UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-K





ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT
OF 1934

For the fiscal year ended December 31, 2007

Commission file number: 000-23847





SHORE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|VIRGINIA                                                       |  | 54-1873994                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

25020 Shore Parkway, Onley, Virginia 23418

(Address of principal executive offices) (Zip code)

Registrants telephone number, including area code: (757) 787-1335





Securities registered
pursuant to Section 12(b) of the Act:



|                               |  |                                          
|------------------------------ |  | -----------------------------------------
|Title of Each Class            |  | Name of Each Exchange on Which Registered
|Common Stock, $0.275 par value |  | The NASDAQ Stock Market LLC              
|                               |  | (NASDAQ Global Market)                   

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





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 in response 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 amendment to this Form 10-K.  x

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.

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

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

On June 30, 2007, the aggregate market value of the 2,108,615 shares of Common Stock of the registrant outstanding on such date, excluding shares
held by affiliates of the registrant, was approximately $28.7 million. This figure is based on the closing price of $13.59 per share of the registrants Common Stock on June 30, 2007.

The number of shares outstanding of the registrants common stock as of March 5, 2008.



|                               |  |                             
|------------------------------ |  | ----------------------------
|Class                          |  | Outstanding at March 5, 2008
|Common Stock, $0.275 par value |  | 2,504,479                   









---

This Form 10-K, including information incorporated by reference into this Form 10-K, contains certain forward-looking
statements. For this purpose any statements contained in this Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as may, will,
expect, believe, anticipate, estimate or continue or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks
and uncertainties, and actual results may differ materially depending on a variety of factors.

PART I

Item 1.

BUSINESS

General

Shore Financial Corporation (the
Company) is a Virginia corporation organized in September 1997 by Shore Bank (the Bank) for the purpose of becoming a unitary holding company of the Bank. The Companys assets primarily consist of its investment in the
Bank and approximately $5.0 million in cash and other investments. The business and management of the Company consists of the business and management of the Bank. The Bank is a Virginia chartered Federal Reserve member commercial bank that began
business in 1961. The Company and the Bank are headquartered in Onley, Virginia.

The Bank operates out of a 19,000 square foot
headquarters and operations facility and delivers its banking services through eight full-service banking centers and two investment offices located on the Eastern Shore of Virginia and Maryland, including the counties of Accomack and Northampton in
Virginia and the Pocomoke City/Worcester County and Salisbury/Wicomico County market areas in Maryland. The Bank has a 22.6% market share of the banking deposits in the Accomack and Northampton Counties in Virginia and 3.1% of the market share in
Wicomico County, Maryland, based on June 30, 2007 deposit information. The Pocomoke facility opened during September 2007 and, therefore, did not factor into the June 2007 deposit data. However, as of December 31, 2007, the Pocomoke
facility had deposits totaling $4.0 million, which would represent 3.2% of the Pocomoke City deposit market as of June 30, 2007 on a pro forma basis. At December 31, 2007, the Company had consolidated assets of $266.7 million, Bank
deposits of $196.6 million and stockholders equity of $27.7 million. Ninety-six dedicated employees staff the Companys facilities.

The Bank offers a full menu of banking products and services in the communities it serves. For business customers, the Bank offers checking, cash management, remote deposit capture, credit card merchant services, internet banking and a
variety of loan options, including operating lines of credit, equipment loans and real estate loans. The Bank is a leading real estate lender in its Virginia markets. For consumers, the Bank offers a totally free checking account, along with
telephone and internet banking services, check cards, free use of the Banks twenty-two ATMs and a full compliment of retail banking products. The Bank has a mortgage banking division that offers a wide variety of residential loans that are
originated on a pre-sold basis. The Bank does not securitize these loans.

The Company also offers other services that complement the core
financial services offered by the Bank. The Banks subsidiary, Shore Investments, Inc. (Shore Investments), provides non-deposit investment products including stocks, bonds, mutual funds, and insurance products through its two
locations and the Banks eight banking centers. An investment officer with over sixteen years of experience in the investment brokerage field manages Shore Investments Virginia office, while a Certified Financial Planner is the



2



---

investment officer in its Maryland office. Shore Investments has also invested in a Virginia title insurance agency, Bankers Title, LLC, that enables the
Bank to offer title insurance policies to its real estate loan customers.

On January 8, 2008, the Company entered into an Agreement
and Plan of Merger (the Merger Agreement) with Hampton Roads Bankshares, Inc. (HRB). The Merger Agreement sets forth the terms and conditions of HRBs acquisition of the Company through the merger of the Company with and
into HRB (the Merger). Shore Bank, a wholly-owned subsidiary of the Company, will become a wholly-owned subsidiary of HRB in the Merger and will operate separately from the Bank of Hampton Roads, a wholly-owned subsidiary of HRB.

Market Area

The Banks
headquarters/operations center and five banking centers are located in Accomack and Northampton Counties, which together form the Eastern Shore of Virginia. These two counties run approximately seventy miles from the Maryland state line south and
have thousands of miles of coastline on the Chesapeake Bay and its tributaries on the west and the Atlantic Ocean on the east. They represent the southern portion of the Delmarva (Delaware-Maryland-Virginia) Peninsula.

The Eastern Shore of Virginia is 20 miles by bridge and tunnel from Hampton Roads, Virginia (Norfolk, Virginia Beach, Chesapeake, Portsmouth, Hampton,
Suffolk), one of the largest population centers in the country. Tourism and agriculture, along with poultry and seafood processing are the predominant industries on the Eastern Shore.

Northamption County, Virginia has experienced significant development in recent years, especially on the southern end of the county. A planned-unit
development named Bay Creek opened in spring 2001 that includes a 3,000-unit gated community and two golf courses designed by golf legends Arnold Palmer and Jack Nicklaus.

Accomack County, Virginia is the home of NASAs Wallops Island Space Facility and the Regional Space Port Authority, as well as the tourist
destinations of Chincoteague Island and the Assateague National Wildlife Refuge that draw over one million visitors annually. Until the recent slowdown in real estate activity, residential development was vibrant in Accomack County and is expected
to continue in coming years. The space flight facility has recently had several successful rocket launches and plans exist for future launches and growth. Additionally, plans and funding initiatives have began for a Wallops Research Park that will
house commercial operations that support the space flight facility as well as Basys, a company that retrofits large aircraft for private use and employs over one hundred people.

The Bank also has two banking centers in Salisbury, Maryland, the crossroads of the Delmarva Peninsula. Salisbury is the regional hub for industry,
commerce, health care, recreation and the arts and is home to Perdue Farms, Peninsula Regional Medical Center, and Salisbury University, as well as a vibrant microwave and wireless communications industry. Along with a strong and diversified
industrial base, wholesalers, retailers, and service firms serving ten counties in three states have made Wicomico County a regional supply center for the Eastern Shore of Delaware, Maryland, and Virginia.

During 2007, the Bank opened its eighth banking location in Pocomoke City, Maryland. Pocomoke is located in Worcester County, Maryland on the
Maryland-Virginia border. It represents a new banking market for the Company that provides growth opportunities from the ever expanding Ocean City/Snow Hill markets and the bordering county of Somerset. Additionally, the branch serves the
Banks customers located in northern Accomack County and allows the Bank to expand its customer base in this area. Since its opening in late September 2007, growth in the branch has exceeded expectations.



3



---

Competition

In its market area, the Bank competes with regional commercial banks and independent community banks with multiple offices on the Eastern Shore. These and certain other non-bank competitors have greater financial resources, diversified
markets, and branch networks than the Bank and may be able to offer similar services at varying costs with higher lending limits. With nationwide banking, the Bank also faces the prospect of additional competitors entering its market area.

The Bank faces strong competition both in originating loans and in attracting deposits. Competition in originating loans comes primarily
from commercial banks and mortgage lenders and to a lesser extent consumer finance companies, credit unions, and savings institutions. The Bank competes for loans principally on the basis of the quality of service it provides to borrowers, the
interest rates and loan fees it charges and the types of loans it originates.

The Bank faces substantial competition in attracting
deposits from other banks, money market and mutual funds, credit unions, insurance companies and brokerage houses. The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the
requirements of investors as to rate of return, liquidity, risk, convenience and other factors. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, having convenient business hours and by marketing
the service it provides as the only locally-owned independent bank on the Eastern Shore of Virginia, one of four in Salisbury/Wicomico, Maryland and one of five in Pocomoke/Worcester, Maryland.

Credit Policies

The principal risk associated with
each of the categories of loans in the Banks portfolio is the creditworthiness of its borrowers. Within each category, such risk is increased or decreased, depending on prevailing economic conditions. The Bank employs extensive written
policies and procedures to mitigate credit risk. The loan portfolio is managed under a specifically defined credit process. This process includes formulation of portfolio management strategy, guidelines for underwriting standards and risk
assessment, procedures for ongoing identification and management of credit deterioration, and regular portfolio reviews to estimate loss exposure and to ascertain compliance with the Banks policies.

In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities that are disclosed but not reflected in
its annual financial statements, including commitments to extend credit. At December 31, 2007, commitments to extend credit totaled $50.3 million.

One-to-Four Family Residential Real Estate and Land Lending. The Banks primary lending program has been the origination of loans secured by one-to-four family residences and land, virtually all of
which are located in its market area. At December 31, 2007, one-to-four family real estate and land loans aggregated $119.9 million or 54.1% of the Banks gross loans. The Bank evaluates both the borrowers ability to make principal
and interest payments and the value of the property that will secure the loan. Federal law permits the Bank to make loans in amounts of up to 100% of the appraised value of the underlying real estate. Generally, loans are made with a loan to value
up to 90% for conventional mortgage loans on primary residences. The Bank generally originates mortgage loans that have an adjustable rate feature in which the rate changes every one, three or five years, but also offers some fifteen and thirty year
fixed rate residential mortgages. Most adjustable rate loans are tied to comparable maturity U.S. Treasury Bills. Where loans are not indexed, they generally have a balloon feature. Additionally, the Bank offers conforming fixed rate mortgages
through its mortgage banking division. There are unquantifiable risks resulting from potential increased costs to the borrower as a result of



4



---

repricing. Accordingly, it is possible that, during periods of rising interest rates, the risk of defaults on adjustable rate mortgages (ARMs)
may increase due to the upward adjustment of interest costs to borrowers.

Construction Lending. The Bank makes local
construction loans, primarily residential and small commercial loans. The construction loans are secured by the property for which the loan was obtained. At December 31, 2007, construction loans outstanding were $5.5 million or 2.5% of gross
loans. The average life of a construction loan is less than twelve months and they either reprice daily based on the prime rate or are fixed during the construction period.

Commercial Real Estate Lending. The Bank also originates commercial real estate loans. Various types of commercial real estate secure these
loans, including multifamily residential buildings, commercial buildings and offices, and raw land used for development. At December 31, 2007, commercial real estate loans aggregated $69.4 million or 31.3% of the Banks gross loans. The
interest rates on commercial real estate loans are usually fixed for 1 to 5 years, generally amortize over 5 to 25 years and may have a call provision. The Banks commercial real estate loans are secured by properties in its market area.

In its underwriting of commercial real estate, the Bank may lend, under federal regulation, up to 100% of the security propertys
appraised value, although the Banks loan to appraised value ratio on such properties is 80% or less in most cases. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real
estate loans may involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation
of a business or a real estate project and thus may be subject to adverse conditions in the real estate market or in the economy generally. The Banks commercial real estate loan underwriting criteria require an examination of debt service
coverage ratios, the borrowers creditworthiness and prior credit history and reputation, and the personal guarantees or endorsements of borrowers.

Commercial Loans. At December 31, 2007, commercial loans aggregated $9.2 million or 4.2% of the Banks gross loans. Commercial business loans generally have a higher degree of risk than
residential mortgage loans, but have commensurably higher yields. To manage these risks, the Bank generally secures appropriate collateral and carefully monitors the financial condition of its large commercial exposures. Commercial business loans
typically are made on the basis of the borrowers ability to make repayment from the cash flow generated by its business and are often secured by business assets, such as accounts receivable, equipment and inventory. As a result, the
availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral for commercial business loans may depreciate over time and cannot be appraised with as
much precision as residential real estate. The Bank has a credit review and monitoring system to regularly review the cash flow and collateral of commercial borrowers.

Consumer Lending. The Bank offers various secured and unsecured consumer loans, including unsecured personal loans and lines of credit, home equity lines of credit, automobile loans, deposit account
loans and installment and demand loans. At December 31, 2007, the Bank had consumer loans of $17.7 million or 8.0% of gross loans. Such loans are generally made to customers with whom the Bank has a preexisting relationship and are generally in
amounts of under $200,000. The Bank originates virtually all of its consumer loans in its market area

Consumer loans may entail greater
risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured, such as lines of credit, or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed



5



---

collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrowers continuing financial
stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit
the amount which can be recovered on such loans.

Employees

At December 31, 2007, the Company had 87 full-time and 9 part-time employees. The Company considers relations with its employees to be good.

Regulation and Supervision

Set forth below is a brief description of certain laws and regulations
that relate to the regulation of the Company and the Bank. The descriptions of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, do not purport to be complete and are qualified in their entirety
by reference to applicable laws and regulations.

The Company

General. The Company, as a bank holding company, is subject to regulation under the Bank Holding Company Act of 1956 (the BHCA) and the regulation, supervision and examination requirements of
the Board of Governors of the Federal Reserve System (the Federal Reserve). Bank holding companies are subject to extensive regulation by the Federal Reserve as set forth in Regulation Y, 12 C.F.R. Part 225. Regulation Y establishes the
registration, reporting, examination, applications, acquisitions, control and divestiture, change in bank control, appraisals, and change in director and senior executive officers requirements applicable to bank holding companies. Regulation Y and
the interpretations and rulings issued by the Federal Reserve thereunder identify various prohibited non-banking activities in which bank holding companies and their subsidiaries may not engage as well as various exempt activities in which a bank
holding company and its subsidiaries may engage either with or, in some cases, without prior Federal Reserve approval. Regulation Y further confirms the authority of the Federal Reserve under the BHCA to impose criminal and civil penalties for
violations of the BHCA and the regulations and orders issued thereunder and to issue cease and desist orders when necessary in connection therewith.

Activities Obligations and Restrictions. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries that are designed to reduce
potential loss exposure to the depositors of the depository institutions and to the Federal Deposit Insurance Corporation (FDIC) insurance funds. For example, under a policy of the Federal Reserve with respect to bank holding company
operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy.

Banking laws also provide that amounts received from the liquidation or other resolution of any insured depository institution by any
receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or stockholder. This
provision would give depositors a preference over general and subordinated creditors and stockholders in the event a receiver is appointed to distribute the asset of any bank or savings bank subsidiaries.



6



---

Exchange Act.The Company is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934, as amended (the Exchange Act), including the filing of annual, quarterly and other reports with the Securities and Exchange Commission (the SEC). As an Exchange Act reporting company, the
Company is directly affected by the Sarbanes-Oxley Act of 2002 and the rules and regulations enacted pursuant thereto (the SOX Act), the corporate responsibility and accounting reform legislation signed into law on July 30, 2002.

The Bank

General. As a state chartered commercial bank, the Bank is subject to regulation, supervision and examination requirements of the Bureau of Financial Institutions of the Virginia State Corporation Commission
(SCC). The Bank is also subject to the regulation, supervision and examination requirements of the Federal Reserve and the FDIC. State and federal laws also govern the activities in which the Bank may engage, the investments it may make
and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Banks operations. The Federal Reserve and the SCC conduct periodic examinations to test the Banks
compliance with various regulatory requirements. The SCC completed its most recent examination in March 2007, while the Federal Reserve completed a compliance examination of the Bank during November 2002 and a safety and soundness examination during
April 2005. Federal and state laws preclude the Bank from disclosing the results of these examinations.

Insurance of
Accounts. The FDIC insures the deposits of the Bank up to the limits set forth under applicable law. On February 15, 2006, federal legislation to reform federal deposit insurance was enacted. The new law merged the old Bank Insurance
Fund and Savings Association Insurance Fund into the single Deposit Insurance Fund (the DIF). On November 2, 2006, the FDIC adopted final regulations establishing a risk-based assessment system that is intended to more closely tie
each banks deposit insurance assessments to the risk it poses to the DIF. Under the new risk-based assessment system, which became effective in the beginning of 2007, the FDIC evaluates each banks risk based on three primary factors:
(1) its supervisory rating, (2) its financial ratios, and (3) its long-term debt issuer rating, if the bank has one. The new rates for most banks will vary between five and seven cents for every $100 of domestic deposits.

Applied to the Banks assessment base of approximately $202.9 million, this translates to an annual deposit premium estimated to be between
$101,500 and $142,000. Most banks, including Shore Bank, have not been required to pay any deposit insurance premiums since 1995. As part of the reform, Congress provided credits to institutions that paid high premiums in the past to bolster the
FDICs insurance reserves. As a result, according to the FDIC, the majority of banks had assessment credits to initially offset all of their premiums in 2007. The assessment credit for the Bank was calculated at $126,900. The assessment credit
was not recognized up front, but has been recognized as a reduction in deposit premiums that would otherwise have been due. At December 31, 2007, the Company had $48,000 of this credit remaining to offset future deposit insurance premiums. The
Company anticipates this credit to continue offsetting premiums through the second quarter of 2008, after which it will begin incurring quarterly premiums of approximately $25,000 based on the Banks December 2007 assessment base. The level of
annual deposit premiums is dependent on the amount of the Banks deposit assessment base.

Check 21. On October 28,
2003, President Bush signed into law the Check Clearing for the 21st Century Act, also known as Check 21. Check 21 gives substitute checks, such as a digital image of a check and copies made from that image, the same legal standing as
the original paper check. Some of the major provisions of Check 21 include:



7



---

| |  |  | allowing check truncation without making it mandatory;
| | - |  | ------------------------------------------------------



| |  |  | demanding that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their rights under
the law;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | legalizing substitutions for and replacements of paper checks without agreement from consumers;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and
demonstrate that the account debit was accurate and valid; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | requiring recrediting of funds to an individuals account on the next business day after a consumer proves that the financial institution has erred.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------

This legislation will likely affect bank capital spending as many financial institutions assess whether technological or
operational changes are necessary to stay competitive and take advantage of the new opportunities presented by Check 21.

Regulatory
Capital Requirements. The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Generally, the Company and the Bank are required to maintain a minimum ratio of total
capital to risk-weighted assets of 8%. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the
Companys financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other
factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum
amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2007, that the
Company meets all capital adequacy requirements to which it is subject. In fact, at December 31, 2007, the Bank exceeded all of its regulatory capital requirements, with total capital to risk-weighted assets, tier 1 capital to risk-weighted
assets and tier 1 capital to average assets ratios of 13.57%, 12.31% and 8.77%, respectively.

Capital Distributions. The
Bank is subject to legal limitations on capital distributions including the payment of dividends, if, after making such distribution, the institution would become undercapitalized (as such term is used in the statute). For all state
member banks of the Federal Reserve seeking to pay dividends, the prior approval of the applicable Federal Reserve Bank is required if the total of all dividends declared in any calendar year will exceed the sum of the banks net profits for
that year and its retained net profits for the preceding two calendar years. Federal law also generally prohibits a depository institution from making any capital distribution (including payment of a dividend or payment of a management fee to its
holding company) if the depository institution would thereafter fail to maintain capital above regulatory minimums. Federal Reserve member banks are also authorized to limit the payment of dividends by any state member bank if such payment may be
deemed to constitute an unsafe or unsound practice. In addition, under Virginia law, no dividend may be declared or paid that would impair a Virginia chartered banks paid-in capital. The SCC has general authority to prohibit payment of
dividends by a Virginia chartered bank if it determines that the limitation is in the public interest and is necessary to ensure the banks financial soundness.



8



---

Financial Modernization Legislation. The Gramm-Leach-Bliley Act of 1999 (GLBA)
was signed into law on November 12, 1999. The main purpose of GLBA is to permit greater affiliations within the financial services industry, primarily banking, securities and insurance. The provisions of GLBA that are believed to be of most
significance to the Company are discussed below.

GLBA repeals sections 20 and 32 of the Glass-Steagall Act, which separated commercial
banking from investment banking, and substantially amends the BHCA, which limited the ability of bank holding companies to engage in the securities and insurance businesses. To achieve this purpose, GLBA provides for a new type of company, the
financial holding company. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including



| |  |  | Securities activities such as underwriting, dealing, brokerage, investment and merchant banking; and
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | Insurance underwriting, sales and brokerage activities.
| | - |  | -------------------------------------------------------

A bank holding company may elect to become a financial holding company only if all of its depository institution subsidiaries are well-capitalized, well-managed and have at least a satisfactory Community Reinvestment
Act rating. While the Company meets the requirements to become a financial holding company, it has not elected to be treated as a financial holding company under GLBA at this time.

GLBA, and certain regulations issued by federal banking agencies, also provide protections against the transfer and use by financial institutions of
consumers nonpublic personal information. A financial institution must provide to its customers, at the beginning of the customer relationship and annually thereafter, the institutions policies and procedures regarding the handling of
customers nonpublic personal financial information. The privacy provisions generally prohibit a financial institution from providing a customers personal financial information to unaffiliated third parties unless the institution
discloses to the customer that the information may be so provided and the customer is given the opportunity to opt out of such disclosure.

USA Patriot Act of 2001.In October 2001, the USA Patriot Act of 2001 (the Patriot Act) was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. which
occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcements and the intelligence communities abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot
Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client
identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Reporting Terrorist Activities.The Federal Bureau of Investigation (FBI) has sent, and will send, banking
regulatory agencies lists of the names of persons suspected of involvement in terrorist attacks. The Bank has been requested, and will be requested, to search its records for any relationships or transactions with persons on those lists. If the Bank
finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.

The Office of Foreign Assets
Control (OFAC), which is a division of the Department of Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with enemies of the United States, as definied by various
Executive



9



---

Orders and Acts of Congress. OFAC has sent, and will send, banking regulatory agencies lists of names of persons and organizations suspected of aiding,
harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed a
security officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software,
which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

Other Regulations.Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Banks loan
operations will also be subject to federal laws applicable to credit transactions, such as:



| |  |  | the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a
financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------

In addition, the deposit operations of the Bank will be subject to:



| |  |  | the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with
administrative subpoenas of financial records; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that Act, which govern automatic deposits to and withdrawals
from deposit accounts and clients rights and liabilities arising from the use of automated teller machines and other electronic banking services.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



10



---

Item 1A.

RISK FACTORS

General economic conditions, either national or in the markets where the Company operates, may
become unfavorable.

The Company is affected by general economic conditions in the United States and, in particular, the markets in
which it operates. An economic downturn within the Companys markets or the nation as a whole could negatively impact household and corporate incomes. This impact may lead to decreased demand for both loan and deposit products and increase the
number of customers who fail to pay interest or principal on their loans.

Due to the limited number of markets in which the Company
operates, it is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Moreover, we cannot give any assurance that we will benefit from any market growth or
favorable economic conditions in our primary market areas if they do occur.

If the Company does not adjust to rapid changes in the financial
services industry, its financial performance may suffer.

The Companys ability to deliver strong financial performance and
returns on investment to shareholders will depend in part on its ability to expand the scope of available financial services offerings to meet the needs and demands of its customers. In addition to the challenge of competing against other banks in
attracting and retaining customers for traditional banking services, the Companys competitors also include securities dealers, brokers, mortgage bankers, investment advisors, specialty finance and insurance companies who seek to offer one-stop
financial services that may include services that banks have not been able or allowed to offer to their customers in the past. The increasingly competitive environment is primarily a result of changes in regulation, changes in technology and product
delivery systems and the accelerating pace of consolidation among financial service providers.

Legislative or regulatory changes or actions, or
significant litigation, could adversely impact the Company or the businesses in which the Company is engaged.

The Company is
subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of its operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors
and the deposit insurance funds. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact the Company or its ability to increase the value of its business. Additionally, actions by regulatory
agencies or significant litigation against the Company could cause it to devote significant time and resources to defending itself and may lead to penalties that materially affect the Company and its shareholders. Future changes in the laws or
regulations or their interpretations or enforcement could be materially adverse to the Company and its shareholders.

The Company is exposed to
operational risk.

Similar to any corporation, the Company is exposed to many types of operational risk, including reputational
risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or
telecommunications systems.



11



---

Negative public opinion can result from the Companys actual or alleged conduct in any number of
activities, including lending practices, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect the
Companys ability to attract and keep customers and can expose it to litigation and regulatory action.

Given the volume of
transactions at the Company, certain errors may be repeated or compounded before they are discovered and successfully rectified. The Companys necessary dependence upon automated systems to record and process its transaction volume may further
increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. The Company may also be subject to disruptions of its operating systems arising from events that
are wholly or partially beyond its control (for example, computer viruses or electrical or telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability. The Company is further exposed to
the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Companys
(or its vendors) business continuity and data security systems prove to be inadequate.

Changes in interest rates could affect the
Companys income and cash flows.

The Companys income and cash flows depend to a great extent on the difference between
the interest rates earned on interest-earning assets such as loans and investment securities, and the interest rates paid on interest-bearing liabilities such as deposits and borrowings. These rates are highly sensitive to many factors that are
beyond the Companys control, including general economic conditions and the policies of various governmental and regulatory agencies (in particular, the Federal Reserve). Changes in monetary policy, including changes in interest rates, will
influence the origination of loans, the prepayment speed of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits or other sources of funding. The impact of
these changes may be magnified if the Company does not effectively manage the relative sensitivity of its assets and liabilities to changes in market interest rates. Fluctuations in these areas may adversely affect the Company and its shareholders.

Changes in accounting standards could impact reported earnings.

The accounting standard setters, including the Financial Accounting Standards Board, SEC and other regulatory bodies, periodically change the financial
accounting and reporting standards that govern the preparation of the Companys consolidated financial statements. These changes can be hard to predict and can materially impact how it records and reports its financial condition and results of
operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

The preparation of the Companys financial statements requires the use of estimates that may vary from actual results.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates that affect the
financial statements. Two of the Companys most critical estimates are the level of the allowance for credit losses and the valuation of certain assets, including available-for-sale investment securities and real estate owned. Due to the
inherent nature of these estimates, the Company cannot provide absolute assurance that it will not significantly increase the allowance for credit losses and/or sustain credit losses that are significantly higher than the provided allowance, nor
that it will not recognize a significant loss or impairment of its investment securities and real estate owned assets. For more information on the sensitivity of these estimates, refer to the Critical Accounting Policies and Judgments section of
Part II.



12



---

The Companys stock price may fluctuate.

The Companys stock price is publicly traded and, therefore, several factors exist that could cause the price to fluctuate substantially in the future. These factors include:



| |  |  | actual or anticipated variations in earnings;
| | - |  | ---------------------------------------------



| |  |  | changes in analysts recommendations or projections regarding bank stocks;
| | - |  | --------------------------------------------------------------------------



| |  |  | the Companys announcements of developments related to its businesses;
| | - |  | ----------------------------------------------------------------------



| |  |  | operating and stock performance of other companies deemed to be peers;
| | - |  | ----------------------------------------------------------------------



| |  |  | new technology used or services offered by traditional and non-traditional competitors;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | news reports of trends, concerns and other issues related to the financial services industry; and
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | the low transaction volume of the Companys stock.
| | - |  | --------------------------------------------------

The Companys stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to the Companys performance. General market price declines or market volatility in the future
could adversely affect the price of its common stock, and the current market price may not be indicative of future market prices.

Even though the
Companys common stock is currently traded on the NASDAQ Stock Markets Global Market, it has less liquidity than the average stock quoted on a national securities exchange.

The trading volume in the Companys common stock on the NASDAQ Global Market has been relatively low when compared with larger companies listed on
the NASDAQ Global Market or the stock exchanges. Because of this, it may be more difficult for shareholders to sell a substantial number of shares for the same price at which shareholders could sell a smaller number of shares. Additionally,
volatility of the stock price may occur on relatively small trading volumes of the Companys stock.

The Company cannot predict the
effect, if any, that future sales of its common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of the common stock. The Company can give no assurance that sales of substantial
amounts of common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of its common stock to decline or impair The Companys future ability to raise capital through sales of its common
stock.



13



---

Item 1B.

UNRESOLVED STAFF COMMENTS

There are no unresolved staff comments currently outstanding.

Item 2.

PROPERTIES

The Companys headquarters is located at 25020 Shore Parkway, Onley, Virginia, a two story colonial brick building built in 2004 that houses the
Companys corporate offices and operations center. The Bank operates eight branch banking offices (5 in Virginia, 2 in Salisbury, Maryland and 1 in Pocomoke City, Maryland), owning five of them free of any encumbrances, owning the building of
one branch site free of any encumbrances, but is leases the land under an agreement expiring in 2009, with two remaining five-year renewals and leases the other two branch locations on a temporary basis. The Bank leases the temporary locations (one
being a formed owned property sold during 2007) under two year leases to house two of its branches while the new locations are being constructed. Shore Investments leases office space under an agreement expiring in 2010, with two optional five-year
renewal periods.

Item 3.

LEGAL PROCEEDINGS

In the ordinary course of its operations, the Company is a party to various legal proceedings. Based
upon information currently available, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the business, financial condition, or results of operations of the Company.

Item 4.

SUBMISSIONS OF MATTERS TO A
VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth quarter of 2007.



14



---

PART II

Item 5.

MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER

MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

The Companys common stock is listed on the NASDAQ Global Market under the
symbol SHBK. The following table sets forth the per share high and low closing prices along with dividends that were paid quarterly on the common stock as reported on the NASDAQ Global Market for the periods indicated:



|               |  |      |       |     |   |                   |  |   |      
|-------------- |  | ---- | ----- | --- | - | ----------------- |  | - | -----
|               |  | High |       | Low |   | CashDividendsPaid
|2006           |  |      |       |     |   |                   |  |   |      
|First Quarter  |  | $    | 15.13 |     | $ | 13.96             |  | $ | 0.058
|Second Quarter |  | $    | 14.67 |     | $ | 13.75             |  | $ | 0.058
|Third Quarter  |  | $    | 17.56 |     | $ | 13.75             |  | $ | 0.058
|Fourth Quarter |  | $    | 15.90 |     | $ | 14.50             |  | $ | 0.070
|               |  |      |      
|2007           |  |      |       |     |   |                   |  |   |      
|First Quarter  |  | $    | 14.75 |     | $ | 13.36             |  | $ | 0.070
|Second Quarter |  | $    | 14.45 |     | $ | 13.00             |  | $ | 0.070
|Third Quarter  |  | $    | 13.83 |     | $ | 12.50             |  | $ | 0.070
|Fourth Quarter |  | $    | 13.30 |     | $ | 11.33             |  | $ | 0.080

At February 22, 2008, there were 2,502,967 shares of common stock outstanding held by 878
stockholders of record.



15



---

Performance Graph

The following graph compares, for the five years ended December 31, 2007, the yearly cumulative total shareholder return on the Companys common stock with (1) the yearly cumulative total shareholder
return on stocks included in the Nasdaq composite stock index and (2) the yearly cumulative total shareholder return on stocks included in the SNL stock index for banks of with less than $500 million in total assets.

There can be no assurance that the Companys stock performance in the future will continue with the same or similar trends depicted in the graph
below.

LOGO



|                            |  |               |  |          |  |          |  |          |  |          |  |         
|--------------------------- |  | ------------- |  | -------- |  | -------- |  | -------- |  | -------- |  | --------
|                            |  | Period Ending
|Index                       |  | 12/31/02      |  | 12/31/03 |  | 12/31/04 |  | 12/31/05 |  | 12/31/06 |  | 12/31/07
|Shore Financial Corporation |  | 100.00        |  | 170.89   |  | 207.25   |  | 180.51   |  | 190.60   |  | 159.53  
|NASDAQ Composite            |  | 100.00        |  | 150.01   |  | 162.89   |  | 165.13   |  | 180.85   |  | 198.60  
|SNL Bank < $500M Index      |  | 100.00        |  | 145.97   |  | 168.49   |  | 178.39   |  | 187.41   |  | 152.17  

Dividend Policy

On January 8, 2008, the Company declared a $0.08 per share quarterly cash dividend paid on February 1, 2008 to shareholders of record on
January 25, 2008. The Company hopes to continue with a quarterly cash dividend on its common stock in the future. Any future determination as to payment of cash dividends will be at the discretion of the Companys Board of Directors and
will depend on the Companys earnings, financial condition, capital requirements and other factors deemed relevant by the Board of Directors. During the years ended December 31, 2007 and 2006, the Bank paid $700,000 and $1.0 million,
respectively, in dividends to the Company.



16



---

Item 6.

