REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM













To the
Board of Directors and


Stockholders
of Severn Bancorp, Inc.








We have audited the accompanying
consolidated statements of financial condition of Severn Bancorp, Inc. and
Subsidiaries as of December 31, 2008 and 2007, and the related consolidated
statements of income, stockholders’ equity, and cash flows for each of the years
in the three-year period ended December 31, 2008.  Severn Bancorp,
Inc.’s management is responsible for these financial statements. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
   We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. The Company is not required to have, nor were we engaged to
perform, an audit of its internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
   In our opinion, the financial
statements referred to above present fairly, in all material respects, the
financial position of Severn Bancorp, Inc. and Subsidiaries as of December 31,
2008 and 2007, and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 2008 in conformity with
accounting principles generally accepted in the United States of
America.
  
  /s/ Beard Miller
Company LLP
  Beard
Miller Company LLP
 Baltimore,
Maryland
 March 2,
2009















F-1





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


CONSOLIDATED STATEMENTS OF
FINANCIAL CONDITION


(dollars
in thousands, except per share data)





December
      31,2008
                                  
                                  
                                  2007ASSETSCash
      and due from banks
                                  
                                  $
                                  14,082
                                  
                                  
                                  $
                                  6,415Interest
      bearing deposits in other banks
                                  
                                  
                                  271
                                  
                                  
                                  
                                  814Federal
      funds sold
                                  
                                  
                                  17,952
                                  
                                  
                                  
                                  4,037Cash
      and cash equivalents
                                  
                                  
                                  32,305
                                  
                                  
                                  
                                  11,266Investment
      securities held to maturity
                                  
                                  
                                  1,345
                                  
                                  
                                  
                                  2,383Loans
      held for sale
                                  
                                  
                                  453
                                  
                                  
                                  
                                  1,101Loans
      receivable, net of allowance for loan losses of$14,813
      and $10,781, respectively
                                  
                                  
                                  896,006
                                  
                                  
                                  
                                  891,913Premises
      and equipment, net
                                  
                                  
                                  30,267
                                  
                                  
                                  
                                  31,289Federal
      Home Loan Bank stock at cost
                                  
                                  
                                  8,694
                                  
                                  
                                  
                                  10,172Accrued
      interest receivable and other assets
                                  
                                  
                                  18,581
                                  
                                  
                                  
                                  14,110Total
      assets
                                  
                                  $
                                  987,651
                                  
                                  
                                  $
                                  962,234LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilitiesDeposits
                                  
                                  $
                                  683,866
                                  
                                  
                                  $
                                  652,773Short-term
      borrowings
                                  
                                  
                                  -
                                  
                                  
                                  
                                  15,000Long-term
      borrowings
                                  
                                  
                                  153,000
                                  
                                  
                                  
                                  175,000Subordinated
      debentures
                                  
                                  
                                  24,119
                                  
                                  
                                  
                                  20,619Accrued
      interest payable and other liabilities
                                  
                                  
                                  2,999
                                  
                                  
                                  
                                  3,566Total
      liabilities
                                  
                                  
                                  863,984
                                  
                                  
                                  
                                  866,958Stockholders’ EquityPreferred
      stock, $0.01 par value, 1,000,000 shares authorized:Preferred
      stock series “A”,  437,500 and 0 shares issued and
      outstanding
                                  
                                  
                                  4
                                  
                                  
                                  
                                  -Preferred
      stock series “B”,  23,393 and 0 shares issued and
      outstanding
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Common
      stock, $0.01 par value, 20,000,000 shares authorized;10,066,679
      shares issued and outstanding
                                  
                                  
                                  101
                                  
                                  
                                  
                                  101Additional
      paid-in capital
                                  
                                  
                                  73,522
                                  
                                  
                                  
                                  46,768Retained
      earnings
                                  
                                  
                                  50,040
                                  
                                  
                                  
                                  48,407Total
      stockholders' equity
                                  
                                  
                                  123,667
                                  
                                  
                                  
                                  95,276Total
      liabilities and stockholders' equity
                                  
                                  $
                                  987,651
                                  
                                  
                                  $
                                  962,234











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




F-2





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


CONSOLIDATED STATEMENTS OF
INCOME


(dollars
in thousands, except per share data)





Years
      Ended December 31,Interest Income
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006Loans
                          
                          $
                          61,703
                          
                          
                          $
                          70,275
                          
                          
                          $
                          68,610Securities,
      taxable
                          
                          
                          74
                          
                          
                          
                          217
                          
                          
                          
                          266Other
                          
                          
                          695
                          
                          
                          
                          1,322
                          
                          
                          
                          1,299Total
      interest income
                          
                          
                          62,472
                          
                          
                          
                          71,814
                          
                          
                          
                          70,175Interest ExpenseDeposits
                          
                          
                          25,950
                          
                          
                          
                          29,347
                          
                          
                          
                          23,706Short-term
      borrowings
                          
                          
                          62
                          
                          
                          
                          488
                          
                          
                          
                          438Long-term
      borrowings and subordinated debentures
                          
                          
                          7,491
                          
                          
                          
                          8,341
                          
                          
                          
                          7,916Total
      interest expense
                          
                          
                          33,503
                          
                          
                          
                          38,176
                          
                          
                          
                          32,060Net
      interest income
                          
                          
                          28,969
                          
                          
                          
                          33,638
                          
                          
                          
                          38,115Provision
      for loan losses
                          
                          
                          7,481
                          
                          
                          
                          2,462
                          
                          
                          
                          1,561Net
      interest income after provision for loan losses
                          
                          
                          21,488
                          
                          
                          
                          31,176
                          
                          
                          
                          36,554Other IncomeMortgage
      banking activities
                          
                          
                          339
                          
                          
                          
                          575
                          
                          
                          
                          817Real
      estate commissions
                          
                          
                          1,035
                          
                          
                          
                          2,451
                          
                          
                          
                          2,018Real
      estate management fees
                          
                          
                          664
                          
                          
                          
                          653
                          
                          
                          
                          578Other
      income
                          
                          
                          753
                          
                          
                          
                          657
                          
                          
                          
                          454Total
      other income
                          
                          
                          2,791
                          
                          
                          
                          4,336
                          
                          
                          
                          3,867Non-Interest ExpensesCompensation
      and related expenses
                          
                          
                          9,117
                          
                          
                          
                          11,070
                          
                          
                          
                          10,334Occupancy
                          
                          
                          1,640
                          
                          
                          
                          1,696
                          
                          
                          
                          706Foreclosed
      real estate expenses, net
                          
                          
                          892
                          
                          
                          
                          231
                          
                          
                          
                          -Legal
      Fees
                          
                          
                          719
                          
                          
                          
                          341
                          
                          
                          
                          141Other
                          
                          
                          4,925
                          
                          
                          
                          3,154
                          
                          
                          
                          2,884Total
      non-interest expenses
                          
                          
                          17,293
                          
                          
                          
                          16,492
                          
                          
                          
                          14,065Income
      before income tax provision
                          
                          
                          6,986
                          
                          
                          
                          19,020
                          
                          
                          
                          26,356Income
      tax provision
                          
                          
                          2,873
                          
                          
                          
                          7,909
                          
                          
                          
                          10,608Net
      income
                          
                          $
                          4,113
                          
                          
                          $
                          11,111
                          
                          
                          $
                          15,748Amortization
      of discount on preferred stock
                          
                          
                          29
                          
                          
                          
                          -
                          
                          
                          
                          -Dividends
      on preferred stock
                          
                          
                          165
                          
                          
                          
                          -
                          
                          
                          
                          -Net
      income available to common stockholders
                          
                          $
                          3,919
                          
                          
                          $
                          11,111
                          
                          
                          $
                          15,748Basic
      earnings per share
                          
                          $
                          0.39
                          
                          
                          $
                          1.10
                          
                          
                          $
                          1.56Diluted
      earnings per share
                          
                          $
                          0.39
                          
                          
                          $
                          1.10
                          
                          
                          $
                          1.56











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






F-2






SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY


Years Ended December 31,
2008, 2007, and 2006


(dollars
in thousands, except per share data)





Preferred
      Stock
                  
                  
                  Common
                    Stock
                  
                  
                  Additional
      Paid-In Capital
                  
                  
                  Retained
                    Earnings
                  
                  
                  Total
      Stockholders’ EquityBalance
      - December 31, 2005
                  
                  $
                  -
                  
                  
                  $
                  83
                  
                  
                  $
                  11,516
                  
                  
                  $
                  61,113
                  
                  
                  $
                  72,712Comprehensive
      IncomeNet
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  15,748
                  
                  
                  
                  15,74810%
      Stock dividend (914,943 shares)
                  
                  
                  -
                  
                  
                  
                  9
                  
                  
                  
                  16,576
                  
                  
                  
                  (16,585
                  )
                  
                  
                  -Stock-based
      compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  163
                  
                  
                  
                  -
                  
                  
                  
                  163Dividends
      on common stock($.22
      per share)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (2,196
                  )
                  
                  
                  (2,196
                  )Exercise
      of stock options (900 shares)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  15
                  
                  
                  
                  -
                  
                  
                  
                  15Balance
      - December 31, 2006
                  
                  
                  -
                  
                  
                  
                  92
                  
                  
                  
                  28,270
                  
                  
                  
                  58,080
                  
                  
                  
                  86,442Comprehensive
      IncomeNet
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  11,111
                  
                  
                  
                  11,11110%
      Stock dividend (915,004 shares)
                  
                  
                  -
                  
                  
                  
                  9
                  
                  
                  
                  18,357
                  
                  
                  
                  (18,366
                  )
                  
                  
                  -Stock-based
      compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  128
                  
                  
                  
                  -
                  
                  
                  
                  128Dividends
      on common stock($.24
      per share)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (2,418
                  )
                  
                  
                  (2,418
                  )Exercise
      of stock options (825 shares)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  13
                  
                  
                  
                  -
                  
                  
                  
                  13Balance
      - December 31, 2007
                  
                  
                  -
                  
                  
                  
                  101
                  
                  
                  
                  46,768
                  
                  
                  
                  48,407
                  
                  
                  
                  95,276Comprehensive
      IncomeNet
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4,113
                  
                  
                  
                  4,113Stock-based
      compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  128
                  
                  
                  
                  -
                  
                  
                  
                  128Dividends
      on common stock($.24
      per share)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (2,416
                  )
                  
                  
                  (2,416
                  )Dividend
      declared on Series Apreferred
      stock ($.08 per share)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (35
                  )
                  
                  
                  (35
                  )Series
      A preferred stock offering
                  
                  
                  4
                  
                  
                  
                  -
                  
                  
                  
                  3,249
                  
                  
                  
                  -
                  
                  
                  
                  3,253Series
      B preferred stock offering
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  23,348
                  
                  
                  
                  -
                  
                  
                  
                  23,348Amortized
      of discount on preferred stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  29
                  
                  
                  
                  (29
                  )
                  
                  
                  -Balance
      - December 31, 2008
                  
                  $
                  4
                  
                  
                  $
                  101
                  
                  
                  $
                  73,522
                  
                  
                  $
                  50,040
                  
                  
                  $
                  123,667











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








F-4





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


CONSOLIDATED STATEMENTS OF
CASH FLOWS


(dollars
in thousands)





