UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q


(Mark
One)


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





For
the quarterly period ended    December 31,
2009.


OR


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





For the transition
period from __________________________ to__________________________





Commission
file number    000-18261








COMMUNITY
      FINANCIAL CORPORATION(Exact
      name of registrant as specified in its
charter)








VIRGINIA
            
            54-1532044(State
      or other jurisdiction of incorporation or organization)
            
            (IRS
      Employer Identification Number)








38
      North Central Ave., Staunton, VA 24401(Address
      of principal executive offices)








(540)
      886-0796(Issuer’s
      telephone number)








(Former
      name, former address and former fiscal year, if changed since last
      report)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 and 15(d) of the Securities Exchange Act of
1934  during the past 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  o





Indicate by check mark whether the
registrant (1) has submitted electronically and posted on its corporate Web
site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (& 232.405 of this chapter) during
the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes  oNo  o





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





Large
      accelerated filer  o
            Accelerated
      filer  o
            Non-Accelerated
      filer  o
            Smaller
      reporting company  x(do
      not check if a smallreporting
      company)





Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).


Yes  o                      No  x





Number of
shares of common stock, par value $.01 per share, outstanding at the close of
business on February 10, 2010:4,361,658.





COMMUNITY
FINANCIAL CORPORATION








INDEX








PART
      I.
            FINANCIAL
      INFORMATIONItem
      1.
            Consolidated
      Financial StatementsConsolidated
      Balance Sheets at December 31, 2009 (unaudited)
              and
      March 31, 2009
            3Consolidated
      Statements of Operations for the
              Three
      and Nine Months Ended December 31, 2009 and 2008
              (unaudited)
            4Consolidated
      Statements of Cash Flows for the Nine
              Months
      Ended December 31, 2009 and 2008 (Unaudited)
            5Notes
      to Unaudited Interim Consolidated
              Financial
      Statements
            6Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
            15Item
      3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            27Item
      4T.
            Controls
      and Procedures
            28PART
      II.
            OTHER
      INFORMATION
            29Signature
      Page
            
            30Exhibit
      Index
            
            31





2





Part I.
Financial Information


Item 1.
Financial Statements





COMMUNITY
      FINANCIAL CORPORATIONCONSOLIDATED
      BALANCE SHEETSDecember
      31,
            
            March
      31,2009
            
            2009(Unaudited)ASSETSCash
      (including interest-bearing deposits of
              approximately
      $1,720,647 and $512,258)
            $  5,395,942
            
            $   2,482,182SecuritiesHeld
      to maturity
            1,500,000
            
            1,700,010Available
      for sale, at fair value
            164,347
            
            207,347Restricted
      investment in Federal
              Home
      Loan Bank stock, at cost
            6,183,600
            
            5,238,600Loans
      receivable, net of allowance for loan
              losses
      of $7,108,827 and $5,955,847
            496,655,689
            
            476,950,379Real
      estate owned and repossessed assets
            2,535,188
            
            1,400,192Property
      and equipment, net
            8,817,927
            
            8,351,679Accrued
      interest receivableLoans
            2,011,241
            
            1,973,676Investments
            17,997
            
            2,799Prepaid
      expenses and other assets
            17,652,089
            
            14,416,972Total
      Assets
            $540,934,020
            
            $512,723,836LIABILITIES
      AND STOCKHOLDERS’ EQUITYLiabilitiesDeposits
            $402,133,152
            
            $365,505,504Borrowings
            86,500,000
            
            95,000,000Securities
      sold under agreement to repurchase
            845,780
            
            1,475,594Advance
      payments by borrowers for
              taxes
      and insurance
            138,741
            
            179,575Other
      liabilities
            2,780,659
            
            4,226,600Total
      Liabilities
            492,398,332
            
            466,387,273Stockholders’
      EquityPreferred
      stock $.01 par value, authorized 3,000,000shares,
      12,643 shares outstanding
            12,643,000
            
            12,643,000Common
      stock, $0.01 par value, authorized
              10,000,000
      shares, 4,361,658
              shares
      outstanding
            43,617
            
            43,617Warrants
            603,153
            
            603,153Discount
      on preferred
            (478,496
            )
            (568,973
            )Additional
      paid in capital
            5,569,558
            
            5,569,558Retained
      earnings
            30,529,087
            
            28,420,439Accumulated
      other comprehensive
              (loss)
            (374,231
            )
            (374,231
            )Total
      Stockholders’ Equity
            48,535,688
            
            46,336,563Total
      Liabilities and Stockholders’ Equity
            $540,934,020
            
            $512,723,836


See
accompanying notes to unaudited interim consolidated financial
statements.


