**UNITED
STATES**


**SECURITIES
AND EXCHANGE COMMISSION**


**Washington,
D.C. 20549** ****





**Form
10-K**





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





[X]
    Annual
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934


For
      the fiscal year ended December 31, 2004.


or


[ 
       ]
    Transition
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934


For
      the transition period from ________ to
________





Commission
File Number **0-49731**





**SEVERN
BANCORP, INC.**


(Exact
name of registrant as specified in its charter)





**MARYLAND**
    
    **52-1726127**(State
      or other jurisdiction
    
    (I.R.S.
      Employer Identification Number)of
      incorporation or organization)**1919A
      West Street, Annapolis, Maryland**
    
    **21401**(Address
      of principal executive offices)
    
    (Zip
      Code)





Registrant's
telephone number, including area code: **** **(410)
268-4554**





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





Securities
registered pursuant to Section 12(g) of the Act





**Common
Stock, par value $.01 per share**


(Title of
Class)





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





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





Indicate
by check mark whether the registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2).


Yes [ ]
No [ **X** ]





The
aggregate market value of the voting stock held by non-affiliates of the
registrant, based on the closing sale price of the registrant’s common stock on
June 30, 2004 was $52,517,827 ($27.86 per share based on shares of common stock
outstanding at June 30, 2004). As of
March 1, 2005, there were issued and outstanding 8,318,184 shares of the
registrant’s common stock.





**Documents
Incorporated by Reference:** Portions
of the definitive Proxy Statement in connection with the Annual Meeting of
Shareholders for the Fiscal Year Ended December 31, 2004 (Part III).



















**Table
of Contents**


***Section***
    
    ***Page
      No.*****PART
      I**
    
    1**Item
      1**
    **Business**
    1**Item
      2**
    **Properties**
    30**Item
      3**
    **Legal
      Proceedings**
    30**Item
      4**
    **Submission
      of Matters to a Vote of Security Holders**
    30**Item
      4.1**
    **Executive
      Officers of Registrant That Are Not Directors**
    30**PART
      II**
    
    31**Item
      5**
    **Market
      for Registrant’s Common Equity and Related Stockholder
      Matters**
    31**Item
      6**
    **Selected
      Financial Data**
    32**Item
      7**
    **Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations**
    36**Item
      7A**
    **Quantitative
      and Qualitative Disclosures About Market Risk**
    42**Item
      8**
    **Financial
      Statements and Supplementary Data**
    43**Item
      9**
    **Changes
      in and Disagreements with Accountants on **Accounting
      and Financial Disclosures****
    43**Item
      9A**
    **Controls
      and Procedures**
    43**Item
      9B**
    **Other
      Information**
    44**PART
      III**
    
    44**Item
      10**
    **Directors
      and Executive Officers of the Registrant**
    44**Item
      11**
    **Executive
      Compensation**
    45**Item
      12**
    **Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters**
    45**Item
      13**
    **Certain
      Relationships and Related Transactions**
    45**Item
      14**
    **Principal
      Accountant Fees and Services**
    45**PART
      IV**
    
    46**Item
      15**
    **Exhibits
      and Financial Statement Schedules**
    46**SIGNATURES**
    
    47




















**SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS**





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





In
addition to the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. Bancorp operations and actual results could differ significantly
from those discussed in the forward-looking statements. Some of the factors that
could cause or contribute to such differences include, but are not limited to,
changes in the economy and interest rates in the nation and Bancorp’s general
market area. The forward-looking statements contained herein include, but are
not limited to, those with respect to management’s determination of the amount
of loan loss allowance; the effect of changes in interest rates; and changes in
deposit insurance premiums.







































**PART
I**





**Item
1. Business**





**Investment
Considerations**





In
analyzing whether to make or to continue an investment in the Company, investors
should consider, among other factors, the following:





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





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





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





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





**Competition.** The
Company faces strong competition from other thrifts, banks, savings institutions
and other financial institutions that have branch offices or otherwise operate
in the Company’s market area, as well as many other companies now offering a
range of financial services. Many of these competitors have substantially
greater financial resources and larger branch systems than the Company. In
addition, many of the Bank’s competitors have higher legal lending limits than
does the Bank. Particularly intense competition exists for sources of funds
including savings and retail time deposits and for loans, deposits and other
services that the Bank offers.




1







****


****


**Allowance
for Loan Losses.** The
Company has established an allowance for loan losses which management believes
to be adequate to offset probable losses on the Company’s existing loans.
However, there is no precise method of estimating loan losses. There can be no
assurance that any future declines in real estate market conditions, general
economic conditions or changes in regulatory policies will not require the
Company to increase its allowance for loan losses.





**Dividends.** While
the Board of Directors expects to continue its policy of regular quarterly
dividend payments, this dividend policy will be reviewed periodically in light
of future earnings, regulatory restrictions and other considerations. No
assurance can be given, therefore, that cash dividends on common stock will be
paid in the future.


****


**Stock
Not an Insured Deposit.** Investments in the shares of the Company’s Common Stock are not deposits insured
against loss by the FDIC or any other entity.





**General**





Severn
Bancorp, Inc. (the “Company” or “Bancorp”) is a savings and loan holding company
chartered in the state of Maryland in 1990. It conducts business through three
subsidiaries: The Bank, its principal subsidiary; Louis Hyatt, Inc. (“HRE”), t/a
Hyatt Commercial (formerly Hyatt Real Estate), a commercial real estate
brokerage and property management company; and SBI Mortgage Company, which has
held mortgages that do not meet the underwriting criteria of the Bank, and is
the parent company of Crownsville Development Corporation, t/a Annapolis Equity
Group, which acquires real estate for syndication and investment
purposes.





On
December 17, 2004, the Company acquired all the common stock of newly formed
Severn Capital Trust I, a Delaware business trust. Severn Capital Trust I issued
$20,000,000 of trust preferred securities in a private placement pursuant to an
applicable exemption from registration. The Company irrevocably and
unconditionally guarantees the trust preferred securities. The proceeds of the
trust preferred securities has been used to purchase subordinated debentures of
the Company.





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





As of
December 31, 2004, Bancorp had total assets of $703,616,000, total deposits of
$527,413,000, and stockholders’ equity of $60,154,000. Net income of Bancorp for
the year ended December 31, 2004 was $12,931,000, of which $12,800,000 was net
income of the Bank.





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





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





S. Scott
Kirkley


Senior
Vice President


Severn
Bancorp, Inc.


1919A
West Street


Annapolis,
Maryland 21401




2














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





**Business
of the Bank**





The Bank
was organized in 1946 in Baltimore, Maryland as Pompei Permanent Building and
Loan Association. It relocated to Annapolis, Maryland in 1980 and its name was
changed to Severn Savings Association. Subsequently, the Bank obtained a federal
charter and changed its name to Severn Savings Bank, FSB. The Bank operates
three full-service branch offices, one administrative office and one accounting
and servicing office. The Bank operates as a federally chartered savings bank
whose principal business is attracting deposits from the general public and
investing those funds in mortgage loans. The Bank also uses advances, or loans
from the Federal Home Loan Bank of Atlanta, to fund its mortgage activities. The
Bank’s revenues are derived principally from interest earned on mortgage loans,
fees charged in connection with the loans and banking services, and gains
realized from the sale of mortgage loans. The Bank’s primary sources of funds
are deposits, advances from the Federal Home Loan Bank of Atlanta, principal
amortization and prepayment of its loans. The principal executive offices of the
Bank are maintained at 1919 A West Street, Annapolis Maryland, 21401. Its
telephone number is 410-268-4554 and its e-mail address is mailman@severnbank.com.





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





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





**The
Thrift Industry**





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





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






3














**Earnings**





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





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





**Competition**





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





**Net
Interest Income**





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





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





**Interest
Rate and Volume of Interest-Related Assets and
Liabilities**





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





For
information regarding the total dollar amount of interest income from
interest-earning assets, the average yields, the amount of interest expense from
interest-bearing liabilities and the average rate, net interest income, interest
rate spread, and the net yield on interest-earning assets, refer to Item 7,
“Management's Discussion and Analysis of Financial Condition and Results of
Operations”.





For
information concerning the extent to which changes in interest rates and changes
in volume of interest-related assets and liabilities have affected the Bank’s
interest income and expense during the fiscal years ending December 31, 2004 and
2003, refer to Item 6, “Selected Financial Data - Rate Volume Table”
..






4







****


****


**Market
Area**





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





The
primary focus of the Bank’s lending activities has been on first mortgage loans
secured by real estate for the purpose of purchasing, refinancing, developing
and constructing one-to-four family residences and commercial properties in and
near Anne Arundel County, Maryland. The Bank does originate mortgage loans
throughout the state of Maryland, Northern Virginia and Delaware. The Bank is an
active participant in the secondary market and sells substantially all
fixed-rate long-term mortgages that it originates.









5










**Loan
Portfolio Composition**





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





2004
    2003
    2002
    2001
    2000Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(dollars
      in thousands)Residential
      mortgage
    
    $
    215,767
    
    
    27.30
    %
    $
    187,498
    
    
    30.83
    %
    $
    142,342
    
    
    28.87
    %
    $
    129,778
    
    
    31.66
    %
    $
    120,775
    
    
    36.85
    %Construction,
      land acquisition anddevelopment
    
    
    343,101
    
    
    43.42
    %
    
    240,757
    
    
    39.58
    %
    
    191,196
    
    
    38.77
    %
    
    163,849
    
    
    39.98
    %
    
    117,325
    
    
    35.80
    %Land
    
    
    33,419
    
    
    4.23
    %
    
    25,820
    
    
    4.25
    %
    
    20,109
    
    
    4.08
    %
    
    16,895
    
    
    4.12
    %
    
    11,390
    
    
    3.48
    %Lines
      of credit
    
    
    29,096
    
    
    3.68
    %
    
    19,581
    
    
    3.22
    %
    
    12,472
    
    
    2.53
    %
    
    8,776
    
    
    2.14
    %
    
    9,486
    
    
    2.89
    %Commercial
      real estate
    
    
    127,768
    
    
    16.17
    %
    
    106,823
    
    
    17.56
    %
    
    90,862
    
    
    18.43
    %
    
    68,599
    
    
    16.74
    %
    
    50,932
    
    
    15.54
    %Commercial
      non-real estate
    
    
    3,859
    
    
    0.49
    %
    
    3,813
    
    
    0.63
    %
    
    3,445
    
    
    0.70
    %
    
    3,393
    
    
    0.83
    %
    
    5,235
    
    
    1.60
    %Home
      equity
    
    
    28,101
    
    
    3.56
    %
    
    18,391
    
    
    3.02
    %
    
    11,197
    
    
    2.27
    %
    
    7,834
    
    
    1.91
    %
    
    5,318
    
    
    1.62
    %Consumer
    
    
    2,489
    
    
    0.31
    %
    
    2,364
    
    
    0.39
    %
    
    3,979
    
    
    0.81
    %
    
    3,220
    
    
    0.79
    %
    
    3,110
    
    
    0.95
    %Loans
      held for sale
    
    
    6,654
    
    
    0.84
    %
    
    3,175
    
    
    0.52
    %
    
    17,481
    
    
    3.54
    %
    
    7,499
    
    
    1.83
    %
    
    4,169
    
    
    1.27
    %Total gross loans
    
    
    790,254
    
    
    100.00
    %
    
    608,222
    
    
    100.00
    %
    
    493,083
    
    
    100.00
    %
    
    409,843
    
    
    100.00
    %
    
    327,740
    
    
    100.00
    %Unearned
      fees, premiums & discounts, net
    
    
    (4,157
    )
    
    
    
    
    (3,344
    )
    
    
    
    
    (2,674
    )
    
    
    
    
    (2,164
    )
    
    
    
    
    (2,149
    )Loans
      in process
    
    
    (123,195
    )
    
    
    
    
    (94,020
    )
    
    
    
    
    (67,593
    )
    
    
    
    
    (61,685
    )
    
    
    
    
    (48,211
    )Allowance
      for loan losses
    
    
    (5,935
    )
    
    
    
    
    (4,832
    )
    
    
    
    
    (3,991
    )
    
    
    
    
    (3,353
    )
    
    
    
    
    (2,728
    )Total loans net
    
    $
    656,967
    
    
    
    
    $
    506,026
    
    
    
    
    $
    418,825
    
    
    
    
    $
    342,641
    
    
    
    
    $
    274,652










6











**Lending
Activities**





**General**





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





The Bank
originated $336,648,000 and $320,902,000 of mortgage loans for the years ending
December 31, 2004 and 2003, respectively.





**Loan
Origination Procedures**





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





For
      the Years ended December 31,2004
    
    
    2003
    
    
    2002(dollars
      in thousands)Held
      for Sale:Beginning
      balance
    
    $
    3,175
    
    $
    17,481
    
    $
    7,499Originations
    
    
    74,370
    
    
    119,660
    
    
    110,565Net
      sales
    
    
    (70,873
    )
    
    (133,872
    )
    
    (100,535
    )Other
    
    
    (18
    )
    
    (94
    )
    
    (48
    )Ending
      balance
    
    $
    6,654
    
    $
    3,175
    
    $
    17,481Held
      for investment:Beginning
      balance
    
    $
    605,047
    
    $
    475,602
    
    $
    402,345Originations
      and purchases
    
    
    262,278
    
    
    201,242
    
    
    233,222Repayments/payoffs
    
    
    (83,725
    )
    
    (71,797
    )
    
    (159,965
    )Ending
      balance
    
    $
    783,600
    
    $
    605,047
    
    $
    475,602





The Bank
originates residential mortgage loans that are intended for sale in the
secondary market as well as loans that are to be held in the Bank’s investment
portfolio. Loans sold in the secondary market are primarily sold to investors
with which the Bank maintains a correspondent relationship. These loans are made
in conformity with standard underwriting criteria to assure maximum eligibility
for possible resale in the secondary market, and are approved either by the
Bank’s underwriter or the correspondent’s underwriter. Loans considered for the
Bank’s portfolio are approved by the Bank’s loan committee, which is comprised
of the Executive Vice President and the Senior Vice President. Meetings of the
loan committee are open to attendance by any member of the Bank’s Board of
Directors who wishes to attend. The loan committee reports to and consults with
the Board of Directors in interpreting and applying the Bank’s lending
policy.