SELECTED FINANCIAL DATA



|                                                                   |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------------------------ |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                   |  | Years Ended December 31,              |        
|                                                                   |  | 2007                                  |         |   | 2006 |   |         | 2005 |  |   | 2004    |   |  | 2003 |        
|                                                                   |  | (In thousands, except per share data) |        
|Income Statement Data:                                             |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Interest income                                                    |  | $                                     | 16,257  |   |      | $ | 15,113  |      |  | $ | 12,851  |   |  | $    | 10,697  |   |  | $ | 9,501   |  
|Interest expense                                                   |  |                                       | 7,452   |   |      |   | 6,618   |      |  |   | 4,414   |   |  |      | 3,275   |   |  |   | 3,275   |  
|Net interest income                                                |  |                                       | 8,805   |   |      |   | 8,495   |      |  |   | 8,437   |   |  |      | 7,422   |   |  |   | 6,226   |  
|Provision (recovery) for loan losses                               |  |                                       | (73     | ) |      |   | 59      |      |  |   | 304     |   |  |      | 419     |   |  |   | 380     |  
|Noninterest income                                                 |  |                                       | 3,400   |   |      |   | 3,392   |      |  |   | 2,379   |   |  |      | 1,920   |   |  |   | 1,889   |  
|Noninterest expense                                                |  |                                       | 8,440   |   |      |   | 7,739   |      |  |   | 6,644   |   |  |      | 5,559   |   |  |   | 4,780   |  
|Income taxes                                                       |  |                                       | 1,107   |   |      |   | 1,156   |      |  |   | 1,193   |   |  |      | 1,011   |   |  |   | 893     |  
|                                                                   |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income                                                         |  | $                                     | 2,731   |   |      | $ | 2,933   |      |  | $ | 2,675   |   |  | $    | 2,353   |   |  | $ | 2,062   |  
|                                                                   |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Per Share Data:                                                    |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income - basic (1)                                             |  | $                                     | 1.09    |   |      | $ | 1.18    |      |  | $ | 1.08    |   |  | $    | 0.95    |   |  | $ | 0.84    |  
|Net income - dilutive (1)                                          |  |                                       | 1.08    |   |      |   | 1.16    |      |  |   | 1.06    |   |  |      | 0.93    |   |  |   | 0.83    |  
|Cash dividends (1)                                                 |  |                                       | 0.29    |   |      |   | 0.25    |      |  |   | 0.22    |   |  |      | 0.18    |   |  |   | 0.14    |  
|Book value at period end                                           |  |                                       | 11.08   |   |      |   | 10.46   |      |  |   | 11.39   |   |  |      | 10.64   |   |  |   | 9.80    |  
|Tangible book value at period end                                  |  |                                       | 10.95   |   |      |   | 10.30   |      |  |   | 11.17   |   |  |      | 10.39   |   |  |   | 9.51    |  
|Average shares outstanding (000s) (1)                             |  |                                       | 2,500   |   |      |   | 2,492   |      |  |   | 2,485   |   |  |      | 2,474   |   |  |   | 2,444   |  
|Balance Sheet Data (period end):                                   |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Assets                                                             |  | $                                     | 266,667 |   |      | $ | 260,676 |      |  | $ | 247,419 |   |  | $    | 237,689 |   |  | $ | 196,550 |  
|Loans, net of unearned income and allowance                        |  |                                       | 218,887 |   |      |   | 207,725 |      |  |   | 192,697 |   |  |      | 175,995 |   |  |   | 140,207 |  
|Securities                                                         |  |                                       | 22,894  |   |      |   | 30,408  |      |  |   | 32,351  |   |  |      | 38,972  |   |  |   | 40,611  |  
|Deposits                                                           |  |                                       | 196,564 |   |      |   | 198,103 |      |  |   | 188,970 |   |  |      | 192,737 |   |  |   | 158,891 |  
|Stockholders equity                                               |  |                                       | 27,721  |   |      |   | 26,126  |      |  |   | 23,629  |   |  |      | 21,959  |   |  |   | 20,201  |  
|Performance Ratios:                                                |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Return on average assets                                           |  |                                       | 1.04    | % |      |   | 1.14    | %    |  |   | 1.10    | % |  |      | 1.08    | % |  |   | 1.11    | %
|Return on average equity                                           |  |                                       | 10.05   | % |      |   | 11.76   | %    |  |   | 11.74   | % |  |      | 11.01   | % |  |   | 10.64   | %
|Net interest margin                                                |  |                                       | 3.63    | % |      |   | 3.57    | %    |  |   | 3.75    | % |  |      | 3.72    | % |  |   | 3.63    | %
|Efficiency (2)                                                     |  |                                       | 68.05   | % |      |   | 63.99   | %    |  |   | 63.54   | % |  |      | 59.47   | % |  |   | 59.70   | %
|Asset Quality Ratios:                                              |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses to period end loans                      |  |                                       | 1.22    | % |      |   | 1.36    | %    |  |   | 1.49    | % |  |      | 1.35    | % |  |   | 1.41    | %
|Allowance for loan losses to nonaccrual loans                      |  |                                       | 340.35  | % |      |   | 308.59  | %    |  |   | 267.95  | % |  |      | 253.05  | % |  |   | 362.68  | %
|Nonperforming assets to period end loans and foreclosed properties |  |                                       | 0.36    | % |      |   | 0.44    | %    |  |   | 0.56    | % |  |      | 0.53    | % |  |   | 0.39    | %
|Net charge-offs (recoveries) to average loans                      |  |                                       | 0.05    | % |      |   | 0.02    | %    |  |   | -0.08   | % |  |      | 0.01    | % |  |   | -0.01   | %
|Capital and Liquidity Ratios:                                      |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Leverage (3)                                                       |  |                                       | 10.40   | % |      |   | 10.02   | %    |  |   | 9.55    | % |  |      | 9.24    | % |  |   | 10.28   | %
|Risk-based:                                                        |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Tier 1 capital                                                     |  |                                       | 14.36   | % |      |   | 13.77   | %    |  |   | 13.21   | % |  |      | 12.74   | % |  |   | 14.37   | %
|Total capital                                                      |  |                                       | 15.60   | % |      |   | 15.09   | %    |  |   | 14.53   | % |  |      | 14.14   | % |  |   | 15.74   | %
|Average loans to average deposits                                  |  |                                       | 106.48  | % |      |   | 104.48  | %    |  |   | 96.93   | % |  |      | 87.60   | % |  |   | 79.78   | %



|(1) | Earnings per share, dividends per share and average share data adjusted to reflect the six-for-five stock split effected by the Company during August 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Computed by dividing noninterest expense, net of nonrecurring expenses, by the sum of net interest income and noninterest income, net of security gains and losses.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Computed as a percentage of stockholders equity to period end assets.
|--- | ----------------------------------------------------------------------



17



---

Item 7.

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Overview

The year 2007 represented a
challenging period for the financial services world. The economy slowed as the real estate boom enjoyed over the past several years came to a halt and the cost of oil and consumer goods rose. Many large homebuilders and mortgage companies faced
significant financial challenges due to the lack of housing demand and resulting mortgage demand. The true repercussions of the subprime loan business, a business not participated in by the Company, occurring in recent years reared its ugly head,
also playing a large part in the mortgage company failures. The large financial institutions and investment firms holding the mortgage-backed securities, collateralized debt obligations and other offshoot products of the mortgage industry ended
taking asset devaluations in the billions of dollars as the demand for these securities, that once appeared endless, became virtually nonexistent. Additionally, it became apparent that many of the subprime loans could not be repaid by the borrowers.

As a result of the subprime fallout, financial markets became nervous with access to low cost funding proving difficult as the capital
markets became volatile and suspect of the industry as a whole. If this financial debacle wasnt enough, rising energy costs began significantly affecting the cost of common goods and services, resulting in a decline in the average
consumers disposal income. As this ordeal played out, it became rather apparent that many individuals had been living off of the rising equity in their homes in recent years as a result of the real estate boom and had become engrossed in debt
that many couldnt afford to service. Although the majority smaller financial institutions such as the Company do not engage in many of the business activities impacting the larger institutions during 2007, the disruptions in the capital
markets and the economy as a whole impacted the Companys financial performance during 2007.

The Company entered 2007 knowing even
before the subprime meltdown came to light the year would be challenging. The real estate industry continued its decline that began during 2006 and, with the yield curve being relatively flat and funding costs continuing to rise, the Companys
net interest margin entered the year under significant pressure. In spite of these challenges, the Company was able to accomplish many strategic initiatives during the year and improve its net interest margin substantially.

During 2007, the Bank added its eighth branch in Pocomoke City, Maryland with growth already exceeding expectations; established three new advisory
boards; began construction on a branch rebuild in Salisbury, Maryland and a branch relocation in Cape Charles, Virginia; added significant strength to its management team with the hiring of four experienced bank executives; introduced remote deposit
capture to its commercial customers with twenty-four outlets operating after only seven months of offering the product; initiated a significant Online Banking upgrade which has resulted in a 40% increase in usage; rebranded the Banks image
through the use of an outside marketing firm; implemented several successful deposit products and promotions; and culminated the year with the negotiation and subsequent announcement of the Companys proposed merger with Hampton Roads
Bankshares.

As for 2007 operating results, the Company producing earnings of $2.73 million during the year, compared to $2.93 million in
2006. These results represented shareholder return of $1.08 per diluted share compared to $1.16 in 2006. Although many of the aforementioned strategic initiatives impacted earnings, the Company benefited immediately from many of them during 2007 and
should continue to do so going forward. The Company also benefited from other factors during the year, including an increase in its net interest margin from a low of 3.31% during January 2007 and 3.57% during 2006 to 3.63% for the 2007 year. As
expected, interest rates in the Banks adjustable rate mortgage loan portfolio began adjusting up as a result of the Federal Reserves aggressive



18



---

monetary policy of interest rate tightening during the first half of 2006. Additionally, the Banks mortgage banking operation experienced a 69.8%
increase in fees generated during the year as compared to 2006.

The Companys total assets grew to $266.7 million at
December 31, 2007, compared to $260.7 million at December 31, 2006, primarily resulting from a 5.2% increase in loans. Total gross loans ended 2007 at $221.6 million, compared to $210.6 million at December 31, 2006. Total deposits
ended the year at $196.6 million, compared to $198.1 million at December 31, 2006. Continued growth in the Banks real estate loan portfolio, specifically those secured by one-to-four family residences, represented the largest portion of
the increase. Deposits were impacted by the continued challenges and aggressive market competition surrounding retail funding and the maturity of $5.0 million in brokered certificates of deposit that were obtained during 2006. The Companys
shareholders equity was $27.7 million at December 31, 2007, compared to $26.1 million at the prior year end.

The Banks
loan portfolio quality remained strong during 2007. The Bank experienced net loan charge-offs of $101,000 during 2007, which is 0.05% of average loans during the period, while the level of nonperforming assets to period end loans was 0.36% at
December 31, 2007. The Bank had no other real estate owned (OREO) or other foreclosed assets at December 31, 2007 and maintained an allowance for loan losses to period end loans of 1.22%.

Results of Operation

General

Net interest income is the major component of the Companys earnings and is equal to the amount by which interest income exceeds interest expense.
Interest income is derived from interest-earning assets composed primarily of loans and securities. Interest expense results from interest-bearing liabilities, primarily consisting of deposits and short-term borrowings. Changes in the volume and mix
of these assets and liabilities, as well as changes in the yields earned and rates paid, determine changes in net interest income. Net interest margin is calculated by dividing net interest income by average earning assets and represents the
Companys net yield on its earning assets.

Interest Income

2007 Compared to 2006

During the year ended December 31, 2007, the Company earned $16.3 million
in interest income, representing a 7.6% increase over the $15.1 million earned for the year ended December 31, 2006. The Companys net interest income benefited from the improvement in its net interest margin and loan growth.

Contributing to the improved net interest margin was a 34 basis point increase in yields on earning assets from 6.33% during 2006 to 6.67% for the
2007 year. Loan yields made up the majority of this increase by improving from 6.57% during 2006 to 6.92% during 2007. Investment yield improved 14 basis points to 5.01% during the year.

Average loans outstanding increased $8.0 million to $214.3 million from $206.3 million during 2006. The Banks real estate mortgage loan portfolio
experienced the most growth with an increase of 5.8% in average balances outstanding, while average commercial loans increased 3.8% and average consumer loans (including home equity lines) declined 7.9%. Real estate mortgage loan balances, which
include construction loans, averaged $121.1 million during 2007, while commercial and consumer loans averaged $76.3 million and $16.8 million, respectively. The Bank realized gross loan production of $66.4 million during 2007 compared to $82.0
million during 2006, which illustrates the impact of a declining real estate market and the economy in general.



19



---

Average securities declined by $3.1 million to $28.4 million during 2007 compared to $31.5 million during 2006 as the Company continued using maturing
securities to fund liquidity needs while the retail deposit market remained competitive. Also, profitable investment opportunities continued to be scarce during most of the year.

2006 Compared to 2005

During the year ended December 31, 2006, the Company earned $15.1 million
in interest income, representing a 17.6% increase over the $12.9 million earned for the year ended December 31, 2005. The Companys net interest income benefited from growth in its loan portfolio and improved yields on earning assets, but
was negatively impacted by increasing cost of funding.

Spearheaded by 10.7% growth in average loans outstanding resulting from $82.0
million on total loan production, average earning assets were $240.2 million during 2006, representing a $13.1 million increase over 2005. Average total loans increased $19.9 million to $206.3 million during 2006 from $186.4 million during 2005. The
Banks real estate mortgage loan portfolio experienced the most growth with an increase of 17.0% in average balances outstanding, while average commercial loans increased 4.2% and average consumer loans (including home equity lines) were flat.
Real estate mortgage loan balances, which include construction loans, averaged $114.5 during 2006, while commercial and consumer loans averaged $73.5 million and $18.2 million, respectively. The Bank realized strong loan production during the first
half of 2006 while production levels slowed to a more moderate pace during the second half of the year. Average securities declined by $6.6 million to $31.5 million during 2006 compared to $38.1 million during 2005. The Company used maturing
securities to fund liquidity needs during 2006 due to limited opportunities in the investment market and the rising cost of funds, mostly due to a flat yield curve.

Yields on earning assets continued to benefit from the Companys asset sensitive financial position. Total yields improved to 6.33% during 2006 compared to 5.69% in 2005. Loans yielded 6.57% during the year,
compared to 6.03% during 2005, resulting primarily from the repricing of adjustable rate loans and loan growth. The maturity of lower yielding investment securities helped improve the yield on securities to 4.87% during 2006, compared to 4.21% for
the year ended December 31, 2005.

Interest Expense

2007 Compared to 2006

The Companys interest expense increased $900,000 to $7.5 million during the year ended
December 31, 2007 compared to $6.6 million during 2006, slowing significantly from prior years growth levels and contributing to the margin improvement. As mentioned, retail deposit growth remained challenging with total average deposits,
including noninterest-bearing demand deposits, increasing only 1.9% to $201.2 million during the year ended December 31, 2007 from $197.4 million during 2006. Average interest-bearing liabilities increased 1.4% to $207.0 million during 2007, as
compared to $204.1 million during 2006, while the cost of interest-bearing liabilities increased 36 basis points from 3.24% during 2006 to 3.60% during 2007. The Companys cost of funds (including demand deposits) was 3.17% during 2007,
compared to 2.86% for the year ended December 31, 2006.

Interest rates rose quickly during the Federal Reserves aggressive
tightening campaign between 2005 and 2006, resulting in a significant impact on the Companys relatively short duration funding portfolio. As the rate increases ceased and ultimately resulted in the Federal Reserve lowing interest rates during
late 2007, the Companys funding costs became more manageable. Notwithstanding the current decline occurring primarily in short-term interest rates, the inability to attract significant low cost deposits continues to put pressure on funding
costs. The Company does not expect a change in this trend for the immediate future.



20



---

The existing competition for retail deposits becomes very apparent when analyzing checking and savings
account balances. Average account balances in this category were $65.5 million during 2007 and the cost of these funds for the year was 1.46%, representing a 2.3% decline in averages balances and a 50 basis point increase in cost over the prior
year. To compensate for this decline and generate adequate liquidity to fund loan demand, the Bank continued to aggressively price its time deposits. Accordingly, average time deposit balances increased to $107.6 million and the cost of these funds
increased by 30 basis points to 4.48% for the year. Average Federal Home Loan Bank (FHLB) borrowings and their related costs were flat during the year at $33.8 million and 4.94%, respectively, although the Bank began relying on them more
late in the year as brokered deposits matured with new brokered deposit funding costs being noncompetitive and normal seasonal deposit declines occurred.

2006 Compared to 2005

As the yield curve became more inverted during 2006, the Company faced the challenge of obtaining
cost-effective funding to support its loan growth and other liquidity needs. During the recent period of rising rates, customers became more interest rate sensitive and began moving funds out of lower yielding accounts into higher yielding accounts.
Also, the uncertainty surrounding the direction of interest rates caused customers to demand shorter term time deposits as opposed those with longer terms. As the retail deposit market became more competitive, the Company looked to the wholesale
funding markets for alternative liquidity needs. Although at different points in 2006 the wholesale markets provided less expensive funding than the retail market, the funds were still costly and, accordingly, negatively impacted the Companys
interest expense.

The Companys interest expense increased $2.2 million to $6.6 million during the year ended December 31, 2006,
compared to $4.4 million during 2005. Average interest-bearing liabilities increased 5.6% to $204.1 million during the year ended December 31, 2006, as compared to $193.4 million during 2005, while the cost of interest-bearing liabilities
increased 96 basis points from 2.28% during 2005 to 3.24% during 2006. Total average deposits, including noninterest-bearing demand deposits, increased 2.7% to $197.4 million during the year ended December 31, 2006 from $192.3 million during
2005. The Companys cost of funds (including demand deposits) was 2.86% during 2006, compared to 2.00% for the year ended December 31, 2005.

Average checking and savings account balances were $67.1 million during 2006 and the cost of these funds for the year was 96 basis points, representing a 18 basis point increase over the prior year. Average time
deposit balances were $103.4 million and the cost of these funds increased by 93 basis points to 4.18% for the year. As part of the increased reliance on wholesale funding during 2006, the Bank purchased $7.0 million of brokered deposits and average
Federal Home Loan Bank (FHLB) borrowings increased by $5.1 million to $33.7 million during the year. Of the total FHLB borrowings outstanding at December 31, 2006, $12.5 million represent amounts with fixed terms up to seven years
while the remaining balance floats based on an overnight rate. The cost of these funds increased 133 basis points to 4.92% during 2006.



21



---

Net Interest Income

2007 Compared to 2006

As a result of the factors discussed above, the Companys net interest income increased 3.6% to
$8.8 million during the year ended December 31, 2007 as compared to $8.5 million in 2006. Although the Company realized improvement in its net interest margin during 2007, the ever-changing interest rate environment and competition continues to
make additional margin improvement challenging.

2006 Compared to 2005

As previously discussed, the Companys net interest margin was negatively impacted by the flat yield curve, resulting in a decline of 18 basis points to 3.57%. The shape of the yield curve diluted the positive
impact of being asset sensitive during 2006, primarily due to the fact that funding rates, which are primarily short-term, were increasing faster than rates on interest earning assets. As a result, the Companys net interest income was
relatively flat at $8.5 million during the year ended December 31, 2006 as compared to $8.4 million in 2005.



22



---

The following tables illustrate average balances of total interest-earning assets and total
interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders equity and the related income, expense, and corresponding weighted average yields and costs. The average balances
used in these tables and other statistical data were calculated using daily average balances.

Average Balances, Income and Expenses,
Yields and Rates



|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|------------------------------------------ |  | ------------------------ | ------- | - | -------------- | - | ---------- | ---- | ---- | -------------- |  | - | -------------- | - | ---------- | - | ------ | -------------- | ---- | - | -------------- | - | ---------- | - |  | - | ------ |  | ---- | -
|                                           |  | Years Ended December 31, |        
|                                           |  | 2007                     |         |   | 2006           |   |            | 2005 |     
|(Dollars In Thousands)                     |  | AverageBalance           |         |   | Income/Expense |   | Yield/Rate |      |      | AverageBalance |  |   | Income/Expense |   | Yield/Rate |   |        | AverageBalance |      |   | Income/Expense |   | Yield/Rate |  
|Assets:                                    |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Securities (1)                             |  | $                        | 28,394  |   |                | $ | 1,424      |      | 5.01 | %              |  | $ | 31,504         |   |            | $ | 1,533  |                | 4.87 | % |                | $ | 38,141     |   |  | $ | 1,607  |  | 4.21 | %
|Loans (net of unearned income):            |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Real estate mortgage                       |  |                          | 121,144 |   |                |   | 7,653      |      | 6.32 | %              |  |   | 114,500        |   |            |   | 6,837  |                | 5.97 | % |                |   | 97,888     |   |  |   | 5,503  |  | 5.62 | %
|Commercial                                 |  |                          | 76,326  |   |                |   | 5,744      |      | 7.53 | %              |  |   | 73,529         |   |            |   | 5,207  |                | 7.08 | % |                |   | 70,573     |   |  |   | 4,540  |  | 6.43 | %
|Home equity lines                          |  |                          | 13,738  |   |                |   | 1,151      |      | 8.38 | %              |  |   | 15,286         |   |            |   | 1,242  |                | 8.13 | % |                |   | 15,636     |   |  |   | 985    |  | 6.30 | %
|Consumer                                   |  |                          | 3,069   |   |                |   | 284        |      | 9.25 | %              |  |   | 2,962          |   |            |   | 271    |                | 9.15 | % |                |   | 2,319      |   |  |   | 205    |  | 8.84 | %
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Total loans                                |  |                          | 214,277 |   |                |   | 14,832     |      | 6.92 | %              |  |   | 206,277        |   |            |   | 13,557 |                | 6.57 | % |                |   | 186,416    |   |  |   | 11,233 |  | 6.03 | %
|Interest-bearing deposits in other banks   |  |                          | 3,019   |   |                |   | 125        |      | 4.14 | %              |  |   | 2,385          |   |            |   | 109    |                | 4.57 | % |                |   | 2,481      |   |  |   | 81     |  | 3.26 | %
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Total earning assets                       |  |                          | 245,690 |   |                |   | 16,381     |      | 6.67 | %              |  |   | 240,166        |   |            |   | 15,199 |                | 6.33 | % |                |   | 227,038    |   |  |   | 12,921 |  | 5.69 | %
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Less: allowance for loan losses            |  |                          | (2,860  | ) |                |   |            |      |      |                |  |   | (2,873         | ) |            |   |        |                |      |   |                |   | (2,611     | ) |  |   |        |  |      |  
|Total nonearning assets                    |  |                          | 20,394  |   |                |   |            |      |      |                |  |   | 19,239         |   |            |   |        |                |      |   |                |   | 19,841     |   |  |   |        |  |      |  
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Total assets                               |  | $                        | 263,224 |   |                |   |            |      |      |                |  | $ | 256,532        |   |            |   |        |                |      |   |                | $ | 244,268    |   |  |   |        |  |      |  
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|                                           |  |                          |         |   |                |   |            |      |     
|Liabilities                                |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Interest-bearing deposits:                 |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Checking and savings                       |  | $                        | 65,533  |   |                | $ | 959        |      | 1.46 | %              |  | $ | 67,053         |   |            | $ | 641    |                | 0.96 | % |                | $ | 79,600     |   |  | $ | 620    |  | 0.78 | %
|Time deposits                              |  |                          | 107,638 |   |                |   | 4,823      |      | 4.48 | %              |  |   | 103,381        |   |            |   | 4,322  |                | 4.18 | % |                |   | 85,165     |   |  |   | 2,766  |  | 3.25 | %
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Total interest-bearing deposits            |  |                          | 173,171 |   |                |   | 5,782      |      | 3.34 | %              |  |   | 170,434        |   |            |   | 4,963  |                | 2.91 | % |                |   | 164,765    |   |  |   | 3,386  |  | 2.06 | %
|FHLB advances                              |  |                          | 33,785  |   |                |   | 1,670      |      | 4.94 | %              |  |   | 33,668         |   |            |   | 1,655  |                | 4.92 | % |                |   | 28,601     |   |  |   | 1,028  |  | 3.59 | %
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Total interest-bearing liabilities         |  |                          | 206,956 |   |                |   | 7,452      |      | 3.60 | %              |  |   | 204,102        |   |            |   | 6,618  |                | 3.24 | % |                |   | 193,366    |   |  |   | 4,414  |  | 2.28 | %
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Non-interest bearing liabilities:          |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Demand deposits                            |  |                          | 28,064  |   |                |   |            |      |      |                |  |   | 27,005         |   |            |   |        |                |      |   |                |   | 27,556     |   |  |   |        |  |      |  
|Other liabilities                          |  |                          | 1,035   |   |                |   |            |      |      |                |  |   | 475            |   |            |   |        |                |      |   |                |   | 554        |   |  |   |        |  |      |  
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Total liabilities                          |  |                          | 236,055 |   |                |   |            |      |      |                |  |   | 231,582        |   |            |   |        |                |      |   |                |   | 221,476    |   |  |   |        |  |      |  
|Stockholders equity                       |  |                          | 27,169  |   |                |   |            |      |      |                |  |   | 24,950         |   |            |   |        |                |      |   |                |   | 22,792     |   |  |   |        |  |      |  
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Total liabilities and stockholders equity |  | $                        | 263,224 |   |                |   |            |      |      |                |  | $ | 256,532        |   |            |   |        |                |      |   |                | $ | 244,268    |   |  |   |        |  |      |  
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Net interest income (1)                    |  |                          |         |   |                | $ | 8,929      |      |      |                |  |   |                |   |            | $ | 8,581  |                |      |   |                |   |            |   |  | $ | 8,507  |  |      |  
|                                           |  |                          |         |   |                |   |            |      |      |                |  |   |                |   |            |   |        |                |      |   |                |   |            |   |  |   |        |  |      |  
|Interest rate spread (1)(2)(3)             |  |                          |         |   |                |   |            |      | 3.07 | %              |  |   |                |   |            |   |        |                | 3.09 | % |                |   |            |   |  |   |        |  | 3.41 | %
|Net interest margin (1)(4)                 |  |                          |         |   |                |   |            |      | 3.63 | %              |  |   |                |   |            |   |        |                | 3.57 | % |                |   |            |   |  |   |        |  | 3.75 | %



|(1) | Presented on a tax equivalent basis. The tax equivalent adjustment to net interest income was $125,000, $86,000 and $70,000 for the years ended December 31, 2007, 2006 and
2005, respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Interest rate spread is the average yield earned on earning assets less the average rate incurred on interest-bearing liabilities.
|--- | ----------------------------------------------------------------------------------------------------------------------------------

|(3) | Net interest margin is derived by dividing net interest income by average total earning assets.
|--- | -----------------------------------------------------------------------------------------------



23



---

The following table describes the impact on the interest income of the Company resulting from changes in
average balances and average rates for the periods indicated. The change in interest due to the mixture of volume and rate has been allocated solely to rate changes.

Volume and Rate Analysis



|                                         |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|---------------------------------------- |  | ---------------------------------------------- | ---- | - | ---------------------------------------------- | - | --- | ---------------------------------------------- |  | - | ------ | - |  | ---- | ----- | - | ------------------ | - | ----- | ------ |  | - | ----- | - |  | ------------------ | ----- | - |  | - | ---- | - |  | - | ----- | -
|                                         |  | Years Ended                                    |     
|                                         |  | December 31, 2007 compared toDecember 31, 2006 |      |   | December 31, 2006 compared toDecember 31,
2005 |   |     | December 31, 2005 compared toDecember 31, 2004 | 
|                                         |  | Change Due To:                                 |      |   | Change Due To:                                 |   |     | Change Due To:                                 | 
|(Dollars In Thousands)                   |  | Volume                                         |      |   | Rate                                           |   |     | Increase(Decrease)                             |  |   | Volume |   |  | Rate |       |   | Increase(Decrease) |   |       | Volume |  |   | Rate  |   |  | Increase(Decrease) |      
|Assets:                                  |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Securities                               |  | $                                              | (151 | ) |                                                | $ | 42  |                                                |  | $ | (109   | ) |  | $    | (280  | ) |                    | $ | 206   |        |  | $ | (74   | ) |  | $                  | (43   | ) |  | $ | 53   |   |  | $ | 10    |  
|Loans (net of unearned income):          |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Real estate mortgage                     |  |                                                | 397  |   |                                                |   | 419 |                                                |  |   | 816    |   |  |      | 934   |   |                    |   | 400   |        |  |   | 1,334 |   |  |                    | 811   |   |  |   | (39  | ) |  |   | 772   |  
|Commercial                               |  |                                                | 198  |   |                                                |   | 339 |                                                |  |   | 537    |   |  |      | 190   |   |                    |   | 477   |        |  |   | 667   |   |  |                    | 704   |   |  |   | 356  |   |  |   | 1,060 |  
|Home equity lines                        |  |                                                | (126 | ) |                                                |   | 35  |                                                |  |   | (91    | ) |  |      | (22   | ) |                    |   | 279   |        |  |   | 257   |   |  |                    | 8     |   |  |   | 260  |   |  |   | 268   |  
|Consumer                                 |  |                                                | 10   |   |                                                |   | 3   |                                                |  |   | 13     |   |  |      | 57    |   |                    |   | 9     |        |  |   | 66    |   |  |                    | (14   | ) |  |   | (1   | ) |  |   | (15   | )
|                                         |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Total loans                              |  |                                                | 479  |   |                                                |   | 796 |                                                |  |   | 1,275  |   |  |      | 1,159 |   |                    |   | 1,165 |        |  |   | 2,324 |   |  |                    | 1,509 |   |  |   | 576  |   |  |   | 2,085 |  
|Interest-bearing deposits in other banks |  |                                                | 29   |   |                                                |   | (13 | )                                              |  |   | 16     |   |  |      | (3    | ) |                    |   | 31    |        |  |   | 28    |   |  |                    | 4     |   |  |   | 52   |   |  |   | 56    |  
|                                         |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Total earning assets                     |  | $                                              | 357  |   |                                                | $ | 825 |                                                |  | $ | 1,182  |   |  | $    | 876   |   |                    | $ | 1,402 |        |  | $ | 2,278 |   |  | $                  | 1,470 |   |  | $ | 681  |   |  | $ | 2,151 |  
|                                         |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|                                         |  |                                                |      |   |                                                |   |     |                                                | 
|Liabilities                              |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Interest-bearing deposits:               |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Checking and savings                     |  | $                                              | (15  | ) |                                                | $ | 333 |                                                |  | $ | 318    |   |  | $    | (98   | ) |                    | $ | 119   |        |  | $ | 21    |   |  | $                  | 32    |   |  | $ | 121  |   |  | $ | 153   |  
|Time deposits                            |  |                                                | 178  |   |                                                |   | 323 |                                                |  |   | 501    |   |  |      | 592   |   |                    |   | 964   |        |  |   | 1,556 |   |  |                    | 1     |   |  |   | 206  |   |  |   | 207   |  
|                                         |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Total interest-bearing deposits          |  |                                                | 163  |   |                                                |   | 656 |                                                |  |   | 819    |   |  |      | 494   |   |                    |   | 1,083 |        |  |   | 1,577 |   |  |                    | 33    |   |  |   | 327  |   |  |   | 360   |  
|FHLB advances                            |  |                                                | 6    |   |                                                |   | 9   |                                                |  |   | 15     |   |  |      | 182   |   |                    |   | 445   |        |  |   | 627   |   |  |                    | 315   |   |  |   | 464  |   |  |   | 779   |  
|                                         |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Total interest-bearing liabilities       |  |                                                | 169  |   |                                                |   | 665 |                                                |  |   | 834    |   |  |      | 676   |   |                    |   | 1,528 |        |  |   | 2,204 |   |  |                    | 348   |   |  |   | 791  |   |  |   | 1,139 |  
|                                         |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  
|Change in net interest income            |  | $                                              | 188  |   |                                                | $ | 160 |                                                |  | $ | 348    |   |  | $    | 200   |   |                    | $ | (126  | )      |  | $ | 74    |   |  | $                  | 1,122 |   |  | $ | (110 | ) |  | $ | 1,012 |  
|                                         |  |                                                |      |   |                                                |   |     |                                                |  |   |        |   |  |      |       |   |                    |   |       |        |  |   |       |   |  |                    |       |   |  |   |      |   |  |   |       |  

Interest Sensitivity

Management evaluates interest rate sensitivity periodically through the use of an asset/liability management reporting model. Using this model, management determines the overall magnitude of interest sensitivity risk
and then formulates policies governing asset generation and pricing, funding sources and pricing, and off-balance-sheet commitments in order to manage sensitivity risk. These decisions are based on managements outlook regarding future interest
rate movements, the state of the local and national economy, and other financial and business risk factors.

An important element of the
Companys asset/liability management process is monitoring its interest sensitivity gap. The interest sensitivity gap is the difference between interest sensitive assets and interest sensitive liabilities at a specific time interval. A gap is
considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities, and is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets during a given period. Generally, during a period of rising interest rates, a negative gap within shorter maturities would adversely affect net interest income, while a positive gap within shorter maturities would result in an
increase in net interest income. Conversely, during a period of falling interest rates, a negative gap within shorter maturities would result in an increase in net interest income while a positive gap within shorter maturities would have the
opposite effect. This gap can be managed by repricing assets or liabilities, by selling investments available for sale, by replacing an asset or liability at maturity, or by adjusting the interest rate during the life of an asset or liability.
Matching the amounts of assets and liabilities maturing in the same time interval helps to hedge the risk and minimize the impact on net interest income in periods of rising or falling interest rates.



24



---

The following table presents the Companys interest sensitivity position at December 31, 2007.
This one-day position, which continually is changing, is not necessarily indicative of the Companys position at any other time.

Interest Sensitivity Analysis



|                                                                            |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|--------------------------------------------------------------------------- |  | ----------------- | ------ | - | ---------- | - | ------- | ----------- |  | - | ----------- | - |  | ----- | ------- | - |  | - | ------- | -
|                                                                            |  | December 31, 2007 |       
|(Dollars In Thousands)                                                      |  | Within90 Days     |        |   | 91-365Days |   |         | 1 to 5Years |  |   | Over 5Years |   |  | Total |        
|Interest-Earning Assets:                                                    |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Loans (1)                                                                   |  | $                 | 54,202 |   |            | $ | 73,519  |             |  | $ | 88,161      |   |  | $     | 5,704   |   |  | $ | 221,586 |  
|Securities (2)                                                              |  |                   | 2,352  |   |            |   | 2,002   |             |  |   | 12,366      |   |  |       | 6,174   |   |  |   | 22,894  |  
|Money market and other short term securities                                |  |                   | 4,037  |   |            |   |        |             |  |   |            |   |  |       |        |   |  |   | 4,037   |  
|Other earning assets                                                        |  |                   |       |   |            |   |        |             |  |   |            |   |  |       | 3,720   |   |  |   | 3,720   |  
|                                                                            |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Total earning assets                                                        |  | $                 | 60,591 |   |            | $ | 75,521  |             |  | $ | 100,527     |   |  | $     | 15,598  |   |  | $ | 252,237 |  
|                                                                            |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Cumulative earning assets                                                   |  | $                 | 60,591 |   |            | $ | 136,112 |             |  | $ | 236,639     |   |  | $     | 252,237 |   |  | $ | 252,237 |  
|                                                                            |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|                                                                            |  |                   |        |   |           
|Interest-Bearing Liabilities:                                               |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Money market savings                                                        |  | $                 | 16,911 |   |            | $ |        |             |  | $ |            |   |  | $     |        |   |  | $ | 16,911  |  
|Interest checking (3)                                                       |  |                   |       |   |            |   |        |             |  |   | 32,096      |   |  |       |        |   |  |   | 32,096  |  
|Savings (3)                                                                 |  |                   | 2,306  |   |            |   | 1,053   |             |  |   | 14,577      |   |  |       |        |   |  |   | 17,936  |  
|Certificates of deposit                                                     |  |                   | 37,173 |   |            |   | 41,992  |             |  |   | 21,940      |   |  |       | 531     |   |  |   | 101,636 |  
|FHLB advances                                                               |  |                   | 11,700 |   |            |   | 7,000   |             |  |   | 22,000      |   |  |       | 417     |   |  |   | 41,117  |  
|                                                                            |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Total interest-bearing liabilities                                          |  | $                 | 68,090 |   |            | $ | 50,045  |             |  | $ | 90,613      |   |  | $     | 948     |   |  | $ | 209,696 |  
|                                                                            |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Cumulative interest-bearing liabilities                                     |  | $                 | 68,090 |   |            | $ | 118,135 |             |  | $ | 208,748     |   |  | $     | 209,696 |   |  | $ | 209,696 |  
|                                                                            |  |                   |        |   |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Period gap                                                                  |  | $                 | (7,499 | ) |            | $ | 25,476  |             |  | $ | 9,914       |   |  | $     | 14,650  |   |  | $ | 42,541  |  
|Cumulative gap                                                              |  | $                 | (7,499 | ) |            | $ | 17,977  |             |  | $ | 27,891      |   |  | $     | 42,541  |   |  | $ | 42,541  |  
|Ratio of cumulative interest-earning assets to interest-bearing liabilities |  |                   | 88.99  | % |            |   | 115.22  | %           |  |   | 113.36      | % |  |       | 120.29  | % |  |   | 120.29  | %
|Ratio of cumulative gap to total earning assets                             |  |                   | -2.97  | % |            |   | 7.13    | %           |  |   | 11.06       | % |  |       | 16.87   | % |  |   | 16.87   | %



|(1) | Includes nonaccrual loans of $793,000, which are spread throughout the categories.
|--- | ----------------------------------------------------------------------------------

|(2) | All securities without specific maturities are included in the 1 to 5 years category since they are not considered as sensitive to interest rate changes.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Management has determined that interest checking and savings accounts, excluding $996,000 in savings accounts with more frequent rate adjustment terms, are not sensitive to changes
in related market rates and, therefore, they are placed in the 1 to 5 years and over 5 years categories, respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Noninterest
Income

2007 Compared to 2006

During the year ended December 31, 2007, the Companys noninterest income was $3.40 million compared to $3.39 million in 2006. Noninterest income benefited from growth in mortgage banking fees and investments brokerage
commissions, while a decline in loan production impacted loan fees during the year. Also impacting noninterest income for the year was a $135,500 decline in net gains from investing activities as compared to the prior year. Excluding gains from
investing activities, core noninterest income increased 4.5% over that earned in 2006.

