Back to GetFilings.com

Securities and Exchange Commission
Washington, D.C. 20549

_________________

FORM 10-Q

|X| Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2004

or

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

_________________

Commission File #000-30521

Pavilion Bancorp, Inc.
(Exact name of registrant as specified in its charter)

135 East Maumee Street, Adrian, Michigan 49221
(Address of principal executive offices, including Zip Code)

Registrant’s telephone number, including area code: (517) 265-5144, Fax (517) 265-3926

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 shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes |X| No [__]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes [__] No |X|

As of August 11, 2004 there were 845,420 outstanding shares of the registrant’s common stock, no par value.

Page 1

ITEM NO.		CROSS REFERENCE TABLE DESCRIPTION		PAGE NO.

Page 2

Independent Accountant’s Report

We have reviewed the consolidated balance sheet of Pavilion Bancorp, Inc. (the Corporation) as of June 30, 2004, and the related consolidated statements of income, and cash flows for the three and six-month period then ended, included in the Corporation’s SEC Form 10-Q. These financial statements are the responsibility of the Corporation’s management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referenced above for them to be in conformity with generally accepted accounting principles.

Plante & Moran, PLLC
Auburn Hills, MI
August 11, 2004

Page 3

PART I
FINANCIAL INFORMATION

ITEM 1- FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS
                              In thousands of dollars

Page 4

CONDENSED CONSOLIDATED STATEMENTS OF
INCOME AND COMPREHENSIVE INCOME (unaudited)
In thousands of dollars, except per share data

Page 5

      CONDENSED CONSOLIDATED STATEMENT OF
         CASH FLOWS (unaudited)
         In thousands of dollars

Page 6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1 – PRINCIPLES OF CONSOLIDATION AND NATURE OF OPERATIONS

The unaudited condensed consolidated financial statements include the accounts of Pavilion Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries, Bank of Lenawee and Bank of Washtenaw (together “the Banks”). Bank of Lenawee includes its wholly-owned subsidiaries, Pavilion Financial Services and Pavilion Mortgage Company. All significant intercompany balances and transactions have been eliminated in consolidation.

The Company is a two-bank holding company which conducts limited business activities. The Banks perform the majority of the Company’s business activities.

The Banks provide a range of banking services to individuals, commercial businesses, light industries and municipal entities located in their service areas. Each 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 Banks offer traditional bank deposit products, including checking, savings, money market savings, individual retirement accounts, and certificates of deposit as well as a mobile banking courier service.

NOTE 2 — BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six month period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

NOTE 3 — EARNINGS PER SHARE

A reconciliation of the numerators and denominators of the basic earnings and diluted earnings per share computations for the three and six months ended June 30, 2004 and 2003 is presented below:

Page 7

NOTE 4 – ACCOUNTING FOR STOCK BASED COMPENSATION

Compensation expense under stock options is reported using the intrinsic value method. The exercise price of stock options is generally equivalent to the market price of the underlying common stock as of the date of grant. No stock-based compensation cost is reflected in net income, for stock options granted with an exercise price equal to or greater than the market price of the underlying common stock at date of grant. For stock options granted below market price, compensation expense is based upon the difference between the market price and the exercise price at the date of grant and is recorded over the vesting period of the options. Compensation expense actually recognized for the three and six months ended June 30, 2004 and 2003 was not significant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation.

The weighted average fair value of stock options granted during the six months ended June 30, 2004 and 2003 were $11.43 and $10.15, respectively. The fair value of options granted during the six months ended June 30, 2004 and 2003 were estimated using an option pricing model with the following weighted average information as of the grant dates:

In future years, as additional options are granted, the proforma effect on net income and earnings per share may increase. Stock options are used to reward directors and certain executive officers and provide them with an additional equity interest. Options are issued for ten year periods and have varying vesting schedules.

