# Exhibit 13

# Rule 14a-3 Annual
Report to Security Holders

---





# 2005

# Annual Report

This is Pavilion Bancorp,
Inc.s (the Company) 2005 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 2005 Summary Annual Report to
Shareholders accompanies the proxy statement and the 2005 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 2005 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: Pamela S. Fisher, 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.

---



2005 ANNUAL REPORT

CONTENTS

|                                  |  | 
|--------------------------------- |  | 
|                                  |  | 
|SELECTED FINANCIAL DATA           |  | 
|                                  |  | 
|CONSOLIDATED FINANCIAL STATEMENTS |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
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|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 
|                                  |  | 

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

---

|                                                       | 2005 | 2004 | 2003 | 2002    | 2001
|------------------------------------------------------ | ---- | ---- | ---- | ------- | ----
|At Year-End:                                           |      |      |      |         |     
|Total assets                                           |      |      | $    | 287,881 |     
|Loans receivable                                       |      |      | $    | 237,598 |     
|Deposits                                               |      |      | $    | 210,748 |     
|Shareholders' equity                                   |      |      | $    | 26,384  |     
|For the Year:                                          |      |     
|Total interest income                                  |      |      | $    | 16,130  |     
|Total interest expense                                 |      |      |      | 4,449   |     
|                                                       |      |      |      |         |     
|Net interest income                                    |      |      |      | 11,681  |     
|Provision for loan losses                              |      |      |      | 342     |     
|Noninterest income                                     |      |      |      | 3,277   |     
|Noninterest expense                                    |      |      |      | 12,075  |     
|                                                       |      |      |      |         |     
|Income before income taxes                             |      |      |      | 2,541   |     
|Provision for income tax                               |      |      |      | 603     |     
|                                                       |      |      |      |         |     
|Net income from continuing operations                  |      |      |      | 1,938   |     
|                                                       |      |      |      |         |     
|Discontinued Operation                                 |      |     
|Income (loss) from operation of discontinued component |      |      |      | -       |     
|Gain on sale of discontinued component                 |      |      |      | -       |     
|Provision (benefit) for income tax                     |      |      |      | -       |     
|                                                       |      |      |      |         |     
|Income (loss) from discontinued operation              |      |      |      | -       |     
|Net income                                             |      |      | $    | 1,938   |     
|                                                       |      |      |      |         |     
|                                                       |      |     
|Financial Ratios:                                      |      |     
|From continuing operations                             |      |     
|Return on average shareholders' equity                 |      |      |      | 6.66    | %   
|Return on average assets                               |      |      |      | 0.71    | %   
|                                                       |      |     
|From combined operations                               |      |     
|Return on average shareholders' equity                 |      |      |      | 6.66    | %   
|Return on average assets                               |      |      |      | 0.71    | %   
|                                                       |      |     
|Per Share Data:                                        |      |     
|Cash dividends declared per share                      |      |      | $    | 0.96    |     
|Dividend payout ratio                                  |      |      |      | 38.0    | %   
|Shareholders' equity per share                         |      |      | $    | 35.88   |     
|Average equity to average assets                       |      |      |      | 10.64   | %   
|                                                       |      |     
|Earnings per share from continuing operations          |      |     
|Basic                                                  |      |      | $    | 2.47    |     
|Diluted                                                |      |      | $    | 2.45    |     
|                                                       |      |     
|Earnings per share from discontinued operation         |      |     
|Basic                                                  |      |      | $    | -       |     
|Diluted                                                |      |      | $    | -       |     
|                                                       |      |     
|Net earnings per share                                 |      |     
|Basic                                                  |      |      | $    | 2.47    |     
|Diluted                                                |      |      | $    | 2.45    |     

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

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# Report of Independent
Registered Public Accounting Firm

# Board of Directors and
ShareholdersPavilion Bancorp, Inc.Adrian, Michigan

We have audited the consolidated statements of income, changes in shareholders equity and cash
flows of Pavilion Bancorp, Inc. for the year ended December 31, 2003. 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 audit.

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

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, Pavilion Bancorp, Inc.'s
 results of operations and cash flows for the year ended December 31, 2003 in
conformity with U.S. generally accepted accounting principles.

| | /s/ Crowe
Chizek and Company LLCCrowe Chizek and Company LLC
| | ------------------------------------------------------------

Grand Rapids,
MichiganJanuary 13, 2004

4

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# Report of Independent
Registered Public Accounting Firm

# To The Board of
Directors and ShareholdersPavilion
Bancorp, Inc.

We have audited
the accompanying balance sheets of Pavilion Bancorp, Inc. as of December 31, 2005 and
2004, and the related statements of income, shareholdersequity, and cash flows for
the years then ended. 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. The financial statements of Pavilion Bancorp, Inc. for the year
ended December 31, 2003, before the restatement described in Note 15, were audited by
other auditors whose report dated January 13, 2004 expressed an unqualified opinion on
those financial statements.

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 2005
and 2004 financial statements referred to above present fairly, in all material respects,
the financial position of Pavilion Bancorp, Inc. at December 31, 2005 and 2004, and the
results of its operations and its cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America.

We also audited the
adjustments described in Note 15 that were applied to restate the 2003 financial
statements. In our opinion, such adjustments are appropriate and have been properly
applied.

| | /s/ Plante & Moran, PLLCPlante & Moran, PLLC
| | --------------------------------------------

Auburn Hills, Michigan

March 1, 2006

5

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# PAVILION BANCORP,
INC.CONSOLIDATED BALANCE SHEETS

---

|December 31,                                         
|-----------------------------------------------------
|
|ASSETS                                               
|Cash and cash equivalents                            
|                                                     
|Total cash and cash equivalents                      
|Securities available for sale (Note 2)               
|Federal Home Loan Bank, Freddie Mac, FNMA stock      
|Federal Reserve Bank stock                           
|Loans held for sale                                  
|Loans (Note 3)                                       
|Less: allowance for loan and lease losses (Note 4)   
|                                                     
|Net loans                                            
|Premises and equipment - net (Note 6)                
|Accrued interest receivable                          
|Mortgage servicing rights (Note 5)                   
|Other assets                                         
|                                                     
|Total assets                                         
|                                                     
|LIABILITIES AND SHAREHOLDERS' EQUITY                 
|LIABILITIES                                          
|Deposits                                             
|Noninterest bearing                                  
|Interest-bearing (Note 7)                            
|                                                     
|Total deposits                                       
|Federal funds purchased (Note 8)                     
|Repurchase agreements (Note 8)                       
|Federal Home Loan Bank advances (Note 8)             
|Accrued interest payable                             
|Other liabilities                                    
|Subordinated debentures (Note 9)                     
|Common stock in ESOP subject to repurchase obligation
|(Note 11)                                            
|                                                     
|Total liabilities                                    
|SHAREHOLDERS' EQUITY (Notes 16 and 17)               
|Common stock and paid-in capital, no par value:      
|3,000,000 shares authorized; shares issued           
|and outstanding: 735,379-2005; 852,140-2004          
|Retained earnings                                    
|Accumulated other comprehensive loss                 
|                                                     
|Total shareholders' equity                           
|                                                     
|Total liabilities and shareholders' equity           
|                                                     

---

See accompanying notes
to the consolidated financial statements.

6

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# PAVILION BANCORP,
INC.CONSOLIDATED STATEMENTS OF INCOME  Years ended December
31, 2005, 2004, 2003

---

|2005                                                  | 2004 | 2003       
|----------------------------------------------------- | ---- | -----------
|Interest and dividend income                          |      |            
|Loans receivable, including fees                      |      | $14,951    
|Debt securities:                                      |     
|Taxable                                               |      | 780        
|Tax-exempt                                            |      | 135        
|Federal funds sold                                    |      | 118        
|Dividend income                                       |      | 146        
|                                                      |      |            
|Total interest and dividend income                    |      | 16,130     
|Interest expense                                      |     
|Deposits                                              |      | 3,334      
|Subordinated debentures                               |      | 359        
|Other borrowed funds                                  |      | 756        
|                                                      |      |            
|Total interest expense                                |      | 4,449      
|                                                      |      |            
|Net interest income                                   |      | 11,681     
|Provision for loan losses (Note 4)                    |      | 342        
|                                                      |      |            
|Net interest income after provision for loan losses   |      | 11,339     
|Noninterest income                                    |     
|Service charges and fees                              |      | 1,318      
|Net gain on sale of loans                             |      | 1,390      
|Loan servicing fees, net of amortization (Note 5)     |      | 287        
|Other                                                 |      | 282        
|                                                      |      |            
|Total noninterest income                              |      | 3,277      
|Noninterest expense                                   |     
|Compensation and employee benefits (Note 11)          |      | 7,194      
|Occupancy and equipment                               |      | 1,449      
|Postage and delivery                                  |      | 300        
|Professional services                                 |      | 673        
|Outside services                                      |      | 1,017      
|Marketing and advertising                             |      | 293        
|Loan and collection                                   |      | 343        
|Director and shareholders                             |      | 178        
|Other                                                 |      | 628        
|                                                      |      |            
|Total noninterest expense                             |      | 12,075     
|                                                      |      |            
|Income from continuing operations before income taxes |      | 2,541      
|Income taxes from continuing operations (Note 10)     |      | 603        
|                                                      |      |            
|Income from continuing operations                     |      | 1,938      
|                                                      |      |            
|Discontinued operation:                               |     
|Income (loss) from discontinued operation,            |     
|net of income taxes of $0, $162, and ($49)            |      | -          
|Gain on sale of discontinued component, net of        |     
|income tax expense of $0, $2,573, and $0              |      | -          
|                                                      |      |            
|Income (loss) from discontinued operation             |      | -          
|                                                      |      |            
|Net income                                            |      | $  1,938   
|                                                      |      |            
|                                                      |      | 2005       
|Earnings per share from continuing operations         |     
|Basic                                                 |      | $    2.47  
|Diluted                                               |      | $    2.45  
|Earnings per share from discontinued operation        |     
|Basic                                                 |      | $         -
|Diluted                                               |      | $         -
|Net earnings per share                                |     
|Basic                                                 |      | $    2.47  
|Diluted                                               |      | $    2.45  

---

See accompanying notes
to the consolidated financial statements.