Years
      Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006Cash Flows from Operating
      ActivitiesNet
      income
                      
                      $
                      4,113
                      
                      
                      $
                      11,111
                      
                      
                      $
                      15,748Adjustments
      to reconcile net income to netcash
      provided by operating activities:Amortization
      of deferred loan fees
                      
                      
                      (2,546
                      )
                      
                      
                      (3,263
                      )
                      
                      
                      (4,211
                      )Net
      amortization of premiums anddiscounts
                      
                      
                      3
                      
                      
                      
                      4
                      
                      
                      
                      31Provision
      for loan losses
                      
                      
                      7,481
                      
                      
                      
                      2,462
                      
                      
                      
                      1,561Provision
      for depreciation
                      
                      
                      1,336
                      
                      
                      
                      1,333
                      
                      
                      
                      362Gain
      on sale of loans
                      
                      
                      (248
                      )
                      
                      
                      (177
                      )
                      
                      
                      (357
                      )Gain
      on sale of foreclosed real estate
                      
                      
                      (209
                      )
                      
                      
                      -
                      
                      
                      
                      -Proceeds
      from loans sold to others
                      
                      
                      14,041
                      
                      
                      
                      20,366
                      
                      
                      
                      31,925Loans
      originated for sale
                      
                      
                      (13,145
                      )
                      
                      
                      (18,320
                      )
                      
                      
                      (31,322
                      )Stock-based
      compensation expense
                      
                      
                      128
                      
                      
                      
                      128
                      
                      
                      
                      163Increase
      in accrued interest receivableand
      other assets
                      
                      
                      (1,146
                      )
                      
                      
                      (1,513
                      )
                      
                      
                      (924
                      )Increase
      (decrease) in accrued interest payableand
      other liabilities
                      
                      
                      (322
                      )
                      
                      
                      (1,765
                      )
                      
                      
                      1,781Net
      cash provided by operating activities
                      
                      
                      9,486
                      
                      
                      
                      10,366
                      
                      
                      
                      14,757Cash Flows from Investing
      ActivitiesProceeds
      from maturing investment securities
                      
                      
                      1,000
                      
                      
                      
                      4,000
                      
                      
                      
                      -Principal
      collected on mortgage backed securities
                      
                      
                      35
                      
                      
                      
                      884
                      
                      
                      
                      988Net
      increase in loans
                      
                      
                      (20,317
                      )
                      
                      
                      (61,947
                      )
                      
                      
                      (54,710
                      )Proceeds
      from sale of foreclosed real estate
                      
                      
                      8,173
                      
                      
                      
                      1,319
                      
                      
                      
                      -Investment
      in premises and equipment
                      
                      
                      (314
                      )
                      
                      
                      (4,013
                      )
                      
                      
                      (10,813
                      )Proceeds
      from disposal of premises andequipment
                      
                      
                      -
                      
                      
                      
                      1,802
                      
                      
                      
                      3Purchase
      of FHLB stock
                      
                      
                      -
                      
                      
                      
                      (704
                      )
                      
                      
                      (955
                      )Redemption
      of FHLB stock
                      
                      
                      1,478
                      
                      
                      
                      -
                      
                      
                      
                      -Net
      cash used in investing activities
                      
                      
                      (9,945
                      )
                      
                      
                      (58,659
                      )
                      
                      
                      (65,487
                      )

















F-5





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


CONSOLIDATED STATEMENTS OF
CASH FLOWS (Continued)


(dollars
in thousands)





For
      the Years Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006Cash Flows from Financing
      ActivitiesNet
      increase in deposits
                      
                      $
                      31,093
                      
                      
                      $
                      26,249
                      
                      
                      $
                      31,631Net
      decrease in short term borrowings
                      
                      
                      (15,000
                      )
                      
                      
                      (3,000
                      )
                      
                      
                      (8,000
                      )Additional
      borrowed funds, long term
                      
                      
                      30,000
                      
                      
                      
                      40,000
                      
                      
                      
                      73,000Repayment
      of borrowed funds, long term
                      
                      
                      (52,000
                      )
                      
                      
                      (20,000
                      )
                      
                      
                      (50,000
                      )Common
      stock dividends paid
                      
                      
                      (2,416
                      )
                      
                      
                      (2,418
                      )
                      
                      
                      (2,196
                      )Series
      “A” preferred stock dividend paid
                      
                      
                      (35
                      )
                      
                      
                      -
                      
                      
                      
                      -Proceeds
      from sale of subordinated debentures
                      
                      
                      3,500
                      
                      
                      
                      -
                      
                      
                      
                      -Proceeds
      from sale of Series A preferred stock, net
                      
                      
                      3,253
                      
                      
                      
                      -
                      
                      
                      
                      -Proceeds
      from sale of Series B preferred stock, net
                      
                      
                      23,348
                      
                      
                      
                      -
                      
                      
                      
                      -Proceeds
      from exercise of options
                      
                      
                      -
                      
                      
                      
                      13
                      
                      
                      
                      15Payment
      of debt issuance costs
                      
                      
                      (245
                      )
                      
                      
                      -
                      
                      
                      
                      -Net
      cash provided by financing activities
                      
                      
                      21,498
                      
                      
                      
                      40,844
                      
                      
                      
                      44,450Increase
      (decrease) in cash and cash equivalents
                      
                      
                      21,039
                      
                      
                      
                      (7,449
                      )
                      
                      
                      (6,280
                      )Cash
      and cash equivalents at beginning of year
                      
                      
                      11,266
                      
                      
                      
                      18,715
                      
                      
                      
                      24,995Cash
      and cash equivalents at end of year
                      
                      $
                      32,305
                      
                      
                      $
                      11,266
                      
                      
                      $
                      18,715Supplemental
      disclosure of cash flows information:Cash
      paid during year for:Interest
                      
                      $
                      33,417
                      
                      
                      $
                      38,326
                      
                      
                      $
                      32,464Income
      taxes
                      
                      $
                      4,900
                      
                      
                      $
                      9,065
                      
                      
                      $
                      11,323Transfer
      of loans to foreclosed real estate
                      
                      $
                      15,258
                      
                      
                      $
                      3,342
                      
                      
                      $
                      970





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














F-6










SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
1 - Summary of
Significant Accounting Policies





A.
            Principles of Consolidation
      - The consolidated financial statements include the accounts of
      Severn Bancorp, Inc. ("Bancorp"), and its wholly-owned subsidiaries, Louis
      Hyatt, Inc., SBI Mortgage Company and SBI Mortgage Company's subsidiary,
      Crownsville Development Corporation, and its subsidiary, Crownsville
      Holdings I, LLC, and Severn Savings Bank, FSB ("the Bank"), and the Bank's
      subsidiaries, Homeowners Title and Escrow Corporation, Severn Financial
      Services Corporation, SSB Realty Holdings, LLC, SSB Realty Holdings II,
      LLC, and HS West, LLC. All intercompany accounts and transactions have
      been eliminated in the accompanying financial
  statements.B.
            Business - The Bank's
      primary business activity is the acceptance of depositsfrom
      the general public and the use of the proceeds for investments and loan
      originations. The Bank is subject to competition from other financial
      institutions.  In addition, the Bank is subject to the
      regulations of certain federal agencies and undergoes periodic
      examinations by those regulatory authorities.Bancorp
      has no reportable segments. Management does not separately allocate
      expenses, including the cost of funding loan demand, between the retail
      and real estate operations of Bancorp.C.
            Estimates - The
      consolidated financial statements have been prepared in conformity with
      accounting principles generally accepted in the United States of America.
      In preparing the financial statements, management is required to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities as of the date of the statement of financial condition and
      revenues and expenses for the period.  Actual results could
      differ significantly from those estimates. Material estimates that are
      particularly susceptible to significant change in the near-term relate to
      the determination of the allowance for loan losses and the fair value of
      foreclosed real estate.D.
            Investment Securities Held to
      Maturity – Investment securities for which the Bank has the
      positive intent and ability to hold to maturity are reported at cost,
      adjusted for premiums and discounts that are recognized in interest income
      using the interest method over the period to maturity.  Declines
      in the fair value of held to maturity securities below their cost that are
      deemed to be other than temporary are reflected in earnings as realized
      losses.  In estimating other than temporary impairment losses,
      management considers (1) the length of time and the extent to which the
      fair value has been less than cost, (2) the financial condition and near
      term prospects of the issuer, and (3) the intent and ability of the Bank
      to retain its investment in the issuer for a period of time sufficient to
      allow for any anticipated recovery in fair
  value.















F-7







SEVERN BANCORP, INC.AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS






Note
1 - Summary of
Significant Accounting Policies - Continued





E.
            Loans Held for Sale -
      Loans held for sale are carried at lower of cost or market value in the
      aggregate.  Net unrealized losses are recognized through a
      valuation allowance by charges to income.  Mortgage loans held
      for sale are generally sold with the mortgage servicing rights released by
      the Bank.  Gains and losses on sales of mortgage loans are
      recognized based on the difference between the selling price and the
      carrying value of the related mortgage loans sold.F.
            Loans - Loans that
      management has the intent and ability to hold for the foreseeable future
      or until maturity or pay-off generally are reported at their outstanding
      unpaid principal balances adjusted for charge-offs, the allowance for loan
      losses, and any deferred fees or costs on originated
      loans.  Interest income is accrued on the unpaid principal
      balance.  Loan origination fees, net of certain direct
      origination costs, are deferred and recognized as an adjustment of the
      related loan yield using the interest method.The
      accrual of interest on loans is discontinued at the time the loan is 90
      days past due.  Past due status is based on contractual terms of
      the loan.  In all cases, loans are placed on non-accrual or
      charged-off at an earlier date if collection of principal or interest is
      considered doubtful.All
      interest accrued but not collected for loans that are placed on
      non-accrual or charged-off is reversed against interest
      income.  The interest on these loans is accounted for on the
      cash-basis or cost-recovery method, until qualifying for return to
      accrual.  Loans are returned to accrual status when all the
      principal and interest amounts contractually due are brought current and
      future payments are reasonably assured.G.
            Allowance for Loan Losses
      - An allowance for loan losses is provided through charges to
      income in an amount that management believes will be adequate to absorb
      losses on existing loans that may become uncollectible, based on
      evaluations of the collectability of loans and prior loan loss
      experience.  The evaluations take into consideration such
      factors as changes in the nature and volume of the loan portfolio, overall
      portfolio quality, review of specific problem loans, and current economic
      conditions that may affect the borrowers' ability to
      pay.  Determining the amount of the allowance for loan losses
      requires the use of estimates and assumptions, which is permitted under
      generally accepted accounting principles. Actual results could differ
      significantly from those estimates.  Management believes the
      allowance for losses on loans is adequate. While management uses available
      information to estimate losses on loans, future additions to the
      allowances may be necessary based on changes in economic conditions,
      particularly in the State of Maryland.  In addition, various
      regulatory agencies, as an integral part of their examination process,
      periodically review the Bank's allowance for losses on
      loans.  Such agencies may require the Bank to recognize
      additions to the allowance based on their judgments about information
      available to them at the time of their
  examination.














