UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





FORM
10-K





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





For
the fiscal year ended December 31, 2007


or





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the transition period from  to .





Commission
File Number 0-49731





SEVERN
BANCORP, INC.




(Exact
name of registrant as specified in its charter)




Maryland
            52-1726127(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification Number)200
      Westgate Circle, Suite 200,  Annapolis, Maryland
            21401(Address
      of principal executive offices)
            (Zip
      Code)





(410)
260-2000


(Registrant’s telephone number,
including area code)





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


Title
      of each class
            Name
      of each exchange on which registeredCommon
      Stock, par value $.01 per share
            Nasdaq
      Capital 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 o  No þ





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 o  No þ


Note - Checking the box above
will not relieve any registrant required to file reports pursuant to Section 13
of 15(d) of the Exchange Act from their obligations under those
Sections.









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  þ  No o





Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of
this chapter) 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.     o





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 definition of “accelerated
filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act. (Check one):




Large accelerated filer   o                                         Accelerated
filer   þ                                     Non-accelerated
filer o


Smaller
reporting company  o





Indicate by check mark whether the
registrant is a shell company (as defined in Rule12b-2 of the
Act).                                                              
Yes o  
No þ








The
aggregate market value of the voting stock held by non-affiliates of the
registrant, based on the closing sale price of the registrant’s common stock on
June 30, 2007 was $79,023,189 ($16.33 per share based on shares of common stock
outstanding at June 30, 2007).





(APPLICABLE
ONLY TO CORPORATE REGISTRANTS)





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





As of March 1, 2008, there were issued
and outstanding 10,066,679 shares of the registrant’s common
stock.





DOCUMENTS
INCORPORATED BY REFERENCE





Portion’s of the registrant’s
Definitive Proxy Statement for its 2008 Annual Meeting of Stockholders, which
Definitive Proxy Statement will be filed with the Securities and Exchange
Commission no later than 120 days after the registrant’s fiscal year-ended
December 31, 2007, are incorporated by reference into Part III of this Form
10-K; provided, however, that the Compensation Committee Report, the Audit
Committee Report and any other information in such proxy statement that is not
required to be included in this Annual Report on Form 10-K, shall not be deemed
to be incorporated herein by reference or filed as a part of this Annual Report
on Form 10-K.








Table
of Contents





Section
            
            Page
      No.PART
      I
            
            1Item
      1
            Business
            1Item
      1A
            Risk
      Factors
            27Item
      1B
            Unresolved
      Staff Comments
            31Item
      2
            Properties
            31Item
      3
            Legal
      Proceedings
            31Item
      4
            Submission of Matters to a Vote
      of Security Holders
            32Item
      4.1
            Executive
      Officers of the Registrant That Are Not Directors
            32PART
      II
            
            33Item
      5
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            33Item
      6
            Selected
      Financial Data
            35Item
      7
            Management’s
      Discussion and Analysis of Financial Conditionand Results of
      Operations
            39Item
      7A
            Quantitative
      and Qualitative Disclosures About Market Risk
            46Item
      8
            Financial
      Statements and Supplementary Data
            47Item
      9
            Changes
      in and Disagreements with Accountants onAccounting
      and Financial Disclosure
            47Item
      9A
            Controls
      and Procedures
            47Item
      9B
            Other
      Information
            51PART III
            
            51Item
      10
            Directors and Executive
      Officers of the Registrant and Corporate Governance
            51Item
      11
            Executive
      Compensation
            51Item
      12
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            52Item
      13
            Certain Relationships and
      Related Transactions, and Director Independence
            52Item
      14
            Principal
      Accounting Fees and Services
            52PART
      IV
            
            53Item
      15
            Exhibits,
      Financial Statement Schedules
            53SIGNATURES
            
            54





i





SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS





Severn Bancorp, Inc. (“Bancorp”) may
from time to time make written or oral “forward-looking statements”, including
statements contained in Bancorp’s filings with the Securities and Exchange
Commission (including this Annual Report on Form 10-K and the exhibits thereto),
in its reports to stockholders and in other communications by Bancorp, pursuant
to the “safe harbor” provisions of the Private Securities Litigation Reform Act
of 1995.





In addition to the historical
information contained herein, the following discussion contains forward-looking
statements that involve risks and uncertainties.  Bancorp operations
and actual results could differ significantly from those discussed in the
forward-looking statements.  Some of the factors that could cause or
contribute to such differences include, but are not limited to, changes in the
economy and interest rates both in the nation and Bancorp’s general market area,
federal and state regulation, competition and other factors detailed in “Item
1A. Risk Factors” of Part I of this Form 10-K.  The forward-looking
statements contained herein include, but are not limited to, those with respect
to management’s determination of the amount of loan loss allowance; and the
effect of changes in interest rates.  The words “anticipated,”
“estimated,” “expected,” “intend,” “may,” “plan,” “will,” “would,” “could,”
“should,” “guidance,” “potential,” “continue,” “project,” “forecast,”
“confident,” and similar expressions are typically used to identify
forward-looking statements.  Bancorp’s operations and actual results
could differ significantly from those discussed in the forward-looking
statements.





Bancorp disclaims any intent or
obligation to publicly update or revise any forward-looking statements,
regardless of whether new information becomes available, future developments
occur or otherwise.





ii


PART I





Item
1.  Business





General





Bancorp is a savings and
loan holding company chartered as a corporation in the state of Maryland in
1990.  It conducts business through three
subsidiaries:  Severn Savings Bank, FSB (“Bank”), its principal
subsidiary; Louis Hyatt, Inc. (“HC”), which is doing business as Hyatt
Commercial, a commercial real estate brokerage and property management company;
and SBI Mortgage Company (“SBI”), which holds mortgages that do not meet the
underwriting criteria of the Bank, and is the parent company of Crownsville
Development Corporation (“Crownsville”), which is doing business as Annapolis
Equity Group, which acquires real estate for syndication and investment
purposes.





On December 17, 2004, Bancorp
acquired all the common stock of newly formed Severn Capital Trust I, a Delaware
business trust.  Severn Capital Trust I issued $20,000,000 of trust
preferred securities in a private placement pursuant to an applicable exemption
from registration under the Securities Act of 1933, as
amended.  Bancorp irrevocably and unconditionally guaranteed the trust
preferred securities.  The proceeds of the trust preferred securities
were used to purchase subordinated debentures of Bancorp.





The Bank has four branches in Anne
Arundel County, Maryland, which offer a full range of deposit products, and
originate mortgages in its primary market of Anne Arundel County, Maryland and,
to a lesser extent, in other parts of Maryland, Delaware and
Virginia.





As of December 31, 2007, Bancorp had
total assets of $962,234,000, total deposits of $652,773,000, and total
stockholders’ equity of $95,276,000. Net income of Bancorp for the year ended
December 31, 2007 was $11,111,000.  For more information, see “Item 6.
Selected Financial Data.”





Bancorp’s internet address is
www.severnbank.com.  Bancorp makes available free of charge on
www.severnbank.com its annual report on Form 10-K, quarterly reports on Form
10-Q and current reports on Form 8-K, and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as
reasonably practicable after it electronically files such material with, or
furnish it to, the SEC.





In addition, we will provide, at no
cost, paper or electronic copies of our reports and other filings made with the
SEC.  Requests should be directed to:





S. Scott
Kirkley


Executive
Vice President


Severn
Bancorp, Inc.


200
Westgate Circle, Suite 200


Annapolis,
Maryland 21401





The information on the website listed
above, is not and should not be considered part of this Annual Report on Form
10-K and is not incorporated by reference in this document.  This
website is and is only intended to be an inactive textual
reference.











1






Business of the
Bank





The Bank was
organized in 1946 in Baltimore, Maryland as Pompei Permanent Building and Loan
Association.  It relocated to Annapolis, Maryland in 1980 and its name
was changed to Severn Savings Association.  Subsequently, the Bank
obtained a federal charter and changed its name to Severn Savings Bank,
FSB.  The Bank operates four full-service branch offices, and one
administrative office.  The Bank operates as a federally chartered
savings bank whose principal business is attracting deposits from the general
public and investing those funds in mortgage loans.   The Bank
also uses advances, or loans from the Federal Home Loan Bank of Atlanta,
(“FHLB-Atlanta”) to fund its mortgage activities.  The Bank provides a
wide range of retail and mortgage banking services. Deposit services include
checking, savings, money market, time deposit and individual retirement
accounts. Loan services include various types of real estate, consumer, and
commercial lending. The Bank also provides safety deposit boxes, ATMs, debit
cards, and internet and telephone banking.





The Bank’s revenues are derived
principally from interest earned on mortgage loans, fees charged in connection
with the loans and banking services, and gains realized from the sale of
mortgage loans.  The Bank’s primary sources of funds are deposits,
advances from the FHLB-Atlanta, principal amortization and prepayment of its
loans.  The principal executive offices of the Bank are maintained at
200 Westgate Circle, Suite 200, Annapolis Maryland, 21401.  Its
telephone number is 410-260-2000 and its e-mail address is mailman@severnbank.com.





In addition to its deposit and
lending activities, the Bank offers title insurance and real estate settlement
services through its wholly owned subsidiary, Homeowner’s Title and Escrow
Corporation (“Homeowner’s”).





As of December 31, 2004, the Bank
owned all of the Common Stock of Severn Preferred Capital Corporation (“Severn
Capital”). On December 22, 2004, the Bank announced it was liquidating Severn
Capital and redeeming the outstanding preferred stock at $20 per share on
January 31, 2005.  Severn Capital was a real estate investment trust
that issued and had outstanding 200,002 shares of Series A Preferred
Stock.  The preferred stock had an aggregate outstanding balance of
$4,000,040 at December 31, 2004, which qualified as regulatory capital of the
Bank.  The Series A Preferred Stock paid a 9% annual non-cumulative
dividend.  On January 31, 2005, the Bank liquidated Severn Capital and
redeemed the outstanding preferred stock at $20 per share.





The Thrift
Industry





Thrift institutions are financial
intermediaries which historically have accepted savings deposits from the
general public and, to a lesser extent, borrowed funds from outside sources and
invested those deposits and funds primarily in loans secured by first mortgage
liens on residential and other types of real estate.  Such
institutions may also invest their funds in various types of short- and
long-term securities.  The deposits of bank and thrift institutions
are insured by the Deposit Insurance Fund (“DIF”) as administered by the Federal
Deposit Insurance Corporation (“FDIC”), and these institutions are subject to
extensive regulations.  These regula­tions govern, among other
things, the lending and other investment powers of thrift institutions,
including the terms of mortgage instruments these institutions are permitted to
utilize, the types of deposits they are permitted to accept, and reserve
require­ments.





The operations of thrift
institutions, including those of the Bank, are significantly affected by general
economic conditions and by related monetary and fiscal policies of the federal
government and regulations and policies of financial institution regulatory
authorities, including the Board of Governors of the Federal Reserve System (the
“FRB”) and the Office of Thrift Supervision (“OTS”).  Lending
activities are influenced by a number of factors including the demand for
housing, conditions in the construction industry, and availability of
funds.  Sources of funds for lending activities include savings
deposits, loan principal payments, proceeds from sales of loans, and borrowings
from the Federal Home Loan Bank (“FHLB”) and other sources.  Savings
flows at thrift institutions such as the Bank are influenced by a number of
factors including interest rates on competing investments and levels of personal
income.


2





Earnings





The Bank’s earnings depend primarily
on the difference between income from interest-earning assets such as loans and
investments, and interest paid on interest-bearing liabilities such as deposits
and borrowings.  The Bank typically engages in long-term mortgage
lending at fixed rates of interest, generally for periods of up to 30 years,
while accepting deposits for consider­ably shorter
periods.  However, many of the Bank’s long-term fixed-rate loans are
sold in the secondary market, resulting in gains on the sale of such loans by
the Bank.





Generally, rapidly rising interest
rates cause the cost of interest-bearing liabilities to increase more rapidly
than yields on interest-earning assets, thereby adversely affecting the earnings
of many thrift institutions.  While the industry has received expanded
lending and borrowing powers in recent years permitting different types of
investments and mortgage loans, including those with floating or adjustable
rates and those with shorter terms, earnings and operations are still highly
influenced by levels of interest rates and financial market conditions and by
substantial investments in long-term mortgage loans.





Competition





The Annapolis, Maryland area has a
high density of financial institutions, many of which are significantly larger
and have greater financial resources than the Bank, and all of which are
competitors of the Bank to varying degrees.  The Bank’s competition
for loans comes primarily from savings and loan associations, savings banks,
mortgage banking companies, insurance companies, and commercial
banks.  Its most direct competition for deposits has historically come
from savings and loan associations, savings banks, commercial banks, and credit
unions.  The Bank faces additional competition for deposits from
short-term money market funds and other corporate and government securities
funds.  The Bank also faces increased competition for deposits from
other financial institutions such as brokerage firms and insurance
companies.  The Bank is a community-oriented financial institution
serving its market area with a wide selection of mortgage
loans.  Management considers the Bank’s reputation for financial
strength and customer service as its major competitive advantage in attracting
and retaining customers in its market area.  The Bank also believes it
benefits from its community orientation.





Net Interest
Income





Net interest income increases during
periods when the spread between the Bank’s weighted average rate at which new
loans are originated and the weighted average cost of interest-bearing
liabilities widens.  Market factors such as interest rates,
competition, consumer preferences, the supply of and demand for housing, and the
availability of funds affect the Bank’s ability to originate loans.





The Bank has supplemented its
interest income through purchases of investments when
appropriate.  This activity generates positive interest rate spreads
on large principal balances with minimal administrative expense.





Interest Rate and Volume of
Interest-Related Assets and Liabilities





Both changes in rate and changes in
the composition of the Bank’s interest-earning assets and interest-bearing
liabilities can have a significant effect on net interest income.





For information concerning the extent
to which changes in interest rates and changes in volume of interest-related
assets and liabilities have affected the Bank’s interest income and expense
during the fiscal years ended December 31, 2007 and 2006, refer to Item 6,
“Selected Financial Data - Rate Volume Table”.





Market
Area





The Bank’s market area for deposit
gathering is primarily Anne Arundel County, Maryland and nearby areas, due to
its four branch locations, all located in Anne Arundel County.  The
principal business of the Bank is attracting deposits from the general public
and investing those deposits, together with other funds, in mortgage and
consumer loans, mortgage-backed securities and investment
securities.  The Bank’s revenues are derived principally from interest
earned on mortgage, consumer and other loans, fees charged in connection with
loans and banking services, interest and dividends earned on other
investments.  The Bank’s primary sources of funds are deposits and
loan interest, principal amortization and prepayments.





3






The primary
focus of the Bank’s lending activities has been on first mortgage loans secured
by real estate for the purpose of purchasing, refinancing, developing and
constructing one-to-four family residences and commercial properties in and near
Anne Arundel County, Maryland.  The Bank does originate mortgage loans
throughout the states of Maryland, Virginia and Delaware.  The Bank
participates in the secondary market and sold approximately 26% of the
fixed-rate long-term mortgages that it originated in 2007.






4





Loan Portfolio
Composition





The
following table sets forth the composition of the Bank’s loan portfolios by type
of loan at the dates indicated.  The table includes a reconciliation
of total net
loans receivable, including loans held for sale, after consideration of
undisbursed portion of loans, deferred loan fees and discounts, and allowances
for losses on loans as of December 31:




2007
            
            2006
            
            2005
            
            2004
            
            2003Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent(dollars
      in thousands)Residential
      mortgage
            $320,303
            32.45%
            
            $249,448
            26.15%
            
            $219,988
            23.71%
            
            $215,767
            27.30%
            
            $187,498
            30.83%Construction,
      land acquisition anddevelopment
            297,823
            30.18%
            
            339,122
            35.55%
            
            390,376
            42.07%
            
            343,101
            43.42%
            
            240,757
            39.58%Land
            93,717
            9.50%
            
            90,747
            9.51%
            
            77,319
            8.33%
            
            33,419
            4.23%
            
            25,820
            4.25%Lines
      of credit
            29,713
            3.01%
            
            40,733
            4.27%
            
            35,491
            3.82%
            
            29,096
            3.68%
            
            19,581
            3.22%Commercial
      real estate
            205,755
            20.85%
            
            193,299
            20.26%
            
            163,449
            17.61%
            
            127,768
            16.17%
            
            106,823
            17.56%Commercial
      non-real estate
            3,416
            0.34%
            
            3,348
            0.35%
            
            3,412
            0.37%
            
            3,859
            0.49%
            
            3,813
            0.63%Home
      equity
            32,748
            3.32%
            
            32,758
            3.44%
            
            32,974
            3.55%
            
            28,101
            3.56%
            
            18,391
            3.02%Consumer
            2,355
            0.24%
            
            1,537
            0.16%
            
            1,768
            0.19%
            
            2,489
            0.31%
            
            2,364
            0.39%Loans
      held for sale
            1,101
            0.11%
            
            2,970
            0.31%
            
            3,216
            0.35%
            
            6,654
            0.84%
            
            3,175
            0.52%Total
      gross loans
            986,931
            100.00%
            
            953,962
            100.00%
            
            927,993
            100.00%
            
            790,254
            100.00%
            
            608,222
            100.00%Deferred
      loan origination fees and costs, net
            (4,898)
            
            
            (4,712)
            
            
            (4,916)
            
            
            (4,157)
            
            
            (3,344)Loans
      in process
            (78,238)
            
            
            (104,747)
            
            
            (136,239)
            
            
            (123,195)
            
            
            (94,020)Allowance
      for loan losses
            (10,781)
            
            
            (9,026)
            
            
            (7,505)
            
            
            (5,935)
            
            
            (4,832)Total
      loans net
            $893,014
            
            
            $835,477
            
            
            $779,333
            
            
            $656,967
            
            
            $506,026







5






Lending
Activities





General





The Bank originates mortgage loans of
all types, including residential, residential-construction,
commercial-construction, commercial and land and residential lot
loans.  To a lesser extent, the Bank also originates non-mortgage
loans, which include consumer, business and commercial loans.  These
loans constitute a small part of the Bank’s portfolio.





