10-K

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

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FORM 10-K

For Annual and Transaction Reports Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006
OR
[ ] 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 000-30521

PAVILION BANCORP, INC.
(Exact name of registrant as specified in its charter)

Michigan
(State or other jurisdiction of
Incorporation or organization)

135 East Maumee Street
Adrian, Michigan
(Address of principal executive offices) 38-3088340
(I.R.S. Employer Identification No.)


49221
(Zip Code)

517-265-5144
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value

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 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 amendments to this Form 10-K. [__]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” (in Rule 12b-2 of the Exchange Act). (Check one:)

Large Accelerated Filer [__]     Accelerated Filer [__]     Non-Accelerated Filer [ X ]

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

State the aggregate market value of the voting and nonvoting common equity held by nonaffiliates computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.

Aggregate Market Value as of June 30, 2006: $33,522,808

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Common stock outstanding at March 9, 2007: 727,852 shares.

Documents Incorporated by Reference

Portions of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held April 19, 2007 are incorporated by reference into Parts II and III of this report.

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Item 1. Business.

        Pavilion Bancorp, Inc. (the “Company”), which was incorporated in Michigan in 1993, is a one-bank holding company that has as its wholly-owned bank subsidiary the Bank of Lenawee (the “Bank”). On April 15, 1993, the Company acquired all of the stock of the Bank of Lenawee, a Michigan banking corporation chartered in 1869. On January 1, 2001 the Bank of Lenawee made the real estate origination component of its business a separate entity named Pavilion Mortgage Company. On April 22, 2002, the Company changed its name from Lenawee Bancorp, Inc. to Pavilion Bancorp, Inc. On October 29, 2004, the Company completed the sale of its former subsidiary, the Bank of Washtenaw, to Community Bancorp, Inc. Please refer to Note 16 to the Company’s financial statements for additional information regarding this transaction. The Company’s financial statements and accompanying notes are incorporated by reference as specified in Item 8, Financial Statements and Supplementary Data, of the Report.

        Business is concentrated primarily in a single industry segment — commercial banking. The Bank provides a full range of banking services to individuals, commercial businesses and industries located in its service area. The Bank maintains a diversified loan portfolio, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. The Bank offers a variety of deposit products, including checking, savings, money market, individual retirement accounts and certificates of deposit.

        The principal markets for financial services are the southern-Michigan communities in which the Bank is located and the areas immediately surrounding these communities. The Bank serves these markets through 7 locations in or near their communities. The Bank does not have any material foreign assets or income.

        The principal source of revenue is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 80.7% of total revenue in 2006 compared to 77.0% in 2005.

        The Bank’s principal competitors are United Bank & Trust, Key Bank, Sky Bank, LaSalle Bank, and TLC Community Credit Union. With the exception of United Bank & Trust and TLC Community Credit Union, each of these financial institutions has headquarters in larger metropolitan areas. Generally, the Bank’s competitors have significantly greater assets and financial resources than the Company. Based on deposit information as of June 30, 2006, the Bank of Lenawee holds an estimated 21.7% of the FDIC insured deposits in Lenawee County. Information as to asset size of competitor financial institutions is derived from publicly available reports filed by and with regulatory agencies.

SUPERVISION AND REGULATION

        The following is a summary of certain statutes and regulations affecting the Company and the Bank. This summary is qualified in its entirety by such statutes and regulations. A change in applicable laws or regulations may have a material effect on the Company, the Bank and the business of the Company and the Bank.

General

        Financial institutions and their holding companies are extensively regulated under federal and state law. Consequently, the growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. Those authorities include, but are not limited to, the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), the FDIC, the Commissioner of the Michigan Office of Financial and Insurance Services (“Commissioner”), the Internal Revenue Service, and state taxing authorities. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.

        Federal and state laws and regulations generally applicable to financial institutions and their holding companies regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, lending activities and practices, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds, the depositors of the Bank, and the public, rather than shareholders of the Bank or the Company.

        Federal law and regulations establish supervisory standards applicable to the lending activities of the Bank, including internal controls, credit underwriting, loan documentation and loan-to-value ratios for loans secured by real property.

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The Company

        General. The Company is a bank holding company and, as such, is registered with, and subject to regulation by, the Federal Reserve Board under the Bank Holding Company Act, as amended (the “BHCA”). Under the BHCA, the Company is subject to periodic examination by the Federal Reserve Board, and is required to file with the Federal Reserve Board periodic reports of its operations and such additional information as the Federal Reserve Board may require.

        In accordance with Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not do so absent such policy. In addition, if the Commissioner deems the Bank’s capital to be impaired, the Commissioner may require the Bank to restore its capital by a special assessment upon the Company as the Bank’s sole shareholder. If the Company were to fail to pay any such assessment, the directors of the Bank would be required, under Michigan law, to sell the shares of the Bank’s stock owned by the Company to the highest bidder at either a public or private auction and use the proceeds of the sale to restore the Bank’s capital.

        Investments and Activities. In general, any direct or indirect acquisition by the Company of any voting shares of any bank which would result in the Company’s direct or indirect ownership or control of more than 5% of any class of voting shares of such bank, and any merger or consolidation of the Company with another bank company, will require the prior written approval of the Federal Reserve Board under the BHCA. In acting on such applications, the Federal Reserve Board must consider various statutory factors, including among others, the effect of the proposed transaction on competition in relevant geographic and product markets, and each party’s financial condition, managerial resources, and record of performance under the Community Reinvestment Act.

        The merger or consolidation of an existing bank subsidiary of the Company with another bank, or the acquisition by such a subsidiary of assets of another bank, or the assumption of liability by such a subsidiary to pay any deposits in another bank, will require the prior written approval of the responsible federal depository institution regulatory agency under the Bank Merger Act, based upon a consideration of statutory factors similar to those outlined above with respect to the BHCA. In addition, in certain such cases an application to, and the prior approval of, the Federal Reserve Board under the BHCA and/or the Commissioner under the Michigan Banking Code, may be required.

        With certain limited exceptions, the BHCA prohibits any bank holding company from engaging, either directly or indirectly through a subsidiary, in any activity other than managing or controlling banks unless the proposed non-banking activity is one that the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under current Federal Reserve Board regulations, such permissible non-banking activities include such things as mortgage banking, equipment leasing, securities brokerage, and consumer and commercial finance company operations. Well-capitalized and well-managed bank holding companies may engage de novo in certain types of non-banking activities without prior notice to, or approval of, the Federal Reserve Board, provided that written notice of the new activity is given to the Federal Reserve Board within 10 business days after the activity is commenced. If a bank holding company wishes to engage in a non-banking activity by acquiring a going concern, prior notice and/or prior approval will be required, depending upon the activities in which the company to be acquired is engaged, the size of the company to be acquired and the financial and managerial condition of the acquiring bank holding company.

        Eligible bank holding companies that elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance activities and any other activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank or financial holding companies. While the Company believes it is eligible to elect to operate as a financial holding company, as of the date of this filing, it has not applied for approval to operate as a financial holding company.

        The Company’s common stock is registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). It is therefore subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act provides for numerous changes to the reporting, accounting, corporate governance and business practices of companies as well as financial and other professionals who have involvement with the U.S. public markets. The Company is subject to all of these new requirements as well as SEC rules and regulations that implement the provisions of the Act.

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        Capital Requirements. 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 things, be denied approval to acquire or establish additional banks or non-bank businesses. In the first quarter of 2006, the Board of Governors of the Federal Reserve System increased the asset size threshold from $150 million to $500 million in consolidated assets for determining whether a Bank Holding Company may qualify for an exemption from the Capital Guidelines. Therefore, the Company is currently exempt from the Capital Guidelines based on the revised threshold. This change only impacts the Company and the Bank must continue to comply with relevant Capital Guidelines.

        The Federal Reserve Board’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a leverage capital requirement expressed as a percentage of total average assets, and (ii) a risk-based requirement expressed as a percentage of total risk-weighted assets. The leverage capital requirement consists of a minimum ratio of Tier 1 capital (which consists principally of shareholders’ equity) to total average assets of 3% for the most highly rated companies, with minimum requirements of 4% to 5% for all others. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital.

        The risk-based and leverage standards presently used by the Federal Reserve Board are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations.

        Dividends. The Company is a corporation separate and distinct from the Bank. Most of the Company’s revenues are received by it in the form of dividends paid by the Bank. Thus, the Company’s ability to pay dividends to its shareholders is indirectly limited by statutory restrictions on the Bank’s ability to pay dividends described below. Further, the Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies. In the policy statement, the Federal Reserve Board expressed its view that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. Additionally, the Federal Reserve Board 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. The Federal Reserve Board has similar enforcement powers over the Bank. The “prompt corrective action” provisions of federal law and regulation authorizes the Federal Reserve Board to restrict the payment of dividends by the Company for an insured bank which fails to meet specified capital levels.

        In addition to the restrictions on dividends imposed by the Federal Reserve Board, the Michigan Business Corporation Act provides that dividends may be legally declared or paid only if after the distribution a corporation, such as the Company, can pay its debts as they come due in the usual course of business and its total assets equal or exceed the sum of its liabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of any holders of preferred stock whose preferential rights are superior to those receiving the distribution. The Company’s Articles of Incorporation do not authorize the issuance of preferred stock and there are no current plans to seek such authorization.

The Bank

        General. The Bank is a Michigan banking corporation, a member of the Federal Reserve System and its deposit accounts are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC. As a Federal Reserve System member and Michigan chartered bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the Federal Reserve Board as its primary federal regulator and the Commissioner, as the chartering authority for Michigan banks. These agencies and the federal and state laws applicable to the Bank and its operations, extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of non-interest bearing reserves on deposit accounts, and the safety and soundness of banking practices.

        Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The federal deposit insurance system was overhauled in 2006 as a result of the enactment of The Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), which was signed into law in February of 2006. Pursuant to the Reform Act, the FDIC has modified its risk-based assessment system for deposit insurance premiums. Under the new system, all insured depository institutions are placed into one of four categories and assessed insurance premiums based primarily on their level of capital and supervisory evaluations.

        The Reform Act requires the FDIC to establish assessment rates for insured depository institutions at levels that will maintain the Deposit Insurance Fund at a Designated Reserve Ratio (DRR) selected by the FDIC within a range of 1.15% to 1.50%. The Reform Act allows the FDIC to manage the pace at which the reserve ratio varies within this range. Effective January 1, 2007, the FDIC established the DRR at 1.25% and adopted new premium rates for 2007. Banks that have not been paying any deposit insurance premiums for the past 10 years will now be required to pay premiums of 5 to 7 basis points (calculated against the bank's deposit base) in 2007. Under the new rate schedule, most well-capitalized banks will pay 5 to 7 basis points annually. That rate increases to 43 basis points for banks that pose significant supervisory concerns. Premiums will be assessed and collected quarterly by the FDIC.

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        These premiums will be initially offset for certain eligible institutions by a one-time assessment credit granted in recognition of historical contributions made by the eligible institutions to the deposit fund. The credit may be applied against the institution's 2007 assessment, and for the three years thereafter, the institution may apply the credit against up to 90% of its assessment. The preliminary estimate issued by the FDIC is that the Bank will qualify for a credit of approximately $219,000; this is an estimate only and is subject to final confirmation by the FDIC.

        FICO Assessments. The Bank, as a member of the DIF, is subject to assessments to cover the payments on outstanding obligations of the Financing Corporation (“FICO”). FICO was created to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the predecessor to the SAIF, to insure the deposits of thrift institutions. From now until the maturity of the outstanding FICO obligations in 2019, DIF members will share the cost of the interest on the FICO bonds on a pro rata basis. It is estimated that FICO assessments during this period will be less than 0.025% of deposits.

        Commissioner Assessments. Michigan banks are required to pay supervisory fees to the Commissioner to fund the operations of the Commissioner. The amount of supervisory fees paid by a bank is based upon the bank’s total assets, as reported to the Commissioner.

        Capital Requirements. The Federal Reserve has established the following minimum capital standards for state-chartered, member banks, such as the Bank: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total average assets of 3% for the most highly-rated banks with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of shareholders’ equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, Federal Reserve regulations provide that higher capital may be required to take adequate account of, among other things, interest rate risk and the risks posed by concentrations of credit, nontraditional activities or securities trading activities.

        Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Federal regulations define these capital categories as follows:

Well capitalized
Adequately capitalized
Undercapitalized
Significantly undercapitalized
Critically undercapitalized Total
Risk-Based
Capital Ratio

10% or above
 8% or above
Less than 8%
Less than 6%
          -- Tier 1
Risk-Based
Capital Ratio

6% or above
4% or above
Less than 4%
Less than 3%
          --

Leverage Ratio

5% or above
4% or above
Less than 4%
Less than 3%
A ratio of tangible equity to
total assets of 2% or less

        As of December 31, 2006, the Bank’s ratios exceeded minimum requirements for the well capitalized category.

        Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: requiring the submission of a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.

        In general, a depository institution may be reclassified to a lower category than is indicated by its capital levels if the appropriate federal depository institution regulatory agency determines the institution to be otherwise in an unsafe or unsound condition or to be engaged in an unsafe or unsound practice. This could include a failure by the institution, following receipt of a less-than-satisfactory rating on its most recent examination report, to correct the deficiency.

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        Dividends. Under Michigan law, the Bank is restricted as to the maximum amount of dividends it may pay on its common stock. The Bank may not pay dividends except out of net income then on hand after deducting its losses and bad debts. A Michigan state bank may not declare or pay a dividend unless the bank will have surplus amounting to at least 20% of its capital after the payment of the dividend.

        As a member of the Federal Reserve System, the Bank is required by federal law to obtain the prior approval of the Federal Reserve Board for the declaration or payment of a dividend, if the total of all dividends declared by the Bank’s Board of Directors in any year will exceed the total of (i) the Bank’s retained net income (as defined and interpreted by regulation) for that year plus (ii) the retained net income for the preceding two years, less any required transfers to surplus. Federal law generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Further, federal regulatory agencies can prohibit a banking institution or bank holding company from engaging in unsafe and unsound business practices and could prohibit payment of dividends if such payment could be deemed an unsafe and unsound business practice.

        Insider Transactions. The Bank is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the Company or its subsidiaries, on investments in the stock or other securities of the Company or its subsidiaries and on the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal shareholders of the Company, and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal shareholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.

        Safety and Soundness Standards. The federal banking agencies have adopted guidelines to promote the safety and soundness of federally insured depository institutions. These guidelines establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

        Investments and Other Activities. Under federal law and regulations, Federal Reserve System member banks and FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law, as implemented by regulations, also prohibits state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the bank’s primary federal regulator determines the activity would not pose a significant risk to the DIF. Impermissible investments and activities must be divested or discontinued within certain time frames set by the bank’s primary federal regulator in accordance with federal law. These restrictions are not currently expected to have a material impact on the operations of the Bank.

        Consumer Protection Laws. The Bank’s businesses include making a variety of types of loans to individuals. In making these loans, the Bank is subject to state usury and regulatory laws and to various federal statutes, including the privacy of consumer financial information provisions of the Gramm-Leach-Bliley Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, and the regulations promulgated under each of these statutes. These laws generally prohibit discrimination, specify disclosures to be made to borrowers regarding credit and settlement costs, and regulate the mortgage loan servicing activities of the Bank, including the maintenance and operation of escrow accounts and the transfer of mortgage loan servicing. In receiving deposits, the Bank is subject to extensive regulation under State and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon the Bank and its directors and officers.

        Branching Authority. The Bank has authority under Michigan law to establish branches anywhere in the State of Michigan, subject to receipt of all required regulatory approvals.

        Banks may establish interstate branch networks through acquisitions of 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.

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        Michigan permits both U.S. and non-U.S. banks to establish branch offices in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the Commissioner, (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.

Item 1A. Risk Factors.

        You should carefully consider the following risk factors, together with the other information provided in this Annual Report on Form 10-K.

        Changes in economic conditions or interest rates may negatively affect the Company’s earnings, capital, and liquidity.

        The results of operations for financial institutions, including the Bank, may be materially and adversely affected by changes in national, state, and local economic conditions. Substantially all of the Bank’s (and its subsidiary mortgage company’s) loans are to, and substantially all of the Bank’s deposits are from, businesses and individuals in southeastern Michigan. A further decline in the economy of this area could adversely affect the Company. The general economic condition of Michigan, and of southeastern Michigan in particular, is expected to be negatively affected by the troubled state of the automotive industry, including the bankruptcy of key automotive suppliers such as Delphi Corp. and Collins and Aikman and substantial layoffs and/or plant closings by General Motors and Ford Motor Company.

        In addition, the Bank’s profitability is heavily influenced by the spread between the interest rates it earns on loans and other investments and the interest rates it pays on deposits and other interest-bearing liabilities. Interest rates are generally increased and decreased by the Federal Reserve Board in an effort to stabilize the growth of the U.S. economy. Like most banking institutions, the Bank’s net interest spread and margin will be affected by these changes in market interest rates. The Bank’s profitability will depend on the Bank’s ability to manage its interest-bearing assets and liabilities to effectively manage these changes in market interest rates.

        The Bank’s allowance for loan and lease losses may not be adequate to cover actual losses.

        The Bank is exposed to the risk that its loan customers will be unable to repay their loans according to the agreed-upon loan terms and that any collateral securing the payment of such loans may not be sufficient to assure repayment. Credit losses are inherent in the lending business and could have a material adverse effect on the operating results of the Bank. The Bank makes various assumptions and judgments about its ability to fully collect all amounts outstanding in its loan portfolio and calculates an allowance for potential losses based on a number of factors. If the Bank’s assumptions in calculating the allowance for loan and lease losses are wrong, the allowance may not be sufficient to cover actual losses, which would have an adverse affect on the operating results of the Bank and may cause the Bank to have to increase the allowance in the future. The actual amount of future provisions for loan losses added to such allowance cannot now be determined and may exceed the amounts of past provisions. In addition, federal bank regulators may require the Bank to increase the allowance for loan and lease losses as a part of such regulators’ periodic review of the adequacy of such allowance. Any increase in the allowance for losses could have a negative effect on the Bank’s net income, financial condition, and results of operations.

        The Company continues to be subject to increased regulatory requirements imposed by the Sarbanes-Oxley Act of 2002, including a requirement that management attest to the Company’s internal controls over financial reporting, which attestation will be reviewed by the Company’s external auditors. These requirements represent increased costs to the Company over past periods.

        The Company is required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002 as well as new rules and regulations adopted by the SEC and the Public Company Accounting Oversight Board. In particular, unless extended, the Company will be required to include management reports on the effectiveness of internal controls over financial reporting as part of its annual report on Form 10-K for the year ended December 31, 2007, pursuant to Section 404 of the Sarbanes-Oxley Act. Management will be required to include an audit report by the independent registered public accountants for the year ended December 31, 2008. The Company expects to continue to spend significant amounts of time and money on compliance with these rules.

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        The Company’s financial condition and profitability is subject to various lending risks.

        Through the Bank and its subsidiaries, Pavilion Mortgage Company and Pavilion Financial Services, the Company is in the lending business. There is an inherent risk that loans made by the Bank and the mortgage company may not be repaid. Such risk is subject to a number of factors, including fluctuations in a borrower’s cash flow and declines in market values of collateral securing loans, which are out of the control of the Company. These factors are often heavily affected by the economic condition of the communities in which the borrowers are located and, as described above, the southeastern Michigan economy may continue to be adversely affected by the troubled automotive industry. The failure of the Bank and the mortgage company to fully collect outstanding loans may have a material adverse effect on the Company’s financial condition and profitability.

        The Company relies heavily on its management and other key personnel, and the loss of any of them may adversely effect its operations.

        The Company and Bank are dependent upon the services of a management team, including the President/Chief Executive Officer and the Chief Financial Officer of the Bank as well as other senior managers and commercial lenders. None of these key personnel are bound by any long-term employment agreement. Losing one or more key members of the management team could adversely affect the operations of the Company.

        The future success of the Company is dependent on its ability to compete effectively in the highly competitive banking industry.

        The Company faces substantial competition in all phases of its operations from a variety of different competitors. The future growth and success of the Company will depend on its ability to compete effectively in this highly competitive environment. The Bank competes for deposits, loans, and other financial services with numerous Michigan-based and out-of-state banks, thrifts, credit unions, and other financial institutions as well as other entities that provide financial services. Some of these competitors are not subject to the same degree of regulation as is the Bank. Many of these financial institutions aggressively compete for business in the Bank’s market area. The Bank’s primary competitors include United Bank & Trust, Key Bank, Sky Bank, LaSalle Bank, and TLC Community Credit Union. Several of the Bank’s competitors have significantly greater assets and financial resources than the Company. The competition in the financial services industry is likely to increase in the future as technological advances enable more companies to provide financial services.

        The Company’s business is subject to significant government regulation, and any regulatory changes may adversely affect the Company and its operations.

        The banking industry is heavily regulated under both federal and state law. These regulations are primarily intended to protect customers of the Bank and not the creditors or shareholders of the Company. As a bank holding company, the Company is subject to extensive regulation by the Federal Reserve Board, in addition to other regulatory and self-regulatory organizations. Regulations affecting the Company, the Bank, and the financial services industry in general are continuously changing, and such changes may have a material adverse effect on the profitability or financial condition of the Company.

        The Company’s operations may be affected by its ability to adapt to and take advantage of technological changes.

        The banking industry continues to experience rapid technological changes with frequent introductions of new technology-driven products and services. The success of the Company will depend in part on its ability to invest in technology resources and/or negotiate favorable contracts with third-party service providers to provide certain back office functions that benefit from technologically advanced resources. Many of the Company’s competitors have substantially greater resources to invest in technological improvements or to do so at a lower cost than is available to the Company. In addition, improvements in the ability to deliver financial products and services over the internet may continue to expand the Bank’s field of competition to institutions located outside of the Bank’s geographic market. There can be no assurance that the Company will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to its customers.

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        The Company’s ability to pay dividends is limited by law and contract.

        The Company is a single-bank holding company and substantially all of the Company’s assets are held by the Bank. The Company’s ability to continue to make dividend payments to shareholders will depend primarily on dividends from the Bank. Dividend payments from the Bank are subject to regulatory limitations, generally based on capital levels and current and retained earnings. See the subsections titled “Dividends” under “SUPERVISION AND REGULATION” above for more detail on the ability of the Bank and the Company to pay dividends. There can be no assurance that the Company will continue to pay dividends at the rate historically paid or at all.

        An investment in the Company’s common stock is relatively illiquid.

        There is only a very limited trading market for the Company’s common stock. A more active or consistent trading market is not expected to develop.

        The Company’s Articles of Incorporation and Bylaws and Michigan laws contain certain provisions that could make a takeover of the Company more difficult.

        The Articles of Incorporation and Bylaws of the Company, as well as Michigan law, include provisions designed to provide the Board of Directors of the Company with time to consider whether a hostile takeover offer for the Company is in the best interests of the Company and its shareholders. These provisions, however, could discourage potential acquisition proposals, could delay or prevent a change in control, and could prevent transactions in which shareholders of the Company might otherwise receive a premium for their shares over then current market prices. In addition, federal law requires the prior approval of the Federal Reserve Board to any acquisition of “control” of the Company. All of these provisions may have the effect of delaying or preventing a change in control of the Company without action by the shareholders of the Company, and therefore, could adversely affect the price of the Company’s common stock.

Item 1B.         Unresolved Staff Comments.

        Not applicable.

Item 2.   Properties.

        The Bank of Lenawee’s main office is located in Adrian and it serves other communities with branch offices in Hudson, Morenci, Tecumseh and Waldron. The Bank’s offices are located throughout Lenawee County and in the southeastern portion of Hillsdale County. The area in which the Bank’s offices are located, which is basically southeastern Michigan, has historically been rural in character but now has a growing urban population as residents choose the area to live in while commuting to Ann Arbor, Detroit, and Toledo. According to the 2005 Population Estimates from the U.S. Census Bureau, the populations of the cities in which the Bank’s offices are located were as follows: Adrian—21,784; Hudson—2,415; Morenci—2,352; Tecumseh—8,863; and Waldron—577; The main office of Bank of Lenawee is a three story 40,768 square foot building constructed in 1906. The Bank’s other offices range in size from 1,200 square feet to 4,000 square feet. With the exception of two branches, all of the offices of Bank of Lenawee are owned.

        The Bank opened a new branch in Hillsdale in January 2007. The Bank is in the process of building another branch office in Tecumseh, Michigan. This construction is expected to be completed in July of 2007.

Item 3.   Legal Proceedings.

        There are no legal proceedings except routine litigation incidental to the ordinary course of business. Although litigation is subject to many uncertainties and the ultimate exposure with respect to many of these matters cannot be ascertained, management does not believe the ultimate outcome of these matters will have a material effect on the financial condition of the Company or the Bank, individually or in the aggregate.

Item 4.   Submission of Matters to Vote of Security Holders.

        No matters were submitted to a vote of the Company’s security holders during the fourth quarter of 2006.

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Additional Item: Executive Officers of Registrant

        The following information concerning executive officers of the Company has been omitted from the Registrant’s proxy statement pursuant to Instruction 3 to Regulation S-K, Item 401(b).

        Officers of the Company are appointed annually by the Board of Directors of the Company and serve at the pleasure of the Board of Directors. Information concerning these executive officers is given below:

        Richard J. DeVries (age 51) was appointed to the Board of Directors of the Company and was promoted to President and Chief Executive Officer of the Company on December 10, 2004. Mr. DeVries joined the Company as the President and CEO of Bank of Lenawee in July 2003 and continues to serve in that capacity. Prior to joining the Company and Bank of Lenawee, Mr. DeVries had over 20 years of senior bank management experience including the positions of Community President at Bank One and was asked to remain on as Community President when Bank One was acquired by Citizens Bank in Ypsilanti, Michigan.

        Mark D. Wolfe (50) has served as the Company’s Senior Vice President of Finance and Chief Financial Officer since March 2006 (and as Interim Chief Financial Officer from March 2005 through January 2006). Prior to joining the Bank in 2001, Mr. Wolfe held the positions of Chief Financial Officer at Herrick Memorial Hospital in Tecumseh, Michigan and Chief Information Officer at Lenawee Health Alliance in Adrian, Michigan.

PART II

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

        The information under the caption “COMMON STOCK DATA” of the Company’s 2006 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13. Notwithstanding the foregoing, the stock performance graph and related data points in such information is only being furnished with this Annual Report on Form 10-K and shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulations 14A or 14C or to the liabilities of Section 18 of the Securities Exchange Act of 1934.

Item 6.   Selected Financial Data.

        The information under the caption “SELECTED FINANCIAL DATA” of the Company’s 2006 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

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

        The information under the caption “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of the Company’s 2006 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

        The information under the caption “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of the Company’s 2006 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

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Item 8.   Financial Statements and Supplementary Data.

        The Company’s consolidated financial statements, accompanying notes and report of independent auditors included in the Company’s 2006 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

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

        None

Item 9A. Controls and Procedures.

        (a)        Evaluation of Disclosure Controls and Procedures.

        The Company’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15(d)-15(e)) as of the end of the period covered by this report, have concluded that as of December 31, 2006, the Company’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company would be made known to them by others within the Company, particularly during the period in which this Form 10-K Annual Report was being prepared.

        (b)        Changes in Internal Controls.

        During the quarter ended December 31, 2006, there were no significant changes in the Company’s internal controls over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

Item 9B. Other Information.

        None

PART III

Item 10.   Directors, Executive Officers and Corporate Governance.

        Information with respect to the Company’s executive officers is included in this report in Part I. The information with respect to directors of the Company, set forth under the caption “INFORMATION ABOUT DIRECTORS AND DIRECTOR NOMINEES” in the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2007, relating to the April 19, 2007 Annual Meeting of Shareholders, is incorporated herein by reference.

        The Board of Directors of the Company has determined that Terence R. Sheehan, a director and member of the Audit Committee, qualifies as an “Audit Committee Financial Expert” as defined in rules adopted by the Commission pursuant to the Sarbanes-Oxley Act of 2002 and is “independent,” as defined by NASD listing standards.

        The Board of Directors of the Company has adopted a Code of Ethics which details principles and responsibilities governing ethical conduct for all Company directors and executive officers. The Code of Ethics can be obtained free of charge by sending a request to the Company’s Corporate Secretary at 135 E. Maumee St., Adrian, Michigan 49221.

        The information set forth under the caption “SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE” in the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2007, relating to the April 19, 2007 Annual Meeting of Shareholders, is incorporated herein by reference.

Item 11.   Executive Compensation.

        The information set forth under the captions “COMPENSATION OF EXECUTIVE OFFICERS,” “COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION,” and “COMPENSATION COMMITTEE REPORT” in the Company’s definitive proxy statement, as filed with the Commission and dated March 19 2007, relating to the April 19, 2007 Annual Meeting of Shareholders, is incorporated herein by reference. Notwithstanding the foregoing, the “COMPENSATION DISCUSSION & ANALYSIS” contained within such definitive proxy statement is not incorporated by reference into this Annual Report on Form 10-K.

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

        The information set forth under the caption “VOTING SECURITIES AND BENEFICIAL OWNERSHIP BY MANAGEMENT AND OTHERS” in the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2007, relating to the April 19, 2007 Annual Meeting of Shareholders, is incorporated herein by reference.

        Securities Authorized for Issuance Under Equity Compensation Plans. The Company had the following equity compensation plans at December 31, 2006:

EQUITY COMPENSATION PLAN INFORMATION

Plan Category	Number of securities to be issued upon exercise of outstanding options (1)		Weighted-average exercise price of outstanding options (2)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (1)) (3)
Equity compensation
plans approved by
security holders		29,405		$46.76		16,481
Equity compensation
plans not approved by
security holders		None		None		None
Total		29,405		$46.76		16,481

These equity compensation plans are more fully described in Note 12 to the Consolidated Financial Statements.

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

        The information set forth under the caption “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” in the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2007, relating to the April 19, 2007 Annual Meeting of Shareholders, is incorporated herein by reference.

        The Board of Directors of the Company is composed of a majority of independent directors (as independence is defined in Rule 4200(a)(15) of the NASD Listing Standards). The independent directors of the Company’s Board of Directors are: Fred R. Duncan, Dan R. Hupp, Barbara A. Mitzel, Emory M. Schmidt, Terence R. Sheehan, Marinus VanOoyen, Edward J. Engle, Jr., Margaret M.S. Noe, and J. David Stutzman. The only directors who are not independent under this standard are Douglas L. Kapnick and Richard J. DeVries. Each of the Audit Committee, Compensation Committee, and Nominating/Corporate Governance Committee of the Board of Directors is comprised solely of independent directors.

Item 14.   Principal Accountant Fees and Services.

        The information set forth under the heading “RELATIONSHIP WITH INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS — Fees of Independent Accountants” in the Company’s definitive proxy statement, as filed with the Commission and dated March 19, 2007, relating to the April 19, 2007 Annual Meeting of Shareholders, is incorporated hereby in reference.