7

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# PAVILION BANCORP,
INC.CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY Years ended December
31, 2005, 2004, and 2003

---

|Common 
 Stock 
Paid-InCapital               | RetainedEarnings | Accumulated
 Other
ComprehensiveIncome (Loss) | Total
Shareholders'Equity
|-------------------------------------------- | ---------------- | --------------------------------------------- | -------------------------
|Balance January 1, 2003                      |                  |                                               | $                        
|Comprehensive income:                        |                  |                                              
|Net income                                   |                  |                                               |                          
|Net change in minimum pension liability      |                  |                                               |                          
|Unrealized gains (losses) on securities      |                  |                                               |                          
|Tax effect                                   |                  |                                               |                          
|                                             |                  |                                               |                          
|Total other comprehensive income             |                  |                                               |                          
|                                             |                  |                                               |                          
|Total comprehensive income                   |                  |                                               |                          
|                                             |                  |                                              
|Change in common stock subject to repurchase |                  |                                               |                          
|                                             |                  |                                              
|Retirement of stock - 28,238 shares          |                  |                                               |                          
|                                             |                  |                                              
|Stock option expense                         |                  |                                               |                          
|                                             |                  |                                              
|Stock options exercised                      |                  |                                               |                          
|                                             |                  |                                              
|Cash dividends - $1.09 per share             |                  |                                               |                          
|                                             |                  |                                              
|Payment of 5% stock dividend                 |                  |                                               |                          
|                                             |                  |                                               |                          
|Balance December 31, 2003                    |                  |                                               |                          
|Comprehensive income:                        |                  |                                              
|Net income                                   |                  |                                               |                          
|Unrealized gains (losses) on securities      |                  |                                               |                          
|Tax effect                                   |                  |                                               |                          
|                                             |                  |                                               |                          
|Total other comprehensive income             |                  |                                               |                          
|                                             |                  |                                               |                          
|Total comprehensive income                   |                  |                                               |                          
|                                             |                  |                                              
|Change in common stock subject to repurchase |                  |                                               |                          
|                                             |                  |                                              
|Retirement of stock                          |                  |                                               |                          
|Stock option expense                         |                  |                                               |                          
|Stock options exercised                      |                  |                                               |                          
|Cash dividends - $1.22 per share             |                  |                                               |                          
|                                             |                  |                                               |                          
|Balance December 31, 2004                    |                  |                                               |                          
|Comprehensive income:                        |                  |                                              
|Net income                                   |                  |                                               |                          
|Unrealized gains (losses) on securities      |                  |                                               |                          
|Tax effect                                   |                  |                                               |                          
|                                             |                  |                                               |                          
|Total other comprehensive income             |                  |                                               |                          
|                                             |                  |                                               |                          
|Total comprehensive income                   |                  |                                               |                          
|                                             |                  |                                              
|Change in common stock subject to repurchase |                  |                                               |                          
|                                             |                  |                                              
|Stock repurchase and retirement              |                  |                                               |                          
|                                             |                  |                                              
|Stock option expense                         |                  |                                               |                          
|Stock options exercised                      |                  |                                               |                          
|Cash dividends - $0.96 per share             |                  |                                               |                          
|                                             |                  |                                               |                          
|Balance December 31, 2005                    |                  |                                               | $                        
|                                             |                  |                                               |                          

---

See accompanying notes
to the consolidated financial statements.

8

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# PAVILION BANCORP,
INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December
31, 2005, 2004 and 2003

---

|2005                                                | 2004 | 2003      
|--------------------------------------------------- | ---- | ----------
|Cash flows from operating activities                |      |           
|Net income                                          |      | $   1,938 
|Adjustments to reconcile net income to              |     
|net cash from operating activities                  |     
|Depreciation                                        |      | 688       
|Stock option expense                                |      | 16        
|Provision for loan losses                           |      | 342       
|Gain on sale of discontinued operation              |      | -         
|Deferred income tax (benefit) provision             |      | (161      
|Amortization (accretion) on investment securities   |     
|available for sale                                  |      | 34        
|Net loss on disposal of assets                      |      | 89        
|Amortization of mortgage servicing rights           |      | 663       
|Origination of mortgage loans held for sale         |      | (60,122   
|Proceeds from sales of mortgage loans held for sale |      | 60,173    
|Net gains on sale of mortgage loans                 |      | (1,390    
|Net change in:                                      |     
|Deferred loan origination fees                      |      | (17       
|Accrued interest receivable                         |      | (222      
|Other assets                                        |      | 159       
|Accrued interest payable                            |      | 434       
|Other liabilities                                   |      | (2,118    
|                                                    |      |           
|Net cash provided by (used in) operating activities |      | 506       
|Cash flows from investing activities                |     
|Proceeds from:                                      |     
|Maturities, calls and principal payments on         |     
|securities available for sale                       |      | 5,233     
|Federal Reserve Bank Stock                          |      | -         
|Proceeds from sale of discontinued operation        |      | -         
|Purchases of:                                       |     
|Securities available for sale                       |      | (3,165    
|Federal Home Loan Bank stock                        |      | (57       
|Federal Reserve Bank stock                          |      | (270      
|Premises and equipment, net                         |      | (1,185    
|Net change in discontinued operation                |      | -         
|Net (increase) decrease in loans                    |      | (30,348   
|Recoveries on loans charged-off                     |      | 67        
|                                                    |      |           
|Net cash (used in) provided by investing activities |      | (29,725   
|Cash flows from financing activities                |     
|Net change in deposits                              |      | 10,756    
|Net change in short term borrowings                 |      | 18,731    
|Proceeds from FHLB advances                         |      | 16,800    
|Repayment of FHLB advances                          |      | (8,485    
|Repurchase of common stock                          |      | (8,518    
|Stock options exercised                             |      | 529       
|Dividends paid                                      |      | (986      
|                                                    |      |           
|Net cash provided by (used in) financing activities |      | 28,827    
|                                                    |      |           
|Net change in cash and cash equivalents             |      | (392      
|Cash and cash equivalents at beginning of year      |      | 11,700    
|                                                    |      |           
|Cash and cash equivalents at  end of year           |      | $ 11,308  
|                                                    |      |           
|Supplemental schedule of noncash activities         |     
|Transfer from:                                      |     
|Loans to foreclosed real estate                     |      | $      295
|Cash paid for:                                      |     
|Interest                                            |      | $   4,015 
|Income taxes                                        |      | $   2,615 

---

See accompanying notes
to the consolidated financial statements.

9

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

# 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 15 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 an
interest in a title insurance 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.

10

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

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, 2005 and 2004. 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 (FHLB stock) and
Federal Reserve Bank stock (FRB stock) are considered restricted investment
securities and are carried at cost. Purchases and sales of FHLB stock are made directly
with the FHLB 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 or cost-recovery method, 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

11

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

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.

12

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

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 $549,000 and
$715,000 at December 31, 2005 and 2004 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:
Stock-based compensation expense is determined under the intrinsic value method, net of
related tax effects. No stock-based compensation cost is reflected in net income unless
options granted have an exercise price that is less than the market price of the
underlying common stock at date of grant. During 2001 stock options were granted with
exercise prices that were less than the fair market value of the underlying common stock
as of the grant date; therefore, the Company is recording compensation expense for the
difference between the strike price and fair market value of the underlying common stock
as of the respective grant dates for the 2001 and earlier stock option grants. Accordingly
compensation expense for these stock options has been recorded during 2005, 2004 and 2003
based on the vesting schedules of the related stock options. Compensation expense for
stock options was $16,000, $43,000 and $43,000 during 2005, 2004 and 2003, respectively.

The following table illustrates the
effect on net income and earnings per share if expense was measured using the fair value
recognition provision of FASB Statement No. 123, Accounting for Stock-Based Compensation
(000s omitted):

|                                         | 2005 | 2004          | 2003
|---------------------------------------- | ---- | ------------- | ----
|Net income as reported                   |      | $      1,938  |     
|Less: Stock-based compensation expense   |     
|Determined under fair value based method |      | (63           | )   
|                                         |      |               |     
|Pro forma net income                     |      | $      1,875  |     
|                                         |      |               |     
|Basic earnings per share - As Reported   |      | $        2.47 |     
|Basic earnings per share - Pro forma     |      | $        2.38 |     
|Diluted earnings per share - As Reported |      | $        2.45 |     
|Diluted earnings per share - Pro forma   |      | $        2.37 |     

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  | 2003
|------------------------------- | ---- | ----- | ----
|Risk-free interest rate         |      | 4.00  | %   
|Expected option life            |      | 8 yea | rs  
|Expected dividend yield         |      | 2.14  | %   
|Expected stock price volatility |      | 25.07 | %   

13

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 1 - SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (continued)

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.

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

|                                             | 2005 | 2004       | 2003
|-------------------------------------------- | ---- | ---------- | ----
|Net income                                   |      | $    1,938 |     
|                                             |      |            |     
|Average number of common shares outstanding  |     
|used to calculate basic earnings per share   |      | 785,117    |     
|Effect of dilutive options                   |      | 4,762      |     
|                                             |      |            |     
|Average number of common shares outstanding  |     
|used to calculate diluted earnings per       |     
|common share                                 |      | 789,879    |     
|                                             |      |            |     
|Number of antidilutive stock options         |     
|excluded from the diluted earnings per share |     
|computation                                  |      | 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.

Stock Dividend: On December
19, 2003, the Company declared a 5% stock dividend payable on January 30, 2004 to
shareholders as of January 16, 2004. All per share data has been restated to reflect the
stock dividend.

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

14

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 1 - SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES (continued)

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.

Recent Accounting
Pronouncements:

SFAS No. 123 (revised 2004):
In December 2004, the Financial Accounting Standards Board, also known as the FASB, issued
a revision to SFAS 123 Share-Based Payment, also known as SFAS123R, that
amends existing accounting pronouncements for share-based payment transactions in which an
enterprise receives employee and certain non-employee services in exchange for (a) equity
instruments of the enterprise or (b) liabilities that are based on the fair value of the
enterprises equity instruments or that may be settled by the issuance of such equity
instruments. SFAS 123R, together with guidance included in Staff Accounting Bulletin No.
107 issued by the SEC on March 29, 2005, also known as SAB 107, eliminates the ability to
account for share-based compensation transactions using the intrinsic value method and
generally requires such transactions be accounted for using a fair-value-based method.
SFAS 123R applies to awards that are granted, modified, or settled in periods beginning
after its applicable effective date. SFAS 123R allows for three alternative transition
methods. The Company currently intends to adopt SFAS 123R and SAB 107 in the first quarter
of 2006. The adoption of SFAS 123R will cause the Company to record a non-cash accounting
charge as an expense each quarter in an amount approximating the fair value of such
share-based compensation meeting the criteria outlined in the provisions of SFAS123R. We
will adopt SFAS 123R using the modified prospective method with no restatement and will
record stock compensation expense of approximately $40,000, net of tax, between the first
quarter of 2006 through the first quarter of 2010 for stock awards outstanding as of
December 31, 2005. Any additional impact that the adoption of this statement will have on
our financial position and results of operations will be determined by share-based
payments granted in future periods and the assumptions on which the value of those
share-based payments is based.