NOTE 5 – SUBSEQUENT EVENT

On July 16, 2004 Pavilion Bancorp executed a definitive agreement for the sale of the Bank of Washtenaw to Dearborn Bancorp, Inc. pending regulatory approval and certain other conditions (“Washtenaw Sale”). Subject to regulatory approval and certain other conditions, the sale is expected to be completed in the fourth quarter for the sum of $15,000,000. As of June 30, 2004 the Bank of Washtenaw has $72.6 million in total assets and $7.1 million in equity. For the six month period ended June 30, 2004 Bank of Washtenaw earned $73,700. A Form 8-K was filed with the Securities and Exchange Commission on July 19, 2004 detailing this transaction.

Page 8

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion provides information about the consolidated financial condition and results of operations of the Company as of June 30, 2004 and for the three and six month periods ended June 30, 2004 and 2003.

The Washtenaw Sale described in Note 5 to the Consolidated Financial Statements is subject to regulatory approval and other conditions. If the Washtenaw sale is completed as contemplated, it is anticipated that the transaction will have a positive impact on the Company’s financial condition and results of operations. The transaction will result in a reduction of consolidated assets (primarily loans, currently $66.5 million), and liabilities (primarily deposits, currently $72.6 million). However, the Company’s capital position is expected to be strengthened by the amount of the net after tax and transaction expense proceeds to be received in the transaction. The earnings on the additional capital are expected to more than offset the earnings contributed by Bank of Washtenaw to the Company’s consolidated results of operations. Management and the Board are developing a plan for the deployment of the additional capital in a manner which will support enhanced growth and expansion in the Lenawee County market area while maximizing the return on that investment. In the interim, the net proceeds from the transaction will be invested in short-term securities.

FINANCIAL CONDITION

Cash and cash equivalents
Cash and cash equivalents of $11.1 million increased 10.0%, or $1.01 million during the first six months of 2004 reflective of routine daily fluctuation.

Securities
Securities available for sale increased $1.6 million or 7.9% to $22.1 million during the first six months of 2004. The increase represents the investment of our customers’ increased deposit accounts funding. The mix of the securities portfolio was enhanced by additional government agency investments.

Loans
During the first six months of 2004, loans, net of allowance for loan losses, increased $5.8 million or 2.1%. The mix of the loan portfolio continues to remain relatively unchanged from prior periods. Over the long term, the trend continues toward an increased portion of small business loans in the Banks’ markets. Additionally, the increase in loans was partially due to the increase in loans held for sale at June 30, 2004. This increase of $2.2 million was due to timing of their sale to third parties including Fannie Mae, Freddie Mac and FHLB. The sale occurred subsequent to month-end.

Credit Quality
The Company continues to monitor the asset quality of the loan portfolio utilizing a loan review officer who, combined with external loan review specialists, periodically submits reports to the Chief Lending Officer and to the Board of Directors regarding the credit quality of each loan portfolio. This review is independent of the loan approval process. Also, management continues to monitor delinquencies, nonperforming assets and potential problem loans to assess the continued quality of the Company’s loan portfolios.

Nonperforming loans are comprised of (1) loans accounted for on a nonaccrual basis, (2) loans contractually past due 90 days or more as to interest or principal payments (but not included in the nonaccrual loans in (1) above) and (3) other nonperforming loans (but not included in (1) or (2) above) which consist of loan arrangements under the Business Manager program. The aggregate amount of nonperforming loans, in thousands of dollars, is shown in the table below. The Company’s classifications of nonperforming loans are generally consistent with loans identified as impaired.

Page 9

The chart below shows the makeup of the Company’s nonperforming assets by type, in thousands of dollars, as of June 30, 2004 and 2003, and December 31, 2003.

The Company decreased its funding of provision for loan losses during the three month period by $.21 million and $.28 million during the six month period ended June 30, 2004 as compared to the same periods in 2003 based on management’s assessment of the adequacy of the allowance for loan losses primarily as a result of smaller growth and an overall improvement in credit quality throughout the portfolio. The allowance provides for probable incurred losses in the current portfolio over time. Near term activity is expected to remain similarly moderate in proportion as experienced this quarter. Activity in the allowance for loan losses, in thousands of dollars, for the six months ended June, 2004 and 2003 follows:

Deposits
Total deposits increased $4.4 million or 1.7% during the six month period to $268.4 million at June 30, 2004 from $264.0 million at December 31, 2003. The non-interest bearing deposits increased $4.7 million or 9.1% during the six month period ended June 30, 2004 as compared to a $9.3 million or 19% increase during the same period in 2003.

