Pavilion Bancorp (PVLN) 10-K 2005 FY Annual report

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

FORM 10-K

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

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

For the fiscal year ended December 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to ________

Commission file number 000-30521

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

Michigan
(State or other jurisdiction of
Incorporation or organization)

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


49221
(Zip Code)

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

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

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [__] No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [__] No [X]

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [X]

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

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

-1-

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

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

Aggregate Market Value as of June 30, 2005: $38,975,087

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

Common stock outstanding at March 10, 2006: 736,765 shares.

Documents Incorporated by Reference

Portions of the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held April 20, 2006 are incorporated by reference into Parts II and III of this report.

-2-

Item 1. Business.

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

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

        The principal markets for financial services are the southern-Michigan communities in which the Bank is located and the areas immediately surrounding these communities. The Bank serves these markets through 8 locations in or near their communities. The Bank does not have any material foreign assets or income.

        The principal source of revenue is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 77% of total revenue in 2005 compared to 75% in 2004.

        The Bank’s principal competitors are United Bank & Trust, Key Bank, Sky Bank, Standard Federal Bank, and TLC Community Credit Union. With the exception of United Bank & Trust and TLC Community Credit Union, each of these financial institutions has headquarters in larger metropolitan areas. Generally, the Bank’s competitors have significantly greater assets and financial resources than the Company. Based on deposit information as of June 30, 2005, the Bank of Lenawee holds an estimated 20.48% of the FDIC insured deposits in Lenawee County. Information as to asset size of competitor financial institutions is derived from publicly available reports filed by and with regulatory agencies.

SUPERVISION AND REGULATION

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

General

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

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

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

-3-

The Company

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

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

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

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

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

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

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

-4-

        Capital Requirements. The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.

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

        The risk-based and leverage standards presently used by the Federal Reserve Board are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. The Federal Reserve Board has not advised the Company of any specific minimum Tier 1 Capital leverage ratio applicable to it.

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

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

The Bank

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

        Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, based upon their respective levels of capital and results of supervisory evaluation. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.

        In early 2006, Congress passed the Federal Deposit Insurance Reform Act of 2005, which made certain changes to the Federal deposit insurance program. These changes included merging the BIF and the Savings Association Insurance Fund (the “SAIF”), increasing retirement account coverage to $250,000 and providing for inflationary adjustments to general coverage beginning in 2010, providing the FDIC with authority to set the fund’s reserve ratio within a specified range, and requiring dividends to banks if the reserve ratio exceeds certain levels. The new statute grants banks an assessment credit based on their share of the assessment base on December 31, 1996, and the amount of the credit can be used to reduce assessments in any year subject to certain limitations. The FDIC is required to issue regulations implementing the new Act.

-5-

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

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

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

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

	Total Risk-Based Capital Ratio	Tier 1 Risk-Based Capital Ratio	Leverage Ratio
Well capitalized	10% or above	6% or above	5% or above
Adequately capitalized	8% or above	4% or above	4% or above
Undercapitalized	Less than 8%	Less than 4%	Less than 4%
Significantly undercapitalized	Less than 6%	Less than 3%	Less than 3%
Critically undercapitalized	--	--	A ratio of tangible equity to total assets of 2% or less

        As of December 31, 2005, the Bank’s ratios exceeded minimum requirements for the well capitalized category.

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

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

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

-6-

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

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

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

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

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

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

        Banks may establish interstate branch networks through acquisitions of other banks. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed only if specifically authorized by state law.

        Michigan permits both U.S. and non-U.S. banks to establish branch offices in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the Michigan Office of Financial and Insurance Services, Division of Financial Institutions, (1) acquisition of Michigan banks by FDIC-insured banks, savings banks or savings and loan associations located in other states, (2) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) consolidation of Michigan banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, (4) establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (5) establishment by foreign banks of branches located in Michigan.

-7-

Item 1A. Risk Factors.

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

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

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

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

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

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

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

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

-8-

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

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

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

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

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

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

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

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

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

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

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

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

-9-

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

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

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

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

Item 1B. Unresolved Staff Comments.

        Not applicable.

Item 2.Properties.