7












Loans
that are sold are typically long-term (15 or more years) loans with fixed
interest rates eligible for resale in the secondary market. Loans retained for
the Bank’s portfolio include construction loans, commercial loans and loans that
periodically reprice or mature prior to the end of an amortized term. Loans are
generally sold with servicing released. However, as of December 31, 2004, the
Bank was servicing $1,812,000 in loans for Federal Home Loan Mortgage
Corporation (“FHLMC”) and $21,551,000 in loans for other investors.





The
following table contains information, as of December 31, 2004, on the percentage
of fixed-rate single-family loans serviced for others by the Bank, by interest
rate category.





Coupon
      range
    
    Percentage
      of PortfolioLess
      than 5.00%
    
    52.6%5.01
      - 6.00%
    
    0.0%6.01
      - 7.00%
    
    6.5%7.01
      - 8.00%
    
    25.4%Over
      8.00%
    
    15.5%100.0%





The
Bank’s mortgage loan approval process is intended to assess the borrower’s
ability to repay the loan, the viability of the loan, and the adequacy of the
value of the property that will secure the loan. The authority of the loan
committee to approve loans is established by the Board of Directors and
currently is commensurate with the Bank’s limitation on loans to one borrower.
The Bank’s maximum amount of loans to one borrower currently is equal to 15% of
the Bank’s unimpaired capital, or $11,036,000 as of December 31, 2004. Loans
greater than this amount require participation by one or more additional
lenders. Letters of credit are subject to the same limitations as direct loans.
The Bank utilizes independent qualified appraisers approved by the Board of
Directors to appraise the properties securing its loans and requires title
insurance or title opinions so as to insure that the Bank has a valid lien on
the mortgaged real estate. The Bank requires borrowers to maintain fire and
casualty insurance on its secured properties.





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





**Commercial
Real Estate Loans**





At
December 31, 2004, the Bank’s commercial real estate loan portfolio totaled
$127,768,000, or 16.2% of the Bank’s total loan portfolio. All of the Bank’s
commercial loans are secured by improved property such as office buildings,
retail strip shopping centers, industrial condominium units and other small
businesses most of which are located in the Bank’s primary lending area. The
largest commercial real estate loan outstanding at December 31, 2004 was a
$4,369,000 loan secured by mobile home parks in Hubert, North Carolina and
California, Maryland and commercial land in California, Maryland. This loan has
consistently performed in accordance with the terms of the debt
instrument.





Loans
secured by commercial real estate properties generally involve a greater degree
of risk than residential mortgage loans. Because payments on loans secured by
commercial real estate properties are often dependent on the successful
operation or management of the properties, repayment of these loans may be
subject to a greater extent to adverse conditions in the real estate market or
the economy.








8












**Construction
Loans**





The Bank
originates loans to finance the construction of one-to-four family dwellings,
and to a lesser extent, commercial real estate. It also originates loans for the
acquisition and development of unimproved property to be used for residential
and/or commercial purposes in cases where the Bank is to provide the
construction funds to improve the properties. As of December 31, 2004, the Bank
had 656 construction loans outstanding in the gross aggregate amount of
$343,101,000, representing 43.4% of its loan portfolio, of which $123,195,000
was unadvanced.





Construction
loan amounts are based on the appraised value of the property and, for builder
loans, a feasibility study as to the potential marketability and profitability
of the project. Construction loans generally have terms of up to one year, with
reasonable extensions as needed, and typically have interest rates that float
monthly at margins typically ranging 1⁄2 percent to 2 percent above the prime
rate. In addition to builders’ projects, the Bank finances the construction of
single family, owner-occupied houses where qualified contractors are involved
and on the basis of strict written underwriting and construction loan
guidelines. Construction loans are structured either to be converted to
permanent loans with the Bank upon the expiration of the construction phase or
to be paid off by financing from another financial institution.





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





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





**Multi-Family
Lending**





The Bank
occasionally originates multi-family loans with terms up to 30 years, but with
rate adjustments or balloon payments generally at three to five years. These
loans are generally made in amounts up to 75% of the appraised value of the
secured property. In making these loans, the Bank bases its underwriting
decision primarily on the net operating income generated by the real estate to
support the debt service, the financial resources and income level of the
borrower, the borrower’s experience in owning or managing similar property, the
marketability of the property and the Bank’s lending experience with the
borrower. The Bank also typically receives a personal guarantee from the
borrower. As of December 31, 2004, $2,668,000, or 0.3% of the Bank’s total loan
portfolio, consisted of multi-family residential loans.





9














**Land
and Residential Building Lots**





Land
loans include loans to developers for the development of residential
subdivisions and loans on unimproved lots primarily to individuals. At December
31, 2004 the Bank had outstanding land and residential building lot loans
totaling $67,509,000, or 8.5% of the Bank’s total loan portfolio. The largest of
these loans is for $4,680,000, is secured by residentially zoned land in Ocean
View, Delaware, and has performed in accordance with the terms of the debt
instrument. Land development loans typically are short-term loans; the duration
of these loans is typically not greater than three years. The interest rate on
land loans is generally at least 1% or 2% over the prime rate. The loan-to-value
ratio generally does not exceed 75%. Loans typically are made to customers of
the Bank and developers and contractors with whom the Bank has had previous
lending experience. In addition to the customary requirements for this type
loan, the Bank may also require a clean Phase I environmental study and
feasibility study to determine the profit potential of the
development.





**Consumer
and Other Loans**





The Bank
also offers other loans, primarily business and commercial loans. These are
loans to businesses not secured by real estate although they may be secured by
equipment, securities, or other collateral. They constitute a relatively small
part of the Bank’s business, and typically are offered to customers with
long-standing relationships with the Bank. At December 31, 2004, $9,354,000, or
1.2%, of the loan portfolio consisted of business and commercial loans. In
addition, approximately 0.2% of the loan portfolio is in consumer
loans.





**Loan
Portfolio Cash Flows**





The
following table sets forth the estimated maturity of the Bank’s loan portfolios
by type of loan at December 31, 2004. The estimated maturity reflects
contractual terms at December 31, 2004. Contractual principal repayments of
loans do not necessarily reflect the actual term of the Bank’s loan portfolios.
The average life of mortgage loans is substantially less than their contractual
terms because of loan prepayments and because of enforcement of "due on sale"
clauses. The average life of mortgage loans tends to increase, however, when
current mortgage loan rates substantially exceed rates on existing mortgage
loans.





Due
    
    
    Due
      afterWithin
    
    
    1
      through
    
    
    Due
      afterone
      year
    
    
    5
      years
    
    
    5
      years
    
    
    Total(dollars
      in thousands)One
      to four family residential
    
    $
    18,655
    
    $
    72,708
    
    $
    147,299
    
    $
    238,662Multifamily
    
    
    136
    
    
    1,872
    
    
    660
    
    
    2,668Commercial
      and industrial real estate
    
    
    7,733
    
    
    41,966
    
    
    78,069
    
    
    127,768Construction
      and land acquisitionand development loans
    
    
    293,310
    
    
    49,695
    
    
    96
    
    
    343,101Land
    
    
    16,737
    
    
    43,944
    
    
    6,828
    
    
    67,509Commercial,
      non-real estate
    
    
    5,345
    
    
    1,102
    
    
    2,907
    
    
    9,354Consumer
    
    
    373
    
    
    563
    
    
    256
    
    
    1,192Total
    
    $
    342,289
    
    $
    211,850
    
    $
    236,115
    
    $
    790,254





The
following table contains certain information as of December 31, 2004 relating to
the loan portfolio of the Bank with the dollar amounts of loans due after one
year that have fixed and floating rates. All loans are shown maturing based upon
contractual maturities and include scheduled payments but not possible
prepayments.








10














Fixed
    
    
    Floating
    
    
    Total(dollars
      in thousands)One
      to four family residential
    
    $
    138,634
    
    $
    81,373
    
    $
    220,007Multifamily
    
    
    1,952
    
    
    580
    
    
    2,532Commercial
      and industrial real estate
    
    
    77,759
    
    
    42,276
    
    
    120,035Construction
      and land acquisitionand development loans
    
    
    16,030
    
    
    33,761
    
    
    49,791Land
    
    
    39,358
    
    
    11,414
    
    
    50,772Commercial,
      non-real estate
    
    
    1,878
    
    
    2,131
    
    
    4,009Consumer
    
    
    819
    
    
    -
    
    
    819Total
    
    $
    276,430
    
    $
    171,535
    
    $
    447,965






**Loans
to One Borrower**





The
aggregate amount of loans that the Bank may make to one borrower is 15% of the
Bank’s unimpaired capital and unimpaired surplus. The Bank’s largest loan at
December 31, 2004 was a $7,000,000 loan secured by assignments of notes, Deeds
of Trust, pledged stock and certificates of deposit. The second largest loan is
in the amount of $4,680,000 and is secured by residentially zoned lots in Ocean
View, Delaware. The third largest loan is in the amount of $4,369,000 and is
secured by various collateral including mobile home parks in California,
Maryland and Hubert, North Carolina. All of these loans have fully performed
since their inception.







**Origination
and Purchase and Sale of Loans**





The Bank
originates residential loans in conformity with standard underwriting criteria
to assure maximum eligibility for possible resale in the secondary market.
Although the Bank has authority to lend anywhere in the United States, they have
confined their loan origination activities to the states of Maryland, Virginia
and Delaware.





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





The
Bank’s mortgage loan approval process is intended to assess the borrower's
ability to repay the loan, the viability of the loan, and the adequacy of the
value of the property that will secure the loan. The loan committee of the Bank
can approve residential and commercial loans ranging up to $11,036,000 (the
maximum amount of a loan to one borrower as of December 31, 2004). The Bank
utilizes independent qualified appraisers approved by the Board of Directors to
appraise the properties securing its loans and requires title insurance or title
opinions so as to insure that the Bank has a valid lien on the mortgaged real
estate. The Bank requires borrowers to maintain fire and casualty insurance on
its secured properties.





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





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





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





11












**Interest
Rates, Points and Fees**





The Bank
realizes interest, point, and fee income from its lending activities. The Bank
also realizes income from commitment fees for making commitments to originate
loans, from prepayment and late charges, loan fees, application fees, and fees
for other miscellaneous services.





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





**Delinquency
and Classified Assets**





**Delinquencies**





The Board
of Directors reviews delinquencies on all loans monthly. The Bank’s collection
procedures include sending a past due notice to the borrower on the 17th day of
nonpayment, making telephone contact with the borrower between 20 and 30 days
after nonpayment, and sending a letter after the 30th day of nonpayment. A
notice of intent to foreclose is sent between 60 and 90 days after delinquency.
When the borrower is contacted, the Bank attempts to obtain full payment of the
past due amount. However, the Bank generally will seek to reach agreement with
the borrower on a payment plan to avoid foreclosure.





The Bank
categorizes its classified assets within four categories: A) Special Mention, B)
Substandard, C) Doubtful and D) Loss. Special Mention loans are 60 days or more
in arrears and include all borrowers who are in bankruptcy that have not missed
any post-petition payments. The Bank reserves 5% on all Special Mention loans.
Substandard loans are loans that are 90 days or more delinquent and are loans
that have borrowers in bankruptcy that have missed a post-petition payment. The
Bank reserves 15% of substandard loans. The Doubtful category consists of loans
where the Bank expects a loss, but not a total loss. Various subjective factors
are considered with the most important consideration being the estimated
underlying value of the collateral. The Bank reserves 50% of the amount of
Doubtful loans. Loans that are classified as “Loss” are fully
reserved.





All loans
are individually evaluated if they are deemed classified. The Bank also
evaluates all delinquent loans, individually. The rest of the portfolio is
evaluated as a group and a determination is made, periodically, concerning the
inherent risks associated with particular types of loans and an allowance is
assigned to those particular groups.





The Bank
allocates reserves to its allowance for loan losses in two ways. Where the Bank
has classified an asset it generally allocates the percentage of that asset
under its classification system to a specific reserve if the asset is classified
as Doubtful or Loss. In cases where loans are classified as Special Mention or
Substandard the Bank usually does not allocate its allowance for loan loss
reserves to a specific reserve. The Bank does not allocate its allowance for
loan losses based upon the unclassified portion of its loan portfolio to
specific loan reserves.





It is the
policy of the Bank to discontinue the accrual of interest on any loan that is 90
days or more past due. The Bank historically has not incurred any significant
losses on delinquent mortgage loans.





The
following table sets forth information as to non-accrual loans. The Bank
discontinues the accrual of interest on loans 90 days or more past due, at which
time all previously accrued but uncollected interest is deducted from income. As
of the most recent reported period, $70,000 would have been recorded for the
year ended December 31, 2004 if the loans had been current in accordance with
their original terms and had been outstanding throughout the year ended December
31, 2004 or since their origination (if held for only part of the fiscal year).
For the year ended December 31, 2004, $37,000 in interest income on such loans
was actually included in net income.





