UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

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

Commission File Number: 000-49772

SOUTHERN MICHIGAN BANCORP, INC.

(Exact Name of Registrant as Specified in its Charter)

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

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

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

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

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 o		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company þ

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

The number of shares outstanding of the Registrant’s Common Stock, $2.50 par value, as of August 12, 2011, was 2,358,599 shares.

 

 

Forward-Looking Statements

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

Risk factors include, but are not limited to, the risk factors described in “Item 1A — Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2010. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

Part I. Financial Information

Item 1. Financial Statements

Southern Michigan Bancorp, Inc.
Unaudited Interim Financial Statements

Consolidated Balance Sheets (Unaudited)
(In thousands, except share data)

		June 30,				December 31,
		2011				2010
ASSETS
Cash and cash equivalents		$	44,935			$	78,833
Federal funds sold			312				275
Securities available for sale			88,015				59,228
Loans held for sale			608				2,637
Loans, net of allowance for loan losses of $5,402 - 2011 ($5,694 - 2010)			300,219				303,830
Premises and equipment, net			12,397				12,599
Accrued interest receivable			2,053				2,107
Net cash surrender value of life insurance			10,129				9,965
Goodwill			13,422				13,422
Other intangible assets, net			1,836				2,005
Other assets			7,394				8,979
TOTAL ASSETS		$	481,320			$	493,880
LIABILITIES
Deposits:
Non-interest bearing		$	60,911			$	59,942
Interest bearing			336,204				349,959
Total deposits			397,115				409,901
Securities sold under agreements to repurchase and overnight borrowings			15,171				15,027
Accrued expenses and other liabilities			4,077				4,476
Other borrowings			8,676				10,079
Subordinated debentures			5,155				5,155
Common stock subject to repurchase obligation in Employee Stock Ownership Plan, shares outstanding — 110,506 in 2011 (107,627 shares in 2010)			1,381				1,399
Total liabilities			431,575				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) — 2,248,093 shares in 2011 (2,233,090 shares in 2010)			5,620				5,583
Additional paid-in capital			18,084				18,033
Retained earnings			25,967				24,692
Accumulated other comprehensive income (loss), net			339				(168	)
Unearned Employee Stock Ownership Plan shares			(265	)			(297	)
Total shareholders’ equity			49,745				47,843
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	481,320			$	493,880

See accompanying notes to interim consolidated financial statements.

Southern Michigan Bancorp, Inc.
Consolidated Statements of Income (Unaudited)
(In thousands, except per share data)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Interest income:
Loans, including fees		$	4,386			$	4,748			$	8,847			$	9,549
Securities:
Taxable			171				142				309				323
Tax-exempt			218				198				434				402
Other			47				34				98				57
Total interest income			4,822				5,122				9,688				10,331
Interest expense:
Deposits			803				934				1,647				1,935
Other			148				175				307				343
Total interest expense			951				1,109				1,954				2,278
Net interest income			3,871				4,013				7,734				8,053
Provision for loan losses			375				150				500				350
Net interest income after provision for loan losses			3,496				3,863				7,234				7,703
Non-interest income:
Service charges on deposit accounts			568				612				1,079				1,182
Trust fees			293				243				568				496
Net gains on security calls and sales			—				207				2				207
Net gains on loan sales			205				161				522				281
Earnings on life insurance assets			84				76				164				150
Gain on life insurance proceeds			—				—				—				156
Income from loan servicing			128				85				225				163
ATM and debit card fee income			257				218				492				425
Other			119				112				257				278
Total non-interest income			1,654				1,714				3,309				3,338
Non-interest expense:
Salaries and employee benefits			2,346				2,437				4,884				4,938
Occupancy, net			336				363				709				744
Equipment			204				233				407				454
Printing, postage and supplies			102				146				243				291
Telecommunication expenses			98				96				197				174
Professional and outside services			199				232				420				525
FDIC assessments			110				147				275				316
Software maintenance			110				97				215				208
Amortization of other intangibles			84				88				169				175
Expenses relating to OREO property			86				154				131				352
ATM expenses			92				83				174				164
Other			421				481				820				906
Total non-interest expense			4,188				4,557				8,644				9,247
INCOME BEFORE INCOME TAXES			962				1,020				1,899				1,794
Federal income tax provision			200				217				389				289
NET INCOME		$	762			$	803			$	1,510			$	1,505
Basic Earnings Per Common Share		$	0.33			$	0.35			$	0.65			$	0.65
Diluted Earnings Per Common Share			0.33				0.35				0.65				0.65
Dividends Declared Per Common Share			0.05				0.05				0.10				0.10

See accompanying notes to interim consolidated financial statements.