F-8




SEVERN BANCORP, INC.AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
1 - Summary of
Significant Accounting Policies - Continued





The
      allowance consists of specific and general components.  The
      specific component relates to loans that are classified as
      impaired.  For such loans that are classified as impaired, an
      allowance is established when the current market value of the underlying
      collateral of the impaired loan is lower than the carrying value of that
      loan.  For loans that are not solely collateral dependent, an
      allowance is established when the present value of the expected future
      cash flows of the impaired loan is lower than the carrying value of that
      loan.  The general component relates to loans that are
      classified as doubtful, substandard or special mention, as well as
      non-classified loans.  The general reserve is based on
      historical loss experience adjusted for qualitative
    factors.A
      loan is considered impaired if it meets either of the following two
      criteria:
              ·Loans
      that are 90 days or more in arrears (nonaccrual loans)
              ·Loans
      where, based on current information and events, it is probable that a
      borrower will be unable to pay all amounts due according to the
      contractual terms of the loan agreement.
              
              Loans
      that experience insignificant payment delays and payment shortfalls
      generally are not classified as impaired.  Management determines
      the significance of payment delays and payment shortfalls on a
      case-by-case basis, taking into consideration all of the circumstances
      surrounding the loan and the borrower, including the length of the delay,
      the reasons for the delay, the borrower’s prior payment record, and the
      amount of the shortfall in relation to the principal and interest
      owed.H.
            Foreclosed Real Estate -
      Real estate acquired through or in the process of foreclosure is recorded
      at fair value less estimated disposal costs.  Management
      periodically evaluates the recoverability of the carrying value of the
      real estate acquired through foreclosure using estimates as described
      under the caption "Allowance for Loan Losses". In the event of a
      subsequent decline, management provides an allowance to reduce real estate
      acquired through foreclosure to fair value less estimated disposal cost.
      Expenses incurred on foreclosed real estate prior to disposition are
      charged to expense. Gains or losses on the sale of foreclosed real estate
      are recognized upon disposition of the property.  Foreclosed
      real estate totaled $6,317,000 and $2,993,000 as of December 31, 2008 and
      2007, respectively and is included in other
  assets.





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















F-9





SEVERN BANCORP, INC.AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
1 - Summary of
Significant Accounting Policies - Continued





J.
            Premises and Equipment -Premises and equipment are carried at cost less accumulated
      depreciation. Depreciation and amortization of premises and equipment is
      accumulated by the use of the straight-line method over the estimated
      useful lives of the assets. Additions and improvements are capitalized,
      and charges for repairs and maintenance are expensed when incurred. The
      related cost and accumulated depreciation are eliminated from the accounts
      when an asset is sold or retired and the resultant gain or loss is
      credited or charged to income.K.
            Income Taxes -Deferred
      income taxes are recognized for temporary differences between the
      financial reporting basis and income tax basis of assets and liabilities
      based on enacted tax rates expected to be in effect when such amounts are
      realized or settled. Deferred tax assets are recognized only to the extent
      that it is more likely than not that such amounts will be realized based
      on consideration of available evidence. The effect on deferred tax assets
      and liabilities of a change in tax rates is recognized in income in the
      period that includes the enactment date.L.
            Statement of Cash Flows -In the statement of cash flows, cash and cash equivalents include
      cash on hand, amounts due from banks, Federal Home Loan Bank of Atlanta
      overnight deposits, and federal funds sold.  Generally, federal
      funds are sold for one day periods.M.
            Earnings Per Share -
      Basic earnings per share of common stock for the years ended December 31,
      2008, 2007 and 2006 is computed by dividing net income available to common
      stockholders by 10,066,679, 10,066,283 and 10,065,289, respectively, the
      weighted average number of shares of common stock outstanding for each
      year. Diluted earnings per share reflect additional common shares that
      would have been outstanding if dilutive potential common shares had been
      issued.  Potential common shares that may be issued by Bancorp
      relate to outstanding stock options, warrants, and convertible preferred
      stock, and are determined using the treasury stock
      method.  Diluted earnings per share of common stock for the
      years ended December 31, 2008, 2007 and 2006, is computed by dividing net
      income for each year by 10,066,679, 10,066,283 and 10,069,056,
      respectively, the weighted average number of diluted shares of common
      stock. The above amounts have been retroactively adjusted to give effect
      to two 10% stock dividends effective March 2007 and
  2006.


















F-10






SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
1 - Summary of
Significant Accounting Policies - Continued








N.
            Employee Stock Ownership Plan
      - Bancorp accounts for its Employee Stock Ownership Plan ("ESOP")
      in accordance with Statement of Position 93-6 of the Accounting Standards
      Division of the American Institute of Certified Public Accountants.
      Bancorp records compensation expense equal to the cash contribution called
      for under the Plan. All ESOP shares are included in the weighted average
      shares outstanding for earnings per share computations. All dividends paid
      on ESOP shares are charged to retained earnings.O.
            Advertising Cost -Advertising cost is expensed as incurred and totaled $476,000,
      $460,000 and $287,000 for the years ended December 31, 2008, 2007, and
      2006, respectively.P.
            Recent Accounting
      Pronouncements-FASB Statement No. 141 (R) “Business Combinations” was issued in
      December of 2007.  This Statement establishes principles and
      requirements for how the acquirer of a business recognizes and measures in
      its financial statements the identifiable assets acquired, the liabilities
      assumed, and any noncontrolling interest in the acquiree.  This
      Statement also provides guidance for recognizing and measuring the
      goodwill acquired in the business combination and determines what
      information to disclose to enable users of the financial statements to
      evaluate the nature and financial effects of the business
      combination.  This new pronouncement will impact the Company’s
      accounting for any business combinations beginning January 1,
      2009.








Note
2 - Investment
Securities





The
amortized cost and fair value of investment securities held to maturity are as
follows:





Amortized
                  Cost
                
                
                Gross
      Unrealized Gains
                
                
                Gross
      Unrealized Losses
                
                
                Fair
                  Value(dollars
      in thousands)December 31, 2008:Mortgage
      backed securities
                
                $
                1,345
                
                
                $
                11
                
                
                $
                27
                
                
                $
                1,329December 31, 2007:Federal
      Home Loan Bank(“FHLB”)
      Notes
                
                $
                1,000
                
                
                $
                -
                
                
                $
                -
                
                
                $
                1,000Mortgage
      backed securities
                
                
                1,383
                
                
                
                3
                
                
                
                56
                
                
                
                1,330$
                2,383
                
                
                $
                3
                
                
                $
                56
                
                
                $
                2,330



















F-11






SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
2 - Investment
Securities – Continued





In 2008
and 2007, there were no notes or mortgage-backed securities pledged as
collateral.





The
following tables show fair value and unrealized losses, aggregated by investment
category and length of time that the individual securities have been in a
continuous unrealized loss position as of December 31, 2008 and 2007. Included
in the table for 2008 and 2007 are four mortgage backed securities. Management
believes that the unrealized losses are the result of interest rate levels
differing from those existing at the time of purchase of the securities and
actual and estimated prepayment speeds.  These unrealized losses are
considered temporary as they reflect fair values on December 31, 2008 and 2007
and are subject to change daily as interest rates fluctuate.





December 31, 2008:
                            
                            Less
      than 12 months
                            
                            
                            12
      Months or More
                            
                            
                            TotalUnrealized
                            
                            
                            
                            
                            Unrealized
                            
                            
                            
                            
                            
                            UnrealizedFair
      Value
                            
                            Losses
                            
                            
                            Fair
      Value
                            
                            Losses
                            
                            
                            Fair
      Value
                            
                            
                            Losses(dollars
      in thousands)Mortgage
      backed securities
                            
                            $
                            -
                            
                            $
                            -
                            
                            
                            $
                            1,151
                            
                            $
                            27
                            
                            
                            $
                            1,151
                            
                            
                            $
                            27December 31, 2007:Mortgage
      backed securities
                            
                            $
                            -
                            
                            $
                            -
                            
                            
                            $
                            1,150
                            
                            $
                            56
                            
                            
                            $
                            1,150
                            
                            
                            $
                            56





Note
3 - Loans
Receivable





Loans
receivable consist of the following:




December
      31,2008
                        
                        
                        2007(dollars
      in thousands)Residential
      mortgage
                        
                        $
                        355,909
                        
                        
                        $
                        320,303Construction,
      land acquisition anddevelopment
                        
                        
                        242,359
                        
                        
                        
                        297,823Land
                        
                        
                        82,642
                        
                        
                        
                        93,717Lines
      of credit
                        
                        
                        34,872
                        
                        
                        
                        29,713Commercial
      real estate
                        
                        
                        214,209
                        
                        
                        
                        205,755Commercial
      non-real estate
                        
                        
                        3,084
                        
                        
                        
                        3,416Home
      equity
                        
                        
                        39,040
                        
                        
                        
                        32,748Consumer
                        
                        
                        1,083
                        
                        
                        
                        2,355973,198
                        
                        
                        
                        985,830LessLoans
      in process
                        
                        
                        (57,940
                        )
                        
                        
                        (78,238
                        )Allowance
      for loan losses
                        
                        
                        (14,813
                        )
                        
                        
                        (10,781
                        )Deferred
      loan origination fees and costs, net
                        
                        
                        (4,439
                        )
                        
                        
                        (4,898
                        )$
                        896,006
                        
                        
                        $
                        891,913















F-12





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
3 - Loans Receivable- Continued





Residential
lending is generally considered to involve less risk than other forms of
lending, although payment experience on these loans is dependent to some extent
on economic and market conditions in the Bank's lending area. Multifamily
residential, commercial, construction and other loan repayments are generally
dependent on the operations of the related properties or the financial condition
of its borrower or guarantor.  Accordingly, repayment of such loans
can be more susceptible to adverse conditions in the real estate market and the
regional economy.





A
substantial portion of the Bank's loans receivable is mortgage loans secured by
residential and commercial real estate properties located in the State of
Maryland.  Loans are extended only after evaluation by management of
customers' creditworthiness and other relevant factors on a case-by-case basis.
The Bank generally does not lend more than 90% of the appraised value of a
property and requires private mortgage insurance on residential mortgages with
loan-to-value ratios in excess of 80%.





In
addition, the Bank generally obtains personal guarantees of repayment from
borrowers and/or others for construction, commercial and multifamily residential
loans and disburses the proceeds of construction and similar loans only as work
progresses on the related projects.





The
following is a summary of the allowance for loan losses for the years ended
December 31:





2008
                  
                  
                  2007
                  
                  
                  2006(dollars
      in thousands)Balance
      at beginning of year
                  
                  $
                  10,781
                  
                  
                  $
                  9,026
                  
                  
                  $
                  7,505Provision
      for loan losses
                  
                  
                  7,481
                  
                  
                  
                  2,462
                  
                  
                  
                  1,561Charge-offs
                  
                  
                  (3,449
                  )
                  
                  
                  (707
                  )
                  
                  
                  (40
                  )Balance
      at end of year
                  
                  $
                  14,813
                  
                  
                  $
                  10,781
                  
                  
                  $
                  9,026





The
allowance for loan losses is based on management’s judgment and evaluation of
the loan portfolio.  Management assesses the adequacy of the allowance
for loan losses and the need for any addition thereto, by considering the nature
and size of the loan portfolio, overall portfolio quality, review of specific
problem loans, economic conditions that may affect the borrowers’ ability to pay
or the value of property securing loans, and other relevant
factors.  While management believes the current allowance is adequate,
changing economic and market conditions may require future adjustments to the
allowance for loan losses.
























