68	%		0.65	%		0.41	%
Return on equity (net income divided by average equity)		6.80	%		6.56	%		4.29	%
Dividend payout ratio (dividends declared per share divided by net income per share)		15.23	%		15.11	%		24.13	%
Equity to assets ratio (average equity divided by average total assets)		9.96	%		9.87	%		9.66	%

Short Term Borrowings

Securities sold under agreements to repurchase (repurchase agreements) are direct obligations and are secured by securities held in safekeeping at a correspondent bank. Repurchase agreements are offered primarily to certain large deposit customers as deposit equivalent investments. Information relating to securities sold under agreements to repurchase is as follows (in thousands):

	2011			2010			2009
At December 31:
Outstanding balance	$	18,074		$	15,027		$	14,799
Average interest rate		0.24	%		0.30	%		0.26	%
Daily average for the year:
Outstanding balance	$	16,162		$	16,714		$	14,789
Average interest rate		0.32	%		0.30	%		0.28	%
Maximum outstanding at any month end	$	18,074		$	18,847		$	14,799

Item 1A. Risk Factors

Risks Related to Southern’s Business

The economic conditions in the State of Michigan could have a material adverse effect on our results of operations and financial condition.

Our success depends primarily on the general economic conditions in the State of Michigan and the specific local markets in which we operate. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers primarily in southwest Michigan. The local economic conditions in this area have a significant impact on the demand for our products and services, as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities, financial, or credit markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our results of operations and financial condition.

12

Difficult market conditions have adversely affected the financial services industry.

The capital and credit markets have been experiencing unprecedented volatility and disruption for an extended period of time. Dramatic declines in the housing market, falling home prices, increased foreclosures and unemployment have negatively impacted the credit performance of mortgage loans and construction and development loans, and resulted in significant write-downs of asset values by financial institutions. These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions.

This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and commercial borrowers and lack of confidence in the financial markets has adversely affected our business, results of operations and financial condition. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience adverse effects, which may be material, on our ability to access capital and on our business, results of operations and financial condition.

Restrictions on the Bank’s ability to pay dividends subjects Southern Michigan Bancorp to liquidity risk.

Southern Michigan Bancorp’s principal source of funds to pay cash dividends and to fund its corporate obligations is the earnings of and dividends paid by the Bank. Southern Michigan Bancorp’s corporate obligations include its obligation to pay interest and principal when and as due under its bank credit agreement, which is secured by a pledge of all of the stock of the Bank, and its obligation to pay interest and principal when due under its junior subordinated debt securities. If the Bank is unable to pay cash dividends to Southern Michigan Bancorp in an amount sufficient to fund these obligations and Southern Michigan Bancorp is unable to access liquidity from other sources, it may be unable to pay dividends and satisfy its other financial obligations. As of December 31, 2011, the Bank could pay $6.7 million of dividends to Southern Michigan Bancorp without prior regulatory approval and Southern Michigan Bancorp had limited liquid assets. Additional information related to our liquidity position may be found in Notes Q and R to the consolidated financial statements.

If the condition of the Bank's loan portfolio worsens, its ability to borrow funds from the Federal Home Loan Bank and Federal Reserve Bank could be adversely affected, which could materially adversely affect the Bank's liquidity position.

As part of its liquidity management, the Bank borrows funds from the Federal Home Loan Bank and has the ability to borrow from the Federal Reserve Bank. Borrowed funds are collateralized by certain investment securities and qualifying residential and commercial real estate loans. The Bank is permitted to borrow an amount of funds up to a certain percentage of the total investment securities and loans pledged as collateral. The Federal Home Loan Bank and Federal Reserve Bank will not accept as collateral any loan that is rated as a 5 (special mention) or worse on our internal loan grading system. If the quality of the Bank's loan portfolio worsens, the Bank could have fewer loans eligible to be pledged as collateral for borrowed funds, reducing the total amount of available funds that the Bank is permitted to borrow. A reduction in the total amount of the available funds that the Bank is permitted to borrow from the Federal Home Loan Bank and Federal Reserve Bank could materially adversely affect the Bank's liquidity position.

13

We are subject to liquidity risk in our operations, which could adversely affect our ability to fund various obligations.

Liquidity risk is the possibility of being unable to meet obligations as they come due, pay deposits when withdrawn, capitalize on growth opportunities as they arise, or pay dividends because of an inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances. Liquidity is derived primarily from retail deposit growth and retention, principal and interest payments on loans and investment securities, net cash provided from operation and access to other funding sources. Liquidity is essential to our business. We must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market down turn or regulatory action that limits or eliminates our access to alternate funding sources. Our ability to borrow could also be impaired by factors that are nonspecific to us, such as severe disruption of the financial markets or negative expectations about the prospects for the financial services industry as a whole.

If Southern’s allowance for loan losses is not sufficient to cover actual loan losses, Southern’s earnings could decrease.

Southern’s loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. Southern may experience significant loan losses, which could have a material adverse effect on its operating results. Southern’s management makes various assumptions and judgments about the collectibility of Southern’s loan portfolio, including the creditworthiness of its borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of Southern’s loans. Southern maintains an allowance for loan losses to cover loan losses that may occur. In determining the size of the allowance, Southern relies on an analysis of its loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions, and other pertinent information.

If Southern’s assumptions are wrong, its current allowance may not be sufficient to cover loan losses, and adjustments may be necessary to allow for different economic conditions or adverse developments in Southern’s loan portfolio. Material increases to Southern’s allowance would materially decrease its net income and could materially decrease shareholders’ equity.

In certain situations, where collection efforts are unsuccessful or acceptable work-out arrangements cannot be reached, Southern may have to write off certain loans in whole or in part. In such situations, Southern may acquire real estate or other assets, if any, which secure the loans through foreclosure or other similar available remedies. In such cases, the amount owed under the defaulted loan often exceeds the value of the assets acquired.

In addition, federal and state regulators periodically review Southern’s allowance for loan losses and may require Southern to increase its provision for loan losses or recognize further loan charge-offs based on judgments different than those of Southern’s management. Any increase in Southern’s allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a material negative effect on Southern’s operating results and shareholders' equity.

Southern is subject to lending risk, which could materially adversely affect Southern’s results of operations and financial condition.

There are inherent risks associated with Southern’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where Southern operates. Increases in interest rates or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans, which could have a material adverse effect on the Southern’s results of operations and financial condition.

14

Southern’s loan portfolio includes a substantial percentage of commercial and industrial loans, which may be subject to greater risks than those related to residential loans.

Southern’s loan portfolio includes a substantial percentage of commercial and industrial loans. Commercial and industrial loans generally carry larger loan balances and involve a greater degree of financial and credit risks than home equity loans or residential mortgage loans. Any significant failure to pay on time by Southern’s customers would hurt Southern’s earnings. The increased financial and credit risk associated with these types of loans is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, the effects of general economic conditions on income-producing properties, and the increased difficulty of evaluating and monitoring these types of loans. The repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate or commercial project. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired. This cash flow shortage may result in the failure to make loan payments. In such cases, Southern may be compelled to modify the terms of the loan. In addition, the nature of these loans is such that they are generally less predictable and more difficult to evaluate and monitor. As a result, repayment of these loans may, to a greater extent than residential loans, be subject to adverse conditions in the real estate market or economy.

Prepayments of loans may negatively impact Southern’s business.

Generally, customers of Southern may prepay the principal amount of their outstanding loans at any time. The speed at which such prepayments occur, as well as the size of such prepayments, are within such customers’ discretion. If customers prepay the principal amount of their loans, and Southern is unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, Southern’s interest income will be reduced. A significant reduction in interest income could have a negative impact on Southern’s results of operations and financial condition.

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 and retain adjustable rate mortgage loans for our portfolio. 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, and would lower our capital ratios as a result of increasing assets and lowering income through expenses and any loss incurred.

15

Southern is subject to interest rate risk, which may negatively affect Southern’s earnings and the value of its assets.

Southern’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond Southern’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence the interest Southern receives on loans and securities and the amount of interest it pays on deposits and borrowings. Such changes could also affect Southern’s ability to originate loans and obtain deposits and the fair value of Southern’s financial assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, Southern’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

Environmental liability associated with commercial lending could result in losses.

In the course of its business, Southern may acquire, through foreclosure, properties securing loans it has originated or purchased that are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, Southern might be required to remove these substances from the affected properties at Southern’s sole cost and expense. The cost of this removal could substantially exceed the value of affected properties. Southern may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on Southern’s business, results of operations and financial condition.

Loss of Southern’s Chief Executive Officer or other executive officers could adversely affect its business.

Southern’s success is dependent upon the continued service and skills of its executive officers and senior management. If Southern loses the services of these key personnel, it could have a negative impact on Southern’s business because of their skills, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

Southern may need to raise additional capital in the future, but that capital might not be available on acceptable terms or at all when it is needed.

Southern is required by federal and state regulatory authorities to maintain adequate levels of capital to support its operations. Southern expects that it may need to raise additional capital to maintain its regulatory capital at desired levels or support its growth. Southern’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside Southern’s control, and on its financial performance. Southern cannot assure you of its ability to raise additional capital on terms acceptable to Southern or at all. If Southern cannot raise additional capital when needed, its ability to maintain assets at current levels or expand its operations through organic growth and acquisitions could be materially impaired.

The Dodd-Frank Act may adversely impact Southern’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, established the federal Bureau of Consumer Financial Protection (the “BCFP”), and requires 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 our business in the future. Compliance with these new laws and regulations will likely result in additional costs and further reduce our non-interest income sources, which could be significant and could adversely impact our results of operations, financial condition or liquidity.

16

Southern is subject to extensive regulation that could limit or restrict its activities.

Southern operates in a highly regulated industry and is subject to examination, supervision, and comprehensive regulation by various federal and state agencies. Southern’s compliance with these regulations is costly and restricts certain of its activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. Southern is also subject to capitalization guidelines established by its regulators, which require Southern to maintain adequate capital to support its growth.

The laws and regulations applicable to the banking industry could change at any time, and Southern cannot predict the effects of these changes on its business and profitability. Future regulatory changes or accounting pronouncements may increase our regulatory capital requirements or adversely affect our regulatory capital levels. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, Southern’s cost of compliance could adversely affect its ability to operate profitably.

Southern may be required to pay additional insurance premiums to the FDIC, which could negatively impact earnings.

Insured institution failures, as well as deterioration in banking and economic conditions, have significantly increased FDIC loss provisions, resulting in a decline in the designated reserve ratio to historical lows. The reserve ratio may continue to decline in the future. In addition, the limit on FDIC coverage has been permanently increased to $250,000. These developments have caused the premiums assessed to Southern by the FDIC to increase. Further, depending upon any future losses that the FDIC insurance fund may suffer, there can be no assurance that there will not be additional premium increases in order to replenish the fund. The FDIC may need to set a higher base rate schedule or impose special assessments due to future financial institution failures and updated failure and loss projections. In addition, a decline in the Bank's CAMEL ratings could subject Southern to increased FDIC insurance premiums. Higher FDIC assessment rates would have an adverse impact on Southern's results of operations.

Southern could be adversely affected by the soundness of other financial institutions, including defaults by larger financial institutions.

Southern’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of credit, trading, clearing, counterparty or other relationships between financial institutions. Southern has exposure to different counterparties, and Southern routinely executes transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by Southern or by other institutions. This is sometimes referred to as “systemic risk” and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which Southern interacts on a daily basis, and therefore could adversely affect Southern.

Many of these transactions expose Southern to credit risk in the event of default of counterparty. In addition, Southern’s credit risk may be exacerbated when the collateral held by Southern cannot be realized or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to Southern. There is no assurance that any such losses would not materially and adversely affect Southern’s business, results of operations or financial condition.

17

Competition from competing financial institutions and other financial service providers may adversely affect Southern’s profitability.

The banking business is highly competitive and Southern experiences competition in each of its markets from many other financial institutions. Southern competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, and national financial institutions that operate offices in Southern’s primary market areas and elsewhere. In addition, some of the institutions that Southern competes against are not subject to the same regulatory restrictions as Southern, and accordingly, may have certain, inherent, cost advantages.

Southern competes with these institutions both in attracting deposits and in making loans. Price competition for loans might result in Southern originating fewer loans, or earning less on its loans, and price competition for deposits might result in a decrease in Southern’s total deposits or higher rates on its deposits. In addition, Southern has to attract its customer base from other existing financial institutions and from new residents. Many of Southern’s competitors are larger financial institutions. While Southern believes it can and does successfully compete with these other financial institutions in its primary markets, Southern may face a competitive disadvantage as a result of its smaller size, lack of geographic diversification, and inability to spread its marketing costs across a broader market. Although Southern competes by concentrating its marketing efforts in its primary markets with local advertisements, personal contacts, and greater flexibility and responsiveness in working with local customers, Southern can give no assurance that this strategy will be successful.

Evaluation of investment securities for other-than-temporary impairment involves subjective determinations and could materially impact Southern's results of operations and financial condition.

The evaluation of impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition or future recovery prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. Estimating future cash flows involves incorporating information received from third-party sources and making internal assumptions and judgments regarding the future performance of the underlying collateral and assessing the probability that an adverse change in future cash flows has occurred. The determination of the amount of other-than-temporary impairments is based upon Southern's periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Southern's management considers a wide range of factors about the security issuer and uses its reasonable judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Impairments to the carrying value of our investment securities may need to be taken in the future, which could have a material adverse effect on our results of operations and financial condition.

If Southern is required to write down goodwill and other intangible assets, its financial condition and results of operations would be negatively affected.

A substantial portion of the value of the merger consideration paid in connection with the merger of FNB Financial Corporation was allocated to goodwill and other intangible assets on Southern’s consolidated balance sheet. The amount of the purchase price that is allocated to goodwill and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired. Southern is required to conduct an annual review to determine whether goodwill is impaired.

Goodwill is tested for impairment annually in the fourth quarter. An impairment test also could be triggered between annual testing dates if an event occurs or circumstances change that would more likely than not reduce the fair value below the carrying amount. Examples of those events or circumstances would include a significant adverse change in business climate; a significant unanticipated loss of customers or assets under management; an unanticipated loss of key personnel; a sustained period of poor investment performance; a significant loss of deposits or loans; a significant reduction in profitability; or a significant change in loan credit quality.

18

Southern cannot assure you that it will not be required to take an impairment charge in the future. Any material impairment charge would have a negative effect on Southern’s financial results and shareholders’ equity.

If Southern is required to take a valuation allowance with respect to its deferred tax assets, its financial condition and results of operations would be negatively affected.

Southern's net deferred tax asset was $1.24 million at December 31, 2011. A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. No valuation allowance was considered necessary at December 31, 2011. If Southern is required in the future to recognize a valuation allowance with respect to its deferred tax assets, its financial condition and results of operations would be negatively affected.

If Southern is required to take a valuation allowance with respect to its mortgage servicing rights, its financial condition and results of operations would be negatively affected.

Southern's mortgage servicing rights were $969,000 at December 31, 2011. No valuation allowance for capitalized mortgage servicing rights was considered necessary at December 31, 2011 or 2010 because the fair value of such rights approximated or exceeded the carrying value. If Southern is required in the future to take a valuation allowance with respect to its mortgage servicing rights, its financial condition and results of operations would be negatively affected.

We hold general obligation municipal bonds in our investment securities portfolio. If one or more issuers of these bonds were to become insolvent and default on its obligations under the bonds, it could have a negative effect on our financial condition and results of operations.

The carrying value of municipal bonds held by us totaled $33.4 million at December 31, 2011, and were issued by different municipalities. There can be no assurance that the financial conditions of these municipalities will not be materially and adversely affected by future economic conditions. If one or more of the issuers of these bonds were to become insolvent and default on their obligations under the bonds, it could have a negative effect on our financial condition and results of operations.

Southern depends upon the accuracy and completeness of information about customers.

In deciding whether to extend credit to customers, Southern may rely on information provided to it by its customers, including financial statements and other financial information. Southern may also rely on representations of customers as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Southern's financial condition and results of operations could be negatively impacted to the extent that Southern extends credit in reliance on financial statements or other information provided by customers that is false or misleading.

Southern may be a defendant in a variety of litigation and other actions, which may have a material adverse effect on Southern's financial condition and results of operations.

Southern and its subsidiaries may be involved from time to time in a variety of litigation arising out of their business. Southern Michigan Bank has a trust department, which may expose us to litigation or claims arising out of the Bank serving as trustee or acting in another fiduciary capacity. Southern's insurance may not cover all claims that may be asserted against it, and any claims asserted against it, regardless of merit or eventual outcome, may harm its reputation or cause it to incur unexpected expenses, which could be material in amount. Should the ultimate expenses, judgments or settlements in any litigation exceed Southern's insurance coverage, they could have a material adverse effect on Southern's financial condition and results of operations. In addition, Southern may not be able to obtain appropriate types or levels of insurance in the future, nor may it be able to obtain adequate replacement policies with acceptable terms, if at all. For additional information on legal matters, see Item 3 of this report.

19

Attractive acquisition opportunities may not be available to Southern in the future, which may negatively impact Southern’s ability to grow its business and effectively compete in existing and new markets.

Southern will continue to consider the acquisition of other businesses. However, Southern may not have the opportunity to make suitable acquisitions on favorable terms in the future. Southern expects that other banking and financial companies, many of which have significantly greater resources than Southern does, will compete with Southern to acquire compatible businesses. This competition could increase prices for acquisitions that Southern might likely pursue. Also, acquisitions of regulated businesses, such as banks, are subject to various regulatory approvals. Failure to maintain regulatory compliance with the various regulations applicable to Southern could make regulatory approvals difficult to obtain. If Southern fails to receive the appropriate regulatory approvals, Southern will not be able to consummate an acquisition that Southern believes is in its best interests.

Southern may face risks with respect to future expansion and acquisitions or mergers, which include substantial acquisition costs, an inability to effectively integrate an acquired business into Southern’s operations, lower than anticipated profit levels, and economic dilution to shareholders.

Southern may seek to acquire other financial institutions or parts of those institutions and may engage in de novo branch expansion in the future. Southern may also consider and enter into new lines of business or offer new products or services. Southern may incur substantial costs to expand. An expansion may not result in the levels of profits it seeks or levels of profits comparable to or better than Southern’s historical experience. Integration efforts for any future mergers or acquisitions may not be successful, which could have a material adverse effect on Southern’s operations and financial condition. Also, Southern may issue equity securities, including Southern common stock and securities convertible into shares of Southern common stock, in connection with future acquisitions, which could cause ownership and economic dilution to its current shareholders.

Changes in accounting standards could impact Southern’s reported earnings.

Current accounting and tax rules, standards, policies and interpretations influence the methods by which financial institutions conduct business and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time. Events that may not have a direct impact on Southern, such as bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board, the Securities Exchange Commission, the Public Company Accounting Oversight Board and various taxing authorities, responding by adopting and/or proposing substantive revision to laws, regulations, rules, standards, policies and interpretations. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Southern’s financial condition and results of operations may be adversely affected by a change in accounting standards.

Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of computer systems or otherwise, or failure or interruption of the Southern's communication or information systems, could severely harm Southern’s business.

As part of the its business, Southern collects, processes and retains sensitive and confidential client and customer information on behalf of Southern and other third parties. Despite the security measures Southern has in place for its facilities and systems, and the security measures of its third party service providers, Southern may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human errors or other similar events.

Southern relies heavily on communications and information systems to conduct its business. Any failure or interruption of these systems could result in failures or disruptions in Southern's customer relationship management, general ledger, deposit, loan and other systems. In addition, customers could lose access to their accounts and be unable to conduct financial transactions during a period of failure or interruption of these systems.

20

Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential customer information, whether by Southern or by its vendors, or failure or interruption of Southern’s communication or information systems, could severely damage Southern’s reputation, expose it to risks of regulatory scrutiny, litigation and liability, disrupt Southern’s operations, or result in a loss of customer business, the occurrence of any of which could have a material adverse effect on Southern’s business.

We continually encounter technological change, and we may have fewer resources than our competitors to continue to invest in technological improvements.

The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers.

Southern’s controls and procedures may fail or be circumvented.

Management regularly reviews and updates Southern's internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of Southern's controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on Southern's business, results of operations and financial condition.

Risks Associated with Southern Common Stock

There is not an active public trading market for Southern common stock.

Southern common stock is traded in the OTC Bulletin Board market. Transactions in the stock are relatively infrequent. Southern does not expect an active trading market for Southern common stock to develop in the near future. This limited market may affect a shareholder's ability to sell shares on short notice, and the sale of a large number of shares at one time could temporarily depress the market price of our common stock.

The market price of our common stock can be volatile, which may make it more difficult to resell our common stock at a desired time and price.

Stock price volatility may make it more difficult for a shareholder to resell our common stock when a shareholder wants to and at prices a shareholder finds attractive or at all. Our stock price can fluctuate significantly in response to a variety of factors, regardless of operating results. These factors include, among other things:

• Variations in our anticipated or actual operating results or the results of our competitors;

• Changes in investors' or analysts' perceptions of the risks and conditions of our business;

• The size of the public float of our common stock;

• Regulatory developments;

• Interest rate changes or credit loss trends;

• Trading volume in our common stock;

• Market conditions; and

• General economic conditions.

21

Our ability to pay dividends is limited and Southern may be unable to pay future dividends.

Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of the Bank to pay dividends to Southern Michigan Bancorp is limited by its obligations to maintain sufficient capital and by other general restrictions on dividends that are applicable to the Bank. If Southern or the Bank do not satisfy these regulatory requirements, Southern Michigan Bancorp would be unable to continue to pay dividends on its common stock. As of December 31, 2011, the Bank was able to pay $6.7 million in dividends to Southern Michigan Bancorp without prior regulatory approval. Additional information on restrictions on payment of dividends by us may be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note Q of our consolidated financial statements, which information is here incorporated by reference.

Southern may issue additional shares of its common stock in the future, which would dilute a shareholder’s ownership of Southern common stock if the shareholder did not, or was not permitted to, invest in the additional issuances.

Southern’s articles of incorporation authorize its board of directors, without shareholder approval, to, among other things, issue additional common stock. The issuance of any additional shares of Southern common stock could be substantially dilutive to a shareholder’s ownership of Southern common stock. To the extent that Southern issues convertible securities, stock appreciation rights, options or warrants to purchase Southern common stock in the future and those convertible securities, stock appreciation rights, options or warrants are exercised, Southern’s shareholders may experience further dilution. Holders of shares of Southern common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, Southern’s shareholders may not be permitted to invest in future issuances of Southern common stock.

Southern may issue debt and equity securities that are senior to Southern common stock as to distributions and in liquidation, which could negatively affect the value of Southern common stock.

In the future, Southern may attempt to increase its capital resources by entering into debt or debt-like financing that is unsecured or secured by all or up to all of Southern’s assets, or issuing debt or equity securities, which could include issuances of secured or unsecured commercial paper, medium-term notes, senior notes, subordinated notes, preferred stock or common stock. In the event of Southern’s liquidation, its lenders and holders of its debt securities would receive a distribution of Southern’s available assets before distributions to the holders of Southern common stock. Because Southern’s decision to incur debt and issue securities in future offerings will depend on market conditions and other factors beyond Southern’s control, Southern cannot predict or estimate the amount, timing or nature of its future offerings and debt financings. Further, market conditions could require Southern to accept less favorable terms for the issuance of its securities in the future. Thus, shareholders will bear the risk of Southern’s future offerings reducing the value of their shares of Southern common stock and diluting their interest in Southern.