Liquidity
The Company’s borrowing position increased $6.5 million during the first six months of 2004 from $14.6 million at year end 2003 to $21.1 million at June 30, 2004. The increase is representative of normal daily fluctuations. The Company has a number of additional liquidity sources should the need arise, including Federal Home Loan Bank advances and the purchase of Federal Funds; management presently has no concerns as to the liquidity position of the Company.

Capital Resources
During the first six months of 2004, equity capital increased $556,000 or 2.10% to $27.1 million, primarily as a result of retention of quarterly earnings offset by the payment of dividends and the $365,000 decrease (net of income tax) in unrealized gains on available for sale securities. The number of outstanding shares at December 31, 2003 of 805,392 increased to 845,420 during the first six months as the result of a 5% stock dividend issued January 30, 2004 less fractional shares paid in cash. Management monitors the capital levels of the Company and the Banks to provide for current and future business opportunities and to meet regulatory guidelines for “well capitalized” institutions. “Well capitalized” institutions are eligible for reduced FDIC premiums, and also enjoy other reduced regulatory restrictions.

Page 10

At June 30, 2004 and December 31, 2003, the Company and the Banks exceeded all regulatory minimum capital requirements and are considered to be “well capitalized.”

Results of Operations

Net Income
Net income declined $90,000 or 5.3% when comparing the results of the first six months of 2004 to the same period in 2003. 2004 revenues are reflective of the reduced activity within the mortgage re-financing market as compared to the same period in 2003. This revenue reduction is offset by an interest expense reduction of 14.2% for the same six months of 2003. Net Income increased by .8% during the three months ended June 30, 2004 as compared to the same period in 2003 due to an increase of the net interest margin after provision for loan losses of $431,000 or 13.4% and a decrease of $40,000 or 9.7% in the federal income tax expense respectively.

Net Interest Income
The yield on interest earning assets decreased 69 basis points for the six months ended June 30, 2004 as compared to the same period in the prior year primarily as a result of the general decline of market rates. The cost of funds on interest bearing liabilities also decreased for the quarter ended June 30, 2004 as compared to the same period during the prior year due to the reduction in interest rates. With interest rates decreasing, the Company’s net interest margin decreased by 30 basis points, as compared to the first six months of 2003, to 4.81 %. Net interest income for the three month period ended June 30, 2004 increased by 13.3% or $431,000 as compared to the same period in 2003. This was the result of lower interest expense and a lower provision for loan losses for the second quarter of 2004 as compared to 2003. The Company’s net interest margin remains quite strong, and management continues to take steps to neutralize portions of this risk.

The following table shows the year to date daily average balances for interest earning assets and interest bearing liabilities, interest earned or paid, and the annualized effective rate or yield, for the six month periods ended June 30, 2004 and 2003.

Page 11

(1)	Non-accrual loans and overdrafts are included in the average balances of loans.

(2)	Includes Federal Home Loan Bank stock.

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

Noninterest Income
For the first six months of 2004, noninterest income from banking products and services declined 38.1% as compared to the same period in 2003 due primarily to a decrease in gains on the sale of mortgages. The Company’s volume of mortgage loan sales into the secondary market continued to decline from net gains of $3.8 million on sales in the first six months of 2003 to $.865 million in the first six months of 2004. This decline was 55.4%, or $.6 million, for the three month period ended June 30, 2004 as compared to 2003. The decline resulted from an increase in mortgage rates from the prior years’ historic lows and the resulting refinancing activity.

Noninterest Expense
Noninterest expense of $7.0 million during the first six months of 2004 declined $.4 million or 6.2% from the level of noninterest expense during the same period of 2003. Most of this decrease was attributable to lower commissions paid to the mortgage origination staff, as was the decrease in noninvestment expense comparing the second quarter of 2004 with the same period in 2003.