F-13








SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
3 - Loans
Receivable - Continued





The
following table presents the Company’s non-performing assets as of December 31,
2008 and December 31, 2007 (dollars in thousands):




December
      31, 2008
                  
                  
                  Number
      of loans
                  
                  
                  December
      31, 2007
                  
                  
                  Number
      of loansLoans
      accounted for on a non-accrual basis:Mortgage
      loans:Residential
      - consumer
                  
                  $
                  30,769
                  
                  
                  
                  73
                  
                  
                  $
                  3,975
                  
                  
                  
                  11Residential
      - builder
                  
                  
                  20,970
                  
                  
                  
                  45
                  
                  
                  
                  3,389
                  
                  
                  
                  6Non-mortgage
      loans:Consumer
                  
                  
                  9
                  
                  
                  
                  2
                  
                  
                  
                  336
                  
                  
                  
                  2Commercial
      loans
                  
                  
                  3,047
                  
                  
                  
                  11
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      non-accrual loans
                  
                  $
                  54,795
                  
                  
                  
                  131
                  
                  
                  $
                  7,700
                  
                  
                  
                  19Accruing
      loans greater than 90 days past due
                  
                  $
                  -
                  
                  
                  
                  
                  
                  
                  $
                  -Foreclosed
      real-estate
                  
                  $
                  6,317
                  
                  
                  
                  
                  
                  
                  $
                  2,993Total
      non-performing assets
                  
                  $
                  61,112
                  
                  
                  
                  
                  
                  
                  $
                  10,693





The
following table summarizes the change in impaired loans for the year ended
December 31, 2008 (dollars in thousands):





Impaired
      loans at December 31, 2007
                  
                  $
                  17,960Added
      to impaired loans
                  
                  
                  77,897Gross
      loans transferred to foreclosed real estate
                  
                  
                  (15,258
                  )Paid
      off prior to foreclosure
                  
                  
                  (10,763
                  )Impaired
      loans at December 31, 2008
                  
                  $
                  69,836





Included
in the above impaired loans amount at December 31, 2008 is $15,041,000 of loans
that are not in non-accrual status.  In addition, there was a total of
$45,534,000 of residential real estate loans included in impaired loans at
December 31, 2008, of which $25,808,000 were to consumers and $19,726,000 to
builders. The collateral supporting impaired loans is individually reviewed by
management to determine its estimated fair market value, and a specific reserve
is established, if necessary, for the difference between the carrying amount of
any loan and the estimated fair market value of the collateral.





Of the
impaired loans, $37,444,000 and $8,256,000 had a specific valuation allowance of
$5,390,000 and $1,228,000 at December 31, 2008 and 2007, respectively. Impaired
loans averaged $43,342,000 during 2008, $18,125,000 during 2007 and $6,614,000
during 2006.  Interest income recognized on these loans totaled
$2,794,000 during 2008, $925,000 during 2007 and $471,000 during
2006.


















F-14







SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
3 - Loans
Receivable - Continued





Interest
income that would have been recorded under the original terms of non-accrual
loans and the interest income actually recognized for the years ended December
31, are summarized below:





2008
                  
                  
                  2007
                  
                  
                  2006(dollars
      in thousands)Interest
      income that would havebeen
      recorded
                  
                  $
                  4,430
                  
                  
                  $
                  649
                  
                  
                  $
                  416Interest
      income recognized
                  
                  
                  2,045
                  
                  
                  
                  406
                  
                  
                  
                  188Interest
      income not recognized
                  
                  $
                  2,385
                  
                  
                  $
                  243
                  
                  
                  $
                  228





As of
December 31, 2008, the Company had foreclosed real estate consisting of 21
residential properties with a carrying value of $6,317,000.  During
the year ended December 31, 2008, the Company sold a total of 18 properties
previously included in foreclosed real estate.  The properties had a
combined net book value of $7,964,000 after total write-downs of $287,000, and
were sold at a combined net gain of $209,000.  In addition, the
Company incurred $135,000 in expenses related to the sale of the
properties.  The following table summarizes the changes in foreclosed
real estate for the year ended December 31, 2008, (dollars in
thousands):





Foreclosed
      real estate at December 31, 2007
                  
                  $
                  2,993Transferred
      from impaired loans, net of specific reserves of $3,130
                  
                  
                  12,128Property
      improvements
                  
                  
                  92Additional
      write downs
                  
                  
                  (932
                  )Property
      sold
                  
                  
                  (7,964
                  )Foreclosed
      real estate at December 31, 2008
                  
                  $
                  6,317





Mortgage
loans serviced for others not included in the accompanying consolidated
statements of financial condition totaled $77,617,000 and $62,825,000 at
December 31, 2008 and 2007, respectively.





The Bank
is a party to financial instruments with off-balance-sheet risk in the normal
course of business to meet the financial needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit,
which involve, to varying degrees, elements of credit risk in excess of the
amount recognized in the statement of financial condition. The contract amounts
of these instruments express the extent of involvement the Bank has in each
class of financial instruments.





The
Bank's exposure to credit loss from non-performance by the other party to the
above mentioned financial instruments is represented by the contractual amount
of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.





Unless
otherwise noted, the Bank requires collateral or other security to support
financial instruments with off-balance-sheet credit risk.









F-15





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
3 - Loans
Receivable - Continued








Financial
      Instruments Whose Contract
                    Amounts
      Represent Credit Risk
                  
                  Contract
      Amount
                    At
      December 31,2008
                  
                  
                  2007(dollars
      in thousands)Standby
      letters of credit
                  
                  $
                  13,183
                  
                  
                  $
                  9,530Home
      equity lines of credit
                  
                  
                  23,299
                  
                  
                  
                  22,895Unadvanced
      construction commitments
                  
                  
                  57,940
                  
                  
                  
                  78,238Mortgage
      loan commitments
                  
                  
                  7,962
                  
                  
                  
                  1,784Lines
      of credit
                  
                  
                  38,016
                  
                  
                  
                  35,840Loans
      sold with limitedrepurchase
      provisions
                  
                  $
                  472
                  
                  
                  $
                  4,054





Standby
letters of credit are conditional commitments issued by the Bank guaranteeing
performance by a customer to various municipalities. These guarantees are issued
primarily to support performance arrangements, limited to real estate
transactions.  The majority of these standby letters of credit expire
within the next twelve months.  The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending other
loan commitments.  The Bank requires collateral supporting these
letters of credit as deemed necessary.  Management believes that the
proceeds obtained through a liquidation of such collateral would be sufficient
to cover the maximum potential amount of future payments required under the
corresponding guarantees.  The current amount of the liability as of
December 31, 2008 and 2007 for guarantees under standby letters of credit issued
is not material.





Home
equity lines of credit are loan commitments to individuals as long as there is
no violation of any condition established in the contract. Commitments under
home equity lines expire ten years after the date the loan closes and are
secured by real estate. The Bank evaluates each customer's credit worthiness on
a case-by-case basis.





Mortgage
loan commitments not reflected in the accompanying statements at December 31,
2008 include $1,422,000 at a fixed rate of 7.00% and $6,540,000 at floating
rates.





Lines of
credit are loan commitments to individuals and companies as long as there is no
violation of any condition established in the contract. Lines of credit have a
fixed expiration date. The Bank evaluates each customer's credit worthiness on a
case-by-case basis.





The Bank
has entered into several agreements to sell mortgage loans to third parties.
These agreements contain limited provisions that require the Bank to repurchase
a loan if the loan becomes delinquent within the terms specified by the
agreement. The credit risk involved in these financial instruments is
essentially the same as that involved in extending loan facilities to customers.
No amount has been recognized in the statement of financial condition at
December 31, 2008 and 2007 as a liability for credit loss related to these
loans.  The Bank has never had to


repurchase
a loan under these agreements.


















F-16





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
4 - Premises and
Equipment





Premises
and equipment are summarized by major classification as follows:





December
      31,
                        
                        
                        Estimated2008
                        
                        
                        2007
                        
                        
                        Useful
      Lives(dollars
      in thousands)Land
                        
                        $
                        1,537
                        
                        
                        $
                        1,537
                        
                        
                        
                        -Building
                        
                        
                        29,047
                        
                        
                        
                        28,925
                        
                        
                        39
      YearsLeasehold
      improvements
                        
                        
                        1,130
                        
                        
                        
                        1,068
                        
                        
                        15-27.5
      YearsFurniture,
      fixtures and equipment
                        
                        
                        2,575
                        
                        
                        
                        2,510
                        
                        
                        3-10
      YearsTotal
      at cost
                        
                        
                        34,289
                        
                        
                        
                        34,040Accumulated
      depreciation
                        
                        
                        (4,022
                        )
                        
                        
                        (2,751
                        )$
                        30,267
                        
                        
                        $
                        31,289





Depreciation
expense was $1,336,000, $1,333,000, and $362,000 for the years ended December
31, 2008, 2007 and 2006, respectively.





HS West,
LLC constructed a building in Annapolis, Maryland that, effective January
2007,  serves as Bancorp’s and the Bank’s administrative headquarters.
A branch office of the Bank is included.  Interest capitalized during the
years ended December 31, 2008, 2007 and 2006 was $0, $319,000 and $1,015,000,
respectively.





The Bank
leases a branch and an office under two long-term leases, which both expire in
2010. The minimum annual rental payments will be $94,000 in 2009 and $37,000 in
2010.





Total
rent expense was $91,000, $89,000, and $147,000 for the years ended December 31,
2008, 2007 and 2006, respectively.
























F-17







SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
5 - Investment in
Federal Home Loan Bank of Atlanta Stock





The Bank
is required to maintain an investment in the stock of the Federal Home Loan Bank
of Atlanta ("FHLB") in an amount equal to at least 1% of the unpaid principal
balances of the Bank's residential mortgage loans or 1/20 of its outstanding
advances from the FHLB, whichever is greater. Purchases and sales of stock are
made directly with the FHLB at par value.





Note
6 - Deposits





Deposits
in the Bank as of December 31, 2008 and 2007 consisted of the
following:





2008
                    
                    
                    2007Category
                    
                    Amount
                    
                    
                    Percent
                    
                    
                    Amount
                    
                    
                    Percent(dollars
      in thousands)NOW
      accounts
                    
                    $
                    12,813
                    
                    
                    
                    1.87
                    %
                    
                    $
                    11,152
                    
                    
                    
                    1.71
                    %Money
      market accounts
                    
                    
                    44,012
                    
                    
                    
                    6.44
                    %
                    
                    
                    87,688
                    
                    
                    
                    13.43
                    %Passbooks
                    
                    
                    53,319
                    
                    
                    
                    7.80
                    %
                    
                    
                    14,891
                    
                    
                    
                    2.28
                    %Certificates
      of deposit
                    
                    
                    554,747
                    
                    
                    
                    81.12
                    %
                    
                    
                    523,698
                    
                    
                    
                    80.23
                    %Non-interest
      bearing accounts
                    
                    
                    18,975
                    
                    
                    
                    2.77
                    %
                    
                    
                    15,344
                    
                    
                    
                    2.35
                    %Total
      deposits
                    
                    $
                    683,866
                    
                    
                    
                    100.00
                    %
                    
                    $
                    652,773
                    
                    
                    
                    100.00
                    %








At
December 31, 2008 scheduled maturities of certificates of deposit are as
follows:








Amount(dollars
      in thousands)One
      year or less
                      
                      $
                      441,274More
      than 1 year to 2 years
                      
                      
                      62,953More
      than 2 years to 3 years
                      
                      
                      20,103More
      than 3 years to 4 years
                      
                      
                      18,755More
      than 4 years to 5 years
                      
                      
                      11,662$
                      554,747





The
aggregate amount of jumbo certificates of deposit with a minimum denomination of
$100,000 was $231,659,000 and $235,729,000 at December 31, 2008 and 2007,
respectively.