Southern Michigan Bancorp, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
(In thousands, except number of shares and per share data)
For the Six Months Ended June 30, 2011 and 2010

														Accumulated
														Other
						Additional								Comprehensive				Unearned
		Common				Paid-In				Retained				Income (Loss),				ESOP
		Stock				Capital				Earnings				Net				Shares				Total
Balance at January 1, 2010		$	5,553			$	18,363			$	22,062			$	193			$	(437	)		$	45,734
Comprehensive income:
Net income											1,505												1,505
Net change in other comprehensive income items															(119	)							(119	)
Total comprehensive income																							1,386
Cash dividends declared — $.10 per share											(234	)											(234	)
Issuance of restricted stock (18,325 shares of common stock at $10.10 per share)			46				(46	)															—
Vesting of restricted stock							37																37
Forfeiture of restricted stock (1,018 shares)			(2	)			2																—
Change in common stock subject to repurchase			(9	)			(338	)															(347	)
Reduction of ESOP obligation																			59				59
Stock option expense							38																38
Balance at June 30, 2010		$	5,588			$	18,056			$	23,333			$	74			$	(378	)		$	46,673
Balance at January 1, 2011		$	5,583			$	18,033			$	24,692			$	(168	)		$	(297	)		$	47,843
Comprehensive income:
Net income											1,510												1,510
Net change in other comprehensive income items															507								507
Total comprehensive income																							2,017
Cash dividends declared — $.10 per share											(235	)											(235	)
Vesting of restricted stock							40																40
Forfeiture of restricted stock (643 shares)			(2	)			2																—
Change in common stock subject to repurchase			(7	)			25																18
Issuance of restricted stock (18,525 shares of common stock at $12.70)			46				(46	)															—
Reduction of ESOP obligation																			32				32
Stock option expense							30																30
Balance at June 30, 2011		$	5,620			$	18,084			$	25,967			$	339			$	(265	)		$	49,745

See accompanying notes to interim consolidated financial statements.

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

		Six Months Ended June 30,
		2011				2010
Operating Activities
Net income		$	1,510			$	1,505
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses			500				350
Depreciation			448				505
Net amortization of investment securities			229				253
Loans originated for sale			(16,608	)			(13,167	)
Proceeds on loans sold			19,159				12,613
Net gains on loan sales			(522	)			(281	)
Gain on life insurance proceeds			—				(156	)
Stock option and restricted stock grant compensation expense			70				75
Net gains on security calls and sales			(2	)			(207	)
Net loss from sale or write down of other real estate owned and repossessed assets			105				269
Amortization of other intangible assets			169				175
Net loss on disposal of premises and equipment			7				5
Net change in obligation under ESOP			32				59
Net change in:
Accrued interest receivable			54				164
Cash surrender value			(164	)			(150	)
Other assets			905				159
Accrued expenses and other liabilities			(399	)			471
Net cash from operating activities			5,493				2,642
Investing Activities
Activity in available for sale securities:
Proceeds on securities sold			—				7,445
Proceeds from maturities and calls			17,490				19,401
Purchases			(45,736	)			(25,196	)
Net change in federal funds sold			(37	)			653
Loan originations and payments, net			3,003				7,909
Proceeds from life insurance			—				421
Proceeds from sale of other real estate owned and repossessed assets			422				459
Proceeds from sale of equipment			57				2
Additions to premises and equipment			(310	)			(483	)
Net cash from investing activities			(25,111	)			10,611
Financing Activities
Net change in deposits			(12,786	)			4,831
Net change in securities sold under agreements to repurchase and overnight borrowings			144				100
Proceeds from other borrowings			—				5,000
Repayments of other borrowings			(1,403	)			(5,341	)
Cash dividends paid			(235	)			(234	)
Net cash from financing activities			(14,280	)			4,356
Net change in cash and cash equivalents			(33,898	)			17,609
Beginning cash and cash equivalents			78,833				24,814
Ending cash and cash equivalents		$	44,935			$	42,423
Cash paid for interest		$	1,970			$	2,326
Cash paid for income taxes			200				70
Transfers from loans to other real estate owned			108				355