Mortgage banking fees increased 69.8% to $221,700
during 2007 as compared to 2006, while investment brokerage commissions grew to $387,400, or 14.9%, over the prior year. Although industry wide the mortgage banking business struggled and qualifying criteria became more stringent as a result of the
subprime debacle, opportunities continued to exist in our markets for well qualified, long-term fixed rate loan products. These loans are pre-sold to third parties so the Company does not fund or securitize these products.



25



---

Accordingly, the Company does not have the exposure on its balance sheet and to its earnings that has
plagued other companies in the financial services industry. Investment brokerage commissions benefited from increased activity and an increase in the Companys commission percentage as a result of the improved production levels.

The Bank generates loan fees from late charges and prepayment penalties on loans and deposit account fees from charges related insufficient funds, check
printing, cashiers checks, service charges, ATM, check cards and others. While these fees are generally core earnings that are not interest sensitive and have provided a stable source of income for the Bank, they can fluctuate during different
economic cycles. With the reduction in gross loan production and loan prepayment activity, loan fees declined by 21% during 2007, while deposit account fees were relatively flat at $2.3 million during 2007 as a result of a flattening in courtesy
overdraft fees generated. The Bank instituted a courtesy overdraft program during 2006 which, as expected, resulted in a significant increase in fees during 2006 over the prior year. However, also as anticipated, the initial boost in revenue
realized during the first year of the program moderated to normal levels going forward.

2006 Compared to 2005

During 2006, the Company continued to benefit in growth of noninterest income, primarily in the areas of deposit account fees and investment brokerage
commissions. During the year ended December 31, 2006, noninterest income increased to $3.39 million from $2.38 million in 2005, representing a 42.6% increase. The addition of a courtesy overdraft product helped increase deposit account fees to
$2.29 million during 2006, representing a 70.2% increase over the $1.34 million generated in 2005. Deposit account fees consist of charges related insufficient funds, check printing, cashiers checks, service charges, ATM, check cards and others.
These fees are core earnings that are not interest sensitive and have provided a stable source of income for the Bank.

Investment
brokerage commissions benefited from increased production by the Companys investment brokers during 2006, one of which was hired during 2005 with fifteen years experience. This resulted in an increase in investment brokerage commissions of
95.9% to $337,200, compared to $172,100 during 2005. The Company also experienced growth of 34.8% and 4.6% in loan fees and other income, respectively, and took advantage of investment portfolio profits by realizing $210,000 of net gains on sales of
securities during 2006, compared to $315,900 of gains on the sales of investments and real estate in 2005. Loan fees primarily consist of late charges and prepayment penalties on loans and are also considered core earnings for the Bank.

Noninterest Expense

2007 Compared to 2006

During the year ended December 31, 2007, the Companys noninterest expenses increased to $8.29 million from $7.74 million
during 2006, while its efficiency ratio was 68.05% compared to 63.99% for 2006. As previously mentioned, the Company tackled many strategic initiatives during 2007 that will provide benefits going forward, but will impact noninterest expense in the
short-term. One such initiative is rebuilding the Salisbury, Maryland branch facility which generated a $147,900 net loss upon disposal of the old facility. The 2007 expense included cost associated with opening the Banks eighth banking
facility and additional personnel employed to enhance the Companys loan administration, operations, mortgage banking and internet banking divisions, as well as, normal annual salary and benefit adjustments. Additionally, the Bank instituted a
new marketing and branding program during the year that entailed a significant upfront investment, but will generate a more consistent message in the markets it serves.



26



---

As a result of the additional personnel, the new branch, normal salary and benefit adjustments and higher
commissions paid to mortgage banking and investment brokerage employees due to production increases, compensation and benefits increased by 9.10% to $4.25 million during the year ended December 31, 2007, as compared to $3.90 million for the
year ended December 31, 2006. In spite of the branch addition and the leasing of two temporary locations due to the branch rebuild and branch relocation, occupancy and equipment expenses remained flat at $1.91 million during 2007, while data
processing expenses increased a nominal 2.8% to $821,100. The new marketing and branding initiative caused marketing and promotion expenses to increase 54.7% to $204,700, while expenses related to the pending merger caused professional fees to
increase 9.3% to $435,900. Other noninterest expenses increased to $670,300, or 11.6%, primarily resulting from higher employee expenses, courier costs and expenses related to increased check card and deposit account activity.

2006 Compared to 2005

During 2006, the
Companys noninterest expenses increased to $7.74 million from $6.64 million during 2005, while its efficiency ratio remained relatively flat at 63.99% compared to 63.54% for 2005. The majority of the increase occurred in compensation and
benefits expense, primarily resulting from increases in commissions associated with operating the Companys investment brokerage services, the expensing of stock options granted to non-executive employees and general increase in compensation
and other benefits. Compensation and benefits increased by 24.0% to $3.90 million during the year ended December 31, 2006, as compared to $3.14 million for the year ended December 31, 2005.

The Company also took on other customer service initiatives, including expansion of the Banks ATM network by seventeen machines, additional
internet banking services and other new deposit products. As a result of these initiatives, occupancy and equipment expenses increased 9.8% to $1.91 million during 2006, compared to $1.74 million for 2005, while data processing costs, professional
fees and other expenses increased 4.8%, 26.0% and 14.2%, respectively.

Provision for Loan Losses

2007 Compared to 2006

During the year ended
December 31, 2007, the Company incurred a net reduction of $72,600 in the provision for loan losses, primarily resulting from an $118,000 downward adjustment to the allowance for loan losses. As discussed under the Asset Quality section
below, management evaluates the allowance for loan losses on a regular basis using a methodology that considers various risk factors in accordance with Statement of Financial Accounting Standard (SFAS) No. 5, Accounting for
Contingencies. During the fourth quarter of 2007, the methodology revealed an excess in the allowance for loan losses and, accordingly, the Bank made the appropriate adjustment. Excluding this adjustment, the loan loss provision was $45,400
which primarily relates to the courtesy overdraft product and is fairly consistent with the $58,700 incurred during 2006.

2006 Compared to 2005

During 2006, the Companys provision for loan losses was $58,700, primarily consisting of write-offs related to the Banks new
courtesy overdraft product instituted during 2006. This amount represents a $245,000 decrease from the 2005 provision of $303,700, primarily resulting from the Banks methodology for evaluating the allowance for loan losses indicating that 2006
levels were commensurate with the risk existing in the Banks loan portfolio at that time.



27



---

Financial Condition

Loan Portfolio

The Banks loan portfolio is comprised of real estate mortgage loans, construction loans,
commercial loans, home equity loans, and consumer loans. The primary market areas in which the Bank originates loans are the counties of Accomack and Northampton, Virginia, Salisbury/Wicomico County, Maryland and Pocomoke City/Worcester County,
Maryland.

Total loans (excluding allowances for loan losses) increased to $221.6 million at December 31, 2007, a 5.2% increase over
the $210.6 million outstanding at December 31, 2006. The growth resulted from gross loan production of approximately $66.4 million, primarily in the category of residential real estate. Residential real estate (including construction and land
loans) increased 6.1% during 2007, while commercial loans grew 5.7% and consumer and home equity loans were flat during the year.

The
following table summarizes the composition of the Banks loan portfolio at the dates indicated.

Loan Portfolio



|                               |  |              |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------ |  | ------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                               |  | December 31, |        
|(Dollars In Thousands)         |  | 2007         |         |   | 2006 |   |         | 2005 |  |   | 2004    |   |  | 2003 |        
|Residential mortgage           |  | $            | 119,910 |   |      | $ | 111,890 |      |  | $ | 97,245  |   |  | $    | 86,537  |   |  | $ | 72,339  |  
|Commercial mortgage            |  |              | 69,448  |   |      |   | 64,698  |      |  |   | 61,917  |   |  |      | 59,414  |   |  |   | 39,621  |  
|Commercial - other             |  |              | 9,168   |   |      |   | 9,682   |      |  |   | 9,590   |   |  |      | 8,673   |   |  |   | 8,568   |  
|Real estate construction (1)   |  |              | 5,492   |   |      |   | 6,340   |      |  |   | 9,026   |   |  |      | 5,658   |   |  |   | 4,005   |  
|Home equity lines of credit    |  |              | 13,882  |   |      |   | 14,743  |      |  |   | 15,293  |   |  |      | 15,581  |   |  |   | 14,951  |  
|Consumer                       |  |              | 3,842   |   |      |   | 3,381   |      |  |   | 2,559   |   |  |      | 2,378   |   |  |   | 2,508   |  
|                               |  |              |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total loans                    |  |              | 221,742 |   |      |   | 210,734 |      |  |   | 195,630 |   |  |      | 178,241 |   |  |   | 141,992 |  
|                               |  |              |         |   |     
|Less:                          |  |              |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Deferred loan (fees) cost, net |  |              | (156    | ) |      |   | (136    | )    |  |   | (82     | ) |  |      | 158     |   |  |   | 217     |  
|Allowance for loan losses      |  |              | (2,699  | ) |      |   | (2,873  | )    |  |   | (2,851  | ) |  |      | (2,404  | ) |  |   | (2,002  | )
|                               |  |              |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loans                      |  | $            | 218,887 |   |      | $ | 207,725 |      |  | $ | 192,697 |   |  | $    | 175,995 |   |  | $ | 140,207 |  
|                               |  |              |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  



|(1) | Amounts are disclosed net of loans in process of approximately $2.9 million, $2.8 million, $5.9 million, $4.2 million and $3.1 million for 2007, 2006, 2005, 2004 and 2003,
respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



28



---

The following table sets forth the composition of the Banks loan portfolio by percentage at the
dates indicated.

Loan Portfolio by Percentage



|                            |  |              |   |  |        |   |  |        |   |  |        |   |  |        |  
|--------------------------- |  | ------------ | - |  | ------ | - |  | ------ | - |  | ------ | - |  | ------ | -
|                            |  | December 31, |  
|                            |  | 2007         |   |  | 2006   |   |  | 2005   |   |  | 2004   |   |  | 2003   |  
|Residential mortgage        |  | 54.08        | % |  | 53.10  | % |  | 49.71  | % |  | 48.55  | % |  | 50.95  | %
|Commercial mortgage         |  | 31.32        | % |  | 30.70  | % |  | 31.65  | % |  | 33.33  | % |  | 27.90  | %
|Commercial - other          |  | 4.13         | % |  | 4.59   | % |  | 4.90   | % |  | 4.87   | % |  | 6.03   | %
|Real estate construction    |  | 2.48         | % |  | 3.01   | % |  | 4.61   | % |  | 3.18   | % |  | 2.82   | %
|Home equity lines of credit |  | 6.26         | % |  | 7.00   | % |  | 7.82   | % |  | 8.74   | % |  | 10.53  | %
|Consumer                    |  | 1.73         | % |  | 1.60   | % |  | 1.31   | % |  | 1.33   | % |  | 1.77   | %
|                            |  |              |   |  |        |   |  |        |   |  |        |   |  |        |  
|Total loans                 |  | 100.00       | % |  | 100.00 | % |  | 100.00 | % |  | 100.00 | % |  | 100.00 | %
|                            |  |              |   |  |        |   |  |        |   |  |        |   |  |        |  

The following table presents the maturities of selected loans outstanding at December 31,
2007.

Maturity Schedule of Loans



|                                     |  |                   |        |                                     |        |                     |           |   |              |               |   |         |  |   |        |  |   |        
|------------------------------------ |  | ----------------- | ------ | ----------------------------------- | ------ | ------------------- | --------- | - | ------------ | ------------- | - | ------- |  | - | ------ |  | - | -------
|                                     |  | December 31, 2007
|                                     |  | Due inone year    |        | Due after oneyear
throughfive years |        | Due afterfive years |           |   |              | Ater one year
|(Dollars In Thousands)               |  |                   |        |                                     | Totals |                     | FixedRate |   | VariableRate
|Residential and commercial mortgages |  | $                 | 23,683 |                                     | $      | 38,015              |           | $ | 127,503      |               | $ | 189,201 |  | $ | 35,067 |  | $ | 130,532
|Commercial - other                   |  |                   | 4,417  |                                     |        | 2,227               |           |   | 2,524        |               |   | 9,168   |  |   | 1,564  |  |   | 3,187  
|Real estate construction             |  |                   | 5,492  |                                     |        | 0                   |           |   | 0            |               |   | 5,492   |  |   | 0      |  |   | 0      
|Home equity lines of credit          |  |                   | 13,882 |                                     |        | 0                   |           |   | 0            |               |   | 13,882  |  |   | 0      |  |   | 0      
|Consumer                             |  |                   | 2,594  |                                     |        | 926                 |           |   | 322          |               |   | 3,842   |  |   | 1,164  |  |   | 84     
|                                     |  |                   |        |                                     |        |                     |           |   |              |               |   |         |  |   |        |  |   |        
|Total                                |  | $                 | 50,068 |                                     | $      | 41,168              |           | $ | 130,349      |               | $ | 221,585 |  | $ | 37,795 |  | $ | 133,803
|                                     |  |                   |        |                                     |        |                     |           |   |              |               |   |         |  |   |        |  |   |        

Securities

When securities are purchased, they are classified as securities held to maturity if management has the positive intent and the Company has the ability to hold them until maturity. These investment securities are
carried at cost adjusted for amortization of premium and accretion of discounts. Unrealized losses in the portfolio are not recognized unless management of the Company believes that other than a temporary decline has occurred. Securities held for
indefinite periods of time and not intended to be held to maturity are classified as available for sale at the time of purchase. Securities available for sale are recorded at fair value. The net unrealized holding gain or loss on securities
available for sale, net of deferred income taxes, is included in other comprehensive income as a separate component of stockholders equity. A decline in the fair value of any securities available for sale below cost, that is deemed other than
temporary, is charged to earnings and results in a new cost basis for the security. Cost of securities sold is determined on the basis of specific identification. The Company holds no securities classified as trading.

Investment Securities. The carrying value of investment securities (effected for all applicable fair value adjustments) amounted to $22.9
million at December 31, 2007, compared to $30.4 million and $32.4 million at December 31, 2006 and 2005, respectively. Decreases in securities primarily resulted from loan demand during 2005 through 2007, slow deposit growth during these
periods and few adequate return opportunities in the investment market. The comparison of amortized cost to fair value is shown in Note 3 of the notes to the financial statements. Note 3 also provides an analysis of gross unrealized gains and losses
of investment securities. Investment securities consist of the following:



29



---

Investment Securities Portfolio



|                                                 |  |                          |        |      |   |        |  |   |       
|------------------------------------------------ |  | ------------------------ | ------ | ---- | - | ------ |  | - | ------
|                                                 |  | Years Ended December 31,
|(Dollars In Thousands)                           |  | 2007                     |        | 2006 |   | 2005  
|Amortized Cost:                                  |  |                          |        |      |   |        |  |   |       
|U.S. Treasury and other U.S. government agencies |  | $                        | 7,959  |      | $ | 12,942 |  | $ | 17,546
|Tax-exempt municipal bonds                       |  |                          | 6,413  |      |   | 6,414  |  |   | 3,996 
|Mortgage-backed securities                       |  |                          | 1,056  |      |   | 1,263  |  |   | 1,528 
|Corporate bonds                                  |  |                          | 1,000  |      |   | 2,003  |  |   | 2,008 
|Common stock                                     |  |                          | 2,425  |      |   | 2,271  |  |   | 1,989 
|Preferred stock                                  |  |                          | 1,864  |      |   | 2,898  |  |   | 1,898 
|Other equity securities                          |  |                          |       |      |   |       |  |   | 817   
|                                                 |  |                          |        |      |   |        |  |   |       
|Total available for sale securities              |  |                          | 20,717 |      |   | 27,791 |  |   | 29,782
|Other investment securities                      |  |                          | 2,670  |      |   | 2,443  |  |   | 2,461 
|                                                 |  |                          |        |      |   |        |  |   |       
|Total securities                                 |  | $                        | 23,387 |      | $ | 30,234 |  | $ | 32,243
|                                                 |  |                          |        |      |   |        |  |   |       

Securities Available for Sale.Securities available for sale are used as part
of the Companys interest rate risk management strategy and may be sold in response to changes in interest rates, changes in prepayment risk, liquidity needs, the need to increase regulatory capital and other factors. The fair value of
securities available for sale totaled $20.2 million at December 31, 2007, compared to $28.0 million and $29.9 million at December 31, 2006 and 2005, respectively. The comparison of fair market value to amortized cost is shown in Note 3 of
the notes to the financial statements. Note 3 also provides an analysis of gross unrealized gains and losses of securities available for sale. The following summarizes available for sale securities for the respective periods.

Securities Available for Sale



|                                                |  |                          |        |      |   |        |  |   |       
|----------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | - | ------
|                                                |  | Years Ended December 31,
|(Dollars In Thousands)                          |  | 2007                     |        | 2006 |   | 2005  
|Fair Value:                                     |  |                          |        |      |   |        |  |   |       
|U.S. Treasury and other U.S.government agencies |  | $                        | 8,056  |      | $ | 12,739 |  | $ | 17,287
|Tax-exempt municipal bonds                      |  |                          | 6,433  |      |   | 6,414  |  |   | 3,988 
|Mortgage-backed securities                      |  |                          | 1,047  |      |   | 1,221  |  |   | 1,492 
|Corporate bonds                                 |  |                          | 1,004  |      |   | 2,022  |  |   | 2,060 
|Common stock                                    |  |                          | 1,928  |      |   | 2,691  |  |   | 2,369 
|Preferred stock                                 |  |                          | 1,756  |      |   | 2,878  |  |   | 1,897 
|Other equity securities                         |  |                          |       |      |   |       |  |   | 797   
|                                                |  |                          |        |      |   |        |  |   |       
|Total available for sale securities             |  |                          | 20,224 |      |   | 27,965 |  |   | 29,890
|Other investment securities                     |  |                          | 2,670  |      |   | 2,443  |  |   | 2,461 
|                                                |  |                          |        |      |   |        |  |   |       
|Total securities                                |  | $                        | 22,894 |      | $ | 30,408 |  | $ | 32,351
|                                                |  |                          |        |      |   |        |  |   |       



30



---

The following table sets forth the maturity distribution and weighted average yields of the securities
portfolio at December 31, 2007. The weighted average yields are calculated on the basis of carrying value of the investment portfolio and on the interest income of investments adjusted for amortization of premium and accretion of discount.

Maturities of Investments



|                                                    |  |                    |        |                 |   |                      |  |      |  
|--------------------------------------------------- |  | ------------------ | ------ | --------------- | - | -------------------- |  | ---- | -
|                                                    |  | Available-for-Sale |       
|(Dollars In Thousands)                              |  | AmortizedCost      |        | FairMarketValue |   | WeightedAverageYield | 
|U.S. Government Agencies and other U.S. securities: |  |                    |        |                 |   |                      |  |      |  
|Within one year                                     |  | $                  | 1,000  |                 | $ | 998                  |  | 4.00 | %
|After one year to five years                        |  |                    | 5,982  |                 |   | 6,034                |  | 4.30 | %
|After five years                                    |  |                    | 977    |                 |   | 1,024                |  | 4.99 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|Total                                               |  |                    | 7,959  |                 |   | 8,056                |  | 4.34 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|                                                    |  |                    |       
|Municipal Securities:                               |  |                    |        |                 |   |                      |  |      |  
|Within one year                                     |  |                    |       |                 |   |                     |  | 0.00 | %
|After one year to five years                        |  |                    | 2,388  |                 |   | 2,395                |  | 3.52 | %
|After five years                                    |  |                    | 4,025  |                 |   | 4,038                |  | 3.88 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|                                                    |  |                    | 6,413  |                 |   | 6,433                |  | 3.74 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|                                                    |  |                    |       
|Mortgage Backed Securities:                         |  |                    |        |                 |   |                      |  |      |  
|Within one year                                     |  |                    |       |                 |   |                     |  | 0.00 | %
|After one year to five years                        |  |                    | 255    |                 |   | 252                  |  | 3.47 | %
|After five years                                    |  |                    | 801    |                 |   | 795                  |  | 4.80 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|                                                    |  |                    | 1,056  |                 |   | 1,047                |  | 4.48 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|                                                    |  |                    |       
|Corporate Bonds:                                    |  |                    |        |                 |   |                      |  |      |  
|Within one year                                     |  |                    | 1,000  |                 |   | 1,004                |  | 6.24 | %
|After one year to five years                        |  |                    |       |                 |   |                     |  | 0.00 | %
|After five years                                    |  |                    |       |                 |   |                     |  | 0.00 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|                                                    |  |                    | 1,000  |                 |   | 1,004                |  | 6.24 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|                                                    |  |                    |       
|Other Securities:                                   |  |                    |        |                 |   |                      |  |      |  
|No stated maturity                                  |  |                    | 6,959  |                 |   | 6,354                |  | 5.42 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  
|Total securities                                    |  | $                  | 23,387 |                 | $ | 22,894               |  | 4.59 | %
|                                                    |  |                    |        |                 |   |                      |  |      |  



31



---

Deposits

The Bank depends on deposits to fund its lending activities, generate fee income opportunities, and create a captive market for loan products. The table below presents a history of average deposits and the rates paid
on interest-bearing deposit accounts for the periods indicated.

Average Deposits and Average Rates Paid



|                                |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|------------------------------- |  | ------------------------ | ------- | ----------- | ---- | - | -------------- | ---- | ----------- |  | ---- | -------------- |  | ----------- | ------- |  | ---- | -
|                                |  | Years Ended December 31, |        
|                                |  | 2007                     |         |             | 2006 |   |                | 2005 |            
|(Dollars In Thousands)          |  | AverageBalance           |         | AverageRate |      |   | AverageBalance |      | AverageRate |  |      | AverageBalance |  | AverageRate |        
|Interest-bearing deposits:      |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|Checking and savings            |  | $                        | 65,533  |             | 1.46 | % |                | $    | 67,053      |  | 0.96 | %              |  | $           | 79,600  |  | 0.78 | %
|Certificates of deposit:        |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|Less than $100,000              |  |                          | 78,968  |             | 4.42 | % |                |      | 77,327      |  | 4.10 | %              |  |             | 66,146  |  | 3.16 | %
|$100,000 and over               |  |                          | 28,670  |             | 4.66 | % |                |      | 26,054      |  | 4.42 | %              |  |             | 19,019  |  | 3.54 | %
|                                |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|Total interest-bearing deposits |  |                          | 173,171 |             | 3.34 | % |                |      | 170,434     |  | 2.91 | %              |  |             | 164,765 |  | 2.06 | %
|Noninterest-bearing deposits    |  |                          | 28,064  |             | 0.00 | % |                |      | 27,005      |  | 0.00 | %              |  |             | 27,556  |  | 0.00 | %
|                                |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|Total average deposits          |  | $                        | 201,235 |             | 2.87 | % |                | $    | 197,439     |  | 2.51 | %              |  | $           | 192,321 |  | 1.76 | %
|                                |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  

Deposits averaged $201.2 million during the year ended December 31, 2007, an increase of 1.9%
and 4.6% over the $197.4 million and $192.3 million during 2006 and 2005, respectively. Certificates of deposit accounted for the largest portion of the increase, followed by noninterest-bearing demand deposits.

The following table is a summary of the maturity distribution of certificates of deposit in amounts of $100,000 or more as of December 31, 2007.

Maturities of CDs of $100,000 or More



|                              |  |                   |        |         |        |  
|----------------------------- |  | ----------------- | ------ | ------- | ------ | -
|                              |  | December 31, 2007 |       
|(Dollars In Thousands)        |  | Amount            |        | Percent |       
|Three months or less          |  | $                 | 10,447 |         | 37.19  | %
|Over three months to one year |  |                   | 11,363 |         | 40.45  | %
|Over one year to five years   |  |                   | 6,282  |         | 22.36  | %
|Over five years               |  |                   |       |         | 0.00   | %
|                              |  |                   |        |         |        |  
|Total                         |  | $                 | 28,092 |         | 100.00 | %
|                              |  |                   |        |         |        |  

Capital Resources

Capital represents funds, earned or obtained, over which banks can exercise greater control in comparison with deposits and borrowed funds. The adequacy of the Companys capital is reviewed by management on an
ongoing basis with reference to the size, composition, and quality of the Companys resources and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will support anticipated
asset growth and absorb potential losses.



32



---

Banking regulations established to ensure capital adequacy require the Company and the Bank to maintain
minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2007, that the Company
meets all capital adequacy requirements to which it is subject.

The following table details the components of Tier 1 and Tier 2 capital
and related ratios for the periods indicated.

Analysis of Capital



|                                                         |  |              |         |   |      |   |         |  
|-------------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                         |  | December 31, |        
|(Dollars In Thousands)                                   |  | 2007         |         |   | 2006 |  
|Tier 1 Capital:                                          |  |              |         |   |      |   |         |  
|Common stock                                             |  | $            | 688     |   |      | $ | 687     |  
|Additional paid-in capital                               |  |              | 8,400   |   |      |   | 8,373   |  
|Retained earnings                                        |  |              | 18,959  |   |      |   | 16,953  |  
|Accumulated other comprehensive income                   |  |              | (326    | ) |      |   | 113     |  
|                                                         |  |              |         |   |      |   |         |  
|Total capital (GAAP)                                     |  |              | 27,721  |   |      |   | 26,126  |  
|Less: Intangibles                                        |  |              | (340    | ) |      |   | (402    | )
|Net unrealized gain (loss) on debt and equity securities |  |              | 326     |   |      |   | (113    | )
|Net unrealized losses on equity securities               |  |              | (399    | ) |      |   |        |  
|                                                         |  |              |         |   |      |   |         |  
|Total Tier 1 capital                                     |  |              | 27,308  |   |      |   | 25,611  |  
|                                                         |  |             
|Tier 2 Capital:                                          |  |              |         |   |      |   |         |  
|Allowable allowances for loan losses                     |  |              | 2,341   |   |      |   | 2,269   |  
|Net unrealized gains on equity securities                |  |              | 15      |   |      |   | 180     |  
|                                                         |  |              |         |   |      |   |         |  
|Total Tier 2 capital                                     |  | $            | 29,664  |   |      | $ | 28,060  |  
|                                                         |  |              |         |   |      |   |         |  
|Risk-weighted assets                                     |  | $            | 190,197 |   |      | $ | 185,991 |  
|                                                         |  |             
|Capital Ratios (1):                                      |  |              |         |   |      |   |         |  
|Tier 1 risk-based capital ratio                          |  |              | 14.36   | % |      |   | 13.77   | %
|Total risk-based capital ratio                           |  |              | 15.60   | % |      |   | 15.09   | %
|Tier 1 capital to average adjusted total assets          |  |              | 10.28   | % |      |   | 9.93    | %



|(1) | The required minimum capital ratios for capital adequacy purposes, as defined collectively by the federal banking agencies, for Tier 1 risk-based capital, total risk-based capital,
and Tier 1 capital to average adjusted assets was 4.0%, 8.0% and 4.0%, respectively. To be considered well capitalized under federal prompt corrective action regulations, these same required ratios are 6.0%, 10.0% and 5.0%, respectively.
See Note 11 of the notes to the financial statements for a detail of the capital ratios.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Asset Quality

Allowance for loan losses.The allowance for loan losses represents an amount management believes is adequate to provide for
probable loan losses inherent in the loan portfolio. Management evaluates the allowance for loan losses on a regular basis using a methodology that considers various risk factors in accordance with SFAS No. 5, Accounting for
Contingencies. This methodology includes analyzing historical loan losses, existing doubtful accounts, the experience of its lenders, growth by loan category, specific



33



---

loan risk (i.e. construction loans), economic conditions and loan to value considerations. The outcome of this methodology results in range that is used to
determine the Banks allowance for loan losses. However, risks of future losses cannot be quantified precisely or attributed to particular loans or classes of loans. Because those risks are influenced by general economic trends as well as
conditions affecting individual borrowers, managements judgment of the allowance is necessarily approximate and imprecise. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into account
such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies.

Set forth below is a table detailing the allowance for loan losses for the periods indicated.

Allowance
for Loan Losses



|                                                                           |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|-------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                           |  | Years Ended December 31, |       
|(Dollars In Thousands)                                                     |  | 2007                     |        |   | 2006 |   |        | 2005 |  |   | 2004   |   |  | 2003 |       
|Balance, beginning of period                                               |  | $                        | 2,873  |   |      | $ | 2,851  |      |  | $ | 2,404  |   |  | $    | 2,002  |   |  | $ | 1,603  |  
|Loans charged off:                                                         |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial                                                                 |  |                          | (43    | ) |      |   |       |      |  |   | (29    | ) |  |      | (11    | ) |  |   |       |  
|Real estate mortgage                                                       |  |                          |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   | (4     | )
|Consumer                                                                   |  |                          | (166   | ) |      |   | (108   | )    |  |   | (18    | ) |  |      | (27    | ) |  |   | (24    | )
|                                                                           |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total loans charged-off                                                    |  |                          | (209   | ) |      |   | (108   | )    |  |   | (47    | ) |  |      | (38    | ) |  |   | (28    | )
|                                                                           |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Recoveries:                                                                |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial                                                                 |  |                          |       |   |      |   | 19     |      |  |   | 172    |   |  |      | 11     |   |  |   |       |  
|Real estate mortgage                                                       |  |                          |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Consumer                                                                   |  |                          | 108    |   |      |   | 52     |      |  |   | 18     |   |  |      | 10     |   |  |   | 47     |  
|                                                                           |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total recoveries                                                           |  |                          | 108    |   |      |   | 71     |      |  |   | 190    |   |  |      | 21     |   |  |   | 47     |  
|                                                                           |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net recoveries (charge-offs)                                               |  |                          | (101   | ) |      |   | (37    | )    |  |   | 143    |   |  |      | (17    | ) |  |   | 19     |  
|Provision (recovery) for loan losses                                       |  |                          | (73    | ) |      |   | 59     |      |  |   | 304    |   |  |      | 419    |   |  |   | 380    |  
|                                                                           |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Balance, end of period                                                     |  | $                        | 2,699  |   |      | $ | 2,873  |      |  | $ | 2,851  |   |  | $    | 2,404  |   |  | $ | 2,002  |  
|                                                                           |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Allowance for loan losses to loans outstanding at end of period            |  |                          | 1.22   | % |      |   | 1.36   | %    |  |   | 1.49   | % |  |      | 1.35   | % |  |   | 1.41   | %
|                                                                           |  |                          |        |   |     
|Allowance for loan losses to nonaccrual loans outstanding at end of period |  |                          | 340.35 | % |      |   | 308.59 | %    |  |   | 267.95 | % |  |      | 253.05 | % |  |   | 362.68 | %
|                                                                           |  |                          |        |   |     
|Net charge-offs (recoveries) to average loans outstanding during period    |  |                          | 0.05   | % |      |   | 0.02   | %    |  |   | -0.08  | % |  |      | 0.01   | % |  |   | -0.01  | %

During 2007, as has been the case over the past five years, the Banks charge-offs continued
to be minimal. Over the past five years, charge-offs have primarily occurred in the consumer loan category. During 2004, the Bank obtained possession of property related to a loan of which $172,000 was charged during 2001. During 2005, the Bank sold
the property, recovered all deficient amounts and recognized a gain of $149,000.

Although growth in the Banks loan portfolio during
2007 primarily occurred in the residential real estate category, a continued emphasis has been placed on growing the commercial and consumer loan categories over the last several years. Increased competition in the real estate mortgage arena and the
desire to diversify contributed to this shift in lending and customer relationships. However, with this change comes increased risk associated with potential loan losses. Based on the results of managements analysis, it believes that
allowances for losses existing at December 31, 2007 are sufficient to cover any anticipated or unanticipated losses on loans outstanding in accordance with SFAS No. 5, Accounting for Contingencies.



34



---

An allocation of the allowance for loan losses in dollars and as a percent of the total allowance is
provided in the following tables. Because all of these factors are subject to change, the allocation is not necessarily predictive of future loan losses in the indicated categories.