F-18






SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
6 - Deposits -
Continued





Interest
expense on deposits is summarized as follows:





For
      Years Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006(dollars
      in thousands)NOW
      accounts
                  
                  $
                  102
                  
                  
                  $
                  115
                  
                  
                  $
                  57Money
      market accounts
                  
                  
                  1,295
                  
                  
                  
                  3,068
                  
                  
                  
                  3,076Passbooks
                  
                  
                  633
                  
                  
                  
                  436
                  
                  
                  
                  573Certificates
      of deposit
                  
                  
                  23,920
                  
                  
                  
                  25,728
                  
                  
                  
                  20,000$
                  25,950
                  
                  
                  $
                  29,347
                  
                  
                  $
                  23,706








Note
7 - Federal Home Loan
Bank Advances





The
Bank's credit availability under the FHLB of Atlanta’s credit availability
program was $303,971,000 and $288,670,000 at December 31, 2008 and 2007,
respectively.  Short-term borrowings with the FHLB were $0 and
$15,000,000 at December 31, 2008 and 2007, respectively with interest at 0.00%
and 4.40% on these dates.   Long-term advances outstanding were
$153,000,000 and $175,000,000 at December 31, 2008 and 2007,
respectively.  The maturities of these long-term advances at December
31, 2008 are as follows (dollars in thousands):





Rate
                      
                      
                      Amount
                      
                      Maturity2.940%
      to 4.996
                      %
                      
                      $
                      28,000
                      
                      20095.000
                      %
                      
                      
                      10,000
                      
                      2010-
                      %
                      
                      
                      -
                      
                      2011-
                      %
                      
                      
                      -
                      
                      2012-
                      %
                      
                      
                      -
                      
                      20131.693%
      to 4.340
                      %
                      
                      
                      115,000
                      
                      Thereafter$
                      153,000





The
Bank's stock in the Federal Home Loan Bank of Atlanta is pledged as security for
the advances and under a blanket floating lien security agreement with the
Federal Home Loan Bank of Atlanta. The Bank is required to maintain as
collateral for its advances, qualified  loans in varying amounts
depending on the loan type.












F-19





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS











Note
8 - 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 (the
capital securities) to third-party investors and investing the proceeds from the
sale of such capital securities solely in subordinated debt securities of
Bancorp (the 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
that matures in 2035 and has a floating rate of interest of LIBOR plus 200 basis
points, which was 6.82% and 7.24% at December 31, 2008 and 2007,
respectively.  $17,000,000 of the proceeds from Bancorp’s issuance of
the debentures was contributed to the Bank, and qualifies as Tier 1 capital for
the Bank under Federal Reserve Board guidelines.





On
November 15, 2008, Bancorp completed a private placement offering consisting of
a total of 70 units, at an offering price of $100,000 per unit, for gross
proceeds of $7.0 million. Each unit consists of 6,250 shares of Bancorp's Series
A 8.0% Non-Cumulative Convertible Preferred Stock and Bancorp's Subordinated
Note in the original principal amount of $50,000.





The
Subordinated Notes earn interest at an annual rate of 8.0%, payable quarterly in
arrears on the last day of March, June, September and December commencing
December 31, 2008.  The Subordinated Notes are redeemable in whole or
in part at the option of Bancorp at any time beginning on December 31, 2009
until maturity, which is December 31, 2018.  Debt issuance costs
totaled $245,000 and are being amortized over 10 years.





Note
9 – Employee Benefit
Plans





The Bank
has a 401(k) Retirement Savings Plan.  Employees may contribute a
percentage of their salary up to the maximum amount allowed by law. The Bank is
obligated to contribute 50% of the employee's contribution, not to exceed 6% of
the employee's annual salary. All employees who have completed one year of
service with the Bank are eligible to participate. The Bank's contribution to
this plan was $124,000, $149,000 and $128,000 for the years ended December 31,
2008, 2007 and 2006, respectively.





The Bank
has an Employee Stock Ownership Plan ("ESOP") for the exclusive benefit of
participating employees. The Bank recognized ESOP expense of $142,000, $140,000
and $140,000 for the years ended December 31, 2008, 2007 and 2006, and had
unallocated shares in the plan totaling 42,100 and 24,700 as of December 31,
2008 and 2007, respectively.























F-20




SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
10 - Stockholders’
Equity





In
February 2007, Bancorp’s Board of Directors declared a 10% stock dividend
effective for shares outstanding on March 15, 2007.  In addition, in
February, 2006, the Board of Directors declared a 10% stock dividend, effective
for shares outstanding as of March 28, 2006. All per share data in the
accompanying financial statements and all share and per share data in the
footnotes have been adjusted to give retroactive effect to these
transactions.





As part
of the private placement offering discussed in Note 8, Bancorp issued a total of
437,500 shares of its Series A 8.0% Non-Cumulative Convertible Preferred Stock
(“Series A Preferred Stock”). The liquidation preference is $8.00 per
share.  Holders of Series A Preferred Stock will not be entitled to
any further distribution on the Series A Preferred Stock. Each share of Series A
Preferred Stock is convertible at the option of the holder into one share of
Bancorp common stock, subject to adjustment upon certain corporate events. The
initial conversion rate is equivalent to an initial conversion price of $8.00
per share of Bancorp common stock. At the option of Bancorp, on and after
December 31, 2013, at any time and from time to time, some or all of the Series
A Preferred Stock may be converted into shares of Bancorp common stock at the
then-applicable conversion rate.  Costs related to the issuance of the
preferred stock totaled $247,000 and were netted against the
proceeds.





If
declared by Bancorp's board of directors, cash dividends at an annual rate of
8.0% will be paid quarterly in arrears on the last day of March, June, September
and December commencing December 31, 2008. Dividends will not be paid on Bancorp
common stock in any quarter until the dividend on the Series A Preferred Stock
has been paid for such quarter; however, there is no requirement that Bancorp's
board of directors declare any dividends on the Series A Preferred Stock and any
unpaid dividends shall not be cumulative.





On
November 21, 2008, Bancorp entered into an agreement with the United States
Department of the Treasury (“Treasury”), pursuant to which Bancorp issued and
sold (i) 23,393 shares of its Series B Fixed Rate Cumulative Perpetual Preferred
Stock, par value $0.01 per share and liquidation preference $1,000 per share,
(the “Series B Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase
556,976 shares of Bancorp’s common stock, par value $0.01 per share, for an
aggregate purchase price of $23,393,000.  Costs related to the
issuance of the preferred stock and warrants totaled $45,000 and were netted
against the proceeds.





The
Series B Preferred Stock qualifies as Tier 1 capital and will pay cumulative
compounding dividends at a rate of 5% per annum for the first five years, and 9%
per annum thereafter. The Series B Preferred Stock may be redeemed by Bancorp
after three years. Prior to the end of three years, the Series B Preferred Stock
may not be redeemed by Bancorp except with proceeds from one or more Qualified
Equity Offerings, as defined in the Purchase Agreement.





The
Series B Preferred Stock has no maturity date and ranks pari passu with
Bancorp’s existing Series A Preferred Stock, in terms of dividend payments and
distributions upon liquidation, dissolution and winding up of
Bancorp.





















F-21








SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
10 - Stockholders’
Equity- continued





The
Series B Preferred Stock is non-voting, other than class voting rights on
certain matters that could adversely affect the Series B Preferred Stock. If
dividends on the Series B Preferred Stock have not been paid for an aggregate of
six quarterly dividend periods or more, whether consecutive or not, Bancorp’s
authorized number of directors will be automatically increased by two and the
holders of the Series B Preferred Stock, voting together with holders of any
then outstanding voting parity stock, will have the right to elect those
directors at Bancorp’s next annual meeting of stockholders or at a special
meeting of stockholders called for that purpose. These preferred share directors
will be elected annually and serve until all accrued and unpaid dividends on the
Series B Preferred Stock have been paid.





The
Warrant has a 10-year term and is immediately exercisable at an exercise price
of $6.30 per share of Common Stock.   The exercise price and
number of shares subject to the Warrant are both subject to anti-dilution
adjustments.   If Bancorp receives aggregate gross cash proceeds
of not less than $23,393,000 from Qualified Equity Offerings on or prior to
December 31, 2009, the number of shares of Common Stock issuable pursuant to
Treasury’s exercise of the Warrant will be reduced by one half of the original
number of shares, taking into account all adjustments, underlying the Warrant.
Pursuant to the Purchase Agreement, Treasury has agreed not to exercise voting
power with respect to any shares of Common Stock issued upon exercise of the
Warrant.





Bancorp’s
ability to declare dividends on its common stock is limited by the terms of
Bancorp’s Series A preferred stock and Series B preferred
stock.  Bancorp may not declare or pay any dividend on, make any
distributions relating to, or redeem, purchase, acquire or make a liquidation
payment relating to, or make any guarantee payment with respect to its common
stock in any quarter until the dividend on the Series A Preferred Stock has been
declared and paid for such quarter, subject to certain minor
exceptions.  Additionally, prior to November 21, 2011, unless Bancorp
has redeemed the Series B preferred stock or the Treasury Department has
transferred the Series B preferred stock to a third party,  Bancorp
may not, without the consent of the Treasury (1) declare or pay any dividend or
make any distribution on its common stock (other than regular quarterly cash
dividends of not more than $0.06 per share) or (2) redeem, purchase or acquire
any shares of our common stock or other equity or capital securities, other than
in connection with benefit plans consistent with past practice and certain other
circumstances specified in the Letter Agreement with the Treasury
Department.





Additionally,
under the terms of Bancorp's 2035 Debentures, if (i) there has occurred and is
continuing an event of default, (ii) Bancorp is in default with respect to
payment of any obligations under the related guarantee or (iii) Bancorp has
given notice of its election to defer payments of interest on the 2035
Debentures by extending the interest distribution period as provided in the
indenture governing the 2035 Debentures and such period, or any extension
thereof, has commenced and is continuing, then Bancorp may not, among other
things, declare or pay any dividends or distributions on, or redeem, purchase,
acquire, or make a liquidation payment with respect to, any of its capital
stock, including common stock.