Unless a shareholder obtains prior consent from Southern, the shareholder will not be permitted to transfer to another party the shareholder’s shares of Southern common stock if the party who would receive the shares would own of record fewer than 100 shares of Southern common stock.

Southern’s articles of incorporation provide that a shareholder may not transfer shares of Southern common stock without the consent of Southern, if, as a result of an attempted transfer, the party who would receive the shares would own fewer than 100 shares of Southern common stock. “Transfer” means any type of disposition, including a sale, gift, contribution, pledge, or other action that results in a change of record ownership of any share of Southern common stock. Southern may withhold its consent in its discretion. This restriction will limit the transferability of shares of Southern common stock and, unless a shareholder obtains Southern’s prior consent, the shareholder will be prohibited from transferring fewer than 100 shares of Southern common stock if the party who would receive the shares would own of record fewer than 100 shares of Southern common stock.

22

Our common stock is not insured by any governmental entity.

Our common stock is not a deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental entity. Investment in our common stock is subject to risk, including possible loss.

Anti-takeover provisions could negatively impact our shareholders.

Our articles of incorporation and the laws of Michigan include provisions which are designed to provide our board of directors with time to consider whether a hostile takeover offer is in the best interests of us and our shareholders. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control. The provisions also could diminish the opportunities for a holder of our common stock to participate in tender offers, including tender offers at a price above the then-current price for our common stock. These provisions could also prevent transactions in which our shareholders might otherwise receive a premium for their shares over then-current market prices, and may limit the ability of our shareholders to approve transactions that they may deem to be in their best interests.

If an entity holds as little as a 5% interest in our outstanding securities, that entity could, under certain circumstances, be subject to regulation as a “bank holding company.”

Any entity, including a “group” composed of natural persons, owning or controlling with the power to vote 25% or more of our outstanding securities, or 5% or more if the holder otherwise exercises a “controlling influence” over us, may be subject to regulation as a “bank holding company” in accordance with the Bank Holding Company Act of 1956, as amended (the “BHC Act”). In addition, any bank holding company or foreign bank with a U.S. presence may be required to obtain the approval of the Federal Reserve Board under the BHC Act to acquire or retain 5% or more of our outstanding securities. Becoming a bank holding company imposes statutory and regulatory restrictions and obligations, such as providing managerial and financial strength for its bank subsidiaries. Regulation as a bank holding company could require the holder to divest all or a portion of the holder's investment in our securities or those nonbanking investments that may be deemed impermissible or incompatible with bank holding company status, such as a material investment in a company unrelated to banking.

Any person not defined as a company by the BHC Act may be required to obtain the approval of the Federal Reserve Board under the Change in Bank Control Act of 1978, as amended, to acquire or retain 10% or more of our outstanding securities.

Any person not otherwise defined as a company by the BHC Act and its implementing regulations may be required to obtain the approval of the Federal Reserve Board under the Change in Bank Control Act of 1978, as amended, to acquire or retain 10% or more of our outstanding securities. Applying to obtain this approval could result in a person incurring substantial costs and time delays. There can be no assurance that regulatory approval will be obtained.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Our offices are as follows:

Southern’s and Southern Michigan Bank’s main office:

51 West Pearl Street, Coldwater, Michigan

Office is owned by Southern Michigan Bank and comprises 27,945 square feet.

Southern Michigan Bank’s branch office:

2 West Chicago Street, Coldwater, Michigan

Office is owned by Southern and comprises 16,848 square feet.

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Southern Michigan Bank’s branch office (drive-thru only):

441 East Chicago Street, Coldwater, Michigan

Office is owned by Southern Michigan Bank and comprises 990 square feet.

Southern Michigan Bank’s branch office:

10 East Carlson, Hillsdale, Michigan

Office is owned by Southern Michigan Bank and comprises 4,353 square feet.

Southern Michigan Bank’s branch office:

202 North Main, Tekonsha, Michigan

Office is owned by Southern Michigan Bank and comprises 2,928 square feet.

Southern Michigan Bank’s branch office:

5350 East Beckley Road, Battle Creek, Michigan

Office is owned by Southern and comprises 14,274 square feet.

Southern Michigan Bank’s branch office:

1110 West Michigan Avenue, Marshall, Michigan

Office is owned by Southern Michigan Bank and comprises 8,788 square feet.

Southern Michigan Bank’s branch office:

225 North Broadway, Union City, Michigan

Office is owned by Southern Michigan Bank and comprises 4,542 square feet.

Southern Michigan Bank’s branch office:

107 North Main Street, Camden, Michigan

Office is owned by Southern Michigan Bank and comprises 2,375 square feet.

Southern Michigan Bank’s branch office:

88 North Main Street, Three Rivers, Michigan

Office is owned by Southern Michigan Bank FNB Financial and comprises approximately 14,256 square feet.

Southern Michigan Bank’s branch office:

1200 North Main Street, Three Rivers, Michigan

Office is owned by Southern Michigan Bank and comprises approximately 3,321 square feet

Southern Michigan Bank’s branch office:

225 U.S. 131, Three Rivers, Michigan

Office is owned by Southern Michigan Bank and comprises approximately 900 square feet

Southern Michigan Bank’s branch office:

235 East Main Street, Centreville, Michigan

Office is owned by Southern Michigan Bank and comprises approximately 1,945 square feet

Southern Michigan Bank’s branch office:

345 North Washington Street, Constantine, Michigan

Office is owned by Southern Michigan Bank and comprises approximately 2,400 square feet

Southern Michigan Bank’s branch office:

136 North Nottawa Road, Mendon, Michigan

Office is owned by Southern Michigan Bank and comprises approximately 2,700 square feet

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Item 3. Legal Proceedings

As of December 31, 2011, there were no material pending legal proceedings to which Southern or any of its subsidiaries were a party or to which any of their properties were subject, other than ordinary routine litigation incidental to the business of Southern and its subsidiaries.

Item 4. Mine Safety Disclosures

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Southern common stock is quoted on the OTC Bulletin Board under the symbol “SOMC.OB.” Trading activity in our common stock is relatively infrequent. Our trading volume and recent share price information can be viewed under the symbol ‘SOMC.OB’ on certain financial websites.

The range of high and low bid prices for shares of Southern common stock for each quarterly period during the past two years is as follows:

Date	High		Low
2010
1st Quarter	$	11.00	$	9.60
2nd Quarter		12.25		10.50
3rd Quarter		12.40		11.30
4th Quarter		13.50		11.75
2011
1st Quarter	$	13.25	$	12.00
2nd Quarter		12.85		11.90
3rd Quarter		12.69		11.80
4th Quarter		12.55		11.05

The prices listed above are OTC Bulletin Board quotations. They reflect inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions.

As of March 9, 2012, there were 2,376,724 shares of Southern common stock issued and outstanding held by 410 holders of record.

The following table summarizes cash dividends declared per share of Southern common stock during 2011 and 2010:

Quarter	2010		2011
1st Quarter	$	0.05	$	0.05
2nd Quarter		0.05		0.05
3rd Quarter		0.05		0.05
4th Quarter		0.05		0.07

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Southern Michigan Bancorp’s principal source of funds to pay cash dividends is the earnings of and dividends paid by the Bank. The Bank is restricted in its ability to pay cash dividends under current laws and regulations. For additional information on restrictions on dividends, see Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note Q to the Southern consolidated financial statements, which information is here incorporated by reference. Limitations on the ability of the Bank to pay cash dividends to Southern Michigan Bancorp could limit its ability to pay dividends in the future.

Information regarding the equity compensation plans at December 31, 2011 is included in Item 12 of this report and is here incorporated by reference.

Item 6. Selected Financial Data

The following tables show summarized historical consolidated financial data for Southern. The tables are unaudited. The information in the tables is derived from Southern’s audited financial statements for 2007 through 2011. This information is only a summary. You should read it in conjunction with the consolidated financial statements, related notes, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and other information included in this report.

	Year Ended
	December 31,
	2011		2010		2009		2008		2007
	(unaudited) (in thousands, except per share amounts)
Southern Michigan Bancorp, Inc.
Income Statement Data:
Net interest income	$	15,927	$	16,245	$	16,538	$	17,740	$	14,906
Provision for loan losses		1,050		1,375		2,725		5,080		745
Net income		3,402		3,098		1,936		813		4,133
Balance Sheet Data (period end):
Assets		509,220		493,880		462,409		474,996		480,178
Deposits		420,511		409,901		380,905		394,043		399,169
Other borrowings		7,751		10,079		10,832		12,492		14,753
Subordinated debentures		5,155		5,155		5,155		5,155		5,155
Shareholders’ equity		51,865		47,843		45,734		44,416		44,219
Common Share Summary:
Diluted earnings per share		1.46		1.34		0.84		0.36		2.28
Dividends per share		0.22		0.20		0.20		0.80		0.80
Book value per share (1)		23.12		21.42		20.59		20.09		19.96
Weighted average diluted shares outstanding		2,333,825		2,315,275		2,291,901		2,281,044		1,813,306

(1) Calculated based on common shares outstanding at year end

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion provides a review of the consolidated financial condition and results of operations of Southern and its subsidiaries for the periods indicated. This discussion should be read in conjunction with the consolidated financial statements and related notes to the consolidated financial statements.

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Overview

Southern Michigan Bancorp, Inc. (Southern) is a Michigan corporation and a bank holding company registered under the Bank Holding Company Act of 1956. Southern wholly owns Southern Michigan Bank & Trust (the Bank) and Southern Michigan Bancorp Capital Trust I, a Delaware statutory trust. The Bank wholly owns FNB Financial Services, Inc., a Michigan corporation.

Our business, which we conduct primarily through the Bank, is concentrated in a single industry segment—commercial banking. We offer a variety of deposit, payment, credit and other financial services to all types of customers. These services include time, savings, and demand deposits, safe deposit services, and automated teller machine services. Loans, including both commercial and consumer, are extended primarily on a secured basis to corporations, partnerships and individuals. Commercial lending covers such categories as business, industry, agricultural, construction, inventory and real estate. Consumer lending covers direct and indirect loans to purchasers of residential real property and consumer goods. We offer trust and investment services, which include investment management, trustee services, IRA rollovers and retirement plans, institutional and personal custody, estate settlement, wealth management, estate planning assistance, wealth transfer planning assistance, charitable gift planning assistance, and cash management custody. We operate 15 banking offices located in Battle Creek, Camden, Centreville, Coldwater, Constantine, Hillsdale, Marshall, Mendon, Tekonsha, Three Rivers, and Union City, Michigan.

On December 1, 2007, we completed the acquisition of FNB Financial Corporation (“FNB”) and its subsidiary bank, FNB Financial. On April 24, 2009, FNB Financial was consolidated with and into the Bank.

At December 31, 2011, on a consolidated basis, we had assets of $509.2 million, deposits of $420.5 million, a net loan portfolio of $327.4 million, trust assets under management totaling $213.6 million, and shareholders’ equity of $51.9 million.

Results of Operations

Southern’s net income for 2011 was $3,402,000 compared to $3,098,000 in 2010, an increase of $304,000, or 9.81%. Provision for loan losses of $1,050,000 was expensed in 2011, down from $1,375,000 in 2010. Non-interest income decreased 5.70%, or $411,000, to $6,796,000 in 2011. Non-interest expense decreased 5.18%, or $946,000, to $17,312,000 in 2011. Following is a summary of percentage changes from prior year for various financial statement elements:

	Percent Change							Percent Change
	from Prior Year							from Prior Year
	2011			2010				2011			2010
Net interest income		-1.96	%		-1.77	%	Total assets		3.11	%		6.81	%
Provision for loan losses		-23.64	%		-49.54	%	Securities available for sale		52.54	%		4.00	%
Non-interest income		-5.70	%		0.49	%	Gross loans		7.52	%		-7.07	%
Non-interest expense		-5.18	%		-3.75	%	Allowance for loan losses		-4.95	%		-6.27	%
Net income		9.81	%		60.02	%	Deposits		2.59	%		7.61	%
							Other borrowings		-23.10	%		-6.95	%
							Shareholders’ equity		8.41	%		4.61	%

Results of operations can be measured by various ratio analyses. Two widely recognized performance indicators are return on average equity and return on average assets. Southern’s return on average equity was 6.80% in 2011, 6.56% in 2010 and 4.29% in 2009. The return on average assets was 0.68% in 2011, 0.65% in 2010 and 0.41% in 2009.

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Net Interest Income

Interest income is the total amount earned on funds invested in loans, investment securities and federal funds sold. Interest expense is the amount of interest paid on interest bearing checking and savings accounts, time deposits, short term advances, subordinated debentures and other long-term borrowings. Net interest income, on a fully taxable equivalent (FTE) basis, is the difference between interest income and interest expense adjusted for the tax benefit received on tax-exempt loan and investment securities. Net interest margin is calculated by dividing net interest income (FTE) by average interest earning assets. Net interest spread is the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities. Because non-interest bearing sources of funds also support earning assets, the net interest margin exceeds the net interest spread.

The presentation of net interest income on a FTE basis is not in accordance with 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 tax equivalent net interest income are itemized in Table 1 below.

Net interest income is the most important source of Southern’s earnings. Changes in Southern’s net interest income are influenced by a number of factors, including changes in the level of interest earning assets, changes in the mix of interest earning assets and interest bearing liabilities, the level and direction of interest rates and the steepness of the yield curve.

For 2011, Southern’s net interest margin (FTE) was 3.67% compared to 3.95% for 2010 and 4.14% for 2009. Southern’s interest rate spread and margin both further decreased as yields on earning assets decreased 0.51%, from 5.01% in 2010 to 4.50% in 2011, while Southern’s cost of funds for deposits and other borrowings decreased 0.24%, from 1.22% in 2010 to 0.98% in 2011.

In 2011, the lower interest margin was a result of reduced rates for all interest earning asset types, partially offset by reduced rates for deposits. The net effect was a decrease of $287,000 in net interest income (FTE) compared to 2010.

In 2010, the lower interest margin was a result of reduced rates for all interest earning asset types and reduced loan and investment volumes partially offset by reduced rates for deposits. The net effect was a decrease of $402,000 in net interest income (FTE) compared to 2009.

The following table presents a summary of net interest income (FTE) for 2011, 2010 and 2009.

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Table 1. Average Balances and Tax Equivalent Interest Rates

	2011								2010								2009
(Dollars in Thousands)	Average Balance			Interest		Yield/ Rate			Average Balance			Interest		Yield/ Rate			Average Balance			Interest		Yield/ Rate
ASSETS
Interest earning assets:
Loans(1)(2)(3)	$	311,117		$	17,973		5.78	%	$	322,349		$	19,251		5.97	%	$	333,397		$	19,966		5.99	%
Taxable investment securities(4)		56,260			631		1.12			33,765			604		1.79			38,329			1,134		2.96
Tax-exempt investment securities(1)		27,323			1,393		5.10			21,023			1,165		5.54			23,044			1,338		5.81
Federal funds sold and other(5)		53,103			172		0.32			45,459			155		0.34			18,487			69		0.37
Total interest earning assets		447,803			20,169		4.50			422,596			21,175		5.01			413,257			22,507		5.45
Non-interest earning assets:
Cash and due from banks		11,226								11,489								11,059
Other assets(6)		49,024								49,828								49,505
Less allowance for loan losses		(5,434	)							(5,757	)							(6,548	)
Total assets	$	502,619							$	478,156							$	467,273
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest bearing liabilities:
Demand deposits	$	173,888		$	519		0.30	%	$	148,968		$	518		0.35	%	$	142,931		$	612		0.43	%
Savings deposits		50,789			44		0.09			47,937			70		0.15			51,450			108		0.21
Time deposits		127,675			2,578		2.02			136,369			3,189		2.34			135,781			3,952		2.91
Securities sold under agreements to repurchase and overnight borrowings		16,171			52		0.32			16,714			50		0.30			14,899			41		0.28
Other borrowings		8,916			402		4.51			12,131			486		4.01			12,284			490		3.99
Subordinated debentures		5,155			156		3.03			5,155			157		3.05			5,155			197		3.82
Total interest bearing liabilities		382,594			3,751		0.98			367,274			4,470		1.22			362,500			5,400		1.49
Non-interest bearing liabilities:
Demand deposits		64,760								58,298								55,934
Other		3,866								4,197								2,852
Common stock subject to repurchase obligation		1,347								1,172								836
Shareholders’ equity		50,052								47,215								45,151
Total liabilities and shareholders’ equity	$	502,619							$	478,156							$	467,273
Net interest income				$	16,418							$	16,705							$	17,107
Interest rate spread							3.52	%							3.79	%							3.96	%
Net margin on interest earning assets							3.67	%							3.95	%							4.14	%

(1) Includes tax equivalent adjustment of interest (assuming a 34% tax rate) for securities and loans of $473,000 and $17,000, respectively for 2011; $396,000 and $64,000, respectively for 2010; and $455,000 and $114,000, respectively for 2009.

(2) Average balance includes average nonaccrual loan balances of $6,063,000 in 2011; $7,139,000 in 2010; and $8,135,000 in 2009.

(3) Interest income includes loan fees of $509,000 in 2011; $494,000 in 2010; and $365,000 in 2009.

(4) Average balance includes average unrealized gain of $737,000 in 2011; $618,000 in 2010; and $976,000 in 2009 on available for sale securities.

(5) Includes average federal reserve deposit account balances of $50,658,000 in 2011, $41,006,000 in 2010 and $15,771,000 in 2009.

(6) Includes $15,267,000 in 2011, $15,612,000 in 2010 and $15,967,000 in 2009 relating to goodwill and other intangible assets.

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The next table sets forth for the periods indicated a summary of changes in interest income and interest expense, based upon a tax equivalent basis, resulting from changes in volume and changes in rates:

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

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

Rate/Volume Variance – change in volume multiplied by the change in rate. This variance was allocated to volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each.

Table 2. Changes in Tax Equivalent Net Interest Income

	2011 Compared to 2010 Increase (Decrease) Due To									2010 Compared to 2009 Increase (Decrease) Due To
(Dollars in Thousands)	Rate			Volume			Net			Rate			Volume			Net
Interest income on:
Loans	$	(619	)	$	(659	)	$	(1,278	)	$	(55	)	$	(660	)	$	(715	)
Taxable investment securities		(279	)		306			27			(407	)		(123	)		(530	)
Tax-exempt investment securities		(99	)		327			228			(59	)		(114	)		(173	)
Federal funds sold and other		(8	)		25			17			(6	)		92			86
Total interest earning assets	$	(1,005	)	$	(1	)	$	(1,006	)	$	(527	)	$	(805	)	$	(1,332	)
Interest expense on:
Demand deposits	$	(79	)	$	80		$	1		$	(119	)	$	25		$	(94	)
Savings deposits		(30	)		4			(26	)		(31	)		(7	)		(38	)
Time deposits		(417	)		(194	)		(611	)		(780	)		17			(763	)
Securities sold under agreements to repurchase and overnight borrowings		4			(2	)		2			4			5			9
Other borrowings		56			(140	)		(84	)		2			(6	)		(4	)
Subordinated debentures		(1	)		—			(1	)		(40	)		—			(40	)
Total interest bearing liabilities	$	(467	)	$	(252	)	$	(719	)	$	(964	)	$	34		$	(930	)
Net interest income	$	(538	)	$	251		$	(287	)	$	437		$	(839	)	$	(402	)

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 to reflect changes in the factors above, as well as actual charge-off experience and any known losses. For further information, see “Allowance for Loan Losses” below.

The provision for loan losses was $1,050,000 in 2011, compared to $1,375,000 in 2010, and $2,725,000 in 2009. The lower provisions in 2011 and 2010 resulted primarily from a continued trend of lower net loan charge-offs. In 2011, net charge-offs totaled $1,332,000 compared to $1,756,000 in 2010 and $3,754,000 in 2009.

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Non-Interest Income

Non-interest income of $6,796,000 decreased $411,000, or 5.7%, in 2011 compared to 2010 and was relatively flat in 2010 at $7,207,000 compared to $7,172,000 in 2009. The 2011 decrease was primarily a result of a decline in service charges on deposit accounts which decreased $380,000, or 15.8%, in 2011 compared to 2010, and were down $334,000, or 12.2%, in 2010 compared to 2009. The Company made changes to its overdraft protection program in July of 2010 and in June of 2011 to comply with regulatory guidance that became effective in August of 2010 and July of 2011, respectively. These changes resulted in a lower volume on non-sufficient funds items which reduced income. Southern also recorded $156,000 gain from life insurance proceeds in 2010 which did not recur in 2011.

Trust fees of $1,120,000 in 2011 increased $123,000, or 12.3%, compared to 2010 and were relatively flat in 2010 at $997,000 compared to $987,000 in 2009. Changes to the trust department fee structure and new account relationships were the primary causes for the increase in 2011.

Net securities gains of $29,000, $207,000 and $682,000 were recognized in 2011, 2010 and 2009, respectively. In 2011, an unanticipated call of securities triggered the gain. During 2009, Southern sold $26.4 million of securities, which significantly reduced the level of mortgage-backed securities it held.

In order to reduce the risk associated with changing interest rates, Southern regularly sells fixed rate real estate mortgage loans in the secondary market. Southern recognizes a profit at the time of the sale. Southern originated real estate mortgage loans of $41,562,000 in 2011 compared to $57,470,000 in 2010 and $41,586,000 in 2009. Net gains on loan sales decreased $66,000 in 2011 compared to 2010. Net gains on loan sales increased $545,000 in 2010 compared to 2009, as a result of lower interest rates and an increase in mortgage lending staff. During 2010, Southern restructured its retail mortgage department to increase local market share.

Income and fees from automated teller machines (ATMs) and debit cards increased $118,000, or 13.2%, in 2011 compared to 2010 and $194,000, or 27.6%, in 2010 compared to 2009. Increases were primarily due to increased volumes of approved transactions.

Income from loan servicing increased $105,000, or 32.7%, in 2011 compared to 2010 and was flat at $321,000 in 2010 compared to 2009. Increased balances in loans sold in the secondary market in 2011 and 2010 resulted in higher loan servicing income.

Non-Interest Expense

Non-interest expense decreased $946,000, or 5.2%, in 2011 compared to 2010 and $712,000, or 3.8%, in 2010 compared to 2009.

Salaries and employee benefits expense decreased $161,000, or 1.6%, in 2011 compared to 2010 and increased $273,000, or 2.8%, in 2010 compared to 2009. At December 31, 2011, Southern had 171 full-time equivalent positions, compared to 196 at both December 31, 2010 and 2009. The reduction in salaries and benefits expense in 2011, as well as full-time equivalent positions, was a result of the closure of two branches in 2011 and one branch in December 2010, as well as a concentrated effort to right-size staffing levels bank wide.

Occupancy expense decreased $159,000, or 11.8%, in 2011 compared to 2010 and was flat at $1,353,000 in 2010 compared to $1,351,000 in 2009. The decrease in 2011 occupancy costs was primarily attributable to the aforementioned branch closures.