The Bank originated and funded
$251,681,000 and $285,820,000 of mortgage loans for the years ended December 31,
2007 and 2006, respectively.





Loan Origination
Procedures





The following table contains
information on the activity of the Bank’s loans held for sale and its loans held
for investment in its portfolio:




For
      the Years ended December 31,2007
            
            
            2006
            
            
            2005(dollars
      in thousands)Held
      for Sale:Beginning
      balance
            
            $
            2,970
            
            
            $
            3,216
            
            
            $
            6,654Originations
            
            
            18,320
            
            
            
            31,322
            
            
            
            73,766Net
      sales
            
            
            (20,189
            )
            
            
            (31,568
            )
            
            
            (77,204
            )Ending
      balance
            
            $
            1,101
            
            
            $
            2,970
            
            
            $
            3,216Held
      for investment:Beginning
      balance
            
            $
            950,992
            
            
            $
            924,777
            
            
            $
            783,600Originations
      and purchases
            
            
            239,336
            
            
            
            260,715
            
            
            
            252,525Repayments/payoffs
            
            
            (204,498
            )
            
            
            (234,500
            )
            
            
            (111,348
            )Ending
      balance
            
            $
            985,830
            
            
            $
            950,992
            
            
            $
            924,777








6


Loans that are sold are typically
long-term (15 or more years) loans with fixed interest rates eligible for resale
in the secondary market.  Loans retained for the Bank’s portfolio
typically include construction loans, commercial loans and loans that
periodically reprice or mature prior to the end of an amortized
term.  Loans are generally sold with servicing
released.  However, as of December 31, 2007, the Bank was servicing
$633,000 in loans for Federal Home Loan Mortgage Corporation (“FHLMC”) and
$62,192,000 in loans for other investors.





The following table contains
information, as of December 31, 2007, on the percentage of fixed-rate
single-family loans serviced for others by the Bank, by interest rate
category.





Interest
      rate range
            
            Percentage
      of PortfolioLess
      than 5.00%
            
            50.8%5.01
      – 6.00%
            
            0.0%6.01
      – 7.00%
            
            1.9%7.01
      – 8.00%
            
            8.0%Over
      8.00%
            
            39.3%100.0%










The procedure for approval of
construction loans is the same for residential mortgage loans, except that the
appraiser evaluates the building plans, construction specifications, and
estimates of construction costs.  The Bank also evaluates the
feasibility of the proposed construction project and the experience and track
record of the developer.  In addition, all construction loans
generally require a commitment from a third-party lender or from the Bank for a
permanent long-term loan to replace the construction loan upon completion of
construction.





Commercial Real Estate
Loans












7






Construction
Loans










Construction loan amounts are based
on the appraised value of the property and, for builder loans, a feasibility
study as to the potential marketability and profitability of the
project.  Construction loans generally have terms of up to one year,
with reasonable extensions as needed, and typically have interest rates that
float monthly at margins ranging from the prime rate to 1 percent above the
prime rate.   In addition to builders’ projects, the Bank
finances the construction of single family, owner-occupied houses where
qualified contractors are involved and on the basis of strict written
underwriting and construction loan guidelines.  Construction loans are
structured either to be converted to permanent loans with the Bank upon the
expiration of the construction phase or to be paid off by financing from another
financial institution.





Construction loans afford the Bank
the opportunity to increase the interest rate sensitivity of its loan portfolio
and to receive yields higher than those obtainable on loans secured by existing
residential properties.  These higher yields correspond to the higher
risks associated with construction lending.   Construction loans
involve additional risks attributable to the fact that loan funds are advanced
upon the security of the project under construction that is of uncertain value
prior to its completion.  Because of the uncertainties inherent in
estimating construction costs as well as the market value of the completed
project and the effects of governmental regulation of real property, it is
relatively difficult to value accurately the total funds required to complete a
project and the related loan-to-value ratio.  As a result,
construction lending often involves the disbursement of substantial funds with
repayment dependent, in part, on the ultimate success of the project rather than
the ability of the borrower or guarantor to repay principal and
interest.  If the Bank is forced to foreclose on a project prior to or
at completion, due to a default, there can be no assurance that the Bank will be
able to recover all of the unpaid balance of the loan as well as related
foreclosure and holding costs.  In addition, the Bank may be required
to fund additional amounts to complete the project and may have to hold the
property for an unspecified period of time.  The Bank has attempted to
address these risks through its underwriting procedures and its limited amount
of construction lending on multi-family and commercial real estate
properties.





It is the policy of the Bank to
conduct physical inspections of each property secured by a construction or
rehabilitation loan for the purpose of reporting upon the progress of the
construction of improvements.  These inspections, referred to as
“construction draw inspections,” are to be performed at the time of a request
for an advance of construction funds.  If no construction advance has
been requested, a fee inspector or senior officer of the institution makes an
inspection of the subject property at least quarterly.





Multi-Family
Lending







8





Land and Residential
Building Lots





Land loans include loans to
developers for the development of residential subdivisions and loans on
unimproved lots primarily to individuals.  At December 31, 2007, the
Bank had outstanding land and residential building lot loans totaling
$98,066,000, or 9.9% of the Bank’s total loan portfolio.  The largest
of these loans for $4,612,000, is secured by seven parcels in Severn, Maryland,
and has performed in accordance with the terms of the debt
instrument.  Land development loans typically are short-term loans;
the duration of these loans is typically not greater than three
years.  The interest rate on land loans is generally at least 1% or 2%
over the prime rate.   The loan-to-value ratio generally does not
exceed 75%. Loans typically are made to customers of the Bank and developers and
contractors with whom the Bank has had previous lending
experience.  In addition to the customary requirements for this type
loan, the Bank may also require a satisfactory Phase I environmental study and
feasibility study to determine the profit potential of the
development.





Consumer and Other
Loans










Loan Portfolio Cash
Flows










Due
            
            
            Due
      afterWithin
      one
            
            
            1
      through
            
            
            Due
      afteryear
      or less
            
            
            5
      years
            
            
            5
      years
            
            
            Total(dollars
      in thousands)One
      to four family residential
            
            $
            35,369
            
            
            $
            50,943
            
            
            $
            282,509
            
            
            $
            368,821Multifamily
            
            
            1,362
            
            
            
            1,971
            
            
            
            3,571
            
            
            
            6,904Commercial
      and industrial real estate
            
            
            13,995
            
            
            
            58,413
            
            
            
            132,827
            
            
            
            205,235Construction
      and land acquisitionand
      development loans
            
            
            250,450
            
            
            
            47,373
            
            
            
            -
            
            
            
            297,823Land
            
            
            40,235
            
            
            
            48,940
            
            
            
            8,891
            
            
            
            98,066Commercial,
      non-real estate
            
            
            4,589
            
            
            
            1,093
            
            
            
            2,044
            
            
            
            7,726Consumer
            
            
            1,460
            
            
            
            717
            
            
            
            179
            
            
            
            2,356Total
            
            $
            347,460
            
            
            $
            209,450
            
            
            $
            430,021
            
            
            $
            986,931








9






The following table contains certain
information as of December 31, 2007 relating to the loan portfolio of the Bank
with the dollar amounts of loans due after one year that have fixed and floating
rates.  All loans are shown maturing based upon contractual maturities
and include scheduled payments but not possible prepayments.





Fixed
            
            
            Floating
            
            
            Total(dollars
      in thousands)One
      to four family residential
            
            $
            185,797
            
            
            $
            147,656
            
            
            $
            333,453Multifamily
            
            
            1,738
            
            
            
            3,804
            
            
            
            5,542Commercial
      and industrial real estate
            
            
            75,676
            
            
            
            115,564
            
            
            
            191,240Construction
      and land acquisitionand
      development loans
            
            
            12,915
            
            
            
            34,458
            
            
            
            47,373Land
            
            
            33,766
            
            
            
            24,065
            
            
            
            57,831Commercial,
      non-real estate
            
            
            2,029
            
            
            
            1,108
            
            
            
            3,137Consumer
            
            
            895
            
            
            
            -
            
            
            
            895Total
            
            $
            312,816
            
            
            $
            326,655
            
            
            $
            639,471





Loans to One
Borrower





Under
regulatory guidelines, t





Origination and Purchase and
Sale of Loans










Loan originations are developed from
a number of sources, primarily from referrals from real estate brokers,
builders, and existing and walk-in customers.  The Bank also utilizes
the services of loan brokers in its market area.  Loan brokers are
paid on a commission basis (generally 1% of the loan amount) for loans brokered
to the Bank.





The Bank’s mortgage loan approval
process is intended to assess the borrower's ability to repay the loan, the
viability of the loan, and the adequacy of the value of the property that will
secure the loan.  The loan committee of the Bank can approve single
residential and commercial loans up to $2 million, and loans that aggregate up
to $5 million to one borrower.  Single loans greater than $2 million,
or relationships greater than $4 million, up to $16,160,000 (the maximum amount
of a loan to one borrower as of December 31, 2007), must also have Board of
Director’s approval. The Bank utilizes independent qualified appraisers approved
by the Board of Directors to appraise the properties securing its loans and
requires title insurance or title opinions so as to insure that the Bank has a
valid lien on the mortgaged real estate. The Bank requires borrowers to maintain
fire and casualty insurance on its secured properties.





The procedure for approval of
construction loans is the same as for residential mortgage loans, except that
the appraiser evaluates the building plans, construction specifications, and
estimates of construction costs.  The Bank also evaluates the
feasibility of the proposed construction project and the experience and track
record of the developer.  In addition, all construction loans
generally require a commitment from a third-party lender or from the Bank for a
permanent long-term loan to replace the construction loan upon completion of
construction.




10






Consumer loans are underwritten on
the basis of the borrower's credit history and an analysis of the borrower's
income and expenses, ability to repay the loan, and the value of the collateral,
if any.





Currently, it is the Bank’s policy to
originate both fixed-rate and adjustable-rate loans. The Bank is currently
active in the secondary market and sells the majority of its fixed-rate loan
products.





Interest Rates, Points and
Fees










The Bank accounts for loan
origination fees in accordance with the Statement of Financial Accounting
Standards (“SFAS”) on Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans ("SFAS No. 91") issued by the Financial
Accounting Standards Board (the "FASB"). SFAS No. 91 prohibits the
immediate recognition of loan origination fees as revenues and requires that
such income (net of certain direct loan origination costs) for each loan be
amortized, generally by the interest method, over the estimated life of the loan
as an adjustment of yield.  The Bank also realizes income from gains
on sales of loans, and servicing released fees for loans sold with servicing
released.





Delinquency and Classified
Assets





Delinquencies




























11













At
      December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(dollars
      in thousands)Loans
      accounted for on a non-accrual basis:Mortgage
      loans:One-to-four
      family real estate
            
            $
            4,992
            
            
            $
            3,487
            
            
            $
            1,693
            
            
            $
            915
            
            
            $
            378Home
      equity lines of credit
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            50Commercial
            
            
            336
            
            
            
            98
            
            
            
            -
            
            
            
            -
            
            
            
            -Land
            
            
            2,372
            
            
            
            2,342
            
            
            
            -
            
            
            
            24
            
            
            
            24Non-mortgage
      loans:Consumer
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            17Commercial
      loans
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      non-accrual loans
            
            $
            7,700
            
            
            $
            5,927
            
            
            $
            1,693
            
            
            $
            939
            
            
            $
            469Accruing
      loans greater than 90 days past due
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Foreclosed
      real-estate
            
            $
            2,993
            
            
            $
            970
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Total
      non-performing assets
            
            $
            10,693
            
            
            $
            6,897
            
            
            $
            1,693
            
            
            $
            939
            
            
            $
            469Total
      non-accrual loans to net loans
            
            
            0.9
            %
            
            
            0.7
            %
            
            
            0.2
            %
            
            
            0.1
            %
            
            
            0.1
            %Allowance
      for loan losses to total non-performing loans,including
      loans contractually past due 90 days or more
            
            
            140.0
            %
            
            
            152.3
            %
            
            
            443.3
            %
            
            
            632.1
            %
            
            
            1030.5
            %Total
      non-accrual and accruing loans greater than90
      days past due to total assets
            
            
            0.8
            %
            
            
            0.7
            %
            
            
            0.2
            %
            
            
            0.1
            %
            
            
            0.1
            %Total
      non-performing assets to total assets
            
            
            1.1
            %
            
            
            0.8
            %
            
            
            0.2
            %
            
            
            0.1
            %
            
            
            0.1
            %





Classified Assets and
Allowance for Loan Losses





Federal regulations provide for the
classification of loans and other assets, such as debt and equity securities,
considered by the OTS to be of lesser quality, as “substandard,” “doubtful” or
“loss assets.” An asset is considered substandard if the paying capacity and net
worth of the obligor or the collateral pledged, if any, inadequately protects
it.  Substandard assets include those characterized by the distinct
possibility that the insured institution will sustain some loss if the
deficiencies are not corrected.  Assets classified as doubtful have
all of the weaknesses inherent in those classified substandard with the added
characteristic that the weaknesses present make collection or liquidation in
full highly questionable and improbable, on the basis of currently existing
facts, conditions, and values.  Assets classified as loss assets are
those considered uncollectible and of such little value that their continuance
as assets without the establishment of a specific loss reserve is not
warranted.  Assets that do not currently expose the insured
institution to a sufficient degree of risk to warrant classification in one of
these categories but possess credit deficiencies or potential weakness are
required to be designated special mention by management.


12







When an
insured institution classifies problem assets as either substandard or doubtful,
it is required to establish general allowance for losses in an amount deemed
prudent by management.  General allowances represent loss allowances
which have been established to recognize the inherent risk associated with
lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets.  When an insured institution
classifies problem assets as loss assets, it is required either to establish a
specific allowance for losses equal to the full amount of the asset so
classified or to charge-off such amount.  An institution’s
determination as to the classification of its assets is subject to scrutiny by
the OTS, which can require the establishment of additional general or specific
loss allowances.  The Bank reviews monthly the assets in its portfolio
to determine whether any assets require classification in accordance with
applicable regulations.