12














At
      December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars
      in thousands)Loans
      accounted for on a non-accrual basis:Mortgage
      loans:One-to-four
      family real estate
    
    $
    915
    
    $
    378
    
    $
    1,366
    
    $
    1.801
    
    $
    872Home
      equity lines of credit
    
    
    -
    
    
    50
    
    
    -
    
    
    -
    
    
    -Commercial
    
    
    -
    
    
    -
    
    
    253
    
    
    300
    
    
    292Land
    
    
    24
    
    
    24
    
    
    139
    
    
    -
    
    
    -Non-mortgage
      loans:Consumer
    
    
    -
    
    
    17
    
    
    -
    
    
    -
    
    
    14Commercial
      loans
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total
      non-accrual loans
    
    $
    939
    
    $
    469
    
    $
    1,758
    
    $
    2,101
    
    $
    1,178Foreclosed
      real-estate
    
    $
    -
    
    $
    -
    
    $
    224
    
    $
    312
    
    $
    312Total
      non-performing assets
    
    $
    939
    
    $
    469
    
    $
    1,982
    
    $
    2,413
    
    $
    1,490Total
      non-accrual loans to net loans
    
    
    0.1
    %
    
    0.1
    %
    
    0.4
    %
    
    0.6
    %
    
    0.4
    %Allowance
      for loan losses to total non-performing loans,including
      loans contractually past due 90 days or more
    
    
    632.1
    %
    
    1030.5
    %
    
    227.0
    %
    
    159.6
    %
    
    231.6
    %Total
      non-accrual and accruing loans greater than90
      days past due to total assets
    
    
    0.1
    %
    
    0.1
    %
    
    0.4
    %
    
    0.6
    %
    
    0.4
    %Total
      non-performing assets to total assets
    
    
    0.1
    %
    
    0.1
    %
    
    0.4
    %
    
    0.7
    %
    
    0.5
    %





**Classified
Assets and Allowance for Loan Losses**





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





13












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





Total
classified loans as of December 31, 2004 were $2,532,000. Allowance for loan
losses as of December 31, 2004 was $5,935,000, which is 0.8% of gross loans
receivable and 632.1% of total non-performing loans.





[see
table on following page]























14










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








2004
    2003
    2002
    2001
    2000Percentage
    
    
    
    
    
    Percentage
    
    
    
    
    
    Percentage
    
    
    
    
    
    Percentage
    
    
    
    
    
    Percentageof
      Loans in each
    
    
    
    
    
    of
      Loans in each
    
    
    
    
    
    of
      Loans in each
    
    
    
    
    
    of
      Loans in each
    
    
    
    
    
    of
      Loans in eachCategory
    
    
    
    
    
    Category
    
    
    
    
    
    Category
    
    
    
    
    
    Category
    
    
    
    
    
    CategoryAllowance
      Amount
    
    
    to
      Total Loans
    
    
    Allowance
      Amount
    
    
    to
      Total Loans
    
    
    Allowance
      Amount
    
    
    to
      Total Loans
    
    
    Allowance
      Amount
    
    
    to
      Total Loans
    
    
    Allowance
      Amount
    
    
    to
      Total Loans(dollars
      in thousands)Residential,
      one to four family
    
    $
    2,000
    
    
    30.20
    %
    $
    1,938
    
    
    36.20
    %
    $
    1,542
    
    
    36.58
    %
    $
    1,081
    
    
    36.90
    %
    $
    995
    
    
    41.95
    %Multifamily
    
    
    20
    
    
    0.34
    %
    
    21
    
    
    0.14
    %
    
    21
    
    
    0.27
    %
    
    24
    
    
    0.26
    %
    
    18
    
    
    .031
    %Commercial
      and industrial real estate
    
    
    1,009
    
    
    16.17
    %
    
    1,154
    
    
    18.48
    %
    
    881
    
    
    19.33
    %
    
    850
    
    
    17.46
    %
    
    658
    
    
    16.48
    %Construction
      and land acquisition anddevelopment
      loans
    
    
    2,577
    
    
    43.42
    %
    
    1,173
    
    
    39.58
    %
    
    1,202
    
    
    38.77
    %
    
    917
    
    
    39.98
    %
    
    662
    
    
    35.80
    %Land
    
    
    251
    
    
    8.54
    %
    
    476
    
    
    4.25
    %
    
    300
    
    
    4.08
    %
    
    413
    
    
    4.12
    %
    
    308
    
    
    3.48
    %Business,
      commercial
    
    
    70
    
    
    1.18
    %
    
    59
    
    
    1.16
    %
    
    33
    
    
    0.79
    %
    
    52
    
    
    .97
    %
    
    75
    
    
    1.71
    %Other
    
    
    8
    
    
    0.15
    %
    
    11
    
    
    0.19
    %
    
    12
    
    
    0.18
    %
    
    16
    
    
    .31
    %
    
    12
    
    
    0.27
    %Total
    
    $
    5,935
    
    
    100.00
    %
    $
    4,832
    
    
    100.00
    %
    $
    3,991
    
    
    100.00
    %
    $
    3,353
    
    
    100.00
    %
    $
    2,728
    
    
    100.00
    %












15










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




At
      or for the Year EndedDecember
      312004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars
      in thousands)Average
      loans outstanding, net
    
    $
    600,030
    
    $
    466,512
    
    $
    384,537
    
    $
    313,798
    
    $
    246,631Total
      gross loans outstanding at end of period
    
    $
    790,254
    
    $
    608,222
    
    $
    493,083
    
    $
    409,844
    
    $
    327,740Allowance
      balance at beginning of period
    
    $
    4,832
    
    $
    3,991
    
    $
    3,353
    
    $
    2,728
    
    $
    2,147Provision
      for loan losses
    
    
    1,200
    
    
    900
    
    
    670
    
    
    709
    
    
    591Actual
      charge-offs1-4
      family residential real estate
    
    
    97
    
    
    25
    
    
    -
    
    
    74
    
    
    30Other
    
    
    -
    
    
    34
    
    
    32
    
    
    10
    
    
    -Total
      charge-offs
    
    
    97
    
    
    59
    
    
    32
    
    
    84
    
    
    30RecoveriesTotal
      recoveries
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    20Net
      charge offs
    
    
    97
    
    
    59
    
    
    32
    
    
    84
    
    
    10Allowance
      balance at end of period
    
    $
    5,935
    
    $
    4,832
    
    $
    3,991
    
    $
    3,353
    
    $
    2,728Net
      charge offs as a percent of average loans
    
    
    0.02
    %
    
    0.01
    %
    
    0.01
    %
    
    0.03
    %
    
    0.00
    %Allowance
      for loan losses to total gross loans at end of period
    
    
    0.75
    %
    
    0.79
    %
    
    0.81
    %
    
    0.82
    %
    
    0.83
    %








**Investment
Activities**





Federal
thrift institutions, such as the Bank, have authority to invest in various types
of liquid assets, including United States Treasury obliga-tions and securities
of various federal agencies, certificates of deposit at insured banks, bankers'
acceptances and federal funds. As a member of the FHLB System, the Bank must
maintain minimum levels of liquid assets specified by the OTS, which vary from
time to time. Subject to various regulatory restrictions, federal thrift
institutions may also invest a portion of their assets in certain commercial
paper, corporate debt securities and mutual funds whose assets conform to the
investments that a federal thrift institution is authorized to make directly.





The
carrying amounts of the Bank’s investment securities held to maturity, as of the
dates indicated are presented in the following table:




At
      December 31,2004
    
    2003
    
    2002(dollars
      in thousands)FHLB
      Notes
    
    $
    5,000
    
    $
    6,000
    
    $
    4,000Mortgage-backed
      securities
    
    
    4,955
    
    
    6,721
    
    
    5,661Total
      Investment Securities Held to Maturity
    
    $
    9,955
    
    $
    12,721
    
    $
    9,661















16








Investment
Scheduled Maturity Table





As of
December 31, 2004








More
      than One to
    More
      than Five toOne
      Year or Less
    Five
      Years
    Ten
      Years
    More
      than Ten Years
    Total
      Investment SecuritiesCarrying
    
    
    Average
    
    
    Carrying
    
    
    Average
    
    
    Carrying
    
    
    Average
    
    
    Carrying
    
    
    Average
    
    
    Carrying
    
    
    Average
    
    
    FairAmount
    
    
    Yield
    
    
    Amount
    
    
    Yield
    
    
    Amount
    
    
    Yield
    
    
    Amount
    
    
    Yield
    
    
    Amount
    
    
    Yield
    
    
    Value(dollars
      in thousands)FHLB
      Notes
    
    -
    
    
    -
    
    $
    4,000
    
    
    2.6
    %
    $
    1,000
    
    
    5.05
    %
    
    -
    
    
    -
    
    $
    5,000
    
    
    3.1
    %
    $
    4,922Mortgage-backed
      securities
    
    -
    
    
    -
    
    
    1,815
    
    
    4.5
    %
    
    -
    
    
    -
    
    
    3,140
    
    
    5.5
    %
    
    4,955
    
    
    5.1
    %
    
    4,892Total
    $
    -
    
    
    -
    %
    $
    5,815
    
    
    3.2
    %
    $
    1,000
    
    
    5.05
    %
    $
    3,140
    
    
    5.5
    %
    $
    9,955
    
    
    4.1
    %
    $
    9,814















17








**Foreclosed
Real Estate**





As of
December 31, 2004, Bancorp owned no real estate through foreclosure.





**Deposits**





Deposits
are attracted principally from within the Bank’s primary market areas through
the offering of a variety of deposit instruments, including passbook and
statement accounts and certificates of deposit ranging in terms from three
months to five years. Deposit account terms vary, principally on the basis of
the minimum balance required, the time periods the funds must remain on deposit
and the interest rate. The Bank also offers individual retirement
accounts.





The
Bank’s policies are designed primarily to attract deposits from local residents
rather than to solicit deposits from areas outside their primary markets.
Interest rates paid, maturity terms, service fees and withdrawal penalties are
established by the Bank on a periodic basis. Determination of rates and terms
are predicated upon funds acquisition and liquidity requirements, rates paid by
competitors, growth goals and federal regulations.





Deposits
in the Bank as of December 31, 2004, 2003 and 2002 consisted of savings programs
described below:





2004
    
    
    2003
    
    
    2002(dollars
      in thousands)NOW
      accounts
    
    $
    4,872
    
    $
    8,610
    
    $
    3,321Money
      market accounts
    
    
    131,014
    
    
    152,413
    
    
    132,767Passbooks
    
    
    18,198
    
    
    19,191
    
    
    18,190Certificates
      of deposit
    
    
    356,447
    
    
    226,902
    
    
    210,983Non-interest
      bearing accounts
    
    
    16,882
    
    
    12,610
    
    
    12,590Total
      deposits
    
    $
    527,413
    
    $
    419,726
    
    $
    377,851






The Bank
held certificates of deposit totaling $356,447,000 at December 31, 2004,
maturing as follows:





(dollars
      in thousands)One
      year or less
    
    $
    231,089More
      than 1 year to 2 years
    
    
    79,172More
      than 2 years to 3 years
    
    
    26,707More
      than 3 years to 4 years
    
    
    12,062More
      than 4 years to 5 years
    
    
    7,376More
      than 5 years
    
    
    41$
    356,447










18









The
following table contains information pertaining to the certificates of deposit
held by the Bank in excess of $100,000 as of December 31, 2004.





Jumbo
      Certificateof
      DepositsTime
      Remaining Until Maturity
    
    
    (dollars
      in thousands)Less
      than three months
    
    $
    11,6183
      months to 6 months
    
    
    17,1036
      months to 12 months
    
    
    64,040Greater
      than 12 months
    
    
    39,109Total
    
    $
    131,870





**Liquidity
and Asset/Liability Management**





Two major
objectives of asset and liability management are to maintain adequate liquidity
and to control the interest sensitivity of the balance sheet.





Liquidity
is the measure of a company’s ability to maintain sufficient cash flow to fund
operations and to meet financial obligations to depositors and borrowers.
Liquidity is provided by the ability to attract and retain deposits and by
principal and interest payments on loans and maturing securities in the
investment portfolio. A strong core deposit base, supplemented by other deposits
of varying maturities and rates, contributes to the Bank’s
liquidity.





Funds
available through short-term borrowings and asset maturities are considered
adequate to meet all current needs, and management is continually monitoring the
Bank’s liquidity position to meet projected needs.





Interest
rate sensitivity is maintaining the ability to reprice interest earning assets
and interest bearing liabilities in relationship to changes in the general level
of interest rates. Management attributes interest rate sensitivity to a steady
net interest margin through all phases of interest rate cycles. Management
attempts to make the necessary adjustments to constrain adverse savings in net
interest income resulting from interest rate movements through GAP analysis and
income simulation modeling techniques.





**Short
Term Borrowings**





The Bank
has an available line of credit, secured by its residential mortgage portfolio,
in the amount of Thirty Percent (30%) of its total assets, with the Federal Home
Loan Bank of Atlanta (the “FHLB-Atlanta”). As of December 31, 2004, the
available line of credit with the FHLB-Atlanta was $210,422,000. The Bank, from
time to time, utilizes the line of credit when interest rates are more favorable
then obtaining deposits from the public. The following table sets forth
short-term borrowings with the FHLB-Atlanta, with original maturities of one
year or less.





Years
      ended December 31,2004
    
    
    2003
    
    
    2002(dollars
      in thousands)Short
      term borrowings and notes payableAverage
      balance outstanding during the period
    
    $
    15,567
    
    $
    1,500
    
    $
    4,917Maximum
      amount outstanding at any month-end duringthe
      period
    
    
    41,000
    
    
    8,000
    
    
    14,000Weighted
      Average interest rate during the period
    
    
    1.67
    %
    
    0.62
    %
    
    3.16
    %Total
      short term borrowings at period end
    
    
    -
    
    
    6,000
    
    
    -Weighted
      average interest rate at period end
    
    
    0.0
    %
    
    1.15
    %
    
    0.00
    %








19








**Employees**





As of
December 31, 2004, the Company and its subsidiaries had approximately 110
employees on a full-time or part-time basis. The Company’s employees are not
represented by any collective bargaining group, and management considers its
relations with its employees to be excellent.





**Severn
Capital**





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





**Hyatt
Real Estate**





Bancorp
acquired Hyatt Commercial, a real estate brokerage and property management
company, in June 2001. Hyatt Commercial is a real estate brokerage company
specializing in commercial real estate sales, leasing and property management.
It owns the facility within which it is located, at 1919 West Street, and is
also the owner of the property known as 1919A West Street, which is leased to
the Bank for its administrative offices





**Crownsville
Development Corporation**





Crownsville
Development Corporation trading as Annapolis Equity Group (“AEG”) is a
subsidiary of SBI and is engaged in the business of acquiring real estate for
investment and syndication purposes. AEG acquired two properties in
2004.