SFAS No. 154: In May 2005, the
FASB issued Statement of Financial Accounting Standards No. 154, Accounting
Changes and Error Corrections. This statement replaces APB 20 cumulative effect
accounting with retroactive restatement of comparative financial statements. It applies to
all voluntary changes in accounting principle and defines retrospective
application to differentiate it from restatements due to incorrect accounting. The
provisions of this statement are effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005 and will become
effective for the Company beginning in 2006. The adoption of this accounting principle is
not expected to have a significant impact on our financial position or results of
operations.

# NOTE 2  SECURITIES

The amortized cost and estimated fair
market value of available-for-sale securities are as follows at December 31, 2005 and 2004
(000s omitted):

|                                               | AmortizedCost | Gross
UnrealizedGains | Gross
UnrealizedLosses | EstimatedMarket Value
|---------------------------------------------- | ------------- | --------------------- | ---------------------- | ---------------------
|2005                                           |               |                       |                        |                      
|U.S. Treasury & government agencies            |               | $  20,164             |                        | $       -            
|Obligations of states & political subdivisions |               | 4,350                 |                        | 31                   
|Mortgage-backed securities                     |               | 1,353                 |                        | 5                    
|                                               |               |                       |                        |                      
|Total available for sale securities            |               | $  25,867             |                        | $    36              
|                                               |               |                       |                        |                      
|2004                                           |              
|U.S. Treasury & government agencies            |               | $  20,161             |                        | $       -            
|Obligations of states & political subdivisions |               | 5,815                 |                        | 89                   
|Mortgage-backed securities                     |               | 1,980                 |                        | 33                   
|                                               |               |                       |                        |                      
|Total available for sale securities            |               | $  27,956             |                        | $   122              
|                                               |               |                       |                        |                      

15

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 2  SECURITIES(continued)

Contractual maturities of securities
at December 31, 2005 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
|-------------------------- | ------------------
|
|Due in one year or less    |                   
|Due from one to five years |                   
|Due from five to ten years |                   
|Due after ten years        |                   
|                           |                   
|Total debt securities      |                   
|Mortgage-backed securities |                   
|                           |                   
|Total                      |                   
|                           |                   

Information pertaining to securities
with gross unrealized losses at December 31, 2005 and 2004, 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, 2005                | Less Than Twelve Months | Twelve Months or More
|----------------------------------- | ----------------------- | ---------------------
|
|Available-for-sale securities:      |                         |                      
|U.S. treasury & government agencies |                         | $         -          
|Obligations of states & political   |                        
|subdivisions                        |                         | 10                   
|Mortgage-backed securities          |                         | -                    
|                                    |                         |                      
|Total available-for-sale securities |                         | $      10            
|                                    |                         |                      

|At December 31, 2004                | Less Than Twelve Months | Twelve Months or More
|----------------------------------- | ----------------------- | ---------------------
|
|Available-for-sale securities:      |                         |                      
|U.S. treasury & government agencies |                         | $   178              
|Obligations of states & political   |                        
|subdivisions                        |                         | 10                   
|Mortgage-backed securities          |                         | 4                    
|                                    |                         |                      
|Total available-for-sale securities |                         | $   192              
|                                    |                         |                      

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 $16,102,000 and $4,949,000 at December 31, 2005 and 2004 were pledged to
secure repurchase agreements and other borrowings. Of the $16,102,000 pledged in 2005,
$15,811,000 was pledged to secure repurchase agreements with third party financial
institutions and certain customers and $291,000 was pledged to the Federal Reserve Bank as
security for treasury tax and loan (TT&L).

16

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

# NOTE 3  LOANS
RECEIVABLE

Major categories of loans in the
portfolio are as follows at December 31, 2005 and 2004 (000s omitted):

|                            | 2005 | 2004    
|--------------------------- | ---- | --------
|Commercial                  |      | $125,378
|Agricultural                |      | 38,778  
|Residential mortgage        |      | 28,113  
|Residential construction    |      | 11,902  
|Home equity lines of credit |      | 20,693  
|Consumer                    |      | 12,734  
|                            |      |         
|Total loans receivable      |      | $237,598
|                            |      |         

Certain directors and executive
officers of the Company, including associates of such persons, were loan customers of the
Company during 2005 and 2004. A summary of aggregate related-party loan activity for loans
aggregating $60,000 or more to any related party at December 31, 2005 and 2004 is as
follows (000s omitted):

|                       | 2005 | 2004   
|---------------------- | ---- | -------
|Balance at January 1   |      | $ 5,140
|New loans              |      | 1,440  
|Repayments             |      | (1,655 
|Other adjustments      |      | -      
|                       |      |        
|Balance at December 31 |      | $ 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, 2005, 2004 and 2003 are as
follows (000s omitted):

|                          | 2005 | 2004    | 2003
|------------------------- | ---- | ------- | ----
|Beginning balance         |      | $ 2,495 |     
|Charge-offs               |      | (221    | )   
|Recoveries                |      | 67      |     
|Provision for loan losses |      | 342     |     
|                          |      |         |     
|Ending balance            |      | $ 2,683 |     
|                          |      |         |     

Impaired loans at December 31, 2005,
2004 and 2003 are as follows (000s omitted):

|                                                                     | 2005 | 2004         | 2003
|-------------------------------------------------------------------- | ---- | ------------ | ----
|Impaired loans with no allowance for loan and lease losses allocated |      | $          - |     
|Impaired loans with allowance for loan and lease losses allocated    |      | $  1,404     |     
|Total impaired loans                                                 |      | $  1,404     |     
|Amount of the allowance allocated to impaired loans                  |      | $     254    |     
|Average investment in impaired loans                                 |      | $  1,269     |     
|Interest income recognized during impairment                         |      | $       27   |     
|Cash-basis interest income recognized                                |      | $       10   |     

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

17

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 4 - ALLOWANCE FOR
LOAN AND LEASE LOSSES (continued)

Nonperforming loans at December 31,
2005 and 2004 were as follows (000s omitted):

|                                                    | 2005 | 2004   
|--------------------------------------------------- | ---- | -------
|Loans past due over 90 days still accruing interest |      | $   672
|Nonaccrual loans                                    |      | $1,104 

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

# 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 $376,036,000, $374,022,000 and $392,514,000 at December 31,
2005, 2004 and 2003 and are not included in the accompanying consolidated balance sheets.
Related escrow balances were $958,000, $408,000, and $835,000 December 31, 2005, 2004, and
2003.

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

|                                  | December 31,
|--------------------------------- | ------------
|
|Annual constant prepayment speed  |             
|Weighted average life (in months) |             
|Discount rate                     |             

At December 31, 2005 and 2004 the
estimated fair value of the mortgage loan servicing portfolio was $4.6 million and $4.1
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):

|                                      | 2005 | 2004    | 2003
|------------------------------------- | ---- | ------- | ----
|Beginning balance                     |      | $ 2,827 |     
|Mortgage servicing rights capitalized |      | 734     |     
|Mortgage servicing rights amortized   |      | (663    | )   
|                                      |      |         |     
|Ending balance                        |      | $ 2,898 |     
|                                      |      |         |     

There was no valuation allowance at
December 31, 2005, 2004 and 2003 for mortgage servicing rights.

# NOTE 6  PREMISES
AND EQUIPMENT

Major classifications of bank premises
and equipment at December 31, 2005 and 2004 are summarized as follows (000s
omitted):

|                               | 2005 | 2004      
|------------------------------ | ---- | ----------
|Land                           |      | $      561
|Buildings and improvement      |      | 5,343     
|Furniture and equipment        |      | 5,135     
|Construction in process        |      | 1,041     
|                               |      |           
|Total premises and equipment   |      | 12,080    
|Less: accumulated depreciation |      | (5,945    
|                               |      |           
|Net carrying amount            |      | $   6,135 
|                               |      |           

19

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 6  PREMISES
AND EQUIPMENT (Continued)

The Company is currently constructing
a new branch with a total estimated cost of $1,624,000, of which $1,041,000 has been
incurred through December 31, 2005. The estimated cost to complete construction is
approximately $583,000. Completion is expected in April 2006.

Depreciation expense for the years
ended December 31, 2005, 2004 and 2003 amounted to $688,000, $579,000 and $570,000,
respectively. The anticipated annual expense from an operating lease is $53,000.
Currently, the lease is in the sixth year of a ten year lease. Inflationary adjustments to
the cost of such lease, based on changes in the Consumers Price Index, will begin in 2006.