[see
table on following page]





13


The
following table summarizes the allocation of the allowance for loan losses by
loan type and the percent of loans in each category compared to total loans at
the dates indicated:








2007
            
            2006
            
            2005
            
            2004
            
            2003Percentage
      of
            
            
            
            Percentage
      of
            
            
            
            Percentage
      of
            
            
            
            Percentage
      of
            
            
            
            Percentage
      ofLoans
      in each
            
            
            
            Loans
      in each
            
            
            
            Loans
      in each
            
            
            
            Loans
      in each
            
            
            
            Loans
      in eachAllowance
            
            Category
      to
            
            Allowance
            
            Category
      to
            
            Allowance
            
            Category
      to
            
            Allowance
            
            Category
      to
            
            Allowance
            
            Category
      toAmount
            
            Total
      Loans
            
            Amount
            
            Total
      Loans
            
            Amount
            
            Total
      Loans
            
            Amount
            
            Total
      Loans
            
            Amount
            
            Total
      Loans(dollars
      in thousands)One
      to four family residential
            $3,378
            
            40.73%
            
            $2,202
            
            32.41%
            
            $1,706
            
            29.74%
            
            $2,000
            
            30.20%
            
            $1,938
            
            36.20%Multifamily
            35
            
            0.76%
            
            33
            
            0.57%
            
            67
            
            0.49%
            
            20
            
            0.34%
            
            21
            
            0.14%Commercial
      and industrial real estate
            3,332
            
            22.41%
            
            2,512
            
            20.45%
            
            1,965
            
            17.73%
            
            1,009
            
            16.17%
            
            1,154
            
            18.48%Construction
      and land acquisition anddevelopment
      loans
            1,849
            
            24.29%
            
            2,253
            
            35.44%
            
            2,684
            
            42.07%
            
            2,577
            
            43.42%
            
            1,173
            
            39.58%Land
            2,027
            
            10.72%
            
            1,731
            
            10.10%
            
            882
            
            8.78%
            
            251
            
            8.54%
            
            476
            
            4.25%Commercial,
      non-real estate
            150
            
            0.83%
            
            288
            
            0.87%
            
            193
            
            1.00%
            
            70
            
            1.18%
            
            59
            
            1.16%Other
            10
            
            0.26%
            
            7
            
            0.16%
            
            8
            
            0.19%
            
            8
            
            0.15%
            
            11
            
            0.19%Total
            $10,781
            
            100.00%
            
            $9,026
            
            100.00%
            
            $7,505
            
            100.00%
            
            $5,935
            
            100.00%
            
            $4,832
            
            100.00%








14





The
following table contains information with respect to Bancorp’s allowance for
loan losses for the periods indicated:





At
      or for the Year EndedDecember
      312007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(dollars
      in thousands)Average
      loans outstanding, net
            
            $
            858,305
            
            
            $
            819,038
            
            
            $
            738,028
            
            
            $
            600,030
            
            
            $
            466,512Total
      gross loans outstanding at end of period
            
            $
            986,931
            
            
            $
            953,962
            
            
            $
            927,993
            
            
            $
            790,254
            
            
            $
            608,222Total
      net loans outstanding at end of period
            
            $
            893,014
            
            
            $
            835,477
            
            
            $
            779,333
            
            
            $
            656,967
            
            
            $
            506,026Allowance
      balance at beginning of period
            
            $
            9,026
            
            
            $
            7,505
            
            
            $
            5,935
            
            
            $
            4,832
            
            
            $
            3,991Provision
      for loan losses
            
            
            2,462
            
            
            
            1,561
            
            
            
            1,570
            
            
            
            1,200
            
            
            
            900Actual
      charge-offs1-4
      family residential real estate
            
            
            270
            
            
            
            -
            
            
            
            -
            
            
            
            97
            
            
            
            25Other
            
            
            449
            
            
            
            40
            
            
            
            -
            
            
            
            -
            
            
            
            34Total
      charge-offs
            
            
            719
            
            
            
            40
            
            
            
            -
            
            
            
            97
            
            
            
            59RecoveriesTotal
      recoveries
            
            
            12
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      charge offs
            
            
            707
            
            
            
            40
            
            
            
            -
            
            
            
            97
            
            
            
            59Allowance
      balance at end of period
            
            $
            10,781
            
            
            $
            9,026
            
            
            $
            7,505
            
            
            $
            5,935
            
            
            $
            4,832Net
      charge offs as a percent of average loans
            
            
            0.08
            %
            
            
            0.00
            %
            
            
            0.00
            %
            
            
            0.02
            %
            
            
            0.01
            %Allowance
      for loan losses to total gross loans at end of period
            
            
            1.09
            %
            
            
            0.95
            %
            
            
            0.81
            %
            
            
            0.75
            %
            
            
            0.79
            %Allowance
      for loan losses to net loans at end of period
            
            
            1.21
            %
            
            
            1.08
            %
            
            
            0.96
            %
            
            
            0.90
            %
            
            
            0.95
            %








Investment
Activities














At
      December 31,2007
            2006
            2005(dollars in thousands)FHLB
      Notes
            $1,000
            $5,000
            $5,000Mortgage-backed
      securities
            1,383
            2,271
            3,290Total
      Investment Securities Held to Maturity
            $2,383
            $7,271
            $8,290






15







Investment
Scheduled Maturity Table





As of
December 31, 2007





More
      than One  to
              
              More
      than Five  toOne
      Year or Less
              
              Five
      Years
              
              Ten
      Years
              
              More
      than Ten Years
              
              Total
      Investment SecuritiesCarrying
              Average
              
              Carrying
              Average
              
              Carrying
              Average
              
              Carrying
              Average
              
              Carrying
              Average
              FairAmount
              Yield
              
              Amount
              Yield
              
              Amount
              Yield
              
              Amount
              Yield
              
              Amount
              Yield
              Value(dollars
      in thousands)FHLB
      Notes
              -
              -
              
              -
              -
              
              $1,000
              5.05%
              
              -
              -
              
              $1,000
              5.05%
              $1,000FNMA
      Notes
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              -FFCB
      Note
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              -Mortgage-backed
      securities
              -
              -
              
              -
              -
              
              -
              -
              
              1,383
              5.59%
              
              1,383
              5.59%
              1,330Total
              $-
              -
              
              $-
              -
              
              $1,000
              5.05%
              
              $1,383
              5.59%
              
              $2,383
              5.36%
              $2,330





16


Deposits




















2007
            
            
            2006
            
            
            2005(dollars
      in thousands)NOW
      accounts
            
            $
            11,152
            
            
            $
            9,314
            
            
            $
            7,683Money
      market accounts
            
            
            87,688
            
            
            
            89,120
            
            
            
            99,911Passbooks
            
            
            14,891
            
            
            
            18,526
            
            
            
            17,505Certificates
      of deposit
            
            
            523,698
            
            
            
            490,865
            
            
            
            445,592Non-interest
      bearing accounts
            
            
            15,344
            
            
            
            18,699
            
            
            
            24,202Total
      deposits
            
            $
            652,773
            
            
            $
            626,524
            
            
            $
            594,893





The following table contains
information pertaining to the certificates of deposit held by the Bank in excess
of $100,000 as of December 31, 2007.





Jumbo
      Certificateof
      DepositsTime
      Remaining Until Maturity
            
            (dollars
      in thousands)Less
      than three months
            
            $
            57,7993
      months to 6 months
            
            
            63,4156
      months to 12 months
            
            
            72,141Greater
      than 12 months
            
            
            42,374Total
            
            $
            235,729







17








Liquidity and
Asset/Liability Management
























Short Term
Borrowings












Years
      ended December 31,2007
            
            
            2006
            
            
            2005(dollars
      in thousands)Short
      term borrowings and notes payableAverage
      balance outstanding during the period
            
            $
            10,417
            
            
            $
            8,250
            
            
            $
            25,833Maximum
      amount outstanding at any month-end duringthe
      period
            
            
            25,000
            
            
            
            26,000
            
            
            
            41,000Weighted
      average interest rate during the period
            
            
            4.68
            %
            
            
            5.31
            %
            
            
            3.30
            %Total
      short term borrowings at period end
            
            
            15,000
            
            
            
            18,000
            
            
            
            26,000Weighted
      average interest rate at period end
            
            
            4.40
            %
            
            
            5.41
            %
            
            
            3.33
            %







18


Employees





As of
December 31, 2007, Bancorp and its subsidiaries had approximately 118 full-time
equivalent employees.    Bancorp’s employees are not
represented by any collective bargaining group, and management considers its
relations with its employees to be excellent.





Severn
Capital





The Bank
formed Severn Capital in 1997 for the purpose of acquiring, holding and managing
mortgage loans.  Severn Capital had elected to be subject to tax as a
real estate investment trust under the Internal Revenue Code of 1986, as
amended, and regulations promulgated thereunder (the “Code”).  The
Bank owned all of the common stock of Severn Capital and administered the
day-to-day operations of Severn Capital for a fee.   There were
200,002 shares of preferred stock of Severn Capital outstanding, which were held
by third parties and which were reflected as minority interest in the
consolidated financial statements.   Dividends on the preferred
stock were payable quarterly, in an amount equal to $1.80 per annum per
preferred share.  On January 31, 2005, the Bank liquidated Severn
Capital and redeemed the shares at $20 per share.





Hyatt
Commercial





Bancorp
acquired Hyatt Commercial, a real estate brokerage and property management
company, in June 2001.  Hyatt Commercial is a real estate brokerage
company specializing in commercial real estate sales, leasing and property
management.  It owned property at 1919 and 1919A West Street, which
was leased to unrelated parties.  Hyatt Commercial sold the properties
during the first quarter of 2007.





Crownsville Development
Corporation





Crownsville,
which is doing business as Annapolis Equity Group, is a subsidiary of SBI and is
engaged in the business of acquiring real estate for investment and syndication
purposes.  In 2006, Crownsville brokered the acquisition of three
properties in Delaware and facilitated the syndication of the
properties.





SBI Mortgage
Company





SBI is a
subsidiary of Bancorp that has engaged in the origination of mortgages not
suitable for the Bank.  It owns subsidiary companies that have or are
negotiating to purchase real estate for investment purposes.  As of
December 31, 2007, SBI had $2,866,000 in outstanding mortgage loans and it had
$472,000 invested in subsidiaries, which funds were held in cash, pending
potential acquisition of investment real estate.





HS West,
LLC





HS West,
LLC (“HS”) is a subsidiary of the Bank, and constructed a building in Annapolis,
Maryland that serves as Bancorp’s and the Bank’s administrative headquarters. A
branch office of the Bank is included.  In addition, HS leases space
to four unrelated companies and to a company in which the President of Bancorp
and the Bank is a partner.





Homeowners Title and Escrow
Corporation





Homeowners
Title and Escrow Corporation, is a subsidiary of the Bank, and is engaged in the
business of conducting loan settlements for the Bank.







19






Regulation




The
financial services industry in the Bank’s market area is highly competitive,
including competition from commercial banks, savings banks, credit unions,
finance companies and non-bank providers of financial services. Several of the
Bank’s competitors have legal lending limits that exceed that of the Bank’s, as
well as funding sources in the capital markets that exceeds the Bank’s
availability. The increased competition has resulted from a changing legal and
regulatory climate, as well as from the economic climate.





General





Savings
and loan holding companies and savings associations are extensively regulated
under both federal and state law.  This regulation is intended
primarily to protect depositors and the Deposit Insurance Fund (“DIF”), and not
the stockholders of Bancorp.  The summary below describes briefly the
regulation that is applicable to Bancorp and the Bank, does not purport to be
complete and is qualified in its entirety by reference to applicable laws and
regulations.





Regulation
of Bancorp




General.  As
a unitary savings and loan holding company, Bancorp is required to register and
file reports with the OTS and is subject to regulation and examination by the
OTS.  In addition, the OTS has enforcement authority over Bancorp and
its subsidiaries, which also permits the OTS to restrict or prohibit activities
that are determined to be a serious risk to the subsidiary savings
association.





Activities Restriction
Test.  As a unitary savings and loan holding company,
Bancorp generally is not subject to activity restrictions, provided the Bank
satisfies the Qualified Thrift Lender (“QTL”) test. The termination of the
“unitary thrift holding company exemption” in 1999 did not affect Bancorp
because Bancorp was grandfathered under the law.  Under certain
circumstances, Bancorp could lose its grandfathered status.  If the
Bank failed to meet the QTL test, then Bancorp would become subject to the
activities restrictions applicable to multiple savings and loan holding
companies and, unless the Bank qualified as a QTL within one year thereafter,
Bancorp would be required to register as, and would become subject to the
restrictions applicable to, a bank holding company. Additionally, if Bancorp
were to acquire control of another savings association, other through merger or
other combination with the Bank or other than in a supervisory acquisition where
the acquired association also met the QTL test, Bancorp would thereupon become a
multiple savings and loan holding company and would thereafter be subject to
further restrictions on its activities.  Bancorp presently intends to
continue to operate as a unitary savings and loan holding company.




Restrictions on
Acquisitions.  Except under limited circumstances,
savings and loan holding companies, such as Bancorp, are prohibited from
acquiring, without prior approval of the OTS, (i) control of any other savings
and loan holding company or substantially all of the assets thereof; (ii) more
than 5% of the voting shares of a savings association or holding company thereof
which is not a subsidiary; (iii) acquiring through a merger, consolidation or
purchase of assets of another savings institution (or holding company thereof)
or acquiring all or substantially all of the assets of another savings
institution (or holding company thereof); or (iv) acquiring control of an
uninsured institution.  In evaluating proposed acquisitions of savings
institutions by holding companies, the OTS considers the financial and
managerial resources and future prospects of the holding company and the target
institution, the effect of the acquisition on the risk to the DIF, the
convenience and the needs of the community and competitive factors.





No director or
officer of a savings and loan holding company or person owning or controlling by
proxy or otherwise more than 25% of such company’s stock, may acquire control of
any savings association, other than a subsidiary savings association, or of any
other savings and loan holding company. Certain individuals, including Alan J.
Hyatt, Louis Hyatt, and Melvin Hyatt, and their respective spouses
(“Applicants”), filed an Application for Notice of Change In Control (“Notice”)
in April 2001 pursuant to 12 CFR Section 574.3(b).  The Notice called
for the Applicants to acquire up to 32.32% of Bancorp’s issued and outstanding
shares of stock of Bancorp by April 16, 2002.  The OTS approved
requests by the Applicants to extend the time to consummate such acquisition of
shares to December 20, 2008.  The Applicants currently own
approximately 29.29% of the total outstanding shares of Bancorp as of
December 31, 2007.




20






The OTS
is prohibited from approving any acquisition that would result in a multiple
savings and loan holding company controlling savings institutions in more than
one state, subject to two exceptions: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies; and (ii) the acquisition of
savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions.  The states
vary in the extent to which they permit interstate savings and loan holding
company acquisitions.





Federal
Securities Law.  Bancorp’s securities are registered with the
Securities and Exchange Commission under the Securities Exchange Act of 1934, as
amended.  As such, Bancorp is subject to the information, proxy
solicitation, insider trading, and other requirements and restrictions of the
Securities Exchange Act of 1934.





The
Sarbanes-Oxley Act of 2002.The
Sarbanes-Oxley Act is applicable to all companies with equity securities
registered or that file reports under the Securities Exchange Act of 1934,
including Bancorp. In particular, the Sarbanes-Oxley Act established  new
requirements in the areas of financial disclosure and corporate governance,
including: (i) new requirements for audit committees, including independence,
expertise and responsibilities; (ii) requiring the chief executive officer
and chief financial officer to certify to the accuracy of periodic reports filed
with the SEC; (iii) new standards for auditors and regulation of audits;
(iv) increased disclosure and reporting obligations for the reporting
company and its directors and executive officers; (v) accelerated filing
requirements for SEC reports; (vi) disclosures concerning internal controls and
procedures; (vii) requiring the company’s independent registered public
accounting firm that issues the audit report to attest to and report on
management’s assessment of the company’s internal controls; and (viii) new and
increased civil and criminal penalties for fraud and other violations of the
securities laws.





We have
incurred additional expense in complying with the provisions of the
Sarbanes-Oxley Act and implemented regulations, particularly those regulations
relating to the establishment of internal controls over financial
reporting.





Financial
Services Modernization Legislation.  In November 1999, the
Gramm-Leach-Bliley Act of 1999 (“GLBA”) was enacted. The GLBA generally permits
banks, other depository institutions, insurance companies and securities firms
to enter into combinations that result in a single financial services
organization to offer customers a wider array of financial services and products
so long as they do not pose a substantial risk to the safety and soundness of
depository institutions or the financial system generally.





The GLBA
may have the result of increasing the amount of competition that Bancorp and the
Bank face from larger institutions and other types of companies offering
financial products, many of which may have substantially more financial
resources than Bancorp and the Bank.





Maryland
Corporation Law.  Bancorp is incorporated under the laws of the
State of Maryland, and is therefore subject to regulation by the state of
Maryland.  The rights of Bancorp’s stockholders are governed by the
Maryland General Corporation Law.




Regulation
of the Bank




General.  As
a federally chartered, DIF-insured savings association, the Bank is subject to
extensive regulation by the OTS and the FDIC.  Lending activities and
other investments of the Bank must comply with various statutory and regulatory
requirements.  The Bank is also subject to certain reserve
requirements promulgated by the FRB.  The OTS, in conjunction with the
FDIC, regularly examines the Bank and prepares reports for the consideration of
the Bank’s Board of Directors on any deficiencies found in the operations of the
Bank.  The relationship between the Bank and depositors and borrowers
is also regulated by federal and state laws, especially in such matters as the
ownership of savings accounts and the form and content of mortgage documents
utilized by the Bank.




21











Regulatory
Capital Requirements.  OTS regulations require that the Bank
meet three minimum requirement standards including: (i) tangible capital equal
to 1.5% of adjusted total assets; (ii) a leverage ratio consisting of Tier I or
“core” capital equal to at least 4% of adjusted total assets; and (iii)
risk-based capital equal to at least 8% of total risk-weighted
assets.