Note
11- Stock-Based
Compensation





The
Company has a stock-based compensation plan for directors, officers, and other
key employees of the Company.  The aggregate number of shares of
common stock that may be issued with respect to the awards granted under the
plan is 500,000 plus any shares forfeited












F-22






SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
11- Stock-Based
Compensation - Continued





under the
Company’s old stock-based compensation plan.  Under the terms of the
plan, the Company has the ability to grant various stock compensation
incentives, including stock options, stock appreciation rights, and restricted
stock.  The stock-based compensation is granted under terms and
conditions determined by the Compensation Committee of the Board of
Directors.  Under the stock based compensation plan, stock options
generally have a maximum term of ten years, and are granted with an exercise
price at least equal to the fair market value of the common stock on the date
the options are granted.  Generally, options granted to directors of
the Company vest immediately, and options granted to officers and employees vest
over a five-year period, although the Compensation Committee has the authority
to provide for different vesting schedules.





The
Company follows SFAS 123R to account for stock-based
compensation.  SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized as
compensation expense in the statement of income at fair value.  SFAS
123R requires an entity to recognize the expense of employee services received
in share-based payment transactions and measure the expense based on the grant
date fair value of the award.  The expense is recognized over the
period during which an employee is required to provide service in exchange for
the award. Stock-based compensation expense included in the consolidated
statements of income for the years ended December 31, 2008, 2007 and 2006
totaled $128,000, $128,000 and $163,000, respectively.  The total
income tax benefit recognized in the consolidated statements of income for
stock-based compensation for the years ended December 31, 2008, 2007 and 2006
was  $0.





No
options were granted in 2008 and 2007. The weighted average grant-date fair
value of options granted in 2006 was $5.56.  The fair value of the
options awarded under the option plan is estimated on the date of grant using
the Black-Scholes valuation model, which is dependent upon certain assumptions
as presented below:








2006Expected
      life (in years)
                          
                          
                          4.83Risk-free
      interest rate
                          
                          
                          4.59
                          %Expected
      volatility
                          
                          
                          53.66
                          %Expected
      dividend yield
                          
                          
                          4.54
                          %





The
expected life of the options was estimated using the average vesting period of
the options granted and represents the period of time that options granted are
expected to be outstanding. The risk-free interest rate is the U.S. Treasury
rate commensurate with the expected life of the options on the grant
date.  Volatility of the Company’s stock price was based on historical
volatility.  Dividend yield was based on historical dividends divided
by the average market price for that period.





















F-23








SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
11- Stock-Based
Compensation - Continued





Information
regarding the Company’s stock option plan as of and for the years ended December
31, 2008 and 2007 is as follows:





WeightedWeighted
                                  
                                  
                                  Average
                                  
                                  
                                  AggregateAverage
                                  
                                  
                                  Remaining
                                  
                                  
                                  IntrinsicShares
                                  
                                  
                                  Price
                                  
                                  
                                  Life
                                  
                                  
                                  ValueOptions
      outstanding, December 31, 2006
                                  
                                  
                                  123,640
                                  
                                  
                                  $
                                  15.85Options
      granted
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Options
      exercised
                                  
                                  
                                  (825
                                  )
                                  
                                  
                                  15.62
                                  
                                  
                                  
                                  
                                  
                                  $
                                  -Options
      outstanding, December 31, 2007
                                  
                                  
                                  122,815
                                  
                                  
                                  
                                  15.85Options
      granted
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Options
      exercised
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Options
      forfeited
                                  
                                  
                                  (7,865
                                  )
                                  
                                  
                                  15.62Options
      outstanding, December 31, 2008
                                  
                                  
                                  114,950
                                  
                                  
                                  $
                                  15.87
                                  
                                  
                                  
                                  1.97
                                  
                                  
                                  $
                                  -Options
      exercisable, December 31, 2008
                                  
                                  
                                  69,071
                                  
                                  
                                  $
                                  15.87
                                  
                                  
                                  
                                  0.14
                                  
                                  
                                  $
                                  -Option
      price range at December 31, 2008
                                  
                                  
                                  $15.62 to
$17.18








The
following table summarizes the nonvested options in the Company’s stock option
plan as of December 31, 2008.





WeightedAverageShares
                          
                          
                          PriceNonvested
      options outstanding, December 31, 2007
                          
                          
                          72,035
                          
                          
                          
                          15.87Nonvested
      options granted
                          
                          
                          -
                          
                          
                          
                          -Nonvested
      options vested
                          
                          
                          (18,291
                          )
                          
                          
                          15.85Nonvested
      options forfeited
                          
                          
                          (7,865
                          )
                          
                          
                          15.62Nonvested
      options outstanding, December 31, 2008
                          
                          
                          45,879
                          
                          
                          $
                          15.89





As of
December 31, 2008, there was $275,000 of total unrecognized stock-based
compensation cost related to non-vested stock options, which is expected to be
recognized over a period of twenty-six months.





Note
12 - Regulatory
Matters





The Bank
is required to maintain an average daily balance with the Federal Reserve Bank
in a non-interest bearing account. The amount in such account at December 31,
2008 was $300,000.





The Bank
is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possible additional discretionary, actions by
the regulators that, if undertaken, could have a direct material effect on the
Bank’s financial statements.  Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank’s
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Bank’s capital












F-24




SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
12 - Regulatory
Matters - Continued





amounts
and classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.





Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table below) of total
and Tier I capital (as defined in the regulations) and risk-weighted assets (as
defined), and of Tier I capital (as defined) to average assets (as
defined).  Management believes, as of December 31, 2008, that the Bank
meets all capital adequacy requirements to which it is subject.





As of
December 31, 2008, the most recent notification from the regulators categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action.  To be categorized as well capitalized the Bank
must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes have changed the Bank’s category. The
Bank’s actual capital amounts and ratios are also presented in the
table.





The
following table presents the Bank's actual capital amounts and ratios at
December 31, 2008 and 2007:





Actual
                
                
                For
      Capital
                  Adequacy
      Purposes
                
                
                To
      Be Well
                  Capitalized
      Under
                  Prompt
      Corrective
                  Action
      ProvisionsAmount
                
                
                %
                
                
                Amount
                
                
                %
                
                
                Amount
                
                
                %(dollars
      in thousands)December
      31, 2008Tangible
      (1)
                
                $
                132,890
                
                
                
                13.5
                %
                
                $
                14,743
                
                
                
                1.50
                %
                
                
                N/A
                
                
                
                N/ATier
      I capital (2)
                
                
                132,890
                
                
                
                16.9
                %
                
                
                N/A
                
                
                
                N/A
                
                
                $
                47,047
                
                
                
                6.00
                %Core
      (1)
                
                
                132,890
                
                
                
                13.5
                %
                
                
                39,314
                
                
                
                4.00
                %
                
                
                49,142
                
                
                
                5.00
                %Total
      (2)
                
                
                142,199
                
                
                
                18.1
                %
                
                
                62,730
                
                
                
                8.00
                %
                
                
                78,412
                
                
                
                10.00
                %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
                %








(1) To
adjusted total assets.


(2) To
risk-weighted assets.








Bancorp’s
main source of income is dividends from the Bank.  As a result,
Bancorp's dividends to its shareholders will depend primarily upon receipt of
dividends from the Bank.





OTS
regulations limit the payment of dividends and other capital distributions by
the Bank. The Bank is required to obtain OTS approval if the total amount of the
Bank’s capital distribution (including the proposed dividend) for the current
year exceeds net income for that year to date plus the Bank’s retained net
income for the preceding two years.  Additionally, the Bank may
not












F-25




SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
12 - Regulatory
Matters - Continued





pay
dividends on its stock in an amount that would reduce its capital levels below
its regulatory capital requirements.








Note
13 - Income
Taxes





The
income tax provision consists of the following for the years ended December
31:





2008
                            
                            
                            2007
                            
                            
                            2006(dollars
      in thousands)CurrentFederal
                            
                            $
                            3,747
                            
                            
                            $
                            7,471
                            
                            
                            $
                            9,186State
                            
                            
                            965
                            
                            
                            
                            1,595
                            
                            
                            
                            2,0434,712
                            
                            
                            
                            9,066
                            
                            
                            
                            11,229DeferredFederal
                            
                            
                            (1,461
                            )
                            
                            
                            (863
                            )
                            
                            
                            (511
                            )State
                            
                            
                            (378
                            )
                            
                            
                            (294
                            )
                            
                            
                            (110
                            )(1,839
                            )
                            
                            
                            (1,157
                            )
                            
                            
                            (621
                            )Total
      income tax provision
                            
                            $
                            2,873
                            
                            
                            $
                            7,909
                            
                            
                            $
                            10,608






The
amount computed by applying the statutory federal income tax rate to income
before federal taxes is greater than the taxes provided for the following
reasons for the years ended December 31:





2008
                            
                            
                            2007
                            
                            
                            2006Amount
                            
                            
                            Percent
      of Pretax
                              Income
                            
                            
                            Amount
                            
                            
                            Percent
      of Pretax Income
                            
                            
                            Amount
                            
                            
                            Percent
      of
                              Pretax
                              Income(dollars
      in thousands)Statutory
      Federalincome
      tax rate
                            
                            $
                            2,375
                            
                            
                            
                            34.0
                            %
                            
                            $
                            6,657
                            
                            
                            
                            35.0
                            %
                            
                            $
                            9,225
                            
                            
                            
                            35.0
                            %State
      tax net ofFederal
      incometax
      benefit
                            
                            
                            387
                            
                            
                            
                            5.5
                            %
                            
                            
                            846
                            
                            
                            
                            4.5
                            %
                            
                            
                            1,256
                            
                            
                            
                            4.8
                            %Other
      adjustments
                            
                            
                            111
                            
                            
                            
                            1.6
                            %
                            
                            
                            406
                            
                            
                            
                            2.1
                            %
                            
                            
                            127
                            
                            
                            
                            0.4
                            %$
                            2,873
                            
                            
                            
                            41.1
                            %
                            
                            $
                            7,909
                            
                            
                            
                            41.6
                            %
                            
                            $
                            10,608
                            
                            
                            
                            40.2
                            %











The
Company does not have any unrecognized tax benefits at December 31, 2008 or
2007.
















F-26




SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
13 - Income
Taxes - Continued





The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007
are presented below:





2008
                    
                    
                    2007(dollars
      in thousands)Deferred
      Tax Assets:Allowances
      for loan losses
                    
                    $
                    5,979
                    
                    
                    $
                    4,352Reserve
      on foreclosed real estate
                    
                    
                    286
                    
                    
                    
                    32Reserve
      for uncollected interest
                    
                    
                    758
                    
                    
                    
                    261Other
                    
                    
                    42
                    
                    
                    
                    26Total
      deferred tax assets
                    
                    
                    7,065
                    
                    
                    
                    4,671Deferred
      Tax Liabilities:Federal
      Home Loan Bank stock dividends
                    
                    
                    (84
                    )
                    
                    
                    (84
                    )Loan
      origination costs
                    
                    
                    (715
                    )
                    
                    
                    (874
                    )Accelerated
      depreciation
                    
                    
                    (875
                    )
                    
                    
                    (342
                    )Prepaid
      expenses
                    
                    
                    (301
                    )
                    
                    
                    (119
                    )Other
                    
                    
                    (1
                    )
                    
                    
                    (2
                    )Total
      deferred tax liabilities
                    
                    
                    (1,976
                    )
                    
                    
                    (1,421
                    )Net
      deferred tax assets
                    
                    $
                    5,089
                    
                    
                    $
                    3,250








Note
14 - Related Party
Transactions





During
the years ended December 31, 2008, 2007 and 2006, the Bank engaged in the
transactions described below with parties that may be deemed
affiliated.