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Item 15.   Exhibits and Financial Statement Schedules.

(a) 1. Financial Statements

The following consolidated financial statements of the Company and Reports of Plante & Moran, PLLC, Independent Registered Public Accounting Firm, are incorporated by reference under Item 8 “Financial Statements and Supplementary Data” of this Form 10-K:

Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Reports of Plante & Moran, PLLC, Independent Registered Public Accounting Firm

2. Financial Statement Schedules
Not applicable

3. Exhibits (Numbered in accordance with Item 601 of Regulation S-K)
The Exhibit Index is located on the final page of this report on 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, dated March 19, 2007.

PAVILION BANCORP, INC.


/s/ Richard J. DeVries
——————————————
Richard J. DeVries
President and Chief Executive Officer


/s/ Mark D. Wolfe
——————————————
Mark D. Wolfe
Senior Vice President Finance and Chief Financial Officer

        Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed on March 19, 2007 by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Each director of the Registrant, whose signature appears below, hereby appoints Richard J. DeVries and Mark D. Wolfe, and each of them severally, as his or her attorney-in-fact, to sign in his or her name and on his or her behalf, as a director of the Registrant, and to file with the Commission any and all Amendments to this Report on Form 10-K.

Signatures

/s/ Richard J. DeVries
——————————————
Richard J. DeVries /s/ Fred R. Duncan
——————————————
Fred R. Duncan

/s/ Edward J. Engle, Jr.
——————————————
Edward J. Engle, Jr. /s/ Dan R. Hupp
——————————————
Dan R. Hupp

/s/ Douglas L. Kapnick
——————————————
Douglas L. Kapnick /s/ Barbara A. Mitzel
——————————————
Barbara A. Mitzel

/s/ Margaret M.S. Noe
——————————————
Margaret M.S. Noe
——————————————
Emory M. Schmidt

/s/ Terence R. Sheehan
——————————————
Terence R. Sheehan
——————————————
J. David Stutzman

/s/ Marinus VanOoyen
——————————————
Marinus VanOoyen

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EXHIBIT INDEX

        The following exhibits are filed herewith, indexed according to the applicable assigned number:

Exhibit
Number

10.4 Employment Agreement, dated July 1, 2003, by and among the Registrant, the Bank of Lenawee, and Richard J. DeVries, as amended by an Employment Agreement Extension Agreement dated February 22, 2007.

10.5 Employment Agreement, dated February 22, 2007, by and among the Registrant, the Bank of Lenawee, and Mark D. Wolfe.

13 Rule 14a-3 2006 Annual Report to Shareholders (this report, except for those portions which are expressly incorporated by reference in this filing, is furnished for the information of the Securities and Exchange Commission and is not deemed “filed”as part of this filing).

21 Subsidiaries of Registrant

23 Consent of Plante & Moran, PLLC - Independent Registered Public Accounting Firm.

24 Powers of Attorney. Contained on the signature page of this report.

31.1 Certificate of President and Chief Executive Officer of Pavilion Bancorp, Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certificate of Chief Financial Officer of Pavilion Bancorp, Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certificate of President and Chief Executive Officer of Pavilion Bancorp, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Certificate of Chief Financial Officer of Pavilion Bancorp, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

        The following exhibits, indexed according to the applicable assigned number, were previously filed by the Registrant and are incorporated by reference in this Form 10-K Annual Report.

Exhibit
Number

3.1 Articles of Incorporation of the Registrant are incorporated by reference to Exhibit 3.1 of the Registrant’s Registration Statement on Form 10, as amended.

3.2 Amendment to Articles of Incorporation of Registrant incorporated by reference to Exhibit 3 of the Registrant’s Report on Form 10-Q for the quarter ended March 31, 2002.

3.3 Bylaws of the Registrant are incorporated by reference to Exhibit 3.2 of the Registrant’s Registration Statement on Form 10, as amended.

3.4 Amendment to Bylaws of Registrant incorporated by reference to Exhibit 99.1 of the Form 8-K filed October 4, 2006.

4 Form of Registrant’s Stock Certificate is incorporated by reference to Exhibit 4 of the Registrant’s Registration Statement on Form 10, as amended.

10.1 2001 Stock Option Plan, incorporated by reference to Appendix A to the Registrant’s Definitive Proxy Statement filed with respect to its April 18, 2001 annual meeting of shareholders.

10.2 1996 Stock Option Plan, incorporated by reference to Exhibit 10.1 to the Registrant's Registration Statement filed on Form 10, as amended.

10.3 Pay for Performance Plan (executive bonus plan), incorporated by reference to Exhibit 10 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004, as amended.

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EX-10

Exhibit 10.4

EMPLOYMENT AGREEMENT

This Agreement is made this 1st day of July , 2003, by and between Pavilion Bancorp, Inc., a Michigan Corporation (herein referred to as the “Holding Company”) and the Bank of Lenawee, a Michigan banking corporation (herein referred to as the “Company”), and Richard J. DeVries (herein referred to as “Executive”).

WHEREAS, the Company desires to employ Executive and Executive desires to continue to be employed by the Company, upon the terms and subject to the conditions hereinafter set forth.

NOW, THEREFORE, in consideration of the premises and the mutual covenants and agreements set forth below, the parties agree as follows:

1. Employment of Executive and Duties.

The Company agrees to appoint and to continue the employment of Executive as President and Chief Executive Officer of the Bank of Lenawee and Executive accepts such employment and agrees to serve as President in accordance with the terms of this Agreement. Executive shall perform on a fill-time basis such duties and responsibilities as are assigned to him from time to time by the Board of Directors or by the Chair of the Board of Directors.

Executive shall faithfully devote all of his time, attention and energy to the management, supervision, promotion and improvement of the business and affairs of the Company and shall carry out all of his working duties in strict observance of the interests of the Company.

2. Term.

The term of employment under this Agreement shall commence on July 1, 2003, and shall continue to and include July 1, 2006, unless earlier terminated in accordance with Section 3 of this Agreement. This Agreement supersedes and cancels all prior agreements, oral, written or otherwise. This Agreement may be extended only by mutual written agreement signed by both the Executive and the Chair of the Board of Directors of the Company, and Executive shall have no expectancy that his employment or this Agreement will be extended or renewed without such mutual written extension. In the event the Company elects not to extend this Employment Agreement beyond, its term, the Company agrees to provide Executive with written notice of such, intent no later than April 1, 2006. In the event either party desires to enter into negotiations for a new, successor agreement, written notice of such a request must be provided to the other party no later than January 1, 2006.

3. Duration of Contract and Termination.

3.1 Termination without Cause.

This Agreement may be terminated at any time by either party for any or no cause, or for any or no reason, and the employment relationship between Executive and the Company shall be regarded as an “employment at will.” The Company shall not be required to provide Executive with any prior notice of termination, written or otherwise, and may effect termination of this Agreement and of Executive’s employment immediately upon giving oral or written notice. Executive may terminate this Agreement upon providing the Company with thirty (30) days’ written notice. Written notice shall be served by registered letter or telegram, and the notice period shall commence and run from the date of postmark of such letter or telegram.

In the event the Company terminates Executive’s employment and this Agreement for any reason other than those provided in Paragraph 3.2 and 3.3 below, the Company shall pay Executive a lump sum amount equal to Executive’s monthly salary at the time of termination multiplied by 12, less applicable state, federal and, local income tax and PICA withholdings.

3.2 Termination for Cause.

The Company shall have the right to terminate the employment and services of Executive, effective immediately upon giving oral or written notice, if Executive:

3.2.1 Dies during the term of this Agreement (in which case no notice of termination need be given);

3.2.2 Ceases to render services to the Company as provided in this Agreement (other than by reason of disability) or otherwise breaches any of the terms or provisions of this Agreement on his part to be observed, performed or fulfilled;

3.2.3 Is repeatedly absent from' work without cause acceptable to Company;

3.2.4 Is intoxicated or under the influence of alcohol or controlled substances while on the Company's business or the Company's premises;

3.2.5 Is convicted of a felony or of any violation of law involving moral turpitude;

3.2.6 Embezzles any property belonging to the Company or willfully injures the Company or any property of the Company; or

3.2.7 Engages in gross negligence, fraud, dishonesty or behavior inimical to the business or welfare of the Company.

Termination of this Agreement by its Company for any of the acts or activities of Executive specified in this paragraph 3.2 shall be deemed, for all purposes of this’ Agreement, to be a “Termination for Cause.” In the event Company terminates Executive’s employment for Cause, Executive shall be entitled to receive only Executive’s salary as accrued pro rata through the effective date of his termination of employment and any earned but unpaid time off, all in a single lump sum, less applicable tax and PICA withholdings. Executive shall have no rights to be paid salary or any other payment by the Company upon or after Executive’s Termination for Cause.

2

3.3 Termination Due To Incapacity Or Inability To Perform Duties.

In the event that Executive is unable to perform the functions of the President, whether totally or partially, by reason of illness, accident or incapacity for a period of more than three (3) months, the Company shall have the right at any time subsequent to such period to terminate Executive’s employment and this Employment Agreement by written notice to the Executive, and all obligations of the Company shall thereupon cease, except as otherwise required by any disability insurance policy provided by the Company to the Executive and other executives. During the three-month period during which Executive is unable to perform the functions of the President position due to incapacity, Executive shall receive short-term disability benefits available to other executive personnel and a supplemental monthly payment which, when added to Executive’s monthly disability benefits, provides Executive with a sum equal to his regular monthly salary. During this three-month period, Executive shall not be paid the salary provided in Section 3 of this Agreement. All job functions and performance responsibilities required for the position of President shall be determined by the Board of Directors of the Bank of Lenawee. The Board of Directors of the Bank of Lenawee shall also make the ultimate determination as to whether Executive is performing those functions and responsibilities. In the event that Executive’s employment is terminated pursuant to this Paragraph 3.3 by reason of illness, accident or incapacity, the Company shall pay Executive for a period not to exceed twelve (12) months a supplement which, when added to all other disability and paid leave benefits already provided by or through Company sponsored insurance or benefit programs, will equal two-thirds (2/3) of Executive’s annual base salary be was receiving as of the date of termination,

3.4 Termination By Executive.

Executive shall have the right to terminate this Agreement and his employment provided he gives thirty (30) calendar days advance notice in writing to the Chair of the Board of Directors. The employment relationship and this Agreement shall terminate thirty (30) days after receipt of such notice, and the Company shall be relieved of making any further salary payments to Executive, In the event Executive terminates this Agreement or retires, he shall receive salary which has been earned and accrued pro-rata through die effective date of the termination and earned but unpaid leave but shall not be eligible for any pro-rated bonus under the Company’s senior officer’s bonus plan. Notwithstanding the foregoing, Executive will be paid a lump sum amount equal to Executive’s monthly salary at the time of termination multiplied by 12, less applicable state, federal and local income tax and PICA withholdings, if mid only if (a) Executive’s duties and responsibilities are modified as a result of a “Change in Control” as defined below; or (b) there is an assignment of responsibilities by the Company to Executive which is a substantial diminution of Executive’s then present functions and responsibilities.

3

For purposes of this Agreement, “Change in Control” shall mean the purchase or other acquisition, after July 1, 2003, by any person, entity or group of persons, within the meaning of section 13(d) or 14(d) of the Securities Exchange Act of 1934 (“Act”), or any comparable successor provisions, of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Act) of 30 percent or more of either the outstanding shares of common stock or the combined voting power of the Company’s or the Holding Company’s then outstanding voting securities entitled to vote generally, or the approval by the stockholders of the Company or of the Holding Company of a reorganization, merger, or consolidation, in each case, with respect to which persons who were stockholders of the Company or of the Holding Company immediately prior to such reorganization, merger or consolidation do not immediately thereafter own more than 50 percent of the combined voting power entitled to vote generally in the election of directors of the reorganized, merged or consolidated Company’s or the Holding Company’s then outstanding securities, or a liquidation or dissolution of the Company or the Holding Company, or of the sale of all or substantially all of the Company’s or the Holding Company’s assets.

It is also understood and agreed that payment of any amounts under :subparagraphs 3.1, 3.3 or 3.4 above is further conditioned upon Executive signing a settlement agreement and general release attached hereto in the form of Appendix A or as may be modified from time to time by Company with the consent of Executive.

4. Compensation.

Effective July 1, 2003, the Company shall pay Executive a base salary at an annual rate of $160,000 payable in accordance with the Company’s normal payroll practices. The Company reserves the right to review and adjust the Executive’s salary at any time during the term of this agreement. Such salary shall be paid in periodic installments in accordance with the Company’s normal mode of executive salary payment. All compensation referred to in this Section is stated in. terms of gross amount. The Company will withhold from such gross amount required deductions, such as federal, state and local income taxes and unemployment taxes.

5. Benefits.

5.1 During the term of this Agreement, Executive shall be eligible to receive or participate in those benefits made available to the Company’s other Executives, including, but not limited to group term life and disability insurance programs, medical plan, 40 1(k) savings plan with up to a 2% match in Pavilion Bancorp Inc. stock, defined benefit retirement plan, dental plan, paid time off benefits, Bank observed paid holidays, free Bank services, educational assistance and other reasonable and customary fringe benefits which may from time-to-time be made available by the Company; provided, however, that the availability of such benefits is subject to any applicable eligibility requirement of each such program and to the terms of the plan documents which govern the availability, eligibility and level of such benefits. Executive shall also be eligible to participate in the Pavilion Bancorp, inc. Stock Option Plan, the bonus plan for senior officers and the Section 125 plan. It is further understood and agreed that compensation arrangements among the Executives of the Company vary and, accordingly, a particular benefit may not be made available to Executive even though it is made available to another Executive. Nothing herein shall obligate the Company to continue any such fringe benefits for Executive if discontinued for other Executives of the Company.

4

5.2 The Company will provide Executive with a four-door, full size automobile or comparable vehicle for Executive’s business and personal use. The purchase price of the vehicle shall not exceed $45,000, and the Company shall retain title to the vehicle. The Company will maintain collision and liability insurance coverage on such vehicle so long as the vehicle is driven by Executive and will reimburse Executive for reasonable and customary expenses incurred in the routine maintenance of the vehicle. Upon Executive’s termination from employment or retirement, Executive has the option of either returning the vehicle to the Company or purchasing the vehicle at used car book value.

5.3 On termination of this Agreement and Executive’s employment for whatever reason or upon Executive’s retirement (either early retirement or upon normal retirement age), the Company will purchase Executive’s primary residence located in the Company’s market area based upon two qualified estimates of the fair market value of said home and property, The estimates must be submitted in writing by certified appraisers, one of whom is selected by the Executive and one of whom is selected by the Company. The average of these two estimates will be deemed the purchase price. The Company shall pay all normal closing costs and fees. In no event will the Company be obligated to pay a purchase price for Executive’s residence and property which exceeds $400,000. The Company agrees to effect said purchase no later than six (6) months following Executive’s termination or retirement.

6. Resignation From Board Or Agency Appointments.

        To the extent that Executive serves, solely by virtue of and in connection with his employment by the Company, as a member of any board of directors, board of trustees, or advisory board, or In a capacity representing Company, the Holding Company, or any Affiliate, effective with Executive’s termination of employment from Company, Executive shall resign from any and all positions Executive may have on die Board of Directors of the Bank of Lenawee or its Holding Company or any other representative relationships, Company is hereby appointed as Executive’s attorney-in-fact to tender any such ‘resignation from the Board of Directors of the Bank of Lenawee or its Holding Company or any other Affiliate Board. Executive agrees to cooperate with Company by signing a resignation letter or submitting a written resignation as may be required by any such board or organization to formally effectuate Executive’s resignation from such service or capacity.

7. Expenses.

Traveling and living expenses on business trips and expenses for entertaining customers will be reimbursed by the Company in accordance with the Company’s prevailing rules and policies provided such expenses do not exceed reasonable limits and are supported by complete documentation and receipts detailing the amounts and description of each expenditure.

5

8. Special Obligations of the Executive.

The Executive shall:

8.1 Refrain from gainful employment on behalf of a third party and shall not engage in business on his/her own account unless he/she has been specifically authorized in writing by the Company to do so in each and every case.

8.2 Refrain from divulging any confidential information concerning the Company, the Holding Company, and any affiliates (herein the “Companies”) during and after the termination of employment for whatever reason, including retirement. For purposes of this Agreement, “confidential information” means any details of the business or affairs of the Companies (including, without limitation, financial information, organizational structure, strategic planning, sales, marketing strategies, compensation and incentive plans, data processing and other systems, personnel policies and related compensation programs of the Companies); any customer or client account information or customer lists owned or used by the Companies; and information, knowledge or data of a technical nature (including, without limitation, methods, know-how, formulae, compositions, processes, discoveries, inventions or research methods) of or used by the Companies; any information, knowledge or data relating to future developments and marketing strategies (including, without limitation, research and development) of or used by the Companies; and any and all trade secrets of the Companies or used by the Companies which may be imparted to Executive, and any other information pertaining to the Companies which has not been made public, whether in Companies’ reports, at shareholders’ meetings, in handouts or statements to the press and lectures or publications by authorized Executives or by the Companies, or any of them, In the event there is any dispute or uncertainty as to whether certain information constitutes “confidential information,” the Chair of the Board of Directors of the Company shall determine whether a given item of information is or is not confidential.

Executive shall not impart confidential information to fellow Executives except where necessary for the performance of his/her duties.

Executive may disclose Confidential Information if required by any judicial or governmental request, requirement or order; provided that Executive will take reasonable steps to give the Companies sufficient prior notice in order to contest such request, requirement or order. Executive may also disclose Confidential Information if the information has become known to the general public by means other than Executive’s breach of this Agreement.

8.3 Of his own accord surrender all business documents and records to the Company or its nominated representative upon termination of employment. The Executive may also be required to surrender such documents and records at any time during the term of this Agreement.

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9. Non-Competition.

9.1 Non-Competition and Solicitation. Executive acknowledges and recognizes the highly competitive nature of the business of the Company. In consideration of the compensation described in this Agreement, Executive agrees that for a period of time coextensive with the Term and for one year following Executive’s termination of employment with the Company, for whatever reason and whether or not pursuant to the terms of this Agreement (the “Non-Compete Period”), Executive shall not, either directly or indirectly (and whether or not for compensation), work for, be employed by, own, manage, operate, control, finance, participate or engage in, or have any interest in, any person, firm, entity, financial institution, partnership, limited partnership, limited liability company, corporation or business (whether as an employee, owner, sole proprietor, partner, venturer, member, shareholder; officer, director, agent, creditor, consultant or in any capacity which calls for the rendering of personal services, advice, acts of management, operation or control) which engages in any activity substantially the same as or competitive with the business of the Company as it is then conducted or planned to be conducted (the “Business”), in Lenawee, Washtenaw, Jackson, and Monroe Counties of the State of Michigan (the “Restricted Territory”). The foregoing shall not, however, be deemed to prevent Executive from owning, for investment purposes only, up to 1% of the securities of any corporation the shares of which are traded on a securities exchange or in the over-the-counter market.

Executive further agrees that Executive shall not, directly or indirectly, at any time during the Non-Compete Period: (a) divert or attempt to divert from the Companies any work within the definition of the Business, whether or not in the Restricted Territory; (b) solicit, contact, call upon or attempt to solicit, or provide services to, any of the Companies’ Business Customers, suppliers or actively sought potential customers or suppliers for the purpose of doing anything within the definition of the Business, or any work reasonably related to the Business, whether or not in the Restricted Territory; or (c) induce or attempt ~to induce any person who is an Executive or employee of the Companies to leave the employ of the Companies or of any affiliate of the Companies whether or not in the Restricted Territory. For the purposes of this Agreement, “Business Customer” means any person or entity to, with or from whom the Company has within a three (3) year period preceding the Executive’s termination:

9.1.1 Provided banking, leading, credit, mortgage or other financial services;

9.1.2 Submitted a bid for, or otherwise negotiated for, the providing of products or the performance of services;

9.1.3 Provided products or performed services;

9.1.4 Entered into an agreement for the providing of products or performance of services; or

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9.1.5 Entered into any strategic research and development alliance, strategic marketing alliance, or strategic promotional alliance.

9.2 Remedies. Executive has had knowledge of the affairs, trade secrets, customers, potential customers and other proprietary information with respect to the Business, and Executive acknowledges and agrees that compliance with the covenants set forth in Paragraphs 8.2 and 9 is necessary for the protection of the Business, and the goodwill and other proprietary interests of the Companies and that any violation of this Agreement will cause severe and irreparable injury to the Business, and the goodwill and proprietary interests of the Companies, which injury is not adequately compensable by money damages. Accordingly, in the event of a breach (or threatened or attempted breach) of Paragraph 8.2 and/or 9, any of the Companies, in addition to any other rights and remedies, including disgorgement of all profits wrongfully derived by Executive from such breach, shall be entitled to immediate appropriate injunctive relief or a decree of specific performance, without the necessity of showing any irreparable injury or special damages.

Executive agrees that the remedy at law for breach of the obligations set forth in Paragraphs. 8. and 9 of this Agreement is. inadequate and in the event of a breach or threatened breach thereof Executive agrees that the Companies, without posting any bond, shall be entitled to seek equitable relief in the form of specific performance temporary restraining order, temporary, preliminary or permanent injunction, or Other appropriate equitable remedy.

If, in any judicial proceeding, a court shall refuse to enforce any of the covenants included herein, then said unenforceable covenant(s) shall be deemed modified so as to become enforceable to the maximum extent permitted, and if such modification is not permitted, then such unenforceable covenants shall be deemed eliminated from these provisions for the purpose of the proceeding to the extent necessary to permit the remaining separate covenants to be enforced. It is the intent and agreement of the Company and Executive that these covenants be given the maximum force, effect and application permissible under law. The provisions of Paragraphs 8.2 and 9 shall survive the termination of this Agreement.

10. Assignment and Pledging of Salary.

The Executive shall neither assign nor pledge to third parties his/her salary or any other indemnity which might be due to him from the Company. The duties and obligations of Executive under this Agreement are personal unto the Executive and may not be assigned, delegated or otherwise transferred.

11. Acceptance of Presents.

The Executive may not, in connection with his work for the Company, accept or pledge himself to accept either directly or indirectly any presents, commission or other favor of any kind whatsoever without the prior knowledge of the Company.

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12. Retirement.

Upon retirement or termination of employment for whatever reason, the confidentiality and non-competition obligations of this Agreement shall continue in full force and effect and remain binding on the Executive.

13. Premature Discharge of Executive with Notice.

Without prejudice to the compensation set forth in paragraph 4 of this Agreement, the Company may wholly or partially forego the services of the Executive between the date when notice of termination was first given and the date of contract expiration. In the event the Company decides to wholly or partially forego the services of Executive, Company has the right to pay in cash any remaining salary which the Executive has not yet been paid for the balance of the one-month notice period set forth in paragraph 3.4 of this Agreement,

14. Entire Agreement.

This Agreement, together with the Executive Confidentiality Agreement, contains the entire agreement of the parties hereto with respect to the subject matter hereby referenced and may not be changed, altered or extended (including by additions or deletions), orally or otherwise, except by an agreement or consent in writing signed by both the Executive and the Chair of the Board of Directors of the Company. Such writing may only be signed on behalf of the Company by the Chair of the Board of Directors of the Company. This Agreement supersedes all other agreements, written or otherwise and shall in no event be modified by any oral statement, agreement, commitment, representation or understanding.

15. Severability.

If any term or provision of this Agreement or the application thereof to any circumstance shall, to any extent and for any reason, be held invalid or unenforceable, the remainder of this Agreement, or the application of such term or provision to circumstances other than those as to which it is held to be invalid or unenforceable, shall not be affected thereby and shall be construed as if such invalid or unenforceable term or provision bad never been contained herein, and each term and provision of this Agreement shall be valid and enforceable to the fullest extent permitted by law. If any portion of this Agreement is held to be excessively broad as to time, duration, geographical scope, activity or subject, it shall be construed by limiting or reducing the provision as required so that the provision as limited or reduced is enforceable under applicable law.

16. Successors.

The obligations of the Company under this Agreement, shall be binding upon, and the rights of the Company hereunder shall inure to the benefit of, the Company and its successors and assigns.

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17. Governing Law.

This Agreement shall be governed by and construed in accordance with the laws and judicial decisions of the State of Michigan.

18. Agreement To Arbitrate Employment Claims.

In the event Executive fails for whatever reason to execute the settlement agreement and general release attached hereto as Appendix A, the Company, the Holding Company and Executive agree to submit to final and binding arbitration in accordance with the National Rules for the Resolution of Employment Disputes issued by the American Arbitration Association, effective July 1, 2003, any existing or future employment disputes, controversies or claims arising out of Executive’s employment with the Company or the termination of that employment, including but not limited to claims for breach of contract, common law tort claims, claims for nonpayment of wages, commissions, or overtime pay, claims of unlawful termination or retaliation, and claims of employment discrimination based on race, se; age, national, origin, pregnancy, disability or other status protected by state or federal law or any other bias prohibited by state or federal law. Binding arbitration under the Federal Arbitration Act, 9 U. S.C. Section’ 1, shall be the sole and exclusive means of resolving any dispute arising out of Executive’s employment or the termination from employment by the Company or by Executive, and no other suit or action can be brought by Executive ‘In any, court or in any other forum. In addition, any disputes arising during Executive’s employment involving claims of unlawful discrimination or unlawful harassment under federal or state statutes shall be submitted exclusively to binding arbitration under the above provisions.

Executive understands and agrees that arbitration of such disputes and claims shall be the sole and exclusive means for resolving any and all existing and future disputes or controversies arising out of Executive’s employment with the Company or the termination thereof; with the exception of claims for benefits under the Michigan Workers’ Disability Compensation Act and the Michigan Employment Security Act. Notwithstanding anything contained herein to the contrary, this Agreement to arbitrate shall not be deemed to be a waiver of the Company’s right to secure equitable relief including an injunction if and when otherwise appropriate to enforce Sections 8 and 9 of this Agreement.

Executive understands that by signing this Agreement Executive is waiving any right that he/she may have to a jury trial or a court trial of any employment-related dispute. Executive further understands and agrees that by accepting or continuing employment with the Company, Executive automatically agrees that arbitration is the exclusive forum for all disputes arising out of or related to Executive’s employment with the Company, and Executive agrees to waive all rights to a civil court action regarding his/her employment and the termination of that employment and Executive agrees that only an arbitrator, and neither a Judge nor a jury, will decide the dispute.

If Executive decides to dispute his/her termination or any other alleged incident during his/her employment, including but not limited to unlawful discrimination or harassment, Executive must deliver a written request for arbitration to the Company within one (1) year from the date of termination, or one (1) year from the date on which the alleged incident(s) or conduct occurred, and respond within fourteen (14) calendar days to each communication regarding the selection of an arbitrator and the scheduling of a hearing. Executive expressly waives any longer statute or other period of limitations to the contrary.

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If the Company does not receive a written request for arbitration from Executive within one (1) year, or if Executive does not respond to any communication from the Company about the arbitration proceedings within fourteen (14) calendar days, Executive will have waived any right to raise any claims arising out of the termination of Executive’s employment with the Company, or involving claims of unlawful discrimination or harassment, in arbitration and in any court or other forum. Failure to initiate arbitration as provided herein will forever bar any claim involving that dispute.

If Executive makes a timely request for arbitration, the Company agrees to pay the case management administrative fee charged by the American Arbitration Association. Executive shall have the right to be represented by counsel of his/her own choosing. Executive and the Company shall each bear respective costs for legal representation at any such arbitration. The Executive and the Company shall be given clear notice of all hearing dates. The selected arbitrator shall authorize and supervise pre-hearing discovery and shall be empowered to set a hearing, bear testimony and examine whatever acceptable evidence the Company and Executive may present. Executive’s liability for the costs and fees of arbitration, other than attorney fees, however, shall be limited to $1000. The arbitrator may grant any remedy or relief that a court having jurisdiction of the matter could grant, including reinstatement of the Executive with or without back pay or with partial back pay. If the arbitrator orders reinstatement, the arbitrator shall also designate an alternative monetary award which the Company may, at its option, elect to pay Executive in lieu of reinstatement. The arbitrator is authorized to award a reasonable attorney’s fee in accordance with applicable law. In the absence of an award, each party is responsible for its own attorney fees.

Executive understands and agrees that the decision and award of the arbitrator is final and binding on both the Executive, the Company, and the Holding Company shall provide the exclusive remedy(ies) for resolving any and all disputes between the Company, the Holding Company and Executive arising from the employment relationship, and shall be enforceable in any court of competent jurisdiction, In accordance with 9 U.S.C. § 1 et seq., MCL 600.5001-600.6035; MSA 27A.5000-27A5035 and MCR 3.602, Executive agrees that upon issuance of the arbitrator’s decision and award, judgment in any court of competent jurisdiction shall be rendered on the award and entered so as to enforce its provisions.

EXECUTIVE VOLUNTARILY AND KNOWINGLY AGREES THAT HIS/HER EMPLOYMENT BY THE COMPANY AS OF THIS DATE IS GOOD AND VALUABLE CONSIDERATION FOR THIS AGREEMENT.

EXECUTIVE HAS READ AND UNDERSTANDS THE FOREGOING AND VOLUNTARILY AND KNOWINGLY AGREES TO TUE TERMS AND CONDITIONS OF THIS AGREEMENT.

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EXECUTIVE ACKNOWLEDGES THAT EXECUTIVE HAS READ THIS AGREEMENT, THAT EXECUTIVE UNDERSTANDS ITS TERMS AND THAT BY SIGNING if, EXECUTIVE IS WAIVING ALL RIGHTS TO A TRIAL BEFORE A COURT OR JURY OF ANY AND ALL DISPUTES AND CLAIMS REGARDING EXECUTIVE’S EMPLOYMENT WITH COMPANY OR TUE TERMINATION THEREOF, EXCEPT AS OTHERWISE NOTED HEREIN, THAT. NOW EXIST OR MAY IN THE FUTURE EXIST OR BE KNOWN OR SUSPECTED BY EXECUTIVE.

IN WITNESS WHEREOF, the parties date set forth in the first paragraph of this

Richard J. DeVries
——————————————
EXECUTIVE'S PRINTED NAME

/s/ Richard J. DeVries
——————————————
EXECUTIVE'S SIGNATURE


FOR PAVILION BANCORP BY:


/s/ Douglas L. Kapnick
——————————————
Douglas L. Kapnick, Chairman         President and CEO
——————————————
        POSITION

        July 14, 2003
——————————————
        DATE





        June 26, 2003
——————————————
        DATE

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APPENDIX A

SETTLEMENT AGREEMENT AND GENERAL RELEASE

        This Settlement Agreement and General Release ("Agreement") is made and entered into this _____ day of ,__, 20_, by and between ___________________ (the "Executive"), and_________________________ (the "Employer").

        WHEREAS, Executive and Employer desire to settle and resolve all issues arising out of Executive’s employment with and termination from employment with Employer without any disputes, proceedings or litigation, on the following terms and conditions.