Tier I,
or core capital is defined as common stockholder’s equity, non-cumulative
perpetual preferred stock and related surplus, minority interests in the equity
accounts of consolidated subsidiaries and certain non-withdrawable accounts or
pledged deposits. Tier I (core) capital is generally reduced by the amount of
the saving’s institution’s intangible assets. Limited exceptions to the
deduction of intangible assets exist for certain mortgage servicing rights and
credit card relationships and qualifying supervisory
goodwill.  Tangible capital is generally defined the same as core
capital but does not include an exception for qualifying supervisory goodwill
and is reduced by the amount of all the savings association’s intangible assets
with only a limited exception for certain mortgage servicing
rights.  Both core and tangible capital are further reduced by an
amount equal to a savings institution’s debt and equity investments in
subsidiaries engaged in activities not permissible for national banks (other
than subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies).  Investments in and extensions of credit to such
subsidiaries are required to be fully netted against tangible and core
capital.  At December 31, 2007, the Bank had no such
investments.





Total
capital equals the sum of Tier I (Core) capital and supplementary capital, to
the extent that supplementary capital does not exceed Tier I (core)
capital.  Supplementary capital includes, among other items,
cumulative perpetual preferred stock, perpetual subordinate debt, mandatory
convertible subordinate debt, intermediate-term preferred stock, the portion of
allowance for loan losses not designated for specific loan losses (up to 1.25%
of risk-weighted assets) and up to 45% of unrealized gains on equity
securities.  For purposes of determining total capital, a savings
institution’s assets are reduced by the amount of capital instruments held by
other depository institutions pursuant to reciprocal arrangements and by the
amount of the institution’s equity investments (other than those deducted from
core and tangible capital) and its high loan-to-value ratio land loans and
non-residential construction loans.





A savings
institution’s risk based capital requirement is measured against risk-weighted
assets, which equal the sum of each on-balance sheet asset and the
credit-equivalent amount of each off-balance-sheet item after being multiplied
by an assigned risk weight.  These risk weights range from 0% for cash
to 100% for delinquent loans, property acquired through foreclosure, commercial
loans, and certain other assets.






22







As shown below, the Bank’s regulatory
capital exceeded all minimum regulatory capital requirements applicable to it as
of December 31, 2007.




Actual
            
            
            Required For Capital
              Adequacy Purposes
            
            
            Required To Be Well
              Capitalized Under Prompt Corrective
              Action ProvisionsAmount
            
            
            %
            
            
            Amount
            
            
            %
            
            
            Amount
            
            
            %(dollars
      in thousands)December 31,
      2007Tangible
      (1)
            
            $
            107,734
            
            
            
            11.3
            %
            
            $
            14,321
            
            
            
            1.50
            %
            
            
            N/A
            
            
            
            N/ATier
      I capital (2)
            
            
            107,734
            
            
            
            13.7
            %
            
            
            N/A
            
            
            
            N/A
            
            
            $
            47,144
            
            
            
            6.00
            %Core
      (1)
            
            
            107,734
            
            
            
            11.3
            %
            
            
            38,190
            
            
            
            4.00
            %
            
            
            47,737
            
            
            
            5.00
            %Total
      (2)
            
            
            117,205
            
            
            
            14.9
            %
            
            
            62,859
            
            
            
            8.00
            %
            
            
            78,573
            
            
            
            10.00
            %December 31,
      2006Tangible
      (1)
            
            $
            99,445
            
            
            
            11.0
            %
            
            $
            13,513
            
            
            
            1.50
            %
            
            
            N/A
            
            
            
            N/ATier
      I capital (2)
            
            
            99,445
            
            
            
            13.1
            %
            
            
            N/A
            
            
            
            N/A
            
            
            $
            45,582
            
            
            
            6.00
            %Core
      (1)
            
            
            99,445
            
            
            
            11.0
            %
            
            
            36,034
            
            
            
            4.00
            %
            
            
            45,043
            
            
            
            5.00
            %Total
      (2)
            
            
            108,452
            
            
            
            14.3
            %
            
            
            60,776
            
            
            
            8.00
            %
            
            
            75,971
            
            
            
            10.00
            %








(1)  To
adjusted total assets.


(2)  To
risk-weighted assets.





Enforcement.The OTS has primary enforcement responsibility over federal savings
institutions and has the authority to bring enforcement action against all
“institution-affiliated parties,” including stockholders, attorneys, appraisers
and accountants who knowingly or recklessly participate in wrongful action
likely to have an adverse effect on an insured institution.  Formal
enforcement actions by the OTS may range from issuance of a capital directive or
cease and desist order, to removal of officers or directors of the institution
and the appointment of a receiver or conservator.  The FDIC also has
the authority to terminate deposit insurance or recommend to the director of the
OTS that enforcement action be taken with respect to a particular savings
institution.  If action is not taken by the director of the OTS, the
FDIC has authority to take action under specific circumstances.





Safety and
Soundness Standards.  Federal law requires each federal banking
agency, including the OTS, to prescribe to certain standards relating to
internal controls, information and internal audit systems, loan documentation,
credit underwriting, interest rate risk exposure, asset growth, compensation,
fees and benefits.  In general, the guidelines require, among other
things, appropriate systems and practices to identify and manage the risks and
exposures specified in the guidelines.  The guidelines further provide
that savings institutions should maintain safeguards to prevent the payment of
compensation, fees and benefits that are excessive or that could lead to
material financial loss, and should take into account factors such as comparable
compensation practices at comparable institutions.  If the OTS
determines that a savings institution is not in compliance with the safety and
soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines.  A savings institution
must submit an acceptable compliance plan to the OTS within 30 days of receipt
of a request for such a plan.  Failure to submit or implement a
compliance plan may subject the institution to regulatory
sanctions.





Prompt Corrective
Action.  Under the prompt corrective action regulations, the
OTS is required and authorized to take supervisory actions against
undercapitalized savings associations.  The risk-based capital,
leverage capital, and tangible capital ratios are used to determine an
institution’s capital classification.  For this purpose, a savings
association is placed into one of the following five categories dependent on
their respective capital ratios:





·
            “well
      capitalized” (at least 5% leverage capital, 6% Tier I risk-based capital
      and 10% total risk-based capital);


·
            “adequately
      capitalized” (at least 4% leverage capital, 4% Tier I risk-based capital
      and 8% total risk-based capital);


·
            “undercapitalized”
      (less than 4% leverage capital, 4% Tier I risk-based capital or 8% total
      risk-based capital);


·
            “significantly
      undercapitalized” (less than 3% leverage capital, 3% Tier I risk-based
      capital or 6% total risk-based capital);
and


·
            “critically
      undercapitalized” (less than 2% tangible
  capital).






23






Generally,
the banking regulator is required to appoint a receiver or conservator for an
institution that is “critically undercapitalized”.  The regulation
also provides that a capital restoration plan must be filed with the OTS within
45 days of the date an institution receives notice that it is
“undercapitalized”, “significantly undercapitalized” or “critically
undercapitalized”.  In addition, numerous mandatory supervisory
actions become immediately applicable to the institution, including, but not
limited to, restrictions on growth, investment activities, payment of dividends
and other capital distributions, and affiliate transactions.  The OTS
may also take any one of a number of discretionary supervisory actions against
the undercapitalized institutions, including the issuance of a capital directive
and the replacement of senior executive officers and directors.





At December 31, 2007, the Bank met
the capital requirements of a “well capitalized” institution under applicable
OTS regulations.





Premiums for
Deposit Insurance.  The Bank’s deposits are insured up to
applicable limits by the DIF of the FDIC.





The FDIC
regulations assess insurance premiums based on an institution’s
risk.  Under this assessment system, the FDIC evaluates the risk of
each financial institution based on its supervisory rating, financial ratios,
and long-term debt issuer rating. Risk Category I, which contains the least
risky depository institutions, including the Bank,  is expected to
include more than 90% of all institutions.  The rates for Risk
category I institutions vary between five and seven cents for every $100 of
domestic deposits.  Federal law requires the FDIC to establish a
deposit reserve ratio for the deposit fund of between 1.15% and 1.50% of
estimated deposits.  The FDIC has designated the reserve ratio for the
deposit insurance fund though the first quarter of 2008 at 1.25% of estimated
insured deposits.





The FDIC
is authorized to terminate a depository institution’s deposit insurance upon a
finding by the FDIC that the institution’s financial condition is unsafe or
unsound or that the institution has engaged in unsafe or unsound practices or
has violated any applicable rule, regulation, order or condition enacted or
imposed by the institution’s regulatory agency.  The termination of
deposit insurance for one or more of Bancorp’s subsidiary depository
institutions could have a material adverse effect on Bancorp’s earnings,
depending on the collective size of the particular institutions
involved.





All
FDIC-insured depository institutions must pay an annual assessment to provide
funds for the payment of interest on bonds issued by the Financing Corporation,
a federal corporation chartered under the authority of the Federal Housing
Finance Board.  The bonds, commonly referred to as Financing
Corporation (“FICO”) bonds, were issued to capitalize the Federal Savings and
Loan Insurance Corporation.  The annual FICO assessment rate as of the
first quarter of 2008 is 1.14 basis points (i.e. $0.0114 for every $100 of
assessable deposits).  The FICO assessments are adjusted quarterly to
reflect changes in the assessment bases of the FDIC’s insurance funds and do not
vary depending on a depository institution’s capitalization or supervisory
evaluations.





The FDIC
has authority to increase insurance assessments.  A significant
increase in insurance premiums would likely have an adverse effect on the
operating expenses of the Bank.





Privacy.  Federal
banking rules limit the ability of banks and other financial institutions to
disclose non-public information about consumers to nonaffiliated third
parties.  Pursuant to these rules, financial institutions must
provide:





·
            Initial
      and annual notices to customers about their privacy policies, describing
      the conditions under which they may disclose nonpublic personal
      information to nonaffiliated third parties and affiliates;
    and


·
            a
      reasonable method for customers to “opt out” of disclosures to
      nonaffiliated third parties.






24




Since the
GLBA’s enactment, a number of states have implemented their own versions of
privacy laws.  The Bank has implemented its privacy policies in
accordance with applicable law.





Loans-to-One
Borrower Limitations.  With certain limited exceptions, the
maximum amount that a savings association or a national bank may lend to any
borrower (including certain related entities of the borrower) may not exceed 15%
of the unimpaired capital and surplus of the institution, plus an additional 10%
of unimpaired capital and surplus for loans fully secured by readily marketable
collateral.  Savings associations are additionally authorized to make
loans to one borrower, for any purpose, in an amount not to exceed $500,000 or,
by order of the Director of the OTS, in an amount not to exceed the lesser of
$30,000,000 or 30% of unimpaired capital and surplus to develop residential
housing, provided:





·
            the
      purchase price of each single-family dwelling in the development does not
      exceed $500,000;


·
            the
      savings association is in compliance with its fully phased-in capital
      requirements;


·
            the
      loans comply with applicable loan-to-value requirements;
    and


·
            the
      aggregate amount of loans made under this authority does not exceed 150%
      of unimpaired capital and surplus.





At
December 31, 2007, the Bank’s loans-to-one-borrower limit was $16,160,000 based
upon the 15% of unimpaired capital and surplus measurement.  At
December 31, 2007, the Bank’s largest lending relationships had an outstanding
balance of $7,000,000, and consisted of a line of credit secured by assignments
of notes, Deeds of Trust, pledged stock and certificates of deposit and a
$7,000,000 loan secured by commercial property located in Annapolis, Maryland.
The loans were performing in accordance with its terms.





Qualified Thrift
Lender Test. Savings associations must meet a QTL test, which test may be
met either by maintaining at least 65% of its portfolio assets in qualified
thrift investments or meeting the definition of a “domestic building and loan
association” as defined in the Code, in either case in at least nine of the most
recent twelve month period.  “Portfolio Assets” generally means total
assets of a savings institution, less the sum of specified liquid assets up to
20% of total assets, goodwill and other intangible assets, and the value of
property used in the conduct of the savings association’s
business.  Qualified thrift investments are primarily residential
mortgages and related investments, including certain mortgage-related
securities.  Associations that fail to meet the QTL test must either
convert to a bank charter or operate under specified restrictions. As of
December 31, 2007, the Bank was in compliance with its QTL requirement and met
the definition of a domestic building and loan association.





Affiliate
Transactions. Generally, transactions between a savings bank or its
subsidiaries and its affiliates (i.e. companies that control the Bank or are
under common control with the Bank) must be on terms favorable to the Bank as
comparable transactions with non-affiliates.  In addition, certain of
these transactions are restricted to a percentage of the Bank’s capital and are
subject to specific collateral requirements.





The
bank’s authority to extend credit to executive officers, directors, trustees and
10% stockholders, as well as entities under such person’s control, is currently
governed by  Section 22(g) and 22(h) of the Federal Reserve Act and
Regulation O promulgated by the Federal Reserve Board.  Among other
things, these regulations generally require such loans to be made on terms
substantially similar to those offered to unaffiliated individuals, place limits
on the amounts of the loans the Bank may make to such persons based, in part, on
the Bank’s capital position, and require certain board of directors’ approval
procedures to be followed.





Capital
Distribution Limitations. OTS regulations impose limitations upon all
capital distributions by savings associations, such as cash dividends, payments
to repurchase or otherwise acquire its shares, payments to shareholders of
another institution in a cash-out merger and other distributions charged against
capital.





The OTS
regulations require a savings association to file an application for approval of
a capital distribution if:





·
            the
      association is not eligible for expedited treatment of its filings with
      the OTS;


·
            the
      total amount of all of capital distributions, including the proposed
      capital distribution, for the applicable calendar year exceeds its net
      income for that year to date plus retained net income for the preceding
      two years;


·
            the
      association would not be at least adequately capitalized under the prompt
      corrective action regulations of the OTS following the distribution;
      or


·
            the
      proposed capital distribution would violate any applicable statute,
      regulation, or agreement between the savings association and the OTS, or
      the FDIC, or violate a condition imposed on the savings association in an
      OTS-approved application or notice.






25






In
addition, a savings association must give the OTS notice of a capital
distribution if the savings association is not required to file an application,
but:





·
            would
      not be well capitalized under the prompt corrective action regulations of
      the OTS following the distribution;


·
            the
      proposed capital distribution would reduce the amount of or retire any
      part of the savings association's common or preferred stock or retire any
      part of debt instruments like notes or debentures included in capital,
      other than regular payments required under a debt instrument approved by
      the OTS; or


·
            the
      savings association is a subsidiary of a savings and loan holding
      company.





The OTS
may prohibit a proposed capital distribution that would otherwise be permitted
if the OTS determines that the distribution would constitute an unsafe or
unsound practice.  In addition, the Federal Deposit Insurance Act
provides that an insured depository institution shall not make any capital
distribution, if after making such distribution the institution would be
undercapitalized.





Branching.Under OTS
branching regulations, the Bank is generally authorized to open branches within
or beyond the State of Maryland if the Bank (1) qualifies as a “domestic
building and loan association” under the Code, which qualification requirements
similar to those for a Qualified Thrift Lender under the Home Owners’ Loan Act,
and (2) publishes public notice at least 30 days before opening a branch and no
one opposes the branch.  If a comment in opposition to a branch
opening is filed and the OTS determines the comment to be relevant to the
approval process standards, and to require action in response, the OTS may,
among other things, require a branch application or elect to hold a meeting with
the Bank and the person who submitted the comment.  The OTS authority
preempts any state law purporting to regulate branching by federal savings
banks.





Community
Reinvestment Act and the Fair Lending Laws.  Savings
associations have a responsibility under the Community Reinvestment Act and
related regulations of the OTS to help meet the credit needs of their
communities, including low- and moderate-income neighborhoods. In addition, the
Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from
discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of the Community Reinvestment Act could, at a minimum, result in
regulatory restrictions on its activities and the denial of applications. In
addition, an institution's failure to comply with the Equal Credit Opportunity
Act and the Fair Housing Act could result in the OTS, other federal regulatory
agencies as well as the Department of Justice taking enforcement
actions.  Based on an examination conducted May 30, 2006, the Bank
received a satisfactory rating.





USA Patriot Act
of 2001.The USA Patriot Act of 2001 contains sweeping
anti-money laundering and financial transparency laws and imposes various
regulations on financial institutions, such as the Bank, 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.





Federal Home Loan
Bank System. The Bank is a member of the FHLB-Atlanta. Among other
benefits, each FHLB serves as a reserve or central bank for its members within
its assigned region. Each FHLB is financed primarily from the sale of
consolidated obligations of the FHLB system. Each FHLB makes available loans or
advances to its members in compliance with the policies and procedures
established by the Board of Directors of the individual FHLB.