Allocation of Allowance for Loan Losses



|                       |  |                         |       |                            |             |   |                         |          |                            |  |       |                         |  |                            |     |  |       |  
|---------------------- |  | ----------------------- | ----- | -------------------------- | ----------- | - | ----------------------- | -------- | -------------------------- |  | ----- | ----------------------- |  | -------------------------- | --- |  | ----- | -
|                       |  | Commercial              |       |                            | Real Estate |   |                         | Consumer |                           
|(Dollars In Thousands) |  | Allowancefor LoanLosses |       | Percentageof LoanAllowance |             |   | Allowancefor LoanLosses |          | Percentageof LoanAllowance |  |       | Allowancefor LoanLosses |  | Percentageof LoanAllowance |    
|December 31,           |  |                         |       |                            |             |   |                         |          |                            |  |       |                         |  |                            |     |  |       |  
|2007                   |  | $                       | 1,664 |                            | 61.67       | % |                         | $        | 864                        |  | 32.00 | %                       |  | $                          | 171 |  | 6.33  | %
|2006                   |  |                         | 1,846 |                            | 64.25       | % |                         |          | 864                        |  | 30.06 | %                       |  |                            | 163 |  | 5.68  | %
|2005                   |  |                         | 1,949 |                            | 68.37       | % |                         |          | 242                        |  | 8.49  | %                       |  |                            | 660 |  | 23.14 | %
|2004                   |  |                         | 1,556 |                            | 64.73       | % |                         |          | 242                        |  | 10.07 | %                       |  |                            | 606 |  | 25.20 | %
|2003                   |  |                         | 1,175 |                            | 58.69       | % |                         |          | 278                        |  | 13.89 | %                       |  |                            | 549 |  | 27.42 | %

The following table details information concerning nonaccrual and past due loans, as well as
foreclosed assets.

Nonperforming Assets



|                                                                     |  |              |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|-------------------------------------------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                     |  | December 31, |       
|(Dollars In Thousands)                                               |  | 2007         |        |   | 2006 |   |        | 2005 |  |   | 2004   |   |  | 2003 |       
|Nonaccrual loans:                                                    |  |              |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial                                                           |  | $            | 135    |   |      | $ | 73     |      |  | $ | 194    |   |  | $    | 374    |   |  | $ | 126    |  
|Real estate mortgage                                                 |  |              | 482    |   |      |   | 832    |      |  |   | 811    |   |  |      | 272    |   |  |   | 321    |  
|Home equity lines of credit                                          |  |              | 171    |   |      |   | 24     |      |  |   |       |   |  |      | 120    |   |  |   | 28     |  
|Consumer                                                             |  |              | 5      |   |      |   | 2      |      |  |   | 59     |   |  |      | 184    |   |  |   | 77     |  
|                                                                     |  |              |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total nonaccrual loans                                               |  |              | 793    |   |      |   | 931    |      |  |   | 1,064  |   |  |      | 950    |   |  |   | 552    |  
|Other real estate owned                                              |  |              |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|                                                                     |  |              |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total nonperforming assets                                           |  | $            | 793    |   |      | $ | 931    |      |  | $ | 1,064  |   |  | $    | 950    |   |  | $ | 552    |  
|                                                                     |  |              |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Loans past due 90 or more days accruing interest                     |  |              |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Allowance for loan losses to nonaccrual loans                        |  |              | 340.35 | % |      |   | 308.59 | %    |  |   | 267.95 | % |  |      | 253.05 | % |  |   | 362.68 | %
|Nonperforming assets to period end loans and other real estate owned |  |              | 0.36   | % |      |   | 0.44   | %    |  |   | 0.56   | % |  |      | 0.53   | % |  |   | 0.39   | %

Total nonperforming assets consist of nonaccrual loans and foreclosed properties that are not
producing income for the Bank. The Banks policy is that whenever a loan reaches 90 days delinquent interest accruals are suspended until six months after the loan becomes current again. In recent years, the Bank has experienced strong asset
quality in its loan portfolio. Over the period, low interest rates and a strong real estate market created a vibrant lending environment and provided borrowers the opportunity to finance larger purchases at lower costs. Accordingly, trends in total
nonperforming assets and the related ratios have been relatively positive for the periods presented.

At December 31, 2007, no loans
were identified by the Bank as impaired as defined by generally accepted accounting principles and, accordingly, no specific allowances were provided with respect to impaired loans. At December 31, 2006, the Bank identified



35



---

one loan totaling $3,000 as impaired. However, the Bank did not allocate a valuation allowance for this loan at December 31, 2006. At December 31,
2005, the Bank identified $314,000 of loans as impaired with a valuation allowance allocation of $47,000. At December 31, 2004, no loans were identified by the Bank as impaired and, accordingly, no specific allowances were provided with respect
to impaired loans. At December 31, 2003, the Bank identified one impaired loan totaling $126,000 with no valuation allowance being place on this loan. The Bank obtained and sold the collateral for this loan during the first quarter of 2004 with
the net proceeds being sufficient to satisfy all principal and interest amounts due.

In conjunction with the methodology described above
to calculate the allowance for loan losses, the Bank closely monitors individual loans that are deemed to be potential problem loans. Loans are viewed as potential problem loans when possible credit problems of borrowers or industry trends cause
management to have doubts as to the ability of such borrowers to comply with current repayment terms. Those loans are subject to regular management attention, and their status is reviewed on a regular basis. In instances where management determines
that a specific allowance should be set, the Bank takes such action as deemed appropriate.

As of December 31, 2007, all loans 60 days
or more delinquent, including nonperforming loans, totaled $1.39 million. Additionally, other performing loans totaling $7.68 million existed that were current, but had other potential weaknesses that management considers to warrant additional
monitoring. All loans in these categories are subject to constant management attention, and their status is reviewed on a regular basis. These loans are generally secured by residential and commercial real estate and equipment with appraised values
that exceed the remaining principal balances on such loans.

Liquidity; Asset Management

Liquidity represents the Companys ability to meet present and future obligations through the sale or maturity of existing assets or the acquisition
of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, investments maturing within one year, and investments that are categorized as available-for-sale. The
Companys ability to obtain deposits and purchase funds at favorable rates impacts its liability liquidity. As a result of the Companys management of liquid assets and the ability to generate liquidity through liability funding,
management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors requirements and meet its customers credit needs.

The table below summarizes the Companys balance sheet liquidity position for the periods presented. Additionally, alternative sources of liquidity
are available to the Company in the wholesale funding markets including its capacity to borrow additional funds or purchase brokered certificates of deposits. The Bank has an available line of credit with the FHLB for up to 25% of Bank assets, or
approximately $66.1 million at December 31, 2007. However, the Bank may request an increase in this borrowing capacity from the FHLB. At December 31, 2007, the Bank had sufficient collateral pledged to borrow a total of approximately $87.3
million from the FHLB. The borrowing capacity is subject to certain collateral requirements as stipulated in the FHLB borrowing agreement. Additionally, the Bank maintains available borrowing arrangements of approximately $8.5 million with other
institutions. Based on these factors, the Company maintains sufficient liquidity to meet anticipated needs.



36



---

Summary of Liquid Assets



|                                                         |  |              |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                         |  | December 31, |        
|(Dollars In Thousands)                                   |  | 2007         |         |   | 2006 |   |         | 2005 | 
|Cash and due from banks                                  |  | $            | 11,265  |   |      | $ | 9,470   |      |  | $ | 9,176   |  
|Available-for-sale and other securities                  |  |              | 22,894  |   |      |   | 30,408  |      |  |   | 32,351  |  
|                                                         |  |              |         |   |      |   |         |      |  |   |         |  
|Total liquid assets                                      |  | $            | 34,159  |   |      | $ | 39,878  |      |  | $ | 41,527  |  
|                                                         |  |              |         |   |      |   |         |      |  |   |         |  
|Deposits and other liabilities                           |  | $            | 238,912 |   |      | $ | 234,550 |      |  | $ | 223,790 |  
|                                                         |  |              |         |   |      |   |         |      |  |   |         |  
|Ratio of liquid assets to deposits and other liabilities |  |              | 14.30   | % |      |   | 17.00   | %    |  |   | 18.56   | %
|                                                         |  |              |         |   |      |   |         |      |  |   |         |  

Total cash and cash equivalents were $11.3 million at December 31, 2007, compared to $9.5
million and $9.2 million at December 31, 2006 and 2005, respectively. Net cash flows from operating activities were $3.4 million for the year ended December 31, 2007, compared to $3.7 million and $3.0 million for the years ended
December 31, 2006 and 2005, respectively. This fluctuation primarily resulted from net income growth and other changes in normal operating activities during the periods.

Net cash flows used for investing activities were $5.3 million during the year ended December 31, 2007, compared to $13.2 million and $11.1 million
during the years ended December 31, 2006 and 2005, respectively. Loan growth declined in 2007 with net originations of $11.1 million, compared to net originations of $15.1 million and $17.1 million during the years ended December 31, 2006
and 2005, respectively. Other investment activities continued to be slow due to liquidity needs for loan growth.

Net cash flows from
financing activities were $3.6 million for the year ended December 31, 2007, compared to $9.8 million and $7.8 million during 2006 and 2005, respectively. Deposits declined $1.5 million in 2007, primarily due to run off of retail time deposits
and maturing brokered time deposits, compared to growth of $9.1 million during 2006 and a decline of $3.8 million in 2005. As has been the case over the past three year, the Banks deposit markets continued to be very competitive during 2007,
resulting in a more challenging environment to grow retail deposits profitably. Therefore, wholesale funding sources continued to be used during 2007 to fund liquidity shortfalls. During 2006, the Bank purchased $7.0 million of brokered time
deposits since they were a less expensive alternative funding source to FHLB advances at that time. However, this wholesale product was less competitive during 2007 and, therefore, the Bank relied more heavily on FHLB borrowings to meet liquidity
shortfalls. Net FHLB borrowings increased $5.9 million during 2007, while they were fairly flat at $1.2 million during 2006 and increased $12.1 million during 2005.

The Bank occasionally finds it necessary to borrow funds on a short-term basis due to fluctuations in loan and deposit levels. As discussed above, the Bank has arrangements with the FHLB and other institutions whereby
it may borrow funds overnight and on terms. At December 31, 2007, the Bank had $41.1 million in outstanding FHLB advances, compared to $35.2 million at December 31, 2006.



37



---

The following table details information concerning the Banks short-term borrowings for the periods
presented.

Summary of Borrowed Funds



|                                                                                 |  |              |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                 |  | December 31, |       
|(Dollars In Thousands)                                                           |  | 2007         |        |   | 2006 |   |        | 2005 | 
|Actual period end balances                                                       |  | $            | 18,700 |   |      | $ | 24,750 |      |  | $ | 25,500 |  
|Monthly average balance of short-term borrowings outstanding during the period   |  | $            | 16,276 |   |      | $ | 19,542 |      |  | $ | 21,033 |  
|Weighted-average interest rate on monthly average short-term borrowings          |  |              | 5.29   | % |      |   | 5.09   | %    |  |   | 3.34   | %
|Maximum month-end balance of short-term borrowings outstanding during the period |  | $            | 23,150 |   |      | $ | 29,150 |      |  | $ | 28,500 |  

Contractual Obligations, Contingent Liabilities and Commitments

The following table summarizes the Companys significant contractual obligations, contingent liabilities and certain other commitments outstanding at
December 31, 2007:

Contractural Obligations, Contingent Liabilities and Commitments



|                                                                                                                |  |                        |        |                 |   |           |  |           |        |                  |   |       |  |   |    
|--------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------ | --------------- | - | --------- |  | --------- | ------ | ---------------- | - | ----- |  | - | ---
|                                                                                                                |  | Payments Due By Period
|Contractural Obligations                                                                                        |  | Total                  |        | Less Than1 Year |   | 1-3 Years |  | 3-5 Years |        | More Than5 Years
|(Dollars In Thousands)                                                                                          |  |                        |        |                 |   |           |  |           |        |                 
|Operating lease obligations                                                                                     |  | $                      | 329    |                 | $ | 135       |  | $         | 170    |                  | $ | 24    |  | $ |   
|Other long-term liabilities reflected on the Companys balance sheet under GAAP Federal Home Loan Bank Advances |  |                        | 41,117 |                 |   | 18,700    |  |           | 17,000 |                  |   | 5,000 |  |   | 417
|Other commitments                                                                                               |  |                        |        |                 |   |           |  |           |        |                  |   |       |  |   |    
|Standby letters of credit                                                                                       |  |                        | 1,797  |                 |   | 1,797     |  |           |       |                  |   |      |  |   |   
|Commitments to extend credit                                                                                    |  |                        | 48,040 |                 |   | 48,040    |  |           |       |                  |   |      |  |   |   
|                                                                                                                |  |                        |        |                 |   |           |  |           |        |                  |   |       |  |   |    
|Total contractual obligations                                                                                   |  | $                      | 91,283 |                 | $ | 68,672    |  | $         | 17,170 |                  | $ | 5,024 |  | $ | 417
|                                                                                                                |  |                        |        |                 |   |           |  |           |        |                  |   |       |  |   |    



38



---

Return on Equity and Assets

The following table summarizes ratios considered to be significant indicators of the Companys profitability and financial condition during the periods indicated.

Return on Equity and Assets



|                                      |  |              |   |  |       |   |  |       |  
|------------------------------------- |  | ------------ | - |  | ----- | - |  | ----- | -
|                                      |  | December 31, |  
|                                      |  | 2007         |   |  | 2006  |   |  | 2005  |  
|Return on average assets              |  | 1.04         | % |  | 1.14  | % |  | 1.10  | %
|Return on average equity              |  | 10.05        | % |  | 11.76 | % |  | 11.74 | %
|Average equity to average asset ratio |  | 10.32        | % |  | 9.73  | % |  | 9.33  | %
|Dividend payout ratio                 |  | 26.61        | % |  | 21.19 | % |  | 20.16 | %

Critical Accounting Policies and Judgments

The accounting principles followed by the Company and the methods of applying these principles conform with generally accepted accounting principles and
to general practices within the banking industry. Our most critical accounting policies require managements judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. These policies require the use of subjective
and complex estimates, assumptions and judgments, which are based on information available as of the date of the financial statements and are important to our reported financial condition and results of operations. Accordingly, as this information
changes, our financial statements could reflect different estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.

The allowance for loan losses is established and maintained at levels management deems adequate to cover losses inherent in the loan portfolio, based
upon our evaluation of the risks in the portfolio and changes in the nature and volume of loan activity. Management evaluates the allowance for loan losses on a regular basis using a methodology that considers historical loan losses, existing
doubtful accounts, the experience of its lenders, growth by loan category, specific loan risk (i.e. construction loans), economic conditions and loan to value considerations. Additionally, we consider the impact of economic events and other market
factors, the outcome of which is uncertain. While we use the best information available in establishing the allowance, actual economic conditions differing significantly from our assumptions in determining the loan loss valuation allowance may
result in future adjustments, or regulators may require adjustments based upon information available to them at the time of their examinations. Although we believe that our allowance for loan losses is adequate and properly recorded in our financial
statements, differing economic conditions or alternate methods of estimation could result in materially different amounts of loan losses.

The estimation of fair value is significant to several of our assets, including available-for-sale (AFS) investment securities and OREO. AFS securities are recorded at fair value, while OREO is generally recorded at the lower of
cost or fair value (less estimated selling costs). Fair values can be volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and market conditions, among others. Since these factors
can change significantly and rapidly, fair values are difficult to predict and are subject to material changes, which could impact our financial condition.



39



---

Impact of Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instrumentsan amendment of FASB Statements No. 133 and 140. This statement amends Statements No. 133 and 140 by: permitting fair value remeasurement for any hybrid financial instrument with an embedded derivative that otherwise
would require bifurcation; clarifying which interest-only strips and principal-only strips are not subject to the requirements of Statement No. 133; establishing a requirement to evaluate interests in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifying that concentrations of credit risk in the form of subordination are not embedded derivatives;
and amending Statement No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The
statement was effective for fiscal years beginning after September 15, 2006. The adoption of this standard did not have a material impact on financial condition, results of operations or cash flows.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB Statement
No. 140. This statement amends Statement No. 140 with respect to the accounting for separately recognized servicing assets and servicing liabilities. It requires an entity to recognize a servicing asset or servicing liability each
time an obligation is undertaken to service a financial asset by entering into a servicing contract in certain situations, and requires all separately recognized servicing assets and liabilities to be initially measured at fair value, if
practicable. The statement permits the choice between the amortization method and the fair value measurement method for the subsequent measurement of the servicing assets or liabilities, and allows for a one-time
reclassification of available-for-sale securities to trading securities at initial adoption. The statement also requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of
financial position, and additional disclosures for all separately recognized servicing assets and servicing liabilities. The statement was effective for fiscal years beginning after September 30, 2006. The adoption of this standard did not have
a material impact on financial condition, results of operations or cash flows.

In July 2006, the FASB issued FASB Interpretation
No. 48 (FIN 48), Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement 109, which provides guidance on the measurement, recognition, and disclosure of tax positions taken or expected to be
taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, and disclosure. FIN 48 prescribes that a tax position should only be recognized if it is more-likely-than-not that the
position will be sustained upon examination by the appropriate taxing authority. A tax position that meets this threshold is measured as the largest amount of benefit that is more likely than not (greater than 50 percent) realized upon ultimate
settlement. The cumulative effect of applying FIN 48 is to be reported as an adjustment to the beginning balance of retained earnings in the period of adoption. FIN 48 was effective for fiscal years beginning after December 15, 2006. The
adoption of this standard did not have a material impact on financial condition, results of operations or cash flows.

In September 2006,
the FASB issued SFAS No. 157, Fair Value Measurements. SFAS 157 establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements.
While the Statement applies under other accounting pronouncements that require or permit fair value measurements, it does not require any new fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell
an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. In addition, the Statement establishes a fair value hierarchy, which prioritizes the inputs to valuation
techniques used to measure fair value into three broad levels. Lastly, SFAS No. 157 requires additional disclosures for each interim and annual period separately for each major category of assets and liabilities. The Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management does not expect the adoption of this Statement to have a material impact on the Companys financial
statements.



40



---

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and
Financial Liabilities, including an amendment of FASB Statement No. 115, which permits entities to choose to measure many financial instruments and certain other items at fair value and also establishes fair presentation and disclosure
requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for financial statements issued for fiscal years beginning after
November 15, 2007. The adoption of this standard did not have a material impact on financial condition, results of operations or cash flows.

In December 2007, the FASB issued SFAS 141(R), Business Combinations, which replaces SFAS 141. This Statement establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired in the business combination, liabilities assumed and any non-controlling interest in the acquiree as well as the goodwill acquired in a business combination. SFAS 141(R) also establishes disclosure requirements which
will enable the users to evaluate the nature and financial effects of the business combinations. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact of the
adoption of SFAS 141(R) on the Companys consolidated financial position and results of operations.

In December 2007, the FASB issued
SFAS 160, Non-controlling Interests in Consolidated Financial Statements  Amendment of ARB No. 51, which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent,
the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a parents ownership interest, and the valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. SFAS 160 also establishes expanded disclosure requirements that clearly identify and distinguish between the interest of the parents owners and the interests of the non-controlling owners of a subsidiary. SFAS 160 is effective
for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 160 on the Companys consolidated financial position and results of operations.

Effects of Inflation

The Company believes
that its net interest income and results of operations have not been significantly affected by inflation during the years ended December 31, 2007, 2006 and 2005.



41



---

|Item 7A. | 
|-------- | 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK

The Company uses a third party provider to perform computer modeling methodologies that assist in determining the overall
magnitude of interest sensitivity risk. Based on these methodologies, management formulates policies governing asset generation and pricing, funding sources and pricing, and off-balance-sheet commitments in order to reduce sensitivity risk. These
decisions are based on managements outlook regarding future interest rate movements, the state of the local and national economy, and other financial and business risk factors.

The modeling methodologies used measure interest rate sensitivity by analyzing the potential impact on net interest income under various interest rate
scenarios. One such scenario would assume a hypothetical 200 basis point instantaneous and parallel shift in the yield curve in interest rates. Accordingly, management modeled the impact of a 200 basis point decline in interest rates and a 200 basis
point increase in interest rates at December 31, 2007. The model indicates that a 200 basis point instantaneous and parallel decrease in the yield curve in interest rates would cause net interest income to decrease by $206,000, while a 200
basis point instantaneous and parallel increase in the yield curve in interest rates would cause net interest income to increase by $61,000.

The computer model uses standard algebraic formula for calculating present value. The calculation discounts the future cash flows of the Companys portfolio of interest rate sensitive instruments to present value utilizing techniques
designed to approximate current market rates for securities, current offering rates for loans, and the cost of alternative funding for the given maturity of deposits and then assumes an instantaneous and parallel shift in these rates. The difference
between these numbers represents the resulting hypothetical change in the fair value of interest rate sensitive instruments.

As with any
modeling techniques, certain limitations and shortcomings are inherent in the Companys methodology. Significant assumptions must be made in the calculation including: (1) no growth in volume or balance sheet mix; (2) constant market
interest rates reflecting the average rate from the last month of the given quarter; and (3) pricing spreads to market rates derived from an historical analysis, or from assumptions by instrument type. Additionally, the computations do not
contemplate certain actions management could undertake in response to changes in interest rates.



42



---

|Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
|------- | ------------------------------------------

Consolidated Statements of Financial Condition



|                                                                                                                         |  |                  |             |   |                  |   |            
|------------------------------------------------------------------------------------------------------------------------ |  | ---------------- | ----------- | - | ---------------- | - | -----------
|                                                                                                                         |  | December 31,2007 |             |   | December 31,2006
|ASSETS                                                                                                                   |  |                  |             |   |                  |   |            
|Cash (including interest-earning deposits of approximately $4,036,500 and $2,267,000, respectively)                      |  | $                | 11,265,300  |   |                  | $ | 9,469,800  
|Investment securities:                                                                                                   |  |                  |             |   |                  |   |            
|Available-for-sale (amortized cost of $20,716,600 and $27,791,300, respectively)                                         |  |                  | 20,224,400  |   |                  |   | 27,965,300 
|Other investments, at cost                                                                                               |  |                  | 2,669,600   |   |                  |   | 2,442,700  
|Loans receivable, net                                                                                                    |  |                  | 218,887,300 |   |                  |   | 207,725,200
|Premises and equipment, net                                                                                              |  |                  | 7,371,000   |   |                  |   | 7,044,300  
|Other assets                                                                                                             |  |                  | 6,249,700   |   |                  |   | 6,028,700  
|                                                                                                                         |  |                  |             |   |                  |   |            
|Total Assets                                                                                                             |  | $                | 266,667,300 |   |                  | $ | 260,676,000
|                                                                                                                         |  |                  |             |   |                  |   |            
|                                                                                                                         |  |                 
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                     |  |                  |             |   |                  |   |            
|Deposits:                                                                                                                |  |                  |             |   |                  |   |            
|Interest-bearing                                                                                                         |  | $                | 168,579,200 |   |                  | $ | 172,548,300
|Noninterest-bearing                                                                                                      |  |                  | 27,984,700  |   |                  |   | 25,554,500 
|                                                                                                                         |  |                  |             |   |                  |   |            
|Total deposits                                                                                                           |  |                  | 196,563,900 |   |                  |   | 198,102,800
|Advances from Federal Home Loan Bank                                                                                     |  |                  | 41,116,700  |   |                  |   | 35,233,300 
|Other liabilities                                                                                                        |  |                  | 1,266,000   |   |                  |   | 1,213,600  
|                                                                                                                         |  |                  |             |   |                  |   |            
|Total liabilities                                                                                                        |  |                  | 238,946,600 |   |                  |   | 234,549,700
|                                                                                                                         |  |                  |             |   |                  |   |            
|Stockholders equity                                                                                                     |  |                  |             |   |                  |   |            
|Preferred stock, par value $1 per share, 500,000 shares authorized; none issued and outstanding                          |  |                  |            |   |                  |   |           
|Common stock, par value $.275; 6,000,000 shares authorized; 2,500,927 and 2,497,327 issued and outstanding, respectively |  |                  | 687,800     |   |                  |   | 686,800    
|Additional capital                                                                                                       |  |                  | 8,400,000   |   |                  |   | 8,372,600  
|Retained earnings                                                                                                        |  |                  | 18,959,200  |   |                  |   | 16,953,400 
|Accumulated other comprehensive income (loss)                                                                            |  |                  | (326,300    | ) |                  |   | 113,500    
|                                                                                                                         |  |                  |             |   |                  |   |            
|Total stockholders equity                                                                                               |  |                  | 27,720,700  |   |                  |   | 26,126,300 
|                                                                                                                         |  |                  |             |   |                  |   |            
|Total Liabilities and Stockholders Equity                                                                               |  | $                | 266,667,300 |   |                  | $ | 260,676,000
|                                                                                                                         |  |                  |             |   |                  |   |            

The accompanying notes are an integral part of these financial statements.



43



---

Consolidated Statements of Income



|                                                    |  |                          |            |   |      |   |            |  |   |           
|--------------------------------------------------- |  | ------------------------ | ---------- | - | ---- | - | ---------- |  | - | ----------
|                                                    |  | Years Ended December 31,
|                                                    |  | 2007                     |            |   | 2006 |   | 2005      
|Interest and dividend income                        |  |                          |            |   |      |   |            |  |   |           
|Loans                                               |  | $                        | 14,832,300 |   |      | $ | 13,556,500 |  | $ | 11,232,700
|Investments                                         |  |                          |            |   |      |   |            |  |   |           
|Taxable interest                                    |  |                          | 911,700    |   |      |   | 1,143,900  |  |   | 1,307,600 
|Tax-exempt interest                                 |  |                          | 241,600    |   |      |   | 167,400    |  |   | 135,600   
|Dividends                                           |  |                          | 271,100    |   |      |   | 244,700    |  |   | 174,600   
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Total interest and dividend income                  |  |                          | 16,256,700 |   |      |   | 15,112,500 |  |   | 12,850,500
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Interest expense                                    |  |                          |            |   |      |   |            |  |   |           
|Deposits                                            |  |                          | 5,782,500  |   |      |   | 4,962,700  |  |   | 3,385,900 
|FHLB/other advances                                 |  |                          | 1,669,800  |   |      |   | 1,654,800  |  |   | 1,028,100 
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Total interest expense                              |  |                          | 7,452,300  |   |      |   | 6,617,500  |  |   | 4,414,000 
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Net interest income                                 |  |                          | 8,804,400  |   |      |   | 8,495,000  |  |   | 8,436,500 
|Provision (recovery) for loan losses                |  |                          | (72,600    | ) |      |   | 58,700     |  |   | 303,700   
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Net interest income after provision for loan losses |  |                          | 8,877,000  |   |      |   | 8,436,300  |  |   | 8,132,800 
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Noninterest income                                  |  |                          |            |   |      |   |            |  |   |           
|Deposit account fees                                |  |                          | 2,319,100  |   |      |   | 2,286,400  |  |   | 1,343,100 
|Loan fees                                           |  |                          | 125,700    |   |      |   | 159,100    |  |   | 118,000   
|Mortgage banking fees                               |  |                          | 221,700    |   |      |   | 130,600    |  |   | 173,400   
|Commissions on investment brokerage sales           |  |                          | 387,400    |   |      |   | 337,200    |  |   | 172,100   
|Gains from investment securities activities         |  |                          | 74,500     |   |      |   | 210,000    |  |   | 166,400   
|Gains on sale of real estate                        |  |                          |           |   |      |   |           |  |   | 149,500   
|Other                                               |  |                          | 272,000    |   |      |   | 268,600    |  |   | 256,900   
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Total noninterest income                            |  |                          | 3,400,400  |   |      |   | 3,391,900  |  |   | 2,379,400 
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Noninterest expense                                 |  |                          |            |   |      |   |            |  |   |           
|Compensation and employee benefits                  |  |                          | 4,254,000  |   |      |   | 3,897,600  |  |   | 3,144,100 
|Occupancy and equipment                             |  |                          | 1,906,200  |   |      |   | 1,911,000  |  |   | 1,740,800 
|Data processing                                     |  |                          | 821,100    |   |      |   | 799,000    |  |   | 762,200   
|Professional fees                                   |  |                          | 435,900    |   |      |   | 398,900    |  |   | 316,700   
|Marketing and promotion                             |  |                          | 204,700    |   |      |   | 132,300    |  |   | 148,200   
|Loss on disposal of fixed assets                    |  |                          | 147,900    |   |      |   |           |  |   | 6,500     
|Other                                               |  |                          | 670,300    |   |      |   | 600,400    |  |   | 525,600   
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Total noninterest expense                           |  |                          | 8,440,100  |   |      |   | 7,739,200  |  |   | 6,644,100 
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Income before income taxes                          |  |                          | 3,837,300  |   |      |   | 4,089,000  |  |   | 3,868,100 
|Income taxes                                        |  |                          | 1,106,700  |   |      |   | 1,155,900  |  |   | 1,192,800 
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Net income                                          |  | $                        | 2,730,600  |   |      | $ | 2,933,100  |  | $ | 2,675,300 
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Earnings Per Common Share:                          |  |                          |            |   |      |   |            |  |   |           
|Basic                                               |  | $                        | 1.09       |   |      | $ | 1.18       |  | $ | 1.08      
|                                                    |  |                          |            |   |      |   |            |  |   |           
|Diluted                                             |  | $                        | 1.08       |   |      | $ | 1.16       |  | $ | 1.06      
|                                                    |  |                          |            |   |      |   |            |  |   |           

The accompanying notes are an integral part of these financial statements.



44



---

Consolidated Statements of Stockholders Equity



|                                                                                                 |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  
|------------------------------------------------------------------------------------------------ |  | --------------- |  | ----------- | ------- | ----------------- | - | ---------------- |  | - | ------------------------------------------ | - |  | ----- | -------- | - |  | - | ---------- | -
|                                                                                                 |  | Number ofShares |  | CommonStock |         | AdditionalCapital |   | RetainedEarnings |  |   | AccumulatedOtherComprehensiveIncome (Loss) |   |  | Total |         
|Balance, December 31, 2004                                                                       |  | 2,063,284       |  | $           | 680,900 |                   | $ | 8,199,000        |  | $ | 12,494,400                                 |   |  | $     | 584,700  |   |  | $ | 21,959,000 |  
|Common stock cash dividend declared                                                              |  |                |  |             |        |                   |   |                 |  |   | (538,300                                   | ) |  |       |         |   |  |   | (538,300   | )
|Exercise of stock options, net of 1,492 of existing shares exchanged in lieu of exercise payment |  | 10,923          |  |             | 3,600   |                   |   | 59,100           |  |   |                                           |   |  |       |         |   |  |   | 62,700     |  
|Tax benefit associated with the exercise of stock options                                        |  |                |  |             |        |                   |   | 9,300            |  |   |                                           |   |  |       |         |   |  |   | 9,300      |  
|Comprehensive income (loss)                                                                      |  |                |  |             |        |                   |   |                 |  |   | 2,675,300                                  |   |  |       | (539,400 | ) |  |   | 2,135,900  |  
|                                                                                                 |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  
|Balance, December 31, 2005                                                                       |  | 2,074,207       |  |             | 684,500 |                   |   | 8,267,400        |  |   | 14,631,400                                 |   |  |       | 45,300   |   |  |   | 23,628,600 |  
|Common stock cash dividend declared                                                              |  |                |  |             |        |                   |   |                 |  |   | (610,300                                   | ) |  |       |         |   |  |   | (610,300   | )
|Exercise of stock options                                                                        |  | 7,804           |  |             | 2,300   |                   |   | 53,900           |  |   |                                           |   |  |       |         |   |  |   | 56,200     |  
|Compensation expense associated with the granting of stock options                               |  |                |  |             |        |                   |   | 40,400           |  |   |                                           |   |  |       |         |   |  |   | 40,400     |  
|Tax benefit associated with the exercise of stock options                                        |  |                |  |             |        |                   |   | 10,900           |  |   |                                           |   |  |       |         |   |  |   | 10,900     |  
|6-for-5 Stock Split                                                                              |  | 415,316         |  |             |        |                   |   |                 |  |   | (800                                       | ) |  |       |         |   |  |   | (800       | )
|Comprehensive income                                                                             |  |                |  |             |        |                   |   |                 |  |   | 2,933,100                                  |   |  |       | 68,200   |   |  |   | 3,001,300  |  
|                                                                                                 |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  
|Balance, December 31, 2006                                                                       |  | 2,497,327       |  |             | 686,800 |                   |   | 8,372,600        |  |   | 16,953,400                                 |   |  |       | 113,500  |   |  |   | 26,126,300 |  
|Common stock cash dividend declared                                                              |  |                |  |             |        |                   |   |                 |  |   | (724,800                                   | ) |  |       |         |   |  |   | (724,800   | )
|Exercise of stock options                                                                        |  | 3,600           |  |             | 1,000   |                   |   | 21,700           |  |   |                                           |   |  |       |         |   |  |   | 22,700     |  
|Tax benefit associated with the exercise of stock options                                        |  |                |  |             |        |                   |   | 5,700            |  |   |                                           |   |  |       |         |   |  |   | 5,700      |  
|Comprehensive income (loss)                                                                      |  |                |  |             |        |                   |   |                 |  |   | 2,730,600                                  |   |  |       | (439,800 | ) |  |   | 2,290,800  |  
|                                                                                                 |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  
|Balance, December 31, 2007                                                                       |  | 2,500,927       |  | $           | 687,800 |                   | $ | 8,400,000        |  | $ | 18,959,200                                 |   |  | $     | (326,300 | ) |  | $ | 27,720,700 |  
|                                                                                                 |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  

The accompanying notes are an integral part of these financial statements.