See accompanying notes to interim consolidated financial statements.

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

NOTE A — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary in order to make the financial statements not misleading have been included. Operating results for the six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

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

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.

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 less recoveries. Estimating the risk of loss and the amount of loss on any loan is necessarily subjective. Accordingly, 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.

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.

Impaired Loans: 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 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 that all principal and interest amounts

will not be collected according to the original terms of the loan. Loans for which the terms have been modified and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and are classified as impaired. All nonaccrual loans have also been determined by the Company to meet the definition of an impaired loan.

Reclassifications

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

NOTE B — NEW ACCOUNTING PRONOUNCEMENTS

Adoption of New Accounting Standards: In July 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (ASU) No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses which increases disclosures made about the credit quality of loans and the allowance for credit losses. The disclosures provide additional information about the nature of credit risk inherent in the Company’s loans, how credit risk is analyzed and assessed, and the reasons for the change in the allowance for loan losses. The expanded disclosure requirements of ASU 2010-20 were disclosed in the Company’s December 31, 2010 consolidated financial statements. Other required disclosures about activity that occurs during an interim reporting period are effective for periods beginning on or after December 15, 2010, and are disclosed for the period ended June 30, 2011 in Note D.

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

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

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

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 does not anticipate early adoption of ASU 2011-05.

NOTE C — EARNINGS PER SHARE

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

A reconciliation of the numerators and denominators of basic and diluted earnings per share for the three and six month periods ended June 30, 2011 and 2010 is as follows (dollars in thousands, except per share data):

		Three Months				Three Months				Six Months				Six Months
		Ended				Ended				Ended				Ended
		June 30,				June 30,				June 30,				June 30,
		2011				2010				2011				2010
Basic earnings per share:
Net income		$	762			$	803			$	1,510			$	1,505
Weighted average common shares outstanding			2,344,838				2,340,717				2,342,964				2,338,437
Less unallocated ESOP shares			21,962				28,181				22,915				28,600
Weighted average common shares outstanding for basic earnings per share			2,322,876				2,312,536				2,320,049				2,309,837
Basic earnings per share		$	0.33			$	0.35			$	0.65			$	0.65
Diluted earnings per share:
Net income		$	762			$	803			$	1,510			$	1,505
Weighted average common shares outstanding for basic earnings per share			2,322,876				2,312,536				2,320,049				2,309,837
Add: Dilutive effect of assumed exercise of stock options			4,397				3,520				4,565				2,954
Weighted average common and dilutive potential common shares outstanding			2,327,273				2,316,056				2,324,614				2,312,791
Diluted earnings per share		$	0.33			$	0.35			$	0.65			$	0.65

Stock option awards that were anti-dilutive, and therefore not included in the computation of earnings per share, were as follows: 191,886 and 197,702 as of June 30, 2011 and 2010, respectively.

NOTE D — ALLOWANCE FOR LOAN LOSSES

In evaluating the allowance for loan losses, loans are analyzed based on the department originating the loan, which in some instances may be different than how the (commercial, mortgage or consumer) loans are categorized for regulatory reporting purposes. Required disclosures about activity in the allowance for loan losses for reporting periods subsequent to December 15, 2010 are provided below for the six months ended June 30, 2011. The following is an analysis of the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of and for the six month period ended June 30, 2011 and as of December 31, 2010, as well as summary activity in the allowance for loan losses for the quarter ended June 30, 2010 (in thousands):