        NOW, THEREFORE, in consideration of the promises and of the mutual covenants and agreements contained herein, it is agreed by and between the parties hereto that:

        1.        This Agreement does not constitute any admission by Employer that any action it, its agents or employees took with respect to Executive was wrongful, unlawful or In violation of any local, state or Federal act, statute, or constitution, or susceptible of inflicting any damages or injury whatsoever on Executive, and Employer specifically denies any such wrongdoing or violation. It is further agreed that this Agreement is entered into solely in an effort to resolve fully all matters related to or arising out of Executive’s employment with Employer and his termination therefrom.

        2.        Employer shall pay Executive the sum of One Thousand Dollars ($1,000.00) fifteen (15) days after Executive and Employer execute this Agreement. The aforementioned payment is understood by the parties to be paid in consideration of Executive waiving and otherwise releasing ‘Employer, its directors, officers, members, agents, employees, representatives, attorneys, successors and assigns, of and from any and all claims, demands, rights, liabilities, and causes of action of any kind or nature arising out of or in connection with her employment with Employer or her termination from Employer, It is also agreed and understood that this payment is for any alleged damages, costs and attorney’s fees incurred by Executive and will be subject to payroll taxes or deductions, income or withholding taxes, social security taxes, unemployment taxes, disability taxes or any other taxes which customarily are deducted and/or paid with respect to wages.

        3.        In return for the payment made to Executive pursuant to paragraph 2 herein, Executive hereby generally releases and forever discharges Employer, its Holding Company, subsidiaries, directors, officers, members, agents, employees, representatives, attorneys, successors, and assigns of and from any and all causes of action, claims or demands of any type, including, without limiting the generality of the foregoing general release, claims or causes arising or which could have arisen out of Executive’s employment relationship with. Employer and the termination of his employment relationship with Employer, any and all claims under the Fair Labor Standards Act, 29 U.S.C. § 201 et seq.; the Age Discrimination in Employment Act, 29 U.S.C. § 621 et seq. (1976); Title VII of the Civil Rights Act of 1964, 42 U.S.C. § 2000e et seq.; the Civil Rights Act of 1866, 42 U.S.C. § 1981; the Civil Rights Act of 1991, Pub. L. No. 102-166; the National Labor Relations Act, 29 U.S.C. § 151 et seq. (1976); the Americans With Disabilities Act, 42 U.S.C. § 12101 et seq.; Federal Executive Order 11246; the Family and Medical Leave Act, Pub. L. No. 103-3; the Employee Retirement Income Security Act of 1974 (ERISA), the Older Workers’ Benefit Protection Act, the Elliot-Larsen Civil Rights Act, M.C.L. 37.2101 et seq.; the Michigan Persons With Disabilities’ Civil Rights Act, M.C.L. 37.1101 et seq.; the Michigan Minimum Wage Law of 1964; the Michigan Act Regulating Payment of Wages and Fringe Benefits, M.C.L. 408.471; the Whistleblowers’ Protection Act and/or any other similar federal, state or local statute, law, ordinance, regulation or order, claims for breach of contract, defamation, promissory estoppel or any tortious conduct. The foregoing provision shall not apply to claims for benefits under any employee benefit plan as defined in Section 3(3) of ERISA (exclusive of Executive’s SERA), irrespective of whether the particular benefit plan is a church plan not subject to ERISA.

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        4.        Except as provided herein, the parties also release and forever discharge each other, theft directors, officers, members, agents, employees, representatives, attorneys, successors, assigns, heirs, executors and administrators, of and from any and all other ‘demands, claims, causes of action, obligations, agreements, promises, representations, damages, suits and liabilities regarding Executive’s employment with or termination from Employer, both known and unknown, in law or in equity, of a class or individual nature, including but not limited to, attorneys’ fees and costs. Executive further covenants and agrees never to institute (directly or indirectly) any action or proceeding of any kind against Employer, its agents, employees, representatives, attorneys, successors, assigns, heirs, executors and administrators, regarding Executive’s employment with or termination of employment from Employer.

        5.        As a part of this Agreement, Executive agrees to waive reinstatement and to not seek future employment in any position with Employer, or in any company in which Employer has a substantial (more than twenty-five percent 25%) ownership interest

        6.        Executive agrees that this document and any and all matters concerning this settlement will be regarded as confidential communications between the parties hereto and will not be disseminated by publication of any sort or be released in any manner or means to any newspaper, magazine, radio station, television station, to any future, current or former employee, vendor or ‘customer of Employer or to anyone’ else except as provided for in this Agreement. Except as provided for in this Agreement, if asked about such matters by any ~individual whatsoever, Executive is to reply that “the matter has been resolved” or words of similar effect. It is understood that Executive may, on a limited basis, advise his attorney, accountant and tax preparers of this Agreement, all of whom shall agree to follow the confidentiality provisions of this paragraph.

        7.        It is further agreed that Executive will not encourage or assist any present or past employee of Employer who litigates against or who files administrative charges against Employer, its agents, officers, directors, shareholders or employees, unless required to provide testimony or documents pursuant to a lawful subpoena or as otherwise required by law.

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        8.        This instrument constitutes and contains the entire agreement and understanding between the parties concerning the subject matter of this Agreement, and supersedes all prior negotiations, proposed agreements and understandings, if any, between the parties.

        9.        Executive specifically acknowledges that, at least twenty-one (21) days prior to the required date for executing this document, Executive was given a complete copy of this Agreement and by this Agreement was advised in writing to consult with an attorney concerning its meaning and effect. Executive understands that he may revoke this document in writing, addressed to the.________________________, within seven (7) days after execution hereof, in which event this Agreement will be of no effect and Executive will be entitled to none of the benefits provided hereunder and Paragraph 18 of Executive’s Employment Agreement shall then apply and be controlling.

        10.        Executive states that he has read and understands that this Agreement is meant as a complete and final settlement and release, releasing Employer, its directors, agents, employees, representatives, attorneys, successors, assignees, heirs, executors and’ administrators, of and from any and all claims he may have against them, that he voluntarily agrees to the terms set forth herein, that he knowingly and willingly intends to be legally bound by the same, that he was given adequate opportunity to consider the Agreement, that he discussed it with his legal counsel, that lie has had ample time to study the terms of this Agreement with his attorney and with members of his family, that the terms and conditions hereof were determined by negotiation, and that be executes this Agreement knowingly and of his own free will.

        [EXECUTIVE]


——————————————
Subscribed and Sworn to before me
this ____ day of ______________, 2006.



——————————————
        Notary Public


[EMPLOYER]

By: ________________________

Its: ________________________

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EMPLOYMENT AGREEMENT EXTENSION AGREEMENT

This EMPLOYMENT AGREEMENT Extension Agreement is made this 22nd day of February, 2007, by and between Pavilion Bancorp, Inc., a Michigan Corporation (herein referred to as the “Holding Company”) and the Bank of Lenawee, a Michigan banking corporation (herein referred to as the “Company”), and Richard J. DeVries (herein referred to as “Executive).

WHEREAS, the Company desires to extend the EMPLOYMENT AGREEMENT between the Company and Executive, dated July 1, 2003, for a period of three years beyond the stated EMPLOYMENT AGREEMENT conclusion date of July 1, 2006

NOW, THEREFORE, the Holding Company, Company and Executive hereby agree to extend the EMPLOYMENT AGREEMENT TO July 1, 2009 with the following amendments:

- The “base salary” referred to in the• paragraph found in section 4, page 4, titled “Compensation,” shall be amended to read $205,000, effective January 1, 2007.

- Section 5.2, found on page 5 of the EMPLOYMENT AGREEMENT, which addresses providing an automobile for Executive, will be amended to include the purchase of a new car for the use of Executive every four years, or at the attainment of 90,000 miles, whichever event arrives first. The purchase price of the new car will be approved by the executive committee of the Company.

IN WITNESS WHEREOF, the parties have caused this EMPLOYMENT AGREEMENT Extension Agreement to be executed as of the date set forth in the first paragraph of this Extension Agreement.

Richard J. DeVries
——————————————
EXECUTIVE'S PRINTED NAME

/s/ Richard J. DeVries
——————————————
EXECUTIVE'S SIGNATURE


FOR PAVILION BANCORP. INC., BY:


/s/ Douglas L. Kapnick
——————————————
Douglas L. Kapnick, Chairman         President & CEO
——————————————
        POSITION

        2/22/07
——————————————
        DATE





        2/22/07
——————————————
        DATE

EX-10

Exhibit 10.5

Employment Agreement

This Agreement is made this 22^nd day of February, 2007, by and between Pavilion Bancorp, Inc, a Michigan Corporation (herein referred to as the “Holding Company”) and the Bank of Lenawee, a Michigan banking corporation (herein referred to as the “Company”), and Mark D. Wolfe (herein referred to as “Executive”).

WHEREAS, the Company desires to employ Executive and Executive desires to continue to be employed by the Company, upon the terms and subject to the conditions set forth below.

NOW, THEREFORE, in consideration of the premises and the mutual covenants and agreements set forth below, the parties agree as follows:

1.      Employment of Executive and Duties
The Company agrees to appoint and to continue the employment of Executive as Chief Financial Officer of the Bank of Lenawee and Executive accepts such employment and agrees to serve as Chief Financial Officer in accordance with the terms of this Agreement. Executive shall perform on a full-time basis such duties and responsibilities as are assigned to him from time to time by the President and Chief Executive Officer or by the Chair of the Board of Directors.

Executive shall faithfully devote all of his time, attention and energy to the management, supervision, promotion and improvement of the business and affairs of the Company and shall carry out all of his working duties in strict observance of the interests of the Company.

2.      Term
The term of employment under this Agreement shall commence on February 22, 2007, and shall continue to and include December 31, 2007, unless earlier terminated in accordance with Section 3 of this Agreement. This Agreement supersedes and cancels all prior agreements, oral, written or otherwise. This Agreement may be extended only by mutual written agreement signed by both the Executive and the President and Chief Executive Officer of the Company, and Executive shall have no expectancy that his employment or this Agreement will be extended or renewed without such mutual written extension. In the event the Company elects not to extend this Employment Agreement beyond its term, the Company agrees to provide Executive with written notice of such intent no later than December 1, 2007. In the event either party desires to enter into negotiations for a new, successor agreement, written notice of such a request must be provided to the other party no later than October 1, 2007.

3.      Duration of Contract and Termination.

3.1      Termination without Cause.

This Agreement may be terminated at any time by either party for any or no cause, or for any or no reason, and the employment relationship between Executive and the Company shall be regarded as an “employment at will.” The Company shall not be required to provide Executive with any prior notice of termination, written or otherwise, and may effect termination of this Agreement and of Executive’s employment immediately upon giving oral or written notice. Executive may terminate this Agreement upon providing the Company with thirty (30) days’ written notice. Written notice shall be served by registered letter or telegram, and the notice period shall commence and run from the date of postmark of such letter or telegram.

In the event the Company terminates Executive’s employment and this Agreement for any reason other than those provided in Paragraph 3.2 and 3.3 below, the Company shall pay Executive a lump sum amount equal to Executive’s monthly salary at the time of termination multiplied by 12, less applicable state, federal and local income tax and FICA withholdings.

3.2      Termination for Cause.

The Company shall have the right to terminate the employment and services of Executive, effective immediately upon giving oral or written notice, if Executive:

3.2.1	Dies during the term of this Agreement (in which case no notice of termination need be given);
3.2.2	Ceases to render services to the Company as provided in this Agreement (other than by reason of disability) or otherwise breaches any of the terms or provisions of this Agreement on his part to be observed, performed or fulfilled;
3.2.3	Is repeatedly absent from work without cause acceptable to Company;
3.2.4	Is intoxicated or under the influence of alcohol or controlled substances while on the Company's business or the Company's premises;

3.2.5	Is convicted of a felony or of any violation of law involving moral turpitude;
3.2.6	Embezzles any property belonging to the Company or willfully inures the Company or any property of the Company; or
3.2.7	Engages in gross negligence, fraud, dishonesty or behavior inimical to the business or welfare of the Company.

Termination of this Agreement by its Company for any of the acts or activities of Executive specified in this paragraph 3.2 shall be deemed, for all purposes of this Agreement, to be a “Termination for Cause.” In the event Company terminates Executive’s employment for Cause, Executive shall be entitled to receive only Executive’s salary as accrued pro rata through the effective date of this termination of employment and any earned but unpaid time off, all in a single lump sum, less applicable tax and FICA withholdings. Executive shall have no rights to be paid salary or any other payment by the Company upon or after Executive’s Termination for Cause.

3.3      Termination Due to Incapacity Or Inability To Perform Duties.
In the event that Executive is unable to perform the functions of the Chief Financial Officer, whether totally or partially, by reason of illness, accident or incapacity for a period of more than three (3) months, the Company shall have the right at any time subsequent to such period to terminate Executive’s employment and this Employment Agreement by written notice to the Executive, and all obligations of the Company shall thereupon cease, except as otherwise required by any disability insurance policy provided by the Company to the Executive and other executives. During the three-month period during which Executive is unable to perform the functions of the Chief Financial Officer position due to incapacity, Executive shall receive short-term disability benefits available to executive personnel. During this three-month period Executive shall not be paid the salary provided in Section 3 of this Agreement. All job functions and performance responsibilities required for the position of Chief Financial Officer shall be determined by the President and Chief Executive Officer of the Bank of Lenawee. The President and Chief Executive Officer shall also make the ultimate determination as to whether Executive is performing those functions and responsibilities.

3.4      Termination By Executive.
Executive shall have the right to terminate this Agreement and his employment provided he gives thirty (30) calendar days advance notice in writing to the President and Chief Executive Officer. The employment relationship and this Agreement shall terminate thirty (30) days after receipt of such notice, and the Company shall be relieved of making any further salary payments to Executive. In the event Executive terminates this Agreement or retires, he shall receive salary which has been earned and accrued pro-rata through the effective date of the termination and earned but unpaid leave shall not be eligible for any pro-rated bonus under the Company’s senior officer’s bonus plan. Notwithstanding the foregoing, Executive will be paid a lump sum amount equal to Executive’s monthly salary at the time of termination multiplied by twelve, less applicable state, federal and local income tax and FICA withholdings, if and only if, (a) Executive’s duties and responsibilities are modified as a result of a “Change in Control” as defined below; or (b) there is an assignment of responsibilities by the Company to Executive which is a substantial diminution of Executive’s then present functions and responsibilities.

For purposes of this Agreement, “Change of Control” shall mean the purchase or other acquisition, after February 22, 2007, by any person, entity or group of persons, within the meaning of section 13(d) or 14(d) of the Securities exchange Act of 1934 (“Act”), or any comparable successor provisions, of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Act) of 30 percent or more of either the outstanding shares of common stock or the combined voting power of the Company’s or the Holding Company’s then outstanding voting securities entitled to vote generally, or the approval by the stockholders of the Company or of the Holding Company of a reorganization, merger, or consolidation, in each case, with respect to which persons who were stockholders of the Company or of the Holding Company immediately prior to such reorganization, merger or consolidation do not immediately thereafter own more than 50 percent of the combined voting power entitled to vote generally in the election of directors of the reorganized, merged or consolidated Company’s or the Holding Company’s then outstanding securities, or a liquidation or dissolution of the Company or the Holding Company, or of the sale of all or substantially all of the Company’s or the Holding Company’s assets.

It is also understood and agreed that payment of any amounts under paragraph 3.1 or 3.4 above is further conditioned upon Executive signing a settlement agreement and general release attached hereto in the form of Appendix A or as may be modified from time to time by Company with the consent of Executive.

4.      Compensation.
Effective February 22, 2007, the Company shall pay Executive a base salary at an annual rate of $120,000, payable in accordance with the Company’s normal payroll practices. The Company reserves the right to review and adjust the Executive’s salary at any time during the term of this agreement. Such salary shall be paid in periodic installments in accordance with the Company’s normal mode of executive salary payment. All compensation referred to in this Section is stated in terms of gross amount. The Company will withhold from such gross amount required deductions, such as federal, state and local income taxes and unemployment taxes.

5.      Benefits.

5.1      During the term of this Agreement, executive shall be eligible to receive or participate in those benefits made available to the Company’s other Executives, including, but not limited to group term life and disability insurance programs, medical plan, 401(k) saving plan with up to a 2% match, pension plan, dental plan, paid time off benefits, Bank observed paid holidays, free and discounted Banking services, educational assistance and other reasonable and customary fringe benefits which may from time-to-time be made available by the Company; provided, however, that the availability of such benefits is subject to any applicable eligibility requirement of each such program and to the terms of the plan documents which govern the availability, eligibility and level of such benefits. Executive shall also be eligible to participate in the Pavilion Bancorp, Inc. Stock Option Plan, the bonus plan for senior officers and the Section 125 plan. It is further understood and agreed that compensation arrangements among the Executives of the Company vary and, accordingly, a particular benefit may not be made available to Executive even though it is made available to another Executive. Nothing herein shall obligate the Company to continue any such fringe benefits for Executive if discontinued for other Executives of the Company.

5.1.1	200 shares of Pavilion Bancorp, Inc. stock issued to Executive prior to December 31, 2006;
5.1.2	Annual Tecumseh Country Club membership dues to be paid by Company;
5.1.3	Annual Tecumseh Rotary Club membership dues to be paid by Company;
5.1.4	Payment for two (2) SEC training course to be taken over the next two (2) years;
5.1.5	Payment for two (2) Financial Reporting training courses to be taken over the next two (2) years;
5.1.6	Payment for Bankers School of Finance to be taken over the next three (3) years;

5.1.7  Reimbursement of up to $5000 annually by Company for courses related to an Masters of Business Administration – Finance, observing the Company’s education reimbursement requirements including repayment of the benefit upon termination within stated timeline of education reimbursement policy.

6.      Resignation From Board Or Agency Appointments.
To the extent that Executive serves, solely by virtue of and in connection with his employment by the Company, as a member of any board of directors, board of trustees, or advisory board, or in a capacity representing Company, the Holding Company, or any Affiliate, effective with Executive’s termination of employment from Company, Executive shall resign from any and all positions Executive may have on the Board of Directors of the Bank of Lenawee or its Holding Company or any other representative relationships. Company is hereby appointed as Executive’s attorney-in-fact to tender any such resignation from the Board of Directors of the Bank of Lenawee or its Holding Company or any other Affiliate Board. Executive agrees to cooperate with Company by signing a resignation letter or submitting a written resignation as may be required by any such board or organization to formally effectuate Executive’s resignation from such service or capacity.

7.      Expenses.
Traveling and living expenses on business trips and expenses for entertaining customers will be reimbursed by the Company in accordance with the Company’s prevailing rules and policies provided such expenses do not exceed reasonable limits and are supported by complete documentation and receipts detailing the amounts and description of each expenditure.

8.      Special Obligations of the Executive.
The Executive shall:

8.1 Refrain from gainful employment on behalf of a third party and shall not engage in business on his/her own account unless he/she has been specifically authorized in writing by the Company to do so in each and every case.

8.2 Refrain from divulging any confidential information concerning the Company, the Holding Company, and any affiliates (herein the “Companies”) during and after the termination of employment for whatever reason, including retirement. For purposes of this Agreement, “confidential information” means any details of the business or affairs of the Companies (including, without limitation, financial information, organizational structure, strategic planning, sales, marketing strategies, compensation and incentive plans, data processing and other systems, personnel policies and related compensation programs of the Companies); any customer or client account information or customer lists owned or used by the Companies; and information, knowledge or data of a technical nature (including, without limitation, methods, know-how, formula, compositions, processes, discoveries, inventions or research methods)of or used by the Companies; any information, knowledge or data relating to future developments and marketing strategies (including, without limitation, research and development) of or used by the Companies; and any and all trade secrets of the Companies or used by the Companies which may be imparted to Executive, and any other information pertaining to the Companies which has not been made public, whether in Companies’ reports, at shareholders’ meetings, in handouts or statements to the press and lectures or publications by authorized Executives or by the Companies, or any of them. In the event there is any dispute or uncertainty as to whether certain information constitutes “confidential information,” the President and Chief Executive Officer for the Company shall determine whether a given item of information is or is not confidential.

Executive shall not impart confidential information to fellow Executives except where necessary for the performance of his/her duties.

Executive may disclose Confidential Information if required by any judicial or governmental request, requirement or order; provided that Executive will take reasonable steps to give the Companies sufficient prior notice in order to contest such request, requirement or order. Executive may also disclose Confidential Information if the information has become known to the general public by means other than Executive’s breach of this Agreement.

8.3 Of his own accord surrender all business documents and records to the Company or its nominated representative upon termination of employment. The Executive may also be required to surrender such documents and records at any time during the term of this Agreement.

9.      Non-Competition.

9.1 Non-Competition and Solicitation. Executive acknowledges and recognizes the highly competitive nature of the business of the Company. In consideration of the compensation described in this Agreement, Executive agrees that for a period of time coextensive with the Term and for one year following Executive’s termination of employment with the Company, for whatever reason and whether or not pursuant to the terms of this Agreement (the “Non-Compete Period”), Executive shall not, either directly or indirectly, (and whether or not for compensation), work for be employed by, own, manage, operate, control, finance, participate or engage in, or have any interest in, any person, firm, entity, financial institution, partnership, limited partnership, limited liability company, corporation or business (whether as an employee, owner, sole proprietor, partner, venturer, member, shareholder, officer, director, agent, creditor, consultant or in any capacity which calls for the rendering of personal services, advice, acts for management, operation or control) which engages in any activity substantially the same as or competitive with the business for the Company as it is then conducted or planned to be conducted (the “Business”), in Lenawee, Hillsdale, Washtenaw, Jackson, and Monroe Counties of the State of Michigan (the “Restricted Territory”). The foregoing shall not, however, be deemed to prevent Executive from owning, for investment purposes only, up to 1% of the securities of any corporation the shares of which are traded on a securities exchange or in the over-the-counter market.

Executive further agrees that Executive shall not, directly or indirectly, at any time during the Non-Compete Period: (a) divert or attempt to divert from the Companies any work within the definition of the Business, whether or not in the Restricted Territory; (b) solicit, contact, call upon or attempt to solicit, or provide services to , any of the Companies’ Business Customers, suppliers or actively sought potential customers or suppliers for the purpose of doing anything within the definition of the Business, or any work reasonably related to the Business, whether or not in the Restricted Territory; or (c) induce or attempt to induce any person who is an Executive or employee of the Companies to leave the employ of the Companies or of any affiliate of the Companies whether or not in the Restricted Territory. For the purposes of this Agreement, “Business Customer” means any person or entity to, with or from whom the Company has within a three (3) year period preceding the Executive’s termination:

9.1.1	Provided banking, lending, credit, mortgage or other financial services:
9.1.2	Submitted a bid for, or otherwise negotiated for, the providing of products or the performance of services;
9.1.3	Provided products or performed services;
9.1.4	Entered into an agreement for the providing of products or performance of services; or
9.1.5	Entered into any strategic research and development alliance, strategic marketing alliance, or strategic promotional alliance.

9.2 Remedies. Executive has had knowledge of the affairs, trade secrets, customers, potential customers and other proprietary information with respect to the Business, and Executive acknowledges and agrees that compliance with the covenants set forth in Paragraphs 8.2 and 9 is necessary for the protection of the Business, and the goodwill and other proprietary interests of the Companies and that any violation of this Agreement will cause severe and irreparable injury to the Business, and the goodwill and proprietary interests of the Companies, which injury is not adequately compensable by money damages. Accordingly, in the event of a breach (or threatened or attempted breach) of Paragraph 8.2 and/or 9, any of the Companies, in addition to any other rights and remedies, including disgorgement of all profits wrongfully derived by Executive from such breach, shall be entitled to immediate appropriate injunctive relieve or a decree of specific performance, without the necessity of showing any irreparable injury or special damages.

Executive agrees that the remedy at law for breach of the obligations set forth in Paragraphs 8 and 9 of this Agreement is inadequate and in the event of a breach or threatened breach thereof Executive agrees that the Companies, without posting any bond, shall be entitled to seek equitable relief in the form of specific performance, temporary restraining order, temporary, preliminary or permanent injunction, or other appropriate equitable remedy.

If, in any judicial proceeding, a court shall refuse to enforce any of the covenants included herein, then said unenforceable covenants(s) shall be deemed modified so as to become enforceable to the maximum extent permitted, and if such modification is not permitted, then such unenforceable covenants shall be deemed eliminated from these provisions for the purpose of the proceeding to the extent necessary to permit the remaining separate covenants to be enforced. It is the intent and agreement of the Company and Executive that these covenants be given the maximum force, effect and application permissible under law. The provisions of Paragraphs 8.2 and 9 shall survive the termination of this Agreement.

10.      Assignment and Pledging of Salary.
The Executive shall neither assign nor pledge to third parties his salary or any other indemnity which might be due to him from the Company. The duties and obligations of Executive under this Agreement are personal unto the Executive and my not be assigned, delegated or otherwise transferred.

11.      Acceptance of Presents.
The Executive may not, in connection with his work for the Company, accept or pledge himself to accept either directly or indirectly any presents, commission or other favor of any kind whatsoever without the prior knowledge of the Company.

12.      Retirement.
Upon retirement or termination of employment for whatever reason, the confidentiality and non-competition obligations of this Agreement shall continue in full force and effect and remain binding on the Executive.

13.      Premature Discharge of Executive with Notice.
Without prejudice to the compensation set forth in Paragraph 4 of this Agreement, the Company may wholly or partially forego the services of the Executive between the date when notice of termination was first given and the date of contract expiration. In the event the Company decides to wholly or partially forego the services of Executive, Company has the right to pay in cash any remaining salary which the Executive has not yet been paid for the balance of the one-month notice period set forth in Paragraph 3.4 of this Agreement.

14.      Entire Agreement.
This Agreement, together with the Executive Confidentiality Agreement, contains the entire agreement of the parties hereto with respect to the subject matter hereby referenced and may not be changed, altered or extended (including by additions or deletions), orally or otherwise, except by an agreement or consent in writing signed by both the Executive and the President and Chief Executive Officer of the Company. Such writing may only be signed on behalf of the company by the President and Chief Executive Officer of the Company. This Agreement supersedes all other agreements, written or otherwise and shall in no event be modified by any oral statement, agreement, commitment, representation or understanding.

15.      Severability.
If any term or provision of this Agreement or the application thereof to any circumstance shall, to any extent and for any reason, be held invalid or unenforceable, the remainder of this Agreement, or the application of such term or provision to circumstances other than those as to which it is held to be invalid or unenforceable, shall not be affected thereby and shall be construed as if such invalid or unenforceable term or provision had never been contained herein, and each term and provision of this Agreement shall be valid and enforceable to the fullest extent permitted by law. If any portion of this Agreement is held to be excessively broad as to time, duration, geographical scope, activity or subject, it shall be construed by limiting or reducing the provision as required so that the provision as limited or reduced is enforceable under applicable law.

16.      Successors.
The obligation of the Company under this Agreement shall be binding upon, and the rights of the Company hereunder shall inure to the benefit of, the Company and it successors and assigns.

17.      Governing Law.
This Agreement shall be governed by and construed in accordance with the laws and judicial decisions of the State of Michigan.

18.      Agreement to Arbitrate Employment Claims.
In the event Executive fails for whatever reason to execute the settlement agreement and general release attached hereto as Appendix A, the Company, the Holding company and Executive agree to submit to final and binding arbitration in accordance with the National Rules for the Resolution of Employment Disputes issued by the American Arbitration Association, effective February 22, 2007, any existing or future employment disputes, controversies or claims arising out of Executive’s employment with the Company or the termination of that employment, including but not limited to claims for breach of contract, common law tort claims, claims for nonpayment of wages, commissions, or overtime pay, claims of unlawful termination or retaliation, and claims of employment discrimination based on race, sex, age, national origin, pregnancy, disability or other status protected by state or federal law or any other bias prohibited by state or federal law. Binding arbitration under the Federal Arbitration Act, 9 U.S.C. Section 1, shall be the sole and exclusive means of resolving any dispute arising out of Executive’s employment or the termination from employment by the Company or by Executive, and no other suit or action can be brought by Executive in any court or in any other forum. In addition, any disputes arising during Executive’s employment involving claims of unlawful discrimination or unlawful harassment under federal or state statutes shall be submitted exclusively to binding arbitration under the above provisions.

Executive understands and agrees that arbitration of such disputes and claims shall be the sole and exclusive means for resolving any and all existing and future disputes or controversies arising out of Executive’s employment with the Company or the termination thereof, with the exception of claims for benefits under the Michigan Workers’ Disability Compensation Act, and the Michigan Employment Security Act. Notwithstanding anything contained herein to the contrary, this Agreement to arbitrate shall not be deemed to be a waiver of the Company’s right to secure equitable relief including an injunction if and when otherwise appropriate to enforce Sections 8 and 9 of this Agreement.

Executive understands that by signing this Agreement Executive is waiving any right that he may have to a jury trial or a court trial of any employment-related dispute Executive further understands and agrees that by accepting or continuing employment with the Company, Executive automatically agrees that arbitration is the exclusive forum for all disputes arising out of or related to executive’s employment with the Company, and Executive agrees to waive all rights to a civil court action regarding his employment and the termination of that employment and Executive agrees that only an arbitrator, and neither a Judge nor a jury, will decide the dispute.

If Executive decides to dispute his termination or any other alleged incident during his employment, including but not limited to unlawful discrimination or harassment, Executive must deliver a written request for arbitration to the company within one (1) year from the date of termination, or one (1) year from the date on which the alleged incident(s) or conduct occurred, and respond within fourteen (14) calendar days to each communication regarding the selection of an arbitrator and the scheduling of a hearing. Executive expressly waives any longer statute or other period of limitations to the contrary.

If the Company does not receive a written request for arbitration from Executive within one (1) year, or if Executive does not respond to any communication from the Company about the arbitration proceedings within fourteen (14) calendar days, Executive will have waived any right to raise any claims arising out of the termination of Executive’s employment with the Company, or involving claims of unlawful discrimination or harassment, in arbitration and in any court or other forum. Failure to initiate arbitration as provided herein will forever bar any claim involving that dispute.

If Executive makes a timely request for arbitration the Company agrees to pay the case management administrative fee chaired by the American Arbitration Association. Executive shall have the right to be represented by counsel of his own choosing. Executive and the Company shall each bear respective costs for legal representation at any such arbitration. The Executive and the Company shall be given clear notice of all hearing dates. The selected arbitrator shall authorize and supervise pre-hearing discovery and shall be empowered to set a hearing, hear testimony and examine whatever acceptable evidence the Company and executive may present. Executive’s liability for the costs and fees of arbitration, other than attorney fees, whatsoever, shall be limited to $1000. The arbitrator may grant any remedy or relief that a court having jurisdiction of the matter could grant, including reinstatement of the Executive with or without back pay or with partial back pay. If the arbitrator orders reinstatement, the arbitrator shall also designate an alternative monetary award which the Company may, at is option, elect to pay Executive in lieu of reinstatement. The arbitrator is authorized to award a reasonable attorney fee in accordance with applicable law. In the absence of an award, each party is responsible for its own attorney fees.