Equipment expense decreased $139,000, or 15.5%, in 2011 compared to 2010 and $21,000, or 2.3%, in 2010 compared to 2009. Depreciation expense decreased $106,000 in 2011 compared to 2010 and $59,000 in 2010 compared to 2009, as certain assets became fully depreciated.

Printing, postage and supplies expense decreased $96,000, or 16.2%, in 2011 compared to 2010 and $23,000, or 3.7%, in 2010 compared to 2009. The 2011 reduction was primarily a result of outsourcing the statement rendering and mailing processes to a third party vendor during 2011.

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Professional and outside services decreased $32,000, or 3.4%, in 2011 compared to 2010 and $413,000, or 30.5%, in 2010 compared to 2009. The 2010 decrease primarily resulted from Southern being able to reduce fees paid for outside consulting relating to system conversions.

FDIC deposit assessments decreased $163,000, or 25.5%, in 2011 compared to 2010 and $215,000, or 25.1%, in 2010 compared to 2009. The reduction in 2011 was due to a formula change used to calculate the FDIC assessments. The new formula was effective April 1, 2011. FDIC assessments in the second quarter of 2009 included a one-time special assessment.

Other real estate owned (OREO) expense of $147,000 and loss on sale or writedown of OREO of $118,000 in 2011 both represented decreases as compared to 2010. OREO expense of $195,000 and loss on sale or writedown of OREO of $215,000 in 2010 and $319,000 and $318,000, respectively, in 2009, also represented a decrease compared to the prior year period. There were fewer OREO properties held and sold throughout 2011 than in 2010. At December 31, 2011, Southern reported OREO of $1,530,000, compared to $1,247,000 at December 31, 2010, with 34% of total OREO at December 31, 2011 related to one commercial property.

Income Taxes

Income tax provision was $959,000 in 2011, $721,000 in 2010 and $79,000 in 2009. Tax-exempt income continues to have a major impact on Southern’s tax expense. The benefit offsetting lower coupon rates on municipal instruments is the nontaxable feature of the income earned on such instruments. This resulted in a lower effective tax rate and reduced federal income tax expense by $311,000 in 2011, $289,000 in 2010 and $351,000 in 2009. Additional income tax information is reported in Note L to the consolidated financial statements.

Financial Condition

Total assets at December 31, 2011 totaled $509,220,000, an increase of $15,340,000, or 3.1%, from total assets of $493,880,000 at December 31, 2010. Cash and cash equivalents decreased $36,648,000 and available for sale securities increased $31,116,000 compared to December 31, 2010. Gross loans increased $23,280,000 and deposits increased $10,610,000 compared to December 31, 2010.

Cash and Cash Equivalents

Cash and cash equivalents at December 31, 2011 decreased $36,648,000, or 46.5%, compared to balances at December 31, 2010. At December 31, 2011, Southern had balances of $29,625,000 with the Federal Reserve, compared to $65,031,000 at December 31, 2010. During 2008, the Federal Reserve began paying banks interest on balances maintained at the Federal Reserve. At December 31, 2011 and 2010, the interest rate paid by the Federal Reserve exceeded the overnight federal funds rate paid by Southern’s primary correspondent bank. Balances were moved from cash and cash equivalents into the loan and securities portfolios to improve margin. Loan demand increased during the last half of 2011.

Securities Available for Sale

The securities available for sale portfolio increased $31,116,000, or 52.5%, from December 31, 2010 to December 31, 2011. The portfolio is monitored and securities or federal funds are purchased as deemed prudent by the Asset Liability Management Committee (ALCO).

The securities available for sale portfolio had net unrealized gains of $1,368,000 at December 31, 2011 and $141,000 at December 31, 2010. Management has concluded that unrealized gains and losses within the investment portfolio are temporary because management believes they are a result of market changes, rather than a reflection of credit quality.

At December 31, 2011, Southern had no investment in securities of issuers outside of the United States.

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Loans

Substantially all loans are granted to customers located in Southern’s service area, which is primarily southwest Michigan. Gross loans increased $23,280,000, or 7.5%, in 2011. The increase in 2011 was a result of increased loan demand, primarily in the fourth quarter. Gross loans decreased $23,555,000, or 7.1%, in 2010. The decrease in 2010 resulted from net charge offs and payments received on loans exceeding new loan volume. During 2010, customer demand for new loans was weak. Customers appeared to be waiting for economic conditions to improve before expanding or starting new commercial ventures.

Loan commitments, consisting of unused credit card and home equity lines, available amounts on revolving lines of credit and other approved loans which have not been funded, were $77,147,000 and $60,778,000 at December 31, 2011 and 2010, respectively. A high percentage of these commitments are priced at a variable interest rate, thus minimizing Southern’s risk in a changing interest rate environment.

Nonperforming Assets

Nonperforming assets include nonaccrual loans, loans modified under troubled debt restructurings, accruing loans past due 90 days or more, and other real estate owned, which includes real estate acquired through foreclosures 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.

In the course of working with borrowers, Southern may choose to restructure the contractual terms of certain loans. Southern attempts to work-out an alternative payment schedule with the borrower in order to optimize collectability of the loan. Any loans that are modified are reviewed by Southern to identify if a troubled debt restructuring (“TDR”) has occurred, which is when, for economic or legal reasons related to a borrower’s financial difficulties, Southern grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two.

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

	December 31
	2011			2010			2009
	(Dollars in thousands)
Nonaccrual loans:
Commercial and commercial real estate	$	3,626		$	3,755		$	5,576
Real estate mortgage		2,048			1,451			1,933
Consumer		29			87			76
		5,703			5,293			7,585
Loans contractually past due 90 days or more and still on accrual:
Commercial and commercial real estate		6			1			14
Real estate mortgage		—			—			—
Consumer		—			—			—
		6			1			14
Accruing loans modified under troubled debt restructurings:
Commercial and commercial real estate		1,933			1,745			—
Real estate mortgage		1,607			1,552			702
Consumer		—			—			—
		3,540			3,297			702
Total nonperforming loans		9,249			8,591			8,301
Other real estate owned		1,530			1,247			1,187
Total nonperforming assets	$	10,779		$	9,838		$	9,488
Nonperforming loans to year-end loans		2.78	%		2.78	%		2.49	%
Nonperforming assets to total assets		2.12	%		1.99	%		2.05	%

The balance of nonaccrual restructured loans, which is included in nonaccrual loans, was $694,000 at December 31, 2011, $1,375,000 at December 31, 2010 and $1,493,000 at December 31, 2009.

Nonperforming loans are subject to continuous monitoring by management and estimated losses are specifically allocated for in the allowance for loan losses where appropriate. Nonperforming loans increased from December 31, 2010 to December 31, 2011 as a result of an increase in both nonaccrual loans and troubled debt restructurings. Nonaccrual loans decreased from December 31, 2009 to December 31, 2010, but non-performing loans increased due to an increase in loans modified under troubled debt restructurings. At December 31, 2011, 2010 and 2009, Southern had loans of $9,881,000, $10,766,000 and $11,135,000, respectively, which were considered impaired.

Other real estate owned of $1,530,000 at December 31, 2011, increased $283,000 from December 31, 2010. However, one commercial property was added in 2010 which accounted for 34.1% of the December 31, 2011 balance. During 2011 and 2010, loans of $892,000 and $1,545,000, respectively, were transferred to foreclosed assets. Elevated balances in other real estate continued to reflect the elevated foreclosure activity due to the poor economic conditions in Michigan.

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. This may result in a higher number of loans being classified as nonperforming.

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Allowance for Loan Losses

The allowance for loan losses is based on regular, quarterly assessments of the probable estimated incurred losses inherent in the loan portfolio. The allowance is maintained at a level, which in management’s judgment, is believed adequate to absorb probable incurred loan losses in the loan portfolio. While management uses the information available to make these estimates, future adjustments to the allowance may be necessary due to economic, operating or regulatory conditions beyond Southern’s control.

The allowance is based on two principles of accounting: Accounting Standards Codification (ASC) 450 - 10, Accounting for Contingencies and ASC 310-10, Accounting by Creditors for Impairment of a Loan. The methodology used relies on several key features, including historical loss experience, specific allowances for identified problem loans and a number of other factors recommended in regulatory guidance.

The historical loss component of the allowance is based on considering historical loss experience for each loan category. The component may be adjusted for significant factors that, in management’s judgment, will affect the collectability of the portfolio. The resulting loss estimate could materially differ from the losses actually incurred in the future.

Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific loan credit. As of December 31, 2011, specific reserves totaled $984,000 compared to $1,171,000 at December 31, 2010, a decrease of 16.0%.

The final components of the allowance are based on management’s evaluation of conditions that are not directly measured in the historical loss component or specific allowances. The evaluation of the inherent incurred loss with respect to these conditions is subject to a higher degree of uncertainty. The conditions evaluated in connection with these components of the allowance include current economic conditions, delinquency and charge off trends, loan volume, portfolio mix, concentrations of credit and lending policies, procedures and lending personnel.

The allowance for loan losses was $5,412,000, or 1.63% of loans, at December 31, 2011 compared to $5,694,000, or 1.84% of loans, at December 31, 2010.

The allowance for loan losses at December 31, 2011 consisted of $3,129,000 from the historical loss experience component and specifically allocated reserves, leaving $2,283,000 from the other factors. This compares to $3,238,000 from the historical loss experience component and specifically allocated reserves and $2,456,000 from the other factors at December 31, 2010.

At December 31, 2011, management was not aware of any problem loan that would have a material effect on loan delinquency or loan charge-offs. Loans are subject to continual review and are given management’s attention whenever a problem situation appears to be developing.

Deposits

Deposits have traditionally represented Southern’s principal source of funds. Total deposits increased 2.6%, or $10,610,000, in 2011 compared to 2010 and 7.6%, or $28,996,000, in 2010 compared to 2009. In 2011, deposits increased in all categories, except time deposits. The increase in 2010 was across all deposit types. The majority of deposits are derived from core client sources, relating to long term relationships with local individual, business and public clients. A small amount of brokered deposits, $5,429,000 at December 31, 2011, are maintained, but are not used to support growth. Attracting and keeping traditional deposit relationships will continue to be a focus of Southern.

Southern closed three branches during late 2010 and early 2011. Two of the locations are supported by other branch facilities in near proximity. One location, Cassopolis, was located outside of Southern’s primary market area. Deposit reductions from this location since December 31, 2010 totaled $5,919,000. In addition, Southern made the strategic decision based on current liquidity levels to reduce certificate of deposit rates and specials. As a result, certificate of deposit balances from non-core customers have declined in 2011.

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Subordinated Debentures

In March 2004, Southern Michigan Bancorp Capital Trust I, a trust formed by Southern, closed a pooled private offering of 5,000 trust preferred securities with a liquidation amount of $1,000 per security. Southern issued $5,155,000 of subordinated debentures to the trust in exchange for ownership of all of the common securities of the trust and the proceeds of the preferred securities sold by the trust. Southern is not considered the primary beneficiary of this trust, therefore the trust is not consolidated in Southern’s financial statements, but rather the subordinated debentures are shown as a liability. Southern may redeem the subordinated debentures subject to the receipt by Southern of the proper approval of the Federal Reserve, if such approval is required under applicable capital guidelines or policies of the Federal Reserve. The subordinated debentures may be redeemed on January 7, April 7, July 7 and October 7 of each year either in whole or in integrals of $1,000 at 100% of the principal amount, plus accrued and unpaid interest. The subordinated debentures mature on April 6, 2034. The subordinated debentures are also redeemable in whole but not in part, from time to time upon the occurrence of specific events defined within the trust indenture. Southern has the option to defer interest payments on the subordinated debentures from time to time for a period not to exceed 20 consecutive quarterly periods. Southern’s investment in the common stock of the trust is $155,000 and is included in other assets.

The $5,000,000 in trust preferred securities may be included in Tier I capital (with certain limitations applicable) under current regulatory guidelines and interpretations. The trust preferred securities and subordinated debentures have a variable rate of interest equal to the three month London Interbank Offered Rate (LIBOR) plus 2.75%. The rate at December 31, 2011 was 3.15%.

Capital Resources

Southern obtains funds for operating expenses and dividends to shareholders through dividends from the Bank. In general, the Bank pays only those amounts required to meet the liquidity requirements of Southern, while maintaining appropriate capital levels at the Bank. Capital is maintained at the Bank to support its current operations and projected future growth. See additional discussion under the section titled “Liquidity” below.

Shareholders’ equity increased $4,022,000, or 8.4%, from December 31, 2010 to December 31, 2011. It increased $2,109,000, or 4.6%, from December 31, 2009 to December 31, 2010. The increases for both 2011 and 2010 were primarily attributable to net income offset by dividends to shareholders. The 2011 increase also included $739,000 of accumulated other comprehensive income, primarily related to unrealized gains on available for sale securities, net of related income taxes.

The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other items, be denied approval to acquire or establish additional banks or non-bank businesses.

The FDIC Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, federal banking regulators have established five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, in which all institutions are placed. The FDIC has also specified by regulation the relevant capital levels for each of the categories.

The FDIC is required to take specified mandatory supervisory actions and is authorized to take other discretionary actions with respect to banks in the three undercapitalized categories. The severity of the action depends upon the capital category in which the bank is placed. Subject to a narrow exception, the FDIC must generally appoint a receiver or conservator for a bank that is critically undercapitalized. A bank in any of the undercapitalized categories is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. An under - capitalized bank is also generally prohibited from paying any dividends, increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval.

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Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business. In addition, such a bank would generally not receive regulatory approval of any application that requires the consideration of capital adequacy, such as a branch or merger application, unless the bank could demonstrate a reasonable plan to meet the capital requirement within a reasonable period of time.

Regulatory agencies have determined that the capital component created by the adoption of the requirements of ASC 320-10 should not be included in Tier 1 capital. As such, net unrealized gain or loss on available for sale securities is not included in the capital ratios listed in Note V to the consolidated financial statements, nor common stock subject to repurchase obligation in Southern’s employee stock ownership plan.

As of December 31, 2011, the capital ratios of the Bank exceeded the minimum thresholds to be categorized as “well-capitalized” under applicable regulations. Note V of our consolidated financial statements provides additional information regarding our capital ratios, and is here incorporated by reference.

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. Southern 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 ALCO, whose members are comprised of senior management.

Southern maintains correspondent accounts with regional and national banks for various purposes. Historically, cash sufficient to meet the operating needs of its branches is maintained at its lowest practical levels; however, the Company continues to maintain high levels of liquidity, with investment securities, federal funds and cash 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.

From time to time, Southern is a participant in the federal funds market. Federal funds are generally borrowed or sold for one-day periods. The average balance of federal funds sold was $269,000 in 2011 and $1,485,000 in 2010. During 2011 and 2010, Southern averaged $50,658,000 and $41,006,000, respectively, on deposit at the Federal Reserve.

In the past, Southern has used overnight federal funds lines of credit with correspondent banks as a short term source of liquidity. As of December 31, 2011, Southern had available a $3 million line of credit with a correspondent bank. As a result of the decrease in federal funds lines of credit availability, collateral has been pledged at the Federal Reserve Bank “Discount Window.” At December 31, 2011, $3 million of securities were pledged that could be used for future borrowings. In addition, Southern has $31.9 million of securities which are available to be pledged for future borrowings. Southern also has the ability to borrow $35.9 million from the Federal Home Loan Bank based on FHLB stock owned and collateral pledged.

Southern’s principal source of funds to pay cash dividends is the earnings and dividends paid by the Bank, which are restricted under current banking laws and regulations. Capital guidelines adopted by federal and state regulatory agencies and restrictions imposed by law limit the amount of cash dividends the Bank can pay to Southern. At December 31, 2011, using the most restrictive of these conditions, the aggregate cash dividends the Bank could pay Southern without prior regulatory approval was $6.7 million.

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Impact of Inflation and Changing Prices

The majority of assets and liabilities of a financial institution are monetary in nature and 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.

Commitments and Off-Balance Sheet Risk

Southern maintains off balance sheet financial instruments in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, letters of credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer at any time, as the customer’s needs vary, as long as there is no violation of any condition established in the contract. Letters of credit are used to facilitate customers’ trade transactions. Under standby letters of credit agreements, Southern agrees to honor certain commitments in the event that its customers are unable to do so. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At December 31, 2011, Southern had commitments of $77,147,000 for lines of credit, $1,690,000 in standby letters of credit and no commitments under commercial letters of credit outstanding.

These arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to Southern’s normal credit policies. Collateral generally consists of receivables, inventory and equipment and is obtained based on management’s credit assessment of the customer. These financial instruments are recorded when they are funded.

Interest Rate Sensitivity

Net interest income is the largest component of Southern’s earnings. Net interest income is the difference between the yield on interest earning assets and the cost of interest bearing liabilities. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and enhance consistent growth of net interest income through periods of changing interest rates.

Interest rate risk arises when the maturity or repricing characteristics of assets differ significantly from the maturity or repricing characteristics of liabilities. Accepting this risk can be an important source of profitability and shareholder value. However, excessive levels of interest rate risk could pose a significant threat to Southern’s earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to Southern’s safety and soundness.

A number of tools are used to monitor and manage interest rate risk, including income simulation and market value of equity analyses. The income simulation model is used to estimate the effect that specific interest rate changes would have on net interest income assuming 1-4% up and down ramped and shock changes to interest rates on both a static and dynamic balance sheet over a 24 month period. With the current Federal Reserve target rate at 0%—.25%, no further decrease in rates was modeled at December 31, 2011. Assumptions in the simulation are based on management’s estimates, and are inherently uncertain. As a result, the models cannot predict precisely the impact of higher or lower interest rates on net interest income. The income simulation results are shown in the table below:

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Ramp Change/Dynamic	% Change			Ramp Change/Static	% Change
+400		9.97	%	+400		9.69	%
+300		6.83	%	+300		6.59	%
+200		3.79	%	+200		3.66	%
+100		1.32	%	+100		1.26	%
-100		NA		-100		NA
-200		NA		-200		NA
-300		NA		-300		NA
-400		NA		-400		NA

Shock Change/Dynamic	% Change			Shock Change/Static	% Change
+400		23.55	%	+400		22.18	%
+300		17.15	%	+300		15.88	%
+200		9.93	%	+200		9.03	%
+100		3.12	%	+100		2.89	%
-100		NA		-100		NA
-200		NA		-200		NA
-300		NA		-300		NA
-400		NA		-400		NA

The market value of equity analysis estimates the change in the market value of equity using interest rate change scenarios from +4% to –4% in 1% increments. As with the income simulation analysis, no further rate reductions were assumed as of December 31, 2011. The following table illustrates the percent change in equity based on changes in market interest rates:

	change in market value of equity
4% increase in market rates	16.80%
3% increase in market rates	12.96%
2% increase in market rates	8.86%
1% increase in market rates	4.59%
No change	0.00%
1% decrease in market rates	NA%
2% decrease in market rates	NA%
3% decrease in market rates	NA%
4% decrease in market rates	NA%

The results of the simulations at December 31, 2011 are within the guidelines set and approved by Southern’s Board of Directors, with the exception of the +300 Shock Change/Dynamic and +300 Shock Change/ Static. The guideline limit for these simulations is 15% and both were slightly outside of this limit at December 31, 2011. Management continues to monitor this and report the results to the Board of Directors on a quarterly basis.

Critical Accounting Policies

The discussion and analysis of the financial condition and results of operations are based upon Southern’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires Southern to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

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Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially could result in materially different results under different assumptions and conditions.

Allowance for Loan Losses

The allowance for loan losses is maintained at a level management believes is adequate to absorb probable incurred credit losses inherent in Southern’s loan portfolio. Accounting for loan classifications, accrual status and determination of the allowance for loan losses is based on regulatory guidance. This guidance includes, but is not limited to, generally accepted accounting principles, the uniform retail credit classification and account management policy issued by the Federal Financial Institutions Examination Council, and the joint policy statement on the allowance for loan losses methodologies also issued by the Federal Financial Institutions Examination Council. Using this guidance, management estimates the allowance balance based on past loan loss experience, nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, information in regulatory examination reports, and other factors. Many of the factors listed are inherently subjective, and require the use of significant management estimates.

Fair Value Measurements

Southern uses fair value measurements to record certain financial instruments and to determine fair value disclosures. Available for sale securities are financial instruments recorded at fair value on a recurring basis. Additionally, Southern may be required to record at fair value other financial assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve write-downs of, or specific reserves against, individual assets. ASC 820-10-55, establishes a three level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used in the measurement are observable or unobservable. Observable inputs reflect market driven or market based information obtained from independent sources, while unobservable inputs reflect management estimates about market data.

The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market data. For financial instruments that trade actively and have quoted market prices or observable market data, there is minimal subjectivity involved in measuring fair value. When observable market prices and data are not fully available, management’s judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. When market data is not available, management uses valuation techniques that require more judgment to estimate the appropriate fair value measurement. Fair value is discussed further in Note A under the heading “Fair Values of Financial Instruments” and in Note U, “Fair Value Measurements”, of the notes to the consolidated financial statements.

Mortgage Servicing Rights

Mortgage servicing rights represent the allocated value of servicing loans that are sold with servicing retained by Southern. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Management’s accounting treatment of loan servicing rights is estimated utilizing a discounted cash flow model to determine the value of its servicing rights. The valuation model utilizes mortgage prepayment speeds, the remaining life of the mortgage pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from serving each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value for the right to service those loans.

Acquisition Intangibles

Generally accepted accounting principles require a determination of the fair value of all of the assets and liabilities of an acquired entity, and recording of their fair value on the date of acquisition. A variety of means are employed in determination of fair value, including the use of discounted cash flow analysis, market comparisons, and projected future revenue streams. Once valuations have been adjusted, the net difference between the price paid for the acquired company and the value of its balance sheet is recorded as goodwill. Goodwill is subject to an impairment analysis, performed at least annually. Southern has elected to perform its annual goodwill impairment test as of November 30 each year. Such test was performed by an independent third-party.

40

MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING

Management of Southern Michigan Bancorp, Inc. has prepared and is responsible for the accompanying consolidated financial statements and for their integrity and objectivity. In the opinion of management, the financial statements, which necessarily include amounts based on management’s estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America, on a consistent basis. Management also prepared the other information in the Annual Report and is responsible for its accuracy and consistency with the financial statements.

The 2011 consolidated financial statements have been audited by the independent accounting firm of CliftonLarsonAllen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. Management believes that all representations made to the independent auditors during their audit were valid and appropriate. CliftonLarsonAllen LLP’s auditor’s report is presented on the following page.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Southern is responsible for establishing and maintaining adequate internal control over financial reporting, as defined under Rule 15-d-15(f) of the Exchange Act. Southern’s internal control system is designed to provide reasonable assurance to Southern’s management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles, and includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of Southern; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of Southern are being made only in accordance with authorizations of management and directors of Southern; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Southern’s assets that could have a material effect on the financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal control may change over time.

Southern’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of internal control over financial reporting as of December 31, 2011. In making this assessment, management used the criteria for effective internal control over financial reporting set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control-Integrated Framework”. Based on this assessment, management believes that, as of December 31, 2011, Southern’s internal control over financial reporting was effective based on those criteria.

There were no changes in Southern’s internal control over financial reporting that occurred during the year ended December 31, 2011 that have materially affected, or that are reasonably likely to materially affect, Southern’s internal control over financial reporting.