45



---

Consolidated Statements of Cash Flows



|                                                                           |  |                          |             |   |      |   |             |      |  |   |             |  
|-------------------------------------------------------------------------- |  | ------------------------ | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                           |  | Years Ended December 31, |            
|                                                                           |  | 2007                     |             |   | 2006 |   |             | 2005 | 
|Cash flows from operating activities                                       |  |                          |             |   |      |   |             |      |  |   |             |  
|Net income                                                                 |  | $                        | 2,730,600   |   |      | $ | 2,933,100   |      |  | $ | 2,675,300   |  
|Adjustments to reconcile to net cash provided by operating activities:     |  |                          |             |   |      |   |             |      |  |   |             |  
|Provision (recovery of provision) for loan losses                          |  |                          | (72,600     | ) |      |   | 58,700      |      |  |   | 303,700     |  
|Depreciation and amortization                                              |  |                          | 688,900     |   |      |   | 746,200     |      |  |   | 731,500     |  
|Gains from investment securities activities                                |  |                          | (74,500     | ) |      |   | (210,000    | )    |  |   | (166,400    | )
|Gain on sale of real estate                                                |  |                          |            |   |      |   |            |      |  |   | (149,500    | )
|Loss on disposal of fixed assets                                           |  |                          | 147,900     |   |      |   |            |      |  |   | 6,500       |  
|Other noncash operating activities                                         |  |                          | (163,900    | ) |      |   | (104,600    | )    |  |   | (59,800     | )
|Changes in:                                                                |  |                          |             |   |      |   |             |      |  |   |             |  
|Deferred loan fees                                                         |  |                          | 19,600      |   |      |   | 54,000      |      |  |   | (34,100     | )
|Other assets                                                               |  |                          | (68,300     | ) |      |   | (213,400    | )    |  |   | (75,000     | )
|Other liabilities                                                          |  |                          | 220,100     |   |      |   | 443,000     |      |  |   | (255,100    | )
|                                                                           |  |                          |             |   |      |   |             |      |  |   |             |  
|Net cash flows from operating activities                                   |  |                          | 3,427,800   |   |      |   | 3,707,000   |      |  |   | 2,977,100   |  
|                                                                           |  |                          |             |   |      |   |             |      |  |   |             |  
|Cash flows from investing activities                                       |  |                          |             |   |      |   |             |      |  |   |             |  
|Purchase of available-for-sale securities                                  |  |                          | (828,500    | ) |      |   | (4,984,900  | )    |  |   | (3,108,400  | )
|Proceeds from maturities, sales and calls of available-for-sale securities |  |                          | 7,989,200   |   |      |   | 7,194,200   |      |  |   | 9,716,600   |  
|Purchase of other investments                                              |  |                          | (2,438,000  | ) |      |   | (2,804,500  | )    |  |   | (3,709,300  | )
|Proceeds from maturities, sales and calls of other investments             |  |                          | 2,211,100   |   |      |   | 2,822,700   |      |  |   | 2,981,300   |  
|Proceeds from sale of real estate                                          |  |                          |            |   |      |   |            |      |  |   | 323,100     |  
|Loan originations, net of repayments                                       |  |                          | (11,109,100 | ) |      |   | (15,141,400 | )    |  |   | (17,144,500 | )
|Purchase of premises and equipment                                         |  |                          | (1,099,400  | ) |      |   | (260,800    | )    |  |   | (115,200    | )
|                                                                           |  |                          |             |   |      |   |             |      |  |   |             |  
|Net cash flows from investing activities                                   |  |                          | (5,274,700  | ) |      |   | (13,174,700 | )    |  |   | (11,056,400 | )
|                                                                           |  |                          |             |   |      |   |             |      |  |   |             |  



46



---

Consolidated Statements of Cash Flows



|                                                               |  |                          |              |   |      |   |              |      |  |   |              |  
|-------------------------------------------------------------- |  | ------------------------ | ------------ | - | ---- | - | ------------ | ---- |  | - | ------------ | -
|                                                               |  | Years Ended December 31, |             
|                                                               |  | 2007                     |              |   | 2006 |   |              | 2005 | 
|Cash flows from financing activities                           |  |                          |              |   |      |   |              |      |  |   |              |  
|Net increase (decrease) in demand deposits                     |  | $                        | 8,729,700    |   |      | $ | (13,911,500  | )    |  | $ | (2,177,400   | )
|Net increase (decrease) in time deposits                       |  |                          | (10,268,600  | ) |      |   | 23,043,800   |      |  |   | (1,590,000   | )
|Proceeds from FHLB advances                                    |  |                          | 300,900,000  |   |      |   | 169,400,000  |      |  |   | 133,600,000  |  
|Repayments of FHLB advances                                    |  |                          | (295,016,600 | ) |      |   | (168,216,700 | )    |  |   | (121,516,700 | )
|Proceeds from exercise of stock options                        |  |                          | 22,700       |   |      |   | 56,200       |      |  |   | 62,700       |  
|Payment of dividends on common stock                           |  |                          | (724,800     | ) |      |   | (610,300     | )    |  |   | (538,300     | )
|                                                               |  |                          |              |   |      |   |              |      |  |   |              |  
|Net cash flows from financing activities                       |  |                          | 3,642,400    |   |      |   | 9,761,500    |      |  |   | 7,840,300    |  
|                                                               |  |                          |              |   |      |   |              |      |  |   |              |  
|Change in cash and cash equivalents                            |  |                          | 1,795,500    |   |      |   | 293,800      |      |  |   | (239,000     | )
|                                                               |  |                          |             
|Cash and cash equivalents, beginning of year                   |  |                          | 9,469,800    |   |      |   | 9,176,000    |      |  |   | 9,415,000    |  
|                                                               |  |                          |              |   |      |   |              |      |  |   |              |  
|Cash and cash equivalents, end of year                         |  | $                        | 11,265,300   |   |      | $ | 9,469,800    |      |  | $ | 9,176,000    |  
|                                                               |  |                          |              |   |      |   |              |      |  |   |              |  
|Supplemental disclosure of cash flow information               |  |                          |              |   |      |   |              |      |  |   |              |  
|Cash paid during the period for interest                       |  | $                        | 7,400,600    |   |      | $ | 6,204,300    |      |  | $ | 4,288,700    |  
|Cash paid during the period for income taxes                   |  | $                        | 1,265,000    |   |      | $ | 1,220,000    |      |  | $ | 1,158,500    |  
|Conversion of Trust Preferred Stock investment to common stock |  | $                        |             |   |      | $ |             |      |  |   | 72,000       |  

The accompanying notes are an integral part of these financial statements.



47



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND BUSINESS

Shore Financial Corporation (the Company) is a
Virginia corporation organized in September 1997 by Shore Bank (the Bank) for the purpose of becoming a unitary holding company of the Bank. The Company became a unitary holding company of the Bank on March 16, 1998. The business
and management of the Company consists of the business and management of the Bank. The Bank became a Virginia chartered, Federal Reserve member, commercial bank on March 31, 1998. Previously, the Bank was a federally chartered savings bank. The
Company and the Bank are headquartered on the Eastern Shore in Onley, Virginia.

The Companys assets primarily consist of
approximately $4.7 million in cash and investments and its investment in the Bank. Currently, the Company does not participate in any other activities outside of controlling the Bank. The Bank provides a full range of banking services to individual
and corporate customers through its eight banking offices located on the Eastern Shore of Virginia and Maryland, including the counties of Accomack and Northampton, Virginia, and the Salisbury/Wicomico County area in Maryland. The Companys
common stock became publicly traded in August 1997, upon completing its subscription rights and initial public offerings, which included the sale of 431,250 shares of common stock.

Shore Investments, Inc. (Shore Investments), a subsidiary of the Bank, engages in financial activities supporting the Banks operations.
These activities include, but are not limited to, the selling of investment and insurance products. The Banks subsidiary is invested in a title insurance agency and an investment company while the Company is invested in a trust company, all of
which provide services to banking customers.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, the Bank and Shore Investments. All significant intercompany balances and transactions have been eliminated in consolidation.

Estimates

The
preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination
of the allowance for loan losses and the valuation of real estate owned.



48



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)



Advertising

The Company expenses advertising costs as they are incurred.

Investment Securities

Investments in debt securities classified as held-to-maturity are
stated at cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Management has a positive intent and ability to hold these securities to maturity and, accordingly, adjustments are not made for temporary
declines in their market value below amortized cost. Investments in debt and equity securities classified as trading, if any, are stated at fair value. Unrealized holding gains and losses for trading securities are included in the statement of
income. The Company had no such securities during the periods reported in the financial statements. All other investment securities with readily determinable fair values are classified as available-for-sale. Unrealized holding gains and losses on
available-for-sale securities are excluded from earnings and reported, net of tax effect, in other comprehensive income until realized.

Investments in Federal Home Loan Bank of Atlanta, Federal Reserve Bank of Richmond, VBA Investment Services, Bankers Title of Hampton Roads LLC, Community Bankers Bank and Maryland Financial Bank stock are stated at cost, as these
securities are restricted and do not have readily determinable fair values.

Gains and losses on the sale of securities are determined
using the specific identification method. Other-than-temporary declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost, if any, are included in earnings as realized losses.

Loans Receivable

Loans
receivable consist of real estate loans secured by first deeds of trust on single-family residences, other residential property, commercial property and land located primarily in an area known as the Eastern Shore of Virginia and Maryland, as well
as secured and unsecured consumer and commercial loans.

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

The Bank places loans on nonaccrual status after being delinquent greater than 90 days, or earlier, if the loans have developed inherent problems prior
to being 90 days delinquent that indicate payments of principal or interest will not be made in full. Whenever the accrual of interest is stopped, a specific allowance is established through a charge to income for previously accrued but uncollected
interest income. Thereafter, interest is recognized only as cash is received until six months after the loan is brought current.



49



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Loans Receivable(Continued)



The allowance for loan losses represents an amount management believes is adequate to provide for
probable loan losses inherent in the loan portfolio. Management evaluates the allowance for loan losses on a regular basis using a methodology that considers various risk factors in accordance with Statement of Financial Accounting Standards
(SFAS) No. 5, Accounting for Contingencies. This methodology includes analyzing historical loan losses, existing doubtful accounts, the experience of its lenders, growth by loan category, specific loan risk (i.e. construction
loans), economic conditions and loan to value considerations. However, risks of future losses cannot be quantified precisely or attributed to particular loans or classes of loans. Because those risks are influenced by general economic trends as well
as conditions affecting individual borrowers, managements judgment of the allowance is necessarily approximate and imprecise. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into
account such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies. In the opinion of management, the present allowance is adequate to absorb reasonably
foreseeable loan losses. Additions to the allowance are reflected in current operations. Charge-offs to the allowance are made when the loan is considered uncollectible or is transferred to real estate acquired in settlement of loans.

A loan is considered impaired when it is probable that the Bank will be unable to collect all principal and interest amounts according to the contractual
terms of the loan agreement. A performing loan may be considered impaired. The allowance for loan losses related to loans identified as impaired is primarily based on the excess of the loans current outstanding principal balance over the
estimated fair value of the related collateral. For a loan that is not collateral-dependent, the allowance is recorded at the amount by which the outstanding principal balance exceeds the current best estimate of the future cash flows on the loan
discounted at the loans original effective interest rate. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans
for impairment disclosures.

For impaired loans that are on nonaccrual status, cash payments received are generally applied to reduce the
outstanding principal balance. However, all or a portion of a cash payment received on a nonaccrual loan may be recognized as interest income to the extent allowed by the loan contract, assuming management expects to fully collect the remaining
principal balance on the loan.

Credit Related Financial Instruments

In the ordinary course of business, the Bank has entered into commitments to extend credit, including commitments under home equity lines of credit,
overdraft protection arrangements, commercial lines of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales when
control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of conditions that restrain it from
taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.



50



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)



Real Estate Owned

Real estate acquired through foreclosure is initially recorded at the lower of fair value or the loan balance at date of foreclosure. Subsequently,
property that is held for resale is carried at the lower of cost or fair value minus estimated selling costs. Costs relating to the development and improvement of property are capitalized, whereas those relating to holding the property are charged
to expense.

Management periodically performs valuations, and an allowance for losses is established by a charge to operations if the
carrying value of a property exceeds its fair value minus estimated selling costs.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using accelerated and straight-line methods over the
estimated useful lives of the respective assets. Estimated useful lives are as follows:



|                                |  |               
|------------------------------- |  | --------------
|Buildings                       |  | 25 to 40 years
|Furniture and equipment         |  | 5 to 15 years 
|Computer equipment and software |  | 3 to 5 years  
|Automobiles                     |  | 3 to 5 years  

Income Taxes

Deferred income taxes represent the cumulative tax effect from temporary differences in the recognition of taxable or deductible amounts for income tax
and financial reporting purposes.

Prior to July 1, 1996, in computing federal income taxes, savings banks that met certain
definitional tests and other conditions prescribed by the Internal Revenue Code were allowed, within limitations, to deduct from taxable income an allowance for bad debts based on actual loss experience, a percentage of taxable income before such
deduction or an amount based on a percentage of eligible loans. The applicable percentage of taxable income used for the bad debt deduction was 8%. Effective July 1, 1996, the percentage of taxable income method and the percentage of eligible
loans method for determining the bad debt deduction are no longer available. At December 31, 2007, the cumulative bad debt reserve, upon which no taxes have been paid on tax returns, was approximately $1.2 million. Of this amount, $783,000
represents that portion of the cumulative bad debt reserve for which financial statement income taxes have not been provided, in accordance with Financial Accounting Standards Board (FASB) Statement No. 109, Accounting for Income
Taxes.

Earnings Per Common Share

Basic Earnings Per Share (EPS) excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised, converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Potential
common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method.



51



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)



Comprehensive Income

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

Segment Reporting

Public business enterprises are required to report information about operating segments in annual financial statements, and selected information about operating segments in financial reports issued to
shareholders. Operating segments are components of an enterprise about which separate financial information is available, and evaluated regularly by management in deciding how to allocate resources and in assessing performance. Generally, financial
information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments.

Derivative Instruments and Hedging Transactions

SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, establishes accounting and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure
those instruments at fair value. The Company did not hold derivatives during the periods reported on in the consolidated financial statements.

On
March 13, 2002, the FASB determined that loan commitments related to the acquisition or origination of mortgage loans that will be held for sale must be accounted for as derivative instruments, effective for fiscal quarter beginning after
April 20, 2002. Accordingly, the Company adopted such accounting on July 1, 2002. The Company did not hold any mortgage loans for sale during the periods reported on in the consolidated financial statements.

Cash and Cash Equivalents

Cash equivalents include currency, balances due from banks, interest-earning deposits with maturities of ninety days or less and federal funds sold.

The Company is required to maintain reserves with the Federal Reserve Bank of Richmond. The aggregate daily average reserves required for the final reporting period was $25,000 for each of the years ended
December 31, 2007 and 2006, which was satisfied by the Company.



52



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)



Goodwill and Other Intangibles

The Company adopted Statement of Financial Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142), effective
January 1, 2002. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to an annual assessment for impairment by applying a fair value based test. Additionally, under SFAS 142, acquired
intangible assets are separately recognized if the benefit of the asset can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful life. Branch acquisition transactions were outside the initial scope of SFAS 142 and,
accordingly, intangible assets related to such transactions continued to amortize upon the adoption of SFAS 142. However, in October 2002, the FASB issued Statement No. 147, Acquisitions of Certain Financial Institutions  an amendment
of FASB Statements No. 72 and 144 and FASB Interpretation No. 9. This statement amends previous interpretative guidance on the application of the purchase method of accounting to acquisitions of financial institutions, and
requires the application of FASB Statement No. 141, Business Combinations, and FASB No. 142 to branch acquisitions if such transactions meet the definition of a business combination.

Management has evaluated the deposit acquisition that occurred in 2002. The acquisition of the Susquehanna Bank deposits in the Salisbury, Maryland
market do not qualify as a business combination and the intangible asset related to this deposit acquisition will continue to be amortized over the estimated useful life of the deposits acquired.

Stock Compensation Plans

Prior to January 1, 2006, the Company accounted for stock compensation using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,
whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Companys stock
option plans prior to January 1, 2006 had no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost was recognized for them. On January 1, 2006, the Company adopted SFAS 123(R), Share-Based Payment.
The standard eliminated the ability to account for share-based compensation transactions under the intrinsic value method and required that such transactions be accounted for using a fair value-based method which results in the recognition of
compensation expense in the Companys statement of income. For the years ended December 31, 2007 and 2006, the Company recognized $900 and $40,300 of such expense, respectively.



53



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)



SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure
 an amendment of SFAS 123, Accounting for Stock-Based Compensation, was issued by the FASB in December, 2002. SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

In
accordance with SFAS 148, the Company provides disclosures as if the fair value-based method of measuring all outstanding stock options was already adopted and recognized in 2005. The following table presents the effect on net income and on basic
and diluted net income per share as if the fair value-based method had been applied to all outstanding and unvested awards at December 31, 2005. Since the fair-value based method was adopted in 2006, no such disclosure is necessary for the
years ended December 31, 2007 and 2006.



|                                                                                                                                    |  |                              |           |  
|----------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | --------- | -
|                                                                                                                                    |  | Years EndedDecember 31, 2005 |          
|(Dollars in thousands, except per share data)                                                                                       |  |                              |          
|Net income, as reported                                                                                                             |  | $                            | 2,675,300 |  
|Deduct:                                                                                                                             |  |                              |           |  
|Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                              | (116,600  | )
|                                                                                                                                    |  |                              |           |  
|Pro forma net income                                                                                                                |  | $                            | 2,558,700 |  
|                                                                                                                                    |  |                              |           |  
|Earnings per share:                                                                                                                 |  |                              |           |  
|Basic - as reported                                                                                                                 |  | $                            | 1.08      |  
|                                                                                                                                    |  |                              |           |  
|Basic - pro forma                                                                                                                   |  | $                            | 1.03      |  
|                                                                                                                                    |  |                              |           |  
|Diluted - as reported                                                                                                               |  | $                            | 1.06      |  
|                                                                                                                                    |  |                              |           |  
|Diluted - pro forma                                                                                                                 |  | $                            | 1.01      |  
|                                                                                                                                    |  |                              |           |  



54



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)



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



|                        |  |                          |   |  |       |   |  |       |  
|----------------------- |  | ------------------------ | - |  | ----- | - |  | ----- | -
|                        |  | Years Ended December 31, |  
|                        |  | 2007                     |   |  | 2006  |   |  | 2005  |  
|Dividend yield          |  | 2.10                     | % |  | 1.90  | % |  | 1.90  | %
|Expected life (years)   |  | 7.0                      |   |  | 5.5   |   |  | 5.5   |  
|Expected volatility     |  | 25.00                    | % |  | 25.00 | % |  | 25.00 | %
|Risk-free interest rate |  | 5.00                     | % |  | 4.65  | % |  | 4.65  | %

Accounting for Long-Lived Assets

Effective January 1, 2002, the Company adopted FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The statement specifies criteria for classifying assets as held for sale. The adoption of this statement did not have a material impact
on the Companys financial condition and results of operations.

Guarantees

FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees (FIN 45), requires that a
liability be recognized, at inception, for the fair value of certain guarantees and for the ongoing obligation, if any, to perform over the term of the guarantee. The recognition provisions of FIN 45 are effective for certain guarantees modified or
issued after December 31, 2002. The adoption of FIN 45 did not have a material impact on the Companys results of operation or financial condition.

Lease Commitments

The Company enters into lease commitments for the use of certain real
estate facilities as considered necessary to conduct its operations. These commitments are often for terms of five years with additional renewal options available and generally require monthly lease payments. These leases qualify as operating leases
under applicable accounting guidance and, therefore, the monthly lease payments are expensed as incurred.

Reclassifications

Certain reclassifications of the prior years information have been made to conform to the December 31, 2007 presentation.



55



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)



Accounting Changes

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB Statements No. 133 and 140. This statement amends Statements
No. 133 and 140 by: permitting fair value remeasurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation; clarifying which interest-only strips and principal-only strips are not subject to
the requirements of Statement No. 133; establishing a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation; clarifying that concentrations of credit risk in the form of subordination are not embedded derivatives; and amending Statement No. 140 to eliminate the prohibition on a qualifying special-purpose entity from
holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The statement was effective for fiscal years beginning after September 15, 2006. The adoption of this standard
did not have a material impact on financial condition, results of operations or cash flows.

In March 2006, the FASB issued SFAS
No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB Statement No. 140. This statement amends Statement No. 140 with respect to the accounting for separately recognized servicing assets and
servicing liabilities. It requires an entity to recognize a servicing asset or servicing liability each time an obligation is undertaken to service a financial asset by entering into a servicing contract in certain situations, and requires all
separately recognized servicing assets and liabilities to be initially measured at fair value, if practicable. The statement permits the choice between the amortization method and the fair value measurement method for the
subsequent measurement of the servicing assets or liabilities, and allows for a one-time reclassification of available-for-sale securities to trading securities at initial adoption. The statement also requires separate presentation of servicing
assets and servicing liabilities subsequently measured at fair value in the statement of financial position, and additional disclosures for all separately recognized servicing assets and servicing liabilities. The statement was effective for fiscal
years beginning after September 30, 2006. The adoption of this standard did not have a material impact on financial condition, results of operations or cash flows.

In July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement 109, which provides guidance on the
measurement, recognition, and disclosure of tax positions taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, and disclosure. FIN 48 prescribes that a tax
position should only be recognized if it is more-likely-than-not that the position will be sustained upon examination by the appropriate taxing authority. A tax position that meets this threshold is measured as the largest amount of benefit that is
more likely than not (greater than 50 percent) realized upon ultimate settlement. The cumulative effect of applying FIN 48 is to be reported as an adjustment to the beginning balance of retained earnings in the period of adoption. FIN 48 was
effective for fiscal years beginning after December 15, 2006. The adoption of this standard did not have a material impact on financial condition, results of operations or cash flows.



56



---

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Concluded)



Accounting Changes (Concluded)

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS 157 establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. While the Statement applies under other accounting pronouncements that require or permit fair value measurements, it does not require
any new fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date.
In addition, the Statement establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Lastly, SFAS No. 157 requires additional disclosures for each interim and
annual period separately for each major category of assets and liabilities. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management
does not expect the adoption of this Statement to have a material impact on the Companys financial statements.

In February 2007, the
FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115, which permits entities to choose to measure many financial instruments and certain other
items at fair value and also establishes fair presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is
effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of this standard did not have a material impact on financial condition, results of operations or cash flows.

In December 2007, the FASB issued SFAS 141(R), Business Combinations, which replaces SFAS 141. This Statement establishes principles and
requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired in the business combination, liabilities assumed and any non-controlling interest in the acquiree as well as the goodwill acquired
in a business combination. SFAS 141(R) also establishes disclosure requirements which will enable the users to evaluate the nature and financial effects of the business combinations. SFAS 141(R) is effective for fiscal years beginning after
December 15, 2008. The Company is currently evaluating the potential impact of the adoption of SFAS 141(R) on the Companys consolidated financial position and results of operations.

In December 2007, the FASB issued SFAS 160, Non-controlling Interests in Consolidated Financial Statements  Amendment of ARB No. 51,
which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a
parents ownership interest, and the valuation of retained non-controlling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes expanded disclosure requirements that clearly identify and distinguish between the
interest of the parents owners and the interests of the non-controlling owners of a subsidiary. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact, if any, of
the adoption of SFAS 160 on the Companys consolidated financial position and results of operations.



57



---

NOTE 3 - INVESTMENT SECURITIES

A summary of the amortized cost and estimated fair values of investment securities is as follows:



|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|----------------------------------------------- |  | ------------- | ---------- | -------------------- | - | --------------------- |  | - | ------------------- | - |  | - | ----------
|December 31, 2007                               |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|Available-for-sale                              |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Debt securities:                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|United States government and agency obligations |  | $             | 7,958,900  |                      | $ | 99,700                |  | $ | (2,300              | ) |  | $ | 8,056,300 
|Tax-exempt municipal bonds                      |  |               | 6,412,700  |                      |   | 29,100                |  |   | (8,500              | ) |  |   | 6,433,300 
|Corporate bonds                                 |  |               | 1,000,300  |                      |   | 3,600                 |  |   |                    |   |  |   | 1,003,900 
|Mortgage-backed securities                      |  |               | 1,056,000  |                      |   |                      |  |   | (8,700              | ) |  |   | 1,047,300 
|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Total debt securities                           |  |               | 16,427,900 |                      |   | 132,400               |  |   | (19,500             | ) |  |   | 16,540,800
|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Marketable equity securities:                   |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Common stock                                    |  |               | 2,424,600  |                      |   | 33,200                |  |   | (530,100            | ) |  |   | 1,927,700 
|Preferred stock                                 |  |               | 1,864,100  |                      |   |                      |  |   | (107,900            | ) |  |   | 1,756,200 
|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Total marketable equity securities              |  |               | 4,288,700  |                      |   | 33,200                |  |   | (638,000            | ) |  |   | 3,683,900 
|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                |  |               | 20,716,600 |                      |   | 165,600               |  |   | (657,500            | ) |  |   | 20,224,700
|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Other investment securities (at cost):          |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Federal Home Loan Bank stock                    |  |               | 2,352,400  |                      |   |                      |  |   |                    |   |  |   | 2,352,400 
|Federal Reserve Bank stock                      |  |               | 124,800    |                      |   |                      |  |   |                    |   |  |   | 124,800   
|Community Bankers Bank stock                   |  |               | 63,300     |                      |   |                      |  |   |                    |   |  |   | 63,300    
|Bankers Title of Hampton Roads stock           |  |               | 13,300     |                      |   |                      |  |   |                    |   |  |   | 13,300    
|VBA Investment Services stock                   |  |               | 95,800     |                      |   |                      |  |   |                    |   |  |   | 95,800    
|Maryland Financial Bank stock                   |  |               | 20,000     |                      |   |                      |  |   |                    |   |  |   | 20,000    
|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Total other investment securities               |  |               | 2,669,600  |                      |   |                      |  |   |                    |   |  |   | 2,669,600 
|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                |  | $             | 23,386,200 |                      | $ | 165,600               |  | $ | (657,500            | ) |  | $ | 22,894,300
|                                                |  |               |            |                      |   |                       |  |   |                     |   |  |   |           



58



---

NOTE 3 - INVESTMENT SECURITIES(Continued)



|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|----------------------------------------------- |  | ------------- | ---------- | -------------------- | - | --------------------- |  | - | ------------------ | - |  | - | ----------
|December 31, 2006                               |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFairValue
|Available-for-sale                              |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|Debt securities:                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|United States government and agency obligations |  | $             | 12,942,200 |                      | $ | 1,200                 |  | $ | (204,300           | ) |  | $ | 12,739,100
|Tax-exempt municipal bonds                      |  |               | 6,414,400  |                      |   | 21,200                |  |   | (21,700            | ) |  |   | 6,413,900 
|Corporate bonds                                 |  |               | 2,003,300  |                      |   | 18,600                |  |   |                   |   |  |   | 2,021,900 
|Mortgage-backed securities                      |  |               | 1,262,600  |                      |   |                      |  |   | (41,300            | ) |  |   | 1,221,300 
|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|Total debt securities                           |  |               | 22,622,500 |                      |   | 41,000                |  |   | (267,300           | ) |  |   | 22,396,200
|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|Marketable equity securities:                   |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|Common stock                                    |  |               | 2,271,700  |                      |   | 428,000               |  |   | (9,800             | ) |  |   | 2,689,900 
|Preferred stock                                 |  |               | 2,897,100  |                      |   | 13,900                |  |   | (31,800            | ) |  |   | 2,879,200 
|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|Total marketable equity securities              |  |               | 5,168,800  |                      |   | 441,900               |  |   | (41,600            | ) |  |   | 5,569,100 
|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|                                                |  |               | 27,791,300 |                      |   | 482,900               |  |   | (308,900           | ) |  |   | 27,965,300
|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|Other investment securities:                    |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|Federal Home Loan Bank stock                    |  |               | 2,075,500  |                      |   |                      |  |   |                   |   |  |   | 2,075,500 
|Federal Reserve Bank stock                      |  |               | 124,800    |                      |   |                      |  |   |                   |   |  |   | 124,800   
|Community Bankers Bank stock                   |  |               | 63,300     |                      |   |                      |  |   |                   |   |  |   | 63,300    
|Bankers Title of Hampton Roads stock           |  |               | 13,300     |                      |   |                      |  |   |                   |   |  |   | 13,300    
|VBA Investment Services stock                   |  |               | 145,800    |                      |   |                      |  |   |                   |   |  |   | 145,800   
|Maryland Financial Bank stock                   |  |               | 20,000     |                      |   |                      |  |   |                   |   |  |   | 20,000    
|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|                                                |  |               | 2,442,700  |                      |   |                      |  |   |                   |   |  |   | 2,442,700 
|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           
|                                                |  | $             | 30,234,000 |                      | $ | 482,900               |  | $ | (308,900           | ) |  | $ | 30,408,000
|                                                |  |               |            |                      |   |                       |  |   |                    |   |  |   |           

The amortized cost and estimated fair value of debt securities at December 31, 2007 by
contractual maturity are shown below:



|                                       |  |               |            |           |   |           
|-------------------------------------- |  | ------------- | ---------- | --------- | - | ----------
|                                       |  | AmortizedCost |            | FairValue
|Available-for-sale                     |  |               |            |           |   |           
|Due in one year or less                |  | $             | 2,000,300  |           | $ | 2,002,300 
|Due after one year through five years  |  |               | 8,624,800  |           |   | 8,680,500 
|Due after five years through ten years |  |               | 2,975,100  |           |   | 3,036,700 
|Due after ten years                    |  |               | 2,827,700  |           |   | 2,821,300 
|                                       |  |               |            |           |   |           
|                                       |  | $             | 16,427,900 |           | $ | 16,540,800
|                                       |  |               |            |           |   |           

At December 31, 2007 and 2006, investment securities with a carrying value of approximately
$2.03 million and $974,000, respectively, were pledged as collateral for public deposits.



59



---

NOTE 3 - INVESTMENT SECURITIES(Concluded)

For the years ended December 31, 2007, 2006 and 2005, proceeds from the sales of securities available for sale amounted to $831,000, $1.4 million and
$1.5 million, respectively. Gross realized gains amounted to $156,000, $231,000 and $189,000, respectively, while gross realized losses were $83,000, $21,000 and $23,000, respectively. The tax provision applicable to these net realized gains and
losses amounted to $25,000, $77,000 and $56,000, respectively.

The following table summarizes the Companys investments
gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007.



|                                                |  |                     |         |                  |                   |        |           |       |                  |           |  |           |          |                  |  |   |           |  |   |          |  
|----------------------------------------------- |  | ------------------- | ------- | ---------------- | ----------------- | ------ | --------- | ----- | ---------------- | --------- |  | --------- | -------- | ---------------- |  | - | --------- |  | - | -------- | -
|                                                |  | Less Than 12 Months |         |                  | 12 Months or More |        |           | Total |                 
|Description of Securities                       |  | FairValue           |         | UnrealizedLosses |                   |        | FairValue |       | UnrealizedLosses |           |  | FairValue |          | UnrealizedLosses | 
|United States government and agency obligations |  | $                   |        |                  | $                 |       |           |       | $                | 1,997,600 |  | $         | (2,400   | )                |  | $ | 1,997,600 |  | $ | (2,400   | )
|Tax-exempt municipal bonds                      |  |                     |        |                  |                   |       |           |       |                  | 1,705,200 |  |           | (8,500   | )                |  |   | 1,705,200 |  |   | (8,500   | )
|Corporate bonds                                 |  |                     |        |                  |                   |       |           |       |                  |          |  |           |         |                  |  |   |          |  |   |         |  
|Mortgage-backed securities                      |  |                     |        |                  |                   |       |           |       |                  | 1,047,400 |  |           | (8,700   | )                |  |   | 1,047,400 |  |   | (8,700   | )
|Adjustable Rate Mortgage Fund                   |  |                     |        |                  |                   |       |           |       |                  |          |  |           |         |                  |  |   |          |  |   |         |  
|                                                |  |                     |         |                  |                   |        |           |       |                  |           |  |           |          |                  |  |   |           |  |   |          |  
|Subtotal, debt securities                       |  |                     |        |                  |                   |       |           |       |                  | 4,750,200 |  |           | (19,600  | )                |  |   | 4,750,200 |  |   | (19,600  | )
|                                                |  |                     |         |                  |                   |        |           |       |                  |           |  |           |          |                  |  |   |           |  |   |          |  
|Federal Home Loan Mortgage                      |  |                     |         |                  |                   |        |           |       |                  |           |  |           |          |                  |  |   |           |  |   |          |  
|Corporation common stock                        |  |                     |        |                  |                   |       |           |       |                  |          |  |           | (530,100 | )                |  |   |          |  |   | (530,100 | )
|Preferred stock                                 |  |                     | 505,000 |                  |                   | (3,600 | )         |       |                  | 836,500   |  |           | (28,200  | )                |  |   | 1,341,500 |  |   | (31,800  | )
|Other equity securities                         |  |                     | 90,000  |                  |                   | (4,100 | )         |       |                  | 70,400    |  |           | (5,700   | )                |  |   | 160,400   |  |   | (9,800   | )
|                                                |  |                     |         |                  |                   |        |           |       |                  |           |  |           |          |                  |  |   |           |  |   |          |  
|Subtotal, equity securities                     |  |                     | 595,000 |                  |                   | (7,700 | )         |       |                  | 906,900   |  |           | (564,000 | )                |  |   | 1,501,900 |  |   | (571,700 | )
|                                                |  |                     |         |                  |                   |        |           |       |                  |           |  |           |          |                  |  |   |           |  |   |          |  
|Total temporarily impaired securities           |  | $                   | 595,000 |                  | $                 | (7,700 | )         |       | $                | 5,657,100 |  | $         | (583,600 | )                |  | $ | 6,252,100 |  | $ | (591,300 | )
|                                                |  |                     |         |                  |                   |        |           |       |                  |           |  |           |          |                  |  |   |           |  |   |          |  

There are a total of thirty-seven securities that have unrealized losses as of December 31,
2007: two United States government and agency securities, three United States agency MBS securities, three municipal securities, twenty-five common stock securities and four preferred stock securities. The debt securities are obligations of entities
that are excellent credit risks. The impairment as noted is the result of interest rate market conditions and does not reflect on the ability of the issuers to repay the debt obligations. The losses in the common stock securities reflect recent
swings in the equity markets. The impairment is the result of problems in the credit markets that should correct itself over time, resulting in a high probability of full recovery of investment. The preferred stock category represents ownership in
three reputable companies whose credit ratings remain strong as measured by Moodys and S&P. The Company maintains the ability and intent to hold all securities for the foreseeable future.

Other investment securities are accounted for using the cost method and are not included in the evaluation of impairment. However, these investments were
reviewed by management and no identified events or changes in circumstances were identified that may have a significant adverse effect on their fair value.