Executive understands and agrees that the decision and award of the arbitrator is final and binding on both the Executive, the Company, and the Holding Company shall provide the exclusive remedy(ies) for resolving any and all disputes between the Company, the Holding Company and Executive arising from the employment relationship, and shall be enforceable in any court of competent jurisdiction. In accordance with 9 U.S.C. § 1 etseq., MCL 600.5001-600.6035; MSA 27A.5000-27A.5035 and MCR 3.602, Executive agrees that upon issuance of the arbitrator’s decision and award, judgment in any court of competent jurisdiction shall be rendered on the award and entered so as to enforce its provisions.

EXECUTIVE VOLUNTARILY AND KNOWINGLY AGREES THAT HIS EMPLOYMENT BY THE COMPANY AS OF THIS DATE IS GOOD AND VALUABLE CONSIDERATION FOR THIS AGREEMENT.

EXECUTIVE HAS READ AND UNDERSTANDS THE FOREGOING AND VOLUNTARILY AND KNOWINGLY AGREES TO THE TERMS AND CONDITIONS OF THIS AGREEMETN.

EXECUTIVE ACKNOWLEDGES THAT EXECUTIVE HAS READ THIS AGREEMENT, THAT EXCUTVE UNDERSTANDS ITS TERMS AND THAT BY SIGNING IT, EXECUTIVE IS WAIVING ALL RIGHTS TO A TRIAL BEFORE A COURT OR JURY OF ANY AND ALL DISPUTES AND CLAIMS REGARDING EXECUTIVE’S EMPLOYMENT WITH COMPANY OR THE TERMINATION THEREOF, EXCEPT AS OTHERWISE NOTED HEREIN, THAT NOW EXIST OR MAY IN THE FUTURE EXIST OR BE KNOWN OR SUSPECTED BY EXECUTIVE.

IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the date set forth in the first paragraph of this Agreement.

Mark D. Wolfe
——————————————
Executive's printed name


/s/ Mark D. Wolfe
——————————————
Executive's signature


Chief Financial Officer
——————————————
Position


2/22/07
——————————————
Date

FOR PAVILION BANCORP BY:

/s/ Richard J. DeVries
——————————————
Richard J. DeVries, President & CEO



2/22/07
——————————————
Date

APPENDIX A

SETTLEMENT AGREEMENT AND RELEASE

This Settlement Agreement and General Release ("Agreement") is made and entered into this ____ day of ____________________, 20____, by and between _______________________________________, (the "Executive"), and _____________________________ (the "Employer").

WHEREAS, Executive and Employer desire to settle and resolve all issues arising out of Executive’s employment with and termination from employment with Employer without any disputes, proceedings or litigation, on the following terms and conditions.

NOW, THEREFORE, in consideration of the promises and of the mutual covenants and agreements contained herein, it is agreed by and between the parties hereto that:

1. This Agreement does not constitute any admission by Employer that any action it, its agents or employees took with respect to Executive was wrongful, unlawful or in violation of any local, state or Federal act, statute, or constitution, or susceptible of inflicting any damages or injury whatsoever on Executive, and Employer specifically denies any such wrongdoing or violation. It is further agreed that this Agreement is entered into solely in an effort to resolve fully all matters related to or arising out of Executive’s employment with Employer and his termination therefrom.

2. Employer shall pay Executive the sum of One Thousand Dollars ($1,000) fifteen (15) days after Executive and Employer execute this Agreement. The aforementioned payment is understood by the parties to be paid in consideration of Executive waiving and otherwise releasing Employer, its directors, officers, members, agents, employees, representatives, attorneys, successors and assigns, of and from any and all claims, demands, rights, liabilities, and causes of action of any kind or nature arising out of or in connection with his employment with Employer or his termination from Employer. It is also agreed and understood that this payment is for any alleged damages, costs and attorney’s fees incurred by Executive and will be subject to payroll taxes or deductions, income or withholding taxes, social security taxes, unemployment taxes, disability taxes or any other taxes which customarily are deducted and/or paid with respect to wages.

3. In return for the payment made to Executive pursuant to paragraph 2 herein, Executive hereby generally releases and forever discharges Employer, its Holding Company, subsidiaries, directors, officers, members, agents, employees, representatives, attorneys, successors and assigns from any and all causes of action, claims or demands of any type, including, without limiting the generality of the foregoing general release, claims or causes arising which could have arisen out of Executive’s employment relationship with Employer and the termination of his employment relationship with Employer, any and all claims under the Fair Labor Standards Act, 29 U.S.C. § 201 et seq.; the Age Discrimination in Employment Act, 29 U.S.C. § 621 et seq. (1976); Title VII of the Civil Rights Act of 1964, 42 U.S.C. § 2000e et seq.; the Civil Rights Act of 1866, 42 U.S.C. § 1981; the Civil Rights Act of 1991, Pub. L. No. 102-166; the National Labor Relations Act, 29 U.S.C. § 151 et seq. (1976); the Americans With Disabilities Act, 42 U.S.C. § 12101 et seq.; Federal Executive Order 11246; the Family and Medical Leave Act, Pub. L. No. 103-3; the Employee Retirement Income Security Act of 1974 (ERISA), the Older Workers’ Benefit Protection Act, the Elliot-Larsen Civil Rights Act, M.C.L. 37.2101 et seq.; the Michigan Persons With Disabilities Civil Rights Act, M.C.L. 37.1101 et seq.; the Michigan Minimum Wage Law of 1964; the Michigan Act Regulating Payment of Wages and Fringe Benefits, M.C.L. 408.471; the Whistleblowers’ Protection Act and/or any other similar federal, state or local statute, law, ordinance, regulation or order, claims for breach of contract, defamation, promissory estoppel or any tortuous conduct. The foregoing provision shall not apply to claims for benefits under any employee benefit plan as defined in Section 3(3) of ERISA (exclusive of Executive’s SERA), irrespective of whether the particular benefit plan is a church plan not subject to ERISA.

4. Except as provided herein, the parties also release and forever discharge each other, their directors, officers, members, agents, employees, representatives, attorneys, successors, assigns, heirs, executors and administrators, of and from any and all other demands, claims, causes of action, obligations, agreements, promises, representations, damages, suits and liabilities regarding Executive’s employment with or termination from Employer, both known and unknown, in law or in equity, of a class or individual nature, including but not limited to, attorney’s fees and costs. Executive further covenants and agrees never to institute (directly or indirectly) any action or proceeding of any kind against Employer, its agents, employees, representatives, attorneys, successors, assigns, heirs, executors and administrators, regarding Executive’s employment with or termination of employment from Employer.

5. As a part of this Agreement, Executive agrees to waive reinstatement and to not seek future employment in any position with Employer, or in any company in which Employer has a substantial (more than twenty-five percent (25%)) ownership interest.

6. Executive agrees that this document and any and all matters concerning this settlement will be regarded as confidential communications between the parties hereto and will not be disseminated by publication of any sort or be released in any manner or means to any newspaper, magazine, radio station, television station, to any future, current or former employee, vendor or customer of Employer or to anyone else except as provided for in this Agreement. Except as provided for in this Agreement, if asked about such matters by any individual whatsoever, Executive is to reply that “the matter has been resolved” or words of similar effect. It is understood that Executive may, on a limited basis, advise his attorney, accountant and tax preparers of this Agreement, all of whom shall agree to follow the confidentiality provisions of this paragraph.

7. It is further agreed that Executive will not encourage or assist any present or past employee of Employer who litigates against or who files administrative charges against Employer, its agents, officers, directors, shareholders or employees, unless required to provide testimony or documents pursuant to a lawful subpoena or as otherwise required by law.

8. This instrument constitutes and contains the entire agreement and understanding between the parties concerning the subject matter of this Agreement, and supersedes all prior negotiations, proposed agreements and understandings, if any, between the parties.

9. Executive specifically acknowledges that, at least twenty-one (21) days prior to the required date for executing this document, Executive was given a complete copy of this Agreement and by this Agreement was advised in writing to consult with an attorney concerning its meaning and effect. Executive understands that he may revoke this document in writing, addressed to the President & CEO, within seven (7) days after execution hereof, in which event this Agreement will be of no effect and Executive will be entitled to none of the benefits provided hereunder.

10. Executive states that he has read and understands that this Agreement is meant as a complete and final settlement and release, releasing Employer, its directors, agents, employees, representatives, attorneys, successors, assignees, heirs, executors and administrators, of and from any and all claims he may have against them, that he voluntarily agrees to the terms set forth herein, that he knowingly and willingly intends to be legally bound by the same, that he was given adequate opportunity to consider the Agreement, that he discussed it with his legal counsel, that he has had ample time to study the terms of this Agreement with his attorney and with members of his family, that the terms and conditions hereof were determined by negotiation, and that he executes this Agreement knowingly and of his own free will.

THIS IS A RELEASE READ BEFORE SIGNING

        [EXECUTIVE]


——————————————
Subscribed and Sworn to before me
this ____ day of ______________, 20__.



——————————————
        Notary Public


        [EMPLOYER]

By: ________________________

Its: ________________________

EX-13

Exhibit 13

Rule 14a-3 Annual Report to Security Holders

2006
Annual Report

This is Pavilion Bancorp, Inc.’s (the “Company”) 2006 Annual Report to shareholders, which contains the Company’s audited consolidated financial statements and a detailed financial review. Although attached to the Company’s proxy statement, this report is not part of the Company’s proxy statement, is not deemed to be soliciting material, and is not deemed to be filed with the Securities and Exchange Commission (the “SEC”) except to the extent that it is expressly incorporated by reference in a document filed with the SEC.

The 2006 Summary Annual Report to Shareholders accompanies the proxy statement and the 2006 Annual Report to Shareholders. This report presents information concerning the business and financial results of the Company in a format and level of detail that the Company believes shareholders will find useful and informative.

Shareholders who would like to receive additional information than that contained in this 2006 Annual Report are invited to request the Company’s Annual Report on Form 10-K. Pavilion Bancorp, Inc.’s Form 10-K Annual Report to the Securities and Exchange Commission will be provided to any shareholder without charge upon written request. Requests should be addressed to Pavilion Bancorp, Inc., Attention: Melissa Covell, 135 East Maumee Street, Adrian, Michigan 49221. You may also access our Annual Report on Form 10-K from the Company’s website: www.pavilionbancorp.com.

2006 ANNUAL REPORT
CONTENTS

SELECTED FINANCIAL DATA	3
CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2006 and 2005 and for twelve months ended December 31, 2006, 2005 and 2004
- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	4
- CONSOLIDATED BALANCE SHEETS	5
- CONSOLIDATED STATEMENTS OF INCOME	6
- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY	7
- CONSOLIDATED STATEMENTS OF CASH FLOWS	8
- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	9
SELECTED QUARTERLY FINANCIAL DATA	33
- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS	36
- DISCLOSURE CONTROLS AND PROCEDURES	58

2

SELECTED FINANCIAL DATA
(In thousands, except per share data)

	2006			2005			2004			2003			2002
At year-end:
Total assets	$	295,023		$	287,881		$	259,322		$	323,382		$	287,286
Loans receivable	$	246,129		$	237,598		$	207,159		$	209,467		$	184,837
Deposits	$	235,944		$	210,748		$	199,992		$	202,366		$	189,046
Shareholders' equity	$	27,936		$	26,384		$	31,857		$	26,524		$	25,069
For the year:
Total interest income	$	18,875		$	16,130		$	14,885		$	15,039		$	16,201
Total interest expense		7,050			4,449			2,795			3,252			4,777
Net interest income		11,825			11,681			12,090			11,787			11,424
Provision for loan losses		333			342			693			595			667
Noninterest income		3,068			3,277			3,566			5,840			5,625
Noninterest expense		11,088			12,075			11,809			12,110			11,384
Income before income taxes		3,472			2,541			3,154			4,922			4,998
Provision for income tax		1,071			603			1,001			1,563			1,590
Net income from continuing operations		2,401			1,938			2,153			3,359			3,408
Discontinued operation
Income (loss) from operation of discontinued component		-			-			724			(173	)		(816	)
Gain on sale of discontinued component		-			-			6,990			-			-
Provision (benefit) for income tax		-			-			2,735			(49	)		(263	)
Income (loss) from discontinued operation		-			-			4,979			(124	)		(553	)
Net income	$	2,401		$	1,938		$	7,132		$	3,235		$	2,855
Financial ratios:
From continuing operations
Return on average shareholders' equity		8.84	%		6.66	%		7.38	%		13.02	%		14.02	%
Return on average assets		0.82	%		0.71	%		0.74	%		1.10	%		1.20	%
From combined operations
Return on average shareholders' equity		8.84	%		6.66	%		24.43	%		12.54	%		11.74	%
Return on average assets		0.82	%		0.71	%		2.45	%		1.06	%		1.01	%
Per share data:
Cash dividends declared per share	$	1.07		$	0.96		$	1.22		$	1.09		$	0.82
Dividend payout ratio		32.7	%		38.9	%		14.5	%		28.8	%		25.4	%
Shareholders' equity per share	$	38.50		$	35.88		$	37.38		$	31.37		$	30.16
Average equity to average assets		9.31	%		10.64	%		10.02	%		8.45	%		8.59	%
Earnings per share from continuing operations
Basic	$	3.27		$	2.47		$	2.54		$	3.92		$	3.85
Diluted	$	3.26		$	2.45		$	2.52		$	3.89		$	3.83
Earnings per share from discontinued operation
Basic	$	-		$	-		$	5.88		$	(0.14	)	$	(0.63	)
Diluted	$	-		$	-		$	5.82		$	(0.14	)	$	(0.62	)
Net earnings per share
Basic	$	3.27		$	2.47		$	8.42		$	3.78		$	3.23
Diluted	$	3.26		$	2.45		$	8.34		$	3.75		$	3.21

All per share data has been adjusted to reflect stock splits and stock dividends, including a 5% stock dividend declared on December 19, 2003 and issued January 30, 2004.

3

Report of Independent Registered Public Accounting Firm

To The Board of Directors and Shareholders
Pavilion Bancorp, Inc.

We have audited the accompanying balance sheets of Pavilion Bancorp, Inc. as of December 31, 2006 and 2005, and the related statements of income, shareholders’equity, and cash flows for each year in the three-year period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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 preparation. 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 Pavilion Bancorp, Inc. as of December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each year in the three-year period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

/s/ Plante & Moran, PLLC

Plante & Moran, PLLC

Auburn Hills, Michigan

March 9, 2007

4

PAVILION BANCORP, INC.
CONSOLIDATED BALANCE SHEETS

(000’s omitted)	December 31,
ASSETS	2006			2005
Cash and cash equivalents	$	17,210		$	11,308
Securities available for sale (Note 2)		17,828			25,407
Federal Home Loan Bank, Freddie Mac, FNMA stock		2,053			2,795
Federal Reserve Bank stock		630			630
Loans held for sale		377			927
Loans (Note 3)		246,129			237,598
Less: allowance for loan and lease losses (Note 4)		(2,817	)		(2,683	)
Net loans		243,312			234,915
Premises and equipment - net (Note 6)		8,175			6,135
Accrued interest receivable		1,930			1,651
Mortgage servicing rights (Note 5)		2,558			2,898
Other assets		950			1,215
Total assets	$	295,023		$	287,881
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits
Noninterest bearing	$	46,291		$	45,353
Interest-bearing (Note 7)		189,653			165,395
Total deposits		235,944			210,748
Federal funds purchased (Note 8)		6,601			9,000
Repurchase agreements (Note 8)		7,700			13,663
Federal Home Loan Bank advances (Note 8)		10,885			16,901
Accrued interest payable		851			667
Other liabilities		2,341			2,529
Subordinated debentures (Note 9)		-			5,000
Common stock in ESOP subject to repurchase obligation
(Note 11)		2,765			2,989
Total liabilities		267,087			261,497
SHAREHOLDERS' EQUITY (Notes 17 and 18)
Common stock and paid-in capital, no par value:
3,000,000 shares authorized; shares issued
and outstanding: 725,206-2006; 735,379-2005		10,629			10,724
Retained earnings		17,409			15,963
Accumulated other comprehensive loss		(102	)		(303	)
Total shareholders' equity		27,936			26,384
Total liabilities and shareholders' equity	$	295,023		$	287,881

See accompanying notes to the consolidated financial statements.

5

PAVILION BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2006, 2005, 2004

(000’s omitted, except per share data)	2006		2005		2004
Interest and dividend income
Loans receivable, including fees	$	17,711	$	14,951	$	13,914
Debt securities:
Taxable		701		780		664
Tax-exempt		95		135		120
Federal funds sold		206		118		47
Dividend income		162		146		140
Total interest and dividend income		18,875		16,130		14,885
Interest expense
Deposits		5,467		3,334		2,144
Subordinated debentures		419		359		285
Other borrowed funds		1,164		756		366
Total interest expense		7,050		4,449		2,795
Net interest income		11,825		11,681		12,090
Provision for loan losses (Note 4)		333		342		693
Net interest income after provision for loan losses		11,492		11,339		11,397
Noninterest income
Service charges and fees		1,354		1,318		1,431
Net gain on sale of loans		976		1,390		1,516
Loan servicing fees, net of amortization (Note 5)		97		287		500
Other		641		282		119
Total noninterest income		3,068		3,277		3,566
Noninterest expense
Compensation and employee benefits (Note 11)		6,217		7,194		7,209
Occupancy and equipment		1,502		1,449		1,417
Postage and delivery		297		300		305
Professional services		536		673		301
Outside services		1,171		1,038		1,026
Marketing and advertising		166		272		342
Loan and collection		298		343		322
Director and shareholders (Note 12)		184		191		175
Other		717		615		712
Total noninterest expense		11,088		12,075		11,809
Income from continuing operations before income taxes		3,472		2,541		3,154
Income taxes from continuing operations (Note 10)		1,071		603		1,001
Income from continuing operations		2,401		1,938		2,153
Discontinued operation:
Income (loss) from discontinued operation,
net of income taxes of $0, $0, and $162		-		-		562
Gain on sale of discontinued component, net of
income tax expense of $0, $0, and $2,573		-		-		4,417
Income (loss) from discontinued operation		-		-		4,979
Net income	$	2,401	$	1,938	$	7,132

	2006		2005		2004
Earnings per share from continuing operations
Basic	$	3.27	$	2.47	$	2.54
Diluted	$	3.26	$	2.45	$	2.52
Earnings per share from discontinued operation
Basic	$	-	$	-	$	5.88
Diluted	$	-	$	-	$	5.82
Net earnings per share
Basic	$	3.27	$	2.47	$	8.42
Diluted	$	3.26	$	2.45	$	8.34

See accompanying notes to the consolidated financial statements.

6

PAVILION BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years ended December 31, 2006, 2005, and 2004

(000’s omitted)	Common Stock Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders' Equity
Balance January 1, 2004	$	10,675		$	15,616		$	233		$	26,524
Comprehensive income:
Net income		-			7,132			-			7,132
Unrealized gains (losses) on securities		-			-			(423	)
Tax effect		-			-			144
Total other comprehensive income		-			-			(279	)		(279	)
Total comprehensive income		-			-						6,853
Change in common stock subject to repurchase		(745	)		-			-			(745	)
Retirement of stock		(1	)		-			-			(1	)
Stock option expense		43			-			-			43
Stock options exercised		218			-			-			218
Cash dividends - $1.22 per share		-			(1,035	)		-			(1,035	)
Balance December 31, 2004		10,190			21,713			(46	)		31,857
Comprehensive income:
Net income		-			1,938			-			1,938
Unrealized gains (losses) on securities		-			-			(389	)
Tax effect		-			-			132
Total other comprehensive income		-			-			(257	)		(257	)
Total comprehensive income		-			-						1,681
Change in common stock subject to repurchase		1,555			-			-			1,555
Stock repurchase and retirement		(1,566	)		(6,952	)		-			(8,518	)
Stock option expense		16			-			-			16
Stock options exercised		529			-			-			529
Cash dividends - $0.96 per share		-			(736	)		-			(736	)
Balance December 31, 2005		10,724			15,963			(303	)		26,384
Comprehensive income:
Net income		-			2,401			-			2,401
Unrealized gains (losses) on securities		-			-			305
Tax effect		-			-			(104	)
Total other comprehensive income		-			-			201			201
Total comprehensive income		-			-						2,602
Change in common stock subject to repurchase		(87	)		-			-			(87	)
Retirement of stock		(77	)		(173	)		-			(250	)
Issuance of stock		10									10
Stock option expense		22			-			-			22
Stock options exercised		37			-			-			37
Cash dividends - $1.07 per share		-			(782	)		-			(782	)
Balance December 31, 2006	$	10,629		$	17,409		$	(102	)	$	27,936

See accompanying notes to the consolidated financial statements.

7

PAVILION BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2006, 2005 and 2004

(000’s omitted)	2006			2005			2004
Cash flows from operating activities
Net income	$	2,401		$	1,938		$	7,132
Adjustments to reconcile net income to
net cash from operating activities
Depreciation		715			688			579
Stock option expense		22			16			43
Stock award expense		10			-			-
Provision for loan losses		333			342			693
Gain on sale of discontinued operation		-			-			(6,990	)
Deferred income tax (benefit) provision		(304	)		(161	)		483
Amortization on investment securities available for sale		21			34			188
Net loss on disposal of assets		9			89			-
Amortization of mortgage servicing rights		858			663			444
Origination of mortgage loans held for sale		(42,407	)		(60,122	)		(85,788	)
Proceeds from sales of mortgage loans held for sale		43,415			60,173			86,884
Net gains on sale of mortgage loans		(976	)		(1,390	)		(1,207	)
Net change in:
Deferred loan origination fees		(14	)		(17	)		-
Accrued interest receivable and other assets		(430	)		(63	)		396
Accrued interest payable and other liabilities		119			(1,684	)		(6,921	)
Net cash provided by (used in) operating activities		3,772			506			(4,064	)
Cash flows from investing activities
Proceeds from:
Maturities, calls and principal payments on
securities available for sale		7,861			5,233			8,349
Sales of securities available for sale		990			-			-
Federal Home Loan Bank stock		742			-			-
Federal Reserve Bank stock		-			-			21
Proceeds from the disposition of premises and equipment		1			161			511
Proceeds from sale of discontinued operation		-			-			15,101
Purchases of:
Securities available for sale		(996	)		(3,165	)		(16,410	)
Federal Home Loan Bank stock		-			(57	)		(137	)
Federal Reserve Bank stock		-			(270	)		-
Premises and equipment, net		(2,756	)		(1,346	)		(1,407	)
Net (increase) decrease in loans		(8,348	)		(30,348	)		1,726
Recoveries on loans charged-off		47			67			82
Net cash (used in) provided by investing activities		(2,459	)		(29,725	)		7,836
Cash flows from financing activities
Net change in deposits		25,196			10,756			(2,374	)
Net change in short term borrowings		(8,362	)		18,731			682
Redemption of subordinated debentures		(5,000	)		-			-
Proceeds from FHLB advances		40,400			16,800			2,000
Repayment of FHLB advances		(46,416	)		(8,485	)		(635	)
Redemption of ESOP/401k shares		(311	)		-			-
Repurchase and retirement of common stock		(250	)		(8,518	)		-
Stock options exercised		37			529			218
Dividends paid		(705	)		(986	)		(1,035	)
Net cash provided by (used in) financing activities		4,589			28,827			(1,144	)
Net change in cash and cash equivalents		5,902			(392	)		2,628
Cash and cash equivalents at beginning of year		11,308			11,700			9,072
Cash and cash equivalents at end of year	$	17,210		$	11,308		$	11,700
Supplemental schedule of noncash activities
Transfer from: Loans to foreclosed real estate	$	416		$	295		$	914

Cash paid for:	Interest	$	6,866	$	4,015	$	3,894
	Income taxes	$	1,268	$	2,615	$	805

See accompanying notes to the consolidated financial statements.

8

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting and reporting policies of Pavilion Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, Bank of Lenawee (the “Bank”), conform to accounting principles generally accepted in the United States of America and to general practice within the banking industry. The following describes the significant accounting and reporting policies which are employed in the preparation of the consolidated financial statements.

Principles of Consolidation: The consolidated financial statements include the accounts of the Company, the Bank and the Bank’s wholly-owned subsidiaries, Pavilion Mortgage Company and Pavilion Financial Services, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.

Discontinued Operation: On July 16, 2004 Pavilion Bancorp, Inc. announced that it had signed a definitive agreement to sell the Bank of Washtenaw for $15,101,000 in cash. The sale was completed on October 29, 2004. In accordance with Financial Accounting Standard 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the financial position and results of operations of the Bank of Washtenaw are removed from the detail line items in the Company’s consolidated financial statements and presented separately as “discontinued operation.” Please refer to Note 16 to the Company’s Consolidated Financial Statements for additional information.

Nature of Operations and Industry Segments: The Company is a one-bank holding Company which conducts limited business activities. The Bank performs the majority of business activities.

The Bank provides a full range of banking services to individuals, agricultural businesses, commercial businesses and light industries located in its service area. The Bank maintains a diversified loan portfolio, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. The Bank offers a variety of deposit products, including checking accounts, savings accounts, money market accounts, individual retirement accounts and certificates of deposit. Pavilion Mortgage Company originates personal mortgage loans, and the majority of the mortgage loans originated are sold on the secondary market. Pavilion Financial Services, Inc. owns interests in a title insurance and mortgage reinsurance agency. While the Company monitors the revenue stream of various Company products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company’s banking operations are considered by management to be aggregated into one operating segment. The principal markets for the Bank’s financial services are the communities in which the Bank is located and the areas immediately surrounding these communities. The Bank serves these markets through its offices located in Lenawee and Hillsdale Counties in Michigan.

Use of Estimates: The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America. Management is required to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates and assumptions. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan and lease losses, foreclosed assets, impaired loans, deferred tax assets, mortgage servicing rights and fair value of securities and other financial instruments.

Cash and Cash Equivalents: For the purpose of the consolidated statement of cash flow cash and cash equivalents include cash on hand, demand deposits with other financial institutions, federal funds sold and commercial paper, all of which mature within 90 days.

9

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Securities: Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. There were no such investments at December 31, 2006 and 2005. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of securities held to maturity and securities available for sale below their cost that are deemed to be other than temporary (if any) are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been impacted, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Federal Home Loan Bank Stock and Federal Reserve Bank Stock: Federal Home Loan Bank stock (“FHLBI stock”) and Federal Reserve Bank stock (“FRB stock”) are considered restricted investment securities and are carried at cost. Purchases and sales of FHLBI stock are made directly with the FHLBI at par value. Purchases and sales of FRB stock are made directly with the Federal Reserve at par value.

Mortgage Banking Activities: The Company routinely sells to investors its originated long-term residential fixed rate mortgage loans. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the adjusted carrying value of the related mortgage loans sold.

Loans Held for Sale: Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.

Loans: The Company grants mortgage, commercial and consumer loans to customers. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan and lease losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

Accrual of interest on loans is generally discontinued at the time a loan becomes 90 days delinquent in its payments, unless the credit is well-secured and in the process of collection. Loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

Uncollected accrued interest attributable to the current fiscal year on loans that are placed on nonaccrual or charged-off is reversed against interest income. Uncollected accrued interest attributable to prior fiscal year(s) is reversed against the allowance for loan and lease losses. The interest on these loans is accounted for on the cash-basis, until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan and Lease Losses: The allowance for loan and lease losses (the “allowance”) is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management determines the uncollectibility of a loan balance. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan and lease losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of

10

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

historical experience, industry experience, regulatory guidance, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general, and unallocated components. The specific components relate to certain loans that are classified as doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower that the carrying value of that loan. The general component covers classified and non-classified loans and is based on industry experience, regulatory guidance, and historical loss experience, adjusted for certain qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower including length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral, if the loan is collateral dependent.

Large groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.

Loan Servicing: Servicing assets are recognized as separate assets when rights are acquired through the sale of originated residential mortgage loans. Capitalized servicing rights are reported in other assets and are amortized against noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or on a valuation model that calculates the present value of estimated future net servicing income using market based assumptions. Temporary impairment is recognized through a valuation allowance for an individual stratum to the extent that fair value is less than the capitalized amount for the stratum. If it is later determined that all or a portion of the temporary impairment no longer exists, the valuation allowance is reduced through a recovery of income. An other than temporary impairment results in a permanent reduction to the carrying value of the servicing asset.

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.

11

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Foreclosed Assets: Assets acquired through, or in lieu of, foreclosure are held-for-sale and are initially recorded at fair value (less cost to sell) at the date of the foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. Other real estate owned amounts to $169,000 and $549,000 at December 31, 2006 and 2005 and are included in other assets.

Repurchase Agreements: Repurchase agreement liabilities represent amounts advanced by two third party financial institutions as well as various Bank customers. Repurchase agreements are collateralized with securities owned by the Bank of Lenawee. Securities pledged as collateral for repurchase agreements are held in safekeeping at independent correspondent banks. Repurchase agreements are not covered by federal deposit insurance.

Benefit Plans: A defined benefit pension plan covers substantially all employees, with benefits based on years of service and compensation prior to retirement. The Company also maintains a profit-sharing and 401(k) plan. The profit-sharing and 401(k) plan expense and the amount contributed are determined by the Board of Directors. Employee benefits are discussed further in Note 11.

Stock-Based Compensation: In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment,” which requires that compensation costs related to share-based payment transactions be recognized in the financial statements. SFAS 123R eliminates the alternative to use the intrinsic method of accounting provided for in Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” which generally resulted in no compensation expense recorded in the financial statements related to the grant of stock options to employees or directors if certain conditions were met.

On January 1, 2006, the Company adopted SFAS 123R using the modified prospective method. SFAS 123R requires all share-based payments to employees or non-employee directors, including stock options, to be recognized as expense in the consolidated statement of earnings based on their fair values. Prior to SFAS 123R, only certain pro forma disclosures were required. The amount of compensation is measured at fair value of the options when granted, and this cost is expensed over the required service period, which is normally the vesting period of the options. SFAS 123R applies to awards granted or modified after January 1, 2006 or any unvested awards outstanding at December 31, 2005. Consequently, compensation cost is recorded for prior option grants that vest on or after January 1, 2006, the date of adoption.

12

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

The following table illustrates the effect on net income and earnings per share as of and for the years ended December 31, 2006, 2005 and 2004 if the Company had applied the fair value recognition provisions of SFAS No. 123, to stock-based compensation (000’s omitted):

	2006			2005			2004
Net income as reported	$	2,401		$	1,938		$	7,132
Add: Stock-based compensation expense included in reported net income, net of related tax effects		15			11			28
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects		(15	)		(74	)		(65	)
Pro forma net income	$	2,401		$	1,875		$	7,095
Basic earnings per share - As reported	$	3.27		$	2.47		$	8.42
Basic earnings per share - Pro forma	$	3.27		$	2.38		$	8.34
Diluted earnings per share - As reported	$	3.26		$	2.45		$	8.34
Diluted earnings per share - Pro forma	$	3.26		$	2.37		$	8.30

Advertising Expenses: Advertising expenses are expensed as incurred.