/s/ John H. Castle	/s/ Danice L. Chartrand
John H. Castle	Danice L. Chartrand
Chairman and Chief Executive Officer	Chief Financial Officer
February 10, 2012

41

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 8. Financial Statements and Supplementary Data

SOUTHERN MICHIGAN BANCORP, INC.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Shareholders and Board of Directors

Southern Michigan Bancorp, Inc.

Coldwater, Michigan

We have audited the accompanying consolidated balance sheets of Southern Michigan Bancorp, Inc. and its subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2011. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southern Michigan Bancorp, Inc. and its subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

                                 

Toledo, Ohio

March 30, 2012

42

SOUTHERN MICHIGAN BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

	December 31,
	2011			2010
ASSETS
Cash	$	3,531		$	3,860
Due from banks		38,654			74,973
Cash and cash equivalents		42,185			78,833
Federal funds sold		287			275
Securities available for sale		90,344			59,228
Loans held for sale		1,088			2,637
Loans, net of allowance for loan losses of $5,412–2011 ($5,694–2010)		327,392			303,830
Premises and equipment, net		12,546			12,599
Accrued interest receivable		2,148			2,107
Net cash surrender value of life insurance		10,312			9,965
Goodwill		13,422			13,422
Other intangible assets, net		1,666			2,005
Other assets		7,830			8,979
Total Assets	$	509,220		$	493,880
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Non-interest bearing	$	61,930		$	59,942
Interest bearing		358,581			349,959
Total deposits		420,511			409,901
Securities sold under agreements to repurchase and overnight borrowings		18,074			15,027
Accrued expenses and other liabilities		4,568			4,476
Other borrowings		7,751			10,079
Subordinated debentures		5,155			5,155
Common stock subject to repurchase obligation in Employee Stock Ownership Plan, 115,170 shares outstanding in 2011 (107,627 shares in 2010)		1,296			1,399
Total Liabilities		457,355			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 – 2,358,599 shares in 2011 (2,340,717 shares in 2010)
Outstanding (other than ESOP shares) –2,243,429 shares in 2011 (2,233,090 shares in 2010)		5,609			5,583
Additional paid-in capital		18,278			18,033
Retained earnings		27,576			24,692
Accumulated other comprehensive income (loss), net		571			(168	)
Unearned Employee Stock Ownership Plan shares		(169	)		(297	)
Total Shareholders’ Equity		51,865			47,843
Total Liabilities and Shareholders’ Equity	$	509,220		$	493,880

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

43

SOUTHERN MICHIGAN BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

	Year ended December 31,
	2011		2010		2009
Interest income:
Loans, including fees	$	17,955	$	19,187	$	19,852
Securities:
Taxable		631		604		1,134
Tax-exempt		920		769		883
Other		172		155		69
Total interest income		19,678		20,715		21,938
Interest expense:
Deposits		3,141		3,777		4,671
Other		610		693		729
Total interest expense		3,751		4,470		5,400
Net Interest Income		15,927		16,245		16,538
Provision for loan losses		1,050		1,375		2,725
Net Interest Income after Provision for Loan Losses		14,877		14,870		13,813
Non-interest income:
Service charges on deposit accounts		2,032		2,412		2,746
Trust fees		1,120		997		987
Net securities gains		29		207		682
Net gains on loan sales		1,235		1,301		756
Earnings on life insurance assets		347		349		358
ATM and debit card fee income		1,015		897		703
Brokerage income		217		228		246
Gain on life insurance proceeds		—		156		—
Income from loan servicing		426		321		326
Other		375		339		368
Total non-interest income		6,796		7,207		7,172
Non-interest expense:
Salaries and employee benefits		9,914		10,075		9,802
Occupancy, net		1,194		1,353		1,351
Equipment		757		896		917
Printing, postage and supplies		496		592		615
Telecommunication		376		386		372
Professional and outside services		909		941		1,354
Software maintenance		435		410		415
Amortization of other intangibles		339		350		362
ATM expenses		371		333		521
FDIC deposit assessments		477		640		855
Other real estate owned expenses		147		195		319
Loss on sale or write down of other real estate owned		118		215		318
Other		1,779		1,872		1,769
Total non-interest expense		17,312		18,258		18,970
Income before income taxes		4,361		3,819		2,015
Income tax provision		959		721		79
Net Income	$	3,402	$	3,098	$	1,936
Basic Earnings Per Common Share	$	1.46	$	1.34	$	0.84
Diluted Earnings Per Common Share	$	1.46	$	1.34	$	0.84

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

44

SOUTHERN MICHIGAN BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands, except number of shares and per share data)

Years ended December 31, 2011, 2010 and 2009

	Common Stock			Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss), Net			Unearned ESOP  Shares			Total
Balance at January 1, 2009	$	5,528		$	18,473		$	20,593		$	413		$	(591	)	$	44,416
Comprehensive income:
Net income for 2009								1,936									1,936
Net change in other comprehensive income items											(220	)					(220	)
Total comprehensive income																	1,716
Cash dividends declared—$.20 per share								(467	)								(467	)
Issuance of restricted stock (12,230 shares of common stock at $7.40 per share)		30			(30	)											—
Vesting of restricted stock					47												47
Restricted stock forfeiture (560 shares)		(1	)		1												—
Change in common stock subject to repurchase		(4	)		(213	)											(217	)
Reduction of ESOP obligation														154			154
Stock option expense					85												85
Balance at December 31, 2009		5,553			18,363			22,062			193			(437	)		45,734
Comprehensive income:
Net income for 2010								3,098									3,098
Net change in other comprehensive income items											(361	)					(361	)
Total comprehensive income																	2,737
Cash dividends declared—$.20 per share								(468	)								(468	)
Issuance of restricted stock (18,325 shares of common stock at $10.10 per share)		46			(46	)											—
Vesting of restricted stock					79												79
Restricted stock forfeiture (1,018 shares)		(2	)		2												—
Change in common stock subject to repurchase		(14	)		(440	)											(454	)
Reduction of ESOP obligation														140			140
Stock option expense					75												75
Balance at December 31, 2010		5,583			18,033			24,692			(168	)		(297	)		47,843
Comprehensive income:
Net income for 2011								3,402									3,402
Net change in other comprehensive income items											739						739
Total comprehensive income																	4,141
Cash dividends declared—$.22 per share								(518	)								(518	)
Issuance of restricted stock (18,525 shares of common stock at $12.70 per share)		46			(46	)											—
Vesting of restricted stock					105												105
Restricted stock forfeiture (643 shares)		(2	)		2												—
Change in common stock subject to repurchase		(18	)		121												103
Reduction of ESOP obligation														128			128
Stock option expense					63												63
Balance at December 31, 2011	$	5,609		$	18,278		$	27,576		$	571		$	(169	)	$	51,865

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

45

SOUTHERN MICHIGAN BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Year ended December 31,
	2011			2010			2009
Operating Activities
Net income	$	3,402		$	3,098		$	1,936
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		1,050			1,375			2,725
Depreciation of premises and equipment		869			995			1,054
Deferred income taxes		150			175			506
Amortization of other intangible assets		339			350			362
Net amortization of investment securities		393			586			389
Stock option and restricted stock grant compensation expense		168			154			132
Net gains on security calls and sales		(29	)		(207	)		(682	)
Loans originated for sale		(41,562	)		(57,470	)		(41,586	)
Proceeds on loans sold		44,346			56,739			41,858
Net gains on loan sales		(1,235	)		(1,301	)		(756	)
Net loss from sale or write down of other real estate owned		118			215			318
Gain on life insurance proceeds		—			(156	)		—
Net loss on disposal of premises and equipment		7			29			9
Net change in obligation under ESOP		128			140			154
Net change in:
Accrued interest receivable		(41	)		(53	)		560
Cash surrender value		(347	)		(349	)		(358	)
Other assets		628			826			(1,762	)
Accrued expenses and other liabilities		44			383			145
Net cash from operating activities		8,428			5,529			5,004
Investing Activities
Activity in available for sale securities:
Proceeds on securities sold		—			7,445			26,366
Proceeds from maturities and calls		39,052			48,172			37,683
Purchases		(69,305	)		(58,770	)		(55,348	)
Net change in federal funds sold		(12	)		2,265			780
Proceeds from life insurance		—			421			—
Loan originations and payments, net		(25,504	)		20,254			(4,720	)
Proceeds from sale of other real estate owned and repossessed assets		481			1,239			2,456
Proceeds from sale of equipment		58			91			—
Proceeds from sale of FHLB stock		176			169			—
Additions to premises and equipment		(881	)		(800	)		(691	)
Net cash from investing activities		(55,935	)		20,486			6,526
Financing Activities
Net change in deposits		10,610			28,996			(13,138	)
Net change in securities sold under agreements to repurchase and overnight borrowings		3,047			228			909
Proceeds from other borrowings		—			5,000			8,000
Repayments of other borrowings		(2,328	)		(5,753	)		(9,663	)
Cash dividends paid		(470	)		(467	)		(813	)
Net cash from financing activities		10,859			28,004			(14,705	)
Net change in cash and cash equivalents		(36,648	)		54,019			(3,175	)
Beginning cash and cash equivalents		78,833			24,814			27,989
Ending cash and cash equivalents	$	42,185		$	78,833		$	24,814

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

46

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations and Industry Segments: Southern Michigan Bancorp, Inc. (the Company) is a Michigan corporation and registered bank holding company. The Company’s business is concentrated in a single operating segment: commercial banking. The Company’s wholly-owned subsidiary bank, Southern Michigan Bank & Trust (the Bank), offers individuals, businesses, institutions and government agencies a full range of commercial banking services primarily in the southwest Michigan communities in which the Bank is located and in areas immediately surrounding these communities. The Bank makes commercial and consumer loans to customers. The majority of loans are secured by business assets, commercial and residential real estate, and consumer assets. There are no foreign loans.

Principles of Consolidation: The consolidated financial statements include the accounts of the Company and the Bank after elimination of significant inter-company balances and transactions. The Bank owns FNB Financial Services, which conducts a brokerage business. 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 generally accepted accounting principles, the trust is not consolidated into the financial statements of the Company.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates that are more susceptible to change in the near term include the allowance for loan losses, deferred tax assets, fair values of securities and other financial instruments and pension and post retirement benefit obligations.

Securities: Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Company has the ability at the time of purchase to hold securities until maturity, they are classified as held to maturity and carried at amortized historical cost. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value, with unrealized gains and losses reported in other comprehensive income or loss, net of tax. Securities classified as available for sale include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates, prepayment risk, and other factors.

Premiums and discounts on securities are recognized in interest income using the level yield method over the estimated life of the security. Gains and losses on the sale of available for sale securities are determined using the specific identification method. Securities are written down to fair value and reflected as a loss when a decline in fair value is not temporary. In estimating other than temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the fact that the Company has the intention and the ability to hold the security to maturity.

Loans Held for Sale: Loans held for sale are reported at the lower of cost or market value in the aggregate. Net unrealized losses are recorded in a valuation allowance by charges to income.

Loans: Loans are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term.

Interest income is not reported when full loan repayment is in doubt, typically when payments are past due over 90 days, unless the loan is both well secured and in the process of collection. Past due status is based on the contractual terms of the loan. All interest accrued but not received for these loans is reversed against interest income. Payments received on such loans are reported as principal reductions until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest contractually due are brought current and future payments are reasonably assured.

47

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE A – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs net of recoveries. Estimating the risk of loss and the amount of loss on any loan is necessarily subjective. Management estimates the allowance balance based on past loan loss experience, nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, information in regulatory examination reports, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.

Loan impairment is reported when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature, such as residential mortgage and consumer loans, and on an individual loan basis for other loans. If a loan is determined to be impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s effective interest rate or at the fair value of collateral if repayment is expected solely from the collateral. Loans are evaluated for impairment when payments are delayed, typically 90 days or more, or when it is probable, in the judgment of management, that all principal and interest amounts will not be collected according to the original terms of the loan.

Consumer loans are typically charged-off no later than 120 days past due. Real estate mortgage loans in the process of collection are charged-off on or before they become 365 days past due. Commercial loans are charged-off promptly upon the determination that all or a portion of any loan balance is uncollectible. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.

Premises and Equipment: Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed principally using straight line or accelerated methods over their estimated useful lives. The estimated useful lives are 10 to 40 years for buildings and improvements and 3 to 10 for furniture and equipment. These assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. Maintenance, repairs and minor alterations are charged to current operations as expenditures occur. Major improvements are capitalized. Land is carried at cost.

Mortgage Servicing Rights: Mortgage servicing rights, included in other assets, represent the allocated value of mortgage servicing rights retained on loans sold. Mortgage servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues.

Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to interest rates and then, secondarily, as to geographic and prepayment characteristics. Any impairment of a grouping is reported as a valuation allowance.

Transfers of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

48

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE A – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Transfers of Financial Assets (continued): The transfer of a participating interest in a financial asset must have all of the following characteristics: (1) from the date of transfer, it must represent a proportionate ownership interest in the financial asset, (2) from the date of transfer, all cash flows received, except cash flows allocated as compensation for servicing or other services performed, must be divided proportionately among participating interest holders in the amount equal to their share ownership, (3) the rights of each participating interest holder must have the same priority, and (4) no party has the right to pledge or change the entire financial asset unless all participating interest holders agree to do so.

Company Owned Life Insurance: The Company has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at its net cash surrender value, or the amount that can be realized.

Goodwill and Other Intangible Assets: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value, which is determined through a two-step impairment test. Step 1 includes the determination of the carrying value of the single reporting unit, including the existing goodwill and intangible assets, and estimating the fair value of the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, a second step to the impairment test is required.

The Company’s most recent annual impairment analysis as of November 30, 2011, indicated that the Step 2 analysis was not required.

Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the Company’s balance sheet. Other intangible assets consist of core deposit intangible assets arising from past acquisitions. They are initially measured at fair value and then amortized on an accelerated method over their estimated useful lives, which is 10 years.

Other Real Estate Owned: Other real estate owned was $1,530,000 and $1,247,000 at December 31, 2011 and 2010, respectively, and is included in other assets. Other real estate owned is comprised of properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. These properties are initially recorded at fair value less estimated cost to sell at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and other real estate owned is carried at the lower of carrying amount or fair value less estimated cost to sell. Expenses, gains and losses on disposition, and reductions in carrying value are reported as non-interest expense.

Stock Compensation: The Company has adopted the requirements of “share-based payment transactions”, using the modified prospective transition method. Under this method, the Company recognizes compensation cost for equity-based compensation for all new or modified grants.

See Note N regarding the various assumptions used in computing the compensation expense.

Advertising Costs: Advertising costs are expensed as incurred.

49

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE A – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Benefits from tax positions taken or expected to be taken in a tax return are not recognized if the likelihood that the tax position would be sustained upon examination by a taxing authority is considered to be 50% or less. Any interest and penalties resulting from the filing of the income tax returns is included in the provision for income taxes.

Cash Flow Definition: For purposes of the consolidated statements of cash flows, the Company considers cash and due from banks as cash and cash equivalents. The Company reports net cash flows for customer loan and deposit transactions and short term borrowings with a maturity of 90 days or less.

Earnings and Dividends Per Common Share: Basic earnings per common share is based on 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 reflects the dilutive effect of any additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.

Comprehensive Income: Comprehensive income consists of net income and other comprehensive income or loss. Other comprehensive income or loss includes the net change in unrealized gains and losses on securities available for sale and the changes in the funded status of the pension plan, each net of tax, which are also recognized as a separate component of shareholders’ equity.

Employee Stock Ownership Plan (ESOP): The cost of shares issued to the ESOP but not yet allocated to participants is shown as a reduction to shareholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participants’ accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP shares reduce debt and accrued interest.

Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect such estimates.

Concentrations of Credit Risk: The Company grants commercial, real estate and installment loans to customers mainly in southwest Michigan. Commercial loans include loans collateralized by commercial real estate, business assets and agricultural loans collateralized by crops and farm equipment. Commercial, financial and agricultural loans make up approximately 71% of the loan portfolio at December 31, 2011 (67% at December 31, 2010) and such loans are expected to be repaid from cash flow from operations of businesses. Residential mortgage loans make up approximately 27% of the loan portfolio at December 31, 2011 (30% at December 31, 2010) and are collateralized by mortgages on residential real estate. Consumer loans make up approximately 2% of the loan portfolio at December 31, 2011 (3% at December 31, 2010) and are primarily collateralized by consumer assets.

Operating Segments: While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company wide basis. Operating segments are aggregated into one as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment: commercial banking.

50

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE A – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Financial Instruments with Off-Balance-Sheet Risk: Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and standby letters of credit issued to meet customer needs. The face amount for these items represents the exposure to loss before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Commitments may include interest rates determined prior to funding the loan (rate lock commitments). Rate lock commitments on loans intended to be sold are considered to be derivatives. Such commitments were not material at December 31, 2011 and 2010.

Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any such matters outstanding as of December 31, 2011 that will have a material future adverse effect on the consolidated financial statements.

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

Reclassifications: Certain items in the 2010 and 2009 consolidated financial statements have been reclassified to conform to the current year presentation.

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 an interim reporting period were effective for periods beginning on or after December 15, 2010, and are disclosed for the year ended December 31, 2011 in Note E.

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 for the period ended December 31, 2011 because the most recent Step 1 goodwill impairment test performed as of November 30, 2011 did not result in a negative carrying amount.

51

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE A – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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 was effective July 1, 2011, retrospectively to January 1, 2011, and did not have any impact on the Company’s financial condition or results of operations.

In April 2011, FASB issued ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreement, amending ASC topic 860 to improve accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity by removing, from the assessment of effective control, the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. Consequently, the amendments in ASU 2011-03 also eliminate the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. The other criteria applicable to the assessment of effective control are not changed by the amendments in ASU 2011-03. This guidance is effective for the first interim or annual period beginning on or after December 15, 2011, and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. The adoption of this standard is not expected to have an impact on the Company’s consolidated financial statements.

In May 2011, FASB issued ASU No. 2011-04 Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in ASU 2011-04 generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. ASU 2011-04 results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs. The amendments in ASU 2011-04 are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011 and early application is not permitted. The Company will adopt the methodologies prescribed by ASU 2011-04 by the date required, and does not anticipate the ASU will have a material effect on its financial position or results of operations.

In June 2011, FASB issued ASU No. 2011-05 Amendments to Topic 220, Comprehensive Income. Under the amendments in ASU 2011-05, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Either option requires the entity to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments in ASU 2011-05 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.

The amendments in ASU 2011-05 should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted and the amendments do not require any transition disclosures. The Company did not early adopt ASU 2011-05.

52

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE A – NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

In September 2011, FASB issued ASU 2011-08, Intangibles – Goodwill and Other (Topic 350) Testing Goodwill for Impairment. The amendments in ASU 2011-08 gives the entity the option of first assessing qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after the assessment, the entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. The amendments in ASU 2011-08 are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, however the Company did not early adopt ASU 2011-08.

NOTE B – BASIC AND DILUTED EARNINGS PER COMMON SHARE

A reconciliation of the numerators and denominators of basic and diluted earnings per common share for the years ended December 31, 2011, 2010 and 2009 is presented below:

	2011			2010			2009
Basic Earnings Per Common Share
Net income (in thousands)	$	3,402		$	3,098		$	1,936
Weighted average common shares outstanding		2,350,180			2,339,490			2,322,642
Less: Unallocated ESOP shares		(20,733	)		(27,851	)		(31,090	)
Weighted average common shares outstanding for basic earnings per common share		2,329,447			2,311,639			2,291,552
Basic earnings per common share	$	1.46		$	1.34		$	0.84
Diluted Earnings Per Common Share
Net income (in thousands)	$	3,402		$	3,098		$	1,936
Weighted average common shares outstanding for basic earnings per common share		2,329,447			2,311,639			2,291,552
Add: Dilutive effects of assumed exercises of stock options		4,378			3,636			349
Average shares and dilutive potential of common shares outstanding		2,333,825			2,315,275			2,291,901
Diluted earnings per common share	$	1.46		$	1.34		$	0.84

Stock options for 199,961, 196,394 and 214,822 shares of common stock were not considered in computing diluted earnings per share for 2011, 2010 and 2009, respectively, because they were anti-dilutive.

53

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE C -SECURITIES

Year end investment securities were as follows (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for Sale, December 31, 2011
Federal agencies	$	28,303	$	132	$	—		$	28,435
U.S. government sponsored entities and agencies		22,855		101		—			22,956
States and political subdivisions		32,324		1,124		(3	)		33,445
Asset-backed securities		2,487		—		(11	)		2,476
Mortgage-backed securities		3,007		25		—			3,032
Total	$	88,976	$	1,382	$	(14	)	$	90,344

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for Sale, December 31, 2010
Federal agencies	$	24,117	$	26	$	(37	)	$	24,106
U.S. government sponsored entities and agencies		6,685		3		(10	)		6,678
States and political subdivisions		25,225		372		(227	)		25,370
Asset-backed securities		2,487		—		(11	)		2,476
Mortgage-backed securities		573		25		—			598
Total	$	59,087	$	426	$	(285	)	$	59,228

Securities with unrealized losses at December 31, 2011 and 2010 that have not been recognized in income are as follows (in thousands):

2011	Continued Unrealized Loss for Less than 12 Months					Continued Unrealized Loss for 12 Months or More					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Description of Securities
States and political subdivisions	$	1,005	$	(3	)	$	—	$	—		$	1,005	$	(3	)
Mortgage-backed securities		—		—			2,487		(11	)		2,487		(11	)
Total temporarily impaired	$	1,005	$	(3	)	$	2,487	$	(11	)	$	3,492	$	(14	)

2010	Continued Unrealized Loss for Less than 12 Months					Continued Unrealized Loss for 12 Months or More					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Description of Securities
Federal agencies	$	13,335	$	(37	)	$	—	$	—		$	13,335	$	(37	)
U.S. government sponsored entities and agencies		2,997		(10	)		—		—			2,997		(10	)
States and political subdivisions		5,257		(218	)		883		(9	)		6,140		(227	)
Asset-backed securities		2,487		(11	)		—		—			2,487		(11	)
Total temporarily impaired	$	24,076	$	(276	)	$	883	$	(9	)	$	24,959	$	(285	)

Unrealized losses have not been recognized into income as management believes the issuers are of sound credit quality, management has no intent to sell the securities, the Company has the ability to hold to maturity and the decline in fair value is largely due to changes in market interest rates. The fair value is expected to recover as the notes and bonds approach their maturity date.

54

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE C – SECURITIES (CONTINUED)

The proceeds from sales of securities and the associated gains are listed below (in thousands):

	2011		2010		2009
Proceeds	$	—	$	7,445	$	26,366
Gross gains		—		206		678

The tax provision related to gross realized gains was $70,000 and $231,000 for 2010 and 2009, respectively.

Gains on calls of securities were $29,000, $1,000 and $4,000 for 2011, 2010 and 2009, respectively.

The amortized cost and fair value of the investment securities portfolio are shown by contractual maturity. Contractual maturities of debt securities at year-end 2011 were as follows (in thousands):

	Amortized Cost		Fair Value
Due in one year or less	$	16,504	$	16,599
Due from one to five years		49,879		50,449
Due from five to ten years		13,278		13,742
Due after ten years		3,821		4,046
Mortgage-backed securities		5,494		5,508
Total	$	88,976	$	90,344

Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Securities with a carrying value of $32,089,000 and $28,344,000, respectively, were pledged as collateral for repurchase accounts and for other purposes at year-end 2011 and 2010.