# NOTE 7  DEPOSITS

The following table summarizes
interest-bearing deposits at December 31, 2005 and 2004 (000s omitted):

|                                | 2005 | 2004     
|------------------------------- | ---- | ---------
|NOW accounts                    |      | $  26,273
|Savings                         |      | 47,213   
|Certificates of deposit:        |     
|$100,000 and over               |      | 55,056   
|Under $100,000                  |      | 36,853   
|                                |      |          
|Total interest-bearing deposits |      | $165,395 
|                                |      |          

Stated maturities of time deposits at
December 31, 2005 are as follows (000s omitted):

|           | 
|---------- | 
|2006       | 
|2007       | 
|2008       | 
|2009       | 
|2010       | 
|Thereafter | 
|           | 
|           | 
|           | 

The aggregate amount of certificates
of deposit with minimum denominations of $100,000 was approximately $55.1 million and
$32.8 million as of December 31, 2005 and 2004, respectively. The following table
indicates the schedule of maturities for certificates of deposit with a minimum
denomination of $100,000:

|                                      | 2005 | 2004   
|------------------------------------- | ---- | -------
|Three months or less                  |      | $25,091
|Over three months through six months  |      | 13,380 
|Over six months through twelve months |      | 9,322  
|One to two years                      |      | 5,139  
|Thereafter                            |      | 2,124  
|                                      |      |        
|Total                                 |      | $55,056
|                                      |      |        

# NOTE 8  BORROWED
FUNDS

Borrowed funds at December 31, 2005
and 2004 are as follows (000s omitted):

|                                               | 2005 | 2004    
|---------------------------------------------- | ---- | --------
|Federal funds purchased                        |      | $  9,000
|Repurchase agreements - customers              |      | 3,663   
|Repurchase agreements - financial institutions |      | 10,000  
|Federal Home Loan Bank advances                |      | 16,901  
|                                               |      |         
|Total borrowed funds                           |      | $39,564 
|                                               |      |         

19

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 8  BORROWED
FUNDS (continued)

Federal funds purchased totaled
$9,000,000 and $1,450,000 at December 31, 2005 and 2004, 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 2.50% to
4.56% during 2005. The weighted average interest rate at December 31, 2005 is 4.50%. The
weighted average interest rate paid for the year ended December 31, 2005 was 3.39%.

Repurchase Agreements

The Company has repurchase agreements
with Bank customers as well as third party financial institutions. Information concerning
repurchase agreements at December 31, 2005 and 2004 are summarized as follows (000s
omitted):

Customer Repurchase
Agreements

|                                               | 2005 | 2004    
|---------------------------------------------- | ---- | --------
|Amount outstanding at year-end                 |      | $  3,663
|Weighted average interest rate at year-end     |      | 2.03    
|Average daily balance during the year          |      | $  5,304
|Weighted average interest rate during the year |      | 1.55    
|Maximum month-end balance during the year      |      | $14,177 

Third Party Financial
Institutions Repurchase Agreements

|                                               | 2005
|---------------------------------------------- | ----
|Amount outstanding at year-end                 |     
|Weighted average interest rate at year-end     |     
|Average daily balance during the year          |     
|Weighted average interest rate during the year |     
|Maximum month-end balance during the year      |     

There were no repurchase agreements
outstanding with third party financial institutions during 2004. 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 (FHLB) with fixed and variable
interest rates ranging from 2.93% to 4.90% at December 31, 2005 and from 2.50% to 6.04% at
December 31, 2004. The weighted average interest rate at December 31, 2005 is 4.38%.
Maturity dates range from January 2006 to May 2008. The weighted average remaining
maturity at December 31, 2005 is 265 days, or September 22, 2006. Pursuant to collateral
agreements with the FHLB, the Company pledges various qualified one to four family
mortgage loans as collateral for advances outstanding at the FHLB. At December 31, 2005
and 2004 such pledged mortgage loans had outstanding balances of $31,752,000 and
$29,933,000, respectively. Certain advances are subject to prepayment penalties and the
provisions and conditions of the credit policies of the FHLB.

Scheduled principal reductions on
FHLB advances at December 31, 2005 are as follows (000s omitted):

|                    | 
|------------------- | 
|2006                | 
|2007                | 
|2008                | 
|                    | 
|Total FHLB advances | 
|                    | 

# 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

20

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 9  SUBORDINATED
DEBENTURES(Continued)

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 ofinterest 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,
and the rate of interest is equal to 8.42% as of December 31, 2005. This subordinated
debenture is considered Tier 1 capital (with certain limitations applicable) under current
regulatory guidelines. As of December 31, 2005 and 2004, the outstanding principal
balance of the subordinated debentures was $5.0 million. The principal balance of the
subordinated debentures is presented as a liability in the financial statements.

The trust preferred securities, which
mature December 8, 2031, are 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
are 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 are also redeemable in whole or in part from time to time, upon
the occurrence of specific events defined within the trust indenture. The Company has the
option to defer distributions on the subordinated debentures from time to time for a
period not to exceed 5 consecutive years.

# NOTE 10  INCOME
TAXES

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

|                                 | 2005 | 2004  | 2003
|-------------------------------- | ---- | ----- | ----
|Continuing Operations:           |      |       |     
|Current provision                |      | $ 764 |     
|Deferred (benefit) provision     |      | (161  | )   
|                                 |      |       |     
|Total from continuing operations |      | 603   |     
|Discontinued operation           |      | -     |     
|                                 |      |       |     
|Total                            |      | $ 603 |     
|                                 |      |       |     

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):

|                                        | 2005 | 2004     | 2003
|--------------------------------------- | ---- | -------- | ----
|Statutory rates                         |      | $    864 |     
|Increase (decrease) from:               |     
|Tax-exempt interest income              |      | (74      | )   
|Non-deductible expenses                 |      | 6        |     
|Change in accounting estimate and other |      | (193     | )   
|                                        |      |          |     
|                                        |      | $    603 |     
|                                        |      |          |     

21

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 10  INCOME TAXES
(Continued)

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

|                                                       | 2005 | 2004     | 2003
|------------------------------------------------------ | ---- | -------- | ----
|Deferred tax assets                                    |      |          |     
|Allowance for loan and lease losses                    |      | $    643 |     
|Net deferred loan fees                                 |      | 13       |     
|Pension expense                                        |      | -        |     
|Minimum pension liability                              |      | 42       |     
|Net unrealized losses on securities available-for-sale |      | 156      |     
|Other                                                  |      | 206      |     
|                                                       |      |          |     
|Total deferred tax assets                              |      | 1,060    |     
|                                                       |      |          |     
|Deferred tax liabilities                               |     
|Depreciation                                           |      | (537     | )   
|Mortgage servicing rights                              |      | (985     | )   
|Net unrealized gains on securities available for sale  |      | -        |     
|Prepaid expenses                                       |      | (58      | )   
|Other                                                  |      | (92      | )   
|                                                       |      |          |     
|Total deferred tax liabilities                         |      | (1,672   | )   
|                                                       |      |          |     
|Net deferred tax liability                             |      | $  (612  | )   
|                                                       |      |          |     

# 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 all 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 was adequately
funded in the Plan as of December 31, 2005. The expense of the Plan allocated to the Bank
for the twelve months ended December 31, 2005 and 2004 was $347,817 and $416,109,
respectively. Additionally, the Bank made special underfunding payments into the Plan
during 2005 and 2004 of $-0- and $737,727, 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.

22

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

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 $100,000, $108,000 and $113,000
in 2005, 2004 and 2003, 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, 2005 and 2004, the Trust
held 61,636 and 74,494 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. The appraised value of the shares of Company stock held by the Trust
was $2,989,000 and $4,544,000 at December 31, 2005 and 2004, respectively.

Stock Option Plan

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. Information about options available for grant and options
granted follows:

|                             | AvailableFor Grant | Options   Outstanding | Weighted
 Average
 ExercisePrice
|---------------------------- | ------------------ | --------------------- | --------------------------------
|Balance at January 1, 2003   |                    | 38,951                |                                 
|Options issued               |                    | (7,140                | )                               
|Options exercised            |                    | -                     |                                 
|Options forfeited            |                    | -                     |                                 
|                             |                    |                       |                                 
|Balance at December 31, 2003 |                    | 31,811                |                                 
|Options issued               |                    | (9,030                | )                               
|Options exercised            |                    | -                     |                                 
|Options forfeited            |                    | -                     |                                 
|                             |                    |                       |                                 
|Balance at December 31, 2004 |                    | 22,781                |                                 
|                             |                    |                       |                                 
|Options issued               |                    | (6,300                | )                               
|Options exercised            |                    | -                     |                                 
|Options forfeited            |                    | -                     |                                 
|                             |                    |                       |                                 
|Balance at December 31, 2005 |                    | 16,481                |                                 
|                             |                    |                       |                                 

The weighted average fair value of
stock options granted was $15.85, $11.43 and $9.66 for 2005, 2004 and 2003, respectively.

23

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 11  EMPLOYEE BENEFITS(Continued)

Options exercisable at December 31 of
each year were as follows:

|     | Number ofOptions | Weighted
  Average
 ExercisePrice
|---- | ---------------- | ---------------------------------
|2005 |                  | 25,099                           
|2004 |                  | 28,870                           
|2003 |                  | 24,917                           

Options outstanding at December 31,
2005 were as follows:

|                        | Outstanding | Exercisable
|----------------------- | ----------- | -----------
|
|$17.00 - $24.00         |             | 4,725      
|$34.00 - $42.00         |             | 4,851      
|$48.00 - $52.00         |             | 15,965     
|$55.00 - $61.00         |             | 5,250      
|                        |             |            
|Outstanding at year end |             | 30,791     
|                        |             |            

# NOTE 12 
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, 2005 and 2004, the
following financial instruments were outstanding whose contract amounts represent
off-balance sheet credit risk (000s omitted):

|                                           | 2005 | 2004    
|------------------------------------------ | ---- | --------
|Commitments to extend credit               |      | $  7,370
|Unfunded commitments under lines of credit |      | 61,242  
|Commercial and standby letters of credit   |      | 3,051   
|                                           |      |         
|                                           |      | $71,663 
|                                           |      |         

At December 31, 2005 and 2004
required reserves at the Federal Reserve Bank of Chicago totaled $1,385,000 and
$5,716,000, respectively. These reserves do not earn interest.

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.

24

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 12 - 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.

Lease Commitments: Future
minimum lease payments under the Companys current non-cancelable operating leases
are immaterial.

