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

FORM 10-Q

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(Mark One)

| | [X]  |  | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2008           
| | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------
| |      |  |                                                                                                                                                     
| | [  ] |  | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ____________ to ____________

Commission File Number:  000-49772

SOUTHERN MICHIGAN BANCORP, INC.(Exact Name of Registrant as Specified in its Charter)

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

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

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer      Accelerated filer      Non-accelerated filer     Smaller reporting company X

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

The number of shares outstanding of the Registrant's Common Stock, $2.50 par value, as of November 11, 2008, was 2,311,792 shares.

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Forward-Looking Statements

This report contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and Southern Michigan Bancorp, Inc. Forward-looking statements are identifiable by words or phrases such as "outlook", or "strategy"; that an event or trend "may", "should", "will", or "is likely" to occur or "continue" or "is scheduled" or "on track" or that Southern Michigan Bancorp, Inc. or its management "anticipates", "believes", "estimates", "plans", "forecasts", "intends", "predicts", "projects", or "expects" a particular result, or is "confident," "optimistic" or has an "opinion" that an event will occur, and variations of such words and similar expressions. All of the information concerning interest rate sensitivity is forward-looking. The future effect of changes in the real estate markets and the Michigan and national economy on the banking industry, generally, and Southern Michigan Bancorp, Inc., specifically, are also inherently uncertain. Management's determination of the provision and allowance for loan losses involves judgments that are inherently forward-looking. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("risk factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Southern Michigan Bancorp, Inc. undertakes no obligation to update, amend or clarify forward-looking statements, whether as a result of new information, future events or otherwise.

Risk factors include, but are not limited to, the risk factors described in "Item 1A - Risk Factors" of Southern Michigan Bancorp, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2007; the timing and level of asset growth; changes in banking laws and regulations; changes in tax laws; changes in prices, levies and assessments; the impact of technological advances and issues; governmental and regulatory policy changes; opportunities for acquisitions and the effective completion of acquisitions and integration of acquired entities; the possibility that anticipated cost savings and revenue enhancements from acquisitions, restructurings, reorganizations and bank consolidations may not be realized at amounts projected, at all or within expected time frames; the local and global effects of the ongoing war on terrorism and other military actions, including actions in Iraq; and current uncertainties and fluctuations in the financial and credit markets and stocks of financial services providers due to concerns about credit availability and concerns about the Michigan economy in particular. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

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Part I.  Financial Information

|Item 1. | Financial Statements
|------- | --------------------

SOUTHERN MICHIGAN BANCORP, INC.
UNAUDITED INTERIM FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share data)

|                                                                                                                                       | September 30,
2008 |         | December 31,
2007 |  
|-------------------------------------------------------------------------------------------------------------------------------------- | ------------------ | ------- | ----------------- | -
|ASSETS                                                                                                                                 |                    |         |                   |  
|Cash and cash equivalents                                                                                                              | $                  | 9,968   |                   | $
|Federal funds sold                                                                                                                     |                    | 18,077  |                   |  
|Securities available for sale                                                                                                          |                    | 65,242  |                   |  
|Loans held for sale, net of valuation of -0- in 2008 and 2007                                                                          |                    | 854     |                   |  
|Loans, net of allowance for loan losses of $6,987 - 2008 ($5,156 - 2007)                                                               |                    | 330,249 |                   |  
|Premises and equipment, net                                                                                                            |                    | 13,187  |                   |  
|Accrued interest receivable                                                                                                            |                    | 2,765   |                   |  
|Net cash surrender value of life insurance                                                                                             |                    | 9,418   |                   |  
|Goodwill                                                                                                                               |                    | 13,422  |                   |  
|Other intangible assets                                                                                                                |                    | 2,810   |                   |  
|Other assets                                                                                                                           |                    | 6,922   |                   |  
|TOTAL ASSETS                                                                                                                           | $                  | 472,914 |                   | $
|                                                                                                                                       |                    |         |                   |  
|LIABILITIES                                                                                                                            |                    |         |                   |  
|Deposits :                                                                                                                             |                    |         |                   |  
|Non-interest bearing                                                                                                                   | $                  | 52,119  |                   | $
|Interest bearing                                                                                                                       |                    | 348,617 |                   |  
|Total deposits                                                                                                                         |                    | 400,736 |                   |  
|Securities sold under agreements to repurchase and overnight borrowings                                                                |                    | 3,734   |                   |  
|Accrued expenses and other liabilities                                                                                                 |                    | 4,339   |                   |  
|Other borrowings                                                                                                                       |                    | 12,770  |                   |  
|Subordinated debentures                                                                                                                |                    | 5,155   |                   |  
|Total liabilities                                                                                                                      |                    | 426,734 |                   |  
|                                                                                                                                       |                    |         |                   |  
|Common stock subject to repurchase obligation in
  Employee Stock Ownership Plan, 98,357 shares outstanding in 2008
  (92,203 in 2007) |                    | 1,298   |                   |  
|                                                                                                                                       |                    |         |                   |  
|SHAREHOLDERS' EQUITY                                                                                                                   |                    |         |                   |  
|Preferred stock, 100,000 shares authorized; none issued or outstanding                                                                 |                    | -       |                   |  
|Common stock, $2.50 par value:                                                                                                         |                    |         |                   |  
|Authorized - 4,000,000 shares                                                                                                          |                    |         |                   |  
|Issued - 2,312,507 shares in 2008 (2,307,924 shares in 2007)                                                                           |                    |         |                   |  
|Outstanding (other than ESOP shares) - 2,214,150 shares in 2008
          (2,215,721 shares in 2007)                                   |                    | 5,535   |                   |  
|Additional paid-in capital                                                                                                             |                    | 17,990  |                   |  
|Retained earnings                                                                                                                      |                    | 21,813  |                   |  
|Accumulated other comprehensive income, net                                                                                            |                    | 284     |                   |  
|Unearned Employee Stock Ownership Plan shares                                                                                          |                    | (618    | )                 |  
|Unearned restricted stock compensation                                                                                                 |                    | (122    | )                 |  
|Total shareholders' equity                                                                                                             |                    | 44,882  |                   |  
|TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                                                                                             | $                  | 472,914 |                   | $

See accompanying notes to interim consolidated financial statements.