At December 31, 2011 and 2010, the fair value of securities issued by the State of Michigan and all its political subdivisions totaled $26,314,000 and $19,903,000, respectively. No other securities of any state (including all its political subdivisions) were greater than 10% of shareholders’ equity.

Investments in the Federal Home Loan Bank of Indianapolis stock totaled $1,701,000 and $1,877,000 at December 31, 2011 and 2010, respectively, and are included in other assets because such investments are considered restricted. Such investments are recorded at cost and evaluated for impairment.

At December 31, 2011, the Company had no investment in securities of issuers outside of the United States.

NOTE D – LOANS

Loans at year-end were as follows (in thousands):

	2011			2010
Commercial	$	70,056		$	58,763
Real estate—commercial		150,829			136,371
Real estate—construction		12,479			11,135
Consumer		8,167			10,153
Real estate mortgage		91,273			93,102
		332,804			309,524
Less allowance for loan losses		(5,412	)		(5,694	)
Loans, net	$	327,392		$	303,830

55

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE D – LOANS (CONTINUED)

Credit Risk Elements:

Construction loans are underwritten utilizing independent appraisals, sensitivity analysis of absorption, vacancy and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. Construction loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions and the availability of long-term financing. The Bank typically requires guarantees on these loans. The Bank’s construction loans are secured primarily by properties located in its primary market area.

The Bank originates 1 – 4 family real estate and consumer loans utilizing credit reports to supplement the underwriting process. The Bank’s manual underwriting standards for 1 – 4 family loans are generally in accordance with FHLMC and loan policy manual underwriting guidelines. Properties securing 1 – 4 family real estate loans are appraised by fee appraisers, which are independent of the loan origination function and have been approved by management. The loan-to-value ratios normally do not exceed 80% without credit enhancements such as mortgage insurance. The Bank will lend up to 100% of the lesser of the appraised value or purchase price for conventional 1 – 4 family real estate loans, provided private mortgage insurance is obtained. The underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of their ability to meet existing obligations and payments on the proposed loan. To monitor and manage loan risk, policies and procedures are developed and modified, as needed by management. This activity, coupled with smaller loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, market conditions are reviewed by management on a regular basis. The Bank’s 1 – 4 family real estate loans are secured primarily by properties located in its primary market area.

Commercial and agricultural real estate loans are subject to underwriting standards and processes similar to commercial and agricultural operating loans, in addition to those unique to real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial and agricultural real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Loan to value is generally 75% of the lower of the cost or value of the assets. Appraisals on properties securing these loans are generally performed by fee appraisers approved by the Commercial Loan Committee. Because payments on commercial and agricultural real estate loans are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. Management monitors and evaluates commercial and agricultural real estate loans based on collateral and risk rating criteria. The Bank typically requires guarantees on these loans. The Bank’s commercial and agricultural real estate loans are secured primarily by properties located in its primary market area.

Commercial and agricultural operating loans are underwritten based on the Bank’s examination of current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. This underwriting includes the evaluation of cash flows of the borrower, underlying collateral, if applicable, and the borrower’s ability to manage its business activities. The cash flows of borrowers and the collateral securing these loans may fluctuate in value after the initial evaluation. A first priority lien on the general assets of the business normally secures these types of loans. Loan to value limits vary and are dependent upon the nature and type of the underlying collateral and the financial strength of the borrower. Crop and hail insurance is required for most agricultural borrowers. Loans are generally guaranteed by the principal(s). The Bank’s commercial and agricultural operating lending is principally in its primary market area.

56

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE D – LOANS (CONTINUED)

The Bank has an internal credit analyst who reviews and validates credit risk on a periodic basis, as well as an internal loan review performed throughout the year. Results of the credit analyst are presented to management. Internal loan reviews are presented to management and the Audit Committee. The credit analysis and loan review processes complement and reinforce the risk identification and assessment decisions made by lenders and credit personnel, as well as the Bank’s policies and procedures.

At December 31, 2011 and 2010, certain directors and executive officers of the Company, including their associates and companies in which they are principal owners, were indebted to the Bank.

The following is a summary of loans (in thousands) exceeding $60,000 in the aggregate to these individuals and their associates. Other changes include adjustments for loans applicable to one reporting period that are excludable from the other reporting period.

	2011			2010
Balance at January 1	$	14,099		$	16,578
New loans, including renewals		11,230			7,805
Repayments		(11,659	)		(10,192	)
Other changes, net		(128	)		(92	)
Balance at December 31	$	13,542		$	14,099

The unpaid principal balance of mortgage loans serviced for others, which are not included on the consolidated balance sheet, was $168,025,000 and $151,125,000 at December 31, 2011 and 2010, respectively.

Activity for capitalized mortgage servicing rights, included in other assets, was as follows (in thousands):

	2011			2010			2009
Balance at January 1	$	868		$	753		$	708
Additions		412			371			269
Amortized to expense		(311	)		(256	)		(224	)
Balance at December 31	$	969		$	868		$	753

No valuation allowance for capitalized mortgage servicing rights was considered necessary at December 31, 2011, 2010 or 2009 because the estimated fair value of such rights exceeded the carrying value.

NOTE E – ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses for the years ended December 31 were as follows (in thousands):

	2011			2010			2009
Balance at January 1	$	5,694		$	6,075		$	7,104
Provision for loan losses		1,050			1,375			2,725
Loans charged off		(1,561	)		(2,031	)		(3,926	)
Recoveries		229			275			172
Net charge-offs		(1,332	)		(1,756	)		(3,754	)
Balance at December 31	$	5,412		$	5,694		$	6,075

In evaluating the allowance for loan losses, loans are analyzed based on the department originating the loan (commercial, mortgage or consumer), which in some instances may be different than how the loans are categorized for regulatory reporting purposes. Consequently, loan groupings in Note D may vary from the disclosures in Note E. Required disclosures about activity in the allowance for loan losses for reporting periods subsequent to December 15, 2010 are provided below for the year ended December 31, 2011.

57

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE E – ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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 year ended December 31, 2011 and as of December 31, 2010 (in thousands):

December 31, 2011	2011
	Commercial including Commercial Real Estate			Consumer			Real Estate Mortgage 1st Lien			Real Estate Mortgage Junior Lien			Total
Allowance for Loan Losses:
Balance at January 1	$	4,239		$	87		$	1,211		$	157		$	5,694
Provision for loan losses		498			14			433			105			1,050
Loans charged off		(875	)		(71	)		(498	)		(117	)		(1,561	)
Recoveries		177			38			9			5			229
Balance at December 31	$	4,039		$	68		$	1,155		$	150		$	5,412
Ending balance individually evaluated for impairment	$	744			—		$	240			—		$	984
Ending balance collectively evaluated for impairment		3,295			68			915			150			4,428
Total	$	4,039		$	68		$	1,155		$	150		$	5,412
Total Loans:
Ending balance individually evaluated for impairment	$	6,440		$	29		$	3,326		$	86		$	9,881
Ending balance collectively evaluated for impairment		237,263			7,800			64,927			12,933			322,923
Ending balance	$	243,703		$	7,829		$	68,253		$	13,019		$	332,804

Commercial loans also include demand deposit loan account charge-offs and recoveries amounting to $167,000 and $72,000, respectively, for the year ended December 31, 2011.

58

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE E – ALLOWANCE FOR LOAN LOSSES (CONTINUED)

December 31, 2010	2010
	Commercial including Commercial Real Estate		Consumer		Real Estate Mortgage 1st Lien		Real Estate Mortgage Junior Lien		Total
Allowance for Loan Losses:
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 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
Ending balance	$	216,401	$	9,849	$	69,437	$	13,837	$	309,524

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

December 31, 2011	Unpaid Principal Balance		Allowance for Loan Losses Allocated
With no related allowance recorded:
Commercial	$	135	$	—
Real estate—commercial		2,649		—
Real estate—construction		232		—
Consumer		29		—
Real estate mortgage		2,485		—
With an allowance recorded:
Commercial		744		26
Real estate—commercial		1,403		490
Real estate—construction		—		—
Consumer		—		—
Real estate mortgage		2,204		468
Total	$	9,881	$	984

59

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE E – ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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

Information regarding impaired loans at December 31 follows (in thousands):

	2011		2010		2009
Average balance of impaired loans during the year	$	10,530	$	11,719	$	11,754
Cash basis interest income recognized during the year	$	250	$	345	$	409
Interest income recognized during the year	$	285	$	396	$	367

The following table presents the aging of the recorded investment in past due and nonaccrual loans as of December 31, 2011 and December 31, 2010 by class of loans (in thousands):

December 31, 2011	Loans Past Due Accruing Interest
	30-59 Days		60-89 Days		Over 90 Days		Total		Loans on Non- Accrual		Loans Not Past Due or Non- Accrual		Total
Commercial	$	182	$	120	$	6	$	308	$	413	$	69,335	$	70,056
Real estate—commercial		538		144		—		682		2,982		147,165		150,829
Real estate—construction		—		—		—		—		231		12,248		12,479
Consumer		22		4		—		26		29		8,112		8,167
Real estate mortgage		1,476		780		—		2,256		2,048		86,969		91,273
Total	$	2,218	$	1,048	$	6	$	3,272	$	5,703	$	323,829	$	332,804

60

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE E – ALLOWANCE FOR LOAN LOSSES (CONTINUED)

December 31, 2010	Loans Past Due Accruing Interest
	30-59 Days		60-89 Days		Over 90 Days		Total		Loans on Non- Accrual		Loans Not Past Due or Non- Accrual		Total
Commercial	$	277	$	20	$	1	$	298	$	216	$	58,249	$	58,763
Real estate—commercial		184		—		—		184		2,295		133,892		136,371
Real estate—construction		—		—		—		—		583		10,552		11,135
Consumer		62		—		—		62		87		10,004		10,153
Real estate mortgage		737		28		—		765		2,112		90,225		93,102
Total	$	1,260	$	48	$	1	$	1,309	$	5,293	$	302,922	$	309,524

Modifications:

The Company’s loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (TDR), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

When the Company modifies a loan, management evaluates any possible concession based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole source of repayment for the loan is the liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs. If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs and deferred loan fees or costs), impairment is recognized through an allowance estimate or a charge-off to the allowance.

The following table summarizes the number and volume of TDRs the Company has recorded in its loan portfolio as of December 31, 2011 as well as the amount of specific reserves in the allowance for loan losses relating to TDRs (dollars in thousands):

December 31, 2011	Number of Loans		Amount		Specific Reserves Allocated
Commercial		5	$	733	$	23
Real estate—commercial		5		1,619		13
Real estate—construction		—		—		—
Real estate—mortgage		21		1,882		181
Consumer		—		—		—
Total		31	$	4,234	$	217

61

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE E – ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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

December 31, 2011	Pass		Special Mention		Substandard		Doubtful		Not Risk Rated		Total
Commercial	$	59,492	$	5,855	$	4,709	$	—	$	—	$	70,056
Real estate—commercial		128,405		14,681		7,437		—		306		150,829
Real estate—construction		5,547		2,542		520		—		3,870		12,479
Real estate—mortgage		7,399		3,177		2,743		—		77,954		91,273
Consumer		—		—		—		—		8,167		8,167
Total	$	200,843	$	26,255	$	15,409	$	—	$	90,297	$	332,804

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

62

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE F – PREMISES AND EQUIPMENT, NET

Premises and equipment, net at December 31 consisted of (in thousands):

	2011			2010
Land	$	2,362		$	2,366
Buildings and improvements		16,854			16,854
Furniture and equipment		10,255			9,991
		29,471			29,211
Less accumulated depreciation		(16,925	)		(16,612	)
Totals	$	12,546		$	12,599

Depreciation and amortization expense charged to operations was $869,000, $995,000 and $1,054,000 in 2011, 2010 and 2009, respectively.

Rent expense under operating leases amounted to $50,000, $42,000 and $57,000 in 2011, 2010 and 2009, respectively.

Lease commitments under noncancelable operating equipment leases at December 31, 2011 were as follows (in thousands):

2012	$	43
2013		35
2014		7
2015		7
2016		7
Thereafter		8
Total	$	107

NOTE G – INTANGIBLE ASSETS

Acquired core deposit intangible assets as of December 31 were (in thousands):

	2011			2010
Gross carrying amount	$	3,122		$	3,122
Accumulated amortization		(1,456	)		(1,117	)
Unamortized balance	$	1,666		$	2,005

Amortization of core deposit intangible assets for the years ended December 31, 2011, 2010 and 2009 was $339,000, $350,000 and $362,000, respectively.

Estimated amortization of core deposit intangible assets for each of the five years subsequent to December 31, 2011 is as follows (in thousands):

2012	$	325
2013		296
2014		284
2015		272
2016		260

NOTE H – DEPOSITS

The carrying amount of domestic deposits at year-end follows (in thousands):

	2011		2010
Non-interest bearing checking	$	61,930	$	59,942
Interest bearing checking		110,153		100,388
Savings		53,468		48,579
Money market accounts		74,996		62,845
Time deposits		119,964		138,147
Totals	$	420,511	$	409,901

63

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE H – DEPOSITS (CONTINUED)

The carrying amount of time deposits over $100,000 was $42,358,000 and $54,046,000 at December 31, 2011 and 2010, respectively. Interest expense on time deposits over $100,000 was $898,000, $979,000 and $1,336,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

At year-end 2011, scheduled maturities of time deposits were as follows for the years ending December 31 (in thousands):

2012	$	63,355
2013		23,437
2014		19,670
2015		10,295
2016		3,207
Total	$	119,964

Related party deposits were $24,522,000 and $11,412,000 at December 31, 2011 and 2010, respectively.

NOTE I – OTHER BORROWINGS

Other borrowings at December 31, 2011 and 2010 included $6,117,000 and $7,234,000, respectively, in advances from the Federal Home Loan Bank (FHLB) of Indianapolis. Advances outstanding at December 31, 2011 require payments through December 31, 2013 with fixed interest rates ranging from 2.12% to 4.57%, with a weighted average rate of 2.52%. Principal is due at maturity for $6,000,000 of the advances. The remaining $117,000 FHL Badvance at December 31, 2011 is at a fixed rate of 4.57% with decreasing annual principal payments.

All of the advances are secured by blanket collateral agreements with the FHLB, which gives the FHLB an unperfected security interest in certain one-to-four family mortgage, home equity, and commercial real estate loans. Eligible FHLB loan collateral at December 31, 2011 and 2010 was approximately $75,048,000 and $79,641,000, respectively.

On December 29, 2009 the Company entered into a Business Loan agreement with Great Lakes Bankers Bank (GLBB), consisting of a $3,000,000 term loan, subject to sub-participation of at least $2,100,000 with banks mutually acceptable to both parties, maturing in five years with a variable rate equal to the New York Prime, as published in the Wall Street Journal, with a floor of four and one-half (4.5%) percent. Repayment terms require monthly principal and interest payments amortized over five years. The loan requires compliance with various specified financial covenants and is secured by 100% of the stock of the Bank. At December 31, 2011 and 2010, $1,439,000 and $2,501,000, respectively, was outstanding under the loan.

Other borrowings also include a loan from a local community bank with a balance at December 31, 2011 and 2010 of $195,000 and $344,000, respectively. The loan matures on February 28, 2013 and is unsecured.

At December 31, 2011, scheduled principal reductions on other borrowings were as follows for the years ending December 31 (in thousands):

	FHLB		GLBB		Other		Total
2012	$	5,078	$	458	$	155	$	5,691
2013		1,039		479		40		1,558
2014		—		502		—		502
Total other borrowings	$	6,117	$	1,439	$	195	$	7,751

64

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE J – SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OVERNIGHT BORROWINGS

Securities sold under agreements to repurchase (repurchase agreements) are direct obligations and are secured by securities held in safekeeping at a correspondent bank. Repurchase agreements are offered primarily to certain large deposit customers as deposit equivalent investments. Information relating to securities sold under agreements to repurchase is as follows (in thousands):

	2011			2010
At December 31:
Outstanding balance	$	18,074		$	15,027
Average interest rate		0.24	%		0.30	%
Daily average for the year:
Outstanding balance	$	16,162		$	16,714
Average interest rate		0.32	%		0.30	%
Maximum outstanding at any month end	$	18,074		$	18,847

At December 31, 2011, the Bank had a $3,000,000 line of credit arrangement available to purchase federal funds, with no outstanding borrowings.

NOTE K – SUBORDINATED DEBENTURES AND TRUST PREFERRED SECURITIES

In March 2004, Southern Michigan Bancorp Capital Trust I, a trust formed by the Company, closed a pooled private offering of 5,000 trust preferred securities with a liquidation amount of $1,000 per security. The Company issued $5,155,000 of subordinated debentures to the trust in exchange for ownership of all of the common securities of the trust and the proceeds of the preferred securities sold by the trust. The Company is not considered the primary beneficiary of this trust, therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. The Company may redeem the subordinated debentures, subject to the receipt by the Company of the proper approval of the Federal Reserve, if such approval is required under applicable capital guidelines or policies of the Federal Reserve. The subordinated debentures may be redeemed on January 7, April 7, July 7 and October 7 of each year either in whole or in integrals of $1,000 at 100% of the principal amount, plus accrued and unpaid interest. The subordinated debentures mature on April 6, 2034. The subordinated debentures are also redeemable in whole, but not in part, from time to time upon the occurrence of specific events defined within the trust indenture. The Company has the option to defer interest payments on the subordinated debentures from time to time for a period not to exceed 20 consecutive quarters.

The $5,000,000 in trust preferred securities may be included in Tier I capital (with certain limitations applicable) under current regulatory guidelines and interpretations. The trust preferred securities and subordinated debentures have a variable rate of interest equal to the three month London Interbank Offered Rate (LIBOR) plus 2.75%. The rate at December 31, 2011 was 3.15%. Interest expense related to the subordinated debentures amounted to $156,000 in 2011, $157,000 in 2010, and $197,000 in 2009. The Company’s investment in the common stock of the trust is $155,000 and is included in other assets.

NOTE L – INCOME TAXES

Income tax provision (credit) consists of (in thousands):

	2011		2010		2009
Current	$	809	$	546	$	(427	)
Deferred		150		175		506
Totals	$	959	$	721	$	79

The deferred income tax provision consists of the tax effect of temporary differences, including a credit of $207,000 in 2010 and $23,000 in 2009 resulting from the utilization of net operating loss carryforwards.

65

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE L – INCOME TAXES (CONTINUED)

Income tax provision calculated at the statutory federal income tax rate of 34% differs from actual income tax provision as follows (in thousands):

	2011			2010			2009
Income tax at statutory rate	$	1,483		$	1,298		$	685
Tax-exempt interest income, net		(311	)		(289	)		(351	)
Earnings on life insurance assets, including gain from proceeds in 2010		(118	)		(172	)		(122	)
Low income housing partnership tax credits		(127	)		(127	)		(127	)
Write-off capital loss carryforward		—			60			—
Change in valuation allowance		—			(54	)		—
Other items, net		32			5			(6	)
Totals	$	959		$	721		$	79

Deferred tax assets and liabilities consist of the following at December 31 (in thousands):

	2011			2010
Deferred tax assets:
Allowance for loan losses	$	1,134		$	1,150
Deferred compensation and supplemental retirement liability		769			765
Intangible asset amortization		—			12
Pension liability		170			135
Nonaccrual loan interest		252			245
Tax credit carryforwards		655			796
Stock based compensation		175			146
Other		157			127
Total deferred tax assets		3,312			3,376
Deferred tax liabilities:
Mortgage servicing rights		(329	)		(295	)
Goodwill		(211	)		(191	)
Purchase accounting adjustments		(646	)		(761	)
Net unrealized gain on available for sale securities		(465	)		(48	)
Depreciation		(296	)		(51	)
Other		(124	)		(257	)
Total deferred tax liabilities		(2,071	)		(1,603	)
Net deferred tax assets, included in other assets	$	1,241		$	1,773

At December 31, 2011, the Company has available alternative minimum tax credit carryforwards of $522,000, which may be utilized in the future to the extent computed regular tax exceeds the alternative minimum tax. The Company also has low income housing credit carryforwards of $133,000 at December 31, 2011, which will begin to expire in 2029 if not utilized.

The Company and its subsidiaries file U.S. federal and certain state tax returns. In general, tax returns are no longer subject to tax examinations by tax authorities for years before 2008. The Internal Revenue Service recently completed an examination of the Company’s 2009 federal tax return. The Company expects to pay approximately $284,000 of additional tax which will generate deferred tax assets of a similar amount, resulting in substantially no additional tax provision.

The Company believes that it had no uncertain tax positions as of December 31, 2011 and 2010.

66

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE M – BENEFIT PLANS

Defined Benefit Pension Plan:

Effective December 31, 2009, The Southern Michigan Bank & Trust Pension Plan was fully frozen. Employees who had been grandfathered in when the plan was partially frozen in 2006 had their benefit frozen in 2009. The curtailment resulted in a $125,000 reduction in the projected benefit obligation during 2009. The curtailment gain was entirely used to offset the unrecognized net actuarial loss; and therefore, there was no impact of this gain on net income. The Company uses a December 31 measurement date for the plan.

Information about the pension plan is as follows (in thousands):

	2011			2010
Change in projected benefit obligation:
Beginning benefit obligation	$	(2,214	)	$	(2,272	)
Interest cost		(124	)		(130	)
Actuarial loss		(166	)		(35	)
Benefits paid		408			223
Ending benefit obligation		(2,096	)		(2,214	)
Change in plan assets, at fair value:
Beginning plan assets		1,744			1,937
Actual return		57			56
Employer contributions		82			—
Benefits paid		(408	)		(223	)
Plan expenses paid		(26	)		(26	)
Ending plan assets		1,449			1,744
Net amount recognized in other liabilities – funded status	$	(647	)	$	(470	)

The accumulated benefit obligation for the defined benefit pension plan was $2,096,000 and $2,214,000 at December 31, 2011 and 2010, respectively.

The components of pension expense and related actuarial assumptions were as follows (in thousands):

	2011			2010			2009
Components of net periodic benefit cost:
Service cost, including plan expenses	$	26		$	26		$	29
Interest cost		124			130			145
Expected return on plan assets		(105	)		(114	)		(147	)
Recognized net actuarial loss		17			3			39
Settlement adjustment		92			36			42
Net periodic benefit cost	$	154		$	81		$	108

At December 31, 2011 and 2010 net actuarial losses of $502,000 and $396,000, respectively, have not yet been recognized as a component of net periodic benefit cost. The estimated net loss that will be amortized from accumulated other comprehensive income into net periodic benefit cost for 2012 is $23,000.