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 13 
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, 2005 and 2004 are as follows (000s omitted):

|                                           | 2005 | 2004    
|------------------------------------------ | ---- | --------
|Assets                                     |      |         
|Cash and cash equivalents                  |      | $  3,208
|Securities available for sale              |      | 1,129   
|Investment in subsidiaries                 |      | 30,279  
|Other                                      |      | 159     
|                                           |      |         
|Total assets                               |      | $34,775 
|                                           |      |         
|Liabilities & Shareholders' Equity         |     
|Subordinated debentures                    |      | $  5,000
|Other                                      |      | 402     
|Common stock subject to repurchase in ESOP |      | 2,989   
|Shareholders' equity                       |      | 26,384  
|                                           |      |         
|Total liabilities & shareholders' equity   |      | $34,775 
|                                           |      |         

25

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

The Parent-only condensed statements
of income for the years ended December 31, 2005, 2004 and 2003 are as follows (000s
omitted):

|                                                   | 2005 | 2004        | 2003
|-------------------------------------------------- | ---- | ----------- | ----
|Dividends from subsidiaries                        |      | $         - |     
|Interest income                                    |      | 61          |     
|Interest expense                                   |      | (359        | )   
|Other operating expense                            |      | (290        | )   
|                                                   |      |             |     
|Income (loss) before equity in undistributed       |     
|net income of subsidiary                           |      | (588        | )   
|Equity in undistributed net income from            |     
|subsidiaries                                       |      | 2,344       |     
|                                                   |      |             |     
|Income from continuing operations before           |     
|income taxes                                       |      | 1,756       |     
|Income tax (benefit) provision                     |      | (182        | )   
|                                                   |      |             |     
|Income from continuing operations                  |      | 1,938       |     
|Income (loss) from discontinued operation,         |     
|net of income taxes, $0, $162, ($49)               |      | -           |     
|Gain on sale of discontinued operation, net of tax |      | -           |     
|                                                   |      |             |     
|Net income                                         |      | $ 1,938     |     
|                                                   |      |             |     

26

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 13 PARENT-ONLY
CONDENSED FINANCIAL STATEMENTS (continued)

The condensed statements of cash
flows for the years ended December 31, 2005, 2004 and 2003 are as follows (000s
omitted):

|                                                          | 2005 | 2004      | 2003
|--------------------------------------------------------- | ---- | --------- | ----
|Cash flows from operating activities                      |      |           |     
|Net income                                                |      | $   1,938 |     
|Adjustments to reconcile net income to net cash           |     
|from operating activities                                 |     
|(Equity) excess in undistributed net income of            |     
|subsidiaries                                              |      | (2,344    | )   
|Gain on sale of discontinued operation                    |      | -         |     
|Amortization (accretion) of investment securities         |      | 10        |     
|Stock option expense                                      |      | 16        |     
|Other                                                     |      | (2,362    | )   
|                                                          |      |           |     
|Net cash (used in) provided by operating activities       |      | (2,742    | )   
|Cash flows from investing activities                      |     
|Investment in banking subsidiaries                        |      | -         |     
|Net proceeds from sale of discontinued operation          |      | -         |     
|Purchase of securities available for sale                 |      | (3,165    | )   
|Proceeds from maturities of securities available for sale |      | 3,985     |     
|                                                          |      |           |     
|Net cash provided by (used in) investing activities       |      | 820       |     
|Cash flows from financing activities                      |     
|Repurchase of common stock                                |      | (8,518    | )   
|Issuance of common stock                                  |      | -         |     
|Stock options exercised                                   |      | 529       |     
|Dividends paid                                            |      | (986      | )   
|                                                          |      |           |     
|Net cash used in financing activities                     |      | (8,975    | )   
|                                                          |      |           |     
|Net (decrease) increase in cash and cash equivalents      |      | (10,897   | )   
|Beginning cash and cash equivalents                       |      | 14,105    |     
|                                                          |      |           |     
|Ending cash and cash equivalents                          |      | $   3,208 |     
|                                                          |      |           |     

27

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

# NOTE 14  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 FHLB 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 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.

28

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 14 - 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, 2005 and 2004 are as follows (000s omitted):

|                                | 2005 | 2004     
|------------------------------- | ---- | ---------
|
|Financial assets:               |      |          
|Cash and cash equivalents       |      | $  11,308
|Securities available-for-sale   |      | 25,407   
|Equities                        |      | 3,425    
|Loans held for sale             |      | 927      
|Loans, net                      |      | 234,915  
|Accrued interest receivable     |      | 1,651    
|Financial liabilities:          |     
|Demand and savings deposits     |      | 118,839  
|Time deposits                   |      | 91,909   
|Federal funds purchased         |      | 9,000    
|Federal Home Loan Bank advances |      | 16,901   
|Repurchase agreements           |      | 13,663   
|Accrued interest payable        |      | 667      
|Subordinated debentures         |      | 5,000    

# NOTE 15 
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, 2005, 2004 and 2003 for Bank of
Washtenaw is as follows (000s omitted):

|                             | 2005 | 2004       | 2003
|---------------------------- | ---- | ---------- | ----
|Interest income              |      | $        - |     
|Interest expense             |      | -          |     
|                             |      |            |     
|Net interest income          |      | -          |     
|Provision for loan losses    |      | -          |     
|Noninterest income           |      | -          |     
|Noninterest expenses         |      | -          |     
|                             |      |            |     
|Income (loss) before taxes   |      | -          |     
|                             |      |            |     
|Income tax expense (benefit) |      | -          |     
|                             |      |            |     
|Net income (loss)            |      | $        - |     
|                             |      |            |     

29

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

# NOTE 16 
REGULATORY MATTERS

The Company (on a consolidated basis)
and the Bank are 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 Company and 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 Company and 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, 2005 the Bank was
considered well-capitalized under the regulatory framework for prompt corrective action.
The Companys and the Banks actual capital amounts and ratios at December 31,
2005 and 2004 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
|---------------------------------------- | ------ | ----------------------------------------------------------------------------- | ------------------------------------------------------------------------------------
|
|2005                                     |        |                                                                               |                                                                                     
|Total capital (to risk weighted assets)  |       
|Consolidated                             |        | $37.3                                                                         |                                                                                     
|Bank of Lenawee                          |        | $33.3                                                                         |                                                                                     
|Tier 1 Capital (to risk weighted assets) |       
|Consolidated                             |        | $34.7                                                                         |                                                                                     
|Bank of Lenawee                          |        | $30.6                                                                         |                                                                                     
|Tier 1 Capital (to average assets)       |       
|Consolidated                             |        | $34.7                                                                         |                                                                                     
|Bank of Lenawee                          |        | $30.6                                                                         |                                                                                     
|2004                                     |       
|Total Capital (to risk weighted assets)  |       
|Consolidated                             |        | $43.9                                                                         |                                                                                     
|Bank of Lenawee                          |        | $30.8                                                                         |                                                                                     
|Tier 1Capital (to risk weighted assets)  |       
|Consolidated                             |        | $41.4                                                                         |                                                                                     
|Bank of Lenawee                          |        | $28.3                                                                         |                                                                                     
|Tier 1 Capital (to average assets)       |       
|Consolidated                             |        | $41.4                                                                         |                                                                                     
|Bank of Lenawee                          |        | $28.3                                                                         |                                                                                     

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 and 2004 the entire amount of
subordinated debentures was included as Tier 1 capital of the Company. Please refer to
Note 9 to the Companys Consolidated Financial Statements for additional information.

30

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

# NOTE 17 
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, 2005, the
Banks retained earnings available for the payment of dividends was $9,122,000.
Accordingly, $25,157,000 of the Companys equity in the net assets of the Bank was
restricted at December 31, 2005. Funds available for loans or advances by the Bank to the
Company amounted to $3.3 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 18 - QUARTERLY
RESULTS OF OPERATIONS(unaudited)

The following table summarizes the
Companys quarterly results for the years ended December 31, 2005 and 2004
(000s omitted):

|2005                           | For the Three-Month Period ended
|------------------------------ | --------------------------------
|
|Interest income                |                                 
|Interest expense               |                                 
|                               |                                 
|Net interest income            |                                 
|Provision for loan losses      |                                 
|                               |                                 
|Net interest income after      |                                 
|provision for loan losses      |                                 
|Noninterest income             |                                 
|Noninterest expense            |                                 
|                               |                                 
|Net income before income taxes |                                 
|Federal income tax expense     |                                 
|                               |                                 
|Net income                     |                                 
|                               |                                 
|Net earnings per share         |                                 
|Basic                          |                                 
|Diluted                        |                                 

31

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

NOTE 18 - QUARTERLY
RESULTS OF OPERATIONS (unaudited)(continued)

|2004                               | For the Three-Month Period ended
|---------------------------------- | --------------------------------
|
|Interest income                    |                                 
|Interest expense                   |                                 
|                                   |                                 
|Net interest income                |                                 
|Provision for loan losses          |                                 
|                                   |                                 
|Net interest income after          |                                 
|provision for loan losses          |                                 
|Noninterest income                 |                                 
|Noninterest expense                |                                 
|Federal income tax expense         |                                 
|                                   |                                 
|Net income for continuing          |                                 
|operations                         |                                 
|Discontinued operation             |                                 
|Income from discontinued operation |                                 
|Gain on sale of discontinued       |                                 
|operation                          |                                 
|Provision (benefit) for income tax |                                 
|                                   |                                 
|Income from discontinued           |                                 
|operation                          |                                 
|                                   |                                 
|Net income                         |                                 
|                                   |                                 
|Earnings per share from            |                                 
|continuing operations              |                                 
|Basic                              |                                 
|Diluted                            |                                 
|Earnings per share from            |                                 
|discontinued operation             |                                 
|Basic                              |                                 
|Diluted                            |                                 
|Net earnings per share             |                                 
|Basic                              |                                 
|Diluted                            |                                 

32

---



# PAVILION BANCORP,
INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005,
2004 and 2003

---

# [THIS PAGE
INTENTIONALLY LEFT BLANK]

33

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# 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, 2005 and for the three year period ended December 31, 2005 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 insurance 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 8 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 77.0% of total revenue in 2005 compared to 75.4% in 2004. 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 2004 and 2003.
Mortgage loan sale activity accounted for 7.2% of total revenue in 2005 compared to 8.2%
in 2004 due to this decline. Proceeds from the sale of mortgage loans decreased $26.7
million, or 30.7%, to $60.2 million in 2005, down from $86.9 million in 2004, due to
increases in mortgage rates.

34

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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 15 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 and is independent of the loan origination process. 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:

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:

35

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

---

| | -
         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:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

|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:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

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

|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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

36

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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.

37

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

---

FINANCIAL CONDITION Total assets increased by 11.0%, or
$28.6 million, to $287.9 million at December 31, 2005 from $259.3 million at December 31,
2004. The increase in total assets is attributable to strong loan growth in the current
year.

Total liabilities increased by $34.0
million, or 15.0%, to $261.5 million at December 31, 2005 from $227.5 million at December
31, 2004. The Bank increased the level of deposits and other borrowings in the current
year to fund the growth in the loan portfolio.