Prior to
2007, two subsidiaries rented property from a director of the
Bank.  Rent paid on these properties was $56,000 for the year ended
December 31, 2006.





During
January, 2007, a law firm, in which the President of the Company and Bank is a
partner, entered into a five year lease agreement with a subsidiary of the
Company.  The term of the lease is five years with the option to renew
the lease for three additional five year terms.  The total lease
payments received by the subsidiary were $382,000 and $231,000  for
the years ended December 31, 2008 and 2007, respectively.  In
addition, the law firm represents the Company and the Bank in certain legal
matters. The fees for services rendered by that firm were $715,000, $315,000 and
$325,000 for the years ended December 31, 2008, 2007 and 2006,
respectively.





During
2008, the President and a Director of the Company and Bank each received a
director fee of $127,500 for services relating to the Company’s private
placement sale of its Series A Preferred Stock and Subordinated
Notes.












F-27






SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
15 - Fair Value of
Financial Instruments





Management
uses its best judgment in estimating the fair value of the Company’s financial
instruments; however, there are inherent weaknesses in any estimation
technique.  Therefore, for substantially all financial instruments,
the fair value estimates herein are not necessarily indicative of the amounts
the Company could have realized in a sales transaction on the dates
indicated.  The estimated fair value amounts have been measured as of
their respective year-ends and have not been re-evaluated or updated for
purposes of these financial statements subsequent to those respective
dates.  As such, the estimated fair values of these financial
instruments subsequent to the respective reporting dates may be different than
the amounts reported at year-end.





In
September 2006, the FASB issued FASB Statement No. 157, Fair Value
Measurements, which defines fair value, establishes a framework for measuring
fair value under GAAP, and expands disclosures about fair value measurements.
SFAS 157 applies to other accounting pronouncements that require or permit fair
value measurements. The Company adopted SFAS 157 effective for its fiscal year
beginning January 1, 2008.





The
primary effect of SFAS 157 on the Company was to expand the required disclosures
pertaining to loans accounted for under SFAS No. 114 and foreclosed real
estate.





In
December 2007, the FASB issued FASB Staff Position 157-2, “Effective Date of FASB Statement
No. 157” (“FSP 157-2”).  FSP 157-2 delays the effective date of
SFAS 157 for all non-financial assets and liabilities, except those that are
recognized or disclosed at fair value on a recurring basis (at least annually)
to fiscal years beginning after November 15, 2008 and interim periods within
those fiscal years.  In October 2008, the FASB issued FASB Staff
Position 157-3, “Determining
the Fair Value of a Financial Asset When the Market for the Asset is Not
Active” (“FSP 157-3”), to clarify the application of the provisions of
SFAS 157 in an inactive market and how an entity would determine fair value in
an inactive market.  FSP 157-3 is effective immediately and applies to
the Company’s December 31, 2008 financial statements.  The adoption of
SFAS 157 and FSP 157-3 had no impact on the amounts reported in the financial
statements.





SFAS 157
establishes a fair value hierarchy that prioritizes the inputs to valuation
methods used to measure fair value.  The hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or
liabilities (Level 1 measurements) and the lowest priority to unobservable
inputs (Level 3 measurements).  The three levels of the fair market
hierarchy under SFAS 157 are as follows:





Level 1:
Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities.





Level
2:  Quoted prices in markets that are not active, or inputs that are
observable either directly or indirectly, for substantially the full term of the
asset or liability.





Level
3:  Prices or valuation techniques that require inputs that are both
significant to the fair value measurement and unobservable (i.e. supported with
little or no market activity).





An asset
or liability’s level within the fair value hierarchy is based on the lowest
level of input that is significant to the fair value measurement.














F-28






SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
15 - Fair Value of
Financial Instruments- Continued





The
following table summarizes the valuation of assets and liabilities measured at
fair value on a non-recurring basis, by the above SFAS 157 pricing observability
as of December 31, 2008 (dollars in thousands):





Fair
      Value Measurement at Reporting Date UsingTotal
                    
                    
                    Level 1
                    
                    
                    Level 2
                    
                    
                    Level 3Loans
      accounted for under SFAS 114
                    
                    $
                    32,054
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    $
                    32,054Foreclosed
      real estate
                    
                    
                    6,317
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    6,317








The
following information should not be interpreted as an estimate of the fair value
of the entire Company since a fair value calculation is only provided for a
limited portion of the Company’s assets and liabilities.  Due to a
wide range of valuation techniques and the degree of subjectivity used in making
the estimates, comparisons between the Company’s disclosures and those of other
companies may not be meaningful.  The following methods and
assumptions were used to estimate the fair values of the Bank’s financial
instruments at December 31, 2008 and 2007.





Cash
and cash equivalents:


The
carrying amount reported in the balance sheet for cash and cash equivalents
approximate those assets fair values.





Investment
Securities:


The
Company utilizes a third party source to determine the fair value of its fixed
income securities.  The methodology consists of pricing models based
on asset class and includes available trade, bid, other market information,
broker quotes, proprietary models, various databases and trading desk quotes,
some of which are heavily influenced by unobservable inputs.





FHLB
stock:


The
carrying amount of FHLB stock approximates fair value.





Loans
held for sale:


The value
of loans held for sale is based primarily on investor quotes.





Loans
receivable:


The fair
values of loans receivable was estimated using discounted cash flow analyses,
using market interest rates currently being offered for loans with similar terms
to borrowers of similar credit quality.  These rates were used for
each aggregated category of loans as reported on the Office of Thrift
Supervision Quarterly Report.





Impaired
loans are those that are accounted for under FASB Statement No. 114, “Accounting by Creditors for
Impairment of a Loan” (“SFAS 114”), in which the Company has measured
impairment generally based on the fair value of the loan’s
collateral.  Fair value is generally determined based upon independent
third-party appraisals of the properties, or discounted cash flows based upon
the expected proceeds.  These assets are included as Level 3 fair
values, based upon the lowest level of input that is significant to the fair
value measurements.  The fair value consists of the loan balances
of $37,444,000 less their specific valuation allowances of $5,390,000, as
determined under SFAS 114.














F-29






SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
15 - Fair Value of
Financial Instruments- Continued





Foreclosed Real
Estate: Real estate acquired through or in the process of foreclosure is
recorded at fair value less estimated disposal costs.  Management
periodically evaluates the recoverability of the carrying value of the real
estate acquired through foreclosure using estimates as described under the
caption "Allowance for Loan Losses". In the event of a subsequent decline,
management provides an allowance to reduce real estate acquired through
foreclosure to fair value less estimated disposal cost. Expenses incurred on
foreclosed real estate prior to disposition are charged to expense. Gains or
losses on the sale of foreclosed real estate are recognized upon disposition of
the property.  Foreclosed real estate totaled $6,317,000 and
$2,993,000 as of December 31, 2008 and 2007, respectively and is included in
other assets.





Accrued
interest receivable and payable:


The
carrying amount of accrued interest receivable and accrued interest payable
approximates its fair value.





Deposit
liabilities:


The fair
values disclosed for demand deposit accounts, savings accounts and money market
deposits are, by definition, equal to the amount payable on demand at the
reporting date (i.e., their carrying amounts).  Fair values for
fixed-rate certificates of deposit are estimated using a discounted cash flow
calculation that applies market interest rates currently being offered on
certificates to a schedule of aggregated expected monthly maturities on time
deposits.





FHLB
advances and Subordinated debentures:


Fair
values of long-term debt are estimated using discounted cash flow analysis,
based on rates currently available for advances from the FHLB with similar terms
and remaining maturities. The fair value of subordinated debentures is equal to
the recorded value because either the subordinated debentures have a variable
rate of interest, or have been entered into recently.





Off-balance
sheet financial instruments:


Fair
values for the Company’s off-balance sheet financial instruments (lending
commitments and letters of credit) are not significant and based on fees
currently charged to enter into similar agreements, taking into account, the
remaining terms of the agreements and the counterparties credit
standing.





The
following table summarizes the roll forward of level 3 assets for the year ended
December 31, 2008 (dollars in thousands):





Impaired
      Loans
                                
                                
                                
                                Foreclosed
      Real EstateBalance
      at December 31, 2007
                                
                                $
                                6,599
                                
                                
                                $
                                2,993Transfer
      to foreclosed real estate
                                
                                
                                (7,300
                                )
                                
                                
                                12,128Additions
                                
                                
                                45,370
                                
                                
                                
                                92Additional
      reserves
                                
                                
                                (7,293
                                )
                                
                                
                                (932
                                )Paid
      off/sold
                                
                                
                                (5,322
                                )
                                
                                
                                (7,964
                                )Balance
      at December 31, 2008
                                
                                $
                                32,054
                                
                                
                                $
                                6,317





















F-30




SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
15 - Fair Value of
Financial Instruments - Continued





The above
$7,293,000 in additional reserves recorded against impaired loans was included
in the provision for loan losses on the statement of income for the year ended
December 31, 2008.  The $932,000 of additional reserves recorded
against foreclosed real estate was included in other non-interest expenses on
the statement of income for the year ended December 31,
2008.  Included in the $12,128,000 of loans transferred to foreclosed
real estate were 7 loans totaling $4,828,000 that were not considered impaired
per SFAS No. 114.





The
estimated fair values of the Bank's financial instruments are as
follows:





December
      31, 2008
                        
                        
                        December
      31, 2007Carrying
                          Amount
                        
                        
                        Fair
                          Value
                        
                        
                        Carrying
                          Amount
                        
                        
                        Fair
                          Value(dollars
      in thousands)Financial AssetsCash
      and cash equivalents
                        
                        $
                        32,305
                        
                        
                        $
                        32,305
                        
                        
                        $
                        11,266
                        
                        
                        $
                        11,266Investment
      securities
                        
                        
                        1,345
                        
                        
                        
                        1,329
                        
                        
                        
                        2,383
                        
                        
                        
                        2,330FHLB
      stock
                        
                        
                        8,694
                        
                        
                        
                        8,694
                        
                        
                        
                        10,172
                        
                        
                        
                        10,172Loans
      held for sale
                        
                        
                        453
                        
                        
                        
                        453
                        
                        
                        
                        1,101
                        
                        
                        
                        1,101Loans
      receivable, net
                        
                        
                        896,006
                        
                        
                        
                        899,991
                        
                        
                        
                        891,913
                        
                        
                        
                        877,647Accrued
      interest receivable
                        
                        
                        4,363
                        
                        
                        
                        4,363
                        
                        
                        
                        5,330
                        
                        
                        
                        5,330Financial LiabilitiesDeposits
                        
                        $
                        683,866
                        
                        
                        $
                        687,067
                        
                        
                        $
                        652,773
                        
                        
                        $
                        653,433FHLB
      advances
                        
                        
                        153,000
                        
                        
                        
                        151,142
                        
                        
                        
                        190,000
                        
                        
                        
                        186,275Subordinated
      debentures
                        
                        
                        24,119
                        
                        
                        
                        24,119
                        
                        
                        
                        20,619
                        
                        
                        
                        20,619Accrued
      interest payable
                        
                        
                        1,120
                        
                        
                        
                        1,120
                        
                        
                        
                        1,034
                        
                        
                        
                        1,034Off Balance Sheet
    Commitments
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -



















F-31





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
16 - Condensed
Financial Information (Parent Company Only)





Information as to the financial
position of Severn Bancorp, Inc. as of December 31, 2008 and 2007 and results of
operations and cash flows for each of the years ended December 31, 2008, 2007
and 2006 is summarized below.