Income Taxes: Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the various temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

Earnings per Common Share: Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.

13

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Earnings per common share have been computed based on the following (000’s omitted):

	2006		2005		2004
Net income	$	2,401	$	1,938	$	7,132
Average number of common shares outstanding
used to calculate basic earnings per share		734,352		785,117		846,221
Effect of dilutive options		1,680		4,762		8,682
Average number of common shares outstanding
used to calculate diluted earnings per
common share		736,032		789,879		854,903
Number of antidilutive stock options
excluded from the diluted earnings per share
computation		21,215		5,250		-

Other Comprehensive Income: Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.

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 customers’ 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.

Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed separately. 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 the estimates. The fair value estimates of existing on and off-balance-sheet financial instruments does not include the value of anticipated future business or values of assets and liabilities not considered financial instruments.

Reclassifications: Certain amounts appearing in the prior year’s financial statements have been reclassified to conform to the current year’s financial statements.

14

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Recent Accounting Pronouncements:

Servicing of Financial Assets
In March 2006, the Financial Accounting Standards Board issued SFAS No. 156, “Accounting for Servicing of Financial Assets,” an amendment of FASB Statement No. 140. SFAS No. 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. It requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value. SFAS No. 156 permits an entity to choose either an amortization or fair value measurement method for each class of separately recognized servicing assets and servicing liabilities. It also permits a one-time reclassification of available-for-sale securities to trading securities with recognized servicing rights. Lastly, it requires separate presentation of servicing assets and servicing liabilities. Adoption of the initial measurement provision of this statement is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements, for any period of that fiscal year. Management intends to implement the initial fair value recognition provisions of this pronouncement beginning January 1, 2007, but is still evaluating whether to continue with the amortization method for subsequent measurement or elect the fair value subsequent measurement method.

Accounting for Uncertainty in Income Taxes
In July 2006, the Financial Accounting Standards Board issued FIN No. 48, “Accounting for Uncertainty in Income Taxes.” This interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. This interpretation requires that the Company recognize in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. This interpretation is effective for fiscal years beginning after December 15, 2006 and would be recognized with the cumulative effect of the change in accounting principle recorded as an adjustment to beginning retained earnings. Adoption of this interpretation is not expected to have a material effect on the results of operations or financial condition of the Company.

Establishing Standards on Measuring Fair Value
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP, and expands disclosures about fair value measurements. The Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability at the measurement date. The statement emphasizes that fair value is a market-based measurement and not an entity-specific measurement. The statement establishes a fair value hierarchy used in fair value measurements and expands the required disclosures of assets and liabilities measured at fair value. Management will be required to adopt this statement beginning in 2008. The adoption of this standard is not expected to have a material impact on the Company’s financial condition, results of operations or liquidity.

Accounting for Defined Benefit Pension and Other Postretirement Plans
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS No. 158 amends SFAS No. 87, 88, 106, and 123(R). SFAS No. 158 requires employers to recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status. Secondly, it requires employers to measure the plan assets and obligations that determine its funded status as of the end of the fiscal year. Lastly, employers are required to recognize changes in the funded status of the defined benefit pension or postretirement plan in the year that the changes occur with the changes reported in comprehensive income. The standard is required to be adopted by entities having fiscal years ending after December 15, 2006. The Company is a participant in a multi-employer defined benefit plan, which is not within the scope of this pronouncement. This standard is not expected to have an impact on the Company’s financial condition, results of operations or liquidity.

15

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 2 — SECURITIES

The amortized cost and estimated fair market value of available-for-sale securities are as follows at December 31, 2006 and 2005 (000’s omitted):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
2006
U.S. Treasury & government agencies	$	14,496	$	7	$	169	$	14,334
Obligations of states & political subdivisions		2,507		34		14		2,527
Mortgage-backed securities		979		-		12		967
Total available for sale securities	$	17,982	$	41	$	195	$	17,828
2005
U.S. Treasury & government agencies	$	20,164	$	-	$	441	$	19,723
Obligations of states & political subdivisions		4,350		31		32		4,349
Mortgage-backed securities		1,353		5		23		1,335
Total available for sale securities	$	25,867	$	36	$	496	$	25,407

Contractual maturities of securities at December 31, 2006 are as follows. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately (000’s omitted):

	Available-for-Sale
	Amortized Cost		Market Value
Due in one year or less	$	14,530	$	14,353
Due from one to five years		1,523		1,525
Due from five to ten years		550		564
Due after ten years		400		419
Total debt securities		17,003		16,861
Mortgage-backed securities		979		967
Total	$	17,982	$	17,828

16

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 2 — SECURITIES (continued)

Information pertaining to securities with gross unrealized losses at December 31, 2006 and 2005, aggregated by investment category and length of time that individual securities have been in a continuous loss position are as follows (000’s omitted):

At December 31, 2006	Less Than Twelve Months				Twelve Months or More
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Available-for-sale securities:
U.S. treasury & government agencies	$	-	$	-	$	169	$	13,330
Obligations of states & political
subdivisions		-		-		14		1,241
Mortgage-backed securities		-		-		12		706
Total available-for-sale securities	$	-	$	-	$	195	$	15,277

At December 31, 2005	Less Than Twelve Months				Twelve Months or More
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Available-for-sale securities:
U.S. treasury & government agencies	$	-	$	-	$	441	$	19,723
Obligations of states & political
subdivisions		10		1,676		22		1,230
Mortgage-backed securities		-		-		23		915
Total available-for-sale securities	$	10	$	1,676	$	486	$	21,868

Unrealized losses on securities are considered temporary by management and have not been recognized into income because the issuers’ bonds are of high credit quality, the Company has the intent and ability to hold the securities for the foreseeable future, and the decline in fair value is primarily due to increased market interest rates. The fair value is expected to recover as the bonds approach the maturity date.

Securities with a fair value of approximately $13,431,000 and $16,102,000 at December 31, 2006 and 2005 were pledged to secure repurchase agreements and other borrowings. Of the $13,431,000 pledged in 2006, $13,133,000 was pledged to secure repurchase agreements with third party financial institutions and certain customers and $298,000 was pledged to the Federal Reserve Bank as security for treasury tax and loan (TT&Ls) accounts.

NOTE 3 – LOANS RECEIVABLE

Major categories of loans in the portfolio are as follows at December 31, 2006 and 2005 (000’s omitted):

	2006		2005
Commercial	$	133,545	$	125,378
Agricultural		39,656		38,778
Residential mortgage		30,255		28,113
Residential construction		10,896		11,902
Home equity lines of credit		19,163		20,693
Consumer		12,614		12,734
Total loans receivable	$	246,129	$	237,598

17

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 3 – LOANS RECEIVABLE (continued)

Certain directors and executive officers of the Company, including associates of such persons, were loan customers of the Company during 2006 and 2005. A summary of aggregate related-party loan activity for loans aggregating $50,000 or more to any related party at December 31, 2006 and 2005 is as follows (000’s omitted):

	2006			2005
Balance at January 1	$	4,925		$	5,140
New loans		68			1,440
Repayments		(881	)		(1,655	)
Balance at December 31	$	4,112		$	4,925

NOTE 4 — ALLOWANCE FOR LOAN AND LEASE LOSSES

Activity in the allowance for loan and lease losses for the twelve months ended December 31, 2006, 2005 and 2004 are as follows (000’s omitted):

	2006			2005			2004
Beginning balance	$	2,683		$	2,495		$	2,302
Charge-offs		(246	)		(221	)		(582	)
Recoveries		47			67			82
Provision for loan losses		333			342			693
Ending balance	$	2,817		$	2,683		$	2,495

Impaired loans at December 31, 2006, 2005 and 2004 are as follows (000’s omitted):

	2006		2005		2004
Impaired loans with no allowance for loan and lease losses allocated	$	-	$	-	$	13
Impaired loans with allowance for loan and lease losses allocated	$	2,082	$	1,404	$	900
Total impaired loans	$	2,082	$	1,404	$	913
Amount of the allowance allocated to impaired loans	$	240	$	254	$	151
Average investment in impaired loans	$	1,430	$	1,269	$	1,006
Interest income recognized during impairment	$	48	$	27	$	14

No additional funds are committed to be advanced in connection with impaired loans.

Nonperforming loans at December 31, 2006 and 2005 were as follows (000’s omitted):

	2006		2005
Loans past due over 90 days still accruing interest	$	668	$	672
Nonaccrual loans	$	2,728	$	1,104

Nonperforming loans includes both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

18

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 5 — LOAN SERVICING

The Bank routinely sells to investors its originated residential mortgage loans. The unpaid principal balance of loans serviced for others was approximately $375,841,000, $376,036,000, and $374,022,000 at December 31, 2006, 2005 and 2004 and are not included in the accompanying consolidated balance sheets. Related escrow balances were $1,215,000, $958,000, and $408,000 December 31, 2006, 2005, and 2004.

The key economic assumptions used in determining the fair value of the mortgage servicing rights are as follows:

	December 31,
	2006			2005
Annual constant prepayment speed		12.69			7.48
Weighted average life (in months)		35			27
Discount rate		8.50	%		8.50	%

At December 31, 2006 and 2005 the estimated fair value of the mortgage loan servicing portfolio was $3.5 million and $4.6 million, respectively. The fair value of the mortgage servicing rights is based on the above assumptions.

Activity for capitalized mortgage servicing rights was as follows (000’s omitted):

	2006			2005			2004
Beginning balance	$	2,898		$	2,827		$	2,739
Mortgage servicing rights capitalized		518			734			532
Mortgage servicing rights amortized		(858	)		(663	)		(444	)
Ending balance	$	2,558		$	2,898		$	2,827

There was no valuation allowance at December 31, 2006, 2005 and 2004 for mortgage servicing rights.

NOTE 6 — PREMISES AND EQUIPMENT

Major classifications of bank premises and equipment at December 31, 2006 and 2005 are summarized as follows (000’s omitted):

	2006			2005
Land	$	2,110		$	561
Buildings and improvement		6,399			5,343
Furniture and equipment		5,853			5,135
Construction in process		474			1,041
Total premises and equipment		14,836			12,080
Less: accumulated depreciation		(6,661	)		(5,945	)
Net carrying amount	$	8,175		$	6,135

The Company is currently constructing a new branch with a total estimated cost of $1,808,000 (excluding cost of land totaling approximately $765,000), of which $235,000 has been incurred through December 31, 2006. The estimated cost to complete construction is approximately $1,573,000. Completion is expected in May 2007.

The Company has also acquired a parcel of land at a cost of approximately $503,000 in Adrian for the purpose of constructing another branch scheduled for completion in late 2008. Except for the cost of the land acquisition, no significant costs have been incurred or committed through December 31, 2006.

Depreciation expense for the years ended December 31, 2006, 2005 and 2004 amounted to $715,000, $688,000 and $579,000, respectively.

19

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 6 — PREMISES AND EQUIPMENT (continued)

Future minimum rental commitments under non-cancelable operating leases are as follows at December 31, 2006: $78,000 per year for each year ending December 31, 2007, 2008, and 2009, and $53,000 for the year ending December 31, 2010. One lease is in the seventh year of a ten year lease. The lease provides for inflationary adjustments to the cost of the lease based upon changes in the Consumers Price Index beginning in 2006. No increase was made in the lease rate in the current year.

NOTE 7 — DEPOSITS

The following table summarizes interest-bearing deposits at December 31, 2006 and 2005 (000’s omitted):

	2006		2005
NOW accounts	$	28,722	$	26,273
Savings		44,488		47,213
Certificates of deposit:
$100,000 and over		72,870		55,056
Under $100,000		43,573		36,853
Total interest-bearing deposits	$	189,653	$	165,395

Stated maturities of time deposits at December 31, 2006 are as follows (000’s omitted):

2007	$	104,220
2008		6,240
2009		2,025
2010		3,498
2011		459
Thereafter		1
	$	116,443

The following table indicates the schedule of maturities for certificates of deposit with a minimum denomination of $100,000:

	2006		2005
Three months or less	$	27,605	$	25,091
Over three months through six months		31,750		13,380
Over six months through twelve months		8,065		9,322
One to two years		2,114		5,139
Thereafter		3,336		2,124
Total	$	72,870	$	55,056

NOTE 8 — BORROWED FUNDS

Borrowed funds at December 31, 2006 and 2005 are as follows (000’s omitted):

	2006		2005
Federal funds purchased	$	6,601	$	9,000
Repurchase agreements - customers		2,700		3,663
Repurchase agreements - financial institutions		5,000		10,000
Federal Home Loan Bank advances		10,885		16,901
Total borrowed funds	$	25,186	$	39,564

20

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 8 — BORROWED FUNDS (continued)

Federal funds purchased totaled $6,601,000 and $9,000,000 at December 31, 2006 and 2005, respectively. Federal funds purchased typically mature daily. The Bank utilizes a $10.0 million line of credit at a correspondent bank for this purpose. Rates on this line of credit ranged from 4.4375% to 5.50% during 2006. The weighted average interest rate at December 31, 2006 is 5.375%. The weighted average interest rate paid for the year ended December 31, 2006 was 5.69%.

Repurchase Agreements
The Company has repurchase agreements with Bank customers as well as third party financial institutions. Information concerning repurchase agreements at December 31, 2006 and 2005 are summarized as follows (000’s omitted):

Customer Repurchase Agreements
		2006			2005
Amount outstanding at year-end	$	2,700		$	3,663
Weighted average interest rate at year-end		1.91	%		2.03	%
Average daily balance during the year	$	3,700		$	5,304
Weighted average interest rate during the year		1.74	%		1.55	%
Maximum month-end balance during the year	$	4,863		$	14,177
Third Party Financial Institutions Repurchase Agreements
		2006			2005
Amount outstanding at year-end	$	5,000		$	10,000
Weighted average interest rate at year-end		3.88	%		3.90	%
Average daily balance during the year	$	9,517		$	5,649
Weighted average interest rate during the year		3.89	%		3.90	%
Maximum month-end balance during the year	$	10,000		$	10,000

Both customer and third party financial institution repurchase agreements are terminable upon demand.

Federal Home Loan Bank Advances
The Company has various term advances from the Federal Home Loan Bank of Indianapolis (“FHLBI”) with fixed and variable interest rates ranging from 2.93% to 5.28% at December 31, 2006 and from 2.93% to 4.90% at December 31, 2005. The weighted average interest rate at December 31, 2006 is 4.73%. Maturity dates range from February 2007 to May 2008. The weighted average remaining maturity at December 31, 2006 is 145 days, or May 25, 2007. Pursuant to collateral agreements with the FHLBI, the Company pledges various qualified one to four family mortgage loans as collateral for advances outstanding at the FHLBI. At December 31, 2006 and 2005 such pledged mortgage loans had outstanding balances of $21,616,000 and $31,752,000, respectively. Certain advances are subject to prepayment penalties and the provisions and conditions of the credit policies of the FHLBI.

Scheduled principal reductions on FHLBI advances at December 31, 2006 are as follows (000’s omitted):

2007	$	9,000
2008		1,885
Total FHLBI advances	$	10,885

21

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 9 – SUBORDINATED DEBENTURES

In December 2001, Lenawee Capital Trust I (“Capital Trust”), 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 proceeds of the offering were loaned to the Company in exchange for junior subordinated debentures with terms similar to the Trust Preferred Securities. The sole assets of Capital Trust are the junior subordinated debentures of the Company and payment thereunder. The junior subordinated debentures and the back-up obligations, in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of Capital Trust under the Trust Preferred Securities. Distributions on the Trust Preferred Securities are payable semi-annually at a variable rate of interest and are included in interest expense in the consolidated financial statements. The variable rate of interest is equal to the sum of the six-month London Interbank Offered Rate and 3.75% with a maximum rate of 11.0% during the first five years. This subordinated debenture is considered Tier 1 capital (with certain limitations applicable) under current regulatory guidelines.

The Trust Preferred Securities, which mature December 8, 2031, were subject to mandatory redemption, in whole or in part, upon repayment of the subordinated debentures at maturity or their earlier redemption at the liquidation preference plus accrued but unpaid distributions. The subordinated debentures were redeemable prior to the maturity date at the option of the Company on or after December 8, 2006 at their principal amount plus accrued but unpaid interest. The subordinated debentures were also redeemable in whole or in part from time to time, upon the occurrence of specific events defined within the trust indenture. The Company had the option to defer distributions on the subordinated debentures from time to time for a period not to exceed 5 consecutive years.

The Company redeemed the subordinated debentures on December 8, 2006 at their principal amount plus accrued but unpaid interest. As a result of this redemption, the Company recognized the deferred costs of the original issuance and redemption expense totaling approximately $145,000 before tax. As of December 31, 2005, the outstanding principal balance of the subordinated debentures was $5.0 million.

NOTE 10 – INCOME TAXES

Allocation of income taxes between current and deferred portions is as follows (000’s omitted):

	2006			2005			2004
Continuing Operations:
Current provision	$	1,375		$	764		$	518
Deferred (benefit) provision		(304	)		(161	)		483
Total from continuing operations		1,071			603			1,001
Discontinued operation		-			-			2,735
Total	$	1,071		$	603		$	3,736

Income tax expense from continuing operations calculated at the statutory federal income tax rate of 34% differs from actual income tax expense for continuing operations as follows (000’s omitted):

	2006			2005			2004
Statutory rates	$	1,180		$	864		$	1,072
Increase (decrease) from:
Tax-exempt interest income		(52	)		(74	)		(88	)
Non-deductible expenses		9			6			13
Change in accounting estimate and other		(66	)		(193	)		4
	$	1,071		$	603		$	1,001

22

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 10 – INCOME TAXES (continued)

Year-end deferred tax assets and liabilities consist of (000’s omitted):

	2006			2005			2004
Deferred tax assets
Allowance for loan and lease losses	$	756		$	643		$	609
Net deferred loan fees		-			13			26
Accrued pension liability		42			42			-
Net unrealized losses on securities available-for-sale		52			156			23
Other		268			206			230
Total deferred tax assets		1,118			1,060			888
Deferred tax liabilities
Depreciation		(509	)		(537	)		(590	)
Mortgage servicing rights		(870	)		(985	)		(961	)
Prepaid expenses		(73	)		(58	)		(138	)
Other		(78	)		(92	)		(105	)
Total deferred tax liabilities		(1,530	)		(1,672	)		(1,794	)
Net deferred tax liability	$	(412	)	$	(612	)	$	(906	)

NOTE 11 — EMPLOYEE BENEFITS

Defined Benefit Pension Plan

The Bank is a participant in the multi-employer Financial Institutions Retirement Funds (“FIRF” or the “Plan”), which covers substantially all of its officers and employees. Effective January 1, 2006, all new employees will no longer be eligible to participate in the defined benefit pension plan in use at the Bank for its existing officers and employees. The Plan, for eligible employees with one year of service, provides benefits based on basic compensation and years of service. The Bank’s contributions are determined by FIRF and generally represent the normal cost of the Plan. Specific Plan assets and accumulated benefit information for the Bank’s portion of the Plan are not available. Under the Employee Retirement Income Security Act of 1974 (“ERISA”), a contributor to a multiemployer pension plan may be liable in the event of complete or partial withdrawal for the benefit payments guaranteed under ERISA. Currently, the Bank does not intend to withdraw from the Plan, though management regularly reviews the structure of benefits offered for appropriateness and long-term cost effectiveness. The Bank has met the funding requirements in the Plan as of December 31, 2006. The expense of the Plan allocated to the Bank for the twelve months ended December 31, 2006 and 2005 was $341,344 and $347,817, respectively.

ESOP and 401(k) Plan

The Company adopted an employee stock ownership plan, or ESOP, originally known as the Bank of Lenawee Employee Stock Ownership Plan (the “Plan”), for the purpose of acquiring outstanding shares of the Company’s predecessor, for the benefit of eligible employees. The Plan was effective as of January 1, 1984 and has received notice of qualification by the Internal Revenue Service.

In connection with the adoption of the Plan, a Trust was established to hold the shares acquired. During the period 1984 through 1994, the Company (and its predecessors) made contributions to the Trust. Such contributions consisted of both shares of employer stock or cash which was used to acquire shares of employer stock from others. When cash contributions were used to acquire employer stock from others, such shares were acquired at or below fair market value as determined from time to time by reference to market transactions or by independent appraisal. On January 1, 1995 the Company ceased making contributions to the Plan.

23

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 11 — EMPLOYEE BENEFITS (continued)

Effective January 1, 1996, the Company adopted an amendment to the Plan adding a so-called “cash or deferred” arrangement under Section 401(k) of the Internal Revenue Code and providing for elective contributions by employees (up to 20% of their eligible compensation) and matching contributions by the Company equal to 100% of each eligible employee’s elective contributions (but with the match capped at 2% of his or her eligible compensation). Matching contributions from the Company consist of the Company’s common shares. Since January 1, 1996, the Plan has been known as the Employee Stock Ownership and 401(k) Savings Plan. Expense relating to the 401(k) provision was $59,000, $100,000 and $108,000 in 2006, 2005 and 2004, respectively.

Accumulations of employer stock (now Company stock) allocated under the ESOP prior to 1995 continue to be allocated to employees and are to be held in the Trust until such employees become entitled to a distribution in accordance with the provisions of the Plan (normally at retirement or termination of employment for other reasons). At December 31, 2006 and 2005, the Trust held 57,001 and 61,636 of the Company’s stock, respectively, which includes both the ESOP and 401(k) portions of the plan. Upon distribution of shares to a participant, the participant has the right to require the Company to purchase shares at the most recent appraised value in accordance with the terms and conditions of the ESOP portion of the Plan. Under the 401(k) portion of the plan, the Company’s matching contribution applied to the purchase of Company stock on behalf of a participant is distributed in cash at the most recent appraised value upon termination or voluntary separation from the Company. A participant in the 401(k) plan does not have an option to receive company stock. Additionally, employee contributions to the 401(k) plan, which may not be invested in Company stock, are also distributed in cash when the participant is terminated or voluntarily leaves the Company. As such, these shares are classified as a liability in the financial statements and reported at their redemption value. Changes in redemption value are reported as adjustments to equity. The appraised value of the shares of Company stock held by the Trust was $2,765,000 and $2,989,000 at December 31, 2006 and 2005, respectively.

NOTE 12 – STOCK BASED COMPENSATION

In December 2004, the FASB issued SFAS 123R (revised 2004), “Share-Based Payment,” (“SFAS 123R”) which requires that compensation costs related to share-based payment transactions be recognized in financial statements. SFAS 123R eliminated the alternative to use the intrinsic method of accounting previously allowed under APB 25, “Accounting for Stock Issued to Employees,” which generally did not require any compensation expense to be recognized in the financial statements for the grant of stock options to employees if certain conditions were met. Only certain pro forma disclosures of share-based payments were required.

On January 1, 2006, the Company adopted SFAS 123R using the modified prospective method. SFAS 123R requires all share-based payment to employees, including grants of employee stock options, to be recognized as expense in the consolidated statement of earnings based on their fair values. The amount of compensation expense is determined based on the fair value of the options when granted and is expensed over the required service period, which is normally the vesting period of the options. SFAS 123R applies to awards granted or modified on or after January 1, 2006, and to any unvested awards that were outstanding at December, 31 2005. Consequently, the compensation expense is recorded for prior option grants that vest on or after January 1, 2006, the date of adoption.

At December 31, 2006, the Company has two stock compensation plans. Stock option plans are used to reward directors and certain executive officers and provide them with an additional equity interest. Options are issued for 10 year periods and vest over five years. Additionally, the options that are awarded to a director will become fully vested when an active director reaches the age of 62. Prior to adoption of SFAS 123R, the Company accounted for those plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Minimal stock-based employee compensation related to the Stock Option Plans was reflected in net earnings, as substantially all options granted under the Stock Option Plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

24

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 12 - STOCK BASED COMPENSATION (continued)

The fair value concepts were not changed significantly in SFAS 123R; however, in adopting this standard, companies must choose among alternative valuation models and amortization assumptions. The Company has elected to continue to use both the Black-Scholes option pricing model and the straight-line method of amortization of compensation expense over the requisite service period of the grant. The Company would reconsider use of the Black-Scholes model if additional information in the future indicates another model would be more appropriate at that time, or if grants issued in future periods have characteristics that could not be reasonably estimated using this model.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes pricing model with the following weighted-average assumptions:

	2005		2004
Risk-free interest rate		4.00%		3.75%
Expected option life		8 years		8 years
Expected dividend yield		2.14%		1.73%
Expected stock price volatility		25.07%		19.86%

The weighted average fair value of stock options granted was $15.85 and $11.43 for 2005 and 2004, respectively. There were no options granted in 2006.

The summary of option activity under the Plan as of December 31, 2006, and changes during the year then ended is presented below:

Options	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding, January 1, 2006		30,791		$	45.56
Granted		-			-
Exercised		(1,386	)		17.65
Forfeited or expired		-			-
Outstanding, December 31, 2006		29,405		$	46.76		5.2	$	92,868
Options exercisable, end of period		25,331		$	45.30		4.8	$	92,868

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between the Company’s closing stock price on the last trading day of our fiscal year ended 2006 and the exercise price, times the number of shares) that would have been received by the option holders had all option holders exercised their options on December 31, 2006. Out of the money options (options that have an exercise price that exceeds market value) are excluded from the computation as they are assumed to have no intrinsic value. This amount changes based on the fair market value of the Company’s stock.

The total intrinsic value of options exercised during the years ended December 31, 2006, 2005, and 2004 was approximately $39,800, $326,700, and $169,500, respectively.

25

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 12 - STOCK BASED COMPENSATION (continued)

The summary of the status of the Company’s nonvested shares as of December 31, 2006, and changes during the year then ended, is presented below:

Nonvested Shares	Shares			Weighted Average Grant Date Fair Value
Nonvested at January 1, 2006		5,692		$	13.86
Granted		-			-
Vested		(1,618	)		14.23
Forfeited		-			-
Nonvested at December 31, 2006		4,074		$	13.71

As of December 31, 2006, there was $26,000, net of tax, of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plans. This cost is expected to be fully amortized in four years, with half of the total amortization cost being recognized within the next 18 months. The total fair value of shares vested during the years ended December 31, 2006, 2005, and 2004 was approximately $22,000, $113,000, and $102,000, respectively.

NOTE 13 — COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES

Credit-Related Financial Instruments: The Company is party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Company’s consolidated balance sheets.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for balance sheet instruments.

At December 31, 2006 and 2005, the following financial instruments were outstanding whose contract amounts represent off-balance sheet credit risk (000’s omitted):

	2006		2005
Commitments to extend credit	$	8,416	$	7,370
Unfunded commitments under lines of credit		57,989		61,242
Commercial and standby letters of credit		2,430		3,051
	$	68,835	$	71,663

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based upon management’s credit evaluation of the customer.

26

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 13 - COMMITMENTS, OFF-BALANCE-SHEET RISK AND CONTINGENCIES (continued)

Unfunded commitments under commercial lines of credit and revolving lines of credit are commitments for possible future extensions of credit to existing customers. These lines of credit are typically collateralized and usually carry a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.

Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party, and are used primarily to support public and private borrowing arrangements. Essentially, all letters of credit issued have expiration dates within one year. The Company generally holds collateral supporting those commitments if deemed necessary.

Required Reserves at the Federal Reserve Bank of Chicago: At December 31, 2006 and 2005 the required reserves at the Federal Reserve Bank of Chicago totaled $977,000 and $1,385,000, respectively. These reserves do not earn interest.

Legal Contingencies: Various legal claims arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company’s consolidated financial statements.

NOTE 14 – PARENT-ONLY CONDENSED FINANCIAL STATEMENTS

The following represents the condensed financial statements of Pavilion Bancorp, Inc., (“Parent”) only. The Parent-only financial information should be read in conjunction with the Company’s consolidated financial statements.

The condensed balance sheets at December 31, 2006 and 2005 are as follows (000’s omitted):

	2006		2005
Assets
Cash and cash equivalents	$	405	$	3,208
Securities available for sale		521		1,129
Investment in subsidiaries		29,767		30,279
Other		264		159
Total assets	$	30,957	$	34,775
Liabilities & Shareholders' Equity
Subordinated debentures	$	-	$	5,000
Other		256		402
Common stock subject to repurchase in ESOP		2,765		2,989
Shareholders' equity		27,936		26,384
Total liabilities & shareholders' equity	$	30,957	$	34,775

27

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 14 - PARENT-ONLY CONDENSED FINANCIAL STATEMENTS (continued)

The Parent-only condensed statements of income for the years ended December 31, 2006, 2005 and 2004 are as follows (000’s omitted):

	2006			2005			2004
Dividends from subsidiaries	$	3,600		$	-		$	1,750
Interest income		24			61			20
Interest expense		(419	)		(359	)		(285	)
Other operating expense		(343	)		(290	)		(52	)
Income (loss) before equity in undistributed
net income of subsidiary		2,862			(588	)		1,433
(Excess) equity in undistributed net income
from subsidiaries		(715	)		2,344			750
Income from continuing operations before
income taxes		2,147			1,756			2,183
Income tax (benefit) provision		(254	)		(182	)		30
Income from continuing operations		2,401			1,938			2,153
Income (loss) from discontinued operation,
net of income taxes, $0, $0, $162		-			-			562
Gain on sale of discontinued operation, net of tax		-			-			4,417
Net income	$	2,401		$	1,938		$	7,132

28

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 14 - PARENT-ONLY CONDENSED FINANCIAL STATEMENTS (continued)

The condensed statements of cash flows for the years ended December 31, 2006, 2005 and 2004 are as follows (000’s omitted):

	2006			2005			2004
Cash flows from operating activities
Net income	$	2,401		$	1,938		$	7,132
Adjustments to reconcile net income to net cash
from operating activities
Excess (equity) in undistributed net income of
subsidiaries		715			(2,344	)		(750	)
Gain on sale of discontinued operation		-			-			(6,990	)
Amortization (accretion) of investment securities		7			10			(1	)
Stock option expense		22			16			43
Stock award expense		10			-			-
Other		(329	)		(2,362	)		1,518
Net cash provided by (used in) operating activities		2,826			(2,742	)		952
Cash flows from investing activities
Net proceeds from sale of discontinued operation		-			-			15,101
Purchase of securities available for sale		-			(3,165	)		(1,755	)
Proceeds from maturities of securities available for sale		600			3,985			162
Net cash provided by investing activities		600			820			13,508
Cash flows from financing activities
Redemption of subordinated debentures		(5,000	)		-			-
Redemption and retirement of ESOP/401k shares		(311	)		-			-
Repurchase of common stock		(250	)		(8,518	)		(1	)
Stock options exercised		37			529			218
Dividends paid		(705	)		(986	)		(1,035	)
Net cash used in financing activities		(6,229	)		(8,975	)		(818	)
Net (decrease) increase in cash and cash equivalents		(2,803	)		(10,897	)		13,642
Beginning cash and cash equivalents		3,208			14,105			463
Ending cash and cash equivalents	$	405		$	3,208		$	14,105

29

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 15 — FAIR VALUES OF FINANCIAL INSTRUMENTS

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, rather than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. The aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. The following methods and assumptions were used to estimate fair values for financial instruments:

Cash and Cash Equivalents: The carrying amounts of cash and short-term instruments reasonably approximate fair values.