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SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands, except per share data)

|                                                    | Three Months Ended
September 30, |       | Nine Months Ended
September 30, |  
|--------------------------------------------------- | -------------------------------- | ----- | ------------------------------- | -
|                                                    | 2008                             |       | 2007                            |  
|Interest income:                                    |                                  |       |                                 |  
|Loans, including fees                               | $                                | 5,587 |                                 | $
|Federal funds sold                                  |                                  | 116   |                                 |  
|Securities:                                         |                                  |       |                                 |  
|Taxable                                             |                                  | 455   |                                 |  
|Tax-exempt                                          |                                  | 233   |                                 |  
|Total interest income                               |                                  | 6,391 |                                 |  
|                                                    |                                  |       |                                 |  
|Interest expense:                                   |                                  |       |                                 |  
|Deposits                                            |                                  | 1,615 |                                 |  
|Other                                               |                                  | 253   |                                 |  
|Total interest expense                              |                                  | 1,868 |                                 |  
|Net Interest Income                                 |                                  | 4,523 |                                 |  
|Provision for loan losses                           |                                  | 1,580 |                                 |  
|                                                    |                                  |       |                                 |  
|Net interest income after provision for loan losses |                                  | 2,943 |                                 |  
|                                                    |                                  |       |                                 |  
|Non-interest income:                                |                                  |       |                                 |  
|Service charges on deposit accounts                 |                                  | 726   |                                 |  
|Trust fees                                          |                                  | 297   |                                 |  
|Net gains on security calls and sales               |                                  | -     |                                 |  
|Net gains on loan sales                             |                                  | 81    |                                 |  
|Earnings on life insurance assets                   |                                  | 84    |                                 |  
|Gain on life insurance proceeds                     |                                  | -     |                                 |  
|Income and fees from automated teller machines      |                                  | 166   |                                 |  
|Other                                               |                                  | 201   |                                 |  
|Total non-interest income                           |                                  | 1,555 |                                 |  
|                                                    |                                  |       |                                 |  
|Non-interest expense:                               |                                  |       |                                 |  
|Salaries and employee benefits                      |                                  | 2,715 |                                 |  
|Occupancy, net                                      |                                  | 273   |                                 |  
|Equipment                                           |                                  | 307   |                                 |  
|Printing, postage and supplies                      |                                  | 169   |                                 |  
|Telecommunication expenses                          |                                  | 87    |                                 |  
|Professional and outside services                   |                                  | 324   |                                 |  
|Software maintenance                                |                                  | 82    |                                 |  
|Amortization of other intangibles                   |                                  | 94    |                                 |  
|Other                                               |                                  | 658   |                                 |  
|Total non-interest expense                          |                                  | 4,709 |                                 |  
|INCOME BEFORE INCOME TAXES                          |                                  | (211  | )                               |  
|Federal income tax provision (credit)               |                                  | (232  | )                               |  
|NET INCOME                                          | $                                | 21    |                                 | $
|                                                    |                                  |       |                                 |  
|Basic Earnings Per Common Share                     | $                                | .01   |                                 | $
|Diluted Earnings Per Common Share                   | $                                | .01   |                                 | $
|Dividends Declared Per Common Share                 | $                                | .20   |                                 | $

See accompanying notes to interim consolidated financial statements.

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SOUTHERN MICHIGAN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
(In thousands, except number of shares and per share data)
For the Nine Months Ending September 30, 2008 and 2007

|                                                                                    | Common
Stock |       | Additional
Paid-In
Capital |   | Retained
Earnings |   | Accumulated
Other
Comprehensive
Income
(Loss), Net |        | Unearned
ESOP
Shares |   | Unearned
Compen-
sation |   | Total |     
|----------------------------------------------------------------------------------- | ------------ | ----- | -------------------------- | - | ----------------- | - | -------------------------------------------------- | ------ | -------------------- | - | ----------------------- | - | ----- | ----
|Balance at January 1, 2007                                                          | $            | 4,200 |                            | $ | 5,446             |   | $                                                  | 19,021 |                      | $ | (42                     | ) | $     | (143
|                                                                                    |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Comprehensive income:                                                               |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Net income                                                                          |              |       |                            |   |                   |   |                                                    | 3,129  |                      |   |                         |   |       |     
|Net change in other comprehensive                                                   |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|income items                                                                        |              |       |                            |   |                   |   |                                                    |        |                      |   | 103                     |   |       |     
|Total comprehensive income                                                          |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Cash dividends declared - $.60 per share                                            |              |       |                            |   |                   |   |                                                    | (1,063 | )                    |   |                         |   |       |     
|Change in common stock subject                                                      |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|to repurchase                                                                       |              | (8    | )                          |   | (59               | ) |                                                    |        |                      |   |                         |   |       |     
|Issuance of restricted stock (2,740
  shares of common stock at
  $24.58 per share) |              | 7     |                            |   | 60                |   |                                                    |        |                      |   |                         |   |       |     
|Vesting of restricted stock                                                         |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Net change in obligation under ESOP                                                 |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       | 40  
|Stock option expense                                                                |              |       |                            |   | 57                |   |                                                    |        |                      |   |                         |   |       |     
|Balance at September 30, 2007                                                       | $            | 4,199 |                            | $ | 5,504             |   | $                                                  | 21,087 |                      | $ | 61                      |   | $     | (103
|                                                                                    |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|                                                                                    |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Balance at January 1, 2008                                                          | $            | 5,539 |                            | $ | 17,087            |   | $                                                  | 21,629 |                      | $ | 122                     |   | $     | (103
|                                                                                    |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Comprehensive income:                                                               |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Net income                                                                          |              |       |                            |   |                   |   |                                                    | 1,571  |                      |   |                         |   |       |     
|Net change in other comprehensive                                                   |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|income items                                                                        |              |       |                            |   |                   |   |                                                    |        |                      |   | 162                     |   |       |     
|Total comprehensive income                                                          |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Cash dividends declared - $.60 per share                                            |              |       |                            |   |                   |   |                                                    | (1,387 | )                    |   |                         |   |       |     
|Change in common stock subject                                                      |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|to repurchase                                                                       |              | (15   | )                          |   | 746               |   |                                                    |        |                      |   |                         |   |       |     
|Issuance of restricted stock (5,535
  shares of common stock at $18.00
  per share) |              | 14    |                            |   | 86                |   |                                                    |        |                      |   |                         |   |       |     
|Vesting of restricted stock                                                         |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       |     
|Forfeiture of restricted stock (900 shares
  of common stock at $18.00 per share)   |              | (3    | )                          |   | (13               | ) |                                                    |        |                      |   |                         |   |       |     
|Net change in obligation under ESOP                                                 |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       | 94  
|Purchase of shares by ESOP (28,500
  shares)                                        |              |       |                            |   |                   |   |                                                    |        |                      |   |                         |   |       | (609
|Stock option expense                                                                |              |       |                            |   | 84                |   |                                                    |        |                      |   |                         |   |       |     
|Balance at September 30, 2008                                                       | $            | 5,535 |                            | $ | 17,990            |   | $                                                  | 21,813 |                      | $ | 284                     |   | $     | (618