67

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE M – BENEFIT PLANS (CONTINUED)

Weighted average assumptions for determining projected benefit obligation and net periodic benefit cost:

	2011			2010			2009
Discount rate on benefit obligation		5.0	%		5.5	%		6.0	%
Long-term expected rate of return on plan assets		7.0	%		7.0	%		7.0	%
Rate of compensation increase		N/A			N/A			N/A

	Target Allocation			Percentage of Plan Assets at Year-end						Weighted Average Expected Long-Term Rate of
Asset Category	2012			2011			2010			Return - 2011
Equity securities		0	%		0	%		0	%		0	%
Debt securities		0	%		0	%		0	%		0	%
Cash and time certificates		100	%		100	%		100	%		.20	%
		100	%		100	%		100	%		.20	%

The pension plan assets are managed by the Bank's Trust Department. A written investment policy which we believe meets the standards of the prudent investor rule is followed. In addition, the Northern Trust Company and Main Street Advisors, both of Chicago, have provided investment advisory services, guidance and expertise.

Investments or debt obligations of Southern Michigan Bancorp, Inc. are not allowed as holdings within the plan.

The plan’s investment objective at December 31, 2011 is primarily fixed income investments with a target of 90% time certificates and 10% cash. The allocation percentages may be reduced or increased depending upon market conditions and interest rates. Due to the plan being frozen, the investment allocations have been reevaluated with shorter term objectives.

The investments in the plan are managed for the benefit of the participants. They are structured to meet the cash flow necessary to pay retiring employees. ERISA guidelines for diversification of the investments are followed in all material respects.

Fair Value of Plan Assets: Fair value is the exchange price that would be received for an asset in the principal or most advantageous market for the asset in an orderly transaction between market participants on the measurement date.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Debt Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

68

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE M – BENEFIT PLANS (CONTINUED)

The fair value of the plan assets at December 31, 2011 amounted to $1,449,000 consisting of cash and time certificates with fair value measured using quoted prices in active markets (Level 1). There were no plan assets measured at fair value using significant unobservable inputs (Level 3) as of or for the years ended December 31, 2011 or 2010.

The Company expects to contribute $125,000 to its pension plan in 2012.

At December 31, 2011, estimated future benefit payments from the plan were as follows for the years ending December 31 (in thousands):

2012	$	59
2013		172
2014		140
2015		36
2016		160
2017 – 2021		1,359

Employee Stock Ownership Plan: The Company has an employee stock ownership plan (ESOP) for substantially all full-time employees. The Plan includes a 401(k) provision with the Company’s matching contribution provided in Company stock. The Board of Directors determines the Company’s contribution level annually. Assets of the plan are held in trust by the Bank and administrative costs of the plan are borne by the plan participants. Expense charged to operations for contributions to the plan totaled $253,000, $299,000 and $388,000 in 2011, 2010 and 2009, respectively.

Shares held by the ESOP at year-end are as follows:

	2011		2010
Allocated shares		115,170		107,627
Unallocated shares		15,402		24,021
Total ESOP shares		130,572		131,648

The fair value of the allocated shares held by the ESOP is $1,296,000 and $1,399,000 at December 31, 2011 and 2010, respectively. Upon distribution of shares to a participant, the participant has the right to require the Company to purchase shares at their fair value in accordance with terms and conditions of the plan. As such, these shares are not classified in shareholders’ equity as permanent equity. In 2008, the ESOP obtained a loan for $609,000 to purchase 28,500 shares. The balance of the loan at December 31, 2011 and 2010 was $170,000 and $297,000, respectively. In 2005, the ESOP obtained a loan for $204,000 to purchase 7,568 shares. The loan was repaid in 2010.

Deferred Compensation Plan: Directors and certain officers of the Bank may defer a portion of their director fees or compensation in a non-qualified deferred compensation plan. An account is established for each participant in the plan and credited with the participant’s annual deferred compensation plus interest based on the stated rate determined annually. Upon retirement, participants receive the balance in their account over 15 years. Participants also continue to earn interest during retirement based on their remaining account balance. Participants are immediately vested in their account balances. The plan is intended to be funded by certain bank-owned life insurance contracts. The interest rate paid on deferred compensation balances as of December 31, 2011 ranged from 5.38% to 12.98%. There were no new participants in the plan during 2011. Deferred compensation expense was $232,000, $245,000 and $237,000 in 2011, 2010 and 2009, respectively. The liability for deferred compensation benefits was $1,984,000 and $2,024,000 at December 31, 2011 and 2010, respectively, and is included in accrued expenses and other liabilities in the accompanying consolidated balance sheets.

69

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE M – BENEFIT PLANS (CONTINUED)

Supplemental Retirement Plans: The Bank also maintains a supplemental retirement plan (SERP) to provide annual payments to certain current and former executives subsequent to their retirement. Benefits under the SERP were frozen effective December 31, 2008. Expense associated with the SERP totaled $15,000, $28,000 and $12,000 in 2011, 2010 and 2009, respectively. Liabilities associated with the SERP totaled $207,000 and $226,000 at December 31, 2011 and 2010, respectively.

In December 2011, the Board of Directors approved the Defined Contribution Supplemental Executive Retirement Plan (2011 SERP), which is intended to provide select executive officers with a retirement benefit that is competitive with industry practices for bank executives when combined with the executive’s other employer-funded retirement benefits. In contrast to the frozen SERP, the 2011 SERP is a defined contribution arrangement, which gives the Bank the discretion to make a specific annual nonqualified deferred compensation contribution to the account of participating executives. Whether an annual deferred compensation contribution will be made to the account balance of a participating executive, as well as the amount of the contribution, is at the discretion of the Bank's Board of Directors. The contribution that will be made by the Bank to the account of each executive is determined based on a percentage of base salary. Participants are generally entitled to receive payment of the benefit in their account in 120 equal monthly installments commencing at age 65. The Company’s 2011 contribution, which was accrued at December 31, 2011, amounted to $70,000.

NOTE N – STOCK OPTIONS

The Company has stock based compensation plans as described below. Total compensation cost charged against income for those plans was $168,000, $154,000 and $132,000 in 2011, 2010 and 2009, respectively.

On June 6, 2005, shareholders of the Company approved the Stock Incentive Plan of 2005 to advance the interest of the Company and its shareholders by affording to directors, officers and other employees of the Company an opportunity for increased stock ownership. The plan permits the grant and award of stock options, stock appreciation rights, restricted stock and stock awards. A maximum of 300,000 shares of common stock are available under the plan. The plan will be terminated June 5, 2015 or earlier if determined by the Board of Directors. At December 31, 2011, 99,007 shares were available for issuance under the plan.

On April 17, 2000, the Company approved a Stock Option Plan to advance the interests of the Company and its shareholders by affording to directors, officers and other employees of the Company an opportunity to acquire or increase their proprietary interest in the Company using stock options. Option shares authorized under the plan totaled 115,500. Options were granted with an exercise period of 10 years or less, an exercise price of not less than the fair market value of the stock on the date the options were granted and a vesting period as determined by the Board of Directors. The plan terminated on March 20, 2010.

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 yield assumption is based on the Company’s history and expected dividend payouts.

	2011			2010			2009
Risk-free interest rate		0.33	%		0.96	%		3.58	%
Expected option life		8 years			8 years			8 years
Expected stock price volatility		23.40	%		23.64	%		22.39	%
Dividend yield		2.99	%		3.29	%		3.58	%
Weighted-average fair value of options granted during year	$	1.86		$	1.53		$	0.97

70

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE N – STOCK OPTIONS (CONTINUED)

A summary of the activity in the plans for 2011 follows:

Stock Options	Shares Subject to Options			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at beginning of year		218,977		$	21.29
Granted		8,075			12.70
Exercised		—			—
Forfeited		(6,026	)		18.23
Outstanding at end of year		221,026		$	21.06		4.8 years	$	60,000
Exercisable at year-end		141,276		$	20.85		4.1 years	$	52,000

	2011		2010		2009
Intrinsic value of options exercised		—		—		—
Cash received from option exercise		—		—		—
Tax benefit realized from option exercises		—		—		—

As of December 31, 2011, there was $29,000 of total unrecognized compensation cost related to nonvested stock options granted under the plans. The cost is expected to be recognized over a weighted average period of .4 years.

Restricted Stock – Restricted shares may be issued under the 2005 plan described above. Compensation expense is recognized over the vesting period of the shares based on the market value of the shares on the issue date. The total fair value of shares vested during the years ended December 31, 2011, 2010 and 2009 was $91,000, $39,000 and $29,000, respectively. As of December 31, 2011, there was $376,000 of total unrecognized compensation cost related to unvested shares granted under the plan. The cost is expected to be recognized over a weighted average period of 3.5 years.

A summary of activity in the restricted stock plan for 2011 follows:

	Shares			Weighted Average Grant Date Fair Value
Nonvested at January 1, 2011		30,593		$	10.46
Granted		18,525			12.70
Vested		(7,166	)		11.24
Forfeited		(643	)		10.17
Nonvested at December 31, 2011		41,309		$	11.33

71

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE O – COMMITMENTS

There are various commitments which arise in the normal course of business, such as commitments under commercial letters of credit, standby letters of credit and commitments to extend credit. These arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Bank’s normal credit policies. Collateral generally consists of receivables, inventory and equipment and is obtained based on management’s credit assessment of the customer.

At December 31, 2011 and 2010, the Company had no commitments under commercial letters of credit used to facilitate customers’ trade transactions.

Under standby letter of credit agreements, the Company agrees to honor certain commitments in the event that its customers are unable to do so. At December 31, 2011 and 2010, commitments under outstanding standby letters of credit were $1,690,000 and $1,720,000, respectively.

Loan commitments outstanding to extend credit are detailed below (in thousands):

	2011		2010
Fixed rate	$	3,475	$	4,333
Variable rate		73,672		56,445
Totals	$	77,147	$	60,778

The fixed rate commitments have stated interest rates ranging from 4.50% to 14.00%. The terms of the above commitments range from 1 to 121 months.

Management does not anticipate any losses as a result of the above related transactions; however, the above amount represents the maximum exposure to credit loss for loan commitments and commercial and standby letters of credit.

Certain executives of the Bank have employment contracts which have change of control clauses. The employment contracts provide for the payment of 2.99 times the officer's base salary and bonus if the officer is terminated in the event of a change of control.

NOTE P – ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive income (loss) amounted to $571,000 at December 31, 2011 and $(168,000) at December 31, 2010 and is summarized as follows (in thousands):

	2011			2010
Unrealized gain on available-for-sale securities, net of income taxes of $465 in 2011 and $48 in 2010	$	903		$	93
Pension liability, net of income taxes of $170 in 2011 and $135 in 2010		(332	)		(261	)
Total	$	571		$	(168	)

The changes in the components of accumulated comprehensive income (loss), and related tax effects for the years ended December 31, 2011, 2010 and 2009 are as follows (in thousands):

	2011			2010			2009
Unrealized gain (loss) on available for sale securities	$	1,256		$	(287	)	$	320
Reclassification adjustments for net realized gains included in net income		(29	)		(207	)		(682	)
Accrued pension liability		(106	)		(53	)		29
		1,121			(547	)		(333	)
Tax effect		(382	)		186			113
Other comprehensive income (loss), net of tax	$	739		$	(361	)	$	(220	)

72

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE Q – RESTRICTIONS ON TRANSFERS FROM SUBSIDIARIES

Capital guidelines adopted by federal and state regulatory agencies and restrictions imposed by law limit the amount of cash dividends the Bank can pay to the Company. At December 31, 2011, using the most restrictive of these conditions, the aggregate cash dividends that the Bank could pay the Company without prior regulatory approval was approximately $6.7 million.

NOTE R – SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION

Condensed financial statements of Southern Michigan Bancorp, Inc. follow (in thousands):

Balance Sheets	December 31,
	2011		2010
Assets
Cash and cash equivalents	$	404	$	683
Investment in subsidiary bank		57,947		54,963
Investment in non banking subsidiary		188		189
Premises and equipment, net		844		876
Other assets		778		711
Total Assets	$	60,161	$	57,422
Liabilities and Shareholders’ Equity
Dividends payable	$	165	$	117
Other liabilities		46		63
Other borrowings		1,634		2,845
Subordinated debentures		5,155		5,155
Common stock subject to repurchase obligation in ESOP		1,296		1,399
Shareholders’ equity		51,865		47,843
Total Liabilities and Shareholders’ Equity	$	60,161	$	57,422

Statements of Income	Year ended December 31,
	2011			2010			2009
Dividends from subsidiary bank	$	1,437		$	1,358		$	1,113
Interest income		16			25			34
Interest expense		(266	)		(300	)		(351	)
Rental income from subsidiary bank		137			137			137
Other expenses		(310	)		(290	)		(269	)
		1,014			930			664
Federal income tax credit		(144	)		(146	)		(153	)
		1,158			1,076			817
Equity in net income, less dividends received, of:
Subsidiary bank		2,245			2,023			1,121
Non-banking subsidiary		(1	)		(1	)		(2	)
Net Income	$	3,402		$	3,098		$	1,936

73

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE R – SOUTHERN MICHIGAN BANCORP, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION (CONTINUED)

Statements of Cash Flows	Year ended December 31,
	2011			2010			2009
Operating Activities
Net income	$	3,402		$	3,098		$	1,936
Adjustments to reconcile net income to net cash from operating activities:
Equity in net income, less dividends received, of:
Subsidiary bank		(2,245	)		(2,023	)		(1,121	)
Non-banking subsidiary		1			1			2
Stock option and restricted stock grant compensation expense		168			154			132
Depreciation		32			32			32
Net change in obligation under ESOP		128			140			154
Other, net		(84	)		(224	)		211
Net cash from operating activities		1,402			1,178			1,346
Investing Activity
Retirement of bank stock		—			—			3,000
Financing Activities
Proceeds from other borrowings		—			—			3,000
Repayments of other borrowings		(1,211	)		(644	)		(6,557	)
Cash dividends paid		(470	)		(467	)		(813	)
Net cash from financing activities		(1,681	)		(1,111	)		(4,370	)
Net change in cash and cash equivalents		(279	)		67			(24	)
Beginning cash and cash equivalents		683			616			640
Ending cash and cash equivalents	$	404		$	683		$	616

74

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE S – SUPPLEMENTAL CASH FLOW DISCLOSURES

The following supplemental cash flow disclosures are provided for the years ended December 31, 2011, 2010 and 2009 (in thousands):

	2011			2010			2009
Cash paid during the year for:
Interest	$	3,791		$	4,527		$	5,692
Income taxes		590			492			—
Non-cash operating activities:
Change in deferred income taxes on net unrealized gain on available for sale securities		417			(168	)		123
Change in deferred income taxes on pension liability		(35	)		(18	)		(10	)
Change in pension liability		106			53			29
Non-cash investing activities:
Change in unrealized gain on available for sale securities		1,227			(494	)		(362	)
Transfers from loans to other real estate owned		892			1,545			3,197

NOTE T – FAIR VALUE INFORMATION

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

Cash and cash equivalents: 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 bond’s 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.

75

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE T – FAIR VALUE INFORMATION (CONTINUED)

Securities sold under agreements to repurchase, overnight borrowings and federal funds sold: 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 December 31, 2011 and 2010, the estimated fair values would have been achieved. Market values may differ depending on various circumstances not taken into consideration in this methodology. The estimated fair values at December 31, 2011 and 2010 should not necessarily 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, the trained work force, customer goodwill and similar items.

The estimated fair values of the Company’s financial instruments at year end are as follows (in thousands):

	2011						2010
	Carrying Amount			Fair Value			Carrying Amount			Fair Value
Financial assets:
Cash and cash equivalents	$	42,185		$	42,185		$	78,833		$	78,833
Federal funds sold		287			287			275			275
Securities available for sale		90,344			90,344			59,228			59,228
Loans held for sale		1,088			1,088			2,637			2,637
Loans, net of allowance for loan losses		327,392			333,283			303,830			307,946
Accrued interest receivable		2,148			2,148			2,107			2,107
Financial liabilities:
Deposits	$	(420,511	)	$	(422,493	)	$	(409,901	)	$	(406,143	)
Securities sold under agreements to repurchase and overnight borrowings		(18,074	)		(18,074	)		(15,027	)		(15,027	)
Other borrowings		(7,751	)		(7,860	)		(10,079	)		(9,835	)
Subordinated debentures		(5,155	)		(5,155	)		(5,155	)		(5,155	)
Accrued interest payable		(131	)		(131	)		(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.

Southern also has unrecognized financial instruments which relate to commitments to extend credit and standby letters of credit, as described in Note O. The contract amount of such instruments is considered to be the fair value.

76

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE U – FAIR VALUE MEASUREMENTS

Fair value is defined 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.

Fair value must be determined using 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. A fair value hierarchy for valuation inputs has been established 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.

77

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE U – FAIR VALUE MEASUREMENTS (CONTINUED)

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 was determined using Level 3 valuation techniques, as there is no market available to price these investment securities. The method used for determining the fair value for these investment securities included 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 investment securities.

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 December 31, 2011, 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:
Federal agencies	$	28,435	$	—	$	—	$	28,435
U.S. government sponsored entities and agencies		22,956		—		—		22,956
States and political subdivisions		—		31,213		2,232		33,445
Asset-backed securities		2,476		—		—		2,476
Mortgage-backed securities		—		3,032		—		3,032
Total available for sale	$	53,867	$	34,245	$	2,232	$	90,344
Nonrecurring:
Impaired loans	$	—	$	—	$	8,897	$	8,897
Other real estate owned	$	—	$	—	$	1,530	$	1,530

Impaired loans are reported net of a $984,000 allowance for loan losses.

78

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE U – FAIR VALUE MEASUREMENTS (CONTINUED)

Other real estate owned, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $1,530,000, which is made up of the balance of $1,599,000, net of a valuation allowance of $69,000 at December 31, 2011. Write-downs of other real estate owned amounted to $54,000 for the year ending December 31, 2011 and are included in loss on sale of other real estate owned.

The following table summarizes financial assets (there were no financial liabilities) measured at fair value as of December 31, 2010, 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:
Federal agencies	$	24,106	$	—	$	—	$	24,106
U.S. government sponsored entities and agencies		6,678		—		—		6,678
States and political subdivisions		—		22,378		2,992		25,370
Asset-backed securities		2,476		—		—		2,476
Mortgage-backed securities		—		598		—		598
Total available for sale	$	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.

Other real estate owned, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $1,247,000, which is made up of the balance of $1,356,000, net of a valuation allowance of $109,000 at December 31, 2010. Write-downs of other real estate owned amounted to $109,000 for the year ended December 31, 2010 and are included in loss on sale of other real estate owned.

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 year ending December 31, 2011 and 2010 (in thousands):

	2011			2010
Balance at January 1	$	2,992		$	3,099
Net maturities and calls		(1,264	)		(938	)
Unrealized net gains included in other comprehensive income		153			2
Purchases		351			—
Net transfers into level 3		—			829
Balance at December 31	$	2,232		$	2,992

79

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE V – REGULATORY MATTERS

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action that could have a direct material adverse effect on the consolidated financial statements. Prompt corrective action provisions are not applicable to bank holding companies.

The prompt corrective action regulations provide five capital categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized or worse, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.

At year end, actual capital levels and minimum required levels were as follows (in thousands):

	Actual					Minimum Required For Capital Adequacy Purposes					Minimum Required To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
2011
Total capital (to risk weighted assets)
Consolidated	$	47,309		13.7	%	$	27,684		8.0	%		N/A		N/A
Bank		47,078		13.7			27,572		8.0		$	34,465		10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		42,970		12.4			13,842		4.0			N/A		N/A
Bank		42,756		12.4			13,786		4.0			20,679		6.0
Tier 1 capital (to average assets)
Consolidated		42,970		8.6			19,917		4.0			N/A		N/A
Bank		42,756		8.6			19,963		4.0			24,953		5.0

	Actual					Minimum Required For Capital Adequacy Purposes					Minimum Required To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
2010
Total capital (to risk weighted assets)
Consolidated	$	43,577		13.7	%	$	25,459		8.0	%		N/A		N/A
Bank		44,284		14.0			25,365		8.0		$	31,707		10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		39,578		12.4			12,729		4.0			N/A		N/A
Bank		40,299		12.7			12,683		4.0			19,024		6.0
Tier 1 capital (to average assets)
Consolidated		39,578		8.2			19,263		4.0			N/A		N/A
Bank		40,299		8.4			19,235		4.0			24,044		5.0

80

SOUTHERN MICHIGAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE V – REGULATORY MATTERS (CONTINUED)

Regulatory Developments: On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which brings significant financial reform. Among other things, the law:

• Creates a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation;

• Creates a Consumer Financial Protection Agency authorized to promulgate and enforce consumer protection regulations relating to financial products, which would affect both banks and non-bank finance companies;

• Establishes strengthened capital standards for banks and bank holding companies, and disallows trust preferred securities from being included in Tier 1 capital determination for certain financial institutions;

• Enhances regulation of financial markets, including derivatives and securitization markets;

• Contains a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and prepayments;

• Grants the Board of Governors of the Federal Reserve System the power to regulate debit card interchange fees;

• Prohibits certain trading activities by banks;

• Permanently increases the maximum standards FDIC deposit insurance amount to $250,000; and

• Creates an Office of National Insurance with the U.S. Department of Treasury.

While the provisions of the Act receiving the most public attention have generally been those more likely to affect larger institutions, the Act also contains many provisions which will affect smaller institutions such as the Company in substantial and unpredictable ways. Consequently, compliance with the Act’s provisions may curtail the Company’s revenue opportunities, increase its operating costs, require it to hold higher levels of regulatory capital and/or liquidity or otherwise adversely affect the Company’s business or financial results in the future. The Company’s management is actively reviewing the provisions of the Act and assessing its probable impact on the Company’s business, financial condition, and result of operations. However, because many aspects of the Act are subject to future rulemaking, it is difficult to precisely anticipate its overall financial impact on the Company and Bank at this time.

NOTE W – QUARTERLY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)

	Interest Income		Net Interest Income		Provision for Loan Losses		Net Income		Earnings Per Share
									Basic		Fully Diluted
2011
First Quarter	$	4,866	$	3,863	$	125	$	748	$	.32	$	.32
Second Quarter		4,822		3,871		375		762		.33		.33
Third Quarter		4,944		4,027		375		887		.38		.38
Fourth Quarter		5,046		4,166		175		1,005		.43		.43
2010
First Quarter	$	5,209	$	4,040	$	200	$	702	$	.30	$	.30
Second Quarter		5,122		4,013		150		803		.35		.35
Third Quarter		5,249		4,149		425		870		.38		.38
Fourth Quarter		5,135		4,043		600		723		.31		.31

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SELECTED FINANCIAL DATA

(in thousands, except per share data)

	Year Ended December 31
	2011			2010			2009			2008			2007
Total interest income	$	19,678		$	20,715		$	21,938		$	25,929			23,544
Net interest income		15,927			16,245			16,538			17,740			14,906
Provision for loan losses		1,050			1,375			2,725			5,080			745
Net income		3,402			3,098			1,936			813			4,133
Per share data
Basic earnings per share		1.46			1.34			.84			.36			2.29
Diluted earnings per share		1.46			1.34			.84			.36			2.28
Cash dividends		.22			.20			.20			.80			.80
Balance sheet data:
Gross loans		332,804			309,524			333,079			335,310			335,978
Deposits		420,511			409,901			380,905			394,043			399,169
Other borrowings		7,751			10,079			10,832			12,492			14,753
Common stock subject to repurchase		1,296			1,399			945			728			2,029
Equity		51,865			47,843			45,734			44,416			44,219
Total assets		509,220			493,880			462,409			474,996			480,178
Return on average assets		.68	%		.65	%		.41	%		.17	%		1.18	%
Return on average equity (1)		6.80			6.56			4.29			1.77			12.72
Dividend payout ratio (2)		15.23			15.11			24.13			227.33			36.90
Average equity to average assets (1)		9.96			9.87			9.66			9.59			9.27

(1) Average equity used in the above table excludes common stock subject to repurchase obligation but includes average unrealized appreciation or depreciation on securities available for sale.