26






Under the
capital plan of the FHLB-Atlanta as of December 31, 2007, the Bank was required
to own at least $10,171,600 of the capital stock of the
FHLB-Atlanta.  As of such date, the Bank owned $10,171,600 of the
capital stock of the FHLB-Atlanta and was in compliance with the capital plan
requirements.





Federal Reserve
System.  The FRB requires all depository institutions to
maintain non-interest bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW, and Super NOW checking accounts)
and non-personal time deposits.  At December 31, 2007, the Bank was in
compliance with these requirements.





Activities of
Subsidiaries. A savings association seeking to establish a new
subsidiary, acquire control of an existing company or conduct a new activity
through a subsidiary must provide 30 days prior notice to the FDIC and the OTS
and conduct any activities of the subsidiary in compliance with regulations and
orders of the OTS. The OTS has the power to require a savings association to
divest any subsidiary or terminate any activity conducted by a subsidiary that
the OTS determines to pose a serious threat to the financial safety, soundness
or stability of the savings association or to be otherwise inconsistent with
sound banking practices.





Tying
Arrangements. Federal savings associations are prohibited, subject to
some exceptions, from extending credit to or offering any other services, or
fixing or varying the consideration for such extension of credit or service, on
the condition that the customer obtain some additional service from the
institution or its affiliates or not obtain services of a competitor of the
institution.





Item 1A.  Risk
Factors





Unless
the context indicates otherwise, all references to “we,” “us,” “our” in this
subsection “Risk Factors” refer to the Bancorp and its
subsidiaries.  You should carefully consider the risks described below
as well as elsewhere in this Annual Report on Form 10-K. If any of the risks
actually occur, our business, financial condition or results of future
operations could be materially adversely affected. This Annual Report on Form
10-K contains forward-looking statements that involve risks and uncertainties.
Our actual results could differ materially from those anticipated in the
forward-looking statements as a result of many factors, including the risks
faced by us described below and elsewhere in this Annual Report on Form
10-K.





We
may be adversely affected by changes in economic and political conditions and by
governmental monetary and fiscal policies.





The
thrift industry is affected, directly and indirectly, by local, domestic, and
international economic and political conditions, and by governmental monetary
and fiscal policies.  Conditions such as inflation, recession,
unemployment, volatile interest rates, tight money supply, real estate values,
international conflicts and other factors beyond our control may adversely
affect our potential profitability.  Any future rises in interest
rates, while increasing the income yield on our earning assets, may adversely
affect loan demand and the cost of funds and, consequently, our
profitability.  Any future decreases in interest rates may adversely
affect our profitability because such decreases may reduce the amounts that we
may earn on our assets.  Economic downturns could result in the
delinquency of outstanding loans.  We do not expect any one particular
factor to materially affect our results of operations.  However,
downtrends in several areas, including real estate, construction and consumer
spending, could have a material adverse impact on our ability to remain
profitable.





Changes
in interest rates could adversely affect our financial condition and results of
operations.





The
operations of financial institutions, such as us, are dependent to a large
degree on net interest income, which is the difference between interest income
from loans and investments and interest expense on deposits and borrowings. Our
net interest income is significantly affected by market rates of interest that
in turn are affected by prevailing economic conditions, by the fiscal and
monetary policies of the federal government and by the policies of various
regulatory agencies. Like all financial institutions, our balance sheet is
affected by fluctuations in interest rates. Volatility in interest rates can
also result in disintermediation, which is the flow of funds away from financial
institutions into direct investments, such as US Government and corporate
securities and other investment vehicles, including mutual funds, which, because
of the absence of federal insurance premiums and reserve requirements, generally
pay higher rates of return than financial institutions.






27







Most
of our loans are secured by real estate located in our market
area.  If there is a downturn in our real estate market, these
borrowers may default on their loans and we may not be able to fully recover our
loans.





A
downturn in the real estate market could hurt our business because most of our
loans are secured by real estate.  Substantially all of our real
property collateral is located in the states of Maryland, Virginia and
Delaware.  As of December 31, 2007, approximately 96% of the book
value of our loan portfolio consisted of loans collateralized by various types
of real estate.  Real estate values and real estate markets are
generally affected by changes in national, regional or local economic
conditions, fluctuations in interest rates and the availability of loans to
potential purchasers, changes in tax laws and other governmental statutes,
regulations and policies and acts of nature.  If real estate prices
decline, the value of real estate collateral securing our loans could be
reduced.  Our ability to recover on defaulted loans by foreclosing and
selling the real estate collateral would then be diminished and we would be more
likely to suffer losses on defaulted loans.  Any such downturn could
have a material adverse effect on our business, financial condition and results
of operations.





In
addition, approximately 61% of the book value of our loans consisted of
construction, land acquisition and development loans, commercial real estate
loans and land loans, which present additional risks described in “Item
1.   Business”.





We
are exposed to risk of environmental liabilities with respect to properties to
which we take title.





In the
course of our business, we may foreclose and take title to real estate, and
could be subject to environmental liabilities with respect to these
properties.  We may be held liable to a governmental entity or to
third parties for property damage, personal injury, investigation and clean-up
costs incurred by these parties in connection with environmental contamination,
or may be required to investigate or clean up hazardous or toxic substances, or
chemical releases at a property.  The costs associated with
investigation or remediation activities could be substantial.  In
addition, if we are the owner or former owner of a contaminated site, we may be
subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from the
property.  If we become subject to significant environmental
liabilities, our business, financial condition, results of operations and cash
flows could be materially adversely affected.





Our
operations are located in Anne Arundel County, Maryland, which makes our
business highly susceptible to local economic conditions, and an economic
downturn or recession in that area may adversely affect our ability to operate
profitably.





Unlike
larger banking organizations that are more geographically diversified, our
operations are currently concentrated in Anne Arundel County,
Maryland.  In addition, almost all of our loans have been made to
borrowers in the states of Maryland, Virginia and Delaware.  As a
result of this geographic concentration, our financial results depend largely
upon economic conditions in this market area.  A deterioration or
recession in economic conditions in this market could result in one or more of
the following:





·
            a
      decrease in deposits;


·
            an
      increase in loan delinquencies;


·
            an
      increase in problem assets and
foreclosures;


·
            a
      decrease in the demand for our products and services;
  and


·
            a
      decrease in the value of collateral for loans, especially real estate, and
      reduction in the customers’ borrowing
power.





Any of
the foregoing factors may adversely affect our ability to operate
profitably.






28






We are subject to federal and state
regulation and the
monetary policies of the Federal Reserve Board.  Such regulation and
policies can have a material adverse effect on our earnings and
prospects.





Our
operations are heavily regulated and will be affected by present and future
legislation and by the policies established from time to time by various federal
and state regulatory authorities.  In particular, the monetary
policies of the Federal Reserve Board have had a significant effect on the
operating results of banks in the past, and are expected to continue to do so in
the future.  Among the instruments of monetary policy used by the
Federal Reserve Board to implement its objectives are changes in the discount
rate charged on bank borrowings and changes in the reserve requirements on bank
deposits.  It is not possible to predict what changes, if any, will be
made to the monetary polices of the Federal Reserve Board or to existing federal
and state legislation or the effect that such changes may have on our future
business and earnings prospects





We have established an allowance for
loan losses based on our management's estimate. Actual losses could differ
significantly from those estimates. If the allowance is not adequate, it
could have a material adverse effect on our earnings and the price of our
stock.





We have
established an allowance for loan losses which management believes to be
adequate to offset probable losses on our existing loans.  However,
there is no precise method of estimating loan losses and our ongoing analysis
may cause this estimate to change in the future and actual losses may differ
materially from this estimate.  In addition, there can be no assurance
that any future declines in real estate market conditions, general economic
conditions or changes in regulatory policies will not require us to increase our
allowance for loan losses.  Any increase in the allowance for loan
losses will reduce our earnings and may adversely affect the price of our common
stock.





We compete with a number of local,
regional and national financial institutions for customers.





We face
strong competition from other thrifts, banks, savings institutions and other
financial institutions that have branch offices or otherwise operate in our
market area, as well as many other companies now offering a range of financial
services.  Many of these competitors have substantially greater
financial resources and larger branch systems than we do.  In
addition, many of our competitors have higher legal lending limits than we do.
Particularly intense competition exists for sources of funds including savings
and retail time deposits and for loans, deposits and other services that we
offer.





During
the past several years, significant legislative attention has been focused on
the regulation and deregulation of the financial services
industry.  Non-bank financial institutions, such as securities
brokerage firms, insurance companies and money market funds, have been permitted
to engage in activities that compete directly with traditional bank
business.  Competition with various financial institutions could
hinder our ability to maintain profitable operations and grow our
business.





Our
information systems may experience an interruption or breach in security, which
could result in a loss of business.





We rely
heavily on communications and information systems to conduct our
business.  Any failure, interruption or breach in security of these
systems could result in failures or disruptions in our customer relationship
management, general ledger, deposit, loan and other systems.  While we
have policies and procedures designed to prevent or limit the effect of the
failure, interruption or security breach of our information systems, there can
be no assurance that failures, interruptions or security breaches will not occur
or, if they do occur, that they will be adequately addressed.  The
occurrence of any failures, interruptions or security breaches of our
information systems could damage our reputation, result in a loss of customer
business, subject us to additional regulatory scrutiny, or expose us to civil
litigation and possible financial liability, any of which could have a material
adverse effect on our financial condition and results of
operations.  We depend on third-party providers for many of our
systems and if these providers experience financial, operational or
technological difficulties, or if there is any other disruption in our
relationships with them, we may be required to locate alternative sources of
such services, and we cannot assure you that we would be able to negotiate terms
that are as favorable to us, or could obtain services with similar functionality
as found in our existing systems without the need to expend substantial
resources, if at all.






29






We
continually encounter technological change, and, if we are unable to develop and
implement efficient and customer friendly technology, we could lose
business.





The
financial services industry is continually undergoing rapid technological change
with frequent introductions of new technology-driven products and
services.  The effective use of technology increases efficiency and
enables financial institutions to better serve customers and to reduce
costs.  Our future success depends, in part, upon our ability to
address the needs of our customers by using technology to provide products and
services that will satisfy customer demands, as well as to create additional
efficiencies in our operations.  Many of our competitors have
substantially greater resources to invest in technological
improvements.  We may not be able to effectively implement new
technology-driven products and services or be successful in marketing these
products and services to our customers.  Failure to successfully keep
pace with technological change affecting the financial services industry could
have a material adverse impact on our business and, in turn, our financial
condition and results of operations.





There can be no assurance that we
will continue to pay dividends in the future.





Although
we expect to continue our policy of regular quarterly dividend payments, this
dividend policy will be reviewed periodically in light of future earnings,
regulatory restrictions and other considerations.  No assurance can be
given, therefore, that cash dividends on common stock will be paid in the future
at the same rate or at all.





An
investment in our common stock is not insured against loss.





Investments
in the shares of our common stock are not deposits insured against loss by the
FDIC or any other entity.  As a result, you may lose some or all of
your investment.





Our success depends on our senior
management team and if we are not able to retain them, it could have a
materially adverse effect on us.





We are
highly dependent upon the continued services and experience of our senior
management team, including Alan J. Hyatt, our President and Chief Executive
Officer. We depend on the services of Mr. Hyatt and the other members of our
senior management team to, among other things, continue the development and
implementation of our strategies, and maintain and develop our client
relationships.  We do not have an employment agreement with members of
our senior management nor do we maintain “key-man” life insurance on our senior
management.  If we are unable to retain Mr. Hyatt and other members of
our senior management team, our business could be materially adversely
affected.





“Anti-takeover” provisions may make it
more difficult for a third party to acquire control of us, even if the change in
control would be beneficial to shareholders.





Our charter presently contains certain
provisions which may be deemed to be "anti-takeover" and "anti-greenmail" in
nature in that such provisions may deter, discourage or make more difficult the
assumption of control of us by another corporation or person through a tender
offer, merger, proxy contest or similar transaction or series of
transactions.  For example, our charter provides that our board of
directors may issue up to 1,000,000 shares of preferred stock without
shareholder approval. In addition, our charter provides for a classified board,
with each board member serving a staggered three-year term.  Directors
may be removed only for cause and only with the approval of the holders of at
least 75 percent of our common stock. The overall effects of the "anti-takeover"
and "anti-greenmail" provisions may be to discourage, make more costly or more
difficult, or prevent a future takeover offer, prevent shareholders from
receiving a premium for their securities in a takeover offer, and enhance the
possibility that a future bidder for control of us will be required to act
through arms-length negotiation with the our board of directors.








30






If
we fail to maintain an effective system of internal control over financial
reporting and disclosure controls and procedures, we may be unable to accurately
report our financial results and comply with the reporting requirements under
the Securities Exchange Act of 1934.  As a result, current and
potential shareholders may lose confidence in our financial reporting and
disclosure required under the Securities Exchange Act of 1934, which could
adversely affect our business and we could be subject to regulatory
scrutiny.





Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002, referred to as Section 404, we
are required to include in our Annual Reports on Form 10-K, our management’s
report on internal control over financial reporting and our registered public
accounting firm’s attestation report on our management’s assessment of our
internal control over financial reporting.  While we have reported no
“significant deficiencies” or “material weaknesses” in this Form 10-K, we cannot
guarantee that we will not have any “significant deficiencies” or “material
weaknesses” reported by our independent registered public accounting firm in the
future. Compliance with the requirements of Section 404 is expensive and
time-consuming. If in the future we fail to complete this evaluation in a timely
manner, or if our independent registered public accounting firm cannot timely
attest to our evaluation, we could be subject to regulatory scrutiny and a loss
of public confidence in our internal control over financial
reporting.  In addition, any failure to establish an effective system
of disclosure controls and procedures could cause our current and potential
shareholders and customers to lose confidence in our financial reporting and
disclosure required under the Securities Exchange Act of 1934, which could
adversely affect our business.





Terrorist
attacks and threats or actual war may impact all aspects of our operations,
revenues, costs and stock price in unpredictable ways.





Terrorist
attacks in the United States and abroad, as well as future events occurring in
response to or in connection with them, including, without limitation, future
terrorist attacks against United States targets, rumors or threats of war,
actual conflicts involving the United States or its allies or military or trade
disruptions, may impact our operations.  Any of these events could
cause consumer confidence and savings to decrease or result in increased
volatility in the United States and worldwide financial markets and
economy.  Any of these occurrences could have an adverse impact on our
operating results, revenues and costs and may result in the volatility of the
market price for our common stock and on the future price of our common
stock.





Item
1B.  Unresolved Staff Comments





None





Item
2.  Properties















Item 3.  Legal
Proceedings





There are no material pending legal
proceedings to which Bancorp, the Bank or any subsidiary is a party or to which
any of their property is subject.








31






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





None.





Item
4.1.  Executive Officers of the Registrant that are not
Directors





Thomas G. Bevivino, age 52, joined
Bancorp in 2004 as Controller, and has served as the Chief Financial Officer
since July 1, 2005.  He serves in the same capacity for the
Bank.  Mr. Bevivino was a financial consultant from 2002 until 2004,
and served as Chief Financial Officer of Luminant Worldwide Corporation from
1999 until 2002.


32





PART II





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





The common stock of Bancorp is traded
on the Nasdaq Capital Market under the symbol “SVBI”.  As of February
22, 2008, there were 1,504 stockholders of record of Bancorp’s common
stock.





Registrar and Transfer Company, 10
Commerce Drive, Cranford, New Jersey 07016-3572, serves as the Transfer Agent
and Registrar for Bancorp.





The following table sets forth the
high and low sales prices per share of Bancorp’s common stock for the periods
indicated, as reported on the Nasdaq Capital Market:





Quarterly
Stock Information*





2007
            
            2006Stock
      Price Range
            Per
      Share
            
            
            Stock
      Price Range
            Per
      ShareQuarter
            Low
            High
            Dividend
            
            Quarter
            Low
            High
            Dividend1st
            $16.78
            $22.55
            $.060
            
            1st
            $15.08
            $18.63
            $.0552nd
            16.24
            20.23
            .060
            
            2nd
            16.37
            18.77
            .0553rd
            12.25
            17.00
            .060
            
            3rd
            16.68
            18.64
            .0554th
            8.21
            13.28
            .060
            
            4th
            16.45
            18.10
            .055





* Retroactively adjusted to reflect a
10% stock dividend declared February 20, 2007 effective for shares outstanding
March 15, 2007, and a 10% stock dividend declared February 21, 2006 effective
for shares outstanding on March 28, 2006.