**SBI
Mortgage Company**





SBI is a
subsidiary of Bancorp that has engaged in the origination of mortgages not
suitable for the Bank. It owns subsidiary companies that have or are negotiating
to purchase real estate for investment purposes. As of December 31, 2004, SBI
had $241,000 in outstanding mortgage loans and it had $515,000 invested in
subsidiaries, which funds were held in cash, pending potential acquisition of
investment real estate.





**HS
West, LLC**





HS West,
LLC (“HS”) is a subsidiary of the Bank, and is constructing a building in
Annapolis, Maryland to serve as the Company’s and the Bank’s administrative
headquarters. A branch office of the Bank will be included. As of December 31,
2004, HS has incurred approximately $3,122,000 of costs, which are included in
land and construction in progress. The total cost is expected to be
approximately $20,700,000 before interior fit-out, with completion anticipated
in Spring 2006.





**Regulation**




***Competition***




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




20





******


**


***General***





Savings
and loan holding companies and savings associations are extensively regulated
under both federal and state law. This regulation is intended primarily for the
protection of depositors and SAIF and not for the benefit of stockholders of
Bancorp. The following information describes certain aspects of that regulation
applicable to Bancorp and the Bank, and does not purport to be complete. The
discussion is qualified in its entirety by reference to all particular statutory
or regulatory provisions.





***Regulation
of Bancorp***




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





***Activities
Restriction Test.*** As a
unitary savings and loan holding company, Bancorp generally is not subject to
activity restrictions, provided the Bank satisfies the Qualified Thrift Lender
(“QTL”) test or meets the definition of domestic building and loan association
pursuant to the Code. Bancorp presently intends to continue to operate as a
unitary savings and loan holding company. Recent legislation terminated the
“unitary thrift holding company exemption” for all companies that apply to
acquire savings associations after May 4, 1999. Since Bancorp is grandfathered,
its unitary holding company powers and authorities were not affected. See
“Regulation of Bancorp - Financial Modernization Legislation.” However, if
Bancorp acquires control of another savings association as a separate
subsidiary, it would become a multiple savings and loan holding company, and the
activities of Bancorp and any of its subsidiaries (other than the Bank or any
other SAIF-insured savings association) would become subject to restrictions
applicable to bank holding companies unless such other associations each also
qualify as a QTL or domestic building and loan association and were acquired in
a supervisory acquisition. Furthermore, if Bancorp were in the future to sell
control of the Bank to any other company, such company would not succeed to
Bancorp grandfathered status under and would be subject to the same business
activity restrictions. See “- Regulation of the Bank - Qualified Thrift Lender
Test.”





***Restrictions
on Acquisitions*** . Bancorp
must obtain approval from the OTS before acquiring control of any other
SAIF-insured association. Such acquisitions are generally prohibited if they
result in a multiple savings and loan holding company controlling savings
associations in more than one state. However, such interstate acquisitions are
permitted based on specific state authorization or in a supervisory acquisition
of a failing savings association.





Federal
law generally provides that no “person,” acting directly or indirectly or
through or in concert with one or more other persons, may acquire “control,” as
that term is defined in OTS regulations, of a federally insured savings
association without giving at least 60 days written notice to the OTS and
providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS. For additional restrictions on the acquisition of a unitary thrift holding
company, see “Regulation of Bancorp - Financial Services Modernization
Legislation.” Certain individuals, including Alan J. Hyatt, Louis Hyatt, and
Melvin Hyatt, and their respective spouses (“Applicants”), filed an Application
for Notice of Change In Control (“Notice”) in April 2001 pursuant to 12 CFR
Section 574.3(b). The Notice called for the Applicants to acquire up to 32.32%
of the Company’s issued and outstanding shares of stock of Bancorp by April 16,
2002. The OTS approved requests by the Applicants to extend the time to
consummate such acquisition of shares to January 18, 2006. The Applicants
currently own approximately 29.17% of the total outstanding shares of the
Company as of December 31, 2004.








21














***The
Sarbanes-Oxley Act of 2002***




On
July 30, 2002, the Sarbanes-Oxley Act of 2002 was enacted. The
Sarbanes-Oxley Act represents a comprehensive revision of laws affecting
corporate governance, accounting obligations and corporate reporting. The
Sarbanes-Oxley Act is applicable to all companies with equity securities
registered or that file reports under the Securities Exchange Act of 1934. In
particular, the Sarbanes-Oxley Act established: (i) new requirements for
audit committees, including independence, expertise and responsibilities;
(ii) additional responsibilities regarding financial statements for the
Chief Executive Officer and Chief Financial Officer of the reporting company;
(iii) new standards for auditors and regulation of audits;
(iv) increased disclosure and reporting obligations for the reporting
company and its directors and executive officers; and (v) new and increased
civil and criminal penalties for violations of the securities laws. Many of the
provisions were effective immediately while other provisions became effective
over a period of time and are subject to rulemaking by the SEC. Because
Bancorp’s common stock is registered with the SEC, it is currently subject to
this Act.





Throughout
2002 and 2003, the SEC and Nasdaq Stock Market issued new regulations affecting
Bancorp’s corporate governance and heightening its disclosure requirements.
Among the many new changes are enhanced proxy statement disclosures on corporate
governance, stricter independence requirements for the Board of Directors and
its committees, and posting of various SEC reports on our website. The full
impact of the Sarbanes-Oxley Act is still uncertain and evolving, however the
new legislation and implementing regulations have resulted in increased costs of
compliance, including certain outside professional costs.





We cannot
predict what legislation might be enacted or what regulations might be adopted,
or if enacted or adopted, the effect thereof on our operations.





***USA
Patriot Act of 2001***




On
October 26, 2001, the USA Patriot Act of 2001 was enacted. This act
contains the International Money Laundering Abatement and Financial
Anti-Terrorism Act of 2001, which sets forth anti-money laundering measures
affecting insured depository institutions, broker-dealers and other financial
institutions. The Act requires U.S. financial institutions to adopt new policies
and procedures to combat money laundering and grants the Secretary of the
Treasury broad authority to establish regulations and to impose requirements and
restrictions on the operations of financial institutions.





***Financial
Services Modernization Legislation***




***General*** . In
November 1999, the Gramm-Leach-Bliley Act of 1999 (the “GLB”) was enacted. As a
result of GLB new opportunities became available to financial institution
holding companies as it removed the restrictions that resulted from a regulatory
framework that had its origin in the Great Depression of the 1930s. In addition,
the GLB also contains provisions that expressly preempt any state law
restricting the establishment of financial affiliations, primarily related to
insurance.





The
general effect of GLB is to permit banks, other depository institutions,
insurance companies and securities firms to enter into combinations that result
in a single financial services organization to offer customers a wider array of
financial services and products, through a new entity known as a “financial
holding company.” “Financial activities” is broadly defined to include not only
banking, insurance and securities activities, but other activities incidental to
such financial activities or complementary activities that do not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally.





The GLB
also permits national banks to engage in expanded activities through the
formation of financial subsidiaries. A national bank may have a subsidiary
engaged in any activity authorized for national banks directly or any financial
activity, except for insurance underwriting, insurance investments, real estate
investment or development, or merchant banking, which may only be conducted
through a subsidiary of a financial holding company. Financial activities
include all activities permitted under new sections of the Bank Holding Company
Act or permitted by regulation.








22













To the
extent that the GLB permits banks, securities firms and insurance companies to
affiliate, the financial services industry may experience further consolidation.
The GLB is intended to grant to community banks certain powers as a matter of
right that larger institutions have accumulated on an ad hoc basis and which
unitary savings and loan holding companies already possess. Nevertheless, the
GLB may have the result of increasing the amount of competition that Bancorp and
the Bank faces from larger institutions and other types of companies offering
financial products, many of which may have substantially more financial
resources than Bancorp and the Bank.




***Regulation
of the Bank***




***General*** . As a
federally chartered, SAIF-insured savings association, the Bank is subject to
extensive regulation by the OTS and the Federal Deposit Insurance Corporation
(“FDIC”). Lending activities and other investments of the Bank must comply with
various statutory and regulatory requirements. The Bank is also subject to
certain reserve requirements promulgated by the FRB.





The OTS,
in conjunction with the FDIC, regularly examines the Bank and prepares reports
for the consideration of the Bank’s Board of Directors on any deficiencies found
in the operations of the Bank. The relationship between the Bank and depositors
and borrowers is also regulated by federal and state laws, especially in such
matters as the ownership of savings accounts and the form and content of
mortgage documents utilized by the Bank.





The Bank
must file reports with the OTS and the FDIC concerning its activities and
financial condition, in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with or acquisitions of other
financial institutions. This regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage and is
intended primarily for the protection of the SAIF and depositors. The regulatory
structure also gives the regulatory authorities extensive discretion in
connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such regulations, whether by the OTS, the FDIC or the Congress could
have a material adverse impact on Bancorp, the Bank, and their
operations.





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





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


·
    annual
      notices of their privacy policies to current customers;
  and


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





These
privacy provisions affect how consumer information is transmitted through
diversified financial companies and conveyed to outside vendors. Since GLB’s
enactment, a number of states have implemented their own versions of privacy
laws. The Bank has implemented its privacy policies in accordance with the
law.





***Interagency
Guidance on Response Programs to Protect Against Identity
Theft***





On August
12, 2003, the Federal bank and thrift regulatory agencies requested public
comment on proposed guidance that would require financial institutions to
develop programs to respond to incidents of unauthorized access to customer
information, including procedures for notifying customers under certain
circumstances. The proposed guidance








23








·
    interprets
      previously issued interagency customer information security guidelines
      that require financial institutions to implement information security
      programs designed to protect their customers’ information;
    and


·
    describes
      the components of a response program and sets a standard for providing
      notice to customers affected by unauthorized access to or use of customer
      information that could result in substantial harm or inconvenience to
      those customers, thereby reducing the risk of losses due to fraud or
      identity theft.





We are
not able at this time to determine the impact of any such proposed guidance on
our financial condition or results of operation.





***Premiums
for Deposit Insurance***





Through
the Bank Insurance Fund (“BIF”), the FDIC insures our customer deposits up to
prescribed limits for each depositor. The amount of FDIC assessments paid by
each BIF member institution is based on its relative risk of default as measured
by regulatory capital ratios and other factors. Specifically, the assessment
rate is based on the institution’s capitalization risk category and supervisory
subgroup category. An institution’s capitalization risk category is based on the
FDIC’s determination of whether the institution is well capitalized, adequately
capitalized or less than adequately capitalized. An institution’s supervisory
subgroup category is based on the FDIC’s assessment of the financial condition
of the institution and the probability that FDIC intervention or other
corrective action will be required.





FDIC-insured
depository institutions pay an assessment rate equal to the rate assessed on
deposits insured by SAIF.





The
assessment rate currently ranges from zero to 27 cents per $100 of domestic
deposits. The FDIC may increase or decrease the assessment rate schedule on a
semi-annual basis. Due to continued growth in deposits and some recent bank
failures, the BIF is nearing its minimum reserve ratio of 1.25% of insured
deposits as mandated by law (ratio of net worth of the BIF to the value of the
aggregate domestic deposits held in all BIF members). As of December 31, 2004,
the BIF reserve ratio was 1.30%. If the ratio drops below 1.25%, it is likely
the FDIC will be required to assess premiums on all banks. Any increase in
assessments or the assessment rate could have a material adverse effect on the
company’s earnings, depending on the amount of the increase. Furthermore, the
FDIC is authorized to raise insurance premiums under certain
circumstances.





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





All
FDIC-insured depository institutions must pay an annual assessment to provide
funds for the payment of interest on bonds issued by the Financing Corporation,
a federal corporation chartered under the authority of the Federal Housing
Finance Board. The bonds, commonly referred to as FICO bonds, were issued to
capitalize the Federal Savings and Loan Insurance Corporation. The FDIC
established the FICO assessment rates effective for the first half of 2004 at
approximately 1.54 cents for each $100 of assessable deposits. The FICO
assessments are adjusted quarterly to reflect changes in the assessment bases of
the FDIC’s insurance funds and do not vary depending on a depository
institution’s capitalization or supervisory evaluations.





***Regulatory
Capital Requirements*** . The
federal banking agencies have adopted risk-based minimum capital guidelines
intended to provide a measure of capital that reflects the degree of risk
associated with a banking organization’s operations for both transactions
reported on the balance sheet as assets and transactions which are recorded as
off balance sheet items. Under these guidelines, nominal dollar amounts of
assets and credit equivalent amounts of off balance sheet items are multiplied
by one of several risk adjustment percentages, which range from 0% for assets
with low credit risk federal banking agencies, to 100% for assets with
relatively high credit risk.








24














The
risk-based capital ratio is determined by classifying assets and certain
off-balance sheet financial instruments into weighted categories, with higher
levels of capital being required for those categories perceived as representing
greater risk. Under the capital guidelines, a banking organization’s total
capital is divided into tiers. “Tier I capital” consists of (1) common equity,
(2) qualifying noncumulative perpetual preferred stock, (3) a limited amount of
qualifying cumulative perpetual preferred stock and (4) minority interests in
the equity accounts of consolidated subsidiaries (including trust-preferred
securities), less goodwill and certain other intangible assets. Not more than
25% of qualifying Tier I capital may consist of trust-preferred securities.
“Tier II capital” consists of hybrid capital instruments, perpetual debt,
mandatory convertible debt securities, a limited amount of subordinated debt,
preferred stock that does not qualify as Tier I capital, a limited amount of the
allowance for loan and lease losses and a limited amount of unrealized holding
gains on equity securities. “Tier III capital” consists of qualifying unsecured
subordinated debt. The sum of Tier II and Tier III capital may not exceed the
amount of Tier I capital.