(2) Dividends declared divided by net income.

COMMON STOCK MARKET PRICES AND DIVIDENDS

The Company’s common stock is regularly quoted on the OTC Bulletin Board (OTCBB) under the symbol SOMC.OB. The bid prices described below are quotations reflecting inter-dealer prices, without retail markup, markdown or commissions, and may not necessarily represent actual transactions. As of March 9, 2012, there were 2,376,724 shares of Southern common stock issued and outstanding held by 410 holders of record.

The following table sets forth the range of high and low bid information and dividends declared for the Company’s two most recent fiscal years:

	2010						2011
					Cash Dividends Declared						Cash Dividends Declared
	Closing Price						Closing Price
Quarter Ended	High		Low				High		Low
March 31	$	11.00	$	9.60	$	.05	$	13.25	$	12.00	$	.05
June 30		12.25		10.50		.05		12.85		11.90		.05
September 30		12.40		11.30		.05		12.69		11.80		.05
December 31		13.50		11.75		.05		12.55		11.05		.07

There are restrictions that currently limit the Company’s ability to pay cash dividends. Information regarding dividend payment restrictions is described in Note Q to the consolidated financial statements.

82

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Management of Southern is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rule 15d-15(e) of the Securities Exchange Act of 1934. An evaluation was performed under the supervision, and with the participation, of Southern’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Southern’s disclosure controls and procedures as of December 31, 2011. Based on and as of the time of that evaluation, Southern’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that Southern’s disclosure controls and procedures were effective to ensure that information required to be disclosed by Southern in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms.

The information under the heading “Management’s Report on Internal Control Over Financial Reporting” is here incorporated by reference.

Item 9B. Other Information

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

Directors and Executive Officers

Southern’s board of directors is comprised of three classes, which are as nearly equal in number as possible. Each class of directors serves a successive three-year term of office.

Biographical information concerning the persons who are directors and executive officers of Southern is presented below as of March 9, 2012. For directors, also presented below is the specific experience, qualifications, attributes or skills that led to the conclusion of the Corporate Governance and Nominating Committee and the board of directors that the person should serve as a director. Except as otherwise indicated, all of the named individuals have had the same principal employment for over five years. Executive officers will be appointed annually and serve at the pleasure of the board of directors of Southern.

Director Nominees with Terms Expiring in 2015

Gregory J. Hull (age 64) has been a director of Southern since 1995 and a director of Southern Michigan Bank since 1995. Mr. Hull is President of Hull Farms, Inc. and owner of Dovey’s Roost Farm. In concluding Mr. Hull should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors his 45 years of experience in farm management and satisfying the financial needs that are typical of many Southern agricultural customers, his familiarity with an important market area in which Southern competes and his years of service as a director of Southern.

Thomas E. Kolassa (age 64) has been a director of Southern since 1995 and a director of Southern Michigan Bank since 1995. Mr. Kolassa is a Senior Vice-President of Hub International, Inc., a North American insurance brokerage. In concluding Mr. Kolassa should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors his many years of entrepreneurial experience in his own business ventures, his management and leadership provide quality insights on the business types served by Southern, his familiarity with an important market area in which Southern competes and his years of service as a director of Southern.

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Donald J. Labrecque (age 54) has been a director of Southern since 2004 and a director of Southern Michigan Bank since 2004. Mr. Labrecque is the President of Labrecque Management, LLC, which owns real estate and operates entertainment facilities, including a bowling center, and is President of Kegler Inc. In concluding Mr. Labrecque should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors his extensive entrepreneurial experience in his own business ventures including satisfying the financial needs of those businesses that are typical of many Southern customers and his familiarity with an important market area in which Southern competes.

Thomas D. Meyer (age 67) has been a director of Southern since December 2008. Mr. Meyer is the President of Meyer Ventures LLC, which is a real estate rehabilitation and rental company. In concluding Mr. Meyer should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors his extensive entrepreneurial experience in his own business ventures including satisfying the financial needs of those businesses that are typical of many Southern customers and his familiarity with an important market area in which Southern competes.

Freeman E. Riddle (age 79) has been a director of Southern since 1982 and a director of Southern Michigan Bank since 1982. Mr. Riddle is the Vice-President of Spoor & Parlin, Inc., which provides agricultural machinery and services, and was previously the President of Spoor & Parlin, Inc. In concluding Mr. Riddle should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors his many years of entrepreneurial experience in his own business venture, his management and leadership provide quality insights on the business types served by Southern, his familiarity with an important market area in which Southern competes and his years of service as a director of Southern.

Directors with Terms Expiring in 2014

Dean Calhoun (age 53) has been a director of Southern since 2006 and a director of Southern Michigan Bank since 2006. Mr. Calhoun is President and Chief Executive Officer of Coldwater Veneer, Inc., a veneer manufacturing company, Vice-President of Altenburg Hardwood Lumber Co., Vice-President of International Wood Inc., Chief Executive Officer of Pierson-Hollowell Forest Products Inc., Chief Executive Officer of West Point Veneer, LLC, Chief Executive Officer of Breck County Hardwoods, and Chief Executive Officer of Tri-State Hardwood Co. Inc. In nominating Mr. Calhoun, the Corporate Governance and Nominating Committee considered as important factors his 32 years of entrepreneurial experience in his own business ventures, his management and leadership provide quality insights on the business types served by Southern, and his familiarity with an important market area in which Southern competes and his distinction as the largest shareholder of Southern stock.

John H. Castle (age 54) has been a director of Southern since 2002 and a director of Southern Michigan Bank since 2002. Mr. Castle is Chairman of the Board and Chief Executive Officer of Southern and Southern Michigan Bank. In nominating Mr. Castle, the Corporate Governance and Nominating Committee considered as important factors his extensive experience in the banking industry, his knowledge of the Southern organization and its operations through his day-to-day management and his familiarity with the various market areas in which Southern competes.

Nolan E. Hooker (age 60) has been a director of Southern since 1991 and a director of Southern Michigan Bank since 1991. Mr. Hooker is the President of Best American Car Washes and President of Hooker Oil Company. In nominating Mr. Hooker, the Corporate Governance and Nominating Committee considered as important factors his extensive entrepreneurial experience in his own business ventures including satisfying the financial needs of businesses that are typical of many Southern customers, his familiarity with an important market area in which Southern competes and his years of service as a director of Southern.

84

Directors with Terms Expiring in 2013

John S. Carton (age 71) has been a director of Southern since December 17, 2007. Mr. Carton was appointed to the board of directors pursuant to the Agreement and Plan of Merger, dated April 17, 2007, between Southern and FNB Financial Corporation. Mr. Carton is a former director of FNB Financial Corporation, which Southern acquired effective December 1, 2007. Mr. Carton has been a director of FNB Financial (f/k/a The First National Bank of Three Rivers) since 2003. Mr. Carton is a retired business executive. Before retirement, Mr. Carton was the owner of Pineview Golf Club, a golf course in Three Rivers, Michigan. In concluding Mr. Carton should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors Mr. Carton’s 34 years of bank board service with various financial institutions and his service on various audit committees of those institutions.

H. Kenneth Cole (age 63) has been a director of Southern since 1998 and a director of Southern Michigan Bank since 1998. Mr. Cole is Chief Administrative Officer of Hillsdale College, a private, liberal arts college, located in Hillsdale, Michigan. In concluding Mr. Cole should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors Mr. Cole’s 34 years of experience in financial management positions, his experience and familiarity with financial statements and financial disclosures, his education, including an MBA in accounting, his familiarity with an important market area in which Southern competes and his years of service as a director of Southern.

Gary Hart Haberl (age 59) has been a director of Southern since 2004 and a director of Southern Michigan Bank since 2004. Mr. Haberl is President of Infinisource, Inc., a benefits administrator. In concluding Mr. Haberl should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors his 36 years of marketing experience, his extensive entrepreneurial experience in his own business ventures, his demonstrated business management and leadership background and his familiarity with an important market area in which Southern competes.

Brian P. McConnell (age 49) has been a director of Southern since 2007 and a director of Southern Michigan Bank since 2007. Mr. McConnell is President and Chief Operating Officer of Burr Oak Tool Inc., a manufacturer of production equipment for the heat transfer and tube processing industries. In concluding Mr. McConnell should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors his demonstrated business management and leadership background with a multinational manufacturing company and his familiarity with an important market area in which Southern competes.

Kurt G. Miller (age 56) has been a director of Southern since 2002 and a director of Southern Michigan Bank since 2002. Mr. Miller is President of Southern and Southern Michigan Bank. In concluding Mr. Miller should serve as a director of Southern, the Corporate Governance and Nominating Committee considered as important factors his extensive experience in the banking industry, his knowledge of the Southern organization and its operations through his day-to-day management and his familiarity with the various market areas in which Southern competes.

Executive Officers Who Are Not Directors

Danice L. Chartrand (age 45) is the Senior Vice-President, Chief Financial Officer, Secretary and Treasurer of Southern and Southern Michigan Bank.

Audit Committee

Southern has a separately-designated standing audit committee consisting solely of independent directors as defined by the applicable rules of the NASDAQ Stock Market. During 2011, the Audit Committee consisted of Mr. Cole (Chairman), and Messrs. Carton, Hull, Hooker and Meyer. Mr. Cole is considered an “audit committee financial expert” as defined by the SEC.

85

Code of Ethics

Southern has adopted a code of ethics that applies to our principal executive officer, principal financial officer, and other senior financial and accounting officers. We will provide to any person without charge, upon request, a copy of the code of ethics. To request a copy of the code of ethics, address the request to Southern Michigan Bancorp, Inc., 51 W. Pearl Street, P.O. Box 309, Coldwater, Michigan 49036, Attention Danice L. Chartrand, Secretary.

Shareholder Nomination of Directors

Under Southern’s bylaws, all shareholder nominations for director for which written proxy solicitation by the board of directors is sought, must be made in writing and delivered or mailed to Southern by December 31 of the year preceding the year in which the nomination is proposed. All other shareholder nominations for directors (i) may be made only by a shareholder entitled to vote in the election of directors at the particular meeting at which the nomination is to occur, (ii) must be made by the shareholder in person or by proxy at such meeting, and (iii) only if the shareholder delivers personally, or the Secretary of Southern otherwise receives, written notice that is in compliance with the requirements of Southern's bylaws of the shareholder’s intent to make the nomination at least 30 days, but no more than 90 days, before the anniversary date of the record date for determination of shareholders entitled to vote in the immediately preceding annual meeting of shareholders. Nominations that are not received before the applicable deadline or that otherwise do not comply with the requirements of Southern's bylaws will not be placed on the ballot and will be deemed void and of no effect. Southern’s board of directors believes that advance notice of nominations by shareholders will afford a meaningful opportunity to consider the qualifications of the proposed nominees and, to the extent deemed necessary or desirable by the board of directors, will provide an opportunity to inform shareholders about such qualifications.

86

Item 11. Executive Compensation

SUMMARY COMPENSATION TABLE

The following table summarizes the compensation of Southern’s named executive officers.

Name and Principal Position	Year		Salary(1)		Bonus		Stock Awards (2)		Option Awards (2)		Nonequity Incentive Plan Compen- sation		Non- qualified Deferred Compen- sation Earnings		All Other Compen- sation (3)		Total
John H. Castle		2011	$	226,525	$	33,000	$	63,500	$	5,580	$	—	$	—	$	51,569	$	380,174
Chairman and CEO of Southern and Southern Michigan Bank		2010		226,525		—		50,500		4,590		—		—		16,452	$	298,067
Kurt G. Miller		2011	$	181,425	$	27,000	$	50,800	$	4,464	$	—	$	—	$	42,155	$	305,844
President of Southern and Southern Michigan Bank		2010		181,425		—		40,400		3,672		—		—		13,304		238,801
Danice L. Chartrand		2011	$	124,051	$	15,400	$	23,812	$	2,093	$	—	$	—	$	15,796	$	181,152
Senior Vice President and CFO of Southern and Southern Michigan Bank		2010		124,051		—		18,938		1,721		—		—		5,987		150,697

(1) Includes elective deferrals by employees pursuant to Section 401(k) of the Internal Revenue Code and elective deferrals pursuant to a non-qualified deferred compensation plan.

(2) Amounts included in this column reflect the grant date fair value computed in accordance with FASB ASC Topic 718. Information regarding all forfeitures of option awards during 2011 and assumptions made in the valuation of option awards is presented in Note N to the consolidated financial statements and is here incorporated by reference.

(3) “All Other Compensation” includes the value of Southern’s matching contributions to each executive officer in the qualified savings plan, the taxable benefit of company owned vehicles, company paid life insurance premiums (a benefit that is generally available to Southern’s salaried employees), country club memberships, contributions to the non-qualified supplemental retirement plan, and the dollar value of dividends paid on unvested restricted stock awards and option awards. None of Southern’s named executive officers received perquisites or personal benefits having an aggregate value of $10,000 or greater. The table below provides details regarding all other compensation paid to named executive officers.

87

	Year		Qualified Savings Plan Match		Automobile Allowance		Life and Disability Insurance Premiums		Country Club Membership		SERP		Dividends		Total
Mr. Castle		2011	$	10,406	$	1,118	$	2,696	$	1,300	$	33,979	$	2,070	$	51,569
		2010		9,726		1,030		2,666		1,300		—		1,730		16,452
Mr. Miller		2011	$	8,362	$	946	$	2,677	$	1,300	$	27,214	$	1,656	$	42,155
		2010		7,789		941		1,890		1,300		—		1,384		13,304
Ms. Chartrand		2011	$	5,385	$	—	$	356	$	—	$	9,304	$	751	$	15,796
		2010		5,138		—		238		—		—		611		5,987

Narrative Discussion of Summary Compensation Table

Employment Agreements

John H. Castle Employment Agreement

As an inducement for Mr. Castle’s agreement to serve as a director and Chief Executive Officer of Southern and Southern Michigan Bank, Southern entered into an employment agreement with Mr. Castle in 2004 that continues until either Southern or Mr. Castle provides notice of termination. Under this agreement, Southern agreed to:

• pay Mr. Castle a salary of at least $168,630 per year, or as may be adjusted, less taxes and withholdings, plus possible bonuses and participation in equity plans sponsored by Southern;

• provide Mr. Castle with the use of an automobile at the expense of Southern;

• reimburse Mr. Castle for all documented business expenses;

• continue to pay Mr. Castle his base salary for one year, health care continuation coverage premium for one year and outplacement assistance up to $5,000 if Mr. Castle is terminated without cause;

• pay Mr. Castle 2.99 times his average base salary and bonus if Mr. Castle is terminated, without cause, or quits for “good reason” following a change in control of Southern or within six months before a change in control of Southern;

• provide Mr. Castle with four weeks of paid vacation per year;

• provide Mr. Castle with a country club membership; and

• provide Mr. Castle with the same health and other employee benefits provided to other executive employees of Southern and Southern Michigan Bank.

Mr. Castle agreed not to compete with Southern or Southern Michigan Bank while employed by Southern or Southern Michigan Bank and for one year following termination of Mr. Castle’s employment, unless his employment is terminated by Southern without cause or by Mr. Castle for “good reason” after a change in control of Southern or within six months before a change in control of Southern.

Kurt G. Miller Employment Agreement

As an inducement for Mr. Miller’s agreement to serve as President of Southern and Southern Michigan Bank, Southern entered into an employment agreement with Mr. Miller in 2004 on the same terms as those for Mr. Castle described above, except that Mr. Miller’s base salary was initially at least $134,905 per year, or as may be adjusted, less taxes and withholdings.

88

Danice L. Chartrand Retention Agreement

As an inducement for Ms. Chartrand’s agreement to serve as Chief Financial Officer of Southern and Southern Michigan Bank, Southern entered into a retention agreement with Ms. Chartrand in 2010 that continues until either Southern or Ms. Chartrand provides notice of termination, except that the agreement may not be terminated during an active change in control proposal period or for two years after a change in control.

Under this agreement, Southern agreed to continue to pay Ms. Chartrand her base salary for one year, health care continuation coverage premium for one year and outplacement assistance up to $2,500 if Ms. Chartrand is terminated without cause or quits for “good reason” within two years following a change in control of Southern.

Material Terms of Grants

One half of the option awards granted on June 20, 2011 are exercisable on June 20, 2012 and one-half of the awards are exercisable on June 20, 2013, at an exercise price of $12.70 per share. These options, if not exercised, will expire on June 20, 2021. Stock awards granted on June 20, 2011 vest over the next five years, one-fifth on each anniversary date of the award.

One-half of the option awards granted on January 27, 2010 were exercisable on January 27, 2011 and one-half of the awards were exercisable on January 27, 2012, at an exercise price of $10.10 per share. These options, if not exercised, will expire on January 27, 2020. Stock awards granted on January 27, 2010 vest over the next five years, one-fifth on each anniversary date of the award.

Outstanding Equity Awards at Fiscal Year-End

The following table presents the outstanding equity awards held by each of the named executive officers as of the fiscal year ended December 31, 2011.

89

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END

	Option Awards								Stock Awards
											Market
									Number		Value of
	Number of		Number of						of Shares		Shares
	Securities		Securities						or Units		or Units
	Underlying		Underlying						of Stock		of Stock
	Unexercised		Unexercised						that Have		that
	Options		Options		Option				Not		Have
	(#)		(#)		Exercise		Option		Vested		Not
	Exercisable		Unexercisable		Price		Expiration		(#)		Vested
Name	(1)		(2)		($)		Date		(3)		($)(4)
John H. Castle		1,575		—		15.72		3/17/2013
		8,925		—		20.05		1/2/2014
		8,925		—		25.89		1/2/2015
		10,500		—		22.80		12/19/2015
		9,000		—		24.58		1/29/2017
		16,000		4,000		23.90		4/24/2017
		4,000		—		18.00		6/17/2018
		2000		—		7.40		1/2/2019
		1,500		1,500		10.10		1/27/2020
		—		3,000		12.70		6/20/2021
										200		2,250
										600		6,750
										2,400		27,000
										4,000		45,000
										5,000		56,250
Kurt G. Miller		1,575		—		15.72		3/17/2013
		6,825		—		20.05		1/2/2014
		6,825		—		25.89		1/2/2015
		8,400		—		22.80		12/19/2015
		7,200		—		24.58		1/29/2017
		14,400		3,600		23.90		4/24/2017
		3,200		—		18.00		6/17/2018
		1,600		—		7.40		1/2/2019
		1,200		1,200		10.10		1/27/2020
		—		2,400		12.70		6/20/2021
										160		1,800
										480		5,400
										1,920		21,600
										3,200		36,000
										4,000		45,000
Danice L. Chartrand		945		—		15.72		3/17/02013
		2,625		—		20.05		1/2/2014
		2,625		—		25.89		1/2/2015
		2,625		—		22.80		12/19/2015
		2,250		—		24.58		1/29/2017
		8,800		2,200		23.90		4/24/2017
		1,000		—		18.00		6/17/2018
		750		—		7.40		1/2/2019
		562		563		10.10		1/27/2020
		—		1,125		12.70		6/20/2021
										50		563
										150		1,688
										900		10,125
										1,500		16,875
										1,875		21,094

90

(1) All exercisable options are fully vested.

(2) The non vested options granted in January 2010 and June 2011 vest annually over a 2 year period (50% each year); the options granted in April 2007 vest annually over a 5 year period (20% each year).

(3) Restricted stock awards were granted in January 2007, June 2008, January 2009, January 2010 and June 2011 and vest over a five year period (20% each year)

(4) The market value of shares reported in this column was determined by multiplying the last closing stock price of Southern at December 31, 2011 ($11.25) by the number of shares reported.

Additional Narrative Disclosure

ESOP and 401(k) Plan

The Southern Michigan Bank & Trust Employee Stock Ownership Plan is qualified under Section 401(a) of the Internal Revenue Code of 1986 (the “Code”) and includes 401(k) provisions.

The purpose of the 401(k) plan is to permit Southern Michigan Bank employees, including the named executive officers, to save for retirement on a pre-tax basis. In addition to an employee’s pre-tax contributions, Southern Michigan Bank may make discretionary matching and employee stock ownership plan contributions to the 401(k) plan. If Southern Michigan Bank makes matching or employee stock ownership plan contributions to the 401(k) plan, those contributions are immediately 100% vested. Southern Michigan Bank has generally made a matching contribution to the 401(k) plan each year. All full-time employees who are 21 years of age or older are eligible to participate in the plan.

Each participant in the 401(k) plan has an account to record the participant’s interest in the plan. Amounts contributed by or on behalf of a participant are credited to his or her account. A participant’s benefit from the 401(k) plan is equal to the vested amount in the participant’s account when he or she terminates employment with Southern Michigan Bank. The employee stock ownership portion of the plan, in part, is designed to invest primarily in Southern common stock.

Southern Michigan Bank & Trust Pension Plan

Effective December 31, 2009, The Southern Michigan Bank & Trust Pension Plan was fully frozen. The plan was partially frozen in 2006 for participants who did not meet certain age and years of service requirements. Participants who met the age and years of service requirements continued accruing benefits until the plan was fully frozen in 2009. The named executive officers did not meet the age and years of service requirements, so they did not accrue additional benefits under the plan after the partial freeze in 2006.

Before the freeze, employees were eligible to participate in the Southern Michigan Bank & Trust Pension Plan at age 21 after completing one year of service in which the employee worked at least 1,000 hours. A participant is considered vested after 5 years of vesting service. A year of vesting service is credited for each calendar year that a participant is credited with 1,000 hours of service, including years before the plan was adopted and before the participant reached age 18.

The normal retirement benefit under the plan is calculated using a benefit formula of 35% of the participant’s average compensation (reduced proportionately for less than 30 years of benefit service at normal retirement) multiplied by a fraction based on the participant’s actual years of service compared to the years of service the participant would have accumulated at normal retirement. Average compensation is defined as the highest five year annual average W-2 compensation. Normal retirement age is defined as age 65. An early retirement benefit is available for participants age 55 with 5 years of service. None of the named executive officers are eligible for early retirement benefits from the plan.

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The normal form of benefit from the plan is a qualified joint and survivor annuity. Participants may elect a lump sum, life annuity with period certain or joint and survivor annuity as an optional form of benefit with spousal consent.

Supplemental Executive Retirement Plan

On December 17, 2007, the board of directors of Southern Michigan Bank adopted the Southern Michigan Bank & Trust Supplemental Executive Retirement Plan (the “SERP”). The board of Southern Michigan Bank designated John S. Castle, Kurt G. Miller, and Danice L. Chartrand as participants in the SERP.

Under the SERP, each participant receives a benefit equal to the difference between the pension benefit the participant would have received under the Southern Michigan Bank & Trust Pension Plan (the “Pension Plan”) had the Pension Plan not been frozen (i.e., participants in the Pension Plan no longer accrue benefits under the Pension Plan) effective December 31, 2006, and the pension benefit the participant actually receives from the Pension Plan. The benefits under the Plan are vested under the same schedule as the participant’s benefit under the Pension Plan and will be paid upon the participant’s termination of employment in the form of a lump sum or annuity, as elected by the participant.