Stock Performance
Graph





The graph
below sets forth comparative information regarding the Company’s cumulative
shareholder return on its Common Stock over the last five years. Total
shareholder return is measured by dividing total dividends (assuming dividend
reinvestment) for the measurement period plus share price change for a period by
the share price at the beginning of the measurement period. Severn Bancorp, Inc.'s cumulative
shareholder return is based on an investment of $100 on December 31, 2002, and
is compared to the cumulative total return of the NASDAQ Composite Index and the
SNL Securities LC Thrift Index for thrifts with total assets between $500
million and $1.0 billion (the "SNL Thrift ($500M to $1.0B)
Index")










33







Comparison
of Cumulative Total Return Among Severn, NASDAQ Composite Index


and
SNL Thrift ($500M to $1.0B) Index from December 31, 2002 to  December
31, 2007




























34





Item 6.  Selected
Financial Data








For information concerning quarterly
financial data for Bancorp, see Note 17 to the consolidated financial
statements.





The following financial information
is derived from the audited financial statements of Bancorp.  The
information is a summary and should be read in conjunction with Bancorp’s
audited financial statements and Management’s Discussion and Analysis of
Financial Condition and Results of Operations.





Summary Financial and Other
Data





At
      December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(dollars
      in thousands, except per share information)Balance
      Sheet DataTotal
      assets
            
            $
            962,234
            
            
            $
            911,916
            
            
            $
            849,774
            
            
            $
            703,616
            
            
            $
            540,471Total
      loans, net
            
            
            893,014
            
            
            
            835,477
            
            
            
            779,333
            
            
            
            656,967
            
            
            
            506,026Investment
      securities held to maturity
            
            
            2,383
            
            
            
            7,271
            
            
            
            8,290
            
            
            
            9,955
            
            
            
            12,721Non-performing
      loans
            
            
            7,700
            
            
            
            5,927
            
            
            
            1,693
            
            
            
            939
            
            
            
            469Total
      non-performing assets
            
            
            10,693
            
            
            
            6,897
            
            
            
            1,693
            
            
            
            939
            
            
            
            469Deposits
            
            
            652,773
            
            
            
            626,524
            
            
            
            594,893
            
            
            
            527,413
            
            
            
            419,726Short-term
      borrowings
            
            
            15,000
            
            
            
            18,000
            
            
            
            26,000
            
            
            
            -
            
            
            
            6,000Long-term
      debt
            
            
            175,000
            
            
            
            155,000
            
            
            
            132,000
            
            
            
            89,000
            
            
            
            59,000Total
      liabilities
            
            
            866,958
            
            
            
            825,474
            
            
            
            777,062
            
            
            
            639,462
            
            
            
            487,501Stockholders’
      equity
            
            
            95,276
            
            
            
            86,442
            
            
            
            72,712
            
            
            
            60,154
            
            
            
            48,970Book
      value per common share *
            
            $
            9.46
            
            
            $
            8.59
            
            
            $
            7.23
            
            
            $
            5.97
            
            
            $
            4.86Common
      shares outstanding *
            
            
            10,066,679
            
            
            
            10,065,935
            
            
            
            10,065,002
            
            
            
            10,065,002
            
            
            
            10,065,002Other
      Data:Number
      of:Full
      service retail banking facilities
            
            
            4
            
            
            
            3
            
            
            
            3
            
            
            
            3
            
            
            
            2Full-time
      equivalent employees
            
            
            118
            
            
            
            121
            
            
            
            111
            
            
            
            105
            
            
            
            81*
      Retroactively adjusted to reflect a 10% stock dividend declared February
      20, 2007 effective for shares outstanding March 15, 2007, a 10% stock
      dividend declared February 21, 2006 effective for shares outstanding on
      March 28, 2006, and a two-for-one stock split declared November 17, 2004
      effective for shares outstanding December 15, 2004.





35






Summary of
Operations




For
      the Year Ended December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(dollars
      in thousands, except per share information)Interest
      income
            
            $
            71,814
            
            
            $
            70,175
            
            
            $
            57,135
            
            
            $
            44,829
            
            
            $
            37,087Interest
      expense
            
            
            38,176
            
            
            
            32,060
            
            
            
            21,955
            
            
            
            14,631
            
            
            
            12,341Net
      interest income
            
            
            33,638
            
            
            
            38,115
            
            
            
            35,180
            
            
            
            30,198
            
            
            
            24,746Provision
      for loan losses
            
            
            2,462
            
            
            
            1,561
            
            
            
            1,570
            
            
            
            1,200
            
            
            
            900Net
      interest income after provision for loan losses
            
            
            31,176
            
            
            
            36,554
            
            
            
            33,610
            
            
            
            28,998
            
            
            
            23,846Non-interest
      income
            
            
            4,336
            
            
            
            3,867
            
            
            
            2,748
            
            
            
            3,402
            
            
            
            4,674Non-interest
      expense
            
            
            16,492
            
            
            
            14,065
            
            
            
            12,878
            
            
            
            11,211
            
            
            
            9,616Income
      before income tax provision
            
            
            19,020
            
            
            
            26,356
            
            
            
            23,480
            
            
            
            21,189
            
            
            
            18,904Provision
      for income taxes
            
            
            7,909
            
            
            
            10,608
            
            
            
            8,926
            
            
            
            8,258
            
            
            
            7,575Net
      income
            
            $
            11,111
            
            
            $
            15,748
            
            
            $
            14,554
            
            
            $
            12,931
            
            
            $
            11,329Per
      Share Data:Basic
      earnings per share *
            
            $
            1.10
            
            
            $
            1.56
            
            
            $
            1.45
            
            
            $
            1.29
            
            
            $
            1.11Diluted
      earnings per share *
            
            $
            1.10
            
            
            $
            1.56
            
            
            $
            1.45
            
            
            $
            1.29
            
            
            $
            1.11Cash
      dividends declared per share*
            
            $
            .24
            
            
            $
            .22
            
            
            $
            .20
            
            
            $
            .17
            
            
            $
            .14Weighted
      number of shares outstanding basic *
            
            
            10,066,283
            
            
            
            10,065,289
            
            
            
            10,065,002
            
            
            
            10,065,002
            
            
            
            10,034,690Weighted
      number of shares outstanding diluted *
            
            
            10,066,283
            
            
            
            10,069,056
            
            
            
            10,065,002
            
            
            
            10,065,002
            
            
            
            10,060,670


*
      Retroactively adjusted to reflect a 10% stock dividend declared February
      20, 2007 effective for shares outstanding March 15, 2007, a 10% stock
      dividend declared February 21, 2006 effective for shares outstanding on
      March 28, 2006, and a two-for-one stock split declared November 17, 2004
      effective for shares outstanding December 15,
  2004.









36








Key Operating
Ratios





For
      the Year Ended December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Performance
      Ratios:Return
      on average assets
            
            
            1.19
            %
            
            
            1.77
            %
            
            
            1.84
            %
            
            
            2.02
            %
            
            
            2.23
            %Return
      on average equity
            
            
            12.09
            %
            
            
            19.59
            %
            
            
            21.85
            %
            
            
            23.56
            %
            
            
            25.22
            %Dividend
      payout ratio
            
            
            21.82
            %
            
            
            13.95
            %
            
            
            13.84
            %
            
            
            13.38
            %
            
            
            12.30
            %Net
      interest margin
            
            
            3.81
            %
            
            
            4.50
            %
            
            
            4.58
            %
            
            
            4.81
            %
            
            
            4.99
            %Interest
      rate spread
            
            
            3.45
            %
            
            
            4.20
            %
            
            
            4.32
            %
            
            
            4.60
            %
            
            
            4.77
            %Non-interest
      expense to average assets
            
            
            1.76
            %
            
            
            1.58
            %
            
            
            1.63
            %
            
            
            1.75
            %
            
            
            1.89
            %Efficiency
      ratio
            
            
            43.43
            %
            
            
            33.50
            %
            
            
            33.95
            %
            
            
            33.37
            %
            
            
            32.69
            %Asset
      Quality Ratios:Average
      equity to average assets
            
            
            9.82
            %
            
            
            9.02
            %
            
            
            8.42
            %
            
            
            8.57
            %
            
            
            8.84
            %Nonperforming
      assets to total assetsat
      end of period
            
            
            1.11
            %
            
            
            0.76
            %
            
            
            0.20
            %
            
            
            0.13
            %
            
            
            0.09
            %Nonperforming
      loans to total grossloans
      at end of period
            
            
            0.78
            %
            
            
            0.62
            %
            
            
            0.18
            %
            
            
            0.12
            %
            
            
            0.08
            %Allowance
      for loan losses tonet
      loans at end of period
            
            
            1.21
            %
            
            
            1.08
            %
            
            
            0.96
            %
            
            
            0.90
            %
            
            
            0.95
            %Allowance
      for loan losses tononperforming
      loans at end of period
            
            
            140.01
            %
            
            
            152.29
            %
            
            
            443.30
            %
            
            
            632.10
            %
            
            
            1030.49
            %





37


Average Balance
Sheet




Average
Balance Sheet.  The following table contains for the periods indicated
information regarding the total dollar amounts of interest income from
interest-earning assets and the resulting average yields, the total dollar
amount of interest expense on interest-bearing liabilities and the resulting
average costs, net interest income, and the net yield on interest-earning
assets.




Year
      Ended December 31,2007
            
            2006
            
            2005Average
            
            
            
            Average
            
            
            
            AverageVolume
            Interest
            Yield/Cost
            
            Volume
            Interest
            Yield/Cost
            
            Volume
            Interest
            Yield/Cost(dollars
      in thousands)ASSETSLoans
      (1)
            
            $858,305
            $70,275
            8.19%
            
            $819,038
            $68,610
            8.38%
            
            $738,028
            $56,120
            7.60%Investments
      (2)
            
            3,333
            121
            3.63%
            
            5,000
            154
            3.08%
            
            5,000
            154
            3.08%Mortgage-backed
      securities
            
            1,957
            96
            4.91%
            
            2,823
            112
            3.97%
            
            4,065
            173
            4.26%Other
      interest-earning assets (3)
            
            20,357
            1,322
            6.49%
            
            19,886
            1,299
            6.53%
            
            15,923
            688
            4.32%Total
      interest-earning assets
            
            883,952
            71,814
            8.12%
            
            846,747
            70,175
            8.29%
            
            763,016
            57,135
            7.49%Non-interest
      earning assets
            
            51,317
            
            
            
            44,385
            
            
            
            28,027Total
      Assets
            
            $935,269
            
            
            
            $891,132
            
            
            
            $791,043LIABILITIES
      AND STOCKHOLDERS' EQUITYSavings
      and checking deposits
            
            $132,604
            $3,272
            2.47%
            
            $138,242
            $2,728
            1.97%
            
            $155,513
            $2,455
            1.58%Certificates
      of deposits
            
            514,523
            26,075
            5.07%
            
            483,524
            20,977
            4.34%
            
            408,026
            13,819
            3.39%Borrowings
            
            170,417
            8,829
            5.18%
            
            162,417
            8,355
            5.14%
            
            134,833
            5,681
            4.21%Total
      interest-bearing liabilities
            
            817,544
            38,176
            4.67%
            
            784,183
            32,060
            4.09%
            
            698,372
            21,955
            3.14%Non-interest
      bearing liabilities
            
            25,836
            
            
            
            26,556
            
            
            
            26,059Stockholders'
      equity
            
            91,889
            
            
            
            80,393
            
            
            
            66,612Total
      liabilities and stockholders' equity
            
            $935,269
            
            
            
            $891,132
            
            
            
            $791,043Net
      interest income and Interest rate spread
            
            
            $33,638
            3.45%
            
            
            $38,115
            4.20%
            
            
            $35,180
            4.35%Net
      interest margin
            
            
            
            3.81%
            
            
            
            4.50%
            
            
            
            4.61%Average
      interest-earning assets toaverage
      interest-bearing liabilities
            
            
            
            108.12%
            
            
            
            107.98%
            
            
            
            109.26%(1)
      Non-accrual loans are included in the average balances and in the
      computation of yields.(2)
      Bancorp does not have any tax-exempt securities.(3)
      Other interest earning assets includes interest bearing deposits in other
      banks, federal funds, and FHLB stock investments.





38


Rate Volume
Table





Year
      ended December 31, 2007
            
            
            Year
      ended December 31, 2006vs.
            
            
            vs.Year
      ended December 31, 2006
            
            
            Year
      ended December 31, 2005Total
            
            
            Changes
      Due to
            
            
            Total
            
            
            Changes
      Due toChange
            
            
            Volume
      (1)
            
            
            Rate
      (1)
            
            
            Change
            
            
            Volume
      (1)
            
            
            Rate
      (1)(dollars
      in thousands)Interest-earning
      assetsLoans
            
            $
            1,665
            
            
            $
            3,289
            
            
            $
            (1,624
            )
            
            $
            12,490
            
            
            $
            6,160
            
            
            $
            6,330Investments
            
            
            (33
            )
            
            
            (51
            )
            
            
            18
            
            
            
            -
            
            
            
            -
            
            
            
            -Mortgage-backed
      securities
            
            
            (16
            )
            
            
            (34
            )
            
            
            18
            
            
            
            (61
            )
            
            
            (53
            )
            
            
            (8
            )Other
      interest-earning assets
            
            
            23
            
            
            
            31
            
            
            
            (8
            )
            
            
            611
            
            
            
            171
            
            
            
            440Total
      interest income
            
            $
            1,639
            
            
            $
            3,235
            
            
            $
            (1,596
            )
            
            $
            13,040
            
            
            $
            6,278
            
            
            $
            6,762Interest-bearing
      liabilitiesSavings
      and checking deposits
            
            $
            544
            
            
            $
            (111
            )
            
            $
            655
            
            
            $
            273
            
            
            $
            (272
            )
            
            $
            545Certificates
      of deposits
            
            
            5,098
            
            
            
            1,345
            
            
            
            3,753
            
            
            
            7,158
            
            
            
            2,557
            
            
            
            4,601Borrowings
            
            
            474
            
            
            
            412
            
            
            
            62
            
            
            
            2,674
            
            
            
            1,162
            
            
            
            1,512Total
      interest expense
            
            $
            6,116
            
            
            $
            1,646
            
            
            $
            4,470
            
            
            $
            10,105
            
            
            $
            3,447
            
            
            $
            2,766Net
      change in interest income
            
            $
            (4,477
            )
            
            $
            1,589
            
            
            $
            (6,066
            )
            
            $
            2,935
            
            
            $
            2,831
            
            
            $
            104(1) Changes
      in interest income/expense not arising from volume or rate variances are
      allocated proportionately to rate and volume.







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





Overview





The
primary business of Bancorp is consumer deposit products and residential and
commercial mortgages.  Bancorp operates primarily in Anne Arundel
County, Maryland, as well as surrounding areas in Maryland, Virginia and
Delaware.  Bancorp has experienced similar challenges faced by many
institutions caused by the slowdown in the real estate market, including
increased loan delinquencies and a decrease in the demand for certain loan
products including construction, land acquisition and development loans. In
addition, stronger competition for new loans and deposits has caused the
interest rate spread between Bancorp’s cost of funds and what it earns on loans
to decrease from 2006.  This is primarily due to decreases in interest
rates earned on loans, as interest rates paid on deposits
increased.





Even
though Bancorp’s total loan portfolio has increased from 2006, the decrease in
the interest rate spread has caused net interest income to decrease from
2006.  In addition, Bancorp has experienced an increase in loan
delinquencies, which resulted in the allowance for loan losses to increase from
2006.  The decrease in net interest income and the increase in the
allowance for loan losses, coupled with a modest increase in variable expenses,
such as compensation, office expense and advertising, have
caused  Bancorp’s overall profitability to decrease from
2006.





Bancorp
is challenged with maintaining high asset quality during the recent slowdown in
the real estate market.  It has experienced an increase in delinquent
loans over prior years and has increased its allowance for loan losses from 2006
accordingly.  Bancorp believes that the allowance for loan losses is
adequate.







39






Going
forward, Bancorp’s challenge will be to continue to grow assets in the form of
mortgage loans and commercial loans, while increasing core
deposits.  Increasing loans while maintaining strong asset quality
coupled with increased core deposits, which traditionally have a lower cost of
funds, should enable Bancorp to earn a profitable interest spread.  In
addition, Bancorp will be challenged to maintain low overhead costs should
inflation increase.





Interest
rates are outside the control of Bancorp, so it must attempt to balance its
pricing and duration of its loan portfolio against the risks of rising costs of
its deposits and borrowings.





The
continued success and attraction of Anne Arundel County, Maryland, and vicinity,
will also be important to Bancorp’s ability to originate and grow its mortgage
loans and deposits, as will Bancorp’s continued focus on maintaining a low
overhead.