See accompanying notes to interim consolidated financial statements.

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

|                                                                                              | Nine Months Ended September 30, |        
|--------------------------------------------------------------------------------------------- | ------------------------------- | -------
|                                                                                              | 2008                            |        
|Operating Activities                                                                          |                                 |        
|Net income                                                                                    | $                               | 1,571  
|Adjustments to reconcile net income to net cash                                               |                                 |        
|from operating activities:                                                                    |                                 |        
|Provision for loan losses                                                                     |                                 | 2,730  
|Depreciation                                                                                  |                                 | 909    
|Net accretion of investment securities                                                        |                                 | (52    
|Loss on disposal of fixed assets                                                              |                                 | 49     
|Loans originated for sale                                                                     |                                 | (15,652
|Proceeds on loan sales                                                                        |                                 | 15,359 
|Net gains on loan sales                                                                       |                                 | (295   
|Gain on life insurance proceeds                                                               |                                 | (390   
|Stock option and restricted stock grant compensation expense                                  |                                 | 101    
|Net securities gains                                                                          |                                 | (15    
|Amortization of other intangible assets                                                       |                                 | 281    
|Net change in:                                                                                |                                 |        
|Obligation under ESOP                                                                         |                                 | 94     
|Accrued interest receivable                                                                   |                                 | 622    
|Cash surrender value                                                                          |                                 | (256   
|Other assets                                                                                  |                                 | 1,614  
|Accrued expenses and other liabilities                                                        |                                 | (729   
|Net cash from operating activities                                                            |                                 | 5,941  
|                                                                                              |                                 |        
|Investing Activities                                                                          |                                 |        
|Activity in available for sale securities:                                                    |                                 |        
|Proceeds from maturities and calls                                                            |                                 | 47,462 
|Purchases                                                                                     |                                 | (34,876
|Net change in federal funds sold                                                              |                                 | (11,628
|Loan originations and payments, net                                                           |                                 | (3,369 
|Proceeds from life insurance                                                                  |                                 | 1,241  
|Additions to premises and equipment                                                           |                                 | (810   
|Net cash used in investing activities                                                         |                                 | (1,980 
|                                                                                              |                                 |        
|Financing Activities                                                                          |                                 |        
|Net change in deposits                                                                        |                                 | 1,567  
|Net change in securities sold under agreements to repurchase and
        overnight borrowings |                                 | (6,042 
|Proceeds from other borrowings                                                                |                                 | 600    
|Repayments of other borrowings                                                                |                                 | (2,592 
|Purchase of ESOP shares                                                                       |                                 | (609   
|Cash dividends paid                                                                           |                                 | (1,387 
|Net cash from (used in) financing activities                                                  |                                 | (8,463 
|Net change in cash and cash equivalents                                                       |                                 | (4,502 
|Beginning cash and cash equivalents                                                           |                                 | 14,470 
|Ending cash and cash equivalents                                                              | $                               | 9,968  
|                                                                                              |                                 |        
|Cash paid for interest                                                                        | $                               | 6,567  
|Cash paid for income taxes                                                                    |                                 | 445    
|Transfers from loans to foreclosed assets                                                     |                                 | 1,570  

See accompanying notes to interim consolidated financial statements.

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

NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary in order to make the financial statements not misleading have been included. Operating results for the three months and nine month periods ending September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes of the Company for December 31, 2007 included in the Company's Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission on March 28, 2008. As discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 2007, the Company acquired FNB on December 1, 2007. The transaction was accounted for using the purchase method of accounting and therefore the operating results for the three and nine month periods ending September 30, 2007 do not include FNB.

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

NOTE B - NEW ACCOUNTING PRONOUNCEMENTS

On February 15, 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" (FAS 159). FAS 159 permits, but does not require, entities to measure selected financial assets and liabilities at fair value. Changes in fair value are recorded through the income statement in subsequent periods. The statement provides for a one time opportunity to transfer existing assets and liabilities to fair value at the point of adoption with a cumulative effect adjustment recorded against equity. After adoption, the election to report assets and liabilities at fair value must be made at the point of their inception. There was no impact on the consolidated financial statements of the Company as a result of the adoption of Statement 159 since the Company has not elected the fair value option for any eligible items, as defined in FAS 159.

In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements" (FAS 157) which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FAS 157 also establishes a fair value hierarchy which requires the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

| | Level 1 | Quoted prices in active markets for identical assets or liabilities.                                                                                                                                                                                                                                         
| | ------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |         |                                                                                                                                                                                                                                                                                                              
| | Level 2 | Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
| |         |                                                                                                                                                                                                                                                                                                              
| | Level 3 | Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.                                                                                                                                                              

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On February 12, 2008, the FASB issued Staff Position 157-2 which defers the effective date of Statement 157 for certain non-financial assets and liabilities to fiscal years beginning after November 15, 2008. All other provisions of Statement 157 are effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years.