The
guidelines require a minimum ratio of qualifying total capital to risk-adjusted
assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of
4%. In addition to the risk-based guidelines, federal banking regulators require
banking organizations to maintain a minimum amount of Tier 1 capital to total
assets, referred to as the leverage ratio. For a banking organization rated in
the highest of the five categories used by regulators to rate banking
organizations, the minimum leverage ratio of Tier 1 capital to total assets must
be 3%. In addition to these uniform risk-based capital guidelines and leverage
ratios that apply across the industry, the regulators have the discretion to set
individual minimum capital requirements for specific institutions at rates
significantly above the minimum guidelines and ratios. The Bank is not subject
to any such individual minimum regulatory capital requirement.





As shown
below, the Bank’s regulatory capital exceeded all minimum regulatory capital
requirements applicable to it as of December 31, 2004.







Actual
    For
      Capital
      Adequacy
      Purposes
    To
      Be Well Capitalized Under Prompt Corrective Action
    ProvisionsAmount
    
    
    %
    
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %(dollars
      in thousands)December
      31, 2004Tangible
      (1)
    
    $
    73,572
    
    
    10.5
    %
    $
    10,521
    
    
    1.50
    %
    
    N/A
    
    
    N/ATier
      I capital (2)
    
    
    73,572
    
    
    13.4
    %
    
    N/A
    
    
    N/A
    
    $
    33,023
    
    
    6.00
    %Core
      (1)
    
    
    73,572
    
    
    10.5
    %
    
    28,056
    
    
    4.00
    %
    
    35,070
    
    
    5.00
    %Risk-weighted
      (2)
    
    
    79,419
    
    
    14.4
    %
    
    44,031
    
    
    8.00
    %
    
    55,039
    
    
    10.00
    %December
      31, 2003Tangible
      (1)
    
    $
    49,569
    
    
    9.2
    %
    $
    8,095
    
    
    1.50
    %
    
    N/A
    
    
    N/ATier
      I capital (2)
    
    
    49,569
    
    
    12.0
    %
    
    N/A
    
    
    N/A
    
    $
    24,692
    
    
    6.00
    %Core
      (1)
    
    
    49,569
    
    
    9.2
    %
    
    21,588
    
    
    4.00
    %
    
    26,984
    
    
    5.00
    %Risk-weighted
      (2)
    
    
    54,314
    
    
    13.2
    %
    
    32,923
    
    
    8.00
    %
    
    41,154
    
    
    10.00
    %





(1) To
adjusted total assets.


(2) To
risk-weighted assets.






The Home
Owners’ Loan Act (“HOLA”) permits savings associations not in compliance with
the OTS capital standards to seek an exemption from certain penalties or
sanctions for noncompliance. Such an exemption will be granted only if certain
strict requirements are met, and must be denied under certain circumstances. If
an exemption is granted by the OTS, the savings association still may be subject
to enforcement actions for other violations of law or unsafe or unsound
practices or conditions.





***Predatory
Lending*** . The
term "predatory lending," much like the terms "safety and soundness" and "unfair
and deceptive practices," is far-reaching and covers a potentially broad range
of behavior. As such, it does not lend itself to a concise or a comprehensive
definition. But typically predatory lending involves at least one, and perhaps
all three, of the following elements:








25








·
    making
      unaffordable loans based on the assets of the borrower rather than on the
      borrower's ability to repay an obligation ("asset-based lending");


·
    inducing
      a borrower to refinance a loan repeatedly in order to charge high points
      and fees each time the loan is refinanced ("loan flipping");
      and


·
    engaging
      in fraud or deception to conceal the true nature of the loan obligation
      from an unsuspecting or unsophisticated borrower.





On
October 1, 2002, FRB regulations aimed at curbing such lending became effective.
The rule significantly widens the pool of high-cost home-secured loans covered
by the Home Ownership and Equity Protection Act of 1994, a federal law that
requires extra disclosures and consumer protections to borrowers. The following
triggers coverage under the act:





·
    interest
      rates for first lien mortgage loans in excess of 8 percentage points above
      comparable U.S. Treasury securities,


·
    subordinate-lien
      loans of 10 percentage points above U.S. Treasury securities,
      and


·
    fees
      such as optional insurance and similar debt protection costs paid in
      connection with the credit transaction, when combined with points and fees
      if deemed excessive.





In
addition, the regulations bar loan flipping by the same lender or loan servicer
within a year. Lenders also will be presumed to have violated the law -- which
says loans shouldn't be made to people unable to repay them -- unless they
document that the borrower has the ability to repay. Lenders that violate the
rules face cancellation of loans and penalties equal to the finance charges
paid.





The Bank
is unable at this time to determine the impact of these rule changes and
potential state action in this area on its financial condition or results of
operation.





***Prompt
Corrective Action*** . The
prompt corrective action regulation of the OTS, requires certain mandatory
actions and authorizes certain other discretionary actions to be taken by the
OTS against a savings association that falls within certain undercapitalized
capital categories specified in the regulation.





The
regulation establishes five categories of capital classification:


·
    “well
      capitalized”;


·
    “adequately
      capitalized”;


·
    “undercapitalized”;


·
    “significantly
      undercapitalized”; and


·
    “critically
      undercapitalized”.





Under the
regulation, the risk-based capital, leverage capital, and tangible capital
ratios are used to determine an institution’s capital classification. At
December 31, 2004, the Bank met the capital requirements of a “well capitalized”
institution under applicable OTS regulations.





In
general, the prompt corrective action regulation prohibits an insured depository
institution from declaring any dividends, making any other capital distribution,
or paying a management fee to a controlling person if, following the
distribution or payment, the institution would be within any of the three
undercapitalized categories. In addition, adequately capitalized institutions
may accept brokered deposits only with a waiver from the FDIC and are subject to
restrictions on the interest rates that can be paid on such deposits.
Undercapitalized institutions may not accept, renew, or roll-over brokered
deposits.





If the
OTS determines that an institution is in an unsafe or unsound condition, or if
the institution is deemed to be engaging in an unsafe and unsound practice, the
OTS may, if the institution is well capitalized, reclassify it as adequately
capitalized; if the institution is adequately capitalized but not well
capitalized, require it to comply with restrictions applicable to
undercapitalized institutions; and, if the institution is undercapitalized,
require it to comply with certain restrictions applicable to significantly
undercapitalized institutions. Finally, pursuant to an interagency agreement,
the FDIC can examine any institution that has a substandard regulatory
examination score or is considered undercapitalized - without the express
permission of the institution’s primary regulator.








26








******


******


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





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


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


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


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





At
December 31, 2004, the Bank’s loans-to-one-borrower limit was $11,036,000 based
upon the 15% of unimpaired capital and surplus measurement. At December 31,
2004, the Bank’s largest single lending relationship had an outstanding balance
of $7,000,000, and consisted of a loan secured by assignments of notes, Deeds of
Trust, pledged stock and certificates of deposit. The loan was performing in
accordance with its terms.





***Qualified
Thrift Lender Test*** . Savings
associations must meet a QTL test, which test may be met either by maintaining a
specified level of assets in qualified thrift investments as specified in HOLA
or by meeting the definition of a “domestic building and loan association” as
defined in the Code. Qualified thrift investments are primarily residential
mortgages and related investments, including certain mortgage-related
securities. The required percentage of investments under HOLA is 65% of assets
while the Code requires investments of 60% of assets. An association must be in
compliance with the QTL test or the definition of domestic building and loan
association on a monthly basis in nine out of every 12 months. Associations that
fail to meet the QTL test will generally be prohibited from engaging in any
activity not permitted for both a national bank and a savings association. As of
December 31, 2004, the Bank was in compliance with its QTL requirement and met
the definition of a domestic building and loan association.





***Affiliate
Transactions*** .
Transactions between a savings association and its "affiliates" are
quantitatively and qualitatively restricted under the Federal Reserve Act and
regulations adopted by the Federal Reserve. Affiliates of a savings association
include, among other entities, the savings association's holding company and
companies that are under common control with the savings association. In
general, a savings association or its subsidiaries are limited in their ability
to engage in "covered transactions" with affiliates:





·
    to
      an amount equal to 10% of the association's capital and surplus, in the
      case of covered transactions with any one affiliate; and


·
    to
      an amount equal to 20% of the association's capital and surplus, in the
      case of covered transactions with all
affiliates.





In
addition, a savings association and its subsidiaries may engage in covered
transactions and other specified transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction"
includes:





·
    a
      loan or extension of credit to an affiliate;


·
    a
      purchase of investment securities issued by an
  affiliate;


·
    a
      purchase of assets from an affiliate, with some exceptions;


·
    the
      acceptance of securities issued by an affiliate as collateral for a loan
      or extension of credit to any party; or


·
    the
      issuance of a guarantee, acceptance or letter of credit on behalf of an
      affiliate.






27













In
addition, under the OTS regulations:





·
    a
      savings association may not make a loan or extension of credit to an
      affiliate unless the affiliate is engaged only in activities permissible
      for bank holding companies;


·
    a
      savings association may not purchase or invest in securities of an
      affiliate other than shares of a subsidiary;


·
    a
      savings association and its subsidiaries may not purchase a low-quality
      asset from an affiliate;


·
    covered
      transactions and other specified transactions between a savings
      association or its subsidiaries and an affiliate must be on terms and
      conditions that are consistent with safe and sound banking practices; and


·
    with
      some exceptions, each loan or extension of credit by a savings association
      to an affiliate must be secured by collateral with a market value ranging
      from 100% to 130%, depending on the type of collateral, of the amount of
      the loan or extension of credit.





Regulations
generally exclude all non-bank and non-savings association subsidiaries of
savings associations from treatment as affiliates, except for:





·
    a
      financial subsidiary,


·
    a
      subsidiary controlled by one or more
affiliates,


·
    an
      ESOP, or


·
    a
      subsidiary determined by the OTS or the Federal Reserve to be an
      affiliate.





The
regulations also require savings associations to make and retain records that
reflect affiliate transactions in reasonable detail and provides that specified
classes of savings associations may be required to give the OTS prior notice of
affiliate transactions.





Some of
the entities included in the definition of an affiliate are parent companies,
sister banks, sponsored and advised companies, investment companies whereby the
bank its affiliate serves as investment advisor, and financial subsidiaries of
the bank. Additional restrictions on transactions with affiliates may be imposed
on us under the prompt corrective action provisions of federal law. See “-
Prompt Corrective Action and Other Enforcement Mechanisms.”





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





The OTS
regulations require a savings association to file an application
if:





·
    it
      is not eligible for expedited treatment of its other applications under
      OTS regulations;


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


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


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






28











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





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


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


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





If
neither the savings association nor the proposed capital distribution meets any
of the above listed criteria, the OTS does not require the savings association
to submit an application or give notice when making the proposed capital
distribution. The OTS may prohibit a proposed capital distribution that would
otherwise be permitted if the OTS determines that the distribution would
constitute an unsafe or unsound practice.





***Interstate Banking
and Branching*** *.* A federal
savings association has the ability to establish branches outside its home
state. Commercial banks can also branch across state lines, subject to any state
law limitations or prohibitions. Competition may increase further as banks
branch across state lines and enter new markets.





***Community
Reinvestment Act and the Fair Lending Laws*** **.** Savings
associations have a responsibility under the Community Reinvestment Act and
related regulations of the OTS to help meet the credit needs of their
communities, including low- and moderate-income neighborhoods. In addition, the
Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from
discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of the Community Reinvestment Act could, at a minimum, result in
regulatory restrictions on its activities and the denial of applications. In
addition, an institution's failure to comply with the Equal Credit Opportunity
Act and the Fair Housing Act could result in the OTS, other federal regulatory
agencies as well as the Department of Justice taking enforcement actions. Based
on an examination conducted July 7,2003, the Bank received a satisfactory
rating.





Effective
January 1, 2002, the OTS raised the dollar amount limit in the definition of
small business loans from $500,000 to $2.0 million, if used for commercial,
corporate, business or agricultural purposes. Furthermore, the rule raises the
aggregate level that a thrift can invest directly in community development
funds, community centers and economic development initiatives in its communities
from the greater of a quarter of one percent of total capital or $100,000 to one
percent of total capital or $250,000.





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





·
    1%
      of its aggregate outstanding principal amount of its residential mortgage
      loans, home purchase contracts and similar obligations at the beginning of
      each calendar year; or


·
    5%
      of its FHLB advances or borrowings.





At
December 31, 2004, the Bank was in compliance with this requirement.





A new
capital plan of the FHLB-Atlanta was approved by the Federal Housing Finance
Board on January 23, 2004, and was implemented on December 17, 2004. The new
capital plan authorizes FHLB-Atlanta to issue, redeem and repurchase its capital
stock at its stated par value of $100 per share. Each member of FHLB-Atlanta is
required to own capital stock in an amount equal to the sum of:





*·*
    the
      membership stock requirement, which is the lesser of:


(i) 0.20%
of such member’s total assets as of December 31 of the previous calendar year;
or


(ii) a
specified dollar cap (initially estimated at $25 million); *plus*








29








·
    the
      activity-based stock requirement, which is the aggregate of:


(i) a
specified percentage (initially estimated at 4.50%) of the outstanding advances
from FHLB-Atlanta to each member;


(ii) a
specified percentage (initially estimated at 2.00%) of the “acquired member
assets” (as defined in FHLB regulations) sold by each member to FHLB-Atlanta;
and


(iii) a
specified percentage (initially estimated at 8.00%) of any targeted debt/equity
investment (which satisfies the criteria set forth in the FHLB regulations) sold
by each member to FHLB-Atlanta.





***Federal
Reserve System*** . The FRB
requires all depository institutions to maintain non-interest bearing reserves
at specified levels against their transaction accounts (primarily checking, NOW,
and Super NOW checking accounts) and non-personal time deposits. At December 31,
2004, the Bank was in compliance with these requirements.