In February of 2009, the board of directors froze accrual of additional benefits under the SERP as of December 31, 2008.

2011 Defined Contribution Supplemental Executive Retirement Plan

On December 27, 2011, the Board of Directors entered into a new Supplemental Executive Retirement Plan (“2011 SERP”) arrangement with John H. Castle, Kurt G. Miller and Danice L. Chartrand. The 2011 SERP is intended to provide the executives with a retirement benefit that is competitive with industry practices for bank executives when combined with the executive’s other employer-funded retirement benefits.

In contrast to the frozen 2007 Supplemental Executive Retirement Plan, the 2011 SERP is a defined contribution arrangement. This means that, rather than assuring the executives that they will receive a specific benefit amount in retirement or a benefit amount determined by a formula, the 2011 SERP provides the Bank the discretion to make a specific annual nonqualified deferred compensation contribution to the account of each of the three executives. Subject to the performance conditions described below, whether an annual deferred compensation contribution will be made to the account balance of an executive, as well as the amount of the contribution, is and shall remain discretionary on the part of the Bank's Board of Directors. Although the contribution rate under the 2011 SERP is not fixed and may be changed by the board of directors at any time, the contribution that will be made by the Bank to the account of each executive is expected to be 15% of base salary in the case of Messrs. Castle and Miller and 7.5% of base salary in the case of Ms. Chartrand. The executives are not permitted to make individual contributions to their 2011 SERP accounts.

The 2011 SERP provides that the executives will receive no annual contribution for any year in which the bank does not satisfy performance conditions specified by the Board. Although these may be changed by the Board, the performance conditions currently consist of (x) the Bank having the legal capacity under Michigan law to pay a cash dividend to its holding company, Southern Michigan Bancorp, Inc., and (y) declaration and payment by the Bank of a cash dividend to its holding company not being subject to the requirement for advance approval of or advance notice to the FDIC, the Federal Reserve Board or Federal Reserve Bank of Chicago, or the Michigan Office of Financial and Insurance Regulation under any formal or informal enforcement action taken by any of those regulatory agencies. If the performance conditions are not satisfied, the executives will not receive a contribution. If the performance conditions are satisfied, the Board retains discretion as to whether an annual deferred compensation contribution will be made to the account balance of an executive, as well as the amount of the contribution.

Each executive's account balance is generally payable monthly over 10 years beginning at age 65; however, the account balance is paid out in a single lump sum if a change in control of the Bank occurs. Until the executive's death, termination of employment or attainment of age 65, the executive's account balance earns interest at the prime interest rate as published in The Wall Street Journal. After the executive's death, termination of employment or attainment of age 65, interest will be credited at an annual rate equal to the yield on a 20-year corporate bond rated Aa by Moody’s.

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If a change in control of the Company were to occur, however, the entire account balance would be paid to each executive in a single lump sum immediately after the change in control. The Bank would also be responsible for reimbursement of up to $500,000 of each executive’s legal expenses if the 2011 SERP change-in-control benefit is not timely paid after a change in control.

Non-Qualified Deferred Compensation

The named executive officers are eligible to participate in a non-qualified deferred compensation plan. Participants in the plan may elect to defer up to 100% of their salary and other cash compensation on an annual basis.

The plan provides that Southern will pay to each participant a lump sum or 180 equal monthly payments, as the participant elects, upon early retirement (age 60) or normal retirement (age 65), disability or a change in control of Southern. If the participant’s termination of employment occurs prior to early retirement, the participant will receive a lump sum distribution. No payments will be made before the date that is six months after termination of employment. Payments to which the participant would otherwise have been entitled during the six months will be accumulated and paid on the first day after six months following the date of participant’s termination of employment.

Under terms of the plan, if the executive officer dies while in the active service of Southern, the executive officer’s beneficiary will receive a supplemental death benefit. This supplemental death benefit will be the estimated deferral account balance at the executive officer’s normal retirement age divided by 180, payable monthly for 180 months. The estimated deferral account balance will be calculated by taking the deferral account balance on the date of death plus the average monthly contribution made over the previous 12 months, projected at the current plan interest rate (not to exceed 7%), to the executive officer’s normal retirement age. This amount will not exceed the net death benefit paid to the bank under the executive officer’s bank owned life insurance policy(s). No premiums were paid in 2011 on any named executive’s bank owned life insurance policies.

Agreements with Payments Upon Resignation, Retirement, Termination of Employment, or Change in Control

Upon a named executive officer’s termination of employment for any reason other than death, disability, retirement, or termination for cause, exercisable stock options on the date of termination may be exercised for a period of three months following termination. Unvested shares of restricted stock will automatically vest in an amount equal to the number of shares of restricted stock granted to the named executive officer multiplied by the number of full months that have elapsed since the date of grant divided by the maximum number of full months of the restricted period. Any remaining shares of restricted stock will be forfeited.

Upon a named executive officer’s death or disability, exercisable stock options on the date of death or disability may be exercised for a period of three months following death or disability. Unvested shares of restricted stock will automatically vest in full.

Upon a named executive officer’s retirement, exercisable stock options on the date of retirement may be exercised for the remaining terms of the options. Unvested shares of restricted stock will automatically vest in full.

Upon a change in control of Southern, all unvested stock options held by a named executive officer will become immediately vested and exercisable in full and all unvested shares of restricted stock held by a named executive officer will become immediately vested and nonforfeitable.

Information about the material terms of the employment agreements for John H. Castle and Kurt G. Miller and the Retention Agreement for Danice L. Chartrand that provide payments to Messrs. Castle and Miller and Ms. Chartrand upon their resignation, retirement, termination of employment or a change in control of Southern are described above under “Executive Compensation – Narrative Disclosure to Summary Compensation Table,” and is here incorporated by reference.

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Compensation of Directors

Directors who are not employed by Southern or any subsidiary of Southern (“non-employee directors”) received an annual retainer of $13,000 in 2011. The Chairman of the Audit Committee received an additional $2,000 retainer. The Chairman of the Compensation Committee and the Chairman of the Corporate Governance and Nominating Committee each received an additional $1,000 retainer. Non-employee directors also received a $1,000 discretionary bonus for 2011. Directors who are employed by Southern or the Bank do not receive compensation for their services as a director.

Directors are eligible to participate in a deferred fee plan, which allows the director to defer all or part of his or her director fees. Under the deferred fee plan, directors are entitled to a supplemental death benefit, which is funded by bank owned life insurance. No premiums were paid in 2011 on any directors’ bank owned life insurance policies.

The following table summarizes the compensation of Southern’s directors who are not named executive officers.

DIRECTOR COMPENSATION

							Non-		Non-
							Equity		Qualified
							Incentive		Deferred
	Fees Earned						Plan		Compen-		All Other
	Or Paid in		Stock		Option		Compen-		sation		Compen-
	Cash		Awards		Awards		sation		Earnings		sation			Total
Name	($)(3)		($)(2)(5)		($)(2)(4)		($)		($)		($)(6)			($)
Dean Calhoun		14,000		1,905		93		—		—		70			16,068
John S. Carton		14,000		1,905		93		—		—		68			16,066
H. Kenneth Cole		16,000		1,905		93		—		—		70			18,068
Gary H. Haberl		14,000		1,905		93		—		—		1,146	(1)		17,144
Nolan E. Hooker		15,000		1,905		93		—		—		70			17,068
Gregory J. Hull		15,000		1,905		93		—		—		70			17,068
Thomas E. Kolassa		14,000		1,905		93		—		—		70			16,068
Donald J. Labrecque		14,000		1,905		93		—		—		1,300	(1)		17,298
Brian P. McConnell		14,000		1,905		93		—		—		68			16,066
Thomas D. Meyer		14,000		1,905		93		—		—		65			16,063
Freeman E. Riddle		14,000		1,905		93		—		—		70			16,068

(1) Includes $1,076 and $1,230 for Directors Haberl and Labrecque, respectively, for premiums paid for term insurance to cover supplemental death benefit.

(2) Amounts included in this column reflect the grant date fair value computed in accordance with FASB ASC Topic 718. Information regarding all forfeitures of option awards during 2011 and assumptions made in the valuation of option awards is presented in Note N to the consolidated financial statements and is here incorporated by reference.

(3) Includes amounts deferred under deferred fee plan.

(4) At December 31, 2011, the following option awards were outstanding: Director Calhoun 730; Directors Cole, Hooker, Hull and Kolassa 2,463; Directors Haberl and Labrecque 1,623; Director Riddle 2,148; Directors Carton and McConnell 330 and Director Meyer 255.

(5) At December 31, 2011, the following stock awards, representing unvested shares of restricted stock, were outstanding: Directors Calhoun, Cole, Haberl, Hooker, Hull, Kolassa, Labrecque and Riddle 400; Directors Carton and McConnell 390 and Director Meyer 380.

(6) Includes the dollar value of dividends paid on unvested restricted stock awards and option awards and premiums paid for term insurance.

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Additional Narrative to Director Compensation Table

One-half of the option awards granted on June 20, 2011 are exercisable on June 20, 2012 and one-half of the awards are exercisable on June 20, 2013, at an exercise price of $12.70 per share. These options, if not exercised, will expire on June 20, 2021. Stock awards granted on June 20, 2011 vest over the next five years, one-fifth on each anniversary date of the award.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following tables sets forth information, as of December 31, 2011, concerning the number of shares of Southern common stock held by each entity or person known to Southern to be the beneficial owner of more than five percent of outstanding shares of Southern common stock and certain information concerning the number of shares of Southern common stock held as of December 31, 2011, by each of Southern’s directors, each of the named executive officers, and all of Southern’s directors and executive officers as a group:

Five Percent Shareholders

Amount and Nature of Beneficial

Ownership of Southern Common Stock(1)

Name and Address of Beneficial Owner	Sole Voting and Dispositive Power			Shared Voting or Dispositive Power(2)			Total Beneficial Ownership		Percent of Class(3)
Southern Michigan Bancorp, Inc. and Southern Michigan Bank & Trust 51 West Pearl Street P.O. Box 309 Coldwater, Michigan 49036		—			291,983	(4)		291,983		12.38	%
Dean Calhoun 317 Highland Drive Coldwater, Michigan 49036		770	(6)(7)		167,227			167,997		7.12	%
Gwyn R. Hartman Revocable Living Trust U/A/D 11/16/93 2317 Bay point Way The Villages, Florida 32162		150,041	(5)		—			150,041		6.36	%

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Stock Ownership By Management

Amount and Nature of Beneficial Ownership of

Southern Common Stock(1)

	Sole		Shared
	Voting and		Voting or				Total
Name of	Dispositive		Dispositive		Stock		Beneficial		Percent of
Beneficial Owner	Power(6)		Power(2)		Options(7)		Ownership		Class(3)
Dean Calhoun		90		167,227		680		167,997		7.12	%
John S. Carton		2,901		—		280		3,181		*
John H. Castle		16,986		177		63,925		81,088		3.35	%
Danice L. Chartrand		5,680		—		22,745		28,425		1.19	%
H. Kenneth Cole		682		—		2,413		3,095		*
Gary H. Haberl		107		10,396		1,573		12,076		*
Nolan E. Hooker		2,106		4,303		2,413		8,822		*
Gregory J. Hull		245		3,763		2,413		6,421		*
Thomas E. Kolassa		18,468		—		2,413		20,881		*
Donald J. Labrecque		2,916		—		1,573		4,489		*
Brian P. McConnell		195		2,500		280		2,975		*
Thomas D. Meyer		3,738		—		205		3,943		*
Kurt G. Miller		12,927		12		52,425		65,364		2.71	%
Freeman E. Riddle		1,235		9,000		2,098		12,333		*
All directors and executive officers as a group		68,276		197,378		155,436		421,090		16.75	%

* Less than 1%

(1) The numbers of shares stated are based on information furnished by each person listed and include shares personally owned of record by that person and shares that under applicable regulations are considered to be otherwise beneficially owned by that person. Southern is not responsible for the accuracy of this information.

(2) These numbers include shares as to which the listed person is legally entitled to share voting or dispositive power by reason of joint ownership, trust or other contract or property right, and shares held by spouses, certain relatives and minor children over whom the listed person may have influence by reason of relationship.

(3) Based on a total of 2,358,599 issued and outstanding shares as of December 31, 2011, plus the number of shares subject to stock options that are currently exercisable or that will be exercisable by holders of such stock options within 60 days.

(4) Southern Michigan Bank holds 291,983 shares in various fiduciary capacities. As a matter of internal policy, Southern Michigan Bank does not exercise any power to dispose or direct the disposition of such shares and requires authority from its customers before any disposition. Certain of the customers on whose behalf Southern Michigan Bank holds the securities have the sole right to receive and the power to direct the receipt of dividends from, or proceeds from the sale of, such shares. No single customer has an interest that relates to more than 5% of such shares. Included in the 291,983 shares are 130,572 shares which Southern Michigan Bank is the trustee of an ESOP/401(k) Plan for its employees. Of that number, 115,170 shares are allocated to employee accounts. Southern Michigan Bank holds no power to vote or direct the disposition of shares allocated to employee accounts and Southern Michigan Bank disclaims beneficial ownership of such shares.

(5) Represents 150,041 shares held by Ms. Hartman as trustee.

(6) Includes restricted stock shares that vest within 60 days. 70 shares for Mssrs. Calhoun, Cole, Haberl, Hooker, Hull, Kolassa, Labrecque and Riddle; 60 shares for Mssrs. Carton, McConnell and Meyer; 2,000 shares for Mr. Castle; 1,600 shares for Mr. Miller and 725 shares for Ms. Chartrand.

(7) Includes shares subject to stock options that are currently exercisable or that will be exercisable within 60 days. Listed directors and executives also hold other stock options that will vest at a later date.

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The following table presents information regarding the equity compensation plans both approved and not approved by shareholders at December 31, 2011:

					Number of securities
					remaining available
	Number of		Weighted-average		for future issuance
	securities to		exercise price		under equity
	be issued upon exercise		of outstanding		compensation plans
	of outstanding options,		options, warrants		(excluding securities
	warrants and rights		and rights		reflected in column (a))
	(a)		(b)		(c)
Equity compensation plans approved by shareholders		221,026	$	21.06		99,007
Equity compensation plans not approved by shareholders		—		—		—
Total		221,026	$	21.06		99,007

Southern has no equity compensation plans not approved by shareholders.

Item 13. Certain Relationships and Related Transactions, and Director Independence

Directors, officers, principal shareholders and their associates and family members were customers of, and had transactions (including loans and loan commitments) with, the Bank in the ordinary course of business during 2010. All such loans and commitments were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and did not involve more than a normal risk of collectibility or present other unfavorable features. Similar transactions may be expected to take place in the ordinary course of business in the future. None of these loan relationships presently in effect are in default as of the date of this proxy statement.

We have adopted written policies to implement the requirements of Regulation O of the Federal Reserve System, which restricts the extension of credit to directors and executive officers and their family members and other related interests. Under these policies, extensions of credit that exceed regulatory thresholds must be approved by the board of directors of the Bank. We have adopted a written policy that requires the Audit Committee to review, evaluate, and approve other transactions between Southern and its affiliates or other related parties, including transactions in which a director or executive officer or immediate family member may have a direct or indirect material interest.

Item 14. Principal Accountant Fees and Services

The aggregate fees billed to us by our principal accountant, CliftonLarsonAllen LLP, for the years ended December 31, 2011 and 2010 are as follows:

	2011		2010
Audit Fees(1)	$	140,852	$	140,331
Audit-Related Fees(2)		—		2,500
Tax Fees(3)		19,175		15,500
	$	160,027	$	158,331

(1) Audit fees consist of the audit of the Company’s annual consolidated financial statements, reviews of quarterly reports on Form 10-Q, meetings with the audit committee and related consultations.

(2) Audit related fees in 2010 consist of fees relating to issuance of consent on Form S-3.

(3) Tax fees consist of tax compliance and preparation fees and related tax advice.

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The Audit Committee Charter provides the policy and procedures for the approval by the Audit Committee of all services provided by our independent auditors. The charter requires that all services provided by the independent auditors, including audit-related services and non-audit services, must be pre-approved by the Audit Committee. The charter allows the Audit Committee to delegate to one or more members of the Audit Committee the authority to approve the independent auditors’ services. The decisions of any Audit Committee member to whom authority is delegated to pre-approve services are reported to the full Audit Committee. The charter also provides that the Audit Committee has authority and responsibility to approve and authorize payment of the independent auditors’ fees. Finally, the charter sets forth certain services that the independent auditors are prohibited from providing to Southern or its subsidiaries. All of the services described above were approved by the Audit Committee. None of the audit-related fees or tax fees were approved by the Audit Committee pursuant to the de minimus exception set forth in Section 10A(i)(1)(B) of the Securities Exchange Act of 1934, although the Audit Committee charter allows such approval.

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a) The following documents are filed as part of this Report:

1. Financial Statements.

Report of Independent Registered Public Accounting Firm of CliftonAllenLarson LLP dated March 30, 2012

Consolidated Balance Sheets as of December 31, 2011 and 2010

Consolidated Statements of Income for the years ended December 31, 2011, 2010 and 2009

Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2011, 2010 and 2009

Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009

Notes to Consolidated Financial Statements

2. Financial Statement Schedules.

Schedules are omitted because the required information is either inapplicable or presented in the consolidated financial statements or related notes.

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3. Exhibits

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 fiscal 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 September 28, 2007 in Southern Michigan Bancorp Inc.’s Amendment No. 2 to 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 September 28, 2007 in Southern Michigan Bancorp Inc.’s Amendment No. 2 to 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.
10.1*	Form of Employment Agreement with John H. Castle. Previously filed with the Commission on March 28, 2008 in Southern Michigan Bancorp Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, Exhibit 10.1. Here incorporated by reference.
10.2*	Form of Employment Agreement with Kurt G. Miller. Previously filed with the Commission on March 28, 2008 in Southern Michigan Bancorp Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, Exhibit 10.2. Here incorporated by reference.
10.3*	Form of Retention Agreement with Danice L. Chartrand. Previously filed with the Commision on March 26, 2010 in Southern Michigan Bancorp Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009, Exhibit 10.3. Here incorporated by reference.
10.4*	Southern Michigan Bancorp, Inc. Stock Incentive Plan of 2005. Previously filed with the Commission on March 28, 2008 in Southern Michigan Bancorp Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, Exhibit 10.5. Here incorporated by reference.
10.5*	Form of Southern Michigan Bank & Trust Deferred Compensation Agreement. 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 10.6. Here incorporated by reference.
10.6*	Form of Second Amendment to Southern Michigan Bank & Trust Deferred Compensation Agreement. Previously filed with the Commission on March 28, 2008 in Southern Michigan Bancorp Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, Exhibit 10.7. Here incorporated by reference.
10.7*	Southern Michigan Bancorp., Inc. 2000 Stock Option Plan. 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 10.7. Here incorporated by reference.

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Exhibit Number	Document
10.8*	Form of Southern Michigan Bank & Trust Director Deferred Fee Agreement. 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 10.8. Here incorporated by reference.
10.9*	Southern Michigan Bank & Trust Supplemental Executive Retirement Plan. Previously filed with the Commission on December 19, 2007 in Southern Michigan Bancorp Inc.’s Current Report on Form 8-K, dated December 17, 2007, Exhibit 10.1. Here incorporated by reference.
10.10	Indenture, dated March 25, 2004, between Southern Michigan Bancorp, Inc. and Wilmington Trust Company. Previously filed with the Commission on March 28, 2008 in Southern Michigan Bancorp Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, Exhibit 10.13. Here incorporated by reference.
10.11	Amended and Restated Declaration of Trust of Southern Michigan Bancorp Capital Trust I, dated March 25, 2004. Previously filed with the Commission on March 28, 2008 in Southern Michigan Bancorp Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, Exhibit 10.14. Here incorporated by reference.
10.12	Guarantee Agreement of Southern Michigan Bancorp, Inc., dated March 25, 2004. Previously filed with the Commission on March 28, 2008 in Southern Michigan Bancorp Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, Exhibit 10.15. Here incorporated by reference.
10.13*	Form of Southern Michigan Bank & Trust 2011 Defined Contribution Supplemental Executive Retirement Plan. Previously filed with the Commission on December 28, 2011 in Southern Michigan Bancorp Inc.’s Current Report on Form 8-K, dated December 27, 2011, Exhibit 10.1. Here incorporated by reference.
21	Subsidiaries of Southern Michigan Bancorp, Inc.
23	Consent of CliftonLarsonAllen LLP -Independent Registered Public Accounting Firm.
24	Powers of Attorney.
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certification pursuant to 18 U.S.C. § 1350. This exhibit is furnished to, and not filed with, the Commission.
99.1	Annual Report to Shareholders for fiscal year ended December 31, 2011. This exhibit is furnished to, and not filed with, the Commission.
99.2	Proxy Statement for annual meeting to be held May 10, 2012. This exhibit is furnished to, and not filed with, the Commission.
99.3	Form of Proxy for annual meeting to be held May 10, 2012. This exhibit is furnished to, and not filed with, the Commission.
101.INS	XBRL Instance Document (1)
101.SCH	XBRL Taxonomy Extension Schema Document (1)
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document (1)
101.LAB	XBRL Taxonomy Extension Label Linkbase Document (1)

100

Exhibit Number	Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document (1)
101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document (1)

(1) As provided in Rule 406T of Regulation S-T, these exhibits are furnished to, and not filed with, the Commission.

* These documents are management contracts or compensation plans or arrangements required to be filed as exhibits to this Form 10-K.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.
By	/s/ John H. Castle	March 30, 2012
	John H. Castle
	Chairman and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/ John H. Castle	Chairman and Chief Executive	March 30, 2012
John H. Castle	Officer (Principal Executive Officer)
/s/ Kurt G. Miller	President and Director	March 30, 2012
Kurt G. Miller
/s/ Danice L. Chartrand	Senior Vice President, Chief	March 30, 2012
Danice L. Chartrand	Financial Officer, Secretary and
	Treasurer (Principal Financial and
	Accounting Officer)
/s/ Dean Calhoun	Director	March 30, 2012
Dean Calhoun*
/s/ John S. Carton	Director	March 30, 2012
John S. Carton*
/s/ H. Kenneth Cole	Director	March 30, 2012
H. Kenneth Cole*
/s/ Gary H. Haberl	Director	March 30, 2012
Gary H. Haberl*
/s/ Nolan E. Hooker	Director	March 30, 2012
Nolan E. Hooker*

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/s/ Gregory J. Hull	Director	March 30, 2012
Gregory J. Hull*
/s/ Thomas E. Kolassa	Director	March 30, 2012
Thomas E. Kolassa*
/s/ Donald J. Labrecque	Director	March 30, 2012
Donald J. Labrecque*
/s/ Brian P. McConnell	Director	March 30, 2012
Brian P. McConnell*
/s/ Thomas D. Meyer	Director	March 30, 2012
Thomas D. Meyer*
/s/ Freeman E. Riddle	Director	March 30, 2012
Freeman E. Riddle*

*By	/s/ John H. Castle
	John H. Castle, Attorney-in-Fact

103