The Company adopted the provisions of FAS 157 for the quarter ended March 31, 2008 except for those non-financial assets and liabilities subject to deferral as a result of Staff Position 157-2. There was no impact on the consolidated financial statements of the Company as a result of the adoption of FAS 157.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying consolidated balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Securities available for sale

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Currently, all of the Company's securities are considered to be Level 1 or Level 2 securities and fair values are provided by a third party pricing provider.

Following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying consolidated balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Impaired Loans

Loan impairment is reported when full payment under the loan terms is not expected. Impaired loans are carried at the present value of estimated future cash flows using current market rates, or the fair value of collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. This valuation would be considered Level 3, consisting of appraisals of underlying collateral and discounted cash flow analysis.

The FASB Emerging Issues Task Force finalized in 2007 Issues No. 06-4 and 06-10 dealing with the accounting for deferred compensation and post-retirement benefit aspects of endorsement and collateral assignment split-dollar life insurance arrangements. These Issues require that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants' employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. The Issues are effective for fiscal years beginning after December 15, 2007. The adoption of the Issues effective January 1, 2008 did not have a material impact on the Company's consolidated financial statements.

On November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value through Earnings ("SAB 109"). Previously, SAB 105, Application of Accounting Principles to Loan Commitments, stated that in measuring the fair value of a derivative loan commitment, a company should not incorporate the expected net future cash flows related to the associated servicing of the loan. SAB 109 supersedes SAB 105 and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in measuring fair value for all written loan commitments that are accounted for at fair value through earnings. SAB 105 also indicated that internally-developed intangible assets should not be recorded as part of the fair value of a derivative loan commitment, and SAB 109 retains that view. SAB 109 is effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The adoption of this standard effective January 1, 2008 did not have a material impact on the Company's consolidated financial statements.

---



In December, 2007, FASB issued Statement No. 160, "Noncontrolling Interest in Consolidated Financial Statements" and revised Statement No. 141R, "Business Combinations." Both are effective for annual periods beginning after December 15, 2008. The Company is currently evaluating the impact of these Statements, but does not believe that either will have a material impact on its financial statements.

In March 2008, FASB issued Statement No. 161, "Disclosures about Derivative Instruments and Hedging Activities" (FAS 161). FAS 161 is an amendment of FABS 133, "Accounting for Derivative Instruments and Hedging Activities", and is intended to improve financial reporting transparency regarding derivative instruments and hedging activities. FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. The Company is currently evaluating the impact of FAS 161 on the Company's consolidated financial statements, but does not believe it will have a material impact on the consolidated financial statements.

NOTE C - EARNINGS PER SHARE

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

A reconciliation of the numerators and denominators of basic and diluted earnings per share for the three and nine month periods ended September 30, 2008 and 2007 is as follows (dollars in thousands, except per share data):

|                                                                                 | Three Months
Ended
September 30,
2008 |           | Three Months
Ended
September 30,
2007 |   | Nine Months
Ended
September 30,
2008 |  | Nine Months
Ended
September 30,
2007
|-------------------------------------------------------------------------------- | ------------------------------------- | --------- | ------------------------------------- | - | ------------------------------------ |  | ------------------------------------
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Basic earnings per share:                                                        |                                       |           |                                       |   |                                      |  |                                     
|Net income                                                                       | $                                     | 21        |                                       | $ | 1,082                                |  | $                                   
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Weighted average common
    shares outstanding                                   |                                       | 2,312,771 |                                       |   | 1,771,988                            |  |                                     
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Less unallocated ESOP shares                                                     |                                       | 36,017    |                                       |   | 5,182                                |  |                                     
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Weighted average common shares
    outstanding for basic earnings per share      |                                       | 2,276,754 |                                       |   | 1,766,806                            |  |                                     
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Basic earnings per share                                                         | $                                     | 0.01      |                                       | $ | 0.61                                 |  | $                                   
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Diluted earnings per share:                                                      |                                       |           |                                       |   |                                      |  |                                     
|Net income                                                                       | $                                     | 21        |                                       | $ | 1,082                                |  | $                                   
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Weighted average common shares
    outstanding for basic earnings per share      |                                       | 2,276,754 |                                       |   | 1,766,806                            |  |                                     
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Add: Dilutive effect of assumed
    exercise of stock options                    |                                       | -         |                                       |   | 5,276                                |  |                                     
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Weighted average common and
    dilutive potential common
    shares outstanding |                                       | 2,276,754 |                                       |   | 1,772,082                            |  |                                     
|                                                                                 |                                       |           |                                       |   |                                      |  |                                     
|Diluted earnings per share                                                       | $                                     | 0.01      |                                       | $ | 0.61                                 |  | $                                   

---



Stock option awards outstanding that were anti-dilutive and therefore not included in the computation of earnings per share were as follows: 215,818 and 130,425 for the three months ended September 30, 2008 and 2007, respectively, and 193,675 and 130,425 for the nine months ended September 30, 2008 and 2007, respectively. Shares outstanding in 2008 included the issuance of 535,936 shares in connection with the purchase of FNB.

NOTE D - STOCK OPTIONS

Shareholders of the Company approved a stock option plan in April 2000 and a stock incentive plan in June 2005. The plans were authorized to issue up to 115,500 and 157,500 shares, respectively. In May 2008, shareholders of the Company ratified amendments to the Stock Incentive Plan of 2005, which among other things increased the authorized shares from 157,500 to 300,000. As of September 30, 2008, there were 44,841 shares available for future issuance under the 2000 plan and 140,057 shares available for future issuance under the 2005 plan.

A summary of stock option activity in the plans is as follows for the nine months ended September 30, 2008:

|                                          | Shares  |   | Weighted Average
Price | 
|----------------------------------------- | ------- | - | ---------------------- | 
|                                          |         |   |                        | 
|Outstanding at beginning of year          | 197,108 |   | $ 23.16                | 
|Granted                                   | 21,010  |   | 18.00                  | 
|Exercised                                 | -       |   | -                      | 
|Forfeited                                 | (2,700  | ) | 18.73                  | 
|Outstanding at September 30, 2008         | 215,418 |   | 22.71                  | 
|                                          |         |   |                        | 
|Options exercisable at September 30, 2008 | 94,298  |   | 22.15                  | 

In January 2007, 2,740 shares of restricted stock were issued to employees and directors. The shares vest 20% per year over five years. In June 2008, 5,535 shares of restricted stock were issued to employees and directors. The shares also vest 20% per year over five years. Compensation expense of $17,000 and $9,000 was recorded during the nine months ended September 30, 2008 and 2007, respectively.