        The Bank of Lenawee’s main office is located in Adrian and it serves other communities with branch offices in Hudson, Morenci, Tecumseh and Waldron. The Bank’s offices are located throughout Lenawee County and in the southeastern portion of Hillsdale County. The area in which the Bank’s offices are located, which is basically southeastern Michigan, has historically been rural in character but now has a growing urban population as residents choose the area to live in while commuting to Ann Arbor, Detroit, and Toledo. According to the 2000 U.S. Census, the populations of the cities in which the Bank’s offices are located were as follows: Adrian—21,574; Hudson—2,499; Morenci—2,398; Tecumseh—8,574; and Waldron—590; The main office of Bank of Lenawee is a three story 40,768 square foot building constructed in 1906. The Bank’s other offices range in size from 1,200 square feet to 4,000 square feet. With the exception of one branch, all of the offices of Bank of Lenawee are owned.

        The Bank is in the process of rebuilding a branch office in Hudson, Michigan. This reconstruction is expected to be completed in April of 2006.

Item 3. Legal Proceedings.

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

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

        No matters were submitted to a vote of the Company’s security holders during the fourth quarter of 2005.

Additional Item: Executive Officers of Registrant

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

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

-10-

        Richard J. DeVries (age 50) was appointed to the Board of Directors of the Company and was promoted to President and Chief Executive Officer of the Company on December 10, 2004. Mr. DeVries joined the Company as the President and CEO of Bank of Lenawee in July 2003 and continues to serve in that capacity. Prior to joining the Company and Bank of Lenawee, Mr. DeVries had over 20 years of senior bank management experience including the positions of Community President at Bank One and was asked to remain on as Community President when Bank One was acquired by Citizens Bank in Ypsilanti, Michigan.

        Douglas L. Kapnick (age 62) was elected Chairman of the Board of the Company in September of 2000 and has been a director of Bank of Lenawee since 1982 and has been a director of the holding company since it was formed in 1993. Mr. Kapnick is President of Kapnick & Company, a full service insurance broker with offices in Adrian and Southfield employing a total of approximately 85 persons.

        Pamela S. Fisher (age 56) is the Corporate Secretary of the Company and Executive Vice President and Chief Operating Officer of the Bank of Lenawee. Ms. Fisher joined the Bank of Lenawee in 1979 and has served the Bank in various capacities. She was elected as Executive Vice President of Bank of Lenawee in 2004 and was elected Secretary of the Company in 1995.

        Mark D. Wolfe (49) is the Company’s Controller and Vice President of the Bank of Lenawee. He acted as Interim Chief Financial Officer from March 7, 2005 through January 15, 2006. He was appointed to serve as Chief Financial Officer of the Company on March 3, 2006, in connection with the resignation of Ryan C. Luttenton, who resigned as the Company’s Chief Financial Officer effective March 3, 2006. Prior to joining the Bank in 2001, Mr. Wolfe held the positions of Chief Financial Officer at Herrick Memorial Hospital in Tecumseh, Michigan and Chief Information Officer at Lenawee Health Alliance in Adrian, Michigan.

        Ryan C. Luttenton (age 32) served as the Company’s Chief Financial Officer from January 16, 2006 until March 3, 2006, when he resigned from such position.

PART II

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

        The information under the caption “COMMON STOCK DATA” of the Company’s 2005 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

Item 6.Selected Financial Data.

        The information under the caption “SELECTED FINANCIAL DATA” of the Company’s 2005 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

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

        The information under the captions “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of the Company’s 2005 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

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

        The information under the captions “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of the Company’s 2005 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

-11-

Item 8. Financial Statements and Supplementary Data.

        The Company’s consolidated financial statements, accompanying notes and report of independent auditors included in the Company’s 2005 Annual Report to shareholders, is incorporated herein by reference to Exhibit 13.

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

        None

Item 9A. Controls and Procedures.

        (a)        Evaluation of Disclosure Controls and Procedures.

        The Company’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15(d)-15(e)) as of the end of the period covered by this report, have concluded that as of December 31, 2005, the Company’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company would be made known to them by others within the Company, particularly during the period in which this Form 10-K Annual Report was being prepared.

        (b)        Changes in Internal Controls.

        During the quarter ended December 31, 2005, there were no significant changes in the Company’s internal controls over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

Item 9B. Other Information.

        None

PART III

Item 10. Directors and Executive Officers of the Registrant.

        Information with respect to the Company’s executive officers is included in this report in Part I. The information with respect to directors of the Company, set forth under the caption “INFORMATION ABOUT DIRECTORS AND DIRECTOR NOMINEES” in the Company’s definitive proxy statement, as filed with the Commission and dated March 20, 2006, relating to the April 20, 2006 Annual Meeting of Shareholders, is incorporated herein by reference.