Securities available for sale: Fair values for securities are based on quoted market prices.

Equities: Equities largely include Federal Home Loan Bank of Indianapolis stock and Federal Reserve Bank of Chicago stock. The carrying amounts of FHLBI and FRB stock approximate fair value based on their redemption provisions.

Loans held for sale: Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market rates.

Loans receivable: Fair value of loans receivable are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Accrued interest: The carrying value of accrued interest approximates fair value.

Demand and savings deposits: The carrying value of demand and savings accounts generally approximate the fair value, with the exception of certain larger relationships that may have a periodically negotiated rate of interest. The fair value of such relationships is estimated using a discounted cash flow calculation that applies interest rates currently being offered.

Time deposits: The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits with similar maturities.

Federal funds purchased: The carrying value of the Company’s federal funds purchased approximate the fair value.

Federal Home Loan Bank advances: The fair value of the Company’s Federal Home Loan Bank of Indianapolis advances are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar borrowing arrangements.

Repurchase agreements: The fair value of the Company’s repurchase agreements with third party financial institutions are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar borrowing arrangements. The fair value of the Company’s repurchase agreements with customers reasonably approximate the carrying value.

Subordinated debentures: The fair value of the Company’s subordinated debentures reasonably approximate the carrying value.

30

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 15 - FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments at December 31, 2006 and 2005 are as follows (000’s omitted):

	2006				2005
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	17,210	$	17,210	$	11,308	$	11,308
Securities available-for-sale		17,828		17,828		25,407		25,407
Equities		2,683		2,683		3,425		3,425
Loans held for sale		377		380		927		936
Loans, net		243,312		241,566		234,915		232,870
Accrued interest receivable		1,930		1,930		1,651		1,651
Financial liabilities:
Demand and savings deposits		119,501		119,501		118,839		119,014
Time deposits		116,443		115,832		91,909		91,669
Federal funds purchased		6,601		6,601		9,000		9,000
Federal Home Loan Bank advances		10,885		10,871		16,901		16,795
Repurchase agreements		7,700		7,670		13,663		13,526
Accrued interest payable		851		851		667		667
Subordinated debentures		-		-		5,000		5,000

NOTE 16 – DISCONTINUED OPERATION

On July 16, 2004 Pavilion Bancorp, Inc. announced that it had signed a definitive agreement to sell the Bank of Washtenaw for $15,101,000. The sale was completed on October 29, 2004. In accordance with Financial Accounting Standard 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the results of operations of Bank of Washtenaw are removed from the detail line items in the company’s financial statements and presented separately as “discontinued operation.”

The condensed income statement (unaudited) for the twelve months ended December 31, 2006, 2005 and 2004 for Bank of Washtenaw is as follows (000’s omitted):

	2006		2005		2004
Interest income	$	-	$	-	$	3,428
Interest expense		-		-		1,052
Net interest income		-		-		2,376
Provision for loan losses		-		-		19
Noninterest income		-		-		537
Noninterest expenses		-		-		2,170
Income (loss) before taxes		-		-		724
Income tax expense (benefit)		-		-		162
Net income (loss)	$	-	$	-	$	562

31

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 17 — REGULATORY MATTERS

Beginning in the first quarter of 2006, the Company became exempt from the Capital Guidelines, as the Board of Governors of the Federal Reserve System increased the asset size threshold from $150 million to $500 million in consolidated assets for determining whether a Bank Holding Company may qualify for an exemption from the Capital Guidelines. Under the revised regulatory financial reporting requirements, the Company will only be required to file parent-only financial data on a semi-annual basis. This change only impacts the Company and the Bank will continue to file necessary regulatory reports.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings, and other factors. Prompt corrective action provisions are not applicable for bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts, and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined).

At December 31, 2006 the Bank was considered well-capitalized under the regulatory framework for prompt corrective action. The Bank’s actual capital amounts and ratios at December 31, 2006 and 2005 and the Company’s capital amounts and ratios at December 31, 2005 are presented in the following table (in millions):

	Actual				Minimum Required For Capital Adequacy Action Regulations				Minimum Required to be Well-Capitalized Under Prompt Corrective Purposes
	Amount		Ratio		Amount		Ratio		Amount		Ratio
2006
Total capital (to risk weighted assets)
Bank of Lenawee	$	32.7		12.5%	$	20.9		>=8.0%	$	26.1		>=10.0%
Tier 1 Capital (to risk weighted assets)
Bank of Lenawee	$	29.9		11.4%	$	10.5		>=4.0%	$	15.7		>=6.0%
Tier 1 Capital (to average assets)
Bank of Lenawee	$	29.9		10.4%	$	11.5		>=4.0%	$	14.4		>=5.0%
2005
Total Capital (to risk weighted assets)
Consolidated	$	37.3		15.2%	$	19.6		>=8.0%		n/a		n/a
Bank of Lenawee	$	33.3		13.7%	$	19.4		>=8.0%	$	24.3		>=10.0%
Tier 1 Capital (to risk weighted assets)
Consolidated	$	34.7		14.1%	$	9.8		>=4.0%		n/a		n/a
Bank of Lenawee	$	30.6		12.6%	$	9.7		>=4.0%	$	14.5		>=6.0%
Tier 1 Capital (to average assets)
Consolidated	$	34.7		12.4%	$	11.2		>=4.0%		n/a		n/a
Bank of Lenawee	$	30.6		10.7%	$	11.5		>=4.0%	$	14.3		>=5.0%

As of December 31, 2005, the Company’s regulatory capital includes $5.0 million of subordinated debentures, issued by Lenawee Capital Trust I in December 2001, and are subject to certain limitations. Federal Reserve guidelines limit the amount of subordinated debentures which may be included in Tier 1 capital of the Company to 25% of total Tier 1 capital. At December 31, 2005 the entire amount of subordinated debentures was included as Tier 1 capital of the Company. The Company redeemed the subordinated debentures on December 8, 2006. Please refer to Note 9 to the Company’s Consolidated Financial Statements for additional information.

32

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 18 – RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES

Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the Bank, and loans or advances are limited to 10% of the Bank’s capital stock and surplus on a secured basis. At December 31, 2006, the Bank’s retained earnings available for the payment of dividends was $1,262,000. Accordingly, $28,505,000 of the Company’s equity in the net assets of the Bank was restricted at December 31, 2006. Funds available for loans or advances by the Bank to the Company amounted to $2.1 million.

In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements.

NOTE 19 – QUARTERLY RESULTS OF OPERATIONS (unaudited)

The following table summarizes the Company’s quarterly results for the years ended December 31, 2006 and 2005 (000’s omitted):

	For the Three-Month Period ended
	March 31		June 30		September 30		December 31
2006
Interest income	$	4,480	$	4,620	$	4,918	$	4,857
Interest expense		1,556		1,661		1,919		1,914
Net interest income		2,924		2,959		2,999		2,943
Provision for loan losses		-		105		120		108
Net interest income after
provision for loan losses		2,924		2,854		2,879		2,835
Noninterest income		707		846		719		796
Noninterest expense		3,062		2,688		2,535		2,803
Net income before income taxes		569		1,012		1,063		828
Federal income tax expense		169		317		280		305
Net income	$	400	$	695	$	783	$	523
Net earnings per share
Basic	$	0.54	$	0.95	$	1.06	$	0.72
Diluted	$	0.54	$	0.94	$	1.06	$	0.72

33

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE 19 - QUARTERLY RESULTS OF OPERATIONS (unaudited) (continued)

	For the Three-Month Period ended
	March 31		June 30		September 30		December 31
2005
Interest income	$	3,636	$	3,924	$	4,196	$	4,374
Interest expense		820		986		1,256		1,387
Net interest income		2,816		2,938		2,940		2,987
Provision for loan losses		30		150		105		57
Net interest income after
provision for loan losses		2,786		2,788		2,835		2,930
Noninterest income		939		899		801		638
Noninterest expense		3,328		3,019		2,939		2,789
Net income before income taxes		397		668		697		779
Federal income tax expense		138		204		220		41
Net income	$	259	$	464	$	477	$	738
Net earnings per share
Basic	$	0.30	$	0.57	$	0.63	$	0.97
Diluted	$	0.30	$	0.56	$	0.63	$	0.96

34

PAVILION BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

[THIS PAGE INTENTIONALLY LEFT BLANK]

35

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
This report includes “forward-looking statements” as that term is used in the securities laws. All statements regarding the Company’s expected financial position, business and strategies are forward-looking statements. In addition, the words “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” and similar expressions, as they relate to the Company and its management, are intended to identify forward-looking statements. The presentation and discussion of the provision and allowance for loan and lease losses, determining the fair value of securities and other financial instruments, the valuation of mortgage servicing rights and statements concerning future profitability or future growth or increases, are examples of inherently forward looking statements in that they involve judgments and statements of belief as to the outcome of future events. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on the Company’s operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Company and its business, including additional factors that could materially affect the Company’s financial results, is included in its filings with the Securities and Exchange Commission.

INTRODUCTION

The following “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (the “MD&A”) provides information about the consolidated financial condition and results of operations of Pavilion Bancorp, Inc. (the “Company”) as of December 31, 2006 and for the three year period ended December 31, 2006 and is intended to assist in understanding the results of operations of the Company. Information contained in this section should be read in conjunction with the consolidated financial statements and accompanying notes contained in this report.

BUSINESS OF PAVILION BANCORP, INC.

Pavilion Bancorp, Inc. (the “Company”), a bank holding company, was incorporated in Michigan in 1993. The shareholders elected to change its name to Pavilion Bancorp Inc. from Lenawee Bancorp Inc. on April 18, 2002. The Bank of Lenawee (the “Bank”), a Michigan banking corporation chartered in 1869, is a wholly-owned subsidiary of the Company. Pavilion Mortgage Company, a wholly-owned subsidiary of the Bank, engages in the residential mortgage origination business. Pavilion Financial Services, Inc., a wholly-owned subsidiary of the Bank, owns an interest in a title and mortgage reinsurance agency.

The Company’s primary business is concentrated in a single industry segment — commercial banking. The Bank provides a full range of banking services to individuals, commercial businesses and industries located in its service area. The Bank maintains diversified loan portfolios, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. The Bank offers a variety of deposit products, including checking accounts, savings accounts, money market accounts, individual retirement accounts and certificates of deposit.

The principal markets for financial services provided are in the southern-Michigan communities in which the Bank is located and the areas immediately surrounding these communities. The Bank serves these markets through 7 locations in or near its communities. The Bank does not have any material foreign assets or income.

The principal source of revenue is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 80.7% of total revenue in 2006 compared to 77.0% in 2005. Interest and fees on loans increased in the current year as the loan portfolio grew considerably and the level of mortgage loan sale activity continued to decline from levels experienced in 2005. Mortgage loan sale activity accounted for 4.4% of total revenue in 2006 compared to 7.2% in 2005 due to this decline. Proceeds from the sale of mortgage loans decreased $16.8 million, or 27.8%, to $43.4 million in 2006, down from $60.2 million in 2005, due to increases in mortgage rates and slowing of the real estate market.

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PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

CRITICAL ACCOUNTING POLICIES
Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, the performance of the economy or the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan and lease losses, determining the fair value of securities and other financial instruments, the valuation of mortgage servicing rights and deferred tax and tax provision estimates. Additional information regarding the Company’s critical accounting policies is discussed in detail in Note 1 to the consolidated financial statements.

Discontinued Operation
As previously disclosed in earlier regulatory filings, in accordance with Statement of Financial Accounting Standards No. 144, on July 16, 2004 Pavilion Bancorp, Inc. announced that it had signed a definitive agreement to sell the Bank of Washtenaw for $15,101,000. The sale of the Bank of Washtenaw was initiated to concentrate the Company’s resources in the Lenawee County market and other potential markets that are more homogenous to the Bank’s traditional market area. In accordance with Statement of Financial Accounting Standards 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the financial position and results of operations of the Bank of Washtenaw are removed from the detail line items in the Company’s consolidated financial statements and presented separately as “discontinued operation.” Accordingly, the various supporting schedules contained in the MD&A are also presented with Bank of Washtenaw-related information removed. The sale was completed on October 29, 2004. Please refer to Note 16 to the Company’s Consolidated Financial Statements for additional information.

Allowance for Loan and Lease Losses
The allowance for loan and lease losses is management’s estimate of losses inherent in the Bank’s loan portfolio. Management relies on a number of factors and sources of information in preparing this estimate. These include, but are not limited to, internal credit analyses and loan risk ratings, local economic conditions and trends, regulatory requirements, collateral values, loan types and loan documentation. Accordingly, the allowance for loan and lease losses includes a reserve calculation based on an evaluation of loans determined to be impaired, risk ratings, historical losses, loan types and other subjective factors management may believe to be relevant and/or material. Please refer to the section entitled “Loans, Credit Quality and Allowance for Loan and Lease Losses” located elsewhere in this report for additional information.

Loan Classifications
The Company has established a risk rating system for loans that evaluates a variety of credit quality-related characteristics of each loan being rated. Initial risk ratings for loans are established by the originating (or assigned) lending official. The lending official is responsible for the continuing accuracy of the risk rating and is authorized to downgrade a loan to a lower risk rating if warranted by any information received. Loan risk ratings are also evaluated for accuracy through several processes that are independent of the loan origination process. The Bank retains independent consultants to review the accuracy of loan risk ratings on an annual basis. These results are reported to senior management of the Bank, as well as the Audit Committee and the Board of Directors. Additionally, the Bank’s Chief Credit Officer monitors individual loan risk ratings and overall credit quality through several monitoring systems and reports. The Chief Credit Officer reports directly to the CEO of the Bank. Criticized loans have been risk-rated 5 and are individually included on a monthly Loan Watch Report submitted to senior management and the Board of Directors of the Bank. Classified loans have been risk-rated 6, 7 or 8 and are individually included on a monthly Problem Loan Report submitted to senior management and the Board of Directors of the Bank. The Bank’s Loan Policy specifically defines the characteristics of each risk rating as follows:

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PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

1 Rating: “Essentially risk free credit. Credit to premier customers having the Bank’s highest credit rating based on an extremely strong financial condition, which compares favorably with industry standards (upper quartile of RMA ratios). Secured by readily marketable liquid collateral (traded stocks, bonds, certificates of deposit, savings account, etc.) with comfortable margins. Highly profitable firms that have a track record of always servicing their debts. Possible characteristic of such accounts:

- Substantial net worth

- Low debt to worth ratio

- Significantly above average working capital

- Current accounts payable

- Deposits are 15% of outstanding loans

- 25% of assets are liquid”

2 Rating: “Low risk. Multiple ‘strong’ sources of repayment. Debt of borrower is modest relative to the borrower’s financial strength and ability to pay. Borrower must be profitable, have a demonstrated track record, very strong cash flow and margins above projected needs. Loan supported by unaudited financial statements containing strong balance sheets and five consecutive years of profits combined with a satisfactory relationship with the Bank. Customer demonstrates the ability to manage the working capital position and term financing requirements. Possessing a sound repayment source (and a secondary source) which definitely will allow repayment in a reasonable period of time. Individual loans backed by liquid personal assets, established history and unquestionable character. Other characteristics:

- Significant net worth

- Better than average debt to worth ratio (e.g. 2.0 to 1 or less)

- Above average working capital ratio

- Current accounts payable

- Secured loans must have collateral Loan/value ratio of 70% or lower

- 10% of assets are liquid”

3 Rating: “Moderate risk. ‘Good’ primary and secondary sources of repayment. Debt of the borrower is reasonable relative to borrower’s financial strength and ability to pay. Borrower must be profitable, have a demonstrated track record, exhibits sufficient cash flow and margins above projected needs. Borrowers have satisfactory asset quality and liquidity, adequate debt capacity and coverage, and good management in critical positions. Earning statements may reflect a one year loss, but borrowers have sufficient strength and financial flexibility to offset this event. Occasionally has a need for working capital and or term financing. Other characteristics:

- Acceptable net worth

- Acceptable industry average for debt to worth ratio

- Adequate working capital

- Not significantly slow in paying accounts payable

- Cash flow ratio = 1.3 or above”

4 Rating: “Acceptable risk. Sufficient primary source of repayment and acceptable secondary source of repayment has either:

- Minimum net worth

- Fairly high debt to worth ratio

- Adequate cash flow ratio (1.2 or above) with higher than desired leverage; or marginal cash flow (1.2 or below) with strong capitalization and liquidity.

- Declining earnings, limited additional debt capacity, or market fundamentals that indicate above average risks.”

5 Rating: “Borderline risk, potential weaknesses. Borrowers who exhibit potential credit weaknesses or downward trends deserving Bank management’s attention. If not checked or corrected, these trends will weaken the Bank’s asset position. Acceptable primary source of repayment, but less than preferable secondary source of repayment. Credit will have minimal excess cash flow, and financially will be moderately or highly leveraged. A “satisfactory” credit exhibits manageable credit risk with two measurable sources of repayment. Loans may lack technical or legal support, including deficiencies in loan documentation.

- Little or no net worth

- High debt to worth ratio

- Cash Flow ratio = 1.1 or above

- Start up or deteriorating industries or with a poor and declining market share in an average industry

- An element of asset quality, financial flexibility, or management is below average”

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PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

6 Rating: “Substandard. A loan with well-defined credit weakness or weaknesses that jeopardize liquidation of the debt. A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. These may be loans that have been restructured so that payment terms and collateral represent major concessions to the borrower when compared to normal loan terms. Also, this category should include those loans with contemplated or pending foreclosure or legal action due to the apparent deterioration in the credit. Loans are characterized by the distinct possibility that a bank will sustain loss if the deficiencies are not corrected. Loss potential, while existing in aggregate amount of substandard assets, does not have to exist in individual assets classified substandard.”

7 Rating: “Doubtful. A loan with weaknesses inherent to a substandard loan. The loan also has the added provision that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain known factors which may work to the advantage and strengthening of the asset, (i.e., capital injection, perfecting liens on additional collateral, refinancing plans, etc.) its classification as an estimated loss is deferred until its more exact status may be determined.”

8 Rating: “Loss. Loans classified as Loss are considered uncollectible and of such nominal value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is unpractical or desirable to defer writing-off this basically worthless asset, even though partial recovery may be affected in the future. Losses should be taken in the period in which they surface as uncollectible. Known losses should be in process of charge off.”

Mortgage Servicing Rights (“MSRs”)
The Bank records the original MSRs based on market data. A periodic independent third party valuation is completed to determine potential impairment of MSRs as a result of changes in interest rates and expected future loan repayment speeds. Significant changes in interest rates or repayment speeds could have a significant impact on the carrying value of the MSRs asset. The Bank obtains quarterly independent valuations. For additional information, please refer to Note 5 to the Company’s Consolidated Financial Statements located elsewhere in this report.

Income Taxes
Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based upon the tax effects of the various temporary differences between book and tax bases of the various balance sheet asset and liabilities and gives current recognition to changes in tax rates and laws. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized. For additional information, please refer to Note 10 to the Company’s Consolidated Financial Statements and the section entitled “Federal Income Tax Expense,” both located elsewhere in this report.

39

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

FINANCIAL CONDITION
Total assets increased by 2.5%, or $7.1 million, to $295.0 million at December 31, 2006 from $287.9 million at December 31, 2005. The increase in total assets is attributable to strong loan growth in the current year.

Total liabilities increased by $5.6 million, or 2.1%, to $267.1 million at December 31, 2006 from $261.5 million at December 31, 2005. The Bank increased the level of deposits in the current year to fund the growth in the loan portfolio. Growth in deposits and maturities of securities permitted repayment on certain other borrowings.

Total shareholders’ equity increased $1.5 million, or 5.8%, to $27.9 million at December 31, 2006 compared to $26.4 million at December 31, 2005. Current year net income was the primary reason for the increase, which was offset by current year dividends. Management monitors the capital levels of the Bank to provide for current and future business opportunities and to meet regulatory guidelines for “well capitalized” institutions.

Investments and Fed Funds Sold
Total investments securities available-for-sale decreased 29.8%, or $7.6 million, to $17.8 million at December 31, 2006, compared to $25.4 million at December 31, 2005. The decrease in investment securities is attributable to maturities and repayments on investments being used to fund loan growth and repayment of other borrowings in the current year. Equity investment in the Federal Home Loan Bank of Indianapolis (“FHLBI”) decreased $742,000, or 26.5% to $2.1 million at December 31, 2006 from $2.8 million at December 31, 2005. The Bank reduced the stock investment in FHLBI with the reduction in outstanding advances and collateral. Investment in Federal Reserve Bank (“FRB”) stock remained unchanged at $630,000 at December 31, 2006 compared to December 31, 2005. The Bank did not have any Fed Funds Sold at December 31, 2006 and 2005. The Company had no held-to-maturity securities as of December 31, 2006 and 2005.

The following table presents the maturity schedule of securities (based on estimated fair value) held and weighted average yield of those securities, as of December 31, 2006 (000’s omitted):

	Within One Year				After One but Within Five Years				After Five but within Ten				After Ten Years				Mortgage-Backed Securities				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
U.S. Treasury &
Government agencies	$	13,330		3.05%	$	1,004		5.68%	$	-			$	-			$	-			$	14,334		3.58%
Obligations of state & political subdivisions		1,023		3.86%		521		3.34%		564		4.57%		419		6.75%		-				2,527		4.42%
Mortgage-backed securities		-				-				-				-				967		5.01%		967		5.01%
Total	$	14,353			$	1,525			$	564			$	419			$	967			$	17,828

Maturity information does not incorporate any call provisions that the various securities may contain. Mortgage-backed securities do not have specific maturity dates, and thus have been incorporated into the above table as a separate maturity column. An analysis of the amortized cost and estimated fair market value of the investment portfolio is contained in Note 2 to the Company’s Consolidated Financial Statements.

40

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Loans, Credit Quality and Allowance for Loan and Lease Losses

The following table summarizes the Company’s loan mix at December 31, 2006, 2005, 2004, 2003 and 2002 (000’s omitted):

	2006		2005		2004		2003		2002
Commercial, financial and agricultural	$	173,201	$	164,156	$	143,583	$	154,243	$	139,971
Residential-construction		10,896		11,902		8,768		8,851		8,677
Residential-mortgage		30,255		28,113		21,685		16,630		9,175
Consumer		31,777		33,427		33,123		29,743		27,014
Total	$	246,129	$	237,598	$	207,159	$	209,467	$	184,837

The Company’s loan portfolio increased $8.5 million, or 3.6%, to $246.1 million at December 31, 2006 from $237.6 million at December 31, 2005. Growth in the commercial loan portfolio was the primary cause for the increase. Commercial, financial and agricultural loans increased by $9.0 million, or 5.5%, to $173.2 million at December 31, 2006 from $164.2 million at December 31, 2005. Residential mortgages increased by $2.2 million, or 7.6%, to $30.3 million at December 31, 2006 from $28.1 million at December 31, 2005. The growth in commercial and residential loans was due to management’s focus on business development and expansion of market presence in Hillsdale and Jackson. Other loan categories decreased somewhat in the current year. Specifically, real estate construction loans decreased by $1.0 million, or 8.5%, to $10.9 million at December 31, 2006 from $11.9 million at December 31, 2005. The decline in residential construction is consistent with the slowing in both the real estate and new housing markets in the local area. Consumer loans decreased $1.6 million, or 4.9%, to $31.8 million at December 31, 2006 from $33.4 million at December 31, 2005. The portfolio mix as of December 31, 2006 has remained relatively consistent with the prior year, as much of the commercial loan growth was matched by increases in residential mortgage loans as well.

Management expects continued loan growth in 2007, primarily in the commercial and agricultural loan portfolio. The growth in the commercial lending area will be driven by continued business development efforts. Consumer loans are expected to remain relatively stable or decline slightly with the present interest rate environment.

The following table presents the remaining maturity of total loans outstanding for the categories shown at December 31, 2006, based on scheduled principal repayments (000’s omitted), as well as categorized as fixed or variable rate loans (000’s omitted):

	Due Within 1 Year		Due After 1 but Within 5 Years		Due After 5 Years		Total		Fixed		Variable
Commercial, financial and agricultural	$	40,515	$	42,407	$	90,279	$	173,201	$	69,780	$	103,421
Residential - construction		10,782		-		114		10,896		4,675		6,221
Residential - mortgage		4,112		8,922		17,221		30,255		16,938		13,317
Consumer		1,921		5,234		24,622		31,777		10,694		21,083
Total	$	57,330	$	56,563	$	132,236	$	246,129	$	102,087	$	144,042

Closed-end commercial and agricultural loans, though they may mature within five years, typically have principal amortization periods that exceed five years. Principal balances on commercial and agricultural lines of credit are typically due in full at maturity (usually one year).

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PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Off-Balance Sheet Items
The following is a summary of outstanding commitments by the Company to grant loans, unfunded commitments under lines of credit and letters of credit at December 31, 2006 and 2005 (000’s omitted):

	2006		2005
Commitments to extend credit	$	8,416	$	7,370
Unfunded commitments under lines of credit		57,989		61,242
Commercial and standby letters of credit		2,430		3,051
Total	$	68,835	$	71,663

Outstanding commitments to grant loans, lines of credit and letters of credit decreased $2.9 million, or 3.9% to $68.8 million at December 31, 2006 from $71.7 million at December 31, 2005. The decrease in such off-balance sheet items is due primarily to a reduction in variable rate revolving lines of credit, as borrowers moved to fixed rate products with the rate increases in 2006. Included in these totals are commitments to lend on 1-4 family residences. Such loans are generally sold to the secondary market. Management does not expect that all commitments will result in funded loans.

Criticized and Classified Loans
The following tables present criticized and classified loans of the Bank at December 31, 2006 and 2005 (000’s omitted):

	Loan Risk Ratings
	5		6		7		8		Total
Loan Type
December 31, 2006
Commercial	$	11,875	$	5,648	$	2	$	-	$	17,525
Agricultural		1,128		1,971		-		-		3,099
Residential real estate mortgage		-		1,055		114		-		1,169
Consumer		27		54		-		-		81
Total	$	13,030	$	8,728	$	116	$	-	$	21,874
December 31, 2005
Commercial	$	3,839	$	7,547	$	-	$	-	$	11,386
Agricultural		1,297		1,936		-		-		3,233
Residential real estate mortgage		637		-		-		-		637
Consumer		99		-		-		-		99
Total	$	5,872	$	9,483	$	-	$	-	$	15,355

Loans risk-rated as 5 are considered criticized loans, while loans risk-rated as 6 or higher are considered classified loans. Please refer to the section entitled “Critical Accounting Policies” located within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the definition of each loan risk rating. The Bank’s credit administration function is designed to provide increased information on all types of loans to identify adverse credit risk characteristics in as timely a manner as possible. Total criticized and classified loans increased $6.5 million, or 42.5% to $21.9 million at December 31, 2006 from $15.4 million at December 31, 2005. The largest increase was noted in loans risk-rated 5, which increased $7.1 million, or 121.9%, to $13.0 million at December 31, 2006 from $5.9 million at December 31, 2005. Loans risk-rated 6 decreased $0.8 million, or 8.0%, to $8.7 million at December 31, 2006 from $9.5 million at December 31, 2005. There was $116,000 in loans risk-rated 7 as of December 31, 2006. There were no loans risk-rated 7 at December 31, 2005. There were no loans risk-rated 8 at either December 31, 2006 or 2005. The increase in loan risk-rated 5 is related in large part to enhancements in the Bank’s loan review process including monthly examinations of criticized loans and more coverage of the loan portfolio. Management is focusing on early detection and monitoring of potential credit weakness. Management continues to closely monitor each criticized or classified loan and institute appropriate measures to eliminate the basis of criticism.

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PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

A continual process of monitoring, review and analysis is maintained to identify credit-related weaknesses of loans within the loan portfolio and assure that loans are risk-rated in an accurate and timely manner. Several levels of management oversight and Board of Directors oversight have been established as part of this process. Both internal and external resources are utilized in this process. Internally, the credit administration function reports directly to the CEO of the Company and is not subordinate to the loan origination function. Management maintains a “Loan Watch List” Committee for the purpose of providing continuing oversight of each criticized or classified loan’s financial condition and performance, payment performance, collateral analysis, trend analysis and other relevant information. Loan workout plans are developed and reviewed in detail. Staff resources have been allocated to conduct internal review of loan customers’ financial information. Oversight from the Board of Directors is provided through the Directors Loan Committee, which meets on a monthly basis. Additionally, the full Board of Directors is provided detailed information on criticized and classified loans.

Non-performing Assets
Non-performing assets are comprised of other real estate owned (“OREO”), loans accounted for on a non-accrual basis, and loans contractually past due 90 days or more as to interest or principal payments but still accruing interest. Accrual of interest on loans is generally discontinued at the time a loan becomes 90 days delinquent in its payments, unless the credit is well-secured and in the process of collection.

The following table sets forth information with respect to the Company’s non-performing assets at December 31, 2006, 2005, 2004, 2003 and 2002 (000’s omitted):

	2006			2005		2004		2003		2002
Non-accruing loans past due	$	2,728		$	1,104	$	671	$	1,459	$	603
Loans past due 90 days or more still accruing		668			672		556		693		1,853
Total non-performing loans		3,396			1,776		1,227		2,152		2,456
Other Real Estate		169			549		715		181		1,783
Total non-performing assets	$	3,565		$	2,325	$	1,942	$	2,333	$	4,239
Non-performing loans as a percent
of total loans		1.38%			0.75%		0.59%		1.03%		1.33%
Non-accruing loans
as a percent of total loans		1.11%			0.46%		0.32%		0.70%		0.33%
Non-performing assets as a percent
of total assets		1.21%			0.81%		0.75%		0.72%		1.48%
Non-performing loans as a percent
of the loan loss reserve		120.55	%		66.19%		49.18%		93.48%		116.95	%

Total non-performing assets increased $1.3 million, or 53.3%, to $3.6 million at December 31, 2006 from $2.3 million at December 31, 2005. The increase in non-performing assets primarily related to non-accrual loans. The level of non-performing loans as a percent of total loans increased to 1.38% as of December 31, 2006 compared to 0.75% as of December 31, 2005. Approximately $738,000 of commercial and residential loans went to nonaccrual in the month of December 2006. This increase is reflective of the poor economic conditions within the state of Michigan. Management is working closely with the borrowers to correct the respective deficiencies in these loans. Management is closely monitoring the credit quality of the loan portfolio. As noted above, loans risk-rated as 6 decreased $0.8 million, or 8.0%, during 2006. This decrease was offset by a significant increase in the 5-rated credits, which increased $7.1 million, or 121.9%. The risk that such loans will become nonperforming loans is higher than non-classified loans, despite efforts to eliminate the basis of criticism through the credit administration process.