60



---

NOTE 4 - LOANS RECEIVABLE

Loans receivable are summarized below:



|                                         |  |              |             |      |   |            
|---------------------------------------- |  | ------------ | ----------- | ---- | - | -----------
|                                         |  | December 31,
|                                         |  | 2007         |             | 2006
|Real estate loans:                       |  |              |             |      |   |            
|Coventional mortgage:                    |  |              |             |      |   |            
|Secured by one-to-four family residences |  | $            | 88,739,500  |      | $ | 80,245,200 
|Commercial mortgages                     |  |              | 69,448,200  |      |   | 64,698,400 
|Land                                     |  |              | 31,170,100  |      |   | 31,645,000 
|Short-term construction                  |  |              | 8,967,000   |      |   | 9,160,600  
|Home equity lines of credit              |  |              | 13,882,300  |      |   | 14,742,800 
|Consumer loans                           |  |              | 3,842,000   |      |   | 3,380,800  
|Commercial loans:                        |  |              |             |      |   |            
|Secured                                  |  |              | 5,046,900   |      |   | 5,348,200  
|Unsecured                                |  |              | 4,121,200   |      |   | 4,333,500  
|                                         |  |              |             |      |   |            
|Total loans                              |  |              | 225,217,200 |      |   | 213,554,500
|                                         |  |             
|Less:                                    |  |              |             |      |   |            
|Loans in process                         |  |              | 3,475,100   |      |   | 2,820,100  
|Deferred loan fees (costs), net          |  |              | 156,000     |      |   | 136,400    
|Allowance for loan losses                |  |              | 2,698,800   |      |   | 2,872,800  
|                                         |  |              |             |      |   |            
|                                         |  | $            | 218,887,300 |      | $ | 207,725,200
|                                         |  |              |             |      |   |            

The allowance for loan losses is summarized below:



|                                                  |  |                          |           |   |      |   |           |      |  |   |          
|------------------------------------------------- |  | ------------------------ | --------- | - | ---- | - | --------- | ---- |  | - | ---------
|                                                  |  | Years Ended December 31,
|                                                  |  | 2007                     |           |   | 2006 |   |           | 2005
|Balance at beginning of year                      |  | $                        | 2,872,800 |   |      | $ | 2,850,700 |      |  | $ | 2,404,500
|Provision (provision recovery) charged to expense |  |                          | (72,600   | ) |      |   | 58,700    |      |  |   | 303,700  
|(Charge-offs) recoveries, net                     |  |                          | (101,400  | ) |      |   | (36,600   | )    |  |   | 142,500  
|                                                  |  |                          |           |   |      |   |           |      |  |   |          
|Balance at end of the year                        |  | $                        | 2,698,800 |   |      | $ | 2,872,800 |      |  | $ | 2,850,700
|                                                  |  |                          |           |   |      |   |           |      |  |   |          



61



---

NOTE 4 - LOANS RECEIVABLE(Concluded)

At December 31, 2007, the Bank did not identify any impaired loans as defined by generally accepted accounting principles. At December 31, 2006,
the Bank identified $3,000 of loans as impaired as defined by generally accepted accounting principles. However, the Bank did not allocate a valuation allowance for this loan at December 31, 2006. At December 31, 2005, the Bank identified
$314,000 of loans as impaired as defined by generally accepted accounting principles. Impaired loans at December 2005 had a valuation allowance allocation of $47,000. During late 2007, the Company had one impaired loan of which the collateral was
foreclosed on and sold prior to year end. For the years ended December 31, 2007, 2006 and 2005, the average recorded investment in impaired loans was $37,000, $155,000 and $100,000, respectively, and interest income recognized on impaired
loans, all on the cash basis, was approximately $9,000, $5,000 and $15,000, respectively. No additional funds are committed to be advanced in connection with impaired loans. At December 31, 2007, nonaccrual loans were $793,100 and no loans
existed that are past due 90 days or more and still accruing interest.

NOTE 5 - PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows:



|                                |  |              |            |   |      |   |            |  
|------------------------------- |  | ------------ | ---------- | - | ---- | - | ---------- | -
|                                |  | December 31, |           
|                                |  | 2007         |            |   | 2006 |  
|Land                            |  | $            | 1,138,100  |   |      | $ | 739,500    |  
|Buildings                       |  |              | 6,768,100  |   |      |   | 6,845,900  |  
|Furniture and fixtures          |  |              | 2,580,400  |   |      |   | 2,322,400  |  
|Computer equipment & software   |  |              | 1,005,500  |   |      |   | 904,800    |  
|Automobiles                     |  |              | 110,000    |   |      |   | 145,200    |  
|Construction in process         |  |              | 173,700    |   |      |   | 59,300     |  
|                                |  |              |            |   |      |   |            |  
|                                |  |              | 11,775,800 |   |      |   | 11,017,100 |  
|Less - accumulated depreciation |  |              | (4,404,800 | ) |      |   | (3,972,800 | )
|                                |  |              |            |   |      |   |            |  
|                                |  | $            | 7,371,000  |   |      | $ | 7,044,300  |  
|                                |  |              |            |   |      |   |            |  

Depreciation expense for the years ended December 31, 2007, 2006 and 2005 amounted to
$626,800, $681,200 and $666,400, respectively.



62



---

NOTE 6 - DEPOSITS

Deposits accounts are summarized below:



|                              |  |              |             |      |   |            
|----------------------------- |  | ------------ | ----------- | ---- | - | -----------
|                              |  | December 31,
|                              |  | 2007         |             | 2006
|Demand deposits:              |  |              |             |      |   |            
|Noninterest-bearing           |  | $            | 27,984,700  |      | $ | 25,554,500 
|                              |  |              |             |      |   |            
|Interest-bearing:             |  |              |             |      |   |            
|Savings accounts              |  |              | 17,936,100  |      |   | 19,155,500 
|Checking accounts             |  |              | 32,096,400  |      |   | 24,561,300 
|Money market deposit accounts |  |              | 16,910,500  |      |   | 17,108,700 
|                              |  |              |             |      |   |            
|Total interest-bearing        |  |              | 66,943,000  |      |   | 60,825,500 
|                              |  |              |             |      |   |            
|Total demand deposits         |  |              | 94,927,700  |      |   | 86,380,000 
|Time deposits                 |  |              | 101,636,200 |      |   | 111,722,800
|                              |  |              |             |      |   |            
|                              |  | $            | 196,563,900 |      | $ | 198,102,800
|                              |  |              |             |      |   |            

The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was
approximately $28.1 million and $28.6 million at December 31, 2007 and 2006, respectively.

Time deposits outstanding at
December 31, 2007 mature as follows:



|                    |  |   |            
|------------------- |  | - | -----------
|Within one year     |  | $ | 79,154,000 
|One to two years    |  |   | 8,054,000  
|Two to three years  |  |   | 8,815,000  
|Three to four years |  |   | 2,552,000  
|Four to five years  |  |   | 2,512,000  
|Thereafter          |  |   | 549,200    
|                    |  |   |            
|                    |  | $ | 101,636,200
|                    |  |   |            



63



---

NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of the Bank's financial instruments as of December 31, 2007 and 2006 are as follows:



|                                        |  |                |         |           |   |        
|--------------------------------------- |  | -------------- | ------- | --------- | - | -------
|                                        |  | CarryingAmount |         | FairValue
|                                        |  | (in thousands)
|December 31, 2007                       |  |                |         |           |   |        
|                                        |  |               
|Financial assets                        |  |                |         |           |   |        
|Cash and cash equivalents               |  | $              | 11,265  |           | $ | 11,265 
|Securities                              |  |                | 22,894  |           |   | 22,894 
|Loans, net of allowance for loan losses |  |                | 218,887 |           |   | 221,517
|Accrued interest receivable             |  |                | 1,119   |           |   | 1,119  
|Financial liabilities                   |  |                |         |           |   |        
|Deposits                                |  |                | 196,564 |           |   | 190,538
|Advances from Federal Home Loan Bank    |  |                | 41,117  |           |   | 41,340 
|Accrued interest payable                |  |                | 646     |           |   | 646    
|Unrecognized financial instruments      |  |                |         |           |   |        
|Commitments to extend credit            |  |                | N/A     |           |   | N/A    
|                                        |  |               
|December 31, 2006                       |  |                |         |           |   |        
|                                        |  |               
|Financial assets                        |  |                |         |           |   |        
|Cash and cash equivalents               |  | $              | 9,470   |           | $ | 9,470  
|Securities                              |  |                | 30,408  |           |   | 30,408 
|Loans, net of allowance for loan losses |  |                | 207,725 |           |   | 208,046
|Accrued interest receivable             |  |                | 1,140   |           |   | 1,140  
|Financial liabilities                   |  |                |         |           |   |        
|Deposits                                |  |                | 198,103 |           |   | 187,004
|Advances from Federal Home Loan Bank    |  |                | 35,233  |           |   | 35,078 
|Accrued interest payable                |  |                | 594     |           |   | 594    
|Unrecognized financial instruments      |  |                |         |           |   |        
|Commitments to extend credit            |  |                | N/A     |           |   | N/A    

The following methods and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value.



64



---

NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS(Concluded)

Cash and cash equivalents

For cash
and cash equivalents, the carrying amount is a reasonable estimate of fair value.

Securities

Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market
prices for similar securities. For restricted securities without readily determinable values, the carrying amount is considered a reasonable estimate of fair value.

Loan receivables

The fair value of loans is estimated by discounting future cash flows, using market
rates at which similar loans would be made to borrowers with similar remaining maturities. This calculation ignores loan fees and certain factors affecting the interest rates charged on various loans, such as the borrower's creditworthiness and
compensating balances, and dissimilar types of real estate held as collateral.

Deposit liabilities

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the balance sheet date. The fair
value of fixed-maturity certificates of deposit is estimated by discounting remaining maturities amounts using market rates for similar replacement funding sources.

Accrued interest receivable and payable

The carrying amounts of accrued interest receivable and
payable approximate their fair values.

Advances from Federal Home Loan Bank

The carrying value of advances from the Federal Home Loan Bank due within ninety days from the balance sheet date approximates fair value. For those
borrowings that mature beyond ninety days, the fair value of the borrowing is estimated by discounting future cash flows, using the current rates at which similar borrowings would be obtained from the Federal Home Loan Bank with similar remaining
maturities.

Commitments to extend credit

The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the
borrowers. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Because of the competitive nature of the marketplace, loan fees vary greatly with no fees charged
in many cases. Therefore, management has concluded no value should be assigned.



65



---

NOTE 8 - ADVANCES FROM FEDERAL HOME LOAN BANK

Borrowings (advances) from the Federal Home Loan Bank (FHLB) are scheduled to mature as follows:



|                    |  |              |            |      |   |           
|------------------- |  | ------------ | ---------- | ---- | - | ----------
|                    |  | December 31,
|                    |  | 2007         |            | 2006
|Within one year     |  | $            | 18,700,000 |      | $ | 24,750,000
|One to two years    |  |              | 17,000,000 |      |   | 3,000,000 
|More than two years |  |              | 5,416,700  |      |   | 7,483,300 
|                    |  |              |            |      |   |           
|                    |  | $            | 41,116,700 |      | $ | 35,233,300
|                    |  |              |            |      |   |           

Information regarding FHLB advances is summarized below:



|                                                    |  |                          |            |      |   |           
|--------------------------------------------------- |  | ------------------------ | ---------- | ---- | - | ----------
|                                                    |  | Years Ended December 31,
|                                                    |  | 2007                     |            | 2006
|Monthly average balance of borrowings outstanding   |  | $                        | 33,785,100 |      | $ | 33,667,800
|                                                    |  |                         
|Maximum month-end balance of borrowings outstanding |  | $                        | 41,116,700 |      | $ | 42,683,300

The weighted average interest rate on advances was 4.94%, 4.92% and 3.59% for the years ended
December 31, 2007, 2006 and 2005, respectively. These advances are collateralized by the Bank's investment in FHLB stock, qualifying real estate loans with a principal balance of approximately $105.3 million, and government agency and
mortgage-backed securities with a fair market value of approximately $3.0 million held under a specific collateral agreement. The Bank has an available line of credit with the FHLB for up to 25% of Bank assets, or approximately $66.1 million at
December 31, 2007. However, the Bank may request an increase in this borrowing capacity from the FHLB. At December 31, 2007 the Bank had sufficient collateral pledged to borrow a total of approximately $87.2 million from the FHLB. The
borrowing capacity is subject to certain collateral requirements as stipulated in the FHLB borrowing agreement.



66



---

NOTE 9 - OTHER NONINTEREST INCOME AND EXPENSE

Other noninterest income and expense consists of the following:



|                                            |  |                          |         |      |   |         |  |   |        
|------------------------------------------- |  | ------------------------ | ------- | ---- | - | ------- |  | - | -------
|                                            |  | Years Ended December 31,
|                                            |  | 2007                     |         | 2006 |   | 2005   
|Other noninterest income                    |  |                          |         |      |   |         |  |   |        
|Income from real estate held for investment |  | $                        | 5,900   |      | $ | 24,100  |  | $ | 31,600 
|Safe deposit box rental                     |  |                          | 24,900  |      |   | 20,700  |  |   | 21,200 
|Increase in BOLI cash surrender value       |  |                          | 158,200 |      |   | 147,100 |  |   | 134,700
|Miscellaneous fees and commissions          |  |                          | 83,000  |      |   | 76,700  |  |   | 69,400 
|                                            |  |                          |         |      |   |         |  |   |        
|                                            |  | $                        | 272,000 |      | $ | 268,600 |  | $ | 256,900
|                                            |  |                          |         |      |   |         |  |   |        
|Other noninterest expense                   |  |                          |         |      |   |         |  |   |        
|Education and seminars                      |  | $                        | 52,200  |      | $ | 65,900  |  | $ | 39,200 
|Personnel costs                             |  |                          | 101,000 |      |   | 93,300  |  |   | 77,700 
|Travel                                      |  |                          | 46,000  |      |   | 46,900  |  |   | 34,300 
|Courier cost                                |  |                          | 33,100  |      |   | 27,000  |  |   | 26,700 
|Supervisory fees                            |  |                          | 55,200  |      |   | 48,000  |  |   | 30,400 
|Loan costs                                  |  |                          | 34,300  |      |   | 43,000  |  |   | 48,300 
|ATM/VISA check card fees                    |  |                          | 152,200 |      |   | 119,900 |  |   | 95,700 
|Insurance                                   |  |                          | 38,500  |      |   | 41,500  |  |   | 36,200 
|Bank service charges                        |  |                          | 77,900  |      |   | 72,300  |  |   | 70,900 
|Deposit account write-offs                  |  |                          | 43,600  |      |   | 7,700   |  |   | 26,300 
|Miscellaneous                               |  |                          | 36,300  |      |   | 34,900  |  |   | 39,900 
|                                            |  |                          |         |      |   |         |  |   |        
|                                            |  | $                        | 670,300 |      | $ | 600,400 |  | $ | 525,600
|                                            |  |                          |         |      |   |         |  |   |        



67



---

NOTE 10 - INCOME TAXES

The provision for income taxes (benefit) is summarized below:



|         |  |                          |           |   |      |   |           |      |  |   |           |  
|-------- |  | ------------------------ | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|         |  | Years Ended December 31, |          
|         |  | 2007                     |           |   | 2006 |   |           | 2005 | 
|Current  |  |                          |           |   |      |   |           |      |  |   |           |  
|Federal  |  | $                        | 1,152,400 |   |      | $ | 1,413,300 |      |  | $ | 1,378,300 |  
|State    |  |                          |          |   |      |   |          |      |  |   | 2,000     |  
|         |  |                          |           |   |      |   |           |      |  |   |           |  
|         |  |                          | 1,152,400 |   |      |   | 1,413,300 |      |  |   | 1,380,300 |  
|         |  |                          |           |   |      |   |           |      |  |   |           |  
|Deferred |  |                          |           |   |      |   |           |      |  |   |           |  
|Federal  |  |                          | (45,700   | ) |      |   | (257,400  | )    |  |   | (187,500  | )
|State    |  |                          |          |   |      |   |          |      |  |   |          |  
|         |  |                          |           |   |      |   |           |      |  |   |           |  
|         |  |                          | (45,700   | ) |      |   | (257,400  | )    |  |   | (187,500  | )
|         |  |                          |           |   |      |   |           |      |  |   |           |  
|Total    |  |                          |           |   |      |   |           |      |  |   |           |  
|Federal  |  |                          | 1,106,700 |   |      |   | 1,155,900 |      |  |   | 1,190,800 |  
|State    |  |                          |          |   |      |   |          |      |  |   | 2,000     |  
|         |  |                          |           |   |      |   |           |      |  |   |           |  
|         |  | $                        | 1,106,700 |   |      | $ | 1,155,900 |      |  | $ | 1,192,800 |  
|         |  |                          |           |   |      |   |           |      |  |   |           |  



|                                                 |  |              |           |      |   |          
|------------------------------------------------ |  | ------------ | --------- | ---- | - | ---------
|                                                 |  | December 31,
|                                                 |  | 2007         |           | 2006
|Deferred tax asset                               |  |              |           |      |   |          
|Bad debts and other provisions                   |  | $            | 951,000   |      | $ | 976,000  
|Unrealized loss on securities available for sale |  |              | 168,000   |      |   |         
|Other                                            |  |              | 52,000    |      |   | 39,300   
|                                                 |  |              |           |      |   |          
|Total deferred tax asset                         |  |              | 1,171,000 |      |   | 1,015,300
|                                                 |  |              |           |      |   |          
|Deferred tax liability                           |  |              |           |      |   |          
|FHLB stock                                       |  |              | 70,000    |      |   | 70,000   
|Depreciation                                     |  |              | 227,000   |      |   | 285,000  
|Unrealized gain on securities available for sale |  |              |          |      |   | 59,000   
|                                                 |  |              |           |      |   |          
|Total deferred tax liability                     |  |              | 297,000   |      |   | 414,000  
|                                                 |  |              |           |      |   |          
|Net deferred tax asset                           |  | $            | 874,000   |      | $ | 601,300  
|                                                 |  |              |           |      |   |          



68



---

NOTE 10 - INCOME TAXES(Concluded)

The differences between expected federal and state income tax expense at statutory rates to actual income tax expense are summarized as follows:



|                                               |  |                          |           |   |      |   |           |      |  |   |           |  
|---------------------------------------------- |  | ------------------------ | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                               |  | Years Ended December 31, |          
|                                               |  | 2007                     |           |   | 2006 |   |           | 2005 | 
|Federal income tax expense - at statutory rate |  | $                        | 1,305,000 |   |      | $ | 1,390,000 |      |  | $ | 1,315,000 |  
|Tax effect of:                                 |  |                          |           |   |      |   |           |      |  |   |           |  
|Tax exempt interest income                     |  |                          | (84,000   | ) |      |   | (53,000   | )    |  |   | (50,000   | )
|BOLI cash surrender value increase             |  |                          | (54,000   | ) |      |   | (50,000   | )    |  |   | (46,000   | )
|Dividends received deduction                   |  |                          | (65,000   | ) |      |   | (58,000   | )    |  |   | (42,000   | )
|Other, net                                     |  |                          | 4,700     |   |      |   | (73,100   | )    |  |   | 15,800    |  
|                                               |  |                          |           |   |      |   |           |      |  |   |           |  
|                                               |  | $                        | 1,106,700 |   |      | $ | 1,155,900 |      |  | $ | 1,192,800 |  
|                                               |  |                          |           |   |      |   |           |      |  |   |           |  

The Company adopted the provisions of FASB Interpretation No. 48 (FIN 48),
Accounting for Uncertainty in Income Taxes, which was effective January 1, 2007. FIN 48 provides a comprehensive model for how the Company should recognize, measure, present and disclose in its financial statements uncertain tax
positions that the Company has taken or expects to take on its tax return. The Company does not have any unrecognized tax benefits as defined by FIN 48 and, therefore, there was no effect on the Companys financial position or results of
operations as a result of implementing FIN 48.

The Company files income tax returns in the U.S. federal jurisdiction and the state of
Virginia. With few possible exceptions, the Company is no longer subject to U.S. or state income tax examinations by tax authorities for years before 2004.

NOTE 11 - STOCKHOLDERS EQUITY

The Company is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Companys
financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its banking subsidiary must meet specific capital guidelines that involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other
factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and its banking subsidiary to
maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of
December 31, 2007, that the Company and the Bank meet all capital adequacy requirements to which they are subject.



69



---

NOTE 11 - STOCKHOLDERS EQUITY(Continued)



As of December 31, 2007, the most recent notification from the Federal Deposit Insurance
Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that notification that management believes have changed the Banks category. The Company and the Bank's actual capital amounts and ratios are presented in the table.



|                                          |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|----------------------------------------- |  | ------ | ------ | ----- | ----- | - | ---------------------------- | - | ------ |  | ---- | ------------------------------------------------------------- |  | ----- | ------ |  | ----- | -
|                                          |  |        |        |       |       |   |                              |   |        |  |      | To Be WellCapitalized UnderPrompt CorrectiveAction Provisions | 
|                                          |  |        |        |       |       |   |                              |   |        |  |     
|                                          |  |        |        |       |       |   | For CapitalAdequacy Purposes |   |       
|                                          |  | Actual |        |       |      
|(Dollars in Thousands)                    |  | Amount |        | Ratio |       |   | Amount                       |   | Ratio  |  |      | Amount                                                        |  | Ratio |       
|As of December 31, 2007:                  |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|Total Capital (to Risk-Weighted Assets):  |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|Consolidated                              |  | $      | 29,664 |       | 15.60 | % |                              | $ | 15,216 |  | 8.00 | %                                                             |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |        | 25,361 |       | 13.57 | % |                              |   | 14,954 |  | 8.00 | %                                                             |  |       | 18,693 |  | 10.00 | %
|                                          |  |        |        |       |       |  
|Tier 1 Capital (to Risk-Weighted Assets): |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|Consolidated                              |  | $      | 27,308 |       | 14.36 | % |                              | $ | 7,608  |  | 4.00 | %                                                             |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |        | 23,020 |       | 12.31 | % |                              |   | 7,477  |  | 4.00 | %                                                             |  |       | 11,216 |  | 6.00  | %
|                                          |  |        |        |       |       |  
|Tier 1 Capital (to Average Assets):       |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|Consolidated                              |  | $      | 27,308 |       | 10.28 | % |                              | $ | 10,622 |  | 4.00 | %                                                             |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |        | 23,020 |       | 8.77  | % |                              |   | 10,498 |  | 4.00 | %                                                             |  |       | 13,123 |  | 5.00  | %
|                                          |  |        |        |       |       |  
|As of December 31, 2006:                  |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|Total Capital (to Risk-Weighted Assets):  |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|Consolidated                              |  | $      | 28,060 |       | 15.09 | % |                              | $ | 14,879 |  | 8.00 | %                                                             |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |        | 23,471 |       | 12.97 | % |                              |   | 14,473 |  | 8.00 | %                                                             |  |       | 18,091 |  | 10.00 | %
|                                          |  |        |        |       |       |  
|Tier 1 Capital (to Risk-Weighted Assets): |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|Consolidated                              |  | $      | 25,611 |       | 13.77 | % |                              | $ | 7,440  |  | 4.00 | %                                                             |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |        | 21,180 |       | 11.71 | % |                              |   | 7,236  |  | 4.00 | %                                                             |  |       | 10,855 |  | 6.00  | %
|                                          |  |        |        |       |       |  
|Tier 1 Capital (to Average Assets):       |  |        |        |       |       |   |                              |   |        |  |      |                                                               |  |       |        |  |       |  
|Consolidated                              |  | $      | 25,611 |       | 9.93  | % |                              | $ | 10,319 |  | 4.00 | %                                                             |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |        | 21,180 |       | 8.27  | % |                              |   | 10,247 |  | 4.00 | %                                                             |  |       | 12,809 |  | 5.00  | %

Federal and state banking regulations place certain restrictions on dividends paid and loans or
advances made by the Bank to the Company. The total amount of dividends that may be paid at any date is generally limited to the retained earnings (as defined) for the Bank for the current and past two years, and loans or advances are limited to 10
percent of the Banks capital stock and surplus on a secured basis. In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Banks capital to be reduced below applicable minimum
capital requirements.

At December 31, 2007, the Banks retained earnings available for the payment of dividends was $4.7
million. Accordingly, $18.8 million of the Companys equity in the net assets of the Bank was restricted at December 31, 2007.



70



---

NOTE 11 - STOCKHOLDERS EQUITY(Concluded)

During the year ended December 31, 2007, the Company paid quarterly cash dividends of $0.07 per share for the first, second and third quarters and
$0.08 per share for the fourth quarter. During the year ended December 31, 2006, the Company paid quarterly cash dividends of $0.058 per share for the first, second and third quarters and $0.07 per share for the fourth quarter. During the year
ended December 31, 2005, the Company paid quarterly cash dividends of $0.05 per share for the first and second quarters and $0.058 per share for the third and fourth quarters. During August 2006, the Company effected a six-for-five stock split.
All 2005 and 2006 dividends per share have been adjusted to reflect the August 2006 stock split. On January 8, 2008, the Company declared a $0.08 per share quarterly cash dividend paid on February 1, 2008 to shareholders of record on
January 25, 2008.

During October 2001, the Companys Board of Directors approved a Dividend Reinvestment Plan (DRIP
Plan) whereby shareholders may elect to have cash dividends paid by the Company reinvested in its common stock, subject to certain limitations. Shareholders may also make optional cash payments to purchase additional shares of the
Companys common stock. The DRIP Plan document details the plan and was sent to each shareholder during November 2001.

During May
2007, the Companys Board of Directors approved the repurchase of 125,000 additional shares of common stock on the open market. The Company has not repurchased any shares of common stock under this plan.

NOTE 12 - EMPLOYEE BENEFIT PLANS

401k Profit
Sharing Plan

The Companys 401k Profit Sharing Plan Trust (the Plan) provides for retirement, death and disability
benefits. An employee becomes eligible for participation in the Plan on the first day of the month following their ninety day anniversary date with the Company. However, an employee must be employed on the last day of the year to be eligible for
profit sharing under the Plan.

Employees may elect to defer 2%-15% of their compensation, with the Company making matching contributions
equal to 100% of the first 3% of compensation deferred, and 50% of the next 3%. Matching contributions made by the Company under the Plan totaled approximately $120,300, $107,900 and $87,600 for the years ended December 31, 2007, 2006 and 2005,
respectively. The Company may also elect to make discretionary contributions to the Plan. Accordingly, $120,000, $120,000 and $106,000 of such contributions were made during the years ended December 31, 2007, 2006 and 2005, respectively.



71



---

NOTE 12 - EMPLOYEE BENEFIT PLANS (Continued)



Stock Option Plans

The Company currently has one stock option plan for employees in effect  the 2001 Stock Incentive Plan (the 2001 Plan). The 1992 Stock
Option Plan expired, but certain options deemed earned are still exercisable. The Companys 2001 Plan is designed to attract and retain qualified personnel in key positions, provide employees with a proprietary interest in the Company as an
incentive to contribute to the success of the Company and the Bank and reward employees for outstanding performance and the attainment of targeted goals. The 2001 Plan provides for the grant of incentive stock options intended to comply with the
requirements of Section 422 of the Internal Revenue Code of 1986 (incentive stock options), as well as nonqualified stock options.

The 2001 Plan, approved by the Companys shareholders on April 17, 2001, provides up to 388,800 shares of common stock (as adjusted for the December 2003 20% stock dividend and August 2006 six-for-five stock split) for granting
restricted stock awards and stock options in the form of incentive stock options and nonstatutory stock options to employees of the Company. The 2001 Plan also provides for the granting of restricted stock awards. The 2001 Plan expires on
April 16, 2011.

The 2001 Plan is administered by the Compensation Committee formed by the Companys Board of Directors, each
member of which is a nonemployee director as defined in Rule 16b-3 under the Securities Exchange Act of 1934. The 2001 Plan is in effect for a period of ten years from the date of adoption by the Board of Directors.

Under the 2001 Plan, the committee determines which employees will be granted options, whether such options will be incentive or nonqualified options,
the number of shares subject to each option, whether such options may be exercised by delivering other shares of common stock and when such options become exercisable. In general, the per share exercise price of an incentive stock option shall be at
least equal to the fair market value of a share of common stock on the date the option is granted. The per share exercise price of a nonqualified stock option shall be not less than 50% of the fair market value of a share of common stock on the date
the option is granted.

Stock options shall become vested and exercisable in the manner specified by the committee. In general, each stock
option or portion thereof shall be exercisable at any time on or after it vests and is exercisable for periods of up to 10 years after its date of grant. Stock options are nontransferable except by will or the laws of descent and distribution.

The committee also determines which employees will be awarded restricted stock and the number of shares to be awarded. The value of the
restricted stock is to be at least equal to the fair market value of the common stock on the date the stock is granted. No shares of restricted stock have been awarded.

During the years ended December 31, 2007 and 2006, the Company did not grant incentive stock options under the 2001 Plan. During the year ended December 31, 2005, the Company granted 16,897 incentive stock
options under the 2001 Plan at an average exercise price of $16.40. During the years ended December 31, 2007, 2006 and 2005, the Company granted 500, 10,880 and 24,217 nonqualified stock options under the 2001 plan at an average exercise price
of $13.10, $14.86 and $15.37, respectively.



72



---

NOTE 12 - EMPLOYEE BENEFIT PLANS (Continued)

Stock Option Plan (continued)



The following table represents options outstanding under the Stock Plans:



|                                               |  |                          |   |      |                               |       |                         |   |         |  |         |                               |  |   |         |   |  |                               |   |  |   |      
|---------------------------------------------- |  | ------------------------ | - | ---- | ----------------------------- | ----- | ----------------------- | - | ------- |  | ------- | ----------------------------- |  | - | ------- | - |  | ----------------------------- | - |  | - | -----
|                                               |  | Years Ended December 31,
|                                               |  | 2007                     |   | 2006 |                               |       | 2005                   
|                                               |  | Options                  |   |      | Weighted-AverageExercisePrice |       | AggregateIntrinsicValue |   | Options |  |         | Weighted-AverageExercisePrice |  |   | Options |   |  | Weighted-AverageExercisePrice
|Outstanding - beginning of year                |  | 137,989                  |   |      | $                             | 11.26 |                         |   |         |  | 136,057 |                               |  | $ | 10.85   |   |  | 111,479                       |   |  | $ | 8.43 
|Granted                                        |  | 500                      |   |      |                               | 13.10 |                         |   |         |  | 10,880  |                               |  |   | 14.86   |   |  | 41,114                        |   |  |   | 15.79
|Exercised                                      |  | (3,600                   | ) |      |                               | 6.30  |                         |   |         |  | (8,328  | )                             |  |   | (6.74   | ) |  | (14,898                       | ) |  |   | 6.22 
|Forfeited                                      |  | (4,800                   | ) |      |                               | 14.95 |                         |   |         |  | (620    | )                             |  |   | 15.19   |   |  | (1,638                        | ) |  |   | 12.61
|                                               |  |                          |   |      |                               |       |                         |   |         |  |         |                               |  |   |         |   |  |                               |   |  |   |      
|Outstanding - end of year                      |  | 130,089                  |   |      | $                             | 11.35 |                         | $ | 65,400  |  | 137,989 |                               |  | $ | 11.26   |   |  | 136,057                       |   |  | $ | 10.85
|                                               |  |                          |   |      |                               |       |                         |   |         |  |         |                               |  |   |         |   |  |                               |   |  |   |      
|Exercisable - end of year                      |  | 128,369                  |   |      | $                             | 11.35 |                         | $ | 70,500  |  | 136,529 |                               |  | $ | 11.26   |   |  | 134,857                       |   |  | $ | 10.84
|                                               |  |                          |   |      |                               |       |                         |   |         |  |         |                               |  |   |         |   |  |                               |   |  |   |      
|Weighted average fair value of options granted |  |                          |   |      | $                             | 3.82  |                         |   |         |  |         |                               |  | $ | 3.89    |   |  |                               |   |  | $ | 4.30 
|                                               |  |                          |   |      |                               |       |                         |   |         |  |         |                               |  |   |         |   |  |                               |   |  |   |      

The total intrinsic value of options exercised during the years ended December 31, 2007, 2006
and 2005 was $27,300, $66,100 and $100,800, respectively.



|                               |  |                  |   |  |                                     |     
|------------------------------ |  | ---------------- | - |  | ----------------------------------- | ----
|Nonvested Shares               |  | Number ofOptions |   |  | WeightedAverageGrant DateFair Value
|Nonvested at January 1, 2007   |  | 1,460            |   |  | $                                   | 4.30
|Granted                        |  | 500              |   |  |                                     | 3.82
|Vested                         |  | (240             | ) |  |                                     | 3.90
|Forfeited                      |  |                 |   |  |                                     |    
|                               |  |                  |   |  |                                     |     
|Nonvested at December 31, 2007 |  | 1,720            |   |  | $                                   | 3.87
|                               |  |                  |   |  |                                     |     

As of December 31, 2007, there was $6,700 of total unrecognized compensation costs related to
nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted average period 4.17 years. The total fair value of shares vested during the years ended December 31, 2007, 2006 and
2005 was $900, $40,900 and $172,500 respectively.

Total compensation cost of share-based payment arrangements recognized in income during
2007 was $900. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $300 for 2007.



73



---

NOTE 12 - EMPLOYEE BENEFIT PLANS (Concluded)

Stock Option Plan (concluded)

Cash
received from option exercises under share-based payment arrangements for 2007, 2006 and 2005 was $22,700, $56,200 and $47,000, respectively. Tax deductions from option exercises of share-based arrangements received during 2007, 2006 and 2005 was
$5,700, $10,900 and $9,300, respectively. During 2006 and 2007, no outstanding shares were exchanged towards the exercise of stock options, while 1,492 outstanding shares were exchanged towards the exercise of stock options during 2005.

Other information pertaining to options outstanding at December 31, 2007 is as follows:



|                           |  |                     |  |                                                 |  |                              |       |                   |         |                              |   |      
|-------------------------- |  | ------------------- |  | ----------------------------------------------- |  | ---------------------------- | ----- | ----------------- | ------- | ---------------------------- | - | -----
|                           |  | Options Outstanding |  | Options Exercisable                            
|Range of Exercise Prices   |  | NumberOutstanding   |  | WeightedAverageRemainingContractualLife (Years) |  | WeightedAverageExercisePrice |       | NumberExercisable |         | WeightedAverageExercisePrice
|$5.56 - $8.90              |  | 57,609              |  | 3.98                                            |  | $                            | 7.06  |                   | 57,609  |                              | $ | 7.06 
|$13.50 - $16.40            |  | 72,481              |  | 5.07                                            |  | $                            | 14.87 |                   | 70,761  |                              | $ | 14.87
|                           |  |                     |  |                                                 |  |                              |       |                   |         |                              |   |      
|Outstanding at end of year |  | 130,089             |  |                                                 |  |                              |       |                   | 128,369 |                              |   |      
|                           |  |                     |  |                                                 |  |                              |       |                   |         |                              |   |      

NOTE 13 - RELATED PARTY TRANSACTIONS

In the normal course of business, the Bank makes loans to and receives deposits from directors, officers and other related parties. Loans to employees are
made on substantially the same terms as those prevailing at the time for comparable transactions with other borrowers, except that the interest rate is reduced by a stated amount for primary residence loans, as long as such person remains employed
by the Bank. At December 31, 2007, total deposit balances outstanding of related parties were $1.0 million. A summary of related party loan activity for the periods indicated is as follows:



|                           |  |   |            |  
|-------------------------- |  | - | ---------- | -
|Balance, December 31, 2006 |  | $ | 4,449,400  |  
|Originations               |  |   | 401,100    |  
|Repayments                 |  |   | (1,634,600 | )
|                           |  |   |            |  
|Balance, December 31, 2007 |  | $ | 3,215,900  |  
|                           |  |   |            |  



74



---

NOTE 13 - RELATED PARTY TRANSACTIONS(Concluded)

The Bank has a lease agreement with the Banks former Chairman of the Board of Directors to lease a lot at Four Corners Plaza, Onley, Virginia, for
$2,000 per month expiring in 2009 with two five-year renewals. Each renewal will be at the option of the Bank and the leases will be based on the previous lease rate, after being adjusted for changes in the consumer price index. Shore Investments
Inc. has a lease agreement with a partnership whereby the Companys Chairman of the Board is the majority partner. The lease is for property located in Accomac, Virginia at $1,000 per month expiring in 2010 with two five-year renewal options
available if the Bank chooses to exercise them. The Bank has a lease agreement with a director for two billboard signs at $400 per month each that expires in August 2011.