For the nine months ended September 30, 2008 and 2007, compensation expense of $84,000 and $57,000, respectively, was recorded with respect to options granted in 2007 and 2008. Such expense was computed in accordance with Statement of Financial Accounting Standards No. 123R, "Share-Based Payment."

|Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

The following discussion provides information about the financial condition and results of operations of the Company and its subsidiary banks, Southern Michigan Bank & Trust (SMB&T) and FNB Financial (FNB), for the three and nine month periods ending September 30, 2008 and 2007. Financial results for 2008 were influenced by the acquisition of FNB on December 1, 2007. In accordance with the purchase method of accounting, FNB's results of operations were included in the Company's consolidated statements of income from the date of acquisition. Consequently, comparisons of year to date and quarterly results for the period ended September 30, 2008 to year to date and quarterly results for the period ended September 30, 2007 are affected by the inclusion of FNB's results. The purchase of FNB resulted in an increase in assets of $150,406,000 and an increase in shareholders' equity of $12,711,000.

Results of Operations

For the first nine months of 2008, net income was $1,571,000 and basic and diluted earnings per share were $0.69, compared with net income of $3,129,000 and basic and diluted earnings per share of $1.77 and $1.76, respectively, for the first nine months of 2007. Included in the 2008 results was a $390,000 tax free gain on life insurance proceeds. Negatively impacting income before income taxes for the nine month period of 2008 was a $2,385,000 increase in the provision for loan losses. Over half of the 2008 increase in the provision for loan losses relates to a single large commercial credit in the automotive industry.

Net income for the third quarter of 2008 was $21,000 compared to $1,082,000 for the same period of 2007. Basic and diluted earnings per share decreased from $0.61 for the third quarter of 2007 to $0.01 for the same period of 2008. The Company's provision for loan losses for the third quarter of 2008 was $1,580,000 compared to $145,000 in the third quarter of 2007, a $1,435,000 increase.

---



Return on average assets was .44% for the first nine months of 2008 compared to 1.24% for the first nine months of 2007. Return on average shareholders' equity was 4.56% for the first nine months of 2008, compared to 13.97% for the same period in 2007. Such rates were computed on an annualized basis.

Net Interest Income

The Company derives the greatest portion of its income from net interest income. During 2007, short-term rates were unchanged for the first eight months of the year. Beginning in September of 2007, the Federal Open Market Committee began lowering short-term rates. Through the third quarter of 2008, short-term rates dropped 225basis points. The Company has been able to lower its cost of funds by 95 basis points compared to September 30, 2007, but tax equivalent yields on average assets declined to 6.44% from 7.61% for the same periods, a decline of 117 basis points. This resulted in a decline in the interest rate spread and net interest margin.

The following tables provide information regarding interest income and expense for the nine-month periods ended September 30, 2008 and 2007. Table 1 shows the year-to-date daily average balances for interest earning assets and interest bearing liabilities, interest earned or paid, and the annualized effective rate, for the nine-month periods ended September 30, 2008 and 2007. Table 2 shows the effect on interest income and expense of changes in volume and interest rates. Both tables are on a tax equivalent basis.

Table 1 - Average Balances and Tax Equivalent Interest Rates

|                                                                                 | 2008            |         | 2007     |  
|-------------------------------------------------------------------------------- | --------------- | ------- | -------- | -
|                                                                                 | Average
Balance |         | Interest |  
|ASSETS                                                                           |                 |         |          |  
|Interest earning assets:                                                         |                 |         |          |  
|Loans(1)(2)(3)                                                                   | $               | 335,340 |          | $
|Federal funds sold                                                               |                 | 19,874  |          |  
|Taxable investment securities(4)                                                 |                 | 44,081  |          |  
|Tax-exempt investment
   securities(1)                                           |                 | 24,562  |          |  
|Total interest earning assets                                                    |                 | 423,857 |          |  
|                                                                                 |                 |         |          |  
|Non-interest earning assets:                                                     |                 |         |          |  
|Cash and due from banks                                                          |                 | 11,977  |          |  
|Other assets(5)                                                                  |                 | 49,842  |          |  
|Less allowance for loan losses                                                   |                 | (5,284  | )        |  
|                                                                                 |                 |         |          |  
|Total assets                                                                     | $               | 480,392 |          |  
|                                                                                 |                 |         |          |  
|LIABILITIES AND SHAREHOLDERS' EQUITY                                             |                 |         |          |  
|Interest bearing liabilities:                                                    |                 |         |          |  
|Demand deposits                                                                  | $               | 161,742 |          |  
|Savings deposits                                                                 |                 | 54,391  |          |  
|Time deposits                                                                    |                 | 127,757 |          |  
|Securities sold under agreements to
   repurchase and federal funds
   purchased |                 | 10,091  |          |  
|Other borrowings                                                                 |                 | 13,309  |          |  
|Subordinated debentures                                                          |                 | 5,155   |          |  
|Total interest bearing liabilities                                               |                 | 372,445 |          |  
|                                                                                 |                 |         |          |  
|Non-interest bearing liabilities:                                                |                 |         |          |  
|Demand deposits                                                                  |                 | 55,577  |          |  
|Other                                                                            |                 | 4,818   |          |  
|Common stock subject to
   repurchase obligation                                 |                 | 1,663   |          |  
|Shareholders' equity                                                             |                 | 45,889  |          |  
|Total liabilities and shareholders'
   equity                                    | $               | 480,392 |          |  
|Net interest income                                                              |                 |         |          | $
|Interest rate spread                                                             |                 |         |          |  
|Net yield on interest earning assets                                             |                 |         |          |  