Non-performing loans as a percentage of the loan loss reserve has increased to 120.55% as of December 31, 2006 compared to 66.19% as of December 31, 2005. The non-performing loans are primarily comprised of both commercial and residential real estate properties, which management believes are adequately collateralized or have specific reserves allocated to cover estimated losses.

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PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Other real property that we acquire as a result of the foreclosure process is classified as OREO until it is sold. Our credit administration department decides whether to rehabilitate the property or sell it “as is,” and whether to list the property with a broker or sell it at auction. OREO is carried at the lesser of the cost or net realizable value. Subsequent to foreclosure, valuations are periodically performed by management in order to determine whether additional write-downs are required. Generally, we are able to dispose of a substantial portion of this type of real estate and other repossessed assets during each year, but we invariably acquire additional real estate and other assets through repossession in the ordinary course of business. At December 31, 2006, we had $169,000 of other real estate compared to $549,000 at December 31, 2005.

The following tables detail the allocation among individual loan portfolios within the allowance for loan and lease losses at December 31, 2006, 2005, 2004, 2003 and 2002 (000’s omitted):

	2006						2005
	Allowance		% of Total Allowance		% of Loans to Total Loans		Allowance		% of Total Allowance		% of Loans to Total Loans
Commercial, financial and agricultural	$	1,904		67.59%		70.37%	$	2,088		77.82%		69.09%
Residential-mortgage		285		10.12%		12.29%		84		3.13%		11.83%
Residential-construction		131		4.65%		4.43%		70		2.61%		5.01%
Consumer		313		11.11%		12.91%		262		9.77%		14.07%
Other qualitative factors & trends		184		6.53%		na		179		6.67%		na
	$	2,817		100.00%		100.00%	$	2,683		100.00%		100.00%

	2004						2003
	Allowance		% of Total Allowance		% of Loans to Total Loans		Allowance		% of Total Allowance		% of Loans to Total Loans
Commercial, financial and agricultural	$	1,965		78.76%		69.31%	$	1,991		86.49%		73.64%
Residential-mortgage		97		3.89%		10.47%		9		0.39%		4.22%
Residential-construction		37		1.48%		4.23%		25		1.09%		7.94%
Consumer		311		12.46%		15.99%		126		5.47%		14.20%
Other qualitative factors & trends		85		3.41%		na		151		6.56%		na
	$	2,495		100.00%		100.00%	$	2,302		100.00%		100.00%

	2002
	Allowance		% of Total Allowance		% of Loans to Total Loans
Commercial, financial and agricultural	$	1,613		76.81%		75.85%
Residential-mortgage		18		0.86%		4.67%
Residential-construction		25		1.19%		5.31%
Consumer		182		8.67%		14.17%
Other qualitative factors & trends		262		12.47%		na
	$	2,100		100.00%		100.00%

The allowance for loan and lease losses (the “allowance”) as a percentage of total loans was 1.14% at December 31, 2006, compared to 1.13% at December 31, 2005. For the twelve months ended December 31, 2006 provision for loan losses decreased $9,000, or 2.6%, to $333,000 from $342,000 for the same period in 2005. The allowance as a percentage of loans increased slightly in the current year with some worsening in credit quality. The provision for loan losses decreased in the current year, as the loan portfolio did not grow as significantly in 2006 as compared to 2005. The loan portfolio grew by 3.6% in 2006 compared to 14.7% in 2005. Management continues to closely monitor the credit risk within the individual loan pools. Please refer to the subsection entitled “Criticized and Classified Loans” within the section entitled “Loans, Credit Quality and Allowance for Loan and Lease Losses” above for more detail. Commercial and agricultural loans represent the largest segment of the Company’s loan portfolio. The portion of the allowance attributable to commercial and agricultural loans declined, as a percentage of the entire allowance, to 71.9% (or $2.02 million) at December 31, 2006 from 77.8% (or $2.09 million) at December 31, 2005. This is related to management’s more detail analysis of the required specific reserves on the commercial credits. While other loan categories registered relatively small changes as a percentage of the allowance, the impact on the overall allowance analysis is minimal because of the substantially smaller dollar amounts involved.

44

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The Company maintains an allowance for loan and lease losses believed to be sufficient to absorb estimated probable credit losses inherent in the loan portfolio, recognizing the imprecision inherent in the process of estimating credit losses.

The allowance represents management’s estimate of probable net loan charge-offs in the portfolio at each balance sheet date. The allowance contains provisions for probable losses that have been identified relating to specific borrowing relationships as well as probable losses believed to be inherent in the loan portfolio without specific identification of loan relationships.

The allowance for loan and lease losses represents the Company’s estimate of probable credit losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. The allowance for loan and lease losses is maintained at an adequate level through additions to the provision for loan losses. An appropriate level of the risk allocated allowance is determined based on the application of risk percentages to graded loans by categories. Specific reserves are established for individual loans when deemed necessary by management. In addition, management considers other factors when determining the unallocated allowance, including loan quality, changes in the size and character of the loan portfolio, consultation with regulatory authorities, amount of non-performing loans, delinquency trends, economic conditions and industry trends.

Inherent risks and uncertainties related to the operation of a financial institution require the Company to rely on estimates, appraisals and evaluations of loans to prepare its financial statements. Changes in economic conditions and the financial prospects of borrowers may result in abrupt changes to the estimates, appraisals or evaluations used. In addition, if actual circumstances and losses differ substantially from management’s assumptions and estimates, the allowance for loan and lease losses may not be sufficient to absorb all future losses, and net income could be significantly impacted.

Deposits
Total deposits increased $25.2 million, or 12.0%, to $235.9 million at December 31, 2006 from $210.7 million at December 31, 2005. Specifically, noninterest-bearing deposits increased $0.9 million, or 2.1%, to $46.3 million at December 31, 2006 from $45.4 million at December 31, 2005. The increase in noninterest bearing deposits is attributable to continuing business development efforts. Interest-bearing deposits increased $24.2 million, or 14.7%, to $189.6 million at December 31, 2006 from $165.4 million at December 31, 2005. Specifically, certificates of deposit (“CD’s”) with balances of $100,000 and greater increased $17.8 million, or 32.4%, to $72.9 million at December 31, 2006 from $55.1 million at December 31, 2005. The increase is attributable to a greater amount of local municipal CD’s obtained through a competitive bidding process. Municipal CD’s generally have shorter maturity lengths and thus can reprice more often than longer term CD’s. Certificates of deposit with balances under $100,000 increased $6.7 million, or 18.2%, to $43.6 million at December 31, 2006 from $36.9 million December 31, 2005. The increase is attributable to business development efforts of the retail branches.

Borrowed Funds
Borrowed funds consist of advances from the Federal Home Loan Bank of Indianapolis (“FHLBI”), agreements to repurchase securities sold under Repurchase Agreements (“repos”) with specific customers and third-party financial institutions, and draws on a Federal funds purchased line of credit at a correspondent bank. FHLBI advances decreased by $6.0 million, or 35.6%, to $10.9 million at December 31, 2006 from $16.9 million at December 31, 2005. The decrease in the current year is due to deposit growth outpacing loan growth which provided liquidity to repay the higher rate FHLBI advances. Repurchase agreements decreased $6.0 million, or 43.6%, to $7.7 million at December 31, 2006 from $13.7 million at December 31, 2005. The majority of the decrease is due to the repayment of a $5.0 million repurchase agreement to a third party financial institution. The balance of the decrease is related to fluctuations in normal daily activity within the customer repurchase balances. Borrowings under the Bank’s Federal funds purchased line of credit decreased $2.4 million, or 26.7%, to $6.6 million at December 31, 2006 from $9.0 million at December 31, 2005. The decrease is attributable to normal daily fluctuations in the liquidity needs of the Company.

45

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Amounts borrowed from the FHLBI may be collateralized with either investment securities or certain types of loans. At December 31, 2006 no investment securities were pledged as collateral against FHLBI borrowings. As disclosed in Note 8 to the Company’s Consolidated Financial Statements, $21.6 million and $31.8 million of 1-4 family residential mortgage loans were pledged as collateral at December 31, 2006 and 2005, respectively. For additional information regarding borrowed funds please refer to Note 8 to the Consolidated Financial Statements included elsewhere in this report.

Capital
Beginning in the first quarter of 2006, the Company became exempt from the Capital Guidelines, as the Board of Governors of the Federal Reserve System increased the asset size threshold from $150 million to $500 million in consolidated assets for determining whether a Bank Holding Company may qualify for an exemption from the Capital Guidelines. Under the revised regulatory financial reporting requirements, the Company will only be required to file parent-only financial data on a semi-annual basis. This change only impacts the Company and the Bank will continue to file necessary regulatory reports.

The Bank continues to maintain sufficient risk-based capital levels to remain categorized as “well-capitalized” under federal regulatory requirements. At the Bank level total risk-based capital (RBC) to risk-weighted assets (RWA) decreased from 13.7% at December 31, 2005 to 12.5% at December 31, 2006. Similarly, the ratio of Tier 1 RBC to RWA decreased to 11.4% at December 31, 2006 from 12.6% at December 31, 2005. The ratio of Tier 1 RBC to average assets decreased to 10.4% at December 31, 2006 from 10.7% at December 31, 2005. Risk-based capital levels decreased as a result of a dividend of $3.6 million from the Bank to the Holding Company in December 2006 to provide liquidity to redeem the subordinated debt, as discussed in Note 9 of the consolidated financial statements. The dividend exceeded the net income at the Bank in the current year, thereby reducing capital.

The number of outstanding shares at December 31, 2005 of 735,379 decreased to 725,206 at December 31, 2006, as a result of the redemption and retirement of ESOP/401k shares as well as repurchase and retirement of shares in December 2006. Management monitors the capital levels of the Company and the Bank to provide for current and future business opportunities.

RESULTS OF OPERATIONS

Net Income
2006. Continuing Operations – Income from continuing operations for the year ended December 31, 2006 increased $0.5 million, or 23.9%, to $2.4 million in 2006 compared to $1.9 million in 2005. Basic earnings per share (“EPS”) attributable to continuing operations for the twelve months ended December 31, 2006 were $3.27 compared to $2.47 for the same period in 2005. Diluted EPS for the twelve months ended December 31, 2006 was $3.26 compared to $2.45 for the same period in 2005. Increase in net income due primarily to cost reductions over the prior year as well as some improvement in net interest income.

2005. Continuing Operations – Income from continuing operations for the year ended December 31, 2005 declined $215,000, or 10.0%, to $1.9 million in 2005 compared to $2.2 million in 2004. Basic earnings per share (“EPS”) attributable to continuing operations for the twelve months ended December 31, 2005 were $2.47 compared to $2.54 for the same period in 2004. Diluted EPS for the twelve months ended December 31, 2005 was $2.45 compared to $2.52 for the same period in 2004.

Combined – On a combined basis net income for the year ended December 31, 2005 decreased $5.2 million, or 72.8%, to $1.9 million from $7.1 million for the same period in 2004. Basic EPS for the year ended December 31, 2005 were $2.47 compared to $8.42 for the same period in 2004. Diluted EPS for the year ended December 31, 2005 were $2.45 compared to $8.34 for the same period in 2004. The reason for the decrease is due to the gain on sale of the Bank of Washtenaw in the fourth quarter of 2004, which is discussed in more detail below.

2004. Continuing Operations — Income from continuing operations for the twelve months ended December 31, 2004 declined $1.2 million, or 35.9%, to $2.2 million compared to $3.4 million for the same period in 2003. Basic EPS attributable to continuing operations for the twelve months ended December 31, 2004 were $2.54 compared to $3.92 for the same period in 2003. Diluted EPS for the twelve months ended December 31, 2004 was $2.52 compared to $3.89 for the same period in 2003.

46

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The decline in income from continuing operations results primarily from lower levels of mortgage origination-related income in 2004. Though interest rates remained low compared to historical levels, residential mortgage refinance activity declined as most homeowners had previously refinanced their residential mortgages and wouldn’t have benefited from additional refinance activity.

Discontinued Operation – On October 29, 2004 the Company completed the sale of its former subsidiary, the Bank of Washtenaw (“discontinued operation” or “discontinued component”). All activity attributable to Bank of Washtenaw is presented as a separate item within the Company’s financial statements. Income attributable to discontinued operation for the twelve months ended December 31, 2004 was $5.0 million compared to a loss of $(124,000) for the same period in 2003. Income from the discontinued operation in 2004 consisted of income from the operation of the discontinued component and gain on sale of the discontinued component. In 2004 the Company recognized a net gain of $4.4 million on the sale of Bank of Washtenaw. Income attributable to the operation of the discontinued component in 2004 totaled $562,000 compared to a loss of $(124,000) for the twelve months ended December 31, 2003. Basic EPS attributable to the discontinued operation for the twelve months ended December 31, 2004 were $5.88 compared to $(.14) for the same period in 2003. Diluted EPS for the twelve months ended December 31, 2004 were $5.82 compared to $(.14) for the same period in 2003.

Combined – On a combined basis net income for the twelve months ended December 31, 2004 increased $3.9 million, or 120.5%, to $7.1 million compared to $3.2 million for the same period in 2003. Basic EPS for the twelve months ended December 31, 2004 were $8.42 compared to $3.78 for the same period in 2003. Diluted EPS for the twelve months ended December 31, 2004 were $8.34 compared to $3.75 for the same period in 2003.

Net Interest Income
2006. Net interest income for the twelve months ended December 31, 2006 increased $0.1 million, or 1.2%, to $11.8 million compared to $11.7 million for the same period in 2005. The increase in net interest income was primarily attributable to increases in the volume and yield in the loan portfolio, offset in large part to higher rates paid on interest-bearing liabilities. Total interest income increased by $2.8 million, or 17.0%, to $18.9 million for the twelve months ended December 31, 2006 compared to $16.1 million during the same period in 2005. An increase in the loan portfolio coupled with continued increases in the prime lending rate was the cause of the increase in interest income. Interest expense increased by $2.7 million, or 58.5%, to $7.1 million for the twelve months ended December 31, 2006 compared to $4.4 million during the same period in 2005. Increases in the level of time deposits as well as an increase in rates paid on interest bearing deposits caused the increase in interest expense. Please refer to the discussion of the Rate/Volume Table that follows for additional information.

2005. Net interest income for the twelve months ended December 31, 2005 decreased $409,000, or 3.4%, to $11.7 million compared to $12.1 million for the same period in 2004. The decrease in net interest income was primarily attributable to increases in interest expense attributable to higher levels of deposits and borrowing coupled with increases in rates paid on interest-bearing liabilities. Total interest income increased by $1.2 million, or 8.4%, to $16.1 million for the twelve months ended December 31, 2005 compared to $14.9 million during the same period in 2004. An increase in the loan portfolio coupled with a 2% increase in the prime lending rate was the cause of the increase in interest income. Interest expense increased by $1.6 million, or 59.2%, to $4.4 million for the twelve months ended December 31, 2005 compared to $2.8 million during the same period in 2004. Increases in the level of borrowings and time deposits as well as an increase in rates paid on interest bearing deposits caused the increase in interest expense. Please refer to the discussion of the Rate/Volume Table that follows for additional information.

2004. Net interest income for the twelve months ended December 31, 2004 increased $303,000, or 2.6%, to $12.1 million compared to $11.8 million for the same period in 2003. The increase in net interest income was primarily attributable to decreasing interest expense during 2004. Total interest income declined by $154,000, or 1.0%, to $14.9 million for the twelve months ended December 31, 2004 compared to $15.0 million during the same period in 2003. A lower amount of loans outstanding, coupled with a continued low rate environment were the primary causes of the decline. Interest expense decreased by $457,000, or 14.1%, to $2.8 million for the twelve months ended December 31, 2004 compared to $3.3 million during the same period in 2003. Reductions in rates paid on interest-bearing accounts accounted for most of the decline.

47

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following table presents the Company’s consolidated average balances of interest-earning assets, interest-bearing liabilities, and the amount of interest income or interest expense attributable to each category, the average yield or rate for each category, and the net interest margin for the years ended December 31, 2006, 2005 and 2004 (000’s omitted). Average loans are presented net of unearned income and the allowance for loan and lease losses. Interest on loans includes loan fees. Nonaccrual loans are included in the average balance of loans.

	------------2006------------							------------2005------------							------------2004------------
	Average Balance		Interest		Average Yield/ Rate			Average Balance		Interest		Average Yield/ Rate			Average Balance		Interest		Average Yield/ Rate
Interest-earning assets:
Loans receivable	$	238,495	$	17,711		7.43	%	$	219,995	$	14,951		6.80	%	$	209,600	$	13,914		6.64	%
Securities available for sale (1)		23,548		796		3.38	%		27,257		915		3.36	%		24,063		784		3.26	%
Federal funds sold		3,937		196		4.98	%		3,800		114		3.00	%		4,257		46		1.08	%
Equity securities		3,178		162		5.10	%		3,229		146		4.52	%		3,036		140		4.61	%
Interest-bearing balances with
other financial institutions		191		10		5.24	%		148		4		2.70	%		57		1		1.75	%
Total interest-earning assets		269,349		18,875		7.01	%		254,429		16,130		6.34	%		241,013		14,885		6.18	%
Noninterest-earning assets:
Cash and due from financial institutions		8,834							9,215							12,441
Premises and equipment, net		6,787							5,719							5,640
Other assets		5,881							4,648							4,270
Total assets	$	290,851						$	274,011						$	263,364
Interest-bearing liabilities:
Interest-bearing demand deposits	$	46,146		856		1.85	%	$	49,425		586		1.19	%	$	60,683		328		0.54	%
Savings deposits		27,996		105		0.38	%		31,376		109		0.35	%		33,087		112		0.34	%
Time deposits		104,938		4,506		4.29	%		87,988		2,639		3.00	%		75,767		1,704		2.25	%
Subordinated debentures		4,671		419		8.97	%		5,000		359		7.18	%		5,000		285		5.70	%
Repurchase agreements and other borrowings		28,519		1,164		4.08	%		21,193		756		3.57	%		12,223		366		2.99	%
Total interest-bearing liabilities		212,270		7,050		3.32	%		194,982		4,449		2.28	%		186,760		2,795		1.50	%
Non-interest bearing demand deposits		45,594							43,258							42,343
Other liabilities		5,845							3,164							2,969
Total liabilities		263,709							241,404							232,072
Shareholders' equity		27,142							32,607							31,292
Total liabilities and shareholders' equity	$	290,851						$	274,011						$	263,364
Net interest income			$	11,825						$	11,681						$	12,090
Net spread						3.69	%						4.06	%						4.68	%
Net interest margin (2)						4.39	%						4.59	%						5.02	%
Ratio of interest-earning assets
to interest-bearing liabilities						126.89	%						130.49	%						129.05	%

⁽¹⁾ Interest income on tax-exempt securities has not been adjusted to a taxable equivalent basis.

⁽²⁾ Net interest earnings divided by average interest-earning assets.

2006. The Bank’s net interest margin decreased 20 basis points, to 4.39% for the year ended December 31, 2006 compared to 4.59% for the same period in 2005. This decrease in net interest margin is primarily attributable to increases in rates paid on interest-bearing liabilities. The average rate paid on interest-bearing liabilities increased 104 basis points to 3.32% for the year ended December 31, 2006 compared to 2.28% for the same period in 2005. Much of this increase in rates paid relates to costs of deposits. The average rate paid on interest-bearing demand accounts as well as time deposits increased in the current year in response to competitive pressures in the local market. The cost of the subordinated debentures also increased substantially in 2006 to an average rate of 8.97% up from 7.18% in 2005. Management redeemed the subordinated debt in December 2006 and will likely opt for lower cost liquidity sources. The average yield earned on interest-earning assets increased 67 basis points to 7.01% for the year ended December 31, 2006 up from 6.34% for the same period in 2005. The Company’s net interest margin remains quite strong, and management continues to take steps to neutralize some portion of this risk.

48

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

2005. The Bank’s net interest margin decreased 43 basis points, to 4.59% for the year ended December 31, 2005 compared to 5.02% for the same period in 2004. Much of the decrease in net interest margin is attributable to an increase in the rates paid on interest-bearing liabilities. The Bank’s cost of funds increased as the loan growth was funded primarily by higher rate time deposits and other borrowings. The average rate paid on interest-bearing liabilities increased 78 basis points, to 2.28% for the year ended December 31, 2005 compared to 1.50% for the same period in 2004. The average yield earned on interest-earning assets increased 16 basis points, to 6.34% for the year ended December 31, 2005 compared to 6.18% for the same period in 2004. The yield on loans receivable increased to 6.80% for the year ended December 31, 2005 compared to 6.64% for the same period in 2004. The increases in the overall lending rates caused much of this increase. Improvements to the yield attributable to increases in lending rates were offset by a reduction in the Business Manager portfolio in 2005. The Business Manager was a high yield product which posed higher credit risk to the Bank. Management made the determination in late 2004 to discontinue the product. The Business Manager portfolio averaged $2.1 million in principal in 2004. Without the income from the Business Manager portfolio, the yield on loans would have been 6.51% in 2004. Please refer to the Rate-Volume Table presented below for additional information.

2004. The Bank’s net interest margin decreased 36 basis points, to 5.02% for the twelve months ended December 31, 2004 compared to 5.38% for the same period in 2003. The decrease in net interest margin was primarily attributable to an historically low rate environment in which the average rate earned on interest-earning assets declined more sharply than the decline of the average rate paid on interest-bearing liabilities. The average rate earned on interest-earning assets declined 68 basis points to 6.18% for the twelve months ended December 31, 2004 from 6.86% during the same period in 2003. The average rate paid on interest-bearing liabilities declined 41 basis points to 1.50% for the twelve months ended December 31, 2004 from 1.91% during the same period in 2003.

The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change (the sum of the prior columns). The changes attributable to the combined impact of volume and rate have been allocated on a proportional basis between changes in rate and volume (000’s omitted):

	2006-2005									2005-2004
	Net		Increase/(decrease) due to							Net		Increase/(decrease) due to
	Change			Volume			Rate			Change			Volume			Rate
Interest-earning assets:
Loans receivable	$	2,760		$	1,317		$	1,443		$	1,037		$	690		$	347
Securities available-for-sale		(119	)		(125	)		6			131			104			27
Federal funds sold		82			7			75			68			(5	)		73
Equity securities		16			(3	)		19			6			9			(3	)
Interest-bearing balances with
other financial institutions		6			2			4			3			2			1
Total interest-earning assets		2,745			1,198			1,547			1,245			800			445
Interest-bearing liabilities:
Interest-bearing demand
deposits		270			(61	)		331			258			(61	)		319
Savings deposits		(4	)		(13	)		9			(3	)		(6	)		3
Time deposits		1,867			728			1,139			935			275			660
Subordinated debentures		60			(29	)		89			74			-			74
Repurchase agreements and
other borrowings		408			299			109			390			375			15
Total interest-bearing liabilities		2,601			924			1,677			1,654			583			1,071
Net change in net interest
income	$	144		$	274		($	130	)	($	409	)	$	217		($	626	)

49

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

As the above table indicates, in 2006 net interest income increased $144,000 with the increase in interest income earned on the loans receivable portfolio, which increased $2.8 million for the twelve months ended December 31, 2006. This increase was due to both growth in volume and increases in yield earned. This increase in interest income was largely offset by similar increases in interest expense. For the twelve months ended December 31, 2006 total interest expense increased $2.6 million compared to the same period in 2005. The rate increases were most significant in the interest-bearing demand deposits and time deposits. The rate increases in interest-bearing demand deposits and time deposits accounted for $0.3 million and $1.1 million of the increase in interest expense, respectively. While net interest margin has been reduced due to the above mentioned factors, it still remains strong in comparison to peer community banks. In an effort to preserve margin, the Company plans to reduce the cost of funds through multiple initiatives which include gathering additional core deposits and locking into fixed rate borrowings.

Provision for Loan Losses
The activity in the allowance for loan and lease losses for the twelve months ended December 31, 2006, 2005, 2004, 2003 and 2002 is presented in the following table (000’s omitted):

	Years ended December 31, (in thousands)
	2006			2005			2004			2003			2002
Balance at beginning of year	$	2,683		$	2,495		$	2,302		$	2,100		$	1,891
Loans charged off:
Residential real estate - mortgage		67			22			18			-			23
Residential real estate - construction		-			-			-			-			-
Commercial and agricultural		55			46			427			329			357
Consumer		124			153			137			177			226
		246			221			582			506			606
Recoveries of loans previously charged-off:
Residential real estate - mortgage		-			-			-			-			1
Commercial and agricultural		27			24			51			44			101
Consumer		20			43			31			69			46
		47			67			82			113			148
Net loans charged-off		199			154			500			393			458
Provision for loan losses		333			342			693			595			667
Balance at end of year	$	2,817		$	2,683		$	2,495		$	2,302		$	2,100
Net charge-off ratio		0.08	%		0.07	%		0.24	%		0.20	%		0.25	%
Allowance to total loans		1.14	%		1.13	%		1.20	%		1.10	%		1.14	%

2006. For the year ended December 21, 2006, gross loan charge-offs increased $25,000, or 11.3%, to $246,000 compared to $221,000 for the same period in 2005. The most significant change was in the residential real estate category with increased to $67,000 for the twelve months ended December 31, 2006 compared to $22,000 for the same period in 2005. This increase is reflective of the worsening economic conditions with the local market, as well as the slow real estate market in Michigan. Commercial and agricultural charge-offs increased $9,000, or 19.6%, to $55,000 up from $46,000 for the same period in 2005. Consumer charge-offs decreased in the current year by $29,000, or 19.0%, to $124,000 down from $153,000 for the year ended December 31 2005. The net charge-off rate increased to 0.08% for the twelve months ended December 31, 2006 compared to 0.07% for the same period in 2005. Despite the current year increase, the charge-off rate is still well below the levels experienced in 2004, 2003, and 2002, which were 0.24%, 0.20% and 0.25%, respectively. This decrease is largely due to the discontinuance of the Business Manager program in late 2004, which was a product with the higher yield but also posed a higher credit risk.

50

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Gross recoveries for the year ended December 31, 2006 decreased to $47,000 down from $67,000 for the same period in 2005. The decrease in recoveries is considered a normal business fluctuations and varies based on the circumstances of the related charge-offs.

For the year ended December 31, 2006, provision for loan losses decreased $9,000, or 2.6%, to $333,000 compared to $342,000 for the same period in 2005. The provision for loan losses decreased in the current year, as the loan portfolio did not grow as significantly in 2006 as compared to 2005. The loan portfolio grew by only 3.6% in 2006 compared to 14.7% in 2005.

2005. For the twelve months ended December 31, 2005, gross loan charge-offs decreased $361,000, or 62.0%, to $221,000 compared to $582,000 during the same period in 2004. The gross loan charge-offs for the year ended December 31, 2004 included approximately $165,000 in loan charge-offs related to an accrued interest receivable adjustment, which is discussed in more detail below. After consideration of this adjustment, gross loan charge-offs for the year decreased $196,000, or 47.0%. The most significant change was the decrease in gross charge-offs related to commercial and agricultural loans, which decreased $381,000, or $247,000 after consideration of the charge-offs related to the accrued interest adjustment. This decrease is largely due to the discontinuance of the Business Manager program as indicated above. Levels of criticized loans decreased in 2005 as well. Charge-offs on consumer loans increased somewhat over the prior year levels but the change is considered a normal business fluctuation.

Gross recoveries for the year ended December 31, 2005 decreased to $67,000 down from $82,000 for the same period in 2004. The decrease in recoveries is related to the overall decreased level of charge-offs.

For the twelve months ended December 31, 2005 provision for loan losses decreased $351,000, or 50.6%, to $342,000 from $693,000 for the same period in 2004. The decrease is related to the overall decrease in the level of net charge-offs, as well as a significant improvement in the level of criticized and classified loans during 2005. Please refer to the subsection entitled “Criticized and Classified Loans” within the section entitled “Loans, Credit Quality and Allowance for Loan and Lease Losses” above for more detail.

2004. For the twelve months ended December 31, 2004, gross loan charge-offs increased $76,000, or 15.0%, to $582,000 compared to $506,000 during the same period in 2003. During the fourth quarter of 2004 the Company recognized $165,000 in loan charge-offs related to accrued interest receivable associated with loans previously charged-off or placed on non-accrual status. Any uncollected accrued interest receivable must be written off against the allowance (for uncollected accrued interest attributable to previous calendar years) or income (for uncollected accrued interest attributable to the current calendar year). During the fourth quarter management discovered numerous loans that had been previously charged-off or placed on nonaccrual where uncollected accrued interest had not been written off, as described above. After detailed analysis it was determined that the uncollected accrued interest associated with these loans was attributable to previous calendar years. Accordingly, the aggregate amount was charged against the allowance for loan and lease losses. Written procedures were developed and implemented during the fourth quarter to avoid recurrence. Of the $165,000 in uncollected accrued interest that was charged against the allowance, approximately $134,000 was associated with commercial and agricultural loans.

In the aggregate, commercial loan charge-offs increased $98,000, or 29.8% for the twelve months ended December 31, 2004 compared with the same period in 2003. Discounting the amounts associated with the accrued interest receivable accounting issue, commercial loan charge-offs would have been approximately $293,000, representing a $36,000 decline, or 10.9%. Consumer loan charge-offs decreased by $40,000, or 22.6%, for the twelve months ended December 31, 2004 compared with the same period in 2003. For the year ended 2004 residential mortgage loan charge-offs totaled $18,000, while none were noted in 2003. Recoveries of loans previously charged-off fell $31,000, or 27.4%, for the twelve months ended December 31, 2004 to $82,000 compared to $113,000 for the same period in 2003. The decline in recoveries from previously charged-off loans resulted from typical fluctuations noted with this activity.

For the twelve months ended December 31, 2004 provision for loan losses increased $98,000, or 16.5%, to $693,000 from $595,000 for the same period in 2003. Several factors affected the decision to increase the loan loss provision including a continued elevated amount of criticized and classified loans, significant migration of loans from a 5 risk-rating to a 6 risk-rating, local economic conditions and the overall mix of the loan portfolio.

51

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The amount of provision for loan losses recognized by the Company is based on management’s evaluation as to the amounts required to maintain an allowance adequate to provide for potential losses inherent in the loan portfolio. The level of the allowance is dependent upon the total amount of classified loans, past due and non-performing loans, historical charge-off experience, general economic conditions and management’s assessment of potential losses based upon internal credit evaluation of the loan portfolio and particular loans. In determining the provision for loan losses, management first determines the estimated allowance required for any specifically identified classified loans. Management then estimates potential charge-offs based on historical experience. Management also evaluates the general loan portfolio for credit risk based upon, but not limited to, the criteria noted above, and allocates an amount believed to be sufficient to cover estimated loan charge-offs inherent in the general loan portfolio. Management may then add, at its discretion, an allocation amount to adjust for current economic conditions, any additional perceived credit risk in the portfolio and any other information that management considers relevant.