All related party transactions were consummated in terms equivalent to those that prevail in arms length transactions.

NOTE 14 - COMMITMENTS AND CONTINGENCIES AND OTHER RELATED PARTY TRANSACTIONS

Minimum future lease payments for these
operating leases are as follows:



|                          |  |   |        
|------------------------- |  | - | -------
|Years Ending December 31, |  |   |        
|2008                      |  | $ | 134,700
|2009                      |  |   | 84,000 
|2010                      |  |   | 48,000 
|2011                      |  |   | 38,000 
|2012                      |  |   | 24,300 
|                          |  |   |        
|                          |  | $ | 329,000
|                          |  |   |        

Rental expense under operating leases was $104,200, $53,400 and $30,600 for the years ended
December 31, 2007, 2006 and 2005, respectively.

The Company is a party to credit related financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit. Such commitments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Companys exposure to credit loss is represented by the contractual amount of these commitments. The Company follows
the same credit policies in making commitments as it does for on-balance-sheet instruments.



75



---

NOTE 14 - COMMITMENTS AND CONTINGENCIES AND OTHER RELATED PARTY TRANSACTIONS(Concluded)

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Bank upon extension of credit, is based on management's credit evaluation of the counter party. Collateral held varies but may include single-family residences, other residential property, commercial property and land. At December 31, 2007
and 2006, the Bank had outstanding commitments to originate loans, including outstanding construction loan commitments, with variable interest rates of approximately $11.4 million and $8.4 million, respectively. In addition, unused lines of credit,
primarily at variable rates, amounted to approximately $37.1 million and $36.2 million at December 31, 2007 and 2006, respectively. Standby letters of credit at December 31, 2007 and 2006 were $1.8 million and $984,000, respectively. The
distribution of commitments to extend credit approximates the distribution of loans outstanding.

In the normal course of business, the
Bank has entered into employment agreements with some of its key executives. The Company may terminate the employment agreements with proper notice as specified in the agreements. Termination without cause (as defined in the agreement) entitles the
executive to base salary and benefits for a specified period of time from the date of termination, depending on the agreement.

The Bank
has an agreement with a service company whereby the latter furnishes data processing services to the Bank. The contract was last renewed during 2005 for an additional 60 months that is similar to the previous agreement and to those entered into by
other entities in the financial institution industry. The costs represent normal operating costs to the Bank.

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



76



---

NOTE 15 - EARNINGS PER SHARE RECONCILIATION

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations.



|                                                  |  |                          |           |      |   |           |  |   |          
|------------------------------------------------- |  | ------------------------ | --------- | ---- | - | --------- |  | - | ---------
|                                                  |  | Years Ended December 31,
|                                                  |  | 2007                     |           | 2006 |   | 2005     
|Net income (numerator, basic and diluted)         |  | $                        | 2,730,600 |      | $ | 2,933,100 |  | $ | 2,675,300
|Weighted average shares outstanding (denominator) |  |                          | 2,499,800 |      |   | 2,492,100 |  |   | 2,485,100
|                                                  |  |                          |           |      |   |           |  |   |          
|Earnings per common share - basic                 |  | $                        | 1.09      |      | $ | 1.18      |  | $ | 1.08     
|                                                  |  |                          |           |      |   |           |  |   |          
|Effect of dilutive securities:                    |  |                          |           |      |   |           |  |   |          
|                                                  |  |                          |          
|Weighted average shares outstanding               |  |                          | 2,499,800 |      |   | 2,492,100 |  |   | 2,485,100
|Effect of stock options                           |  |                          | 19,400    |      |   | 30,500    |  |   | 36,200   
|                                                  |  |                          |           |      |   |           |  |   |          
|Diluted average shares outstanding (denominator)  |  |                          | 2,519,200 |      |   | 2,522,600 |  |   | 2,521,300
|                                                  |  |                          |           |      |   |           |  |   |          
|Earnings per common share -assuming dilution      |  | $                        | 1.08      |      | $ | 1.16      |  | $ | 1.06     
|                                                  |  |                          |           |      |   |           |  |   |          

NOTE 16 - PARENT COMPANY

Since its inception, the Companys business activities have been limited to investment activities related to the Bank and its excess cash. Dividends and management fees from the Bank and investment income
represent the only sources of funds for the Company. Certain restrictions exist that limit the amount of dividends the Bank may declare without obtaining regulatory approval. At December 31, 2007, the Bank had approximately $4.7 million
available to declare in dividends under existing regulatory guidelines.

The Companys primary costs consist of its
employees compensation expense, board of directors expenses, public reporting requirements and annual fees associated with being a public company. During the years ended December 31, 2007, 2006 and 2005, the Bank paid the Company
management fees of $564,000, $480,000 and $431,000, respectively, for its proportion of operating costs.



77



---

NOTE 16 - PARENT COMPANY(Continued)



The Companys condensed balance sheets as of December 31, 2007 and 2006, and the related
condensed statements of income and cash flows for years ended December 31, 2007, 2006 and 2005 are provided below:

Condensed Balance Sheets



|                                           |  |              |            |      |   |           
|------------------------------------------ |  | ------------ | ---------- | ---- | - | ----------
|                                           |  | December 31,
|                                           |  | 2007         |            | 2006
|Assets                                     |  |              |            |      |   |           
|Cash and due from banks                    |  | $            | 1,240,000  |      | $ | 682,000   
|Securities available-for-sale              |  |              | 3,501,000  |      |   | 5,224,000 
|Investment in Shore Bank                   |  |              | 23,471,000 |      |   | 21,465,000
|Other assets                               |  |              | 644,000    |      |   | 169,000   
|                                           |  |              |            |      |   |           
|Total assets                               |  | $            | 28,856,000 |      | $ | 27,540,000
|                                           |  |              |            |      |   |           
|Liabilities and Stockholders Equity       |  |              |            |      |   |           
|Liabilities                                |  | $            | 1,136,000  |      | $ | 1,414,000 
|Stockholders equity                       |  |              | 27,720,000 |      |   | 26,126,000
|                                           |  |              |            |      |   |           
|Total liabilities and stockholders equity |  | $            | 28,856,000 |      | $ | 27,540,000
|                                           |  |              |            |      |   |           

Condensed Statements of Income



|                                                                                |  |                          |           |      |   |           |  |   |          
|------------------------------------------------------------------------------- |  | ------------------------ | --------- | ---- | - | --------- |  | - | ---------
|                                                                                |  | Years Ended December 31,
|                                                                                |  | 2007                     |           | 2006 |   | 2005     
|Income                                                                          |  |                          |           |      |   |           |  |   |          
|Dividends from Shore Bank                                                       |  | $                        | 700,000   |      | $ | 1,000,000 |  | $ | 500,000  
|Management Fees from Shore Bank                                                 |  |                          | 564,000   |      |   | 480,000   |  |   | 431,000  
|Investment income                                                               |  |                          | 279,000   |      |   | 239,000   |  |   | 171,000  
|Gain on sales of securities                                                     |  |                          | 125,000   |      |   | 246,000   |  |   | 185,000  
|                                                                                |  |                          |           |      |   |           |  |   |          
|Total income                                                                    |  |                          | 1,668,000 |      |   | 1,965,000 |  |   | 1,287,000
|                                                                                |  |                          |           |      |   |           |  |   |          
|Expenses                                                                        |  |                          |           |      |   |           |  |   |          
|Compensation and benefits                                                       |  |                          | 456,000   |      |   | 441,000   |  |   | 412,000  
|Directors fees                                                                 |  |                          | 98,000    |      |   | 81,000    |  |   | 93,000   
|Accounting and professional fees                                                |  |                          | 140,000   |      |   | 147,000   |  |   | 97,000   
|Other                                                                           |  |                          | 133,000   |      |   | 137,000   |  |   | 73,000   
|                                                                                |  |                          |           |      |   |           |  |   |          
|Total expenses                                                                  |  |                          | 827,000   |      |   | 806,000   |  |   | 675,000  
|                                                                                |  |                          |           |      |   |           |  |   |          
|Income before income taxes and equity in undistributed net income of subsidiary |  |                          | 841,000   |      |   | 1,159,000 |  |   | 612,000  
|Income tax expense                                                              |  |                          |          |      |   |          |  |   |         
|                                                                                |  |                          |           |      |   |           |  |   |          
|Income before equity in undistributed net income of subsidiary                  |  |                          | 841,000   |      |   | 1,159,000 |  |   | 612,000  
|Equity in undistributed net income of subsidiary (1)                            |  |                          | 1,890,000 |      |   | 1,774,000 |  |   | 2,063,000
|                                                                                |  |                          |           |      |   |           |  |   |          
|Net income                                                                      |  | $                        | 2,731,000 |      | $ | 2,933,000 |  | $ | 2,675,000
|                                                                                |  |                          |           |      |   |           |  |   |          



|(1) | Amount in parentheses represents the excess of dividends declared over net income of subsidiary.
|--- | ------------------------------------------------------------------------------------------------



78



---

NOTE 16 - PARENT COMPANY(Concluded)

Condensed Statements of Cash Flows



|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  
|------------------------------------------------------------- |  | ------------------------ | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                              |  | Years Ended December 31, |           
|                                                              |  | 2007                     |            |   | 2006 |   |            | 2005 | 
|Operating Activities                                          |  |                          |            |   |      |   |            |      |  |   |            |  
|Net income                                                    |  | $                        | 2,731,000  |   |      | $ | 2,933,000  |      |  | $ | 2,675,000  |  
|Equity in undistributed net income of subsidiary              |  |                          | (1,890,000 | ) |      |   | (1,774,000 | )    |  |   | (2,063,000 | )
|Other non-cash transactions                                   |  |                          | (5,000     | ) |      |   | 14,000     |      |  |   |           |  
|Gain on sale of securities                                    |  |                          | (125,000   | ) |      |   | (246,000   | )    |  |   | (185,000   | )
|Tax benefit from stock options                                |  |                          | 6,000      |   |      |   | 11,000     |      |  |   | 9,000      |  
|Compensation expense for stock options granted                |  |                          |           |   |      |   | 40,000     |      |  |   |           |  
|Change in other assets                                        |  |                          | (50,000    | ) |      |   | (30,000    | )    |  |   | (9,000     | )
|Change in other liabilities                                   |  |                          | 3,000      |   |      |   | 18,000     |      |  |   | 9,000      |  
|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  
|Cash flows from operating activities                          |  |                          | 670,000    |   |      |   | 966,000    |      |  |   | 436,000    |  
|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  
|Investing Activities                                          |  |                          |            |   |      |   |            |      |  |   |            |  
|Proceeds from sale and calls of available-for-sale securities |  |                          | 1,836,000  |   |      |   | 593,000    |      |  |   | 855,000    |  
|Purchase of available-for-sale securities                     |  |                          | (821,000   | ) |      |   | (1,643,000 | )    |  |   | (877,000   | )
|Purchase of premises and equipment                            |  |                          | (425,000   | ) |      |   |           |      |  |   |           |  
|Sale of premises and equipment                                |  |                          |           |   |      |   |           |      |  |   |           |  
|Other investing activities                                    |  |                          |           |   |      |   |           |      |  |   |           |  
|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  
|Cash flows from investing activities                          |  |                          | 590,000    |   |      |   | (1,050,000 | )    |  |   | (22,000    | )
|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  
|Financing Activities                                          |  |                          |            |   |      |   |            |      |  |   |            |  
|Proceeds from exercise of common stock options                |  |                          | 23,000     |   |      |   | 56,000     |      |  |   | 72,000     |  
|Proceeds from borrowings                                      |  |                          |           |   |      |   | 1,000,000  |      |  |   |           |  
|Payment of dividends on common stock                          |  |                          | (725,000   | ) |      |   | (610,000   | )    |  |   | (538,000   | )
|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  
|Cash flows from financing activities                          |  |                          | (702,000   | ) |      |   | 446,000    |      |  |   | (466,000   | )
|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  
|Change in cash and cash equivalents                           |  |                          | 558,000    |   |      |   | 362,000    |      |  |   | (52,000    | )
|Cash and cash equivalents, beginning of year                  |  |                          | 682,000    |   |      |   | 320,000    |      |  |   | 372,000    |  
|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  
|Cash and cash equivalents, end of year                        |  | $                        | 1,240,000  |   |      | $ | 682,000    |      |  | $ | 320,000    |  
|                                                              |  |                          |            |   |      |   |            |      |  |   |            |  



79



---

NOTE 17 - QUARTERLY CONDENSED STATEMENTS OF INCOME  UNAUDITED

Quarterly Condensed Statements of Income - Unaudited



|                                                    |  |                     |           |         |   |              |  |             |           |  |   |          
|--------------------------------------------------- |  | ------------------- | --------- | ------- | - | ------------ |  | ----------- | --------- |  | - | ---------
|                                                    |  | 2007 Quarters Ended
|                                                    |  | March 31            |           | June 30 |   | September 30 |  | December 31
|Total interest and dividend income                  |  | $                   | 3,926,700 |         | $ | 4,049,600    |  | $           | 4,164,000 |  | $ | 4,116,400
|Net interest income after provision for loan losses |  |                     | 2,067,300 |         |   | 2,195,800    |  |             | 2,277,900 |  |   | 2,336,000
|Noninterest income                                  |  |                     | 829,300   |         |   | 811,700      |  |             | 811,900   |  |   | 799,600  
|Noninterest expense                                 |  |                     | 1,973,300 |         |   | 2,244,900    |  |             | 2,060,500 |  |   | 2,013,500
|Income before income taxes                          |  |                     | 923,300   |         |   | 762,600      |  |             | 1,029,300 |  |   | 1,122,100
|Net income                                          |  |                     | 637,100   |         |   | 574,300      |  |             | 730,400   |  |   | 788,800  
|Earnings per common share - diluted                 |  |                     | 0.25      |         |   | 0.23         |  |             | 0.29      |  |   | 0.31     
|Dividends per common share                          |  |                     | 0.070     |         |   | 0.070        |  |             | 0.070     |  |   | 0.070    
|                                                    |  |                     |           |         |   |              |  |             |           |  |   |          



|                                                    |  |                     |           |         |   |              |  |             |           |  |   |          
|--------------------------------------------------- |  | ------------------- | --------- | ------- | - | ------------ |  | ----------- | --------- |  | - | ---------
|                                                    |  | 2006 Quarters Ended
|                                                    |  | March 31            |           | June 30 |   | September 30 |  | December 31
|Total interest and dividend income                  |  | $                   | 3,495,800 |         | $ | 3,774,500    |  | $           | 3,852,100 |  | $ | 3,990,100
|Net interest income after provision for loan losses |  |                     | 2,102,500 |         |   | 2,093,900    |  |             | 2,045,400 |  |   | 2,194,500
|Noninterest income                                  |  |                     | 795,400   |         |   | 842,200      |  |             | 838,500   |  |   | 915,800  
|Noninterest expense                                 |  |                     | 1,890,700 |         |   | 1,869,100    |  |             | 1,911,600 |  |   | 2,067,800
|Income before income taxes                          |  |                     | 1,007,200 |         |   | 1,067,000    |  |             | 972,300   |  |   | 1,042,500
|Net income                                          |  |                     | 695,000   |         |   | 736,200      |  |             | 670,900   |  |   | 831,000  
|Earnings per common share - diluted                 |  |                     | 0.27      |         |   | 0.29         |  |             | 0.27      |  |   | 0.33     
|Dividends per common share                          |  |                     | 0.058     |         |   | 0.058        |  |             | 0.058     |  |   | 0.070    
|                                                    |  |                     |           |         |   |              |  |             |           |  |   |          

NOTE 18 - SEGMENT INFORMATION

Management determines the Companys operating segments and evaluates their performance by the markets in which the Bank operates. Currently, the Bank operates in two different geographical markets: Virginia and
Maryland. Generally, each market possesses a different customer base and occasionally requires that management approach product pricing and promotion in different manners. However, products offered in each market are similar. Additionally, the
Maryland market represents a newer market to the Bank than does the Virginia market.

The accounting policies of the segments are the same
as those described in the summary of significant accounting policies. The Company evaluates performance based on net interest income from operations and asset growth within the segments.



80



---

NOTE 18 - SEGMENT INFORMATION (Concluded)

Since the Company derives a significant portion of its revenues from interest income and interest expense is the most significant expense, the segments
are reported below using net interest income for the periods indicated. The Other column primarily represents the Companys investment activities resulting from excess cash available within the individual segments. The
Elimination column represents intersegment activities and reconciles the segments to the Companys consolidated financial statements.



|                             |  |          |         |          |   |        |  |   |                                        |   |  |       |         |   |  |   |        
|---------------------------- |  | -------- | ------- | -------- | - | ------ |  | - | -------------------------------------- | - |  | ----- | ------- | - |  | - | -------
|(In thousands)               |  | Virginia |         | Maryland |   | Other  |  |   | Elimination ofIntersegmentTransactions |   |  | Total
|Net Interest Income:         |  |          |         |          |   |        |  |   |                                        |   |  |       |         |   |  |   |        
|Year ended December 31, 2007 |  | $        | 6,575   |          | $ | 1,824  |  | $ | (514                                   | ) |  | $     | 919     |   |  | $ | 8,804  
|Year ended December 31, 2006 |  | $        | 6,400   |          | $ | 1,752  |  | $ | (377                                   | ) |  | $     | 720     |   |  | $ | 8,495  
|Year ended December 31, 2005 |  | $        | 6,174   |          | $ | 1,690  |  | $ | 590                                    |   |  | $     | (17     | ) |  | $ | 8,437  
|                             |  |          |         |          |  
|Assets:                      |  |          |         |          |   |        |  |   |                                        |   |  |       |         |   |  |   |        
|December 31, 2007            |  | $        | 206,469 |          | $ | 53,949 |  | $ | 38,745                                 |   |  | $     | (32,496 | ) |  | $ | 266,667
|December 31, 2006            |  | $        | 198,692 |          | $ | 49,441 |  | $ | 43,531                                 |   |  | $     | (30,988 | ) |  | $ | 260,676

NOTE 19 - BRANCH DEPOSIT ACQUISITION

On December 13, 2002, the Bank acquired certain assets and assumed certain liabilities of the Salisbury, Maryland branch of Susquehanna Bank, a
wholly-owned subsidiary of Susquehanna Bankshares Inc. The approximate fair value of the net assets acquired and deposit liabilities assumed amounted to $50,000 and $17.5 million, respectively. The Bank realized proceeds of approximately $16.8
million from the transaction, net of a deposit premium intangible of $620,000. The Bank is amortizing this intangible over ten years. During the years ended December 31, 2007, 2006 and 2005, the Bank realized amortization expense of $62,000,
$62,000 and $62,000 respectively, on this asset and the accumulated amortization for the periods then ended was $310,000, $248,000 and $186,000, respectively.

NOTE 20 - COMPREHENSIVE INCOME

Total comprehensive income consists of the following for the years indicated:



|                                  |  |                          |           |   |      |   |           |  |   |           |  
|--------------------------------- |  | ------------------------ | --------- | - | ---- | - | --------- |  | - | --------- | -
|                                  |  | Years Ended December 31, |          
|                                  |  | 2007                     |           |   | 2006 |   | 2005      | 
|Net income                        |  | $                        | 2,730,600 |   |      | $ | 2,933,100 |  | $ | 2,675,300 |  
|Other comprehensive income (loss) |  |                          | (439,800  | ) |      |   | 68,200    |  |   | (539,400  | )
|                                  |  |                          |           |   |      |   |           |  |   |           |  
|Total comprehensive income        |  | $                        | 2,290,800 |   |      | $ | 3,001,300 |  | $ | 2,135,900 |  
|                                  |  |                          |           |   |      |   |           |  |   |           |  



81



---

NOTE 20 - COMPREHENSIVE INCOME (Concluded)

The components of other comprehensive income are as follows for the years indicated:



|                                                              |  |                          |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------- |  | ------------------------ | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                              |  | Years Ended December 31, |         
|                                                              |  | 2007                     |          |   | 2006 |   |          | 2005 | 
|Unrealized gains (losses) on available-for-sale securities:   |  |                          |          |   |      |   |          |      |  |   |          |  
|Unrealized holding gains (losses) arising during the period   |  | $                        | (591,600 | ) |      | $ | 316,000  |      |  | $ | (674,600 | )
|Less: reclassification adjustment for gain included in income |  |                          | (74,500  | ) |      |   | (210,000 | )    |  |   | (166,400 | )
|                                                              |  |                          |          |   |      |   |          |      |  |   |          |  
|Total other comprehensive gain (loss) before tax effect       |  |                          | (666,100 | ) |      |   | 106,000  |      |  |   | (841,000 | )
|Tax benefit (expense)                                         |  |                          | 226,300  |   |      |   | (37,800  | )    |  |   | 301,600  |  
|                                                              |  |                          |          |   |      |   |          |      |  |   |          |  
|Net unrealized gain (loss)                                    |  | $                        | (439,800 | ) |      | $ | 68,200   |      |  | $ | (539,400 | )
|                                                              |  |                          |          |   |      |   |          |      |  |   |          |  

NOTE 21 - SUBSEQUENT EVENT

On January 8, 2008, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Hampton Roads Bankshares, Inc. (HRB). The Merger Agreement sets forth the terms and
conditions of HRBs acquisition of the Company through the merger of the Company with and into HRB (the Merger). Shore Bank, a wholly-owned subsidiary of the Company, will become a wholly-owned subsidiary of HRB in the Merger and
will operate separately from the Bank of Hampton Roads, a wholly-owned subsidiary of HRB. Scott C. Harvard will continue to serve as President and Chief Executive Officer of Shore Bank. The headquarters of the surviving entity, Hampton Roads
Bankshares, Inc., will be the current headquarters of HRB and its Board of Directors will be increased, as specified in the Merger Agreement, to include three new members who currently serve as directors of the Company.

Under the terms of the Merger Agreement, HRB will acquire all of the outstanding shares of the Company. The shareholders of the Company will receive, for
each share of the Company common stock that they own immediately prior to the effective time of the Merger, either $22 per share in cash or 1.8 shares of common stock of HRB (the Exchange Ratio). Pursuant to the terms of the Merger
Agreement, shareholders of the Company will have the opportunity to elect to receive cash, shares of common stock of HRB, or a combination of both subject to the allocation and proration procedures set forth in the Merger Agreement. The allocation
and proration procedures are intended to ensure that, in the aggregate, no less than 25% and no more than 45% of the total merger consideration will be cash and the remainder will be common stock of HRB. However, HRB has reserved the right to
increase the cash portion of the consideration up to 50% of the total merger consideration if the shareholders of the Company in the aggregate elect to receive less than 55% of the total consideration in common stock of HRB.



82



---

NOTE 21 - SUBSEQUENT EVENT (Concluded)

In addition, at the effective time of the Merger, each outstanding option to purchase shares of the Company common stock under any of the Companys
stock plans shall vest pursuant to its terms and shall be converted into an option to acquire the number of shares of HRB common stock equal to the number of shares of common stock underlying the option multiplied by the Exchange Ratio. The exercise
price of each option will be adjusted accordingly.

Consummation of the Merger is subject to a number of customary conditions including the
approval of the Merger by the shareholders of each of the Company and HRB and the receipt of all required regulatory approvals. The Merger is expected to be completed in the second quarter of 2008. Pursuant to the Merger Agreement either party may
terminate the Merger Agreement in the event the Merger is not consummated by September 30, 2008. In addition, the Company may terminate the Merger Agreement in the event the Average Price of HRB common stock (as defined in the Merger Agreement)
is less than $9.50 per share and HRB may terminate the Merger Agreement in the event such average price is greater than $14.94 per share. The termination of the Merger Agreement will, in certain circumstances, obligate the Company to pay HRB a
termination fee of $1.0 million to $2.4 million depending on the triggering event and HRB to pay the Company a termination fee of $1.0 million.

On January 8, 2008, the Company declared a $0.08 per share quarterly cash dividend paid on February 1, 2008 to shareholders of record on January 25, 2008.



83



---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors

Shore Financial Corporation and Subsidiaries

We have audited the accompanying consolidated balance sheets of Shore Financial Corporation and Subsidiaries (the Company) as of
December 31, 2007 and 2006, and the related consolidated statements of income, stockholders equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007. Shore Financial
Corporation and Subsidiaries management is responsibility for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Shore Financial
Corporation and Subsidiaries as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles
generally accepted in the United States of America.

LOGO

Norfolk, Virginia

February 27, 2008



84



---

Item 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

Item 9A.

CONTROLS AND
PROCEDURES

Under the supervision and with the participation of our management, including our principal executive officer and principal
financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the year. Based on that evaluation, our principal executive officer and principal financial officer have
concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in
the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required
disclosure.



85



---

MANAGEMENTS REPORT ON INTERNAL

CONTROL OVER FINANCIAL REPORTING

Management of the Company is responsible for
establishing and maintaining adequate internal control over financial reporting. Internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in the United States of America. Management regularly monitors its internal control over financial reporting and takes appropriate action to correct any deficiencies that may be
identified.

Management assessed the Companys internal control over financial reporting as of December 31, 2007. This assessment
was based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that the Company maintained
effective internal control over financial reporting as of December 31, 2007.

Because of its inherent limitations, internal control
over financial reporting may not prevent or detect misstatements. Further, because of changes in conditions, internal control effectiveness may vary over time.

This annual report does not include an attestation report of the Companys registered public accounting firm regarding internal control over financial reporting. Managements report was not subject to
attestation by the Companys registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only managements report in this annual report.



|                                                 
|-------------------------------------------------
|/s/ Scott C. Harvard                             
|Scott C. Harvard                                 
|President and Chief Executive Officer            
|                                                 
|/s/ Steven M. Belote                             
|Steven M. Belote                                 
|Chief Financial Officer and Senior Vice President

March 10, 2008



86



---

PART III

Item 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE

The table below presents information concerning each director of the Company.



|                                                       |  |                                                                                                                                                            
|------------------------------------------------------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|Name (Age)                                             |  | Principal Occupation During Past Five Years (1)                                                                                                            
|Terrell E. Boothe (64) Independent Director            |  | Retired. Director since 1985.                                                                                                                              
|                                                       | 
|The Honorable D. Page Elmore (68) Independent Director |  | Representative, Maryland House of Delegates. Director since 1995.                                                                                          
|                                                       | 
|Dr. Lloyd J. Kellam, III (53) Independent Director     |  | Physician, Eastern Shore Physicians and Surgeons, Nassawadox, Virginia. Director since 1992.                                                               
|                                                       | 
|Henry P. Custis, Jr. (62) Independent Director         |  | Chairman of the Board of the Company and the Bank; Partner, Custis, Lewis & Dix, a law firm located in Accomac, Virginia. Director since 1987.             
|                                                       | 
|L. Dixon Leatherbury (58) Independent Director         |  | President and General Manager, Leatherbury Equipment Co., Cheriton, Virginia; President, Wakefield Equipment Co., Wakefield, Virginia. Director since 1981.
|                                                       | 
|Scott C. Harvard (53)                                  |  | President and Chief Executive Officer of the Company and the Bank. Director since 1985.                                                                    
|                                                       | 
|Richard F. Hall, III (54) Independent Director         |  | Owner, Loblolly Farms, Accomac, Virginia; Owner, Seaside Produce, Accomac, Virginia. Director since 1997.                                                  



|(1) | Includes service as a director of the Bank.
|--- | -------------------------------------------



87



---

The table below presents information concerning each executive officer of the Company.



|                           |  |                                                                                                                                            
|-------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|Name (Age)                 |  | Principal Occupation During Past Five Years (1)                                                                                            
|Scott C. Harvard (53)      |  | President and Chief Executive Officer of the Company and the Bank.                                                                         
|                           | 
|Steven M. Belote (42)      |  | Senior Vice President, Chief Financial Officer and Secretary of the Company; Senior Vice President and Chief Financial Officer of the Bank.
|                           | 
|J. Anderson Duer, Jr. (60) |  | Senior Vice President/Lending of the Bank.                                                                                                 
|                           | 
|Brenda L. Payne (51)       |  | Senior Vice President of the Company; Senior Vice President/Operations and Risk Management of the Bank.                                    



|(1) | Includes service as an officer of the Bank.
|--- | -------------------------------------------

Section 16(a) Beneficial
Ownership Reporting Compliance

Pursuant to Section 16(a) of the Exchange Act, directors and executive officers of the Company are
required to file reports with the SEC indicating their holdings of and transactions in the Companys equity securities. To the Companys knowledge, based solely on a review of the copies of such reports furnished to the Company and written
representations that no other reports were required, insiders of the Company complied with all filing requirements during the fiscal year ended December 31, 2007.

Nomination Procedures

During 2007, the Company did not have a nominating committee. The
Companys independent directors serve in that capacity as provided for in the Companys bylaws. The Board of Directors does not believe that it is necessary to have a nominating committee because it believes that the functions of a
nominating committee can be adequately performed by its independent members. In their capacity as the nominating committee, the independent members of the Board of Directors will accept for consideration shareholders nominations for directors
if made in writing in accordance with the Companys bylaws. The Company does not have a charter with respect to its director nominations process.

The Companys bylaws state that subject to the rights of holders of any class or series of stock having a preference over the common stock as to dividends or upon liquidation, nominations for the election of
directors shall be made by the Board of Directors or a committee appointed by the Board of Directors or by any shareholder entitled to vote in the election of directors generally. However, any shareholder entitled to vote in the election of
directors generally may nominate one or more persons for election as



88



---

directors at a meeting only if written notice of such shareholders intent to make such nomination or nominations has been given, either by personal
delivery or by United States mail, postage prepaid, to the Secretary of the Company not later than (i) with respect to an election to be held at an annual meeting of shareholders, ninety (90) days in advance of such meeting, and
(ii) with respect to an election to be held at a special meeting of shareholders for the election of directors, the close of business on the seventh day following the date on which notice of such meeting is first given to shareholders. Each
notice shall set forth: (a) the name and address of the shareholder who intends to make the nomination and of the person or persons to be nominated; (b) a representation that the shareholder is a holder of record of stock of the Company
entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (c) a description of all arrangements or understandings between the shareholder and each
nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (d) such other information regarding each nominee proposed by such shareholder as would
be required to be included in a proxy statement filed pursuant to the proxy rules of the SEC, had the nominee been nominated, or intended to be nominated, by the Board of Directors; and (e) the consent of each nominee to serve as a director of
the Company if so elected. The chairman of the meeting may refuse to acknowledge the nomination of any person not made in compliance with the foregoing procedure.

Qualifications for consideration as a director nominee may vary according to the particular areas of expertise that may be desired in order to complement the qualifications that already exist among the Board. Among
the factors that the directors consider when evaluating proposed nominees are their independence, financial literacy, business experience, character, judgment and strategic vision. Other considerations would be their knowledge of issues affecting
the business, their leadership experience and their time available for meetings and consultation on Company matters. The independent directors seek a diverse group of candidates who possess the background skills and expertise to make a significant
contribution to the Board, the Company and its shareholders.

Corporate Governance

The Company has a Code of Professional Conduct for Finance Executives that is applicable to all directors and senior executive officers, including
the principal executive officer and principal financial officer (who is also the principal accounting officer). The Code of Professional Conduct for Finance Executives is available on the Companys website under Shore Financial
Corporation/Corporate Governance (www.shorebank.com). The Company intends to post amendments to or waivers, if any, from its Code of Professional Conduct for Finance Executives at this location on its website.

Corporate Governance documents located on the Companys website include the following:



| |  |  | Audit Committee Charter
| | - |  | -----------------------



| |  |  | Code of Conduct for Employees and Directors
| | - |  | -------------------------------------------



| |  |  | Code of Ethical Conduct for Financial Executives
| | - |  | ------------------------------------------------



| |  |  | Corporate Governance Committee Charter
| | - |  | --------------------------------------



| |  |  | Whistleblower Policy
| | - |  | --------------------

Audit Committee

The Audit Committee is comprised of L. Dixon Leatherbury (Chairman), Lloyd J. Kellam, III and Terrell E. Boothe. Mr. Leatherbury
has been designated by the Board of Directors as the audit committee financial expert under SEC rules. The committee has the sole authority and direct responsibility for the appointment, compensation, retention and oversight of the work
of the public accounting firm engaged for the purpose of preparing or issuing an audit report or related services. The accounting firm engaged by the committee must report directly to the committee. The committee also reviews the reports of
examination by the



89



---

regulatory agencies, the independent accountants and the internal auditor, and issues its report to the full Board. A copy of the committees charter is
located on the Companys website (www.shorebank.com). The Audit Committee met four times during 2007.

Item 11.

EXECUTIVE COMPENSATION

Report of the
Compensation Committee

The Compensation Committee is responsible for discharging the responsibilities of the Board with respect to the
compensation of executive officers. The Compensation Committee sets the performance goals and objectives for the chief executive officer and the other executive officers, evaluates their performance with respect to those goals and sets their
compensation based upon their evaluation. In evaluating executive compensation, the Compensation Committee may review salary surveys, retain the services of compensation consultants and consider recommendations from the chief executive officer with
respect to goals and compensation of the other executive officers. The Compensation Committee assesses the information it receives based on its judgment. The committee also reviews director compensation and administers the Companys stock
incentive plan. All decisions with respect to executive and director compensation and the stock incentive plan are approved by the Compensation Committee and recommended to the full Board of Directors.

The Compensation Committee has reviewed and discussed the following Compensation Discussion and Analysis (the CD&A) for the year ended
December 31, 2007 with management. In reliance on these reviews and discussions, the Compensation Committee recommended to the Board, and the Board approved, that the CD&A be included in this report for filing with the SEC.