---



|(1) | Includes tax equivalent adjustment of interest (assuming a 34% tax rate) for securities and loans of $369,000 and $103,000, respectively, for 2008 and $237,000 and $43,000, respectively, for 2007.                            
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Average balance includes average non-accrual loan balances of $7,686,000 in 2008 and $3,377,000 in 2007.                                                                                                                        
|(3) | Interest income includes loan fees of $487,000 in 2008 and $262,000 in 2007.                                                                                                                                                    
|(4) | Average balance includes average unrealized gain of $758,000 in 2008 and unrealized loss of ($28,000) in 2007 on available for sale securities. The yield was calculated without regard to this average unrealized gain or loss.
|(5) | Includes $16,382,000 in 2008 and $620,000 in 2007 relating to goodwill and other intangible assets.                                                                                                                             

Table 2 - Changes in Tax-Equivalent Net Interest Income

|                                                                               | Nine Months Ended September 30,
2008 Over 2007
Increase (Decrease) Due To |      
|------------------------------------------------------------------------------ | ------------------------------------------------------------------------- | -----
|                                                                               |                                                                           |      
|Interest income on:                                                            | Volume                                                                    |      
|                                                                               |                                                                           |      
|Loans                                                                          | $                                                                         | 4,537
|Federal funds sold                                                             |                                                                           | 243  
|Taxable investment securities                                                  |                                                                           | 558  
|Tax-exempt investment securities                                               |                                                                           | 409  
|                                                                               |                                                                           |      
|Total interest earning assets                                                  | $                                                                         | 5,747
|                                                                               |                                                                           |      
|Interest expense on:                                                           |                                                                           |      
|                                                                               |                                                                           |      
|Demand deposits                                                                | $                                                                         | 697  
|Savings deposits                                                               |                                                                           | 123  
|Time deposits                                                                  |                                                                           | 725  
|Securities sold under agreements
   to repurchase & federal funds
   purchased |                                                                           | 135  
|Other borrowings                                                               |                                                                           | 308  
|Subordinated debentures                                                        |                                                                           | -    
|                                                                               |                                                                           |      
|Total interest bearing liabilities                                             | $                                                                         | 1,988
|                                                                               |                                                                           |      
|Net interest income                                                            | $                                                                         | 3,759

As shown in Tables 1 and 2, tax-equivalent net interest income increased $2,874,000 in the first nine months of 2008 compared to the same period in 2007. Increases in the average balances primarily resulted from the FNB acquisition. Net interest income decreased $885,000 due to rate changes comparing the nine months of 2008 with the nine months of 2007 on a tax equivalent basis. This decrease is due primarily to the rate decreases described above.

The presentation of net interest income on a tax equivalent basis is not in accordance with generally accepted accounting principles ("GAAP"), but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income on a tax equivalent basis were $472,000 and $280,000 for the nine months ended September 30, 2008 and 2007, respectively. These adjustments were computed using a 34% federal income tax rate.

---



Provision for Loan Losses

The provision for loan losses is based on an analysis of the required additions to the allowance for loan losses. The provision is charged to income to bring the allowance for loan losses to a level deemed appropriate by management. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses in the loan portfolio. Some factors considered by management in determining the level at which the allowance is maintained include specific credit reviews, historical loan loss experience, current economic conditions and trends, results of examinations by regulatory agencies and the volume, growth and composition of the loan portfolio. The provision is adjusted quarterly, if necessary, to reflect changes in the factors above as well as actual charge-off experience and any known losses.

The provision for loan losses was $1,580,000 for the three month period ending September 30, 2008. Specific reserves increased $1,708,000 from June 30, 2008 levels to $3,456,000 at September 30, 2008, net charge-offs totaled $201,000 for the quarter, and non-performing loans increased 12.1% or $1,131,000 from June 30, 2008 levels to $10,449,000 at September 30, 2008. These increases reflect the difficult Michigan economy and the depressed real estate market. All of which contributed to the higher provision. A provision of $145,000 was recorded for the third quarter of 2007.

For the nine month period ending September 30, 2008 the provision for loan losses was $2,730,000 compared to $345,000 for the same period of 2007.

The allowance was 2.07% of total loans at September 30, 2008 compared to 1.53% at December 31, 2007.

Charge-offs and recoveries for respective loan categories for the nine months ended September 30, 2008 and 2007 were as follows:

|                        | 2008        |       | 2007      
|----------------------- | ----------- | ----- | ----------
|                        | Charge-offs |       | Recoveries
|                        |             |       |           
|Commercial              | $           | 495   |           
|Residential real estate |             | 276   |           
|Consumer                |             | 260   |           
|Total                   | $           | 1,031 |           

Net charge-offs in the first nine months of 2008 were $899,000, or 0.36% of average loans on an annualized basis. Net charge-offs in the first nine months of 2007 were $253,000, or 0.13% of average loans on an annualized basis.

Non-interest income

Total non-interest income increased $475,000, or 44.0%, in the third quarter of 2008 compared to the same quarter of last year, and is up 65.8%, or $1,992,000 year to date. The increase is primarily a result of the FNB acquisition which provided $583,000 of non-interest income during the quarter and $1,734,000 for the nine months. In addition, for the nine month period ending September 30, 2008, the Company recorded a $390,000 gain from life insurance proceeds.

Non-interest expense

Total non-interest expense increased $1,559,000, or 49.5%, in the third quarter of 2008 compared to the same quarter of last year, and is up 54.3%, or $5,063,000, year to date. The FNB purchase generated $1,416,000 of the third quarter increase and $4,449,000 year to date. Salary and employee benefits are the Company's largest single area of expense, and for the quarter and nine month period, provided the largest increase, primarily caused by the staffing of FNB. Occupancy, equipment, telecommunication and software maintenance costs also increased for both the three and nine month periods as an additional 8 branch locations were added from FNB. Amortization of

---

other intangibles was $281,000 higher for year to date 2008, as a result of the core deposit amortization from the FNB acquisition.

Federal income taxes

The provision (credit) for federal income taxes for the nine months ended September 30, 2008 and 2007 resulted in a credit of $75,000 in 2008 and a provision of $1,141,000 in 2007. The effective tax rate of 26.7% for 2007 is in line with the Company's normal effective tax rate, which was 25.8% for the full year 2007 and 27.1% for the full year 2006. Because of the significant decline in 2008 income before income taxes, a federal income tax credit resulted for the three and nine-months ended September 30, 2008 after consideration of tax-exempt interest income, non-taxable life insurance income and other normal tax reconciling items.