Non-interest Income

2006. Total non-interest income decreased $209,000, or 6.4%, to $3.1 million for the year ended December 31, 2006 compared to $3.3 million for the same period in 2005. Service charges on deposit accounts increased $36,000, or 2.7%, to $1.4 million for the year ended December 31, 2006 compared to $1.3 million for the same period in 2005. This increase was due to some increases in rates charged. Net gains on the sale of loans decreased $0.4 million, or 29.8%, to $1.0 million for the year ended December 31, 2006 compared to $1.4 million for the same period in 2005. This is due to a continued decrease in mortgage volume, which is related to higher levels of interest rates as well as softening within the local residential real estate market. Mortgage loan sales were down approximately 27.8% to $43.4 million for 2006 down from $60.2 million for 2005. Loan servicing fees, net of amortization, decreased $190,000, or 66.2%, to $97,000 for the twelve months ended December 31, 2006 compared to $287,000 for the same period in 2005. This decrease is due to increased levels of amortization of the mortgage servicing asset. Other non-interest income increased $359,000, or 127.3%, to $641,000 for the year ended December 31, 2006 up from $282,000 for the same period in 2005. This increase is due largely to fee income earned on Merchant Visa services as well as increases in fees charged for mobile courier service.

2005. Total non-interest income decreased $289,000, or 8.1%, to $3.3 million for the year ended December 31, 2005 compared to $3.6 million for the same period in 2004. Service charges on deposit accounts decreased $113,000, or 7.9%, to $1.3 million for the year ended December 31, 2005 compared to $1.4 million for the same period in 2004. This decrease is reflective of the overall decrease in transactional demand deposit accounts, which generate the majority of fee income. Net gains on sale of loans also decreased 8.3% or $126,000 to $1.4 million in 2005 compared to $1.5 million for the same period in 2004 due to a reduction in mortgage volume. Mortgage loan sales were down approximately 30.7% in 2005 compared to the same period in 2004. The reduction in secondary marketing gains on sale of mortgage loans was offset by increased value in the mortgage servicing rights capitalized resulting in the net reduction of only 8.3%. Loan servicing fees, net of amortization, decreased $213,000, or 42.6%, to $287,000 for the year ended December 31, 2005 compared to $500,000 for the same period in 2004. This decrease is due to increased levels of amortization of the mortgage servicing asset. Other non-interest income increased $163,000, or 137.0%, to $282,000 for the year ended December 31, 2005 compared to $119,000 for the same period in 2004. In 2004, an impairment loss of approximately $140,000 was recognized in the fourth quarter when management made the determination to close one of the two branches in Hudson, which reduced the overall level of other non-interest income.

2004. Total non-interest income decreased $2.2 million, or 38.9%, to $3.6 million for the twelve months ended December 31, 2004 compared to $5.8 million for the same period in 2003. A substantial decline in gains on residential mortgage loan sales accounted for the reduction. For the twelve months ended December 31, 2004 gains on loan sales declined $4.1 million, or 73.2%, to $1.5 million compared to $5.7 million for the same period in 2003. Demand for secondary market residential mortgage loans decreased as significantly fewer homeowners refinanced existing residential mortgages. Loan servicing fees, net of amortization (“loan servicing fees”) registered a substantial increase in 2004. For the twelve months ended December 31, 2004, loan servicing fees increased $2.1 million, or 131.9%, to $500,000 from $(1.6 million) during the same period in 2003. Amortization expense of mortgage servicing rights on secondary market residential mortgage loans declined significantly as residential mortgage refinancing activity decreased.

52

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Non-interest Expenses

2006. For the year ended December 31, 2006, total non-interest expense decreased $1.0 million, or 8.2% to $11.1 million down from $12.1 million for the same period in 2005. Compensation and benefits decreased approximately $1.0 million, or 13.6%, to $6.2 million for the year ended December 31, 2006 compared to $7.2 million for the same period in 2005. This decrease was due in large part to the cost savings associated with Reduction-in-Force plans (“RIF”), which were developed with the goal of increasing operating efficiency. The Bank eliminated various staff positions in the first quarters of 2006 and 2005, and severance packages were provided to employees affected by the RIF. The aggregate cost of the RIF plans were approximately $210,000 and $264,000 for the RIFs that occurred in the first quarter of 2006 and 2005, respectively. Occupancy and equipment expense increased $53,000, or 3.7%, to $1.502 million for the twelve months ended December 31, 2006 up from $1.449 million for the same period in 2005. This increase is primarily related to the costs associated with the new branch that was opened in the first quarter of 2006. Professional services expense decreased $137,000, or 20.4%, to $536,000 for the year ended December 31, 2006 down from $673,000 for 2005. This decrease is due to higher professional services costs associated with the tender offer, contingency planning and other consulting engagements incurred in 2005. Outside services expense increased $133,000, or 12.8%, to $1.17 million for 2006 up from $1.04 million for 2005. This increase is related to higher costs associated with Merchant Visa services. Marketing and advertising expense decreased to $166,000 for the year ended December 31, 2006 down $106,000, or 39.9%, from $272,000 for the same period in 2005. This reduction is due to certain cost controls implemented by management. Loan and collection expense decreased $45,000, or 13.1%, to $298,000 for the twelve months ended December 31 2006 compared $343,000 for the same period in 2005. Other non-interest expense increased to $717,000 for the twelve months ended December 31, 2006, up $102,000, or 16.6%, from $615,000 for the same period in 2005. This increase is due to the deferred costs of the trust preferred issuance which were recognized at the time of redemption. The total costs incurred at redemption were approximately $145,000. Excluding the effect of this one-time charge, non-interest expenses were down for 2006.

2005. For the year ended December 31, 2005, total non-interest expense increased $266,000, or 2.3%, to $12.1 million up from $11.8 million for the same period in 2004. Compensation and employee benefits decreased $15,000, or 0.2%, to $7.2 million for the year ended December 31, 2005. The aggregate cost of the severance packages associated with the 2005 RIF totaled approximately $264,000. This total cost included $137,000 in wages, $70,000 in pension costs, and $57,000 in medical insurance costs. The benefits of the RIF were visible in the latter half of 2005. Occupancy and equipment expense increased $32,000, or 2.3%, to $1.45 million for the year ended December 31, 2005 compared to $1.42 million for the same period in 2004. Postage and delivery expense decreased slightly to $300,000 for the year ended December 31, 2005 compared to $305,000 compared to the same period in 2004. These fluctuations are considered typical in the normal course of business. Expenses related to professional services increased $372,000, or 123.6%, to $673,000 for the year ended December 31, 2005 compared to $301,000 for the same period in 2004. This increase was due to increased payments to the Company’s auditing firms for services related to contingency planning, for Sarbanes-Oxley compliance and for additional work related to the Company’s annual report. In addition, legal and accounting costs were incurred in connection with the tender offer for the Company’s common stock that was completed in the second quarter of 2005. Marketing and advertising expense decreased $70,000, or 20.5%, to $272,000 for the year ended December 31, 2005 down from $342,000 for the same period in 2004. The decrease was due to an overall cost reduction strategy. Loan and collection expense increased $21,000, or 6.5%, to $343,000 for the year ended December 31, 2005 up from $322,000 for 2004. The increase is primarily due to costs associated with the maintenance and disposition of the other real estate assets (OREO). For the year ended December 31, 2005, director and shareholder expense increased $16,000, or 9.1%, to $191,000 compared to $175,000 for the same period in 2004. This increase is due to an increase in directors’ fees as well as an increase in the number of directors from 2004 to 2005. Other non-interest expense decreased $97,000, or 13.6%, to $615,000 for the year ended December 31, 2005 compared to $712,000 for the same period in 2004. The decrease is due to an overall cost reduction strategy implemented by management.

2004. For the twelve months ended December 31, 2004, total non-interest expenses declined $301,000, or 2.5%, to $11.8 million from $12.1 million during the same period in 2003. Various non-interest expenses increased during 2004, while other categories of non-interest expenses decreased. For the twelve months ended December 31, 2004, compensation and employee benefit expenses declined $380,000, or 5.0%, to $7.2 million from $7.6 million during the same period in 2003. A decline in residential mortgage loan-related incentive compensation accounted for the decrease. Occupancy and equipment expense increased $24,000, or 1.7%, to $1.42 million for the twelve months ended December 31, 2004 compared to $1.39 million for the same period in 2003. Various technology

53

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

expenditures to upgrade operational capabilities were incurred during 2004, including digital check imaging. Postage and delivery expense decreased $7,000, or 2.2%, to $305,000 for the twelve months ended December 31, 2004 compared to $312,000 during the same period in 2003. Professional services decreased by $51,000, or 14.5%, to $301,000 for the twelve months ended December 31, 2004 from $352,000 for the same period in 2003. Outside services decreased $44,000 or 4.1% to $1.0 million for the twelve months ended December 31, 2004 from $1.1 million during the same period in 2003. The decrease in 2004 is due to reduced employee recruitment costs and to the reduction in reliance on temporary mortgage processing help provided by outside agencies. Marketing and advertising expense increased $170,000, or 98.8%, to $342,000 for the twelve months ended December 31, 2004 compared to $172,000 for the same period in 2003. The increase in 2004 is due primarily to the Company initiating a campaign to develop a new brand identity throughout its market area. Loan and collection expense decreased by $135,000 or 29.5% to $322,000 for the twelve months ended December 31, 2004 compared to $457,000 for the same period in 2003. The decrease in 2004 was due to the curtailment of the Business Manager program during the fourth quarter of 2004. Other noninterest expenses increased $77,000, or 12.1%, to $712,000 for the twelve months ended December 31, 2004 compared to $635,000 during the same period in 2003. Such change in other noninterest expenses is considered typical in the normal course of business.

Federal Income Tax Expense

2006. The provision for federal income tax increased $468,000, or 77.6%, to $1.1 million (30.8% of pretax income from continuing operations) for the twelve months ended December 31, 2006 compared to $0.6 million (23.7% of pretax income from continuing operations) for the same period in 2005. This increase is primarily related to the increased level of earnings in the current year. The increase is also related to a change in accounting estimate recognized in the fourth quarter of 2005, which is discussed in greater detail below.

2005. The provision for federal income tax associated with continuing operations declined $0.4 million, or 39.8%, to $0.6 million (23.7% of pretax income from continuing operations) for the twelve months ended December 31, 2005 compared to $1.0 million (31.7% of pretax income from continuing operations) for the same period in 2004. The reduction in federal income tax provision, as well as the lower percentage of tax provision to pretax income, is partially attributable to lower pretax income from continuing operations. In addition the Company recognized an expense reduction of $200,000 related to an excess accrual for federal income tax specifically related to final accounting for the sale of the Bank of Washtenaw in 2004. This excess accrual was determined by management after completion of the 2004 federal income tax return and detailed analysis of the 2004 and 2005 federal income tax liabilities, which was performed in the fourth quarter of 2005. Federal income tax expense was adjusted in the fourth quarter related to this change in accounting estimate.

Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations, including the ability to have funds available to respond to the needs of depositors and borrowers as well as maintaining the flexibility to take advantage of investment opportunities. The Company’s primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the FHLBI. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

Liquidity management is both a daily and long-term responsibility of management. The Company adjusts its investments in liquid assets based upon management’s assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of its asset/liability management program. Excess liquid assets are invested generally in interest-earning overnight deposits and short- and immediate-term U.S. Government and agency obligations.

The Company’s most liquid assets are cash and short-term investments. The levels of these assets are dependent on the Company’s operating, financing, lending and investing activities during any given period. At December 31, 2006, cash and short-term investments totaled $17.2 million and securities classified as available for sale totaled $17.8 million. However, available-for-sale securities with a market value of $13.4 million were pledged as collateral for Treasury Tax & Loan accounts and repurchase agreements and therefore were not available for liquidity needs. The amortized cost of the available-for-sale securities was more than the fair value at year end, primarily as the result of increasing interest rates, which resulted in an unrealized loss of $155,000 within the investment portfolio. This unrealized loss, however, is normal given interest rate changes and does not represent a permanent impairment of value to the investment portfolio. Management does not consider such an unrealized loss a material risk to the Company’s capital. Management does not believe the sale of any of the Company’s securities would materially affect the overall financial condition of the Company. Management believes it has sufficient liquidity and sources of funds to meet its obligations.

54

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financing activities consist primarily of activity in deposit accounts, overnight borrowings from our correspondent banks and FHLBI advances. The Bank experienced a net increase in total deposits of $25.1 million for the year ended December 31, 2006. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by the Bank and its local competitors and other factors. To help fund the increased loan demand, the Bank has increased its level of public funds CDs.

The Bank’s borrowing position decreased in 2006 to $25.2 million as of December 31, 2006 down from $39.6 million at December 31, 2005. As of December 31, 2006, the Bank had the ability to borrow a total of $15.1 million from the FHLBI based upon the amount of collateral pledged, of which $10.9 million was outstanding at that date. The Bank has contractual payments due on FHLBI advances totaling $9.0 million in 2007. In addition to the FHLBI, the Bank had available borrowings on a line-of-credit of $10.0 million from a correspondent bank, of which $6.6 million was outstanding at December 31, 2006. The Bank also had outstanding advances on repurchase agreements totaling $7.7 million at December 31, 2006, based on the collateral pledged. Additional advances could be obtained through repurchase agreements, provided additional collateral is pledged. Repurchase agreements are terminable upon demand.

Beginning in the first quarter of 2006, the Company became exempt from the Capital Guidelines, as the Board of Governors of the Federal Reserve System increased the asset size threshold from $150 million to $500 million in consolidated assets for determining whether a Bank Holding Company may qualify for an exemption from the Capital Guidelines. Under the revised regulatory financial reporting requirements, the Company will only be required to file parent-only financial data on a semi-annual basis. This change only impacts the Company and the Bank will continue to file necessary regulatory reports.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings, and other factors. Prompt corrective action provisions are not applicable for bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts, and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined).

55

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

At December 31, 2006 the Bank was considered well-capitalized under the regulatory framework for prompt corrective action. The Bank’s actual capital amounts and ratios at December 31, 2006 and 2005 and the Company’s capital amounts and ratios at December 31, 2005 are presented in the following table (in millions):

	Actual				Minimum Required For Capital Adequacy Purposes				Minimum Required to be Well-Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio		Amount		Ratio			Amount		Ratio
December 31, 2006
Total capital (to risk weighted assets)
Bank of Lenawee	$	32.7		12.5%	$	20.9		>=8.0%		$	26.1		>=10.0%
Tier 1 Capital (to risk weighted assets)
Bank of Lenawee	$	29.9		11.4%	$	10.5		>=4.0%		$	15.7		>=6.0%
Tier 1 Capital (to average assets)
Bank of Lenawee	$	29.9		10.4%	$	11.5		>=4.0%		$	14.4		>=5.0%
December 31, 2005
Total Capital (to risk weighted assets)
Consolidated	$	37.3		15.2%	$	19.6		>=8.0%			n/a		n/a
Bank of Lenawee	$	33.3		13.7%	$	19.4		>=8.0%		$	24.3		>=10.0%
Tier 1 Capital (to risk weighted assets)
Consolidated	$	34.7		14.1%	$	9.8		>=4.0%			n/a		n/a
Bank of Lenawee	$	30.6		12.6%	$	9.7		>=4.0%		$	14.5		>=6.0%
Tier 1 Capital (to average assets)
Consolidated	$	34.7		12.4%	$	11.2		>=4.0%			n/a		n/a
Bank of Lenawee	$	30.6		10.7%	$	11.5		>=4.0%		$	14.3		>=5.0%

Contractual Obligations
The following table presents contractual obligations as of December 31, 2006 (000’s omitted):

	Payments due by period
	Total		Less Than 1 Year		1-3 Years		3-5 Years		More than 5 Years
Time deposits	$	116,443	$	104,220	$	8,265	$	3,957	$	1
Long-term debt obligations (FHLBI advances)		10,885		9,000		1,885		-		-
Capital lease obligations		-		-		-		-		-
Operating lease obligations*		288		78		157		53		-
Purchase agreements		-		-		-		-		-
Total	$	127,616	$	113,298	$	10,307	$	4,010	$	1

* Annual inflation adjustments to one of the operating lease obligations, based on changes in the Consumers Price Index, may take effect in sixth year of ten year lease, at the discretion of the lessor. Potential inflation adjustments are not estimated in this presentation.

Long-term obligations consist of time deposits (certificates of deposit) and advances from the FHLBI. The above schedule represents principal payments only and does not include interest (where applicable).

The Company has contractual payments due on time deposits and FHLBI advances totaling $104.2 million and $9.0 million, respectively, in 2007. The Company anticipates that a significant portion of maturing time deposits will be renewed and retained. Depending on the economic and competitive conditions at the time of maturity, the rates paid on renewed time deposits may differ from rates currently paid. FHLBI advances may be renewed, and additional advances obtained, at prevailing market rates. At December 31, 2006 the Company had the ability to borrow an additional $4.2 million from the FHLBI based on the amount of collateral pledged. The availability to borrow from the FHLBI varies depending on the amount of collateral available for pledging.

56

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following table presents loan commitments by time period as of December 31, 2006 (000’s omitted):

	Amount of commitment expiration per period
	Total		Less Than 1 Year		1-3 Years		3-5 Years		More than 5 Years
Commitments to grant loans	$	8,416	$	8,416	$	-	$	-	$	-
Unfunded commitments under lines of credit		57,989		42,680		-		-		15,309
Commercial and standby letters of credit		2,430		2,430		-		-		-
Total	$	68,835	$	53,526	$	-	$	-	$	15,309

Commitments to grant loans are governed by the Company’s credit underwriting standards, as established in the Company’s Loan Policy. As the above schedule illustrates, in general, it is the Company’s practice to grant loan commitments for a finite period of time, usually lasting one year or less. The most significant departure from this practice involves home equity lines of credit (“HELOC’s”). The Company’s HELOC’s have a contractual draw period of 120 months. The Company has the ability to suspend the draw privileges on a HELOC where a default situation or other impairment issue is identified.

Quantitative and Qualitative Disclosures about Market Risk
The Company’s primary market risk exposure is interest rate risk (“IRR”) and, to a lesser extent, liquidity risk. The Company’s transactions are denominated in U.S. dollars with no specific foreign exchange exposure. Also, the Bank has a limited exposure to commodity prices related to agricultural loans. Any impact that changes in foreign exchange rate and commodity prices would have on interest rates is assumed to be insignificant.

Interest rate risk is the exposure of the Company’s financial condition to adverse movements in interest rates. IRR is generated from differences in the maturities or timing of interest rate adjustments of the Company’s assets, liabilities and off-balance-sheet instruments; from changes in the slope of the yield curve; from imperfect correlations in the adjustment of interest rates earned and paid on different financial instruments with otherwise similar repricing characteristics; and from interest rate related options embedded in the Company’s products such as prepayment and early withdrawal options.

The Company employs several measures to monitor and manage interest rate risk, including interest sensitivity and income simulation analyses. An interest income simulation model is the primary tool used to assess IRR. The simulation model is used to estimate the effect that certain changes in interest rate changes would have on twelve months of pretax net interest income assuming an immediate and sustained up or down proportional change in interest rates of 200 basis points. Key assumptions in the model include prepayment speeds of various types of loans, loan volumes and pricing, and management’s determination of core deposit sensitivity. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes and changes in market conditions.

The following tables provide information about the Company’s financial instruments that are sensitive to changes in interest rates as of December 31, 2006 and 2005. The Company had no derivative financial instruments, or trading portfolio, as of those dates. The expected maturity date values for loans receivable, mortgage-backed securities and investment securities were calculated without adjusting the instrument’s contractual maturity date for expectations of prepayments. Expected maturity date values for non-maturity interest-bearing core deposits were not based upon estimates of the period over which the deposits would be outstanding, but rather the opportunity for repricing.

57

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following table presents principal/notional contractual maturities at December 31, 2006 (000’s omitted):

Principal Amount Maturing In:

	2007		2008		2009		2010		2011		Thereafter		Total		Fair Value
RATE-SENSITIVE ASSETS
Gross loans	$	57,330	$	8,070	$	13,120	$	14,987	$	20,386	$	132,236	$	246,129	$	244,383
Average interest rate		8.1%		7.2%		7.2%		7.0%		7.5%		7.2%
Debt & equity securities	$	17,277	$	-	$	95	$	986	$	1,004	$	1,149	$	20,511	$	20,511
Average interest rate		3.4%		0.0%		5.3%		3.8%		5.7%		5.9%
Other interest-earning assets	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Average interest rate		0.0%		0.0%		0.0%		0.0%		0.0%		0.0%
RATE-SENSITIVE LIABILITIES
Savings & interest bearing
demand deposits	$	73,210	$	-	$	-	$	-	$	-	$	-	$	73,210	$	73,210
Average interest rate		1.3%		0.0%		0.0%		0.0%		0.0%		0.0%
Time deposits	$	104,220	$	6,240	$	2,025	$	3,498	$	459	$	1	$	116,443	$	115,832
Average interest rate		4.8%		3.7%		3.5%		4.8%		4.1%		4.0%
Other borrowings	$	23,529	$	1,657	$	-	$	-	$	-	$	-	$	25,186	$	25,142
Average interest rate		4.5%		2.9%		0.0%		0.0%		0.0%		0.0%

The following table presents principal/notional contractual maturities at December 31, 2005 (000’s omitted):

	2006		2007		2008		2009		2010		Thereafter		Total		Fair Value
RATE-SENSITIVE ASSETS
Gross loans	$	54,724	$	10,302	$	9,072	$	11,275	$	16,010	$	136,215	$	237,598	$	235,553
Average interest rate		7.2%		7.1%		6.9%		6.5%		6.7%		6.7%
Debt & equity securities	$	11,323	$	14,527	$	-	$	176	$	1,091	$	1,715	$	28,832	$	28,832
Average interest rate		3.6%		3.1%		0.0%		5.4%		3.8%		5.2%
Other interest-earning assets	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Average interest rate		0.0%		0.0%		0.0%		0.0%		0.0%		0.0%
RATE-SENSITIVE LIABILITIES
Savings & interest bearing
demand deposits	$	73,486	$	-	$	-	$	-	$	-	$	-	$	73,486	$	73,661
Average interest rate		1.2%		0.0%		0.0%		0.0%		0.0%		0.0%
Time deposits	$	67,191	$	17,503	$	3,817	$	1,176	$	2,222	$	-	$	91,909	$	91,669
Average interest rate		3.4%		3.3%		3.3%		3.4%		4.8%		0.0%
Other borrowings	$	31,679	$	6,228	$	1,657	$	-	$	-	$	5,000	$	44,564	$	44,321
Average interest rate		4.2%		3.8%		2.9%		0.0%		0.0%		8.4%

Disclosure Controls and Procedures
The Company’s management is responsible for establishing and maintaining adequate internal controls over the financial reporting process to ensure that it is able to collect the information it is required to disclose in the reports it files with the SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Additionally, the Company’s principal executive officer (the Company’s chief executive officer) and principal financial officer (the Company’s chief financial officer) are required to evaluate internal controls of the financial reporting process. The framework for evaluating the internal controls of the financial reporting process consists of, but is not limited to, the following criteria:

o Evaluation of financial reporting internal controls is an on-going process that incorporates the evaluation and review for accuracy and completeness of the various internal and external reporting activities conducted throughout each fiscal year. Such reviews are completed in the normal course of business on a periodic basis consistent with the frequency of the reporting activity and include:

58

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

• Review and discussion of various internal reporting activities designed to identify and disclose items of a material nature to management and the Board of Directors.

• Periodic retention of external specialists to review and analyze various activities.

• Preparation and review of monthly financial information that is provided to the Board of Directors and management.

• Review and maintenance of supporting documentation utilized to prepare interim financial information, regulatory reports and quarterly and annual financial statements.

• Review of interim financial reports and supporting documentation in connection with preparation of financial reports and financial statements to evaluate accuracy and consistency.

• Evaluation of various estimates and related methodologies, including those typical for banks and bank holding companies. Primarily, these consist of the allowance for loan and lease losses, mortgage servicing rights and tax provisions. Other estimates, including supporting documentation and methodologies, are reviewed, such as accrual of various operating expenses where there is a timing difference between the incurrence of and payment of such expenses.

The Company’s Chief Executive Officer and the Chief Financial Officer, based on such evaluations noted above of the Company’s financial reporting controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15(d)-15(e)) as of the end of the period covered by this Form 10-K Annual Report, have concluded that the Company’s financial reporting controls and procedures were adequate and effective. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparations and presentation.

59

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Common Stock Data
The Company’s common stock is traded on the over-the-counter market under the stock symbol PVLN.OB. There is limited trading volume of the Company’s common shares of stock.

The following table sets forth the range of high and low sales prices of the Company’s common stock during 2006, 2005, and 2004, based on information made available to the Company, as well as per share cash dividends declared during those periods. The prices shown below reflect inter-dealer prices and may not include retail markups, markdowns, or commissions. The Company is not necessarily aware of all trades of its common stock, therefore other transactions at prices outside the ranges listed below may have occurred:

	Sales Prices (1)				Cash
2006	High		Low		Dividends Declared (1)
First Quarter	$	49.00	$	43.50	$	0.24
Second Quarter	$	46.50	$	44.75	$	0.24
Third Quarter	$	48.00	$	45.50	$	0.24
Fourth Quarter	$	47.00	$	43.25	$	0.35
2005
First Quarter	$	59.80	$	55.00	$	0.24
Second Quarter	$	67.00	$	53.00	$	0.24
Third Quarter	$	55.00	$	50.00	$	0.24
Fourth Quarter	$	50.25	$	46.15	$	0.24
2004
First Quarter	$	52.50	$	48.25	$	0.24
Second Quarter	$	55.00	$	51.30	$	0.24
Third Quarter	$	65.00	$	52.75	$	0.24
Fourth Quarter	$	61.00	$	57.50	$	0.50

⁽¹⁾ All per share data has been adjusted to reflect stock splits and stock dividends including a stock dividend of 5% declared on December 19, 2003 and issued on January 30, 2004 to shareholders as of January 16, 2004.

Total authorized shares of the Company’s common stock are 3,000,000, of which 727,852 shares were issued and outstanding as of March 9, 2007. There were approximately 600 shareholders of record, including trusts and shares jointly owned, as of that date.

The holders of the Company’s common stock are entitled to dividends when, as and if declared by the Board of Directors of the Company out of funds legally available for that purpose. Dividends have typically been declared on a quarterly basis. In determining dividends, the Board of Directors considers the earnings, capital requirements and financial condition of the Company and the Bank, along with other relevant factors. The Company’s principal source of funds for cash dividends is the dividends paid to the Company by the Bank. Dividends are declared at the sole discretion of the Board of Directors. Historical practice for dividends is not a guarantee of future dividends. Additionally, the ability of the Company and the Bank to pay dividends is subject to regulatory restrictions and requirements.

60

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

During the fourth quarter of 2006, the Company made the following repurchases of its common stock:

Period	(a) Total No. of Shares Purchased		(b) Average Price Paid per Share		(c) Total No. of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum No. (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
October 2006		0		N/A		N/A		N/A
November 2006		0		N/A		N/A		N/A
December 2006		5,329		$47.00		5,329		0

61

PAVILION BANCORP, INC.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

SHAREHOLDER RETURN PERFORMANCE GRAPH

        Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on the Corporation’s common stock with that of the cumulative total return on the HEMSCOTTGroup Index and the NASDAQ Stock Market Index for the five-year period ended December 31, 2006. The HEMSCOTTGroup Index is an index composed of 114 banks and bank holding companies located in the Midwest and published by HEMSCOTT, Inc. The following information is based on an investment of $100, on December 31, 2001, in the Corporation’s common stock, the HEMSCOTTGroup Index, and the NASDAQ Stock Market Index, with dividends reinvested. There has been only limited trading in the Corporation’s common stock and the Corporation’s common stock does not trade on any stock exchange or on the NASDAQ market. Accordingly, the returns reflected in the following graph and table are based on sale prices of the Corporation’s stock of which management is aware. There may have been sales at higher or lower prices of which management is not aware.

	2001		2002		2003		2004		2005		2006
Pavilion Bancorp		100.00		88.08		95.08		116.80		99.88		90.12
Regional-Midwest Banks		100.00		95.70		123.04		131.19		125.96		146.02
NASDAQ Market Index		100.00		69.75		104.88		113.70		116.19		128.12

Source: HEMSCOTT, Inc., Richmond, Virginia

62

EX-21

Exhibit 21

Subsidiaries of Registrant

Name Ownership Incorporation

Bank of Lenawee

Pavilion Financial Services, Inc.

Pavilion Mortgage Company l00%

100% by Bank of Lenawee

100% by Bank of Lenawee Michigan

Michigan

Michigan

EX-23

EXHIBIT 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statements of Pavilion Bancorp, Inc. on Form S-8 (File No. 333-86636) and Form S-3D (File No. 333-112651) of our report dated March 9, 2007 on the 2006 Consolidated Financial Statements of Pavilion Bancorp, Inc., which report is included in the 2006 Annual Report on Form 10-K of Pavilion Bancorp, Inc.

/s/ PLANTE & MORAN, PLLC

PLANTE & MORAN PLLC

Auburn Hills, Michigan
March 16, 2007

EX-31

Exhibit 31.1

CERTIFICATIONS

I, Richard J. DeVries, certify that:

1. I have reviewed this Annual Report on Form 10-K of Pavilion Bancorp, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 19, 2007

/s/ Richard J. DeVries
——————————————
Richard J. DeVries
President and Chief Executive Officer

EX-31

Exhibit 31.2

CERTIFICATIONS

I, Mark D. Wolfe, certify that:

1. I have reviewed this Annual Report on Form 10-K of Pavilion Bancorp, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 19, 2007

/s/ Mark D. Wolfe
——————————————
Mark D. Wolfe
Senior Vice President Finance and Chief Financial Officer

EX-32

Exhibit 32.1

I, Richard J. DeVries, President and Chief Executive Officer of Pavilion Bancorp, Inc., certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Annual Report on Form 10-K for the year ended December 31, 2005 which this statement accompanies fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

(2) the information contained in the Annual Report on Form 10-K for the year ended December 31, 2006 fairly presents, in all material respects, the financial condition and results of operations of Pavilion Bancorp, Inc.

Dated: March 19, 2007

/s/ Richard J. DeVries
——————————————
Richard J. DeVries
President and Chief Executive Officer

EX-32

Exhibit 32.2

I, Mark D. Wolfe, Senior Vice President Finance and Chief Financial Officer, of Pavilion Bancorp, Inc., certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Annual Report on Form 10-K for the year ended December 31, 2006 which this statement accompanies fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

(2) the information contained in the Annual Report on Form 10-K for the year ended December 31, 2006 fairly presents, in all material respects, the financial condition and results of operations of Pavilion Bancorp, Inc.

Dated: March 19, 2007

/s/ Mark D. Wolfe
——————————————
Mark D. Wolfe
Senior Vice President Finance and Chief Financial Officer