Federal Income Tax
The reduction in federal incomes taxes of $40,000 and $101,000 during the three and six month periods ended Jun 30, 2004 respectively, is directly related to the decrease in income earned before income taxes.

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 without limitation, changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses, determining the fair value of securities and other financial instruments and the valuation of mortgage servicing rights.

Forward-Looking Statements
This discussion and analysis of financial condition and results of operations and other sections of this Form 10-Q contain forward looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy and about the Company itself. Words such as “anticipates”, “believes”, “estimates”, “expects”, “forecasts”, “foresee”, “intends”, “is likely”, “plans”, “projects”, variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecast in such forward-looking statements. Furthermore, the Company undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise. Future Factors include:

Page 12

These are representative of the Future Factors that could cause a difference between an actual outcome and a forward-looking statement.

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company’s primary market risk exposure is interest rate risk and liquidity risk. All of the Company’s transactions are denominated in U.S. dollars with no specific foreign exchange exposure. The Company has a limited exposure to commodity prices and land values related to agricultural loans. Any impacts that changes in foreign exchange rates and commodity prices would have on interest rates are assumed to not be significant.

Interest rate risk (IRR) is the exposure of a banking organization’s financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and stockholder value; however, excessive levels of IRR could pose a significant threat to the Company’s earnings and capital base. Accordingly, effective risk management that maintains IRR at prudent levels is essential to the Company’s safety and soundness.

Evaluating a financial institution’s exposure to changes in interest rates includes assessing both the adequacy of the management process used to control IRR and the organization’s quantitative level of exposure. When assessing the IRR management process, the Company seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain IRR at prudent levels with consistency and continuity. Evaluating the quantitative level of IRR exposure requires the Company to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity, and, where appropriate, asset quality.

The Company has not experienced a material change in its financial instruments that are sensitive to changes in interest rates since December 31, 2003, which information can be located in the Company’s annual report on Form 10-K.

ITEM 4 – CONTROLS AND PROCEDURES

Page 13

PART II
OTHER INFORMATION

ITEM 1 — LEGAL PROCEEDINGS

The Company is not involved in any material legal proceedings. The Company's wholly-owned subsidiaries, Bank of Lenawee and Bank of Washtenaw, are involved in ordinary routine litigation incident to their business; however, no such proceedings are expected to result in any material adverse effect on the operations or earnings of the Banks. Neither the Banks nor the Company are involved in any proceedings to which any director, principal officer, affiliate thereof, or person who owns of record or beneficially five percent (5%) or more of the outstanding stock of the Company or the Banks, or any associate of the foregoing, is a party or has a material interest adverse to the Company or the Banks.

ITEM 2 — CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

      Not Applicable

ITEM 3 — DEFAULTS UPON SENIOR SECURITIES — None

ITEM 4 — SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The annual meeting of our shareholders was held on April 22, 2004. At that meeting, the following matters were submitted to a vote of the shareholders. There were 845,425 voting shares outstanding on March 8, 2004, the record date for the meeting. 610,069 shares or 72% voted as follows:

ITEM 5 — OTHER INFORMATION — None

ITEM 6 — EXHIBITS AND REPORTS ON FORM 8-K

Page 14

(b)	Reports on Form 8-K.

Report on Form 8-K dated April 30, 2004, submitting a shareholder report with respect to the first quarter results of operations.

        Report on Form 8-K dated June 21, 2004, submitting a press release announcing a cash dividend.

Page 15

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Page 16

EXHIBIT INDEX

Exhibit         Description

Page 17

EXHIBIT 31.1

I, Douglas L. Kapnick, certify that:

Date: August 11, 2004

Page 18

EXHIBIT 31.2

I, Mark D. Wolfe, certify that:

Date: August 11, 2004

Page 19

EXHIBIT 32.1

        Douglas L. Kapnick, Chief Executive Officer of Pavilion Bancorp, Inc. and Mark D. Wolfe, Interim 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:

Dated: August 11, 2004

Page 20