December
      31,2008
                  
                  
                  2007(dollars
      in thousands)Statements
      of Financial ConditionCash
                  
                  $
                  8,289
                  
                  
                  $
                  1,905Equity
      in net assets of subsidiaries:Bank
                  
                  
                  132,890
                  
                  
                  
                  107,734Non-Bank
                  
                  
                  4,887
                  
                  
                  
                  4,367Loans,
      net of allowance for loan losses of
                    $41
      and $0, respectively
                  
                  
                  1,157
                  
                  
                  
                  1,199Other
      assets
                  
                  
                  1,317
                  
                  
                  
                  1,628Total
      assets
                  
                  $
                  148,540
                  
                  
                  $
                  116,833Subordinated
      debentures
                  
                  $
                  24,119
                  
                  
                  $
                  20,619Other
      liabilities
                  
                  
                  754
                  
                  
                  
                  938Total
      liabilities
                  
                  
                  24,873
                  
                  
                  
                  21,557Stockholders’
      equity
                  
                  
                  123,667
                  
                  
                  
                  95,276Total
      liabilities and stockholders’ equity
                  
                  $
                  148,540
                  
                  
                  $
                  116,833





For
      the Years Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006(dollars
      in thousands)Statements
      of IncomeInterest
      income
                        
                        $
                        118
                        
                        
                        $
                        116
                        
                        
                        $
                        129Interest
      expense on subordinated debentures
                        
                        
                        1,188
                        
                        
                        
                        1,487
                        
                        
                        
                        1,443Net
      interest expense
                        
                        
                        (1,070
                        )
                        
                        
                        (1,371
                        )
                        
                        
                        (1,314
                        )Dividends
      received from subsidiaries
                        
                        
                        3,393
                        
                        
                        
                        6,182
                        
                        
                        
                        3,424General
      and administrative expenses
                        
                        
                        50
                        
                        
                        
                        282
                        
                        
                        
                        292Income
      before income taxes and equity in
                        
                        
                        2,273
                        
                        
                        
                        4,529
                        
                        
                        
                        1,818undistributed
      net income of subsidiariesIncome
      tax benefit
                        
                        
                        57
                        
                        
                        
                        2
                        
                        
                        
                        415Equity
      in undistributed net income of subsidiaries
                        
                        
                        1,783
                        
                        
                        
                        6,580
                        
                        
                        
                        13,515Net
      income
                        
                        $
                        4,113
                        
                        
                        $
                        11,111
                        
                        
                        $
                        15,748














F-32




SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





Note
16 - Condensed
Financial Information (Parent Company Only) - Continued








For
      the Years Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006(dollars
      in thousands)Statements
      of Cash FlowsCash Flows from Operating
      Activities:Net
      income
                        
                        $
                        4,113
                        
                        
                        $
                        11,111
                        
                        
                        $
                        15,748Adjustments
      to reconcile net income to netcash
      provided by operating activities:Equity
      in undistributed earnings of subsidiaries
                        
                        
                        (1,783
                        )
                        
                        
                        (6,580
                        )
                        
                        
                        (13,515
                        )Provision
      for loan losses
                        
                        
                        41
                        
                        
                        
                        -
                        
                        
                        
                        -(Increase)
      decrease in other assets
                        
                        
                        311
                        
                        
                        
                        (705
                        )
                        
                        
                        (57
                        )Stock-based
      compensation expense
                        
                        
                        128
                        
                        
                        
                        128
                        
                        
                        
                        163Increase
      (decrease) in other liabilities
                        
                        
                        61
                        
                        
                        
                        153
                        
                        
                        
                        (300
                        )Cash
      provided by operating activities
                        
                        
                        2,871
                        
                        
                        
                        4,107
                        
                        
                        
                        2,039Cash Flows from Investing
      Activities:Net
      decrease in loans
                        
                        
                        1
                        
                        
                        
                        -
                        
                        
                        
                        657Investment
      in subsidiaries
                        
                        
                        (23,893
                        )
                        
                        
                        (1,440
                        )
                        
                        
                        (700
                        )Cash
      used in investing activities
                        
                        
                        (23,892
                        )
                        
                        
                        (1,440
                        )
                        
                        
                        (43
                        )Cash Flows from Financing
      Activities:Dividends
      paid on common stock
                        
                        
                        (2,416
                        )
                        
                        
                        (2,418
                        )
                        
                        
                        (2,196
                        )Series
      A preferred stock dividend paid
                        
                        
                        (35
                        )
                        
                        
                        -
                        
                        
                        
                        -Proceeds
      from sale of subordinated debentures
                        
                        
                        3,500
                        
                        
                        
                        -
                        
                        
                        
                        -Proceeds
      from sale of Series A preferred stock, net
                        
                        
                        3,253
                        
                        
                        
                        -
                        
                        
                        
                        -Proceeds
      from sale of Series B preferred stock, net
                        
                        
                        23,348
                        
                        
                        
                        -
                        
                        
                        
                        -Proceeds
      from exercise of options
                        
                        
                        -
                        
                        
                        
                        13
                        
                        
                        
                        15Payment
      of debt issuance cost
                        
                        
                        (245
                        )
                        
                        
                        -
                        
                        
                        
                        -Cash
      provided by (used in) financing activities
                        
                        
                        27,405
                        
                        
                        
                        (2,405
                        )
                        
                        
                        (2,181
                        )Increase
      (decrease) in cash and cash equivalents
                        
                        
                        6,384
                        
                        
                        
                        262
                        
                        
                        
                        (185
                        )Cash
      and cash equivalents at beginning of year
                        
                        
                        1,905
                        
                        
                        
                        1,643
                        
                        
                        
                        1,828Cash
      and cash equivalents at end of year
                        
                        $
                        8,289
                        
                        
                        $
                        1,905
                        
                        
                        $
                        1,643















F-33





SEVERN BANCORP, INC. AND
SUBSIDIARIES


Annapolis,
Maryland


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS








Note
17 - Quarterly
Financial Data (Unaudited)





Summarized
unaudited quarterly financial data for the year ended December 31, 2008 is as
follows:





First
                    Quarter
                  
                  
                  Second
                    Quarter
                  
                  
                  Third
                    Quarter
                  
                  
                  Fourth
                    Quarter(dollars
      in thousands, except per share data)Interest
      income
                  
                  $
                  17,151
                  
                  
                  $
                  15,741
                  
                  
                  $
                  15,048
                  
                  
                  $
                  14,532Interest
      expense
                  
                  
                  9,234
                  
                  
                  
                  8,363
                  
                  
                  
                  7,924
                  
                  
                  
                  7,982Net
      interest income
                  
                  
                  7,917
                  
                  
                  
                  7,378
                  
                  
                  
                  7,124
                  
                  
                  
                  6,550Provision
      for loan losses
                  
                  
                  750
                  
                  
                  
                  750
                  
                  
                  
                  2,865
                  
                  
                  
                  3,116Net
      interest income after provision for loan losses
                  
                  
                  7,167
                  
                  
                  
                  6,628
                  
                  
                  
                  4,259
                  
                  
                  
                  3,434Other
      income
                  
                  
                  520
                  
                  
                  
                  852
                  
                  
                  
                  737
                  
                  
                  
                  682Other
      expenses
                  
                  
                  4,086
                  
                  
                  
                  4,734
                  
                  
                  
                  3,988
                  
                  
                  
                  4,485Income
      (loss) before income tax provision
                  
                  
                  3,601
                  
                  
                  
                  2,746
                  
                  
                  
                  1,008
                  
                  
                  
                  (369
                  )Income
      tax provision (benefit)
                  
                  
                  1,466
                  
                  
                  
                  1,125
                  
                  
                  
                  421
                  
                  
                  
                  (139
                  )Net
      income (loss)
                  
                  $
                  2,135
                  
                  
                  $
                  1,621
                  
                  
                  $
                  587
                  
                  
                  $
                  (230
                  )Per
      share data:Earnings
      (loss) – basic
                  
                  $
                  .21
                  
                  
                  $
                  .16
                  
                  
                  $
                  .06
                  
                  
                  $
                  (.04
                  )Earnings
      (loss) – diluted
                  
                  $
                  .21
                  
                  
                  $
                  .16
                  
                  
                  $
                  .06
                  
                  
                  $
                  (.04
                  )





Summarized unaudited
quarterly financial data for the year ended December 31, 2007 is as
follows:





First
                    Quarter
                  
                  
                  Second
                    Quarter
                  
                  
                  Third
                    Quarter
                  
                  
                  Fourth
                    Quarter(dollars
      in thousands, except per share data)Interest
      income
                  
                  $
                  18,013
                  
                  
                  $
                  17,987
                  
                  
                  $
                  18,201
                  
                  
                  $
                  17,613Interest
      expense
                  
                  
                  8,956
                  
                  
                  
                  9,449
                  
                  
                  
                  9,872
                  
                  
                  
                  9,899Net
      interest income
                  
                  
                  9,057
                  
                  
                  
                  8,538
                  
                  
                  
                  8,329
                  
                  
                  
                  7,714Provision
      for loan losses
                  
                  
                  425
                  
                  
                  
                  537
                  
                  
                  
                  750
                  
                  
                  
                  750Net
      interest income after provision for loan losses
                  
                  
                  8,632
                  
                  
                  
                  8,001
                  
                  
                  
                  7,579
                  
                  
                  
                  6,964Other
      income
                  
                  
                  1,689
                  
                  
                  
                  1,292
                  
                  
                  
                  673
                  
                  
                  
                  682Other
      expenses
                  
                  
                  4,386
                  
                  
                  
                  4,349
                  
                  
                  
                  4,014
                  
                  
                  
                  3,743Income
      before income tax provision
                  
                  
                  5,935
                  
                  
                  
                  4,944
                  
                  
                  
                  4,238
                  
                  
                  
                  3,903Income
      tax provision
                  
                  
                  2,445
                  
                  
                  
                  2,053
                  
                  
                  
                  1,806
                  
                  
                  
                  1,605Net
      income
                  
                  $
                  3,490
                  
                  
                  $
                  2,891
                  
                  
                  $
                  2,432
                  
                  
                  $
                  2,298Per
      share dataEarnings
      – basic1
                  
                  $
                  .35
                  
                  
                  $
                  .29
                  
                  
                  $
                  .24
                  
                  
                  $
                  .23Earnings
      – diluted1
                  
                  $
                  .35
                  
                  
                  $
                  .29
                  
                  
                  $
                  .24
                  
                  
                  $
                  .23





1Retroactively adjusted to
reflect a 10% stock dividend declared February 20, 2007 and a 10% stock dividend
declared February 21, 2006.










F-34