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





**Item
2. Properties**





Bancorp
has three retail branch locations in Anne Arundel County, Maryland, of which it
owns two and leases the third. The Bank’s currently leases its executive office
located in Annapolis, Maryland from HRE, a wholly owned subsidiary of Bancorp.
HRE owns its office building in Annapolis, Maryland.





The Bank
leases administrative office space in Annapolis, Maryland from a third party.
Homeowner’s Title, a subsidiary of the Bank, leases office space in Annapolis,
Maryland from a limited liability company of which Alan J. Hyatt, Bancorp’s
Chairman and Chief Executive Officer, is a principal, on a term of 3 years,
subject to the right of Homeowner’s Title to exercise early termination, at its
option. Current monthly rental paid by Homeowner’s Title is $3,665.





HS West,
LLC (“HS”) is a subsidiary of the Bank, and is constructing a building in
Annapolis, Maryland to serve as the Company’s and the Bank’s administrative
headquarters. A branch office of the Bank will be included. As of December 31,
2004, HS has incurred approximately $3,122,000 of costs, which are included in
land and construction in progress. The total cost is expected to be
approximately $20,700,000 before interior fit-out, with completion anticipated
in Spring 2006.





**Item
3. Legal Proceedings**





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





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





None.





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





Cecelia
Lowman has served as the Chief Financial Officer of Bancorp since 1984. She
serves in the same capacities for the Bank.








30














**PART
II**





**Item
5. Market for Registrant's Common Equity and Related Stockholder
Matters**





(a)  none


(b)  none


(c)  none





Quarterly
Stock Information*





**2004**
    
    **2003**Stock
      Price Range
    Per
      Share
    
    
    Stock
      Price Range
    Per
      ShareQuarter
    Low
    High
    Dividend
    
    Quarter
    Low
    High
    Dividend1st
    $15.30
    $17.10
    $.050
    
    1st
    $7.91
    $11.00
    $.0402nd
    13.03
    15.88
    .050
    
    2nd
    10.04
    12.55
    .0403rd
    14.13
    14.63
    .055
    
    3rd
    10.80
    16.00
    .0454th
    16.45
    22.00
    .055
    
    4th
    14.93
    17.10
    .045





*Adjusted
to give retroactive effect to a 2 for 1 stock split declared November 17, 2004
effective for shares outstanding December 15, 2004.





Common
stock of Bancorp is traded on the Nasdaq Small-Cap Market under the symbol
“SVBI”.





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





See Item
12 of the Annual Report on Form 10-K and Note 12 to the consolidated financial
statements for information regarding equity compensation plans.














31













**Item
6. Selected Financial Data**





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





Summary Financial and Other Data





At
      December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars
      in thousands, except per share information)Balance
      Sheet DataTotal
      assets
    
    $
    703,616
    
    $
    540,471
    
    $
    458,415
    
    $
    366,890
    
    $
    293,230Total
      loans, net
    
    
    656,967
    
    
    506,026
    
    
    418,825
    
    
    342,641
    
    
    274,652Investment
      securities held to maturity
    
    
    9,955
    
    
    12,721
    
    
    9,661
    
    
    7,213
    
    
    9,779Nonperforming
      loans
    
    
    939
    
    
    469
    
    
    1,758
    
    
    2,101
    
    
    1,178Total
      nonperforming assets
    
    
    939
    
    
    469
    
    
    1,982
    
    
    2,413
    
    
    1,490Deposits
    
    
    527,413
    
    
    419,726
    
    
    377,925
    
    
    268,918
    
    
    229,312Short-term
      borrowings
    
    
    -
    
    
    6,000
    
    
    -
    
    
    -
    
    
    18,000Long-term
      debt
    
    
    89,000
    
    
    59,000
    
    
    34,000
    
    
    25,000
    
    
    16,000Total
      liabilities
    
    
    639,462
    
    
    487,501
    
    
    415,233
    
    
    332,059
    
    
    268,009Stockholders’
      equity
    
    $
    60,154
    
    $
    48,970
    
    $
    39,181
    
    $
    30,830
    
    $
    21,329Book
      value per common share *
    
    $
    7.23
    
    $
    5.89
    
    $
    4.73
    
    $
    3.80
    
    $
    3.29Common
      shares outstanding *
    
    
    8,318,184
    
    
    8,318,184
    
    
    8,285,184
    
    
    8,114,184
    
    
    6,478,632Other
      Data:Number
      of:Full
      service retail banking facilities
    
    
    3
    
    
    2
    
    
    2
    
    
    2
    
    
    2Full-time
      equivalent employees
    
    
    105
    
    
    81
    
    
    69
    
    
    67
    
    
    66
  *
      Retroactively adjusted to reflect two-for-one stock split declared
      November 17, 2004 effective for shares outstanding December 15, 2004, and
      three-for-one stock splitdeclared
      February 19, 2002 and effective for shares outstanding as of March
      1, 2002.






32











Summary
of Operations


For
      the Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars
      in thousands, except per share information)Interest
      and dividend income
    
    $
    44,619
    
    $
    37,087
    
    $
    33,402
    
    $
    29,489
    
    $
    24,271Interest
      expense
    
    
    14,631
    
    
    12,341
    
    
    13,799
    
    
    16,094
    
    
    13,387Net
      interest income
    
    
    29,988
    
    
    24,746
    
    
    19,603
    
    
    13,395
    
    
    10,884Provision
      for loan losses
    
    
    1,200
    
    
    900
    
    
    670
    
    
    708
    
    
    591Net
      interest income after provision for loan losses
    
    
    28,788
    
    
    23,846
    
    
    18,933
    
    
    12,687
    
    
    10,293Non-interest
      income
    
    
    3,612
    
    
    4,674
    
    
    4,133
    
    
    2,570
    
    
    1,439Non-interest
      expense
    
    
    11,211
    
    
    9,616
    
    
    8,447
    
    
    6,588
    
    
    5,348Income
      before income tax provision
    
    
    21,189
    
    
    18,904
    
    
    14,619
    
    
    8,669
    
    
    6,384Provision
      for income taxes
    
    
    8,258
    
    
    7,575
    
    
    5,671
    
    
    3,413
    
    
    2,439Net
      income
    
    $
    12,931
    
    $
    11,329
    
    $
    8,948
    
    $
    5,256
    
    $
    3,945Per
      Share Data:Basic
      earnings per share *
    
    $
    1.56
    
    $
    1.34
    
    $
    1.06
    
    $
    0.69
    
    $
    0.58Diluted
      earnings per share *
    
    $
    1.56
    
    $
    1.33
    
    $
    1.06
    
    $
    0.69
    
    $
    0.56Weighted
      number of shares outstanding basic *
    
    
    8,318,184
    
    
    8,293,132
    
    
    8,184,376
    
    
    7,294,902
    
    
    6,475,776Weighted
      number of shares outstanding diluted *
    
    
    8,318,184
    
    
    8,314,604
    
    
    8,206,446
    
    
    7,366,692
    
    
    6,661,830
  *
      Retroactively adjusted to reflect two-for-one stock split declared
      November 17, 2004 effective for shares outstanding December 15, 2004, and
      three-for-one stock splitdeclared
      February 19, 2002 and effective for shares outstanding as of March
      1, 2002.








33








Key
Operating Ratios


For
      the Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars
      in thousands)**Performance
      Ratios:**Return
      on average assets
    
    
    2.02
    %
    
    2.23
    %
    
    2.14
    %
    
    1.55
    %
    
    1.47
    %Return
      on average equity
    
    
    23.56
    %
    
    25.22
    %
    
    25.58
    %
    
    20.22
    %
    
    20.04
    %Net
      interest margin
    
    
    4.81
    %
    
    4.99
    %
    
    4.86
    %
    
    4.05
    %
    
    4.17
    %Interest
      rate spread
    
    
    4.60
    %
    
    4.77
    %
    
    4.59
    %
    
    3.65
    %
    
    3.75
    %Non-interest
      expense to average assets
    
    
    1.75
    %
    
    1.89
    %
    
    2.02
    %
    
    1.95
    %
    
    2.00
    %Efficiency
      ratio
    
    
    33.37
    %
    
    32.69
    %
    
    35.59
    %
    
    41.27
    %
    
    43.40
    %**Asset
      Quality Ratios:**Equity
      to Assets
    
    
    8.55
    %
    
    9.06
    %
    
    8.55
    %
    
    8.40
    %
    
    7.27
    %Nonperforming
      assets to total assets at
      end of period
    
    
    0.13
    %
    
    0.09
    %
    
    0.43
    %
    
    0.66
    %
    
    0.51
    %Nonperforming
      loans to total grossloans at end of period
    
    
    0.12
    %
    
    0.08
    %
    
    0.36
    %
    
    0.51
    %
    
    0.36
    %Allowance
      for loan losses to totalgross loans at end of
      period
    
    
    0.75
    %
    
    0.79
    %
    
    0.81
    %
    
    0.82
    %
    
    0.83
    %Allowance
      for loan losses to nonperforming loans at end of
      period
    
    
    632.1
    %
    
    1030.49
    %
    
    227.02
    %
    
    159.59
    %
    
    231.58
    %












34








**Average
Balance Sheet**


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





Years
      Ended December 31,2004
    
    2003
    
    2002Average
    
    
    
    Average
    
    
    
    AverageVolume
    Interest
    Yield/Cost
    
    Volume
    Interest
    Yield/Cost
    
    Volume
    Interest
    Yield/Cost(dollars
      in thousands)ASSETSLoans
      (1)
    
    $600,030
    $43,881
    7.31%
    
    $466,512
    $36,403
    7.80%
    
    $384,537
    $32,723
    8.51%Investments
      (2)
    
    5,250
    165
    3.15%
    
    6,167
    243
    3.94%
    
    7,339
    362
    4.93%Mortgage-backed
      securities
    
    5,686
    254
    4.46%
    
    6,586
    210
    3.18%
    
    1,346
    54
    4.00%Other
      interest-earning assets (3)
    
    12,656
    319
    2.52%
    
    16,749
    231
    1.38%
    
    10,123
    263
    2.60%Total
      interest-earning assets
    
    623,622
    44,619
    7.15%
    
    496,014
    37,087
    7.48%
    
    403,345
    33,402
    8.28%Non-interest
      earning assets
    
    16,552
    
    
    
    11,894
    
    
    
    13,979Total
      Assets
    
    $640,174
    
    
    
    $507,908
    
    
    
    $417,324LIABILITIES
      AND STOCKHOLDERS' EQUITYSavings
      and checking deposits
    
    $192,946
    $2,670
    1.38%
    
    $187,979
    $2,997
    1.59%
    
    $138,961
    $3,485
    2.51%Certificates
      of deposits
    
    284,636
    8,622
    3.03%
    
    222,819
    7.964
    3.57%
    
    198,613
    8,815
    4.44%Borrowings
    
    96,250
    3,339
    3.47%
    
    43,833
    1,380
    3.15%
    
    36,500
    1,499
    4.11%Total
      interest-bearing liabilities
    
    573,832
    14,631
    2.55%
    
    454,631
    12,341
    2.71%
    
    374,074
    13,799
    3.69%Non-interest
      bearing liabilities
    
    11,451
    
    
    
    8,360
    
    
    
    8,271Stockholders'
      equity
    
    54,891
    
    
    
    44,917
    
    
    
    34,979Total
      liabilities and stockholders' equity
    
    $640,174
    
    
    
    $507,908
    
    
    
    $417,324Net
      interest income and Interest rate spread
    
    
    $29,988
    4.60%
    
    
    $24,746
    4.77%
    
    
    $19,603
    4.59%Net
      interest margin
    
    
    
    4.81%
    
    
    
    4.99%
    
    
    
    4.86%Average
      interest-earning assets toaverage
      interest-bearing liabilities
    
    
    
    107.92%
    
    
    
    109.10%
    
    
    
    107.82%(1)
      Non-accrual loans are included in the average balances and in the
      computation of yields.(2)
      The Company does not have any tax-exempt securities.(3)
      Other interest earning assets includes interest bearing deposits in other
      banks, federal funds, and FHLB stock investments.







35













**Rate
Volume Table**





Year
      ended December 31, 2004
    Year
      ended December 31, 2003vs.
    vs.Year
      ended December 31, 2003
    Year
      ended December 31, 2002Total
    
    Changes
      Due to
    
    Total
    
    Changes
      Due toChange
    
    
    Volume
      (1)
    
    
    Rate
      (1)
    
    
    Change
    
    
    Volume
      (1)
    
    
    Rate
      (1)(dollars
      in thousands)Interest-earning
      assetsLoans
    
    $
    7,478
    
    $
    9,882
    
    $
    (2,404
    )
    $
    3,680
    
    $
    6,631
    
    $
    (2,951
    )Investments
    
    
    (78
    )
    
    (33
    )
    
    (45
    )
    
    (119
    )
    
    (53
    )
    
    (66
    )Mortgage-backed
      securities
    
    
    44
    
    
    (31
    )
    
    75
    
    
    156
    
    
    170
    
    
    (14
    )Other
      interest-earning assets
    
    
    88
    
    
    (67
    )
    
    155
    
    
    (32
    )
    
    121
    
    
    (153
    )Total
      interest income
    
    $
    7,532
    
    $
    9,751
    
    $
    (2,219
    )
    $
    3,685
    
    $
    6,869
    
    $
    (3,184
    )Interest-bearing
      liabilitiesSavings
      and checking deposits
    
    $
    (327
    )
    $
    76
    
    $
    (403
    )
    $
    (488
    )
    $
    1,010
    
    $
    (1,498
    )Certificates
      of deposits
    
    
    658
    
    
    1,979
    
    
    (1,321
    )
    
    (851
    )
    
    1,000
    
    
    (1,851
    )Borrowings
    
    
    1,959
    
    
    1,806
    
    
    153
    
    
    (119
    )
    
    340
    
    
    (459
    )Total
      interest expense
    
    $
    2,290
    
    $
    3,861
    
    $
    (1,571
    )
    $
    (1,458
    )
    $
    2,350
    
    $
    (3,808
    )Net
      change in interest income
    
    $
    5,242
    
    $
    5,890
    
    $
    (648
    )
    $
    5,143
    
    $
    4,519
    
    $
    624
  (1)
      Changes in interest income/expense not arising from volume or rate
      variances are allocated proportionately to rate and
  volume.