Total shareholders equity
decreased $5.5 million, or 17.2%, to $26.4 million at December 31, 2005 compared to $31.9
million at December 31, 2004. The Company completed a tender offer in May 2005, which was
the primary cause of the decrease in shareholders equity. As a result of this tender
offer, the number of outstanding shares at December 31, 2004 of 852,140 decreased to
735,379 at December 31, 2005, as the Company repurchased approximately 15% of the
outstanding shares. Current year net income partially offset the decrease in capital
caused by the tender offer. Management monitors the capital levels of the Company and 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 8.9%, or $2.5 million, to $25.4 million at December 31, 2005,
compared to $27.9 million at December 31, 2004. The decrease in investment securities is
attributable to maturities and repayments on investments being used to fund loan growth in
the current year. Equity investment in the Federal Home Loan Bank of Indianapolis
(FHLB) registered minor changes, increasing, $57,000, or 2.1% to $2.8 million
at December 31, 2005 from $2.7 million at December 31, 2004. Investment in Federal Reserve
Bank (FRB) stock increased to $630,000 at December 31, 2005 from $360,000 at
December 31, 2004. The Bank did not have any Fed Funds Sold at December 31, 2005 and 2004.
The Company had no held-to-maturity securities as of December 31, 2005 and 2004.

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, 2005 (000s omitted):

|                     | Within One Year | After One butWithin Five Years | After Five butwithin Ten | After Ten Years | Mortgage-BackedSecurities | Total
|-------------------- | --------------- | ------------------------------ | ------------------------ | --------------- | ------------------------- | -----
|
|U.S. Treasury &      |                 |                                |                          |                 |                           |      
|Government agencies  |                 |                                | $                        | 6,568           |                           |      
|                     |                 |                               
|Obligations of state |                 |                               
|& political          |                 |                               
|subdivisions         |                 |                                |                          | 1,327           |                           |      
|                     |                 |                               
|Mortgage-backed      |                 |                               
|securities           |                 |                                |                          | -               |                           |      
|                     |                 |                                |                          |                 |                           |      
|Total                |                 |                                | $                        | 7,895           |                           |      
|                     |                 |                                |                          |                 |                           |      

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.

38

---



# 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, 2005, 2004, 2003, 2002 and 2001 (000s
omitted):

|                                       | 2005 | 2004     | 2003 | 2002     | 2001
|-------------------------------------- | ---- | -------- | ---- | -------- | ----
|Commercial, financial and agricultural |      | $164,156 |      | $143,583 |     
|Residential-construction               |      | 11,902   |      | 8,768    |     
|Residential-mortgage                   |      | 28,113   |      | 21,685   |     
|Consumer                               |      | 33,427   |      | 33,123   |     
|                                       |      |          |      |          |     
|Total                                  |      | $237,598 |      | $207,159 |     
|                                       |      |          |      |          |     

The Companys loan portfolio
increased $30.4 million, or 14.7%, to $237.6 million at December 31, 2005 from $207.2
million at December 31, 2004. Growth in the commercial loan portfolio was the primary
cause for the increase. Commercial, financial and agricultural loans increased by $20.6
million, or 14.3%, to $164.2 million at December 31, 2005 from $143.6 million at December
31, 2004. The growth in commercial loans was due to managements focus on business
development as well as a move into a new local market, Hillsdale county. Other loan
categories experienced growth as well. Specifically, real estate construction loans
increased by $3.1 million, or 35.7%, to $11.9 million at December 31, 2005 from $8.8
million at December 31, 2004. The growth in residential construction was due to the
continued growth of real estate development in local markets, specifically in the Raisin
and Tecumseh Townships. Residential mortgages increased by $6.4 million, or 29.6%, to
$28.1 million at December 31, 2005 from $21.7 million at December 31, 2004. The growth in
the residential mortgage portfolio was specifically in response to the increased demand
for mortgage bridge loans. Consumer loans increased only $0.3 million, or 0.9%, increase
to $33.4 million at December 31, 2005 from $33.1 million at December 31, 2004. The
portfolio mix as of December 31, 2005 has remained relatively consistent with the prior
year, as much of the commercial loan growth was matched by increases in residential
construction and mortgage loans as well.

Management expects continued loan
growth in 2006, primarily in the commercial and agricultural loan portfolio, as well as
the residential-construction 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,
2005, based on scheduled principal repayments (000s omitted), as well as categorized
as fixed or variable rate loans (000s omitted):

|                           | Due Within1 Year | Due After 1
but Within5 Years | Due After5 Years | Total   | Fixed | Variable 
|-------------------------- | ---------------- | ----------------------------- | ---------------- | ------- | ----- | ---------
|Commercial, financial and  |                  | $39,692                       |                  | $37,420 |       | $  87,044
|agricultural               |                 
|Residential - construction |                  | 11,902                        |                  | -       |       | -        
|Residential - mortgage     |                  | 3,271                         |                  | 8,319   |       | 16,523   
|Consumer                   |                  | 1,094                         |                  | 7,165   |       | 25,168   
|                           |                  |                               |                  |         |       |          
|Total                      |                  | $55,959                       |                  | $52,904 |       | $128,735 
|                           |                  |                               |                  |         |       |          

The majority of loans originated by
the Bank are fixed rate loans that have a maturity which will occur after five years.
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).

39

---



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

---

Off-Balance Sheet ItemsThe 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, 2005 and 2004 (000s omitted):

|                                         | 2005 | 2004   
|---------------------------------------- | ---- | -------
|Commitments to extend credit             |      | $64,340
|Credit card arrangements                 |      | 4,272  
|Commercial and standby letters of credit |      | 3,051  
|                                         |      |        
|Total                                    |      | $71,663
|                                         |      |        

Outstanding commitments to grant
loans, lines of credit and letters of credit decreased $2.8 million, or 3.8% to $71.7
million at December 31, 2005 from $74.5 million at December 31, 2004. 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 2005.
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, 2005 and 2004 (000s
omitted):

|                                 |  | Loan Risk Ratings |  |         
|-------------------------------- |  | ----------------- |  | --------
|
|Loan Type                        |  |                   |  |         
|December 31, 2005                | 
|Commercial                       |  | $  3,839          |  | $  7,547
|Agricultural                     |  | 1,297             |  | 1,936   
|Residential real estate mortgage |  | 637               |  | -       
|Consumer                         |  | 99                |  | -       
|                                 |  |                   |  |         
|Total                            |  | $  5,872          |  | $  9,483
|                                 |  |                   |  |         
|December 31, 2004                | 
|Commercial                       |  | $  9,354          |  | $10,765 
|Agricultural                     |  | 2,107             |  | 1,368   
|Residential real estate mortgage |  | 337               |  | 318     
|Consumer                         |  | 117               |  | 34      
|                                 |  |                   |  |         
|Total                            |  | $11,915           |  | $12,485 
|                                 |  |                   |  |         

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 decreased $9.0 million, or 37.1% to $15.4 million at
December 31, 2005 from $24.4 million at December 31, 2004. The largest decrease was noted
in loans risk-rated 5, which decreased $6.0 million, or 50.7%, to $5.9 million at December
31, 2005 from $11.9 million at December 31, 2004. Loans risk-rated 6 decreased $3.0
million, or 24.0%, to $9.5 million at December 31, 2005 from $12.5 million at December 31,
2004. There were no loans risk-rated 7 and 8 at either December 31, 2005 or 2004. The
decrease in loans risk-rated 5 and 6 was due to the pay-off of several such loans and
continued efforts of management to closely monitor such loans and work with the respective
borrowers to effect corrective action. Management continues to closely monitor each loan
adversely criticized or classified and institute appropriate measures to eliminate the
basis of criticism.

40

---



# 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, 2005,
2004, 2003, 2002 and 2001 (000s omitted):

|                                              | 2005 | 2004   | 2003 | 2002    | 2001
|--------------------------------------------- | ---- | ------ | ---- | ------- | ----
|Non-accruing loans past due                   |      | $1,104 |      | $   671 |     
|Loans past due 90 days or more still accruing |      | 672    |      | 556     |     
|                                              |      |        |      |         |     
|Total non-performing loans                    |      | 1,776  |      | 1,227   |     
|Other Real Estate                             |      | 549    |      | 715     |     
|                                              |      |        |      |         |     
|Total non-performing assets                   |      | $2,325 |      | $1,942  |     
|                                              |      |        |      |         |     
|Non-performing loans as a percent             |     
|of total loans                                |      | 0.75   | %    | 0.59    | %   
|Loans past due 90 days or more still accruing |     
|as a percent of total loans                   |      | 0.46   | %    | 0.32    | %   
|Non-performing assets as a percent            |     
|of total assets                               |      | 0.81   | %    | 0.75    | %   
|Non-performing loans as a percent             |     
|of the loan loss reserve                      |      | 66.19  | %    | 49.18   | %   

Total non-performing assets increased
$0.4 million, or 19.7%, to $2.3 million at December 31, 2005 from $1.9 million at December
31, 2004. 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 0.75% as of
December 31, 2005 compared to 0.59% as of December 31, 2004. The increase is related
specifically to three credits which went on non-accrual late in the fourth quarter of
2005. 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 $3.0 million, or 24.0%,
during 2005. 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 66.19% as of December 31, 2005 compared to
49.18% as of December 31, 2004. The non-performing loans are primarily comprised of
commercial real estate properties, which management believes are adequately collateralized
or have specific reserves allocated to cover estimated losses.

Other real property that we acquire
as a result of the foreclosure process is classified as other real estate
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. Other real estate 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,
2005, we had $549,000 of other real estate compared to $715,000 at December 31, 2004.

41

---



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

---

The following tables detail the
allocation among individual loan portfolios within the allowance for loan and lease losses
at December 31, 2005, 2004, 2003, 2002 and 2001 (000s omitted):

|                                       | 2005 | 2004  
|-------------------------------------- | ---- | ------
|
|Commercial, financial and agricultural |      | $2,088
|Residential-mortgage                   |      | 84    
|Residential-construction               |      | 70    
|Consumer                               |      | 262   
|Other qualitative factors & trends     |      | 179   
|                                       |      |       
|                                       |      | $2,683
|                                       |      |       

|                                       | 2003 | 2002  
|-------------------------------------- | ---- | ------
|
|Commercial, financial and agricultural |      | $1,991
|Residential-mortgage                   |      | 9     
|Residential-construction               |      | 25    
|Consumer                               |      | 126   
|Other qualitative factors & trends     |      | 151   
|                                       |      |       
|                                       |      | $2,302
|                                       |      |       

|                                       | 2001
|-------------------------------------- | ----
|
|Commercial, financial and agricultural |     
|Residential-mortgage                   |     
|Residential-construction               |     
|Consumer                               |     
|Other qualitative factors & trends     |     
|                                       |     
|                                       |     
|                                       |     

The allowance for loan and lease
losses (the allowance) as a percentage of total loans was 1.13% at December
31, 2005, compared to 1.20% at December 31, 2004. 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. Several factors affected the decision to decrease the loan loss
provision including a significant decrease in the level of criticized and classified
loans, as well as the discontinuance of the Business Manager Program (which was a higher
yield, higher risk product discontinued by the Bank in late 2004). 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 77.8% (or
$2.09 million) at December 31, 2005 from 78.8% (or $1.97 million) at December 31, 2004.
This is due in large part to the reduction in the criticized and classified commercial and
agricultural loans, as well as the discontinuance of the Business Manager Program. 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.

42

---



# 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 $10.8
million, or 5.4%, to $210.8 million at December 31, 2005 from $200.0 million at December
31, 2004. Specifically, noninterest-bearing deposits increased $1.2 million, or 2.6%, to
$45.4 million at December 31, 2005 from $44.2 million at December 31, 2004. The increase
in noninterest bearing deposits is attributable to continuing business development
efforts. Interest-bearing deposits increased $9.6 million, or 6.2%, to $165.4 million at
December 31, 2005 from $155.8 million at December 31, 2004. Specifically, certificates of
deposit (CDs) with balances of $100,000 and greater increased $22.3
million, or 67.9%, to $55.1 million at December 31, 2005 from $32.8 million at December
31, 2004. 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 decreased $1.1 million, or 3.0%, to $36.9 million
at December 31, 2005 from $38.0 million December 31, 2004. The decrease is attributable to
more competitive pricing in the Banks local market areas.

Borrowed FundsBorrowed funds consist of advances
from the Federal Home Loan Bank of Indianapolis (FHLB), 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. FHLB advances increased by $8.3 million, or 96.8%,
to $16.9 million at December 31, 2005 from $8.6 million at December 31, 2004. The increase
is due to current year loan growth exceeding growth in deposits. Repurchase agreements
increased $11.2 million, or 450.5%, to $13.7 million at December 31, 2005 from $2.5
million at December 31, 2004. The majority of the increase is due to the addition of
repurchase agreements entered into with two third party financial institutions totaling
$10.0 million. These agreements provided additional funding to support current year loan
growth. The balance of the increase is related to fluctuations in normal daily activity
within the customer repurchase balances. Borrowings under the Banks Federal funds
purchased line of credit increased $7.5 million, or 520.7%, to $9.0 million at December
31, 2005 from $1.5 million at December 31, 2004. The increase is attributable to normal
daily fluctuations in the liquidity needs of the Company.

Amounts borrowed from the FHLB may be
collateralized with either investment securities or certain types of loans. At December
31, 2005 no investment securities were pledged as collateral against FHLB borrowings. As
disclosed in Note 8 to the Companys Consolidated Financial Statements, $31.8 million
and $29.9 million of 1-4 family residential mortgage loans were pledged as collateral at
December 31, 2005 and 2004, respectively. For additional information regarding borrowed
funds please refer to Note 8 to the Consolidated Financial Statements included elsewhere
in this report.

43

---



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

---

Capital The Company continues to maintain
sufficient risk-based capital levels to remain as adequately-capitalized under
federal regulatory requirements. For bank holding companies there is no
well-capitalized designation. The Bank continues to maintain sufficient
risk-based capital levels to remain categorized as well-capitalized under
federal regulatory requirements. On a consolidated basis, total risk-based capital (RBC)
to risk-weighted assets (RWA) decreased from 20.4% at December 31, 2004 to 15.2% at
December 31, 2005. Similarly, the ratio of Tier 1 RBC to RWA decreased to 14.1% at
December 31, 2005 from 19.2% at December 31, 2004. The ratio of Tier 1 RBC to average
assets decreased to 12.4% at December 31, 2005 from 13.4% at December 31, 2004. Risk-based
capital levels decreased as a result of the tender offer completed by the Company in the
second quarter of 2005. The Company purchased 128,832 of its common shares at $66.00 per
share pursuant to its self tender offer, which expired May 20, 2005. The number of
outstanding shares at December 31, 2004 of 852,140 decreased to 735,379 at December 31,
2005, as a result of the repurchase of approximately 15% of the shares outstanding at
December 31, 2004. Management monitors the capital levels of the Company and the Bank to
provide for current and future business opportunities.

# RESULTS OF OPERATIONS

Net Income2005.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.

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.

44

---



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

---

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
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 below 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. Please refer to the
          discussion of the Rate/Volume Table below for additional information.

45

---



# 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, 2005, 2004 and 2003 (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.

|                                                                  | --------2005-------- | --------2004-------- | --------2003--------
|----------------------------------------------------------------- | -------------------- | -------------------- | --------------------
|
|Interest-earning assets:                                          |                      |                      |                     
|Loans receivable                                                  |                      |                      | $                   
|Securities available for sale(1)                                  |                      |                      |                     
|Federal funds sold                                                |                      |                      |                     
|Equity securities                                                 |                      |                      |                     
|Interest-bearing balances with other financial institutions       |                      |                      |                     
|                                                                  |                      |                      |                     
|Total interest-earning assets                                     |                      |                      |                     
|Noninterest-earning assets:                                       |                      |                     
|Cash and due from financial institutions                          |                      |                      |                     
|Premises and equipment, net                                       |                      |                      |                     
|Other assets                                                      |                      |                      |                     
|                                                                  |                      |                      |                     
|Total assets                                                      |                      |                      | $                   
|                                                                  |                      |                      |                     
|Interest-bearing liabilities:                                     |                      |                     
|Interest-bearing demand                                           |                      |                     
|deposits                                                          |                      |                      | $                   
|Savings deposits                                                  |                      |                      |                     
|Time deposits                                                     |                      |                      |                     
|Subordinated debentures                                           |                      |                      |                     
|Repurchase agreements and other borrowings                        |                      |                      |                     
|                                                                  |                      |                      |                     
|                                                                  |                      |                     
|Total interest-bearing liabilities                                |                      |                      |                     
|Non-interest bearing demand deposits                              |                      |                      |                     
|Other liabilities                                                 |                      |                      |                     
|Total liabilities                                                 |                      |                      |                     
|Shareholders' equity                                              |                      |                      |                     
|                                                                  |                      |                      |                     
|Total liabilities and shareholders' equity                        |                      |                      | $                   
|                                                                  |                      |                      |                     
|Net interest income                                               |                      |                      |                     
|                                                                  |                      |                      |                     
|Net spread                                                        |                      |                      |                     
|Net interest margin (2)                                           |                      |                      |                     
|Ratio of  interest-earning assets to interest-bearing liabilities |                      |                      |                     

(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.

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 in 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. The Companys net interest margin remains quite strong, and
          management continues to take steps to neutralize some portion of this risk.

46

---



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

---

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. Please refer to the Rate-Volume Table presented below for additional
          information.

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):

|                                   | 2005-2004 | 2004-2003
|---------------------------------- | --------- | ---------
|
|
|Interest-earning assets:           |           |          
|Loans receivable                   |           | $ 1,037  
|Securities available-for-sale      |           | 131      
|Federal funds sold                 |           | 68       
|Equity securities                  |           | 6        
|Interest-bearing balances with     |          
|other financial institutions       |           | 3        
|                                   |           |          
|Total interest-earning assets      |           | 1,245    
|Interest-bearing liabilities:      |          
|Interest-bearing demand            |          
|deposits                           |           | 258      
|Savings deposits                   |           | (3       
|Time deposits                      |           | 935      
|Subordinated debentures            |           | 74       
|Repurchase agreements and          |          
|other borrowings                   |           | 390      
|                                   |           |          
|Total interest-bearing liabilities |           | 1,654    
|                                   |           |          
|Net change in net interest income  |           | $  (409  
|                                   |           |          

As the above table indicates, in 2005
net interest income decreased $409,000 primarily due to increased rates paid on
interest-bearing liabilities. For the twelve months ended December 31, 2005 total interest
expense increased $1.7 million compared to the same period in 2004. 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 $319,000 and
$660,000 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. In an effort to preserve margin, the Company plans to reduce the cost of funds
through multiple initiatives which include gathering additional core deposits, locking
into fixed rate borrowings and a continued effort to improve loan yields.

47

---



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

---

Provision for Loan Losses The activity in the allowance for
loan and lease losses for the twelve months ended December 31, 2005, 2004, 2003, 2002 and
2001 is presented in the following table (000s omitted):

|                                            | Years ended December 31,
     (in thousands)
|------------------------------------------- | --------------------------------------------
|
|Balance at beginning of year                |                                             
|Loans charged off:                          |                                             
|Real estate - mortgage                      |                                             
|Real estate - construction                  |                                             
|Commercial and agricultural                 |                                             
|Consumer                                    |                                             
|                                            |                                             
|                                            |                                             
|                                            |                                             
|Recoveries of loans previously charged-off: |                                             
|Real estate mortgage                        |                                             
|Commercial and agricultural                 |                                             
|Consumer                                    |                                             
|                                            |                                             
|                                            |                                             
|                                            |                                             
|Net loans charged-off                       |                                             
|Provision for loan losses                   |                                             
|                                            |                                             
|Balance at end of year                      |                                             
|                                            |                                             
|Net charge-off ratio                        |                                             
|                                            |                                             
|Allowance to total loans                    |                                             
|                                            |                                             

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, which was a product with a higher yield but
          also posed higher credit risk. 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.

48

---



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

---

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.

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

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.

49

---



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

---

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.

# Non-interest Expenses

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. In 2005, the Bank began to see
          some benefit from the Reduction-in-Force plan (RIF) that was
          developed with the goal of increasing operational efficiency. The Bank
          eliminated various staff positions in the first quarter of 2005, and severance
          packages were provided to employees affected by the RIF. The aggregate cost of
          these severance packages 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 $63,000, or 17.7%, to $293,000 for the year ended December 31, 2005
          down from $356,000 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 $46,000, or 34.8%, to
          $178,000 compared to $132,000 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 $127,000, or
          16.8%, to $628,000 for the year ended December 31, 2005 compared to $755,000 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 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 $58,000 or 54.2% 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
          $184,000, or 107.0%, to $356,000 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 an accounts receivable financing program during the fourth
          quarter of 2004. Other noninterest expenses increased $120,000, or 18.9%, to
          $755,000 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.