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

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

Item 11. Executive Compensation.

        The information set forth under the caption “COMPENSATION OF EXECUTIVE OFFICERS,” in the Company’s definitive proxy statement, as filed with the Commission and dated March 20, 2006, relating to the April 20, 2006 Annual Meeting of Shareholders, is incorporated herein by reference.

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

        The information set forth under the caption “VOTING SECURITIES AND BENEFICIAL OWNERSHIP BY MANAGEMENT AND OTHERS” in the Company’s definitive proxy statement, as filed with the Commission and dated March 20, 2006, relating to the April 20, 2006 Annual Meeting of Shareholders, is incorporated herein by reference.

-12-

        Securities Authorized for Issuance Under Equity Compensation Plans.The Company had the following equity compensation plans at December 31, 2005:

EQUITY COMPENSATION PLAN INFORMATION

Plan Category	Number of securities to be issued upon exercise of outstanding options (1)	Weighted-average exercise price of outstanding options (2)	Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (1)) (3)
Equity compensation
plans approved by
security holders	30,791	$45.56	16,481
Equity compensation
plans not approved by
security holders	None	None	None
Total	30,791	$45.56	16,481

These equity compensation plans are more fully described in Note 11 to the Consolidated Financial Statements.

Item 13. Certain Relationships and Related Transactions.

        The information set forth under the caption “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” in the Company’s definitive proxy statement, as filed with the Commission and dated March 20, 2006, relating to the April 20, 2006 Annual Meeting of Shareholders, is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services.

        The information set forth under the heading “RELATIONSHIP WITH INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS — Fees of Independent Accountants” in the Company’s definitive proxy statement, as filed with the Commission and dated March 20, 2006, relating to the April 20, 2006 Annual Meeting of Shareholders, is incorporated hereby in reference.

Item 15. Exhibits and Financial Statement Schedules.

(a) 1. Financial Statements

The following consolidated financial statements of the Company and Reports of Plante & Moran, PLLC and Crowe Chizek and Company LLC, Independent Registered Public Accounting Firm, are incorporated by reference under Item 8 “Financial Statements and Supplementary Data” of this Form 10-K:
      Consolidated Balance Sheets
      Consolidated Statements of Income
      Consolidated Statements of Changes in Shareholders’ Equity
      Consolidated Statements of Cash Flows
      Notes to Consolidated Financial Statements
      Reports of Plante & Moran, PLLC and Crowe Chizek and Company LLC,
      Independent Registered Public Accounting Firm

2. Financial Statement Schedules
Not applicable

3. Exhibits (Numbered in accordance with Item 601 of Regulation S-K)
The Exhibit Index is located on the final page of this report on Form 10-K.

-13-

SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, dated March 20, 2006.

PAVILION BANCORP, INC.


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

/s/ Mark D. Wolfe
——————————————
Mark D. Wolfe
Chief Financial Officer

        Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed on March 20, 2006 by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Each director of the Registrant, whose signature appears below, hereby appoints Richard J. DeVries and Mark D. Wolfe, and each of them severally, as his or her attorney-in-fact, to sign in his or her name and on his or her behalf, as a director of the Registrant, and to file with the Commission any and all Amendments to this Report on Form 10-K.

Signatures

/s/ Richard J. DeVries
——————————————
Richard J. DeVries

——————————————
Fred R. Duncan

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

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

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

/s/ Terence R. Sheehan
——————————————
Terence R. Sheehan

——————————————
J. David Stutzman

——————————————
Marinus VanOoyen

-14-

EXHIBIT INDEX

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

Exhibit
Number

13 Rule 14a-3 2005 Annual Report to Shareholders (this report, except for those portions which are expressly incorporated by reference in this filing, is furnished for the information of the Securities and Exchange Commission and is not deemed “filed” as part of this filing).

21 Subsidiaries of Registrant

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

23.2 Consent of Crowe Chizek and Company LLC - Registered Public Accounting Firm.

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

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

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

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

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

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

Exhibit
Number

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

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

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

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

10 2001 Stock Option Plan, incorporated by reference to Appendix A to the Registrant’s Definitive Proxy Statement filed with respect to its April 18, 2001 annual meeting of shareholders.

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

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

-15-