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





**Critical
Accounting Policies**





The
Company’s significant accounting policies are set forth in note 1 of the
consolidated financial statements for the year ended December 31, 2004 which are
set forth on pages F-1 through F-34. Of these significant accounting policies,
the Company considers the policy regarding the allowance for loan losses to be
its most critical accounting policy, given the uncertainty in evaluating the
level of the allowance required to cover credit losses inherent in the loan
portfolio and the material effect that such judgments can have on the results of
operations. In addition, changes in economic conditions can have a significant
impact on the allowance for loan losses and therefore the provision for loan
losses and results of operations. The Company has developed appropriate policies
and procedures for assessing the adequacy of the allowance for loan losses,
recognizing that this process requires a number of assumptions and estimates
with respect to its loan portfolio. The Company’s assessments may be impacted in
future periods by changes in economic conditions, the impact of regulatory
examinations, and the discovery of information with respect to borrowers that is
not known to management at the time of the issuance of the consolidated
financial statements.








36














**Overview**





The
primary business of Bancorp is mortgage lending. The markets in which Bancorp
operates, Anne Arundel County, Maryland, as well as surrounding areas in
Maryland, northern Virginia and Delaware, have enjoyed strong real estate
demand. This has fueled Bancorp’s growth, along with the demand to refinance
existing mortgages as a result of historically low interest rates. Refinancing
activity began to slow down toward the end of 2003, and slowed considerably in
2004. However, with interest rates remaining low, construction lending and
purchase money mortgage lending have continued to be extremely
active.





Bancorp
has been able to take advantage of the continued low interest rate environment
and had maintained a low cost of liabilities. Interest rates paid on deposits
have remained low, as have interest rates paid for borrowing funds from the
FHLB-Atlanta. The difference between Bancorp’s costs of funds and what it earns
on mortgage loans is the interest rate “spread”. This spread has increased as
Bancorp’s growing portfolio of mortgage loans coupled with the fees earned on
loans sold in the secondary market, has driven up overall revenues. While
variable expenses, such as compensation, have increased, Bancorp’s overall
expenses have remained modest, which has resulted in increasing
profitability.





Bancorp’s
asset quality has remained excellent, as there have been minimal losses due to
defaulting loans.





Going
forward, Bancorp’s challenge will be to continue to grow assets in the form of
mortgage loans, while earning a profitable spread, and continuing to maintain
good asset quality.





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





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





Subsequent
to the end of 2004, management discovered that certain cash accounts maintained
by the Company at other financial institutions were not reconciled by the
Company. The Company is now in the process of reconciling these accounts which
involve a discrepancy in the amount of approximately $500,000 at December 31,
2004. Management expects to have the accounts reconciled by the end of the first
quarter reporting period ending on March 31, 2005. It is anticipated that any
required adjustments, charges or reserves will be taken during this period.
Management does not believe that the required adjustments, if any, will have a
material adverse effect on the Company’s financial condition. Management has
implemented additional controls over this process since year-end to correct this
deficiency, including requiring reconciliation of such accounts on a daily
basis.





**Financial
Condition**





Total
assets increased by $163,145,000, or 30.2%, at December 31, 2004 to
$703,616,000, compared to $540,471,000 at December 31, 2003. The following
discusses the material changes between the December 31, 2004 and 2003 balance
sheets.





**Loans**





**Loans
Held For Sale.** At
December 31, 2004 loans held for sale totaled $6,654,0000, compared to
$3,175,000 at December 31, 2003. This increase of $3,479,000, or 109.6%, was
primarily due to the timing of loans pending sale at year-end.





**Loans
Receivable.** Total net
portfolio loans receivable were $650,313,000 at December 31, 2004, an increase
of $147,462,000, or 29.3%, from $502,851,000 at December 31, 2003. The increase
in the loan portfolio resulted from the continued strong loan demand due to
continued historically low interest rates. The increase in the loan portfolio
included increases in residential mortgage loans, residential construction loans
and commercial mortgage loans.








37








****


****


**Liabilities**





**Deposits.** Total
deposits at December 31, 2004 increased to $527,413,000 from $419,726,000 at
December 31, 2003, an increase of $107,687,000 or 25.7%. This increase is
primarily attributable to growth in certificates of deposit. The increase in
deposits was primarily used to fund loan growth.





**FHLB
Advances.** FHLB
advances totaled $89,000,000 at December 31, 2004, compared to $65,000,000 at
December 31, 2003, an increase of $24,000,000, or 36.9%. This increase was the
result of management’s decision to borrow funds from FHLB at more favorable
rates than would have been necessary to attract the needed funds through
customer deposits.





**Subordinated
Debentures.** Bancorp
has a non-consolidated subsidiary trust, Severn Capital Trust I, of which 100%
of the common equity is owned by Bancorp. The trust was formed for the purpose
of issuing corporation-obligated mandatorily redeemable capital securities (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 the Bancorp on January 7, 2010.





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





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





Standby
letters of credit, which are obligations of the Company to guarantee performance
of borrowers to governmental entities, were $7,866,000 as of December 31, 2004,
which was consistent with the balance of $7,982,000 as of December 31, 2003. The
Company continues to see demand by its borrowers for letter of credit
requirements.





Construction
loans in process totaled $123,195,000 at December 31, 2004.





Home
equity loans increased $5,355,000, or 44.1%, from $12,142,000 as of December 31,
2003 to $16,497,000 as of December 31, 2004. Home equity loans are loans that
allow the borrowers to draw funds up to a specified loan amount, from time to
time. The Company’s management believes it has sufficient liquidity resources to
have the funding available as these borrowers draw on these loans. This increase
was a result of the general increase in loan demand and the continued low
interest rates offered on home equity loans.





Loan
commitments as of December 31, 2004 were $18,188,000, compared to $24,520,000 as
of December 31, 2003, a decrease of $6,332,000, or 25.8%. Loan commitments are
obligations of the Company to provide loans, and such commitments are made in
the usual course of business. This decrease was a result of a temporary timing
difference of new loan commitments at the end of 2004.





Lines of
credit, which are obligations of the Company to fund loans made to certain
borrowers, totaled $24,831,000 as of December 31, 2004, compared to $20,436,000
as of December 31, 2003. This increase of $4,395,000, or 21.5%, was a result of
increased demand for this type of loan product. The Company’s management
believes it has sufficient liquidity resources to have the funding available as
these borrowers draw on these loans.








38












Loans
sold and serviced with limited repurchase provisions decreased $7,168,000, or
21.8%, from $32,877,000 as of December 31, 2003, to $25,709,000 as of December
31, 2004. This decrease was the result of the slowdown in the market for loans
sold on the secondary market.





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





**Comparison
of Results of Operations for the Years Ended December 31, 2004 and
2003.**





**General.** Bancorp’s
net income for the year ended December 31, 2004 was $12,931,000, or $1.56 per
share diluted, after the two-for-one stock split effective December 15, 2004.
This is compared to $11,329,000, or $1.33 per share diluted, as adjusted for the
stock split, for the year ended December 31, 2003. This increase of $1,602,000,
or 14.1%, was primarily the result of the continued growth in the Company’s
mortgage portfolio coupled with the Company’s continued ability to maintain low
operating expenses.





**Net
Interest Income.** Net
interest income (interest earned net of interest charges) totaled $29,988,000
for the year ended December 31, 2004, compared to $24,746,000 for the year ended
December 31, 2003, an increase of $5,242,000 or 21.2%. This increase was
primarily due to the growth in the loan portfolio which offset a decrease in the
Company’s interest rate spread of .17% to 4.60% for the year ended December 31,
2004, compared to 4.77% for the same period in 2003. The Company’s interest rate
spread decreased over the past year because interest rates earned on the Bank’s
loans have fallen faster than the interest rates paid on the Bank’s interest
bearing liabilities. The Company is uncertain whether it will be able to
continue to attract low cost liabilities, as it has done in the last year due to
the general expectation of rising interest rates in the future.





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





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





As of
December 31, 2004, the total allowance for loan losses was $5,935,000 as
compared to $4,832,000 as of December 31, 2003, which is an increase of
$1,103,000, or 22.8%. The increase was a result of the current year’s addition
to the allowance and minimal charge offs being incurred. During the year ended
December 31, 2004, the provision for loan losses was $1,200,000 compared to
$900,000 for the year ended December 31, 2003. This increase of $300,000 or
33.3%, was a result of increased loan growth and management’s determination that
adding to the provision for loan losses was, more or less appropriate for the
level of inherent risk in its portfolio as compared to the year ended December
31, 2003.








39












**Other
Income and Non Interest Expense.** Mortgage
banking activities decreased $1,056,000, or 42.4% to $1,435,000 for the year
ended December 31, 2004, compared to $2,491,000 for the same period last year.
This decrease is primarily the result of a $772,000 decrease in gain on sale of
loans, and a $284,000 decrease in mortgage processing and servicing fees for the
year ended December 31, 2004 compared to the same period last year. The decrease
in the gain on sale of loans is attributable to the reduction in 2004 of loans
sold on the secondary market. The decrease in mortgage processing and servicing
fees relates to a slowdown during 2004 of residential mortgages being refinanced
and the reduction in loans sold on the secondary market.





Real
estate commissions and real estate management fees for the year ended December
31, 2004 were $1,234,000 and $404,000, respectively, as compared to $1,160,000
and $369,000, respectively, for the same period last year. In the aggregate,
this was an increase of $109,000 or 7.1%. This increase is primarily due to
increased activity from the continued strong real estate market and a focus on
the commercial market, which generally generates higher revenues.





Compensation
and related expenses totaled $8,167,000 for the year ended December 31, 2004
compared to $6,976,000 for the year ended December 31, 2003, an increase of
$1,191,000 or 17.1%. This increase was the result of additional Bank employees
needed for a new branch that opened in 2004, and increased loan volume. As of
December 31, 2004, the Company had 95 full-time equivalent employees compared to
81 at December 31, 2003.





Other
non-interest expense totaled $2,434,000 for the year ended December 31, 2004
compared to $2,106,000 for the year ended December 31, 2003, an increase of
$328,000, or 15.6%. This increase is primarily a result of increased advertising
for the new branch, and an increase in office expenses for the new branch and
additional employees hired during 2004.





Income
taxes for the year ended December 31, 2004 were $8,258,000, compared to
$7,575,000 for the year ended December 31, 2003, an increase of $683,000 or
9.0%. The effective tax rate for the years ended December 31, 2004 and 2003 was
39.0% and 40.0%, respectively.





**Liquidity
and Capital Resources.** Bancorp’s
liquidity is determined by its ability to raise funds through loan payments,
maturing investments, deposits, borrowed funds, capital, or the sale of loans.
Based on the internal and external sources available, Bancorp’s liquidity
position exceeded anticipated short-term and long-term needs at December 31,
2004. Core deposits, considered to be stable funding sources and defined to
include all deposits except time deposits of $100,000 or more, equaled 73.7% of
total deposits at December 31, 2004. The Bank’s experience is that a substantial
portion of certificates of deposit will renew at time of maturity and will
remain on deposit with the Bank. Additionally, loan payments, maturities,
deposit growth and earnings contribute a flow of funds available to meet
liquidity requirements.





In
addition to its ability to generate deposits, Bancorp has external sources of
funds which may be drawn upon when desired. The primary source of external
liquidity is an available line of credit equal to 30% of the Bank’s assets with
FHLB-Atlanta. The available line of credit with FHLB-Atlanta was $210,422,000 at
December 31, 2004, of which $89,000,000 was outstanding at that
time.





In
assessing its liquidity the management of Bancorp considers operating
requirements, anticipated deposit flows, expected funding of loans, deposit
maturities and borrowing availability, so that sufficient funds may be available
on short notice to meet obligations and business opportunities as they arise. In
addition, management expects to incur an additional $17,578,000, before interior
fit-out, for construction costs associated with its new headquarters.
Construction is expected to be completed in February 2006. As of December 31,
2004 Bancorp had $18,188,000 outstanding in loan commitments, which Bancorp
expects to fund from the sources of liquidity described above. This amount does
not include undisbursed lines of credit, home equity loans and standby letters
of credit, in the aggregate amount of $50,194,000, which Bancorp anticipates it
will be able to fund, if required, from these liquidity sources in the regular
course of business.





In
addition to the foregoing, the payment of dividends is a use of cash, but is not
expected to have a material effect on liquidity.








40












**Contractual
Obligations**





The
following table contains for the periods indicated information regarding the
financial obligations owing by the Company for leases of certain
properties.





**Payments
      due by period**
      (dollars
      in thousands)**Total**
    
    
    **Less
      than 1 year**
    
    
    **1-3**
      **years**
    
    
    **3-5**
      **years**
    
    
    **More
      than 5 years**Long
      term debt
    
    $
    89,000
    
    $
    2,000
    
    $
    25,000
    
    $
    10,000
    
    $
    52,000Subordinated
      debentures
    
    
    20,619
    
    
    -
    
    
    -
    
    
    -
    
    
    20,619Operating
      lease obligations
    
    
    399
    
    
    99
    
    
    145
    
    
    120
    
    
    35Certificates
      of Deposit
    
    
    356,447
    
    
    231,089
    
    
    105,879
    
    
    19,438
    
    
    41Total
    
    $
    466,465
    
    $
    233,188
    
    $
    131,024
    
    $
    29,558
    
    $
    72,695








**Comparison
of Operating Results for the Years Ended December 31, 2003 and
2002**





**General.** Bancorp’s net income for the year ended December 31, 2003 was $11,329,000 or
$1.33 per share diluted, compared to $8,948,000, or $1.06 per share diluted, for
the year ended December 31, 2002, an increase of $2,381,000, or 26.6%. This
increase was primarily the result of increases in loan origination volume and in
the loan portfolio, as well as the increase in interest income, coupled with a
reduction in the cost of deposits and other liabilities.