Critical Accounting
Policies





Bancorp’s
significant accounting policies and recent accounting pronouncements are set
forth in Note 1 of the consolidated financial statements for the year ended
December 31, 2007 which are set forth on pages F-1 through F-33.  Of
these significant accounting policies, Bancorp considers the policy regarding
the allowance for loan losses to be its most critical accounting policy, given
the uncertainty in evaluating the level of the allowance required to cover
credit losses inherent in the loan portfolio and the material effect that such
judgments can have on the results of operations.  In addition, changes
in economic conditions can have a significant impact on the allowance for loan
losses and therefore the provision for loan losses and results of operations as
well as the valuation of foreclosed real estate.  Bancorp has
developed policies and procedures for assessing the adequacy of the allowance
for loan losses, recognizing that this process requires a number of assumptions
and estimates with respect to its loan portfolio.  Bancorp’s
assessments may be impacted in future periods by changes in economic conditions,
the impact of regulatory examinations, and the discovery of information with
respect to borrowers that is not known to management at the time of the issuance
of the consolidated financial statements.





Financial
Condition





Total
assets increased by $50,318,000, or 5.5%, at December 31, 2007 to
$962,234,000, compared to $911,916,000 at December 31, 2006.  The
following discusses the material changes between the December 31, 2007 and 2006
balance sheets.





Loans





Loans Held For
Sale.Loans held for sale decreased by $1,869,000, or 62.9%
at December 31, 2007 to $1,101,000, compared to $2,970,000 at December 31,
2006.  This decrease was primarily due to a slowdown in loans sold on
the secondary market, and the timing of loans pending sale at
year-end.





Loans
Receivable.Total net portfolio loans receivable increased by
$59,406,000, or 7.1% at December 31, 2007, to $891,913,000, compared to
$832,507,000 at December 31, 2006.  The increase in the loan portfolio
resulted from Bancorp’s ability to attract and retain loan customers in spite of
a downturn in the real estate market.  This increase was the result of
Bancorp’s focus on community lending and increased marketing
efforts.  The increase in the loan portfolio was primarily due to an
increase in residential loan demand and an increase in funding of commercial
loan obligations partially offset by a decrease in construction, land
acquisition and development loans.





Premises and
Equipment





Premises
and equipment increased by $878,000, or 2.9% at December 31, 2007 to
$31,289,000, compared to $30,411,000 at December 31, 2006.  The
increase was primarily due to the final construction costs that were incurred
during 2007 for Bancorp’s new administrative headquarters that opened January
2007.








40








Liabilities





Deposits.Total
deposits increased by $26,249,000, or 4.2% at December 31, 2007 to $652,773,000,
compared to $626,524,000 at December 31, 2006.  This increase was
primarily attributable to Bancorp’s expanded deposit products and its desire to
maintain its competitive edge in the community.  This resulted in
growth in certificates of deposit and interest bearing checking accounts
partially offset by a decrease in money market accounts.  The net
increase in deposits was primarily used to fund loan growth.





FHLB Advances.FHLB
advances increased $17,000,000, or 9.8% at December 31, 2007 to $190,000,000,
compared to $173,000,000 at December 31, 2006.  This increase was the
result of management’s decision to borrow funds from FHLB at more favorable
rates than would have been necessary to attract the needed funds through
customer deposits.





Subordinated
Debentures.  Bancorp has a non-consolidated subsidiary trust,
Severn Capital Trust I, of which 100% of the common equity is owned by
Bancorp.  The trust was formed for the purpose of issuing
corporation-obligated mandatorily redeemable capital securities (“capital
securities”) to third-party investors and investing the proceeds from the sale
of such capital securities solely in subordinated debt securities of Bancorp
(“debentures”).  The debentures held by the trust are the sole assets
of the trust.  Distributions on the capital securities issued by the
trust are payable quarterly at a rate per annum equal to the interest rate being
earned by the trust on the debentures held by the trust.  The capital
securities are subject to mandatory redemption, in whole or in part, upon
repayment of the debentures.  Bancorp has entered into an agreement
which, taken collectively, fully and unconditionally guarantees the capital
securities subject to the terms of the guarantee.  The debentures held
by Severn Capital Trust I are first redeemable, in whole or in part, by Bancorp
on January 7, 2010.





The
subordinated debentures from Bancorp to the trust consist of a $20,619,000 note,
which is at a floating rate of interest of LIBOR (5.24% at December 31, 2007)
plus 200 basis points, and matures in 2035.





Off-Balance Sheet
Arrangements.  Bancorp has certain outstanding commitments and
obligations that could impact Bancorp’s financial condition, liquidity, revenues
or expenses.  These commitments and obligations include standby
letters of credit, home equity lines of credit, loan commitments, lines of
credit, and loans sold and serviced with limited repurchase
provisions.





Standby
letters of credit, which are obligations of Bancorp to guarantee performance of
borrowers to governmental entities, increased $3,498,000, or 58.0% as of
December 31, 2007 to $9,530,000, compared to $6,032,000 as of December 31, 2006.
In 2007, Bancorp experienced an increase in demand from its borrowers for letter
of credit requirements.





Unadvanced
construction loans decreased $26,509,000, or 25.3% as of December 31, 2007 to
$78,238,000, compared to $104,747,000 as of December 31, 2006. This decrease was
primarily the result of increased funding of existing construction loan
obligations in addition to a decrease in new construction loan
originations.





Home
equity lines of credit decreased $2,189,000, or 8.7%, as of December 31, 2007 to
$22,895,000, compared to $25,084,000 as of December 31, 2006.  This
decrease was a result of stronger competition for home equity loans during 2007.
Home equity lines of credit allow the borrowers to draw funds up to a specified
loan amount, from time to time.  Bancorp’s management believes it has
sufficient liquidity resources to have the funding available as these borrowers
draw on these loans.





Loan
commitments decreased $13,031,000, or 88.0%, as of December 31, 2007 to
$1,784,000, compared to $14,815,000 as of December 31, 2006. This decrease was a
result of a general slowdown in the demand for new loans at the end of 2007 and
the timing of loan commitments booked at year end.  Loan commitments
are obligations of Bancorp to provide loans, and such commitments are made in
the usual course of business.





Lines of
credit, which are obligations of Bancorp to fund loans made to certain
borrowers, increased $2,345,000, or 7.0%, to $35,840,000 as of December 31,
2007, compared to $33,495,000 as of December 31, 2006.  The increase
was a result of stronger demand for this type of loan product during
2007.  Bancorp’s management believes it has sufficient liquidity
resources to have the funding available as these borrowers draw on these
loans.





41






Loans
sold and serviced with limited repurchase provisions decreased $2,035,000, or
33.4%, as of December 31, 2007 to $4,054,000, compared to $6,089,000 as of
December 31, 2006.  This decrease was the result of the slowdown in
the market for loans sold on the secondary market.





Bancorp
uses the same credit policies in making commitments and conditional obligations
as it does for its on-balance sheet instruments.





Comparison of Results of
Operations for the Years Ended December 31, 2007 and 2006.





General.Bancorp’s
net income for the year ended December 31, 2007 was $11,111,000, or $1.10 per
share diluted.  This is compared to $15,748,000, or $1.56 per share
diluted in 2006.  This decrease of $4,637,000, or 29.4%, was
primarily the result of Bancorp experiencing similar challenges faced by many
institutions caused by the slowdown in the real estate market, including
increased loan delinquencies and a compression of its interest rate margin, as
well as increased occupancy costs.





Net Interest
Income.Net interest income (interest earned net of interest
charges) decreased $4,477,000, or 11.7%, to $33,638,000 for the year ended
December 31, 2007, compared to $38,115,000 for the year ended December 31,
2006.  This decrease was primarily due to a decrease in Bancorp’s
interest rate spread partially offset by an increase in its loan
portfolio.  Bancorp’s interest rate spread decreased by 0.74% to 3.46%
for the year ended December 31, 2007, compared to 4.20% for the year ended
December 31, 2006.  This decrease was the result of a decrease in
interest rates earned on its loans, while the interest rates paid on its
interest bearing liabilities increased.    Bancorp is
uncertain whether it will be able to reduce the interest rate paid on its
interest bearing liabilities by attracting lower cost deposits, due to the
general expectation of continued increased competition for deposit
accounts.





Provision for Loan
Losses.TheBank’s loan portfolio is
subject to varying degrees of credit risk and an allowance for loan losses is
maintained to absorb losses inherent in its loan portfolio.  Credit
risk includes, but is not limited to, the potential for borrower default and the
failure of collateral to be worth what the Bank determined it was worth at the
time of the granting of the loan.  The Bank monitors its loan
portfolio at least as often as quarterly and its loan delinquencies at least as
often as monthly.  All loans that are delinquent and all loans within
the various categories of the Bank’s portfolio as a group are
evaluated.  The Bank’s Board, with the advice and recommendation of
the Bank’s delinquency committee, estimates an allowance to be set aside for
loan losses.  Included in determining the calculation are such factors
as the inherent risk contained within the portfolio after considering the state
of the general economy, economic trends, consideration of particular risks
inherent in different kinds of lending and consideration of known information
that may affect loan collectibility.  An increase in the loan loss
provision from the beginning of the year to the end of a year is the result
after an analysis of the aforementioned factors and applying that rationale to
the total portfolio.





As more
commercial and higher loan-to-value loans are contained in the portfolio, the
greater the allowance for loan losses will be.  Changes in estimation
methods may take place based upon the status of the economy and the estimate of
the value of collateral and, as a result, the allowance may increase or
decrease.  The loan loss allowance has increased when the Board
believes trends are negative and contributions to the allowance have decreased
when trends are more positive.  Management believes that the allowance
for loan losses is adequate.





The total
allowance for loan losses increased $1,755,000, or 19.4% to $10,781,000 as of
December 31, 2007, compared to $9,026,000 as of December 31,
2006.  The increase was a result of the current year’s addition to the
allowance partially offset by charge offs incurred.   During the
year ended December 31, 2007, the provision for loan losses was $2,462,000
compared to $1,561,000 for the year ended December 31, 2006.  This
increase of $901,000 or 57.7% was a result of an increase in loan delinquencies,
an increase in the loan portfolio, and management’s determination that adding to
the provision for loan losses was appropriate for the level of inherent risk in
its portfolio as compared to the year ended December 31, 2006.






42







Other Income and Non Interest
Expenses.Revenues from mortgage banking activities decreased
$242,000, or 29.6% to $575,000 for the year ended December 31, 2007, compared to
$817,000 for the year ended December 31, 2006.  This decrease was
primarily the result of a $180,000 decrease in gain on sale of loans, and a
decrease in mortgage processing and servicing fees of $55,000 for the year ended
December 31, 2007 compared to the year ended December 31, 2006.  These
decreases were attributable to a general slowdown in loan activity, which
resulted in fewer loans sold on the secondary market during 2007 and less
mortgage processing and servicing fees during 2007.





Real
estate commissions increased $433,000, or 21.5% to $2,451,000 for the year ended
December 31, 2007, compared to $2,018,000 for the year ended December 31,
2006.  This increase was primarily the result of commissions earned on
large settlements that took place during 2007.  Real estate management
fees increased $75,000, or 13.0% to $653,000 for the year ended December 31,
2007, compared to $578,000 for the year ended December 31, 2006. This increase
was primarily due to additional properties being managed in 2007.





Other
non-interest income increased $203,000, or 44.7% to $657,000 for the year ended
December 31, 2007, compared to $454,000 for the year ended December 31,
2006. This increase was primarily a result of a one-time gain of $105,000
realized on a sale of an investment by Crownsville, and miscellaneous fees
collected by the Bank.





Compensation
and related expenses increased $736,000, or 7.1% to $11,070,000 for the year
ended December 31, 2007, compared to $10,334,000 for the year ended December 31,
2006.  This increase was primarily the result of higher health care
costs paid by Bancorp, and salary rate increases.  As of December 31,
2007, Bancorp had 118 full-time equivalent employees compared to 121 at December
31, 2006.





Occupancy
increased $990,000, or 140.2% to $1,696,000 for the year ended December 31,
2007, compared to $706,000 for the year ended December 31, 2006.  This
increase was primarily due to increased depreciation incurred on the new
headquarters by HS.





Other
non-interest expense increased $701,000, or 23.2% to $3,726,000 for the year
ended December 31, 2007, compared to $3,025,000 for the year ended December 31,
2006.  This increase was primarily the result of a $261,000 increase
in costs incurred relating to foreclosed real estate, a $192,000 increase in
legal fees relating to loan delinquencies, a $173,000 increase in advertising
relating to new product promotions and a $101,000 increase in professional fees
relating to new policy development for the year ended December 31, 2007,
compared to the year ended December 31, 2006.





Income
Taxes.  Income taxes decreased $2,699,000, or 25.4% to
$7,909,000 for the year ended December 31, 2007, compared to $10,608,000 for the
year ended December 31, 2006 due to lower pretax income.  The
effective tax rate for the years ended December 31, 2007 and 2006 was 41.6% and
40.2%, respectively.





Comparison
of Operating Results for the Years Ended December 31, 2006 and 2005





General.Bancorp’s
net income for the year ended December 31, 2006 was $15,748,000, or $1.56 per
share diluted.  This compared to $14,554,000, or $1.45 per share
diluted in 2005.  This increase of $1,194,000, or 8.2%, was primarily
the result of the growth in Bancorp’s mortgage portfolio and Bancorp’s continued
ability to maintain low operating expenses.





Net Interest
Income.Net interest income (interest earned net of interest
charges) increased $2,935,000, or 8.3% to $38,115,000 for the year ended
December 31, 2006, compared to $35,180,000 for the year ended December 31,
2005.  This increase was primarily due to the growth in the loan
portfolio, which offset a 0.15% decrease in Bancorp’s interest rate spread to
4.20% for the year ended December 31, 2006, compared to 4.35% for the year ended
December 31, 2005.  Bancorp’s interest rate spread decreased over the
past year because interest rates earned on the Bank’s loans have risen slower
than the rise in interest rates paid on the Bank’s interest bearing
liabilities.





Provision for Loan
Losses.The total allowance for loan losses increased
$1,521,000, or 20.3%, to $9,026,000 as of December 31, 2006, compared to
$7,505,000 as of December 31, 2005.  This increase was a result of the
addition to the allowance and minimal charge offs being incurred
in  2006.   During the year ended December 31, 2006,
the provision for loan losses was $1,561,000 compared to $1,570,000 for the year
ended December 31, 2005.  This decrease of $9,000 or 0.6%, was a
result of slower loan growth and management’s determination that adding to the
provision for loan losses was appropriate for the level of inherent risk in its
portfolio as compared to the year ended December 31, 2005.





43






Other Income and Non Interest
Expenses.Revenues from mortgage banking activities decreased
$599,000, or 42.3%, to $817,000 for the year ended December 31, 2006, compared
to $1,416,000 for the year ended December 31, 2005.  This decrease was
primarily the result of a $159,000 decrease in mortgage processing and servicing
fees and a $440,000 decrease in the gain on sale of loans for the year ended
December 31, 2006 compared to the year ended December 31, 2005.  These
decreases were attributable to a general slowdown in loan activity, which
resulted in fewer loans sold on the secondary market during 2006 and less
mortgage processing and servicing fees during 2006.





Real
estate commissions increased $1,473,000, or 270.3%, to $2,018,000 for the year
ended December 31, 2006, compared to $545,000 for the year ended December 31,
2005.  This increase was primarily the result of commissions earned on
several large settlements that took place during 2006.  Real estate
management fees increased $152,000, or 35.7%, to $578,000 for the year ended
December 31, 2006, compared to $426,000 for the year ended December 31, 2005.
This increase was primarily due to additional properties being managed in
2006.





Other
non-interest income increased $93,000, or 25.8%, to $454,000 for the year ended
December 31, 2006, compared to $361,000 for the year ended December 31,
2005. This increase was primarily a result of an increase in rents
collected and savings charges.





Compensation
and related expenses increased $1,254,000, or 13.8%, to $10,334,000 for the year
ended December 31, 2006, compared to $9,080,000 for the year ended December 31,
2005.  This increase was the result of additional Bank employees
hired, higher commissions paid on loan growth, and salary rate
increases.  As of December 31, 2006, Bancorp had 121 full-time
equivalent employees compared to 111 at December 31, 2005.





Occupancy
decreased $13,000, or 1.8%, to $706,000 for the year ended December 31, 2006,
compared to $719,000 for the year ended December 31, 2005.