By the Compensation Committee of the Board of Directors

Terrell E. Boothe, Chairman

Henry P. Custis, Jr.

Richard F. Hall, III

Compensation Discussion and
Analysis

Compensation Philosophy

Total compensation is intended to reward performance, retain excellent employees, keep employees focused on the goals of the Company and be competitive in the marketplace. Executive compensation is designed to:



| |  |  | Reward executives for the enhancement of shareholder value.
| | - |  | -----------------------------------------------------------



| |  |  | Support an environment that rewards performance with respect to Company goals.
| | - |  | ------------------------------------------------------------------------------



| |  |  | Attract and retain key executives critical to the long term success of the Company.
| | - |  | -----------------------------------------------------------------------------------



| |  |  | Integrate compensation programs with the short and long term strategic plans of the Company.
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | Align the interests of the executives with the long term interests of the shareholders.
| | - |  | ---------------------------------------------------------------------------------------



90



---

The compensation programs of the Company for its executive officers are generally administered at the
direction of the Compensation Committee and reviewed annually.

Compensation Overview

Elements of compensation for the executive officers include: base salary, a cash bonus incentive compensation plan, stock incentive awards, 401(k) plan,
health, disability, life insurance and perquisites. The Compensation Committee generally determines base salaries for our executives during February of each year with any changes being effective in March of that same year. During this time, the
committee also approves and adopts the new Executive Incentive Compensation Plan (EICP) for the year and typically considers stock awards to the executive officers and other eligible employees.

In determining executive compensation, the Compensation Committee reviews all elements of each executive officers total compensation and considers
both objective and subjective criteria. With respect to the objective portion of the performance evaluation, the committee specifically considers certain financial performance measures of the Company which may include, but are not limited to, net
income and return on equity. Additionally, the Compensation Committee reviews the results of the Virginia Bankers Associations annual compensation survey, comparing executive compensation with other similarly-sized banking companies across the
Commonwealth of Virginia, the compensation of other executives from comparable public banking companies available through public filings, the performance of the Companys stock and the shareholders return. As to the subjective component,
the Compensation Committee considers the executives level of responsibility and performance and the individuals contribution in achieving the Companys long-term mission. Additionally, the Compensation Committee considers input from
the President and Chief Executive Officer (CEO) with respect to executive officers that report to him and makes appropriate recommendations to the Board of Directors. In determining the President and CEOs compensation, the
committee uses the same objective and subjective measures previously discussed and their subjective assessment of the President and CEOs contributions to the overall success of the Company.

During 2007, the only executive officers of the Company who earned annual compensation in excess of $100,000 were Scott C. Harvard, President and CEO, J.
Anderson Duer, Jr., Senior Vice President/Lending (Bank) and Steven M. Belote, Senior Vice President and Chief Financial Officer (the named executive officers). The following table provides information on the total compensation paid or
accrued during the years indicated below to the named executive officers. The Company did not issue any stock awards during the year presented and the Company does not have a pension plan or a deferred compensation plan for its executive officers.
Consequently, these items are eliminated from the table.



91



---

Summary Compensation Table



|                                                                  |      |           |        |                     |                 |              |     |                                          |  |                           |         |                   |     |             |  |     |               |  |     |                
|----------------------------------------------------------------- | ---- | --------- | ------ | ------------------- | --------------- | ------------ | --- | ---------------------------------------- |  | ------------------------- | ------- | ----------------- | --- | ----------- |  | --- | ------------- |  | --- | ---------------
|Name and Principal Position                                       |      |           |        | Annual Compensation |                 | OptionAwards |     | Non-EquityIncentive PlanCompensation (1) |  | All OtherCompensation (2) |         | TotalCompensation
|                                                                  | Year |           | Salary |                     | Bonus           |              |     |                                          | 
|Scott C. HarvardPresident and Chief Executive Officer             |      | 2007 2006 |        | $ $                 | 171,700 167,500 |              | $ $ | -0- -0-                                  |  | $ $                       | -0- -0- |                   | $ $ | -0- 56,950  |  | $ $ | 31,450 31,893 |  | $ $ | 203,150 256,343
|                                                                  |      |           |        |                     |                 |              |    
|J. Anderson Duer, Jr.Senior Vice President/Lending                |      | 2007 2006 |        | $ $                 | 100,500 98,000  |              | $ $ | -0- -0-                                  |  | $ $                       | -0- -0- |                   | $ $ | -0- 5,292   |  | $ $ | 9,115 9,816   |  | $ $ | 109,615 113,108
|                                                                  |      |           |        |                     |                 |              |    
|Steven M. BeloteSenior Vice President and Chief Financial Officer |      | 2007 2006 |        | $ $                 | 107,300 104,000 |              | $ $ | -0- -0-                                  |  | $ $                       | -0- -0- |                   | $ $ | 2,700 5,616 |  | $ $ | 9,210 9,611   |  | $ $ | 119,210 119,227



|(1) | Consists of cash amounts earned under the Companys Executive Incentive Compensation Plan.
|--- | ------------------------------------------------------------------------------------------

|(2) | Amounts shown include: (i) amounts accrued on behalf of each officer under the Companys 401(k) Plan ($15,900 for Mr. Harvard); and (ii) the dollar value of life
insurance premiums paid on behalf of each officer ($15,300 for Mr. Harvard).
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Base Salary

The Compensation Committee determines the base salary of executive officers based on what it considers necessary or appropriate to attract the level of
competence needed for the position. The committee reviews base salary levels annually, focusing on individual performance from prior years, current industry conditions and current market considerations to ensure that base salary levels for the
Companys executive officers are competitive within a range that the committee considers to be reasonable and necessary. The committee also reviews the Virginia Bankers Associations Annual Salary Survey and the compensation of other
executives from comparable public banking companies available through public filings in determining the base salaries for the Companys executive officers.

Executive Incentive Compensation Plan

The Company provides incentive compensation to its executive officers in the form of
annual cash bonuses relating to shorter term financial and operational achievements during the year through the Companys EICP. It is the committees general philosophy that management be rewarded for their performance as a team and, when
considered appropriate, individually in the attainment of these goals. Accordingly, the EICP is designed to focus management on the Companys overall corporate goals as well as various individual goals that the executive is in a position to
impact directly. Although an executive officer may be eligible to receive an award under the plan, the granting of the awards to any individual or the officers as a group is entirely at the discretion of the committee.



92



---

During the year ended December 31, 2007, the committee designed the EICP around the Company
achieving its overall corporate financial and operational goals. The committee measured three financial goals in 2007 and weighted their impact with respect to the bonus awards based on what the committee considered commensurate with the
Companys goals. These goals consisted of certain targets regarding net income, return on equity and individual goals for each officer that drove the Companys overall performance. Each executive had the opportunity to earn payout
percentages ranging from 20% to 60% of base compensation for the President and CEO and from 10% to 30% of base compensation for the other named executive officers.

Long Term Incentive Program - Stock Incentive Plan

The Company also provides long term incentive compensation to its
executive officers and key employees under its 2001 Stock Incentive Plan (the 2001 plan). The 2001 plan provides for incentive stock options, non-qualified stock options and restricted stock awards. The Compensation Committee administers
the 2001 plan and determines on what basis the options and shares are to be awarded. The committees philosophy on the long term incentive awards program is that it should:



| |  |  | Be designed to align the interest of executives with the long term interest of the shareholders.
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | Reward long term performance.
| | - |  | -----------------------------



| |  |  | Help retain executives through business plan cycles where short term compensation may be reduced due to longer term strategic goals.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------

Stock Incentive Plan

The Company currently has
one stock incentive plan for employees in effect  the 2001 Stock Incentive Plan. The 1992 Stock Option Plan has expired, but certain options deemed earned are still exercisable. The 2001 plan is designed to attract and retain qualified
personnel in key positions, provide employees with a proprietary interest in the Company as an incentive to contribute to the success of the Company and reward employees for outstanding performance and the attainment of targeted goals. The 2001 plan
provides for the grant of incentive stock options intended to comply with the requirements of Section 422 of the Internal Revenue Code of 1986 (incentive stock options), as well as non-qualified stock options and restricted stock
awards. The 2001 plan is administered by the Compensation Committee, each member of which is a non-employee director as defined in Rule 16b-3 under the Exchange Act. Unless sooner terminated, the 2001 plan is in effect for a period of
ten years from the date of adoption by the Board of Directors.

Under the 2001 plan, the committee determines which executive officers will
be granted options, whether such options will be incentive or non-qualified options, the number of shares subject to each option, whether such options may be exercised by delivering other shares of common stock and when such options become
exercisable. In general, the per share exercise price of a stock option must be at least equal to the fair market value of a share of common stock on the date the option is granted.

Stock options shall become vested and exercisable in the manner specified by the committee. In general, each stock option or portion thereof shall be
exercisable at any time on or after it vests. Stock options are nontransferable except by will or the laws of descent and distribution. Non-qualified stock options may be transferred to immediate family members or a family trust.

The committee also determines which executive officers will be awarded restricted stock and the number of shares to be awarded. The compensation value
the committee places on the restricted stock at the time of an award is at least equal to the fair market value of the Companys common stock on the date of the stock award. No shares of restricted stock have been awarded under the 2001 plan.



93



---

Stock Option Awards

The Compensation Committee typically determines stock option awards for its executive officers at the same time it is considering all executive performance and compensation. However, the committee may consider these
grants at other times during the year if they consider it necessary. When the Compensation Committee decides to grant stock options they generally award them to all employees, including executive officers, on the same date as determined by the
committee.

During 2007, the Company did not grant stock options to its named executive officers. Consequently, the Grants of Plan-Based
Awards table has not been presented. The following table provides information concerning stock options outstanding to the named executive officers at December 31, 2007. The Company did not have any outstanding restricted stock awards at
December 31, 2007 and, therefore, did not include items related to stock awards in the table below.

Outstanding Equity Awards at
Year-End



|                      |  |                                                            |  |                                                              |  |                                                                                        |  |                                  |                                  |                       |                                                            
|--------------------- |  | ---------------------------------------------------------- |  | ------------------------------------------------------------ |  | -------------------------------------------------------------------------------------- |  | -------------------------------- | -------------------------------- | --------------------- | -----------------------------------------------------------
|                      |  | Option Awards                                             
|Name                  |  | Number ofSecuritiesUnderlyingUnexercisedOptionsExercisable |  | Number ofSecuritiesUnderlyingUnexercisedOptionsUnexercisable |  | Equity Incentive PlanAwards: Number ofSecurities UnderlyingUnexercised UnearnedOptions |  | OptionExercisePrice perShare (1) |                                  | OptionExpiration Date
|Scott C. Harvard      |  | 11,520 11,520 11,241 7,406 6,097 13,657                    |  | -0- -0- -0- -0- -0- -0-                                      |  | -0- -0- -0- -0- -0- -0-                                                                |  | $                                | 5.56 6.68 8.89 13.50 16.40 14.57 |                       | 5/31/2011 3/01/2012 3/01/2013 3/01/2014 3/01/2015 4/12/2015
|                      |  |                                                            |  |                                                              | 
|J. Anderson Duer, Jr. |  | 2,880 1,440 1,440 2,400 2,400                              |  | -0- -0- -0- -0- -0-                                          |  | -0- -0- -0- -0- -0-                                                                    |  | $                                | 5.56 6.68 8.89 13.50 16.40       |                       | 5/31/2011 3/01/2012 3/01/2013 3/01/2014 3/01/2015          
|                      |  |                                                            |  |                                                              | 
|Steven M. Belote      |  | 2,880 2,880 2,880 3,600 3,600                              |  | -0- -0- -0- -0- -0-                                          |  | -0- -0- -0- -0- -0-                                                                    |  | $                                | 5.56 6.68 8.89 13.50 16.40       |                       | 5/31/2011 3/01/2012 3/01/2013 3/01/2014 3/01/2015          



|(1) | The exercise price is based on the market value of a share of common stock at the time the option was granted.
|--- | --------------------------------------------------------------------------------------------------------------



94



---

Options Exercised and Stock Vested

The following table provides information concerning stock options exercised or vested to the named executive officers during the year ended
December 31, 2007.

2007 Option Exercises and Stock Vested



|                      |  |                                         |  |                              |        |                                        |     |                             |    
|--------------------- |  | --------------------------------------- |  | ---------------------------- | ------ | -------------------------------------- | --- | --------------------------- | ---
|                      |  | Option Awards                           |  | Stock Awards                
|Name                  |  | Number of SharesAcquired on Exercise(#) |  | Value Realizedon Exercise($) |        | Number of SharesAcquired on Vesting(#) |     | Value Realizedon Vesting($)
|Scott C. Harvard      |  | -0-                                     |  |                              | -0-    |                                        | -0- |                             | -0-
|                      |  |                                         |  |                             
|J. Anderson Duer, Jr. |  | 1,440                                   |  | $                            | 10,600 |                                        | -0- |                             | -0-
|                      |  |                                         |  |                             
|Steven M. Belote      |  | -0-                                     |  |                              | -0-    |                                        | -0- |                             | -0-

General Benefits

The Company provides a range of employee benefits that cover life, health and disability insurance, vacation and personal leave, as well as 401(k) retirement and other plans. Management reviews employee benefits
annually to determine their effectiveness in providing total compensation packages that are competitive in the marketplace. Management will recommend changes to the Compensation Committee as deemed necessary and the committee will make changes as
considered appropriate based on its underlying benefit philosophy. The committees philosophy regarding the Companys benefits is that they should:



| |  |  | Provide protection to employees so that the employees are not distracted and can focus on work.
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | Match competitive forms of benefits in the market.
| | - |  | --------------------------------------------------



| |  |  | Encourage retention of productive employees while avoiding entitlements.
| | - |  | ------------------------------------------------------------------------



| |  |  | Provide a vehicle to encourage retirement planning for employees.
| | - |  | -----------------------------------------------------------------

401(k) Profit Sharing Plan

The Company maintains a 401(k) profit sharing plan (the 401(k)
plan). The 401(k) plan is designed to promote the future economic welfare of the Companys employees and to encourage employee savings. Employee deferrals of salary and employer contributions made under the 401(k) plan, together with the
income thereon, are accumulated in individual accounts maintained in trust on behalf of the employee participants and are made available to the employee participants upon retirement and under certain other circumstances as provided in the 401(k)
plan. Employee deferrals of salary and employer contributions made under the 401(k) plan are made on a tax-deferred basis.

A full-time
employee of the Company becomes eligible to participate in the 401(k) plan on their three month anniversary date of employment. Participants may elect to defer amounts between 2-15% of their annual compensation to the 401(k) plan, subject to certain
limits imposed by law. The Company makes matching contributions equal to 100% of the first 3% of compensation deferred and 50% of the next 3%. The Company may also make discretionary profit sharing contributions, allocated to eligible employees on
the basis of relative compensation, or qualified nonelective contributions allocated on the basis of relative compensation but only to eligible non-highly compensated employees. During 2007, the Company contributed $240,300 to the 401(k)
plan, $16,200, $9,100 and $9,200 of which was for the benefit of Messrs. Harvard, Duer and Belote, respectively.



95



---

Employment Contracts, Termination and Change in Control Arrangements

In its quest to attract and retain key executives critical to the long term success of the Company, the committee will enter into employment contracts,
termination and change in control agreements with executives that are considered vital to carrying out the Companys mission. These arrangements are commonplace in the financial services industry for executive officers.

On December 14, 1999, the Company and Mr. Harvard entered into an employment agreement regarding his services to the Company. The agreement had
a three year initial term, and on December 31 of each year automatically renews for successive two-year terms, unless the Company elects not to extend the term of the agreement. The employment agreement provides for an annual base salary of
$120,000, which is adjustable annually at the discretion of the Board, and annual cash bonuses in such amounts as determined by the Board. The Company may terminate Mr. Harvards employment at any time, but any termination by the Company
other than termination for cause (as defined in the agreement) will not effect Mr. Harvards right to receive compensation or other benefits pursuant to the terms of the agreement. If Mr. Harvard is terminated for cause
during the term of agreement, he will have no right to receive compensation or other benefits for any period after such termination. In the event that Mr. Harvard is terminated without cause, he shall receive his salary and certain benefits for
a period of twelve months from the date of such termination. The employment agreement will terminate in the event that there is a change in control of the Company, at which time the change in control agreement described below between the Company and
Mr. Harvard will become effective and any termination benefits will be determined and paid solely pursuant to the change in control agreement.

The Company also has an agreement with Mr. Harvard that becomes effective upon a change in control of the Company. Under the terms of this agreement, the Company or its successor agrees to continue Mr. Harvard in its employ for a
term of three years after the date of a change in control. During the contract term, Mr. Harvard will retain commensurate authority and responsibilities and compensation benefits. He will receive a base salary at least equal to the immediate
prior year, a bonus at least equal to the highest annual bonus paid for the two years before the change in control and would be eligible to participate in the most favorable incentive, savings, retirement, welfare benefits, fringe benefits and
vacation plans and programs generally applicable to peer executives in the Company and its affiliates. If Mr. Harvards employment is terminated during the three years other than for cause or disability as defined in the agreement, or if
he should terminate employment because a material term of the contract is breached by the Company, he will be entitled to a lump sum payment, in cash, within thirty days after the date of termination. This lump sum will be equal to 2.99 times the
sum of Mr. Harvards base salary, annual bonus and equivalent benefits.

On March 1, 2000, the Company and Mr. Duer
entered into an employment agreement regarding his services to the Company. The agreement had a one year initial term, and on March 1 of each year automatically renews for a one year term, unless the Company elects not to extend the term of the
agreement. The employment agreement provides for an annual base salary of $68,500, which is adjustable annually at the discretion of the Board, and other benefits as defined by the agreement. The Company may terminate Mr. Duers employment
at any time, but any termination by the Company other than termination for cause (as defined in the agreement) will not effect Mr. Duers right to receive compensation or other benefits pursuant to the terms of the agreement.
If Mr. Duer is terminated for cause during the term of agreement, he will have no right to receive compensation or other benefits for any period after such termination. In the event that Mr. Duer is terminated without cause, including
termination following a change in control of the Company, or if he resigns after a change in control pursuant to the terms of his agreement, he shall receive his salary and certain benefits for a period of six months from the date of such
termination.



96



---

On March 1, 2000, the Company and Mr. Belote entered into an employment agreement regarding his
services to the Company. The agreement had a one year initial term, and on March 1 of each year automatically renews for a one year term, unless the Company elects not to extend the term of the agreement. The employment agreement provides for
an annual base salary of $65,000, which is adjustable annually at the discretion of the Board, and other benefits as defined by the agreement. The Company may terminate Mr. Belotes employment at any time, but any termination by the
Company other than termination for cause (as defined in the agreement) will not effect Mr. Belotes right to receive compensation or other benefits pursuant to the terms of the agreement. If Mr. Belote is terminated for
cause during the term of agreement, he will have no right to receive compensation or other benefits for any period after such termination. In the event that Mr. Belote is terminated without cause, including termination following a change in
control of the Company, or if he resigns after a change in control pursuant to the terms of his agreement, he shall receive his salary and certain benefits for a period of six months from the date of such termination.

Compensation of Directors

The Compensation Committee
determines the compensation of the Board of Directors of the Company. The committee reviews director compensation of peer companies in surveys provided by the Virginia Bankers Association and director compensation from comparable public banking
companies available through public filings.

Each member of the Board of Directors of the Company receives an annual retainer of $9,000
regardless of whether he attends meetings of the Board plus $500 for each meeting attended, except for Henry P. Custis, Jr., who receives an annual retainer of $18,000 as Chairman of the Board of the Company plus the $500 attendance fee, and
Mr. Harvard, who is not compensated for his service as director. In addition, each director, excluding Mr. Harvard, is paid $250 for each Company or Bank committee meeting attended. The chair of the Investment, Asset/Liability Management
and Compensation committees is paid $500 per meeting attended, and the chair of the Audit committee is compensated $700 per meeting, with other audit committee members receiving $350 per meeting attended. The following table sets forth all of the
director compensation for 2007.

Director Compensation



|                             |  |                            |        |                        |     |       |   |       
|---------------------------- |  | -------------------------- | ------ | ---------------------- | --- | ----- | - | ------
|Name                         |  | Fees Earned orPaid in Cash |        | All Other Compensation |     | Total
|Henry P. Custis, Jr          |  | $                          | 24,500 |                        | -0- |       | $ | 24,500
|Terrell E, Boothe (1)        |  | $                          | 18,800 |                        | -0- |       | $ | 18,800
|Richard F. Hall, III         |  | $                          | 18,300 |                        | -0- |       | $ | 18,300
|L. Dixon Leatherbury         |  | $                          | 19,300 |                        | -0- |       | $ | 19,300
|Dr. Lloyd J. Kellam, III (1) |  | $                          | 17,000 |                        | -0- |       | $ | 17,000
|D. Page Elmore               |  | $                          | 15,400 |                        | -0- |       | $ | 15,400



|(1) | Mr. Boothe has elected to defer the director fees earned for the Company into the Virginia Bankers Associations non-qualified deferred compensation plan.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------



97



---

Compensation Committee Interlocks and Insider Participation

During 2007 and up to the present time, there were transactions between the Companys banking subsidiary and certain members of the Compensation
Committee or their associates, all consisting of extensions of credit by the Bank in the ordinary course of business. Each transaction was made on substantially the same terms, including interest rates, collateral and repayment terms, as those
prevailing at the time for comparable transactions with the general public. In the opinion of management and the Companys Board, none of the transactions involved more than the normal risk of collectibility or present other unfavorable
features.

All members of the Compensation Committee are independent directors, and none of them are present or past employees or officers
of the Company or its subsidiaries. None of the executive officers has served on the board or compensation committee (or other committee serving an equivalent function) of any other entity, one of whose executive officers served on our board or
compensation committee.



98



---

|Item 12. | 
|-------- | 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth, as of February 22, 2008, certain information as to
the common stock beneficially owned by (i) the only persons or entities, including any group as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, who or which was known to the Company to be the
beneficial owner of more than 5% of the issued and outstanding shares of common stock, (ii) the directors of the Company, (iii) each executive officer named in the Summary Compensation Table below and (iv) all directors and executive
officers of the Company as a group.



|                                                             |  |                                             |        |  |                 |  
|------------------------------------------------------------ |  | ------------------------------------------- | ------ |  | --------------- | -
|Name of Beneficial Owner                                     |  | Amount and Natureof BeneficialOwnership (1) |        |  | Percentof Class |  
|Richard F. Hall, Jr. P. O. Box 6 Accomac, Virginia 23301     |  | 237,600                                     | (2)    |  | 9.5             | %
|                                                             |  |                                            
|Directors and Named Executive Officers:                      |  |                                             |        |  |                 |  
|Terrell E. Boothe                                            |  | 25,577                                      | (2)    |  | 1.0             | %
|Henry P. Custis, Jr                                          |  | 183,609                                     | (3)    |  | 7.3             | %
|D. Page Elmore                                               |  | 18,542                                      |        |  | *               |  
|Richard F. Hall, III                                         |  | 58,450                                      | (2)    |  | 2.2             | %
|Scott C. Harvard                                             |  | 98,719                                      | (2)(4) |  | 3.8             | %
|Dr. Lloyd J. Kellam, III                                     |  | 9,033                                       | (2)    |  | *               |  
|L. Dixon Leatherbury                                         |  | 47,448                                      |        |  | 1.8             | %
|J. Anderson Duer, Jr                                         |  | 23,041                                      | (4)    |  | *               |  
|Steven M. Belote                                             |  | 23,028                                      | (4)    |  | *               |  
|All directors and executive officers As a group (10 persons) |  | 506,007                                     | (2)(5) |  | 19.5            | %



|* | Represents less than 1% of Company common stock.
|- | ------------------------------------------------

|(1) | For purposes of this table, beneficial ownership has been determined in accordance with the provisions of Rule 13d-3 of the Exchange Act under which, in general, a person is deemed
to be the beneficial owner of a security if he has or shares the power to vote or direct the voting of the security or the power to dispose of or direct the disposition of the security, or if he has the right to acquire beneficial ownership of the
security within 60 days.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes shares held by affiliated corporations, close relatives and minor children, and shares held jointly with spouses or as custodians or trustees, as follows: Mr. Hall
Jr., 86,400 shares; Mr. Boothe, 252 shares; Mr. Hall III, 14,544 shares; Mr. Harvard, 1,657 shares; Dr. Kellam, 93 shares..
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Mr. Custiss address is c/o Custis, Lewis & Dix, P.O. Box 577, Accomac, Virginia 23301.
|--- | ---------------------------------------------------------------------------------------

|(4) | Includes 61,441, 10,560 and 15,840 shares that may be acquired by Messrs. Harvard, Duer and Belote, respectively, pursuant to currently exercisable options granted under the
Companys 1992 Stock Option Plan and 2001 Stock Incentive Plan.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes 98,401 shares that may be acquired by executive officers pursuant to currently exercisable options granted under the Companys 1992 Stock Option Plan and 2001 Stock
Incentive Plan.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



99



---

Equity Compensation Plan Information

The following table summarizes information, as of December 31, 2007, relating to the equity compensation plans of the Company pursuant to which
grants of options to acquire shares of common stock may be granted from time to time.



|                                                       |  |                                                                                      |     |  |                                                                          |       |                                                                                     |        
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------ | --- |  | ------------------------------------------------------------------------ | ----- | ----------------------------------------------------------------------------------- | -------
|                                                       |  | Number of Shares to beIssued Upon Exerciseof Outstanding Options,Warrants and Rights |     |  | Weighted-AverageExercise Price ofOutstanding Options,Warrants and Rights |       | Number of SharesRemaining Availablefor Future IssuanceUnder EquityCompensation
Plan
|Equity compensation plans approved by shareholders (1) |  | 130,089                                                                              | (2) |  | $                                                                        | 11.35 |                                                                                     | 243,500
|                                                       |  |                                                                                      |    
|Equity compensation plans not approved by shareholders |  |                                                                                     |     |  |                                                                          |      |                                                                                     |       
|                                                       |  |                                                                                      |     |  |                                                                          |       |                                                                                     |        
|Total                                                  |  | 130,089                                                                              |     |  | $                                                                        | 11.35 |                                                                                     | 243,500
|                                                       |  |                                                                                      |     |  |                                                                          |       |                                                                                     |        



|(1) | These plans are the Companys 1992 Stock Option Plan and 2001 Stock Incentive Plan.
|--- | -----------------------------------------------------------------------------------

|(2) | Consists of options granted pursuant to the Companys stock incentive plans.
|--- | ----------------------------------------------------------------------------



|Item 13. | 
|-------- | 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
AND DIRECTOR INDEPENDENCE

Certain directors and executive officers of the Company and the Bank, members of their immediate families,
and corporations, partnerships and other entities with which such persons are associated, are customers of the Bank. In the ordinary course of business, the Bank makes loans available to such parties which are made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for comparable transactions with other borrowers, except that the Bank reduces the interest rate by one percentage point on primary residential mortgage loans made to full-time
employees. It is the belief of management that these loans neither involve more than the normal risk of collectibility nor present other unfavorable features.

The Bank has a lease agreement with Richard F. Hall, Jr., the former Chairman of the Bank and the father of Richard F. Hall, III, a director, with respect to the real property on which a branch office is located. The
initial term of the lease began in 1987 for a twelve year period with four five-year renewals. Each renewal will be at the option of the Bank and the renewal leases will be based on the previous lease rate after being adjusted for changes in the
consumer price index. The current lease payment is $2,000 per month.

The Banks subsidiary, Shore Investments Inc., has a lease
agreement with Accawmacke Associates, a general partnership of which the Companys Chairman, Henry P. Custis, Jr., is a partner, with respect to the real property on which an investment brokerage office is located. The initial term of the lease
began in 2005 for a five year period with two five-year renewals at the option of Shore Investments. The current lease payment is $1,000 per month.



100



---

The Bank has a lease agreement with Richard F. Hall, III with respect to certain billboards the Bank uses
for advertising. The lease began in 2006 for a five year period and current lease payments are $800 per month.



|Item 14. | 
|-------- | 

PRINCIPAL ACCOUNTING FEES AND SERVICES

The following table shows the fees billed for the audit and other services provided by Goodman & Company, L.L.P. for the fiscal years ended
December 31, 2007 and 2006.



|                       |  |      |        |      |   |       
|---------------------- |  | ---- | ------ | ---- | - | ------
|                       |  | 2006 |        | 2007
|Audit Fees (1)         |  | $    | 38,350 |      | $ | 42,050
|Audit-related Fees (2) |  |      |       |      |   | 2,350 
|Tax Fees (3)           |  |      | 3,800  |      |   | 3,750 
|All Other Fees         |  |      |       |      |   |      
|                       |  |      |        |      |   |       
|Total                  |  | $    | 42,150 |      | $ | 48,150
|                       |  |      |        |      |   |       



|(1) | Audit Fees: Audit fees represent professional services rendered in connection with the audit of the Companys annual financial statements and reviews of the financial
statements included in the Companys Forms 10-Q for the fiscal years.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Audit-related Fees: Audit-related fees represent professional services rendered in connection with Sarbanes-Oxley compliance and miscellaneous other accounting matters.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Tax Fees: Tax fees consisted of tax return preparation and other tax related services rendered.
|--- | -----------------------------------------------------------------------------------------------

The Audit Committee pre-approves all audit, audit related, and tax services on an annual basis, and in addition, authorizes individual engagements that
exceed pre-established thresholds. Any additional engagement that falls below the pre-established thresholds must be reported by management at the Audit Committee meeting immediately following the initiation of such an engagement.



101



---

PART IV

Item 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES

The following documents are filed as part of this report:

(a)(1) Financial Statements

The following consolidated financial statements and reports of independent auditors of
the Company are in Part II, Item 8 on pages 44 thru 87:

Consolidated Balance Sheets - December 31, 2007 and 2006

Consolidated Statements of Income - Years ended December 31, 2007, 2006 and 2005

Consolidated Statements of Changes in Stockholders Equity - Years ended December 31, 2007, 2006 and 2005

Consolidated Statements of Cash Flows -Years ended December 31, 2007, 2006 and 2005

Notes to Consolidated Financial Statements

Report of Independent Registered Public Accounting Firm

(a)(2) Financial Statement Schedules

All schedules are omitted since they are not required, are not applicable, or the required information is shown in the consolidated
financial statements or notes thereto.

(a)(3) The following exhibits are filed as part of this Form 10-K and this list includes the
Exhibit Index.



|     |  |                                                                                                               
|---- |  | --------------------------------------------------------------------------------------------------------------
|No.  |  | Description                                                                                                   
|3.1  |  | Articles of Incorporation of Registrant, as amended.*****                                                     
|     | 
|3.2  |  | Bylaws of Registrant.*                                                                                        
|     | 
|10.1 |  | Companys 1992 Incentive Stock Option Plan.*                                                                  
|     | 
|10.2 |  | Amended and Restated Employment Agreement between the Company and Scott C. Harvard.***                        
|     | 
|10.3 |  | Management Continuity Agreement between the Company and Scott C. Harvard.***                                  
|     | 
|10.4 |  | Companys 2001 Stock Incentive Plan.****                                                                      
|     | 
|10.5 |  | Form of Employment Agreement between the Company and each of J. Anderson Duer, Jr. and Steven M. Belote.******
|     | 
|11.0 |  | Earnings Per Share Computation.**                                                                             



102



---

|     |  |                                                                                                                     
|---- |  | --------------------------------------------------------------------------------------------------------------------
|     | 
|21.0 |  | Subsidiaries of the Registrant  Reference is made to Item 1. Business for the required information.              
|     | 
|31.1 |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
|     | 
|31.2 |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
|     | 
|32.1 |  | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
|     | 
|32.2 |  | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).



|* | Incorporated herein by reference from the Companys Registration Statement on Form S-4 (Registration No. 333-35389) filed by the Company with the Commission on
September 15, 1997.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** | Information required herein is incorporated by reference from Note 15 on page 58 of the financial statements attached hereto to this Form 10-K.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------

|*** | Incorporated herein by reference from the Companys Annual Report on Form 10-KSB for the year ended December 31, 2001.
|--- | ----------------------------------------------------------------------------------------------------------------------

|**** | Incorporated herein by reference from the Companys Registration Statement on Form S-8 (Registration No. 333-82838) filed by the Company with the Commission on
February 15, 2002.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|***** | Incorporated herein by reference from the Companys Current Report on Form 8-K filed by the Company with the Commission on September 6, 2006.
|----- | ---------------------------------------------------------------------------------------------------------------------------------------------

|****** | Incorporated herein by reference from the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
|------ | --------------------------------------------------------------------------------------------------------------------



103



---

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.



SHORE FINANCIAL CORPORATIONBy:

/s/ Scott C. HarvardScott C. Harvard President and Chief Executive
OfficerDated: March 10, 2008


Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.



|                         |  |                                                                    |  |               
|------------------------ |  | ------------------------------------------------------------------ |  | --------------
|Signature                |  | Capacity                                                           |  | Date          
|                         |  |                                                                   
|/s/ Henry P. Custis, Jr. |  | Chairman of the Board and Director                                 |  | March 10, 2008
|Henry P Custis, Jr.      |  |                                                                    | 
|                         |  |                                                                   
|/s/ Scott C. Harvard     |  | President (Principal Executive Officer) and Director               |  | March 10, 2008
|Scott C. Harvard         |  |                                                                    | 
|                         |  |                                                                   
|/s/ Steven M. Belote     |  | Senior Vice President (Principal Financial and Accounting Officer) |  | March 10, 2008
|Steven M. Belote         |  |                                                                    | 
|                         |  |                                                                   
|/s/ Terrell E. Boothe    |  | Director                                                           |  | March 10, 2008
|Terrell E. Boothe        |  |                                                                    |  |               
|                         |  |                                                                   
|/s/ D. Page Elmore       |  | Director                                                           |  | March 10, 2008
|D. Page Elmore           |  |                                                                    |  |               
|                         |  |                                                                   
|/s/ Richard F. Hall, III |  | Director                                                           |  | March 10, 2008
|Richard F. Hall, III     |  |                                                                    |  |               
|                         |  |                                                                   
|/s/ Lloyd J. Kellam, III |  | Director                                                           |  | March 10, 2008
|Lloyd J. Kellam, III     |  |                                                                    |  |               
|                         |  |                                                                   
|/s/ L. Dixon Leatherbury |  | Director                                                           |  | March 10, 2008
|L. Dixon Leatherbury     |  |                                                                    |  |               



104