3





CONSOLIDATED
      STATEMENTS OF OPERATIONSThree
      Months Ended
            
            Nine
      Months EndedDecember
      31
            
            December
      312009
            
            2008
            
            2009
            
            2008(Unaudited)
            
            (Unaudited)INTEREST
      INCOMELoans
            $6,921,988
            
            $7,001,975
            
            $20,896,873
            
            $21,340,801Investment
      securities
            11,663
            
            29,005
            
            36,789
            
            96,025Other
            51,452
            
            21,816
            
            117,300
            
            437,999Total
      interest income
            6,985,103
            
            7,052,796
            
            21,050,962
            
            21,874,825INTEREST
      EXPENSEDeposits
            1,672,258
            
            2,581,964
            
            5,642,388
            
            8,075,755Borrowed
      money
            223,602
            
            429,895
            
            723,469
            
            1,717,759Total
      interest expense
            1,895,860
            
            3,011,858
            
            6,365,857
            
            9,793,514NET
      INTEREST INCOME
            5,089,243
            
            4,040,938
            
            14,685,105
            
            12,081,311PROVISION
      FOR LOAN LOSSES
            1,367,160
            
            893,684
            
            2,299,395
            
            1,646,225NET
      INTEREST INCOME AFTER
              PROVISION
      FOR LOAN LOSSES
            3,722,083
            
            3,147,254
            
            12,385,710
            
            10,435,086NONINTEREST
      INCOME (LOSS)Service
      charges, fees and commissions
            888,471
            
            799,919
            
            2,605,504
            
            2,297,656Other
            142,632
            
            97,460
            
            368,060
            
            288,309Net
      other-than-temporary impairment
              losses
            ---
            
            (482,368
            )
            ---
            
            (11,535,709
            )Total
      noninterest income (loss)
            1,031,103
            
            415,011
            
            2,973,564
            
            (8,949,744
            )NONINTEREST
      EXPENSECompensation
      & benefits
            1,838,999
            
            2,061,308
            
            6,297,693
            
            5,990,212Occupancy
            430,526
            
            392,023
            
            1,232,948
            
            1,128,087Data
      processing
            346,424
            
            359,482
            
            1,131,612
            
            1,053,513Federal
      insurance premium
            164,874
            
            57,798
            
            619,282
            
            227,643Advertising
            137,575
            
            135,840
            
            365,988
            
            343,364Other
            525,487
            
            520,128
            
            1,440,380
            
            1,460,156Total
      noninterest expense
            3,443,885
            
            3,526,579
            
            11,087,903
            
            10,202,975INCOME
      (LOSS) BEFORE TAXES
            1,309,301
            
            35,686
            
            4,271,371
            
            (8,717,633
            )INCOME
      TAXES
            477,763
            
            (4,203,338
            )
            1,598,134
            
            (3,431,877
            )NET
      INCOME (LOSS)
            $831,538
            
            $4,239,024
            
            $2,673,237
            
            $(5,285,756
            )Effective
      Dividend on Preferred Stock
            188,197
            
            4,021
            
            564,590
            
            4,021NET
      INCOME (LOSS) AVAILABLE
              TO
      COMMON STOCKHOLDERS
            $ 643,341
            
            $4,235,003
            
            $2,108,647
            
            $(5,289,777
            )BASIC
      EARNINGS (LOSS) PER
              COMMON
      SHARE
            $0.15
            
            $0.97
            
            $0.48
            
            $(1.21
            )DILUTED
      EARNINGS (LOSS) PER
              COMMON
      SHARE
            $0.15
            
            $0.97
            
            $0.48
            
            $(1.21
            )DIVIDENDS
      PER COMMON SHARE
            $0.00
            
            $0.00
            
            $0.00
            
            $
      0.13See
      accompanying notes to unaudited interim consolidated financial
      statements.   4
    COMMUNITY
      FINANCIAL CORPORATIONCONSOLIDATED
      STