# Exhibit 13

# Rule 14a-3 Annual
Report to Security Holders

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# 2006Annual Report

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

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

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

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2006 ANNUAL REPORT CONTENTS

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

2

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

---

|                                                       | 2006 | 2005 | 2004 | 2003    | 2002
|------------------------------------------------------ | ---- | ---- | ---- | ------- | ----
|                                                       |      |      |      |         |     
|At year-end:                                           |      |      |      |         |     
|Total assets                                           |      |      | $    | 295,023 |     
|Loans receivable                                       |      |      | $    | 246,129 |     
|Deposits                                               |      |      | $    | 235,944 |     
|Shareholders' equity                                   |      |      | $    | 27,936  |     
|For the year:                                          |      |     
|Total interest income                                  |      |      | $    | 18,875  |     
|Total interest expense                                 |      |      |      | 7,050   |     
|                                                       |      |      |      |         |     
|Net interest income                                    |      |      |      | 11,825  |     
|Provision for loan losses                              |      |      |      | 333     |     
|Noninterest income                                     |      |      |      | 3,068   |     
|Noninterest expense                                    |      |      |      | 11,088  |     
|                                                       |      |      |      |         |     
|Income before income taxes                             |      |      |      | 3,472   |     
|Provision for income tax                               |      |      |      | 1,071   |     
|                                                       |      |      |      |         |     
|                                                       |      |     
|Net income from continuing operations                  |      |      |      | 2,401   |     
|                                                       |      |      |      |         |     
|                                                       |      |     
|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                                             |      |      | $    | 2,401   |     
|                                                       |      |      |      |         |     
|                                                       |      |     
|Financial ratios:                                      |      |     
|From continuing operations                             |      |     
|Return on average shareholders' equity                 |      |      |      | 8.84    | %   
|Return on average assets                               |      |      |      | 0.82    | %   
|                                                       |      |     
|From combined operations                               |      |     
|Return on average shareholders' equity                 |      |      |      | 8.84    | %   
|Return on average assets                               |      |      |      | 0.82    | %   
|                                                       |      |     
|Per share data:                                        |      |     
|Cash dividends declared per share                      |      |      | $    | 1.07    |     
|Dividend payout ratio                                  |      |      |      | 32.7    | %   
|Shareholders' equity per share                         |      |      | $    | 38.50   |     
|Average equity to average assets                       |      |      |      | 9.31    | %   
|                                                       |      |     
|Earnings per share from continuing operations          |      |     
|Basic                                                  |      |      | $    | 3.27    |     
|Diluted                                                |      |      | $    | 3.26    |     
|                                                       |      |     
|Earnings per share from discontinued operation         |      |     
|Basic                                                  |      |      | $    | -       |     
|Diluted                                                |      |      | $    | -       |     
|                                                       |      |     
|Net earnings per share                                 |      |     
|Basic                                                  |      |      | $    | 3.27    |     
|Diluted                                                |      |      | $    | 3.26    |     

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

To The Board of
Directors and ShareholdersPavilion
Bancorp, Inc.

We have audited the accompanying
balance sheets of Pavilion Bancorp, Inc. as of December 31, 2006 and 2005, and the
related statements of income, shareholdersequity, and cash flows for each year in
the three-year period ended December 31, 2006. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
financial position of Pavilion Bancorp, Inc. as of December 31, 2006 and 2005, and the
consolidated results of its operations and its cash flows for each year in the three-year
period ended December 31, 2006, in conformity with accounting principles generally
accepted in the United States of America.

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

Auburn Hills, Michigan

March 9, 2007

4

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# PAVILION BANCORP, INC. CONSOLIDATED BALANCE
SHEETS

---

|December 31,                                         
|-----------------------------------------------------
|                                                     
|                                                     
|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 17 and 18)               
|Common stock and paid-in capital, no par value:      
|3,000,000 shares authorized; shares issued           
|and outstanding: 725,206-2006; 735,379-2005          
|Retained earnings                                    
|Accumulated other comprehensive loss                 
|                                                     
|Total shareholders' equity                           
|                                                     
|                                                     
|Total liabilities and shareholders' equity           
|                                                     

---

See accompanying notes
to the consolidated financial statements.

5

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# PAVILION BANCORP, INC. CONSOLIDATED
STATEMENTS OF INCOMEYears ended December
31, 2006, 2005, 2004

---

|2006                                                  | 2005 | 2004
|----------------------------------------------------- | ---- | ----
|                                                      |      |     
|Interest and dividend income                          |      |     
|Loans receivable, including fees                      |      |     
|Debt securities:                                      |      |     
|Taxable                                               |      |     
|Tax-exempt                                            |      |     
|Federal funds sold                                    |      |     
|Dividend income                                       |      |     
|                                                      |      |     
|Total interest and dividend income                    |      |     
|                                                      |      |     
|Interest expense                                      |      |     
|Deposits                                              |      |     
|Subordinated debentures                               |      |     
|Other borrowed funds                                  |      |     
|                                                      |      |     
|Total interest expense                                |      |     
|                                                      |      |     
|                                                      |      |     
|Net interest income                                   |      |     
|                                                      |      |     
|Provision for loan losses (Note 4)                    |      |     
|                                                      |      |     
|                                                      |      |     
|Net interest income after provision for loan losses   |      |     
|                                                      |      |     
|Noninterest income                                    |      |     
|Service charges and fees                              |      |     
|Net gain on sale of loans                             |      |     
|Loan servicing fees, net of amortization (Note 5)     |      |     
|Other                                                 |      |     
|                                                      |      |     
|Total noninterest income                              |      |     
|                                                      |      |     
|Noninterest expense                                   |      |     
|Compensation and employee benefits (Note 11)          |      |     
|Occupancy and equipment                               |      |     
|Postage and delivery                                  |      |     
|Professional services                                 |      |     
|Outside services                                      |      |     
|Marketing and advertising                             |      |     
|Loan and collection                                   |      |     
|Director and shareholders (Note 12)                   |      |     
|Other                                                 |      |     
|                                                      |      |     
|Total noninterest expense                             |      |     
|                                                      |      |     
|                                                      |      |     
|Income from continuing operations before income taxes |      |     
|Income taxes from continuing operations (Note 10)     |      |     
|                                                      |      |     
|Income from continuing operations                     |      |     
|                                                      |      |     
|                                                      |      |     
|Discontinued operation:                               |      |     
|Income (loss) from discontinued operation,            |      |     
|net of income taxes of $0, $0, and $162               |      |     
|Gain on sale of discontinued component, net of        |      |     
|income tax expense of $0, $0, and $2,573              |      |     
|                                                      |      |     
|                                                      |      |     
|Income (loss) from discontinued operation             |      |     
|                                                      |      |     
|                                                      |      |     
|Net income                                            |      |     
|                                                      |      |     

|2006                                           | 2005 | 2004
|---------------------------------------------- | ---- | ----
|                                               |      |     
|Earnings per share from continuing operations  |      |     
|Basic                                          |      |     
|Diluted                                        |      |     
|Earnings per share from discontinued operation |      |     
|Basic                                          |      |     
|Diluted                                        |      |     
|Net earnings per share                         |      |     
|Basic                                          |      |     
|Diluted                                        |      |     

---

See accompanying notes
to the consolidated financial statements.

6

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

---

|Common
Stock
Paid-In
Capital                 | Retained
Earnings | Accumulated
Other
Comprehensive
Income (Loss) | Total
Shareholders'
Equity
|-------------------------------------------- | ----------------- | --------------------------------------------- | --------------------------
|                                             |                   |                                               |                           
|Balance January 1, 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 |                   |                                               |                           
|                                             |                   |                                              
|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                    |                   |                                               |                           
|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                          |                   |                                               |                           
|Issuance of stock                            |                   |                                               |                           
|Stock option expense                         |                   |                                               |                           
|Stock options exercised                      |                   |                                               |                           
|Cash dividends - $1.07 per share             |                   |                                               |                           
|                                             |                   |                                               |                           
|Balance December 31, 2006                    |                   |                                               | $                         
|                                             |                   |                                               |                           

---

See accompanying notes
to the consolidated financial statements.

7

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

---

|2006                                                       | 2005 | 2004
|---------------------------------------------------------- | ---- | ----
|                                                           |      |     
|Cash flows from operating activities                       |      |     
|Net income                                                 |      |     
|Adjustments to reconcile net income to                     |      |     
|net cash from operating activities                         |      |     
|Depreciation                                               |      |     
|Stock option expense                                       |      |     
|Stock award expense                                        |      |     
|Provision for loan losses                                  |      |     
|Gain on sale of discontinued operation                     |      |     
|Deferred income tax (benefit) provision                    |      |     
|Amortization on investment  securities  available for sale |      |     
|Net loss on disposal of assets                             |      |     
|Amortization of mortgage servicing rights                  |      |     
|Origination of mortgage loans held for sale                |      |     
|Proceeds from sales of mortgage loans held for sale        |      |     
|Net gains on sale of mortgage loans                        |      |     
|Net change in:                                             |      |     
|Deferred loan origination fees                             |      |     
|Accrued interest receivable and other assets               |      |     
|Accrued interest payable and other liabilities             |      |     
|                                                           |      |     
|Net cash provided by (used in) operating activities        |      |     
|Cash flows from investing activities                       |      |     
|Proceeds from:                                             |      |     
|Maturities, calls and principal payments on                |      |     
|securities available for sale                              |      |     
|Sales of securities available for sale                     |      |     
|Federal Home Loan Bank stock                               |      |     
|Federal Reserve Bank stock                                 |      |     
|Proceeds from the disposition of premises and equipment    |      |     
|Proceeds from sale of discontinued operation               |      |     
|Purchases of:                                              |      |     
|Securities available for sale                              |      |     
|Federal Home Loan Bank stock                               |      |     
|Federal Reserve Bank stock                                 |      |     
|Premises and equipment, net                                |      |     
|Net (increase) decrease in loans                           |      |     
|Recoveries on loans charged-off                            |      |     
|                                                           |      |     
|Net cash (used in) provided by investing activities        |      |     
|Cash flows from financing activities                       |      |     
|Net change in deposits                                     |      |     
|Net change in short term borrowings                        |      |     
|Redemption of subordinated debentures                      |      |     
|Proceeds from FHLB advances                                |      |     
|Repayment of FHLB advances                                 |      |     
|Redemption of ESOP/401k shares                             |      |     
|Repurchase and retirement of common stock                  |      |     
|Stock options exercised                                    |      |     
|Dividends paid                                             |      |     
|                                                           |      |     
|Net cash provided by (used in) financing activities        |      |     
|                                                           |      |     
|Net change in cash and cash equivalents                    |      |     
|Cash and cash equivalents at beginning of year             |      |     
|                                                           |      |     
|Cash and cash equivalents at end of year                   |      |     
|                                                           |      |     
|Supplemental schedule of noncash activities                |      |     
|Transfer from:  Loans to foreclosed real estate            |      |     

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

---

See accompanying notes
to the consolidated financial statements.

8

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

---

NOTE 1  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES

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

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

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

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

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

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

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

9

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

---

NOTE 1  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)

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

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

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

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

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

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

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

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

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

10

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

---

NOTE 1  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)

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

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

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

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

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

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

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

11

---



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

---

NOTE 1  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)

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

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

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

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

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

12

---



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

---

NOTE 1  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)

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

|                                                                                                                                         | 2006 | 2005 | 2004
|---------------------------------------------------------------------------------------------------------------------------------------- | ---- | ---- | ----
|                                                                                                                                         |      |      |     
|Net income as reported                                                                                                                   |      |      | $   
|Add:  Stock-based  compensation expense included in  reported  net  income,  net of  related  tax
effects                                |      |      |     
|Deduct:  Total stock-based  compensation expense
determined  under  fair value  based  method for all awards, net of related tax effects |      |      |     
|                                                                                                                                         |      |      |     
|                                                                                                                                         |      |     
|Pro forma net income                                                                                                                     |      |      | $   
|                                                                                                                                         |      |      |     
|                                                                                                                                         |      |     
|Basic earnings per share - As reported                                                                                                   |      |      | $   
|Basic earnings per share - Pro forma                                                                                                     |      |      | $   
|                                                                                                                                         |      |     
|Diluted earnings per share - As reported                                                                                                 |      |      | $   
|Diluted earnings per share - Pro forma                                                                                                   |      |      | $   

Advertising Expenses:
Advertising expenses are expensed as incurred.

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

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

13

---



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

---

NOTE 1  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)

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

|                                             | 2006 | 2005 | 2004
|-------------------------------------------- | ---- | ---- | ----
|                                             |      |      |     
|Net income                                   |      |      | $   
|                                             |      |      |     
|                                             |      |     
|Average  number of common shares outstanding |      |     
|used to calculate basic earnings per share   |      |      |     
|                                             |      |     
|Effect of dilutive options                   |      |      |     
|                                             |      |      |     
|                                             |      |     
|Average  number of common shares outstanding |      |     
|used  to  calculate diluted earnings  per    |      |     
|common share                                 |      |      |     
|                                             |      |      |     
|                                             |      |     
|Number of antidilutive stock options         |      |     
|excluded from the diluted earnings per share |      |     
|computation                                  |      |      |     
|                                             |      |      |     

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

Financial Instruments with
Off-Balance Sheet Risk: Financial instruments include off-balance sheet credit
instruments, such as commitments to make loans and standby letters of credit issued to
meet customers needs. The face amount for these items represents the exposure to
loss before considering customer collateral or ability to repay. Such financial
instruments are recorded when they are funded.

Fair Values of Financial
Instruments: Fair values of financial instruments are estimated using relevant market
information and other assumptions, as more fully disclosed separately. Fair value
estimates involve uncertainties and matters of significant judgment regarding interest
rates, credit risk, prepayments, and other factors, especially in the absence of broad
markets for particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. The fair value estimates of existing on and
off-balance-sheet financial instruments does not include the value of anticipated future
business or values of assets and liabilities not considered financial instruments.

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

14

---



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

---

NOTE 1  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Recent Accounting
Pronouncements:

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

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

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

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

15

---



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

---

NOTE 2 
SECURITIES

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

|                                               | Amortized
Cost | Gross
Unrealized
Gains | Gross
Unrealized
Losses | Estimated
Market Value
|---------------------------------------------- | -------------- | ---------------------- | ----------------------- | ----------------------
|                                               |                |                        |                         |                       
|2006                                           |                |                        |                         |                       
|U.S. Treasury & government agencies            |                |                        | $                       | 14,496                
|Obligations of states & political subdivisions |                |                        |                         | 2,507                 
|Mortgage-backed securities                     |                |                        |                         | 979                   
|                                               |                |                        |                         |                       
|Total available for sale securities            |                |                        | $                       | 17,982                
|                                               |                |                        |                         |                       
|                                               |                |                       
|2005                                           |                |                       
|U.S. Treasury & government agencies            |                |                        | $                       | 20,164                
|Obligations of states & political subdivisions |                |                        |                         | 4,350                 
|Mortgage-backed securities                     |                |                        |                         | 1,353                 
|                                               |                |                        |                         |                       
|Total available for sale securities            |                |                        | $                       | 25,867                
|                                               |                |                        |                         |                       

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

|                           | Available-for-Sale
|-------------------------- | ------------------
|                          
|                           |                   
|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                      |                   
|                           |                   

16

---



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

---

NOTE 2  SECURITIES(continued)

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

|At December 31, 2006                | Less Than Twelve Months | Twelve Months or More
|----------------------------------- | ----------------------- | ---------------------
|                                    |                         |                      
|                                    |                         |                      
|                                    |                         |                      
|Available-for-sale securities:      |                         |                      
|                                    |                         |                      
|U.S. treasury & government agencies |                         |                      
|Obligations of states & political   |                         |                      
|subdivisions                        |                         |                      
|Mortgage-backed securities          |                         |                      
|                                    |                         |                      
|Total available-for-sale securities |                         |                      
|                                    |                         |                      

|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                        |                         |                      
|Mortgage-backed securities          |                         |                      
|                                    |                         |                      
|Total available-for-sale securities |                         |                      
|                                    |                         |                      

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

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

NOTE 3  LOANS
RECEIVABLE

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

|                            | 2006 | 2005
|--------------------------- | ---- | ----
|                            |      |     
|Commercial                  |      |     
|Agricultural                |      |     
|Residential mortgage        |      |     
|Residential construction    |      |     
|Home equity lines of credit |      |     
|Consumer                    |      |     
|                            |      |     
|Total loans receivable      |      |     
|                            |      |     

17

---



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

---

NOTE 3  LOANS RECEIVABLE(continued)

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

|                       | 2006 | 2005
|---------------------- | ---- | ----
|                       |      |     
|Balance at January 1   |      |     
|New loans              |      |     
|Repayments             |      |     
|                       |      |     
|Balance at December 31 |      |     
|                       |      |     

NOTE 4 
ALLOWANCE FOR LOAN AND LEASE LOSSES

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

|                          | 2006 | 2005 | 2004
|------------------------- | ---- | ---- | ----
|                          |      |      |     
|Beginning balance         |      |      | $   
|Charge-offs               |      |      |     
|Recoveries                |      |      |     
|Provision for loan losses |      |      |     
|                          |      |      |     
|Ending balance            |      |      | $   
|                          |      |      |     

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

|                                                                     | 2006 | 2005 | 2004
|-------------------------------------------------------------------- | ---- | ---- | ----
|                                                                     |      |      |     
|Impaired loans with no allowance for loan and lease losses allocated |      |      | $   
|Impaired loans with allowance for loan and lease losses allocated    |      |      | $   
|Total impaired loans                                                 |      |      | $   
|Amount of the allowance allocated to impaired loans                  |      |      | $   
|Average investment in impaired loans                                 |      |      | $   
|Interest income recognized during impairment                         |      |      | $   

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

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

|                                                    | 2006 | 2005
|--------------------------------------------------- | ---- | ----
|                                                    |      |     
|Loans past due over 90 days still accruing interest |      |     
|Nonaccrual loans                                    |      |     

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

18

---



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

---

NOTE 5  LOAN
SERVICING

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

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

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

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

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

|                                      | 2006 | 2005 | 2004
|------------------------------------- | ---- | ---- | ----
|                                      |      |      |     
|Beginning balance                     |      |      | $   
|Mortgage servicing rights capitalized |      |      |     
|Mortgage servicing rights amortized   |      |      |     
|                                      |      |      |     
|Ending balance                        |      |      | $   
|                                      |      |      |     

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

NOTE 6  PREMISES
AND EQUIPMENT

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

|                               | 2006 | 2005
|------------------------------ | ---- | ----
|                               |      |     
|Land                           |      |     
|Buildings and improvement      |      |     
|Furniture and equipment        |      |     
|Construction in process        |      |     
|                               |      |     
|Total premises and equipment   |      |     
|Less: accumulated depreciation |      |     
|                               |      |     
|Net carrying amount            |      |     
|                               |      |     

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

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

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

19

---



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

---

NOTE 6  PREMISES
AND EQUIPMENT (continued)

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

NOTE 7  DEPOSITS

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

|                                | 2006 | 2005
|------------------------------- | ---- | ----
|                                |      |     
|NOW accounts                    |      |     
|Savings                         |      |     
|Certificates of deposit:        |      |     
|$100,000 and over               |      |     
|Under $100,000                  |      |     
|                                |      |     
|Total interest-bearing deposits |      |     
|                                |      |     

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

|           | 
|---------- | 
|2007       | 
|2008       | 
|2009       | 
|2010       | 
|2011       | 
|Thereafter | 
|           | 
|           | 
|           | 

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

|                                      | 2006 | 2005
|------------------------------------- | ---- | ----
|                                      |      |     
|Three months or less                  |      |     
|Over three months through six months  |      |     
|Over six months through twelve months |      |     
|One to two years                      |      |     
|Thereafter                            |      |     
|                                      |      |     
|Total                                 |      |     
|                                      |      |     

NOTE 8  BORROWED
FUNDS

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

|                                               | 2006 | 2005
|---------------------------------------------- | ---- | ----
|                                               |      |     
|Federal funds purchased                        |      |     
|Repurchase agreements - customers              |      |     
|Repurchase agreements - financial institutions |      |     
|Federal Home Loan Bank advances                |      |     
|                                               |      |     
|Total borrowed funds                           |      |     
|                                               |      |     

20

---



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

---

NOTE 8  BORROWED FUNDS (continued)

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

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

|                                                         |  | 
|-------------------------------------------------------- |  | 
|Customer Repurchase Agreements                           |  | 
|                                                         |  | 
|                                                         |  | 
|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                |  | 
|                                                         |  | 
|Third Party Financial Institutions Repurchase Agreements |  | 
|                                                         |  | 
|                                                         |  | 
|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                |  | 

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

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

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

|                     | 
|-------------------- | 
|2007                 | 
|2008                 | 
|                     | 
|Total FHLBI advances | 
|                     | 

21

---



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

---

NOTE 9 
SUBORDINATED DEBENTURES

In December 2001, Lenawee Capital
Trust I (Capital Trust), a trust formed by the Company, closed a pooled
private offering of 5,000 Trust Preferred Securities with a liquidation amount of $1,000
per security. The proceeds of the offering were loaned to the Company in exchange for
junior subordinated debentures with terms similar to the Trust Preferred Securities. The
sole assets of Capital Trust are the junior subordinated debentures of the Company and
payment thereunder. The junior subordinated debentures and the back-up obligations, in the
aggregate, constitute a full and unconditional guarantee by the Company of the obligations
of Capital Trust under the Trust Preferred Securities. Distributions on the Trust
Preferred Securities are payable semi-annually at a variable rate 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. This subordinated
debenture is considered Tier 1 capital (with certain limitations applicable) under current
regulatory guidelines.

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

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

NOTE 10  INCOME
TAXES

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

|                                 | 2006 | 2005 | 2004
|-------------------------------- | ---- | ---- | ----
|                                 |      |      |     
|Continuing Operations:           |      |      |     
|Current provision                |      |      | $   
|Deferred (benefit) provision     |      |      |     
|                                 |      |      |     
|Total from continuing operations |      |      |     
|Discontinued operation           |      |      |     
|                                 |      |      |     
|Total                            |      |      | $   
|                                 |      |      |     

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

|                                        | 2006 | 2005 | 2004
|--------------------------------------- | ---- | ---- | ----
|                                        |      |      |     
|Statutory rates                         |      |      | $   
|Increase (decrease) from:               |      |     
|Tax-exempt interest income              |      |      |     
|Non-deductible expenses                 |      |      |     
|Change in accounting estimate and other |      |      |     
|                                        |      |      |     
|                                        |      |      | $   
|                                        |      |      |     

22

---



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

---

NOTE 10  INCOME TAXES
(continued)

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

|                                                       | 2006 | 2005 | 2004
|------------------------------------------------------ | ---- | ---- | ----
|                                                       |      |      |     
|Deferred tax assets                                    |      |      |     
|Allowance for loan and lease losses                    |      |      | $   
|Net deferred loan fees                                 |      |      |     
|Accrued pension liability                              |      |      |     
|Net unrealized losses on securities available-for-sale |      |      |     
|Other                                                  |      |      |     
|                                                       |      |      |     
|Total deferred tax assets                              |      |      |     
|                                                       |      |      |     
|Deferred tax liabilities                               |      |     
|Depreciation                                           |      |      |     
|Mortgage servicing rights                              |      |      |     
|Prepaid expenses                                       |      |      |     
|Other                                                  |      |      |     
|                                                       |      |      |     
|Total deferred tax liabilities                         |      |      |     
|                                                       |      |      |     
|Net deferred tax liability                             |      |      | $   
|                                                       |      |      |     

NOTE 11 
EMPLOYEE BENEFITS

Defined Benefit
Pension Plan

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

ESOP and 401(k) Plan

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

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

23

---



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

---

NOTE 11  EMPLOYEE
BENEFITS (continued)

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

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

NOTE 12  STOCK
BASED COMPENSATION

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

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

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

24

---



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

---

NOTE 12 - STOCK BASED
COMPENSATION  (continued)

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

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

|                                | 2005 | 2004
|------------------------------- | ---- | ----
|                                |      |     
|Risk-free interest rate         |      |     
|Expected option life            |      |     
|Expected dividend yield         |      |     
|Expected stock price volatility |      |     

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

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

|Options                            | Shares | Weighted
Average
Exercise Price | Weighted Average
Remaining
Contractual Term | Aggregate
Intrinsic
Value
|---------------------------------- | ------ | ------------------------------- | ------------------------------------------- | -------------------------
|                                   |        |                                 |                                             |                          
|Outstanding, January 1, 2006       |        |                                 |                                             | 30,791                   
|Granted                            |        |                                 |                                             | -                        
|Exercised                          |        |                                 |                                             | (1,386                   
|Forfeited or expired               |        |                                 |                                             | -                        
|                                   |        |                                 |                                             |                          
|Outstanding, December 31, 2006     |        |                                 |                                             | 29,405                   
|                                   |        |                                 |                                             |                          
|Options exercisable, end of period |        |                                 |                                             | 25,331                   
|                                   |        |                                 |                                             |                          

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

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

25

---



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

---

NOTE 12 - STOCK BASED
COMPENSATION (continued)

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

|Nonvested Shares               | Shares | Weighted
Average
Grant Date
Fair Value
|------------------------------ | ------ | --------------------------------------
|                               |        |                                       
|Nonvested at January 1, 2006   |        |                                       
|Granted                        |        |                                       
|Vested                         |        |                                       
|Forfeited                      |        |                                       
|                               |        |                                       
|Nonvested at December 31, 2006 |        |                                       
|                               |        |                                       

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

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

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

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

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

|                                           | 2006 | 2005
|------------------------------------------ | ---- | ----
|                                           |      |     
|Commitments to extend credit               |      |     
|Unfunded commitments under lines of credit |      |     
|Commercial and standby letters of credit   |      |     
|                                           |      |     
|                                           |      |     
|                                           |      |     

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

26

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

---

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

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

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

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

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

NOTE 14 
PARENT-ONLY CONDENSED FINANCIAL STATEMENTS

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

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

|                                           | 2006 | 2005
|------------------------------------------ | ---- | ----
|                                           |      |     
|Assets                                     |      |     
|Cash and cash equivalents                  |      |     
|Securities available for sale              |      |     
|Investment in subsidiaries                 |      |     
|Other                                      |      |     
|                                           |      |     
|Total assets                               |      |     
|                                           |      |     
|                                           |      |     
|Liabilities & Shareholders' Equity         |      |     
|Subordinated debentures                    |      |     
|Other                                      |      |     
|Common stock subject to repurchase in ESOP |      |     
|Shareholders' equity                       |      |     
|                                           |      |     
|Total liabilities & shareholders' equity   |      |     
|                                           |      |     

27

---



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

---

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

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

|                                                   | 2006 | 2005 | 2004
|-------------------------------------------------- | ---- | ---- | ----
|                                                   |      |      |     
|Dividends from subsidiaries                        |      |      | $   
|Interest income                                    |      |      |     
|Interest expense                                   |      |      |     
|Other operating expense                            |      |      |     
|                                                   |      |      |     
|                                                   |      |     
|Income (loss) before equity in undistributed       |      |     
|net income of subsidiary                           |      |      |     
|                                                   |      |     
|(Excess) equity in undistributed net income        |      |     
|from subsidiaries                                  |      |      |     
|                                                   |      |      |     
|                                                   |      |     
|Income from continuing operations before           |      |     
|income taxes                                       |      |      |     
|Income tax (benefit) provision                     |      |      |     
|                                                   |      |      |     
|                                                   |      |     
|Income from continuing operations                  |      |      |     
|Income (loss) from discontinued operation,         |      |     
|net of income taxes, $0, $0, $162                  |      |      |     
|Gain on sale of discontinued operation, net of tax |      |      |     
|                                                   |      |      |     
|Net income                                         |      |      | $   
|                                                   |      |      |     

28

---



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

---

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

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

|                                                          | 2006 | 2005 | 2004
|--------------------------------------------------------- | ---- | ---- | ----
|                                                          |      |      |     
|Cash flows from operating activities                      |      |      |     
|Net income                                                |      |      | $   
|Adjustments to reconcile net income to net cash           |      |     
|from operating activities                                 |      |     
|Excess (equity) in undistributed net income of            |      |     
|subsidiaries                                              |      |      |     
|Gain on sale of discontinued operation                    |      |      |     
|Amortization (accretion) of investment securities         |      |      |     
|Stock option expense                                      |      |      |     
|Stock award expense                                       |      |      |     
|Other                                                     |      |      |     
|                                                          |      |      |     
|Net cash provided by (used in) operating activities       |      |      |     
|                                                          |      |     
|Cash flows from investing activities                      |      |     
|Net proceeds from sale of discontinued operation          |      |      |     
|Purchase of securities available for sale                 |      |      |     
|Proceeds from maturities of securities available for sale |      |      |     
|                                                          |      |      |     
|Net cash provided by investing activities                 |      |      |     
|                                                          |      |     
|Cash flows from financing activities                      |      |     
|Redemption of subordinated debentures                     |      |      |     
|Redemption and retirement of ESOP/401k shares             |      |      |     
|Repurchase of common stock                                |      |      |     
|Stock options exercised                                   |      |      |     
|Dividends paid                                            |      |      |     
|                                                          |      |      |     
|Net cash used in financing activities                     |      |      |     
|                                                          |      |      |     
|Net (decrease) increase in cash and cash equivalents      |      |      |     
|                                                          |      |     
|Beginning cash and cash equivalents                       |      |      |     
|                                                          |      |      |     
|Ending cash and cash equivalents                          |      |      | $   
|                                                          |      |      |     

29

---



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

---

NOTE 15  FAIR
VALUES OF FINANCIAL INSTRUMENTS

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

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

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

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

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

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

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

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

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

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

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

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

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

30

---



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

---

NOTE 15 - FAIR VALUES
OF FINANCIAL INSTRUMENTS(continued)

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

|                                | 2006 | 2005
|------------------------------- | ---- | ----
|                                |     
|                                |      |     
|                                |      |     
|Financial assets:               |      |     
|Cash and cash equivalents       |      |     
|Securities available-for-sale   |      |     
|Equities                        |      |     
|Loans held for sale             |      |     
|Loans, net                      |      |     
|Accrued interest receivable     |      |     
|                                |      |     
|Financial liabilities:          |      |     
|Demand and savings deposits     |      |     
|Time deposits                   |      |     
|Federal funds purchased         |      |     
|Federal Home Loan Bank advances |      |     
|Repurchase agreements           |      |     
|Accrued interest payable        |      |     
|Subordinated debentures         |      |     

NOTE 16 
DISCONTINUED OPERATION

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

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

|                             | 2006 | 2005 | 2004
|---------------------------- | ---- | ---- | ----
|                             |      |      |     
|Interest income              |      |      | $   
|Interest expense             |      |      |     
|                             |      |      |     
|Net interest income          |      |      |     
|Provision for loan losses    |      |      |     
|Noninterest income           |      |      |     
|Noninterest expenses         |      |      |     
|                             |      |      |     
|                             |      |     
|Income (loss) before taxes   |      |      |     
|                             |      |      |     
|                             |      |     
|Income tax expense (benefit) |      |      |     
|                             |      |      |     
|                             |      |     
|Net income (loss)            |      |      | $   
|                             |      |      |     

31

---



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

---

NOTE 17 
REGULATORY MATTERS

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

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

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

|                                         | Actual | Minimum Required
For
Capital Adequacy
Action Regulations | Minimum Required to be
Well-Capitalized Under
Prompt Corrective
Purposes
|---------------------------------------- | ------ | -------------------------------------------------------- | ------------------------------------------------------------------------
|                                         |        |                                                          |                                                                         
|                                         |        |                                                          |                                                                         
|2006                                     |        |                                                          |                                                                         
|Total capital (to risk weighted assets)  |        |                                                         
|Bank of Lenawee                          |        |                                                          | $                                                                       
|Tier 1 Capital (to risk weighted assets) |        |                                                         
|Bank of Lenawee                          |        |                                                          | $                                                                       
|Tier 1 Capital (to average assets)       |        |                                                         
|Bank of Lenawee                          |        |                                                          | $                                                                       
|                                         |        |                                                         
|2005                                     |        |                                                         
|Total Capital (to risk weighted assets)  |        |                                                         
|Consolidated                             |        |                                                          | $                                                                       
|Bank of Lenawee                          |        |                                                          | $                                                                       
|Tier 1 Capital (to risk weighted assets) |        |                                                         
|Consolidated                             |        |                                                          | $                                                                       
|Bank of Lenawee                          |        |                                                          | $                                                                       
|Tier 1 Capital (to average assets)       |        |                                                         
|Consolidated                             |        |                                                          | $                                                                       
|Bank of Lenawee                          |        |                                                          | $                                                                       

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

32

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

---

NOTE 18 
RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES

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

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

NOTE 19 
QUARTERLY RESULTS OF OPERATIONS (unaudited)

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

|                               | For the Three-Month Period ended
|------------------------------ | --------------------------------
|                               |                                 
|                               |                                 
|2006                           |                                 
|                               |                                 
|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                        |                                 

33

---



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

---

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

|                               | For the Three-Month Period ended
|------------------------------ | --------------------------------
|                               |                                 
|                               |                                 
|2005                           |                                 
|                               |                                 
|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                        |                                 

34

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

---

# [THIS PAGE
INTENTIONALLY LEFT BLANK]

35

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

---

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

INTRODUCTION

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

BUSINESS OF PAVILION
BANCORP, INC.

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

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

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

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

36

---



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

---

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

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

37

---



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

---

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

|- | Substantial
net worth
|- | ---------------------

|- | Low
debt to worth ratio
|- | -----------------------

|- | Significantly
above average working capital
|- | -------------------------------------------

|- | Current
accounts payable
|- | ------------------------

|- | Deposits
are 15% of outstanding loans
|- | -------------------------------------

|- | 25%
of assets are liquid
|- | -------------------------

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

|- | Significant
net worth
|- | ---------------------

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

|- | Above
average working capital ratio
|- | -----------------------------------

|- | Current
accounts payable
|- | ------------------------

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

|- | 10%
of assets are liquid
|- | -------------------------

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

|- | Acceptable
net worth
|- | --------------------

|- | Acceptable
industry average for debt to worth ratio
|- | ---------------------------------------------------

|- | Adequate
working capital
|- | ------------------------

|- | Not
significantly slow in paying accounts payable
|- | -------------------------------------------------

|- | Cash
flow ratio = 1.3 or above
|- | -------------------------------

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

|- | Minimum
net worth
|- | -----------------

|- | Fairly
high debt to worth ratio
|- | -------------------------------

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

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

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

|- | Little
or no net worth
|- | ----------------------

|- | High
debt to worth ratio
|- | ------------------------

|- | Cash
Flow ratio = 1.1 or above
|- | ------------------------------

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

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

38

---



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

39

---



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

---

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

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

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

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

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

|                                              | Within One Year | After One but
Within Five Years | After Five but
within Ten | After Ten Years | Mortgage-Backed
Securities | Total
|--------------------------------------------- | --------------- | ------------------------------- | ------------------------- | --------------- | -------------------------- | -----
|                                              |                 |                                 |                           |                 |                            |      
|                                              |                 |                                 |                           |                 |                            |      
|U.S. Treasury &                               |                 |                                 |                           |                 |                            |      
|Government agencies                           |                 |                                 | $                         | 13,330          |                            |      
|                                              |                 |                                
|Obligations of state & political subdivisions |                 |                                 |                           | 1,023           |                            |      
|                                              |                 |                                
|Mortgage-backed securities                    |                 |                                 |                           | -               |                            |      
|                                              |                 |                                 |                           |                 |                            |      
|Total                                         |                 |                                 | $                         | 14,353          |                            |      
|                                              |                 |                                 |                           |                 |                            |      

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

40

---



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

---

# Loans, Credit
Quality and Allowance for Loan and Lease Losses

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

|                                       | 2006 | 2005 | 2004 | 2003    | 2002
|-------------------------------------- | ---- | ---- | ---- | ------- | ----
|                                       |      |      |      |         |     
|Commercial, financial and agricultural |      |      | $    | 173,201 |     
|Residential-construction               |      |      |      | 10,896  |     
|Residential-mortgage                   |      |      |      | 30,255  |     
|Consumer                               |      |      |      | 31,777  |     
|                                       |      |      |      |         |     
|Total                                  |      |      | $    | 246,129 |     
|                                       |      |      |      |         |     

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

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

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

|                                       | Due Within 1
Year | Due After 1
but Within 5
Years | Due After 5
Years | Total  | Fixed | Variable
|-------------------------------------- | ----------------- | ------------------------------ | ----------------- | ------ | ----- | --------
|                                       |                   |                                |                   |        |       |         
|                                       |                   |                                |                   |        |       |         
|Commercial, financial and agricultural |                   |                                | $                 | 40,515 |       | $       
|Residential - construction             |                   |                                |                   | 10,782 |       |         
|Residential - mortgage                 |                   |                                |                   | 4,112  |       |         
|Consumer                               |                   |                                |                   | 1,921  |       |         
|                                       |                   |                                |                   |        |       |         
|Total                                  |                   |                                | $                 | 57,330 |       | $       
|                                       |                   |                                |                   |        |       |         

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).

41

---



# 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, 2006 and 2005 (000s omitted):

|                                           | 2006 | 2005
|------------------------------------------ | ---- | ----
|                                           |      |     
|Commitments to extend credit               |      |     
|Unfunded commitments under lines of credit |      |     
|Commercial and standby letters of credit   |      |     
|                                           |      |     
|Total                                      |      |     
|                                           |      |     

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

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

|                                 | Loan Risk Ratings
|-------------------------------- | -----------------
|                                 |                  
|                                 |                  
|Loan Type                        |                  
|December 31, 2006                |                  
|Commercial                       |                  
|Agricultural                     |                  
|Residential real estate mortgage |                  
|Consumer                         |                  
|                                 |                  
|Total                            |                  
|                                 |                  
|                                 |                  
|                                 |                  
|December 31, 2005                |                  
|Commercial                       |                  
|Agricultural                     |                  
|Residential real estate mortgage |                  
|Consumer                         |                  
|                                 |                  
|Total                            |                  
|                                 |                  

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

42

---



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

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

|                                              | 2006 | 2005 | 2004 | 2003   | 2002
|--------------------------------------------- | ---- | ---- | ---- | ------ | ----
|                                              |      |      |      |        |     
|Non-accruing loans past due                   |      |      | $    | 2,728  |     
|Loans past due 90 days or more still accruing |      |      |      | 668    |     
|                                              |      |      |      |        |     
|Total non-performing loans                    |      |      |      | 3,396  |     
|Other Real Estate                             |      |      |      | 169    |     
|                                              |      |      |      |        |     
|Total non-performing assets                   |      |      | $    | 3,565  |     
|                                              |      |      |      |        |     
|                                              |      |     
|Non-performing loans as a percent             |      |     
|of total loans                                |      |      |      | 1.38%  |     
|Non-accruing loans                            |      |     
|as a percent of total loans                   |      |      |      | 1.11%  |     
|Non-performing assets as a percent            |      |     
|of total assets                               |      |      |      | 1.21%  |     
|Non-performing loans as a percent             |      |     
|of the loan loss reserve                      |      |      |      | 120.55 | %   

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

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

43

---



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

---

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

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

|                                       | 2006 | 2005
|-------------------------------------- | ---- | ----
|                                       |      |     
|                                       |      |     
|                                       |      |     
|Commercial, financial and agricultural |      |     
|Residential-mortgage                   |      |     
|Residential-construction               |      |     
|Consumer                               |      |     
|Other qualitative factors & trends     |      |     
|                                       |      |     
|                                       |      |     
|                                       |      |     

|                                       | 2004 | 2003
|-------------------------------------- | ---- | ----
|                                       |      |     
|                                       |      |     
|                                       |      |     
|Commercial, financial and agricultural |      |     
|Residential-mortgage                   |      |     
|Residential-construction               |      |     
|Consumer                               |      |     
|Other qualitative factors & trends     |      |     
|                                       |      |     
|                                       |      |     
|                                       |      |     

|                                       | 2002
|-------------------------------------- | ----
|                                       |     
|                                       |     
|                                       |     
|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 1.14% at December
31, 2006, compared to 1.13% at December 31, 2005. For the twelve months ended December 31,
2006 provision for loan losses decreased $9,000, or 2.6%, to $333,000 from $342,000 for
the same period in 2005. The allowance as a percentage of loans increased slightly in the
current year with some worsening in credit quality. The provision for loan losses
decreased in the current year, as the loan portfolio did not grow as significantly in 2006
as compared to 2005. The loan portfolio grew by 3.6% in 2006 compared to 14.7% in 2005.
Management continues to closely monitor the credit risk within the individual loan pools.
Please refer to the subsection entitled Criticized and Classified Loans within
the section entitled Loans, Credit Quality and Allowance for Loan and Lease
Losses above for more detail.Commercial and agricultural loans represent the
largest segment of the Companys loan portfolio. The portion of the allowance
attributable to commercial and agricultural loans declined, as a percentage of the entire
allowance, to 71.9% (or $2.02 million) at December 31, 2006 from 77.8% (or $2.09 million)
at December 31, 2005. This is related to managements more detail analysis of the
required specific reserves on the commercial credits. While other loan categories
registered relatively small changes as a percentage of the allowance, the impact on the
overall allowance analysis is minimal because of the substantially smaller dollar amounts
involved.

44

---



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

---

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

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

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

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

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

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

45

---



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

---

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

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

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

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

RESULTS OF OPERATIONS

Net Income2006.Continuing Operations  Income from continuing operations for the year
          ended December 31, 2006 increased $0.5 million, or 23.9%, to $2.4 million in
          2006 compared to $1.9 million in 2005. Basic earnings per share
          (EPS) attributable to continuing operations for the twelve months
          ended December 31, 2006 were $3.27 compared to $2.47 for the same period in
          2005. Diluted EPS for the twelve months ended December 31, 2006 was $3.26
          compared to $2.45 for the same period in 2005. Increase in net income due
          primarily to cost reductions over the prior year as well as some improvement in
          net interest income.

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

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

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

46

---



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

---

The decline in income from continuing
operations results primarily from lower levels of mortgage origination-related income in
2004. Though interest rates remained low compared to historical levels, residential
mortgage refinance activity declined as most homeowners had previously refinanced their
residential mortgages and wouldnt have benefited from additional refinance activity.

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

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

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

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

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

47

---



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

---

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

|                                           | ------------2006------------ | ------------2005------------ | ------------2004------------
|------------------------------------------ | ---------------------------- | ---------------------------- | ----------------------------
|                                           |                              |                              |                             
|                                           |                              |                              |                             
|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.
|--- | -------------------------------------------------------------------------------------

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

48

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

---

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

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

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

|                                   | 2006-2005 | 2005-2004
|---------------------------------- | --------- | ---------
|                                   |           |          
|
|                                   |           |          
|                                   |           |          
|Interest-earning assets:           |           |          
|Loans receivable                   |           |          
|Securities available-for-sale      |           |          
|Federal funds sold                 |           |          
|Equity securities                  |           |          
|Interest-bearing balances with     |           |          
|other financial institutions       |           |          
|                                   |           |          
|Total interest-earning assets      |           |          
|                                   |           |          
|Interest-bearing liabilities:      |           |          
|Interest-bearing demand            |           |          
|deposits                           |           |          
|Savings deposits                   |           |          
|Time deposits                      |           |          
|Subordinated debentures            |           |          
|Repurchase agreements and          |           |          
|other borrowings                   |           |          
|                                   |           |          
|Total interest-bearing liabilities |           |          
|                                   |           |          
|Net change in net interest         |           |          
|income                             |           |          
|                                   |           |          

49

---



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

---

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

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

|                                            | Years ended December 31,(in thousands)
|------------------------------------------- | --------------------------------------
|                                            |                                       
|                                            |                                       
|Balance at beginning of year                |                                       
|Loans charged off:                          |                                       
|Residential real estate - mortgage          |                                       
|Residential real estate - construction      |                                       
|Commercial and agricultural                 |                                       
|Consumer                                    |                                       
|                                            |                                       
|                                            |                                       
|                                            |                                       
|Recoveries of loans previously charged-off: |                                       
|Residential 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                    |                                       
|                                            |                                       

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

50

---



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

---

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

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

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

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

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

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

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

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

51

---



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

---

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

Non-interest Income

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

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

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

52

---



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

---

Non-interest Expenses

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

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

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

53

---



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

---

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

Federal Income Tax
Expense

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

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

Liquidity and Capital
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 FHLBI. While maturities and scheduled amortization of loans and
securities are predictable sources of funds, deposit flows and mortgage prepayments are
greatly influenced by general interest rates, economic conditions and competition.

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

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

54

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

---

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

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

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

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

55

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

---

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

|                                         | Actual | Minimum Required
For
Capital Adequacy
Purposes | Minimum Required to be
Well-Capitalized Under
Prompt Corrective
Action Regulations
|---------------------------------------- | ------ | ---------------------------------------------- | ----------------------------------------------------------------------------------
|                                         |        |                                                |                                                                                   
|                                         |        |                                                |                                                                                   
|December 31, 2006                        |        |                                                |                                                                                   
|Total capital (to risk weighted assets)  |        |                                               
|Bank of Lenawee                          |        |                                                | $                                                                                 
|Tier 1 Capital (to risk weighted assets) |        |                                               
|Bank of Lenawee                          |        |                                                | $                                                                                 
|Tier 1 Capital (to average assets)       |        |                                               
|Bank of Lenawee                          |        |                                                | $                                                                                 
|                                         |        |                                               
|December 31, 2005                        |        |                                               
|Total Capital (to risk weighted assets)  |        |                                               
|Consolidated                             |        |                                                | $                                                                                 
|Bank of Lenawee                          |        |                                                | $                                                                                 
|Tier 1 Capital (to risk weighted assets) |        |                                               
|Consolidated                             |        |                                                | $                                                                                 
|Bank of Lenawee                          |        |                                                | $                                                                                 
|Tier 1 Capital (to average assets)       |        |                                               
|Consolidated                             |        |                                                | $                                                                                 
|Bank of Lenawee                          |        |                                                | $                                                                                 

Contractual ObligationsThe following table presents
contractual obligations as of December 31, 2006 (000s omitted):

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

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

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

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

56

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

---

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

|                                           | Amount of commitment expiration per period
|------------------------------------------ | ------------------------------------------
|                                           |                                           
|                                           |                                           
|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.

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

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

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

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

57

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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, 2006 (000s omitted):

# Principal Amount
Maturing In:

|                              | 2007 | 2008 | 2009 | 2010    | 2011 | Thereafter | Total | Fair Value
|----------------------------- | ---- | ---- | ---- | ------- | ---- | ---------- | ----- | ----------
|                              |      |      |      |         |      |            |       |           
|RATE-SENSITIVE ASSETS         |      |      |      |         |      |            |       |           
|Gross loans                   |      |      | $    | 57,330  |      | $          | 8,070 |           
|Average interest rate         |      |      |      | 8.1%    |      |            | 7.2%  |           
|Debt & equity securities      |      |      | $    | 17,277  |      | $          | -     |           
|Average interest rate         |      |      |      | 3.4%    |      |            | 0.0%  |           
|Other interest-earning assets |      |      | $    | -       |      | $          | -     |           
|Average interest rate         |      |      |      | 0.0%    |      |            | 0.0%  |           
|                              |      |     
|RATE-SENSITIVE LIABILITIES    |      |     
|Savings & interest bearing    |      |     
|demand deposits               |      |      | $    | 73,210  |      | $          | -     |           
|Average interest rate         |      |      |      | 1.3%    |      |            | 0.0%  |           
|Time deposits                 |      |      | $    | 104,220 |      | $          | 6,240 |           
|Average interest rate         |      |      |      | 4.8%    |      |            | 3.7%  |           
|Other borrowings              |      |      | $    | 23,529  |      | $          | 1,657 |           
|Average interest rate         |      |      |      | 4.5%    |      |            | 2.9%  |           

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

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

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

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

58

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

---

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

| |  | Periodic
retention of external specialists to review and analyze various activities.
| | - | ------------------------------------------------------------------------------------

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

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

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

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

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

59

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

---

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

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

|               | Sales Prices (1) | Cash
|-------------- | ---------------- | ----
|
|First Quarter  |                  |     
|Second Quarter |                  |     
|Third Quarter  |                  |     
|Fourth Quarter |                  |     
|               |                  |     
|
|First Quarter  |                  |     
|Second Quarter |                  |     
|Third Quarter  |                  |     
|Fourth Quarter |                  |     
|               |                  |     
|
|First Quarter  |                  |     
|Second Quarter |                  |     
|Third Quarter  |                  |     
|Fourth Quarter |                  |     

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

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

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

60

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

---

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

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

61

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

---

# SHAREHOLDER RETURN
PERFORMANCE GRAPH

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



|                       | 2001 | 2002 | 2003 | 2004   | 2005 | 2006
|---------------------- | ---- | ---- | ---- | ------ | ---- | ----
|                       |      |      |      |        |      |     
|Pavilion Bancorp       |      |      |      | 100.00 |      |     
|Regional-Midwest Banks |      |      |      | 100.00 |      |     
|NASDAQ Market Index    |      |      |      | 100.00 |      |     

Source: HEMSCOTT, Inc.,
Richmond, Virginia

62

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