**Net
Interest Income.** Net
interest income (interest earned net of interest charges) totaled $24,746,000
for the year ended December 31, 2003, compared to $19,603,000 for the year ended
December 31, 2002, an increase of $5,143,000, or 26.2%. The change was primarily
due to growth in the loan portfolio and reduction of interest on deposits. The
interest rate spread increased to 4.77% at December 31, 2003 compared to 4.59%
at December 31, 2002. The Bank’s interest rate spread increased because interest
rates paid on the Bank’s deposits have fallen faster than the interest rates
earned on the Bank’s assets.





**Provision
for Loan Losses.** During
the year ended December 31, 2003, the provision for loan losses was $900,000
compared to $670,000 for the year ended December 31, 2002. This increase of
$230,000, or 34.3%, was a result of the Bank’s management assessment of the
adequacy of the loan provision by considering the nature and size of the loan
portfolio, the overall portfolio quality, and specific problem loans. As of
December 31, 2003, the allowance for loan losses was $4,832,000, compared to
$3,991,000 as of December 31, 2002, an increase of $841,000, or 21.1%. This
increase was a result of contributions made to the provision for loan losses
without any material charge offs to reduce the overall allowance for loan
losses.





**Other
Income and Non Interest Expense.** Mortgage
banking activities increased $503,000, or 25.3%, to $2,491,000 for the year
ended December 31, 2003, compared to $1,988,000 for the year ended December 31,
2002. This increase was primarily the result of an $299,000 increase in gain on
sale of loans, and a $204,000 increase in mortgage processing and servicing fees
for the year ended December 31, 2003 compared to the same period last year. The
increases are attributable to the increase volume in loan originations and
increased refinancing of residential mortgages in 2003 compared to
2002.





Real
estate commissions and real estate management fees for the year ended December
31, 2003 were $1,160,000 and $369,000, respectively, compared to $1,237,000 and
$383,000, respectively, for the year ended December 31, 2002. In the aggregate,
this decrease was $91,000, or 5.6%, and was primarily the result of the timing
of commercial real estate activity.








41














Compensation
and related expenses totaled $6,976,000 for the year ended December 31, 2003,
compared to $6,065,000 for the year ended December 31, 2002, an increase of
$911,000, or 15.0%. The increase during 2003 was primarily attributable to
increased staffing and compensation levels due to the increase in loan
production commissions at Hyatt Commercial.





Other
non-interest expense totaled $2,106,000 for the year ended December 31, 2003,
compared to $1,894,000 for the year ended December 31, 2002, an increase of
$212,000, or 11.2%. This increase is primarily a result of increased
advertising, and an increase in office expenses for the additional employees
hired during 2003





Income
taxes for the year ended December 31, 2003 were $7,575,000, compared to
$5,671,000 for the year ended December 31, 2002. The effective tax rate for the
years ended December 31, 2003 and 2002 were 40.0% and 38.8%,
respectively.





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





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





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





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





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








42












Exposure
to interest rate risk is actively monitored by Bancorp’s management. Its
objective is to maintain a consistent level of profitability within acceptable
risk tolerances across a board range of potential interest rate environments.
Bancorp uses the OTS Net Portfolio Value (“NPV”) model to monitor its exposure
to interest rate risk, which calculates changes in NPV. The following table
represents Bancorp’s NPV at December 31, 2004. The NPV was calculated by the
OTS, based upon information provided to the OTS.





**INTEREST
RATE SENSITIVITY OF NET PORTFOLIO VALUE (NPV)**


Net
      Portfolio Value
    NPV
      as % of PV of AssetsChange
      In Rates
    $
      Amount
    $
      Change
    %
      Change
    NPV
      Ratio
    Change(dollars
      are in thousands)+300
      bp
    92,605
    (13,851)
    (13%)
    13.13%
    (143bp)+200
      bp
    98,035
    (8,420)
    (8%)
    13.72%
    (85bp)+100
      bp
    102,835
    (3,621)
    (3%)
    14.22%
    (35bp)0
      bp
    106,456
    
    
    14.57%-100
      bp
    108,895
    2,439
    +2%
    14.77%
    +20bp-200
      bp
    -
    -
    -%
    -%
    -bp-300
      bp
    -
    -
    -%
    -%
    -bp





12/31/2004
    09/30/2004
    12/31/2003RISK
      MEASURES: FOR A GIVEN RATE SHOCKPre-Shock
      NPV Ratio: NPV as % of PV of Assets
    14.57%
    12.30%
    13.52%Post-Shock
      NPV Ratio
    13.72%
    11.67%
    12.51%Sensitivity
      Measure: Decline in NPV Ratio
    85bp
    63bp
    100bpTB
      13a Level of Risk
    Minimal
    Minimal
    Minimal





Note:
Calculations of 2/12/2005 using CMR data edited 2/11/2005. CMR Report filing is
required. For this quarter, the Sensitivity Measure is defined as the decline in
the pre-shock NPV ratio caused by a 100 basis point decrease of a 200 basis
point increase in interest rates, whichever produces the larger decline.





Due to
the abnormally low prevailing interest rate environment, this report no longer
provides NPV estimates for changes in interest rates of (200) or
greater.





**Item
8. Financial Statements and Supplementary Data**





Financial
statements and supplementary data are included herein at pages F1 through
F34.





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





None.





**Item
9A. Controls and Procedures**





Under the
supervision and with the participation of the Company's management, including
its Chief Executive Officer and Chief Financial Officer, the Company has
evaluated the effectiveness of its disclosure controls and procedures (as
defined in Securities Exchange Act Rule 13a-15(e)) as of December 31, 2004.
During its evaluation, management discovered that certain cash accounts
maintained by the Company at other financial institutions were not reconciled by
the Company. The Company is now in the process of reconciling these accounts
which involve a discrepancy in the amount of approximately $500,000 at December
31, 2004. Management expects to have the accounts reconciled by the end of the
first quarter reporting period ending on March 31, 2005. It is anticipated that
any required adjustments, charges or reserves will be taken during this period.
Management does not believe that the required adjustments, if any will have a
material adverse effect on the Company’s financial condition. Management has
implemented additional controls over this process since year-end to correct this
deficiency, including requiring reconciliation of such accounts on a daily
basis. Based upon this evaluation, and after implementing the additional
controls discussed above, the Chief Executive Officer and Chief Financial
Officer have concluded that, as of the period covered by this report, the
Company's disclosure controls and procedures are adequate in reaching a
reasonable level of assurance that material information relating to the Company
and its consolidated subsidiaries is made known to them by others within those
entities, particularly during the period in which are periodic reports are being
prepared.








43










There
have not been any changes in the Company's internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the most recent fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting, except for the changes discussed above which
occurred subsequent to the end of the fourth quarter.





A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within Bancorp have been detected. Because of
the inherent limitations in a cost-effective control system, misstatements due
to error or fraud may occur and not be detected.





**Item
9B. Other Information**





The
Company does not have any employees. The executive officers of the Company are
employees at-will of the Bank. The Board of Directors of the Bank has a
Compensation Committee which determines the compensation of the executive
officers of the Company. Annually, the Compensation Committee of the Bank’s
Board of Directors evaluates profiles of comparable financial institutions to
assure that the compensation to its executive officers is comparable to its peer
group. Other factors used by the Compensation Committee in determining
compensation for its executive officers include an assessment of the overall
financial condition of the Bank, including an analysis of the Bank’s asset
quality, interest rate risk exposure, capital position, net income and
consistency of earnings. The Bank’s return on average assets and return on
equity is considered and compared to its peer group. The complexity of the
activities of the executive officers are considered, and intangible items are
considered such as the reputation and general standing of the Bank within the
community and the likelihood of continuing successful and profitable
results.





Based on
the considerations set forth above, at its meeting on November 16, 2004, the
Compensation Committee approved bonuses for the Bank’s executive officers for
fiscal year 2004 as follows: Alan J. Hyatt, $151,000; Melvin E. Meekins, Jr. ,
$107,000; S. Scott Kirkley, $65,000; and Cecelia Lowman, $40,100. In addition,
the Compensation Committee, at its meeting on November 16, 2004, approved the
annual base salaries of the Bank’s executive officers for fiscal year 2005 as
follows: Alan J. Hyatt, $250,000; Melvin E. Meekins, Jr., $298,000; S. Scott
Kirkley, $208,000; and Cecelia Lowman, $148,000.




**PART
III**





**Item
10. Directors and Executive Officers of the Registrant**





Reference
is made to the section captioned “Proposal 1: Election of Directors” in
Bancorp's Proxy Statement dated March 21, 2005 for the information required by
this Item, which is hereby incorporated by reference.





Reference
is made to the section captioned “Stock Ownership” in Bancorp’s Proxy Statement
dated March 21, 2005 for the information required by this Item, which is hereby
incorporated by reference.





Reference
is made to the section captioned “Director Independence” in Bancorp’s Proxy
Statement dated March 21, 2005 for the information required by this Item, which
is hereby incorporated by reference.





Reference
is made to the section captioned “Section 16(a) Beneficial Ownership Reporting
Compliance” in Bancorp’s Proxy Statement dated March 21, 2005 for the
information required by this Item, which is hereby incorporated by
reference.








44












**Item
11. Executive Compensation**





Reference
is made to the section captioned “Director and Executive Officer Compensation”
in Bancorp's Proxy Statement dated March 21, 2005 for the information required
by this Item, which is hereby incorporated by reference.





**Item
12. Security Ownership of Certain Beneficial Owners and
Management**





Reference
is made to the sections captioned “Stock Ownership” and “Director and Executive
Officer Compensation” in Bancorp's Proxy Statement dated March 21, 2005 for the
information required by this Item, which is hereby incorporated by reference.





The
Bank’s Stock Option Plan (“Plan”) provided for the granting of options to
acquire common stock to directors and key employees. Option prices were equal to
or greater than fair market value of the common stock at the date of the grant.
The Bank granted options to purchase 156,000 shares, of which all have been
exercised as of December 31, 2003.





The
following table summarizes the status of and changes in the Plan.





Shares
    
    
    Weighted
      Average Exercise PriceOutstanding
      at December 31, 2001
    
    
    105,000
    
    $
    5.59Exercised
      in 2002
    
    
    85,500
    
    
    5.62Forfeited
      in 2002
    
    
    1,500
    
    
    5.50Outstanding
      at December 31, 2002
    
    
    18,000
    
    
    5.50Exercised
      in 2003
    
    
    16,500
    
    
    5.50Forfeited
      in 2003
    
    
    1,500
    
    
    5.50Outstanding
      at December 31,2003
    
    
    -
    
    $
    -








As of
December 31, 2004, there were 144,000 options available to be granted under the
Plan.





**Item
13. Certain Relationships and Related Transactions**





Reference
is made to the section captioned “Certain Relationships and Transactions Where
Certain Persons Have Material Interests” in Bancorp's Proxy Statement dated
March 21, 2005 for the information required by this Item, which is hereby
incorporated by reference.





**Item
14. Principal Accountant Fees and Services**





Reference
is made to the section captioned “Relationship with Independent Auditors” in
Bancorp's Proxy Statement dated March 21, 2005 for the information required by
this Item, which is hereby incorporated by reference.


******


Reference
is made to the section captioned “Report of the Audit Committee” in Bancorp’s
Proxy Statement dated March 21, 2005 for the information required by this Item,
which is hereby incorporated by reference.








45














**PART
IV**





**Item
15. Exhibits and Financial Statement Schedules**





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





1.  Financial
Statements


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


·  CONSOLIDATED
STATEMENTS OF FINANCIAL CONDITION AT DECEMBER 31, 2004 AND DECEMBER 31, 2003


·  CONSOLIDATED
STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND
2002


·  CONSOLIDATED
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND
2002


·  CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2004, 2003
AND 2002.


·  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS PAGES F7 ****** -
F34





2.  Financial
Statement Schedules


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





3. Exhibits


The following exhibits are filed as part of this report:





**Exhibit
No.**  **Description
of Exhibit**





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




3.2  Bylaws of
Severn Bancorp, Inc. (1)





10.1   Description
of compensation of directors and officers





10.2   Stock
Option Plan





10.5  Employee
Stock Ownership Plan (1)





14 Code of
Ethics (2)





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





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





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





(1)  Incorporated
by reference to Exhibit bearing the same number in Bancorp's Registration
Statement of Form 10 filed with the Securities and Exchange Commission on June
7, 2002.





(2)  Incorporated
by reference to Exhibit bearing the same number in Bancorp's 2003 Form 10-K
filed with the Securities and Exchange Commission on March 25,
2004.








46














**SIGNATURES**





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





SEVERN BANCORP,
INC.







March 15,
2005            /s/
Alan J. Hyatt


Alan J.
Hyatt


Chairman of the
Board, President,


Chief Executive Officer and Director





















































47













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





March 15,
2005          /s/
Alan J. Hyatt


Alan J.
Hyatt


Chairman of the
Board,


President, Chief
Executive Officer


and
Director





March 15,
2005          /s/ S.
Scott Kirkley


S. Scott Kirkley,
Senior Vice


President, Secretary,
Treasurer and Director





March 15,
2005          /s/
Melvin E. Meekins, Jr.


Melvin E. Meekins,
Jr., Executive


Vice President and
Director





March 15,
2005          /s/ Melvin
Hyatt


Melvin Hyatt,
Director





March 15,
2005          /s/
Ronald P. Pennington


Ronald P. Pennington,
Director





March 15,
2005          /s/ T.
Theodore Schultz


T. Theodore Schultz,
Director





March 15,
2005          /s/
Albert W. Shields


Albert W. Shields,
Director





March 15,
2005          /s/
Louis DiPasquale, Jr.


Louis DiPasquale, Jr.,
Director





March 15,
2005          /s/
Keith Stock


Keith Stock,
Director











48