		2011
														Real
		Commercial								Real Estate				Estate
June 30, 2011		including								Mortgage				Mortgage
Allowance for Loan Losses:		CRE				Consumer				1st Lien				Junior Lien				Total				2010
Balance at January 1		$	4,239			$	86			$	1,211			$	158			$	5,694			$	6,075
Provision for loan losses			175				31				149				145				500				350
Loans charged off			(523	)			(40	)			(241	)			(105	)			(909	)			(799	)
Recoveries			101				5				8				3				117				100
Balance at June 30		$	3,992			$	82			$	1,127			$	201			$	5,402			$	5,726
Ending balance individually evaluated for impairment		$	817				—			$	232			$	13			$	1,062
Ending balance collectively evaluated for impairment		$	3,175			$	82			$	895			$	188			$	4,340
Total Loans:
Ending balance		$	216,699			$	8,512			$	67,036			$	13,374			$	305,621
Ending balance individually evaluated for impairment		$	7,071			$	39			$	3,041			$	44			$	10,195
Ending balance collectively evaluated for impairment		$	209,628			$	8,473			$	63,995			$	13,330			$	295,426

Commercial loans also include demand deposit loan account charge-offs and recoveries amounting to $78,000 and $42,000, respectively, for the six months ended June 30, 2011.

														Real
														Estate
		Commercial								Real Estate				Mortgage
December 31, 2010		including								Mortgage				Junior
Allowance for Loan Losses:		CRE				Consumer				1st Lien				Lien				Total
Ending balance individually evaluated for impairment		$	867				—			$	300			$	4			$	1,171
Ending balance collectively evaluated for impairment		$	3,372			$	87			$	911			$	153			$	4,523
Total		$	4,239			$	87			$	1,211			$	157			$	5,694
Total Loans:
Ending balance		$	216,401			$	9,849			$	69,437			$	13,837			$	309,524
Ending balance individually evaluated for impairment		$	7,676			$	87			$	2,881			$	122			$	10,766
Ending balance collectively evaluated for impairment		$	208,725			$	9,762			$	66,556			$	13,715			$	298,758

The following tables present loans individually evaluated for impairment by class of loans as of June 30, 2011 and December 31, 2010 (in thousands):

		Unpaid				Allowance for
		Principal				Loan Losses
June 30, 2011		Balance				Allocated
With no related allowance recorded:
Commercial		$	118			$	—
Real estate — commercial			2,900				—
Real estate — construction			157				—
Consumer			39				—
Real estate mortgage			2,296				—
With an allowance recorded:
Commercial			863				157
Real estate — commercial			1,525				407
Real estate — construction			79				4
Consumer			—				—
Real estate mortgage			2,218				494
Total		$	10,195			$	1,062

		Unpaid				Allowance for
		Principal				Loan Losses
December 31, 2010		Balance				Allocated
With no related allowance recorded:
		$
Commercial			608			$	—
Real estate — commercial			2,685				—
Real estate — construction			—				—
Consumer			87				—
Real estate mortgage			2,495				—
With an allowance recorded:
Commercial			588				99
Real estate — commercial			1,823				413
Real estate — construction			583				173
Consumer			—				—
Real estate mortgage			1,897				486
Total		$	10,766			$	1,171

The following table presents the aging of the recorded investment in past due and nonaccrual loans for the year to date periods ended June 30, 2011 and December 31, 2010 by class of loans (in thousands):

										Greater than								Loans Not
						60-89				90 Days Past				Total Past				Past Due
		30-59 Days				Days Past				Due & Non				Due &Non				or Non
June 30, 2011		Past Due				Due				Accrual				Accrual				Accrual				Total
Commercial		$	57			$	—			$	436			$	493			$	55,533			$	56,026
Real estate — commercial			51				—				3,288				3,339				136,772				140,111
Real estate — construction			134				—				236				370				11,809				12,179
Consumer			65				12				40				117				8,726				8,843
Real estate mortgage			499				—				2,534				3,033				85,429				88,462
Total		$	806			$	12			$	6,534			$	7,352			$	298,269			$	305,621

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

Troubled Debt Restructurings:

The Company has allocated $311,000 and $379,000 of specific reserves to customers whose loan terms have been modified as of June 30, 2011 and December 31, 2010, respectively. The Company intends to lend no additional amounts to these customers.