Other
non-interest expense decreased $54,000, or 1.8%, to $3,025,000 for the year
ended December 31, 2006, compared to $3,079,000 for the year ended December 31,
2005. This decrease was primarily a result of a one-time cash
reconciliation charge off of $135,000 in 2005 and a decrease in miscellaneous
expenses of approximately $67,000, partially offset by increases in professional
fees of approximately $68,000 and an increase in advertising expenses of
approximately $97,000.





Income
Taxes.  Income taxes increased $1,682,000, or 18.8%, to
$10,608,000 for the year ended December 31, 2006, compared to $8,926,000 for the
year ended December 31, 2005.  The effective tax rate for the years
ended December 31, 2006 and 2005 was 40.2% and 38.0%, respectively.





Liquidity
and Capital Resources.





Bancorp’s
liquidity is determined by its ability to raise funds through loan repayments,
maturing investments, deposits, borrowed funds, capital, or the sale of
loans.  Based on the internal and external sources available,
Bancorp’s liquidity position exceeded anticipated short-term and long-term needs
at December 31, 2007.  Core deposits, considered to be stable funding
sources and defined to include all deposits except time deposits of $100,000 or
more, equaled 64% of total deposits at December 31, 2007.  The Bank’s
experience is that a substantial portion of certificates of deposit will renew
at time of maturity and will remain on deposit with the
Bank.  Additionally, loan payments, maturities, deposit growth and
earnings contribute a flow of funds available to meet liquidity
requirements.





In
addition to its ability to generate deposits, Bancorp has external sources of
funds, which may be drawn upon when desired.  The primary source of
external liquidity is an available line of credit equal to 30% of the Bank’s
assets with FHLB-Atlanta.  The available line of credit with
FHLB-Atlanta was $288,670,000 at December 31, 2007, of which $190,000,000 was
outstanding at that time.  Short-term borrowings were $15,000,000 and
long-term advances were $175,000,000.








44





The
maturities of these long-term advances at December 31, 2007 are as follows
(dollars in thousands):





Description
            
            Rate
            
            
            Amount
            
            MaturityFHLB
      advances
            
            3.33%
      to 5.012%
            
            
            
            37,000
            
            2008FHLB
      advances
            
            4.995%
      to 4.996%
            
            
            
            13,000
            
            2009FHLB
      advances
            
            
            5.00
            %
            
            
            10,000
            
            2010FHLB
      advances
            
            
            -
            %
            
            
            -
            
            2011FHLB
      advances
            
            
            -
            %
            
            
            -
            
            2012FHLB
      advances
            
            2.64%
      to 4.430%
            
            
            
            115,000
            
            Thereafter$
            175,000


























Contractual
Obligations





The following table contains for the
periods indicated information regarding the financial obligations owing by
Bancorp under contractual obligations.





Payments
      due by period
              (dollars
      in thousands)Less
      than
            
            
            
            
            
            
            
            
            More
      thanTotal
            
            
            1 year
            
            
            1 to 3 years
            
            
            3 to 5 years
            
            
            5 yearsLong
      term debt
            
            $
            175,000
            
            
            $
            37,000
            
            
            $
            23,000
            
            
            $
            -
            
            
            $
            115,000Subordinated
      debentures
            
            
            20,619
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            20,619Operating
      lease obligations
            
            
            225
            
            
            
            94
            
            
            
            131
            
            
            
            -
            
            
            
            -Certificates
      of Deposit
            
            
            523,698
            
            
            
            442,996
            
            
            
            46,329
            
            
            
            34,260
            
            
            
            113Total
            
            $
            719,542
            
            
            $
            480,090
            
            
            $
            69,460
            
            
            $
            34,260
            
            
            $
            135,732







45





Item 7A. Quantitative and
Qualitative Disclosures About Market Risk





Qualitative Information About Market
Risk.The principal objective of Bancorp’s interest rate risk
management is to evaluate the interest rate risk included in balance sheet
accounts, determine the level of risks appropriate given Bancorp’s business
strategy, operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with Bancorp’s interest
rate risk management policy.  Through this management, Bancorp seeks
to reduce the vulnerability of its operations to changes in interest
rates.  The Board of Directors of Bancorp is responsible for reviewing
assets/liability policies and interest rate risk position.  The Board
of Directors reviews the interest rate risk position on a quarterly basis and,
in connection with this review, evaluates Bancorp’s business activities and
strategies, the effect of those strategies on Bancorp’s net interest margin and
the effect that changes in interest rates will have on Bancorp’s loan
portfolio.  While continuous movement of interest rates is certain,
the extent and timing of these movements is not always
predictable.  Any movement in interest rates has an effect on
Bancorp’s profitability.  Bancorp faces the risk that rising interest
rates could cause the cost ofinterest bearing
liabilities, such as deposits and borrowings, to rise faster than the yield on
interest earning assets, such as loans and investments.  Bancorp’s
interest rate spread and interest rate margin may be negatively impacted in a
declining interest rate environment even though Bancorp generally borrows at
short-term interest rates and lends at longer-term interest
rates.  This is because loans and other interest earning assets may be
prepaid and replaced with lower yielding assets before the supporting interest
bearing liabilities reprice downward.  Bancorp’s interest rate margin
may also be negatively impacted in a flat or inverse-yield curve
environment.  Mortgage origination activity tends to increase when
interest rates trend lower and decrease when interest rates rise.





Bancorp’s
primary strategy to control interest rate risk is to sell substantially all
long-term fixed-rate loans in the secondary market.  To further
control interest rate risk related to its loan servicing portfolio, Bancorp
originates a substantial amount of construction loans that typically have terms
of one year or less.  The turnover in construction loan portfolio
assists Bancorp in maintaining a reasonable level of interest rate
risk.





Quantitative Information About Market
Risk.The primary market risk facing Bancorp is interest rate
risk.  From an enterprise prospective, Bancorp manages this risk by
striving to balance its loan origination activities with the interest rate
market.  Bancorp attempts to maintain a substantial portion of its
loan portfolio in short-term loans such as construction loans.  This
has proven to be an effective hedge against rapid increases in interest rates as
the construction loan portfolio reprices rapidly.





The
matching of maturity or repricing of interest earning assets and interest
bearing liabilities may be analyzed by examining the extent to which these
assets and liabilities are interest rate sensitive and by monitoring the Bank’s
interest rate sensitivity gap.  An interest earning asset or interest
bearing liability is interest rate sensitive within a specific time period if it
will mature or reprice within that time period.  The difference
between rate sensitive assets and rate sensitive liabilities represents the
Bank’s interest sensitivity gap.





Exposure
to interest rate risk is actively monitored by Bancorp’s
management.  Its objective is to maintain a consistent level of
profitability within acceptable risk tolerances across a broad range of
potential interest rate environments.  Bancorp uses the OTS Net
Portfolio Value (“NPV”) model to monitor its exposure to interest rate risk,
which calculates changes in NPV.  The following table represents
Bancorp’s NPV at December 31, 2007.  The NPV was calculated by the
OTS, based upon information provided to the OTS.







INTEREST
RATE SENSITIVITY OF NET PORTFOLIO VALUE (NPV)




Net
      Portfolio Value
            
            
            NPV
      as % of PV of AssetsChange In Rates
            
            
            $ Amount
            
            
            $ Change
            
            
            % Change
            
            
            NPV Ratio
            
            
            Change(dollars
      are in thousands)+300
            bp
            
            
            106,592
            
            
            
            (19,373
            )
            
            
            (15
            %)
            
            
            11.28
            %
            
            
            (156
            bp)+200
            bp
            
            
            115,018
            
            
            
            (10,948
            )
            
            
            (9
            %)
            
            
            12.00
            %
            
            
            (84
            bp)+100
            bp
            
            
            121,626
            
            
            
            (4,339
            )
            
            
            (3
            %)
            
            
            12.53
            %
            
            
            (31
            bp)+50
            bp
            
            
            124,072
            
            
            
            (1,894
            )
            
            
            (2
            %)
            
            
            12.71
            %
            
            
            (13
            bp)0
            bp
            
            
            125,965
            
            
            
            
            
            
            
            
            
            
            
            12.84
            %-50
            bp
            
            
            126,679
            
            
            
            714
            
            
            
            1
            %
            
            
            12.85
            %
            
            
            1
            bp-100
            bp
            
            
            128,263
            
            
            
            2,297
            
            
            
            2
            %
            
            
            12.95
            %
            
            
            11
            bp-200
            bp
            
            
            127,758
            
            
            
            1,793
            
            
            
            1
            %
            
            
            12.77
            %
            
            
            (7
            bp)





The above
table suggests that if interest rates rise 100 bps, Bancorp’s interest sensitive
assets would decline in value by $4,339,000.





46






Item 8.  Financial
Statements and Supplementary Data





Financial statements and
supplementary data are included herein at pages F-1 through F-33.








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





None.





Item 9A.  Controls
and Procedures
































47







MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING








Severn
Bancorp, Inc. (“Bancorp”) is responsible for the preparation, integrity, and
fair presentation of the consolidated financial statements included in this
annual report.  The consolidated financial statements and notes
included in this annual report have been prepared in conformity with United
States generally accepted accounting principles, and as such, include some
amounts that are based on management’s best estimates and
judgments.





Bancorp’s
management is responsible for establishing and maintaining effective internal
control over financial reporting.  The system of internal control over
financial reporting, as it relates to the financial statements, is evaluated for
effectiveness by management and tested for reliability through a program of
internal audits and management testing and review.  Actions are taken
to correct potential deficiencies as they are identified.  Any system
of internal control, no matter how well designed, has inherent limitations,
including the possibility that a control can be circumvented or overridden and
misstatements due to error or fraud may occur and not be
detected.  Also, because of changes in conditions, internal control
effectiveness may vary over time.  Accordingly, even an effective
system of internal control will provide only reasonable assurance with respect
to financial statement preparation.





Management
assessed the effectiveness of Bancorp’s internal control over financial
reporting as of December 31, 2007.  In making this assessment, it used
the criteria set forth by the Committee of Sponsorship Organizations of the
Treadway Commission (COSO) in Internal Control – Integrated
Framework.  Based
on its assessment, management concluded that as of December 31, 2007, Bancorp’s
internal control over financial reporting is effective and meets the criteria of
the Internal Control–
Integrated
Framework.





Bancorp’s
independent registered public accounting firm, Beard Miller Company LLP, has
issued an attestation report on Bancorp’s internal control over financial
reporting.  This report appears on pages 49 and 50.







/s/
      Alan J. Hyatt
            
            /s/
      Thomas G. BevivinoAlan
      J. Hyatt
            
            Thomas
      G. BevivinoPresident
      and Chief Executive Officer
            
            Principal
      Financial Officer











48








REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
    To the
Board of Directors and
 Stockholders
of Severn Bancorp, Inc.
   We have audited Severn Bancorp Inc.’s
internal control over financial reporting as of December 31, 2007, based on
criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Severn Bancorp Inc.’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting
included in the accompanying Management’s Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion on the
company’s internal control over financial reporting based on our
audit.
  We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
  A company’s internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
  Because of its inherent limitations,
internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
  In our
opinion, Severn Bancorp Inc. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2007, based on
criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO)
 49
  We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated statements of financial
condition and the related consolidated statements of income, stockholders’
equity and cash flows of Severn Bancorp Inc. and Subsidiaries, and our report
dated February 28, 2008 expressed an unqualified opinion.
  
 /s/ Beard
Miller Company LLP
  Beard
Miller Company LLP
 Baltimore,
Maryland
 February
28, 2008











50





Item 9B.  Other
Information















PART III





Item
10.  Directors and Executive Officers of the Registrant and Corporate
Governance

























Item
11.  Executive Compensation





Reference is made to the section
captioned “Executive and Director Compensation” in Bancorp's Proxy Statement for
the information required by this Item, which is hereby incorporated by
reference.











51







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





Reference is made to the section
captioned “Stock Ownership” “Principal Stockholders” and “Executive and Director
Compensation” in Bancorp's Proxy Statement for the information required by this
Item, which is hereby incorporated by reference.  The following table
provides certain information as of December 31, 2007 with respect to Bancorp’s
equity based compensation plans.








Number
      of
            
            
            
            Number
      ofsecurities
      to be
            
            
            
            securitiesissued
      upon
            
            Weighted-average
            
            remaining
      availableexercise
      of
            
            exercise
      price of
            
            for
      future issuanceoutstanding
            
            outstanding
            
            under
      equityoptions,
      warrants
            
            options,
      warrants
            
            compensationPlan
      Category
            
            and
      rights
            
            and
      rights
            
            plansEquity
      compensationplan
      approved bysecurity
      holders
            
            122,815
            
            $15.85
            
            -Equity
      compensationplans
      not approved bysecurity
      holders
            
            -
            
            -
            
            -Total
            
            122,815
            
            $15.85
            
            -








Item 13.  Certain
Relationships and Related Transactions, and Director
Independence















Item
14.  Principal Accounting Fees and Services













52







PART IV





Item
15.  Exhibits, Financial Statement Schedules





(a)                The
following consolidated financial statements of Bancorp and its wholly owned
sub­sidiaries are filed as part of this report:





1.          Financial
Statements


·REPORTS OF BEARD
MILLER COMPANY LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.


·CONSOLIDATED
STATEMENTS OF FINANCIAL CONDITION AT DECEMBER 31, 2007 AND DECEMBER 31,
2006


·CONSOLIDATED
STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2007, 2006, AND
2005


·CONSOLIDATED
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2007, 2006, AND
2005


·CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2007, 2006
AND 2005.


·NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





2.          Financial Statement
Schedules


All
financial statement schedules have been omitted, as required information is
either inapplicable or included in the consolidated financial statements or
related notes.





3.          Exhibits


The following exhibits are filed as
part of this report:





Exhibit
No.                      Description of
Exhibit





3.1            Articles of
Incorporation of Severn Bancorp, Inc.(1)


3.2            Bylaws of
Severn Bancorp, Inc., as amended


10.1+                   Description
of compensation of directors and officers


10.2+                   Stock
Option Plan (3)


10.3+                   Employee
Stock Ownership Plan (1)


10.4+                   Form
of Common Stock Option Agreement(4)


14                       
Code of Ethics (2)


21.1                     Subsidiaries
of Severn Bancorp, Inc.(5)


23.1                     Consent
of Independent Registered Public Accounting Firm


31.1                     Certification
of CEO pursuant to Section 302 of Sarbanes-Oxley Act of 2002


31.2                     Certification
of CFO pursuant to Section 302 of Sarbanes-Oxley Act of 2002


32                       
Certification of CEO and CFO pursuant to Section 906 of Sarbanes-Oxley Act of
2002





+ Denotes
management contract, compensatory plan or arrangement.





(1)Incorporated by reference from
Bancorp's Registration Statement on Form 10 filed with the Securities and
Exchange Commission on June 7, 2002.





(2)Incorporated by reference from
Bancorp's 2003 Form 10-K filed with the Securities and Exchange Commission on
March 25, 2004.





(3)Incorporated by reference from
Bancorp's 2004 Form 10-K filed with the Securities and Exchange Commission on
March 21, 2005.





(4)Incorporated by reference
from Bancorp’s Current Report on Form 8-K filed with the Securities and Exchange
Commission on March 20, 2006.





(5)Incorporated by reference from
Bancorp’s 2006 Form 10-K filed with the Securities and Exchange Commission on
March 14, 2007.








53








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.





SEVERN BANCORP, INC.





March 11,
2008                                                           /s/ Alan J.
Hyatt


Alan J. Hyatt


Chairman of the Board,
President,


Chief Executive Officer and
Director


54





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.





March 11,
2008                                                           /s/ Alan J.
Hyatt


Alan J. Hyatt


Chairman of the Board,


President, Chief Executive
Officer


and
Director





March 11,
2008                                                           /s/ Thomas G.
Bevivino


Thomas G. Bevivino, Executive
Vice


President
and Chief Financial Officer





March 11,
2008                                                           /s/ S. Scott
Kirkley


S. Scott
Kirkley, Executive Vice


President,
Secretary, Treasurer and Director





March 11,
2008                                                           /s/ Melvin E. Meekins,
Jr.


Melvin E.
Meekins, Jr.,


Vice
Chairman of the Board





March 11,
2008                                                           /s/Melvin
Hyatt


Melvin Hyatt, Director





March 11,
2008                                                           /s/ Ronald P.
Pennington


Ronald P.
Pennington, Director





March 11,
2008                                                           /s/ T. Theodore
Schultz


T.
Theodore Schultz, Director





March 11,
2008                                                           /s/ Albert W.
Shields


Albert W.
Shields, Director





March 11,
2008                                                           /s/ Louis DiPasquale,
Jr.


Louis DiPasquale, Jr.,
Director





March 11,
2008                                                           /s/ Keith
Stock


Keith Stock, Director








55