50

---



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

---

Federal Income Tax
Expense  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.

In 2004, the Company also recognized
a $2.6 million provision for federal income tax associated with the sale of its former
subsidiary, the Bank of Washtenaw.

Liquidity and Capital
ResourcesLiquidity 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 FHLB. 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, 2005, cash and short-term investments totaled $11.3 million and
securities classified as available for sale totaled $25.4 million. However,
available-for-sale securities with a market value of $16.1 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 $460,000 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.

Financing activities consist
primarily of activity in deposit accounts, overnight borrowings from our correspondent
banks and FHLB advances. The Bank experienced a net increase in total deposits of $10.8
million for the year ended December 31, 2005. 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
increased in 2005 to $39.6 million as of December 31, 2005 up from $12.5 million at
December 31, 2004. As of December 31, 2005, the Bank had the ability to borrow a total of
$21.9 million from the FHLB based upon the amount of collateral pledged, of which $16.9
million was outstanding at that date. The Bank has contractual payments due on FHLB
advances totaling $14.0 million in 2006. In addition to the FHLB, the Bank had available
borrowings on a line-of-credit of $10.0 million from a correspondent bank, of which $9.0
million was outstanding at December 31, 2005. The Bank also had outstanding advances on
repurchase agreements totaling $13.7 million at December 31, 2005, based on the collateral
pledged. Additional advances could be obtained through repurchase agreements, provided
additional collateral is pledged. Repurchase agreements are terminable upon demand.

51

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

---

The Company is subject to various
regulatory capital requirements administered by the Federal Deposit Insurance Corporation
including a risk-based capital measure. The risk-based capital guidelines include both a
definition of capital and a framework for calculating risk-weighted assets by assigning
balance sheet assets and off-balance sheet items to broad risk categories. The Banks
capital amounts and classification are also subject to qualitative judgments by regulators
about components, risk weightings, and other factors.

At December 31, 2005 and December 31,
2004, the Company and the Bank exceeded all regulatory minimum capital requirements. For
bank holding companies there is no well-capitalized designation. The Bank
continues to maintain sufficient risk-based capital levels to remain categorized as
well-capitalized under federal regulatory requirements.

|                                         | Actual | Minimum Required  
       For         
 Capital Adequacy  
Purposes | Minimum Required to be
 Well-Capitalized Under
   Prompt Corrective
        Action Regulations
|---------------------------------------- | ------ | ------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------
|
|December 31, 2005                        |        |                                                                     |                                                                                               
|Total capital (to risk weighted assets)  |       
|Consolidated                             |        | $37.3                                                               |                                                                                               
|Bank of Lenawee                          |        | $33.3                                                               |                                                                                               
|Tier 1 Capital (to risk weighted assets) |       
|Consolidated                             |        | $34.7                                                               |                                                                                               
|Bank of Lenawee                          |        | $30.6                                                               |                                                                                               
|Tier 1 Capital (to average assets)       |       
|Consolidated                             |        | $34.7                                                               |                                                                                               
|Bank of Lenawee                          |        | $30.6                                                               |                                                                                               
|December 31, 2004                        |       
|Total Capital (to risk weighted assets)  |       
|Consolidated                             |        | $43.9                                                               |                                                                                               
|Bank of Lenawee                          |        | $30.8                                                               |                                                                                               
|Tier 1 Capital (to risk weighted assets) |       
|Consolidated                             |        | $41.4                                                               |                                                                                               
|Bank of Lenawee                          |        | $28.3                                                               |                                                                                               
|Tier 1 Capital (to average assets)       |       
|Consolidated                             |        | $41.4                                                               |                                                                                               
|Bank of Lenawee                          |        | $28.3                                                               |                                                                                               

On May 29, 2005, the Company
purchased 128,832 of its common shares at $66.00 per share pursuant to its self tender
offer, which expired May 20, 2005. The aggregate cost of the purchase was approximately
$8.6 million, including fees and expenses of approximately $91,000. The Company utilized
available cash and short-term investments to fund this transaction. Based on the
foregoing, the Company considers its liquidity and capital resources sufficient to meets
its outstanding short-term and long-term needs.

52

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

---

Contractual Obligations The following table presents
contractual obligations as of December 31, 2005 (000s omitted):

|                                           | Payments due by period
|------------------------------------------ | ----------------------
|
|Time deposits                              |                       
|Long-term debt obligations (FHLB advances) |                       
|Capital lease obligations                  |                       
|Operating lease obligations*               |                       
|Junior subordinated debenture              |                       
|Purchase agreements                        |                       
|                                           |                       
|Total                                      |                       
|                                           |                       

* Annual inflation adjustments to the
operating lease obligation, based on changes in the Consumers Price Index, will take
effect in 2006 (sixth year of ten year lease). Inflation adjustments are not estimated in
this presentation.

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

The Company has contractual payments
due on time deposits and FHLB advances totaling $67.2 million and $14.0 million,
respectively, in 2006. 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. FHLB advances may be renewed, and additional advances obtained,
at prevailing market rates. At December 31, 2005 the Company had the ability to borrow an
additional $5.0 million from the FHLB based on the amount of collateral pledged. The
availability to borrow from the FHLB varies depending on the amount of collateral
available for pledging.

The following table presents loan
commitments by time period as of December 31, 2005 (000s omitted):

|                                           | Amount of commitment expiration per period
|------------------------------------------ | ------------------------------------------
|
|Commitments to grant loans                 |                                           
|Unfunded commitments under lines of credit |                                           
|Commercial and standby letters of credit   |                                           
|                                           |                                           
|Total                                      |                                           
|                                           |                                           

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.

53

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

---

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, 2005 and 2004. 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.

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

# Principal Amount
Maturing In:

|                              | 2006 | 2007           | 2008 | 2009           | 2010 | Thereafter   | Total | Fair Value    
|----------------------------- | ---- | -------------- | ---- | -------------- | ---- | ------------ | ----- | --------------
|RATE-SENSITIVE ASSETS         |      |                |      |                |      |              |       |               
|Gross loans                   |      | $    54,724    |      | $    10,302    |      | $   9,072    |       | $    11,275   
|Average interest rate         |      | 7.2            | %    | 7.1            | %    | 6.9          | %     | 6.5           
|Debt & equity securities      |      | $    11,323    |      | $    14,527    |      | $          - |       | $         176 
|Average interest rate         |      | 3.6            | %    | 3.1            | %    | 0.0          | %     | 5.4           
|Other interest-earning assets |      | $            - |      | $            - |      | $          - |       | $            -
|Average interest rate         |      | 0.0            | %    | 0.0            | %    | 0.0          | %     | 0.0           
|                             
|RATE-SENSITIVE LIABILITIES    |     
|Savings & interest bearing    |     
|demand deposits               |      | $    73,486    |      | $            - |      | $          - |       | $            -
|Average interest rate         |      | 1.2            | %    | 0.0            | %    | 0.0          | %     | 0.0           
|Time deposits                 |      | $    67,191    |      | $    17,503    |      | $   3,817    |       | $     1,176   
|Average interest rate         |      | 3.4            | %    | 3.3            | %    | 3.3          | %     | 3.4           
|Other borrowings              |      | $    31,679    |      | $     6,228    |      | $   1,657    |       | $            -
|Average interest rate         |      | 4.2            | %    | 3.8            | %    | 2.9          | %     | 0.0           

54

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# 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, 2004 (000s omitted):

|                              | 2005 | 2006           | 2007 | 2008           | 2009 | Thereafter     | Total | Fair Value    
|----------------------------- | ---- | -------------- | ---- | -------------- | ---- | -------------- | ----- | --------------
|RATE-SENSITIVE ASSETS         |      |                |      |                |      |                |       |               
|Gross loans                   |      | $    43,959    |      | $    17,065    |      | $    15,784    |       | $    11,452   
|Average interest rate         |      | 6.3            | %    | 6.7            | %    | 6.6            | %     | 6.6           
|Debt & equity securities      |      | $    10,988    |      | $     7,926    |      | $     6,113    |       | $         724 
|Average interest rate         |      | 3.3            | %    | 3.0            | %    | 3.2            | %     | 4.1           
|Other interest-earning assets |      | $            - |      | $            - |      | $            - |       | $            -
|Average interest rate         |      | 0.0            | %    | 0.0            | %    | 0.0            | %     | 0.0           
|RATE-SENSITIVE LIABILITIES    |     
|Savings & interest bearing    |     
|demand deposits               |      | $    85,022    |      | $            - |      | $            - |       | $            -
|Average interest rate         |      | 0.7            | %    | 0.0            | %    | 0.0            | %     | 0.0           
|Time deposits                 |      | $    44,343    |      | $    15,781    |      | $     5,193    |       | $     1,987   
|Average interest rate         |      | 2.2            | %    | 2.8            | %    | 2.6            | %     | 3.1           
|Other borrowings              |      | $     6,614    |      | $     4,020    |      | $         228  |       | $     1,656   
|Average interest rate         |      | 3.0            | %    | 5.9            | %    | 2.9            | %     | 2.9           

|Disclosure  Controls
and ProceduresThe 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:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

| |  | 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.

55

---



# 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 2005, 2004,
and 2003, 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 Dividends
|-------------- | ---------------- | --------------
|
|2005           |                  |               
|First Quarter  |                  | $    59.80    
|Second Quarter |                  | $    67.00    
|Third Quarter  |                  | $    55.00    
|Fourth Quarter |                  | $    50.25    
|               |                 
|2004           |                  |               
|First Quarter  |                  | $    52.50    
|Second Quarter |                  | $    55.00    
|Third Quarter  |                  | $    65.00    
|Fourth Quarter |                  | $    61.00    
|               |                 
|2003           |                  |               
|First Quarter  |                  | $    45.71    
|Second Quarter |                  | $    49.52    
|Third Quarter  |                  | $    51.43    
|Fourth Quarter |                  | $    49.52    

(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 736,765 shares were issued and
outstanding as of March 10, 2006. 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.

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