Financial Condition

The Company's balance sheet decreased 1.5%, or $7,264,000 at September 30, 2008 compared to December 31, 2007.

Securities held for sale

Securities available for sale decreased $12.3 million at September 30, 2008 from December 31, 2007. The Company has elected not to replace some maturing investments to meet anticipated liquidity needs. The Company's portfolio does not have any Fannie Mae or Freddie Mac equity securities or non-agency mortgage backed securities that have been the topic of much recent public discussion. The Company's current and projected tax position continues to make carrying tax-exempt securities beneficial. The investment in local municipal issues also reflects the Company's commitment to the development of the local area through support of its local political subdivisions. Unrealized gains and losses within the investment portfolio are temporary since they are a result of market changes, rather than a reflection of credit quality.

Federal funds sold

Federal funds sold at September 30, 2008 increased $11.6 million as called and maturing investment securities were invested in overnight federal funds to meet liquidity needs.

Nonperforming assets

Nonperforming assets include non-accrual loans, accruing loans past due 90 days or more, and other real estate owned, which includes real estate acquired through foreclosures and deeds in lieu of foreclosure.

A loan generally is classified as non-accrual when full collectibility of principal or interest is doubtful or a loan becomes 90 days past due as to principal or interest, unless management determines that the estimated net realizable value of the collateral is sufficient to cover the principal balance and accrued interest. When interest accruals are discontinued, unpaid interest is reversed. Nonperforming loans are returned to performing status when the loan is brought current and has performed in accordance with contract terms for a period of time.

The following table sets forth the aggregate amount of nonperforming assets in each of the following categories:

---

(Dollars in thousands)

|                                        | 9/30/08 |        | 12/31/07 |   | 9/30/07 |  
|--------------------------------------- | ------- | ------ | -------- | - | ------- | -
|Non-accrual loans:                      |         |        |          |   |         |  
|Commercial, financial and agricultural  | $       | 7,071  |          | $ | 3,032   |  
|Real estate mortgage                    |         | 2,554  |          |   | 1,342   |  
|Installment                             |         | 14     |          |   | 31      |  
|                                        |         | 9,639  |          |   | 4,405   |  
|Loans contractually past due 90 days or |         |        |          |   |         |  
|more and still on accrual:              |         |        |          |   |         |  
|Commercial, financial and agricultural  |         | 349    |          |   | 411     |  
|Real estate mortgage                    |         | 461    |          |   | -       |  
|Installment                             |         | -      |          |   | 18      |  
|                                        |         | 810    |          |   | 429     |  
|                                        |         |        |          |   |         |  
|Total nonperforming loans               |         | 10,449 |          |   | 4,834   |  
|Other real estate owned                 |         | 1,257  |          |   | 866     |  
|                                        |         |        |          |   |         |  
|Total nonperforming assets              | $       | 11,706 |          | $ | 5,700   |  
|Nonperforming loans to total loans      |         | 3.10   | %        |   | 1.44    | %
|Nonperforming assets to total assets    |         | 2.48   | %        |   | 1.19    | %

Nonperforming loans are subject to continuous monitoring by management and estimated losses are specifically allocated for in the allowance for loan losses where appropriate.

In management's evaluation of the loan portfolio risks, any significant future increases in nonperforming loans is dependent to a large extent on the economic environment. In a deteriorating or uncertain economy, such as the Company is faced with today, management applies more conservative assumptions when assessing the future prospects of borrowers and when estimating collateral values. The highly publicized declines in the real estate markets and the economic issues in Michigan and nationally are impacting the Company, resulting in a higher number of loans being classified as nonperforming. Due to the uncertainty in the economy, both nationally and within Michigan, it's management's opinion that nonperforming assets will continue to remain at elevated levels into 2009.

The increase in non-accrual loans at September 30, 2008 is primarily the result of three commercial credits, totaling $5,284,000, being placed on non-accrual, net of the payoff or charge-off of some non-accrual loans. Collection efforts continue with all delinquent borrowers.

Holdings of other real estate owned increased by $391,000 since the end of 2007. Other real estate owned includes properties that were acquired through foreclosure or in lieu of foreclosure. The properties include residential homes and lots as well as commercial properties.

Securities sold under agreements to repurchase

Securities sold under agreements to repurchase decreased $6.0 million or 61.8% as of September 30, 2008 compared to December 31, 2007, as one customer moved $7.0 million to a short term certificate of deposit.

Deposits

Deposits increased $1.6 million at September 30, 2008 compared to December 31, 2007. However, with the $7.0 million moved into a certificate of deposit from the securities sold under agreements to repurchase, all other deposits are down a net $5.4 million. The decrease is primarily in money market accounts and was reflective of normal fluctuations of a few large depositors.

---



Shareholders' equity

Total shareholders' equity at September 30, 2008 increased $663,000 from the year ended December 31, 2007. The increase is attributable to the current year's net income, offset by dividends declared to shareholders, as well as the items described on page 5.

The following table summarizes the Company's capital ratios as of September 30, 2008 and December 31, 2007:

|                               | September 30, 2008 |   | December 31, 2007 |      | Regulatory Minimums
|------------------------------ | ------------------ | - | ----------------- | ---- | -------------------
|Total risk-based capital ratio | 10.9               | % |                   | 10.9 | %                  
|Tier I capital ratio           | 9.7                | % |                   | 9.5  | %                  
|Leverage ratio                 | 8.0                | % |                   | 10.3 | %                  

Liquidity

Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. The subsidiary banks maintain certain levels of liquid assets (the most liquid of which are cash and cash equivalents, federal funds sold and investment securities) in order to meet these demands. Maturing loans and investment securities are the principal sources of asset liquidity.

The subsidiary banks maintain correspondent accounts with a number of other banks for various purposes. In addition, cash sufficient to meet the operating needs of its branches is maintained at its lowest practical levels. At times, the subsidiary banks are a participant in the federal funds market. Federal funds are generally borrowed or sold for one-day periods. The subsidiary banks have available credit arrangements at September 30, 2008 enabling them to purchase up to $24,000,000 in federal funds should the need arise.