Credit Quality Indicators:

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

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the 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 June 30, 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):

						Special												Not Risk
June 30, 2011		Pass				Mention				Substandard				Doubtful				Rated				Total
Commercial		$	42,916			$	8,161			$	4,949			$	—			$	—			$	56,026
Real estate — commercial			116,789				14,199				8,199				368				556				140,111
Real estate — construction			6,504				1,045				625				—				4,005				12,179
Real estate — mortgage			7,435				1,147				3,263				—				76,617				88,462
Consumer			—				—				—				—				8,843				8,843
Total		$	173,644			$	24,552			$	17,036			$	368			$	90,021			$	305,621

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

NOTE E — STOCK OPTIONS

Shareholders of the Company approved a stock option plan in April 2000 and a stock incentive plan in June 2005. The plans authorized the Company to issue up to 115,500 and 157,500 shares, respectively. In May 2008, shareholders of the Company ratified amendments to the Stock Incentive Plan of 2005, which among other things increased the authorized shares for issuance from 157,500 to 300,000. On March 20, 2010, the April 2000 stock option plan terminated. As of June 30, 2011, there were 99,007 shares available for future issuance under the 2005 plan.

A summary of stock option activity is as follows for the six months ended June 30, 2011:

						Weighted Average
		Shares				Price
Outstanding at beginning of year			218,977			$	21.29
Granted			8,075				12.70
Exercised			—				—
Forfeited			6,026				18.23
Outstanding at June 30, 2011			221,026			$	21.06
Options exercisable at June 30, 2011			141,276			$	20.85

The Company recorded compensation expense of $30,000 and $38,000, respectively, related to stock options during the six month periods ended June 30, 2011 and 2010.

Restricted Stock — Shares of restricted stock may also be granted under the Stock Incentive Plan of 2005. Compensation expense is recognized over the vesting period of the shares based on the market value of the shares on the grant date. All shares of restricted stock issued and outstanding vest 20% per year over five years. Compensation expense related to the award of shares of restricted stock was $40,000 and $37,000, respectively, during the six months ended June 30, 2011 and 2010. As of June 30, 2011, there was $440,000 of total unrecognized compensation expense related to non-vested shares of restricted stock granted under the plan, which is expected to be recognized over a weighted average period of 4.0 years.

						Weighted
						Average
						Grant
						Date Fair
		Shares				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 June 30, 2011			41,309			$	11.33

NOTE F — FAIR VALUE INFORMATION

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

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

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

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

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

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

Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of expected monthly maturities on time deposits.

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

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

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

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

While these estimates of fair value are based on management’s judgment of appropriate factors, there is no assurance that if the Company had disposed of such items at June 30, 2011 or December 31, 2010, the estimated fair values would have been realized. Market values may differ depending on various circumstances not taken into consideration in this methodology. The estimated fair values at June 30, 2011 and December 31, 2010, should not be considered to apply at subsequent dates.

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

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

		June 30, 2011								December 31, 2010
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
Financial assets:
Cash and cash equivalents		$	44,935			$	44,935			$	78,833			$	78,833
Federal funds sold			312				312				275				275
Securities available for sale			88,015				88,015				59,228				59,228
Loans held for sale			608				608				2,637				2,637
Loans, net of allowance for loan losses			300,219				303,684				303,830				307,946
Accrued interest receivable			2,053				2,053				2,107				2,107
Financial liabilities:
Deposits		$	(397,115	)		$	(399,537	)		$	(409,901	)		$	(406,143	)
Securities sold under agreements to repurchase and overnight borrowings			(15,171	)			(15,171	)			(15,027	)			(15,027	)
Other borrowings			(8,676	)			(8,836	)			(10,079	)			(9,835	)
Subordinated debentures			(5,155	)			(5,155	)			(5,155	)			(5,155	)
Accrued interest payable			(155	)			(155	)			(171	)			(171	)