The Company's principal source of funds to pay cash dividends is the earnings and dividends paid by its subsidiary banks. The Company also has available $3,000,000 at September 30, 2008 on a revolving line of credit for general working capital purposes.

Impact of Inflation and Changing Prices

The majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Another significant effect of inflation is on other expenses, which tend to rise during periods of general inflation.

|Item 4T. | Controls and Procedures
|-------- | -----------------------

An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of September 30, 2008. Based on and as of the time of that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report.

There was no change in the Company's internal control over financial reporting that occurred during the three months ended September 30, 2008 that has materially affected, or that is reasonably likely to materially affect, the Company's internal control over financial reporting.

---



Part II.  Other Information

|Item 1A. | Risk Factors
|-------- | ------------

Information concerning risk factors is contained in the section entitled "Risk Factors" in Southern Michigan Bancorp, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission on March 28, 2008. As of the date of this report, Southern does not believe that there has been a material change in the nature or categories of the Company's risk factors, as compared to the information disclosed in the Company's Annual Report on Form 10-K.

|Item 6. | Exhibits
|------- | --------

| |  | Exhibits.  The following exhibits are filed as part of this report on Form 10-Q:
| |  | --------------------------------------------------------------------------------

| | ExhibitNumber |  | Document                                                                                                                                                                                                                                                                                                                                 
| | ------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 2             |  | Agreement and Plan of Merger between Southern Michigan Bancorp, Inc. and FNB Financial Corporation, dated April 17, 2007. Previously filed with the Commission on September 28, 2007 in Southern Michigan Bancorp Inc.'s Amendment No. 2 to Form S-4 Registration Statement, Exhibit 2. Here incorporated by reference.                  
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 3.1           |  | Articles of Incorporation of Southern Michigan Bancorp, Inc., as amended. Previously filed with the Commission on September 28, 2007 in Southern Michigan Bancorp Inc.'s Amendment No. 2 to Form S-4 Registration Statement, Exhibit 3.1. Here incorporated by reference.                                                                
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 3.2           |  | Amended and Restated Bylaws of Southern Michigan Bancorp, Inc., as amended. Previously filed with the Commission on September 28, 2007 in Southern Michigan Bancorp Inc.'s Amendment No. 2 to Form S-4 Registration Statement, Exhibit 3.2. Here incorporated by reference.                                                              
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 4.1           |  | Selected provisions of Articles of Incorporation of Southern Michigan Bancorp, Inc., as amended. See Exhibit 3.1.                                                                                                                                                                                                                        
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 4.2           |  | Selected provisions of Amended and Restated Bylaws of Southern Michigan Bancorp, Inc., as amended. See Exhibit 3.2.                                                                                                                                                                                                                      
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 4.3           |  | Long-Term Debt. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the Securities and Exchange Commission upon request.
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 10            |  | Separation Agreement between Southern Michigan Bancorp, Inc. and Richard E. Dyer.                                                                                                                                                                                                                                                        
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 31.1          |  | Certification of Chairman of the Board and Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                  
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 31.2          |  | Certification of Senior Vice President, Chief Financial Officer, Secretary and Treasurer under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                            
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 32            |  | Certification pursuant to 18 U.S.C. § 1350.                                                                                                                                                                                                                                                                                              

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Signatures

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

|                         | SOUTHERN MICHIGAN BANCORP, INC.                                                                                                                           
|------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|                         |                                                                                                                                                           
|                         |                                                                                                                                                           
|Date:  November 14, 2008 | By: /s/ John H. Castle                                                                                                                                    
|                         | John H. Castle
      Chairman of the Board and Chief Executive Officer
      (Principal Executive Officer)                                                
|                         |                                                                                                                                                           
|                         |                                                                                                                                                           
|Date:  November 14, 2008 | By: /s/ Danice L. Chartrand                                                                                                                               
|                         | Danice L. Chartrand
      Senior Vice President, Chief Financial
      Officer, Secretary and Treasurer
      (Principal Financial and Accounting Officer)

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Exhibit Index

| | ExhibitNumber |  | Document                                                                                                                                                                                                                                                                                                                                 
| | ------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 2             |  | Agreement and Plan of Merger between Southern Michigan Bancorp, Inc. and FNB Financial Corporation, dated April 17, 2007. Previously filed with the Commission on September 28, 2007 in Southern Michigan Bancorp Inc.'s Amendment No. 2 to Form S-4 Registration Statement, Exhibit 2. Here incorporated by reference.                  
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 3.1           |  | Articles of Incorporation of Southern Michigan Bancorp, Inc., as amended. Previously filed with the Commission on September 28, 2007 in Southern Michigan Bancorp Inc.'s Amendment No. 2 to Form S-4 Registration Statement, Exhibit 3.1. Here incorporated by reference.                                                                
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 3.2           |  | Amended and Restated Bylaws of Southern Michigan Bancorp, Inc., as amended. Previously filed with the Commission on September 28, 2007 in Southern Michigan Bancorp Inc.'s Amendment No. 2 to Form S-4 Registration Statement, Exhibit 3.2. Here incorporated by reference.                                                              
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 4.1           |  | Selected provisions of Articles of Incorporation of Southern Michigan Bancorp, Inc., as amended. See Exhibit 3.1.                                                                                                                                                                                                                        
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 4.2           |  | Selected provisions of Amended and Restated Bylaws of Southern Michigan Bancorp, Inc., as amended. See Exhibit 3.2.                                                                                                                                                                                                                      
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 4.3           |  | Long-Term Debt. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the Securities and Exchange Commission upon request.
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 10            |  | Separation Agreement between Southern Michigan Bancorp, Inc. and Richard E. Dyer.                                                                                                                                                                                                                                                        
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 31.1          |  | Certification of Chairman of the Board and Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                  
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 31.2          |  | Certification of Senior Vice President, Chief Financial Officer, Secretary and Treasurer under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                            
| |               |  |                                                                                                                                                                                                                                                                                                                                          
| | 32            |  | Certification pursuant to 18 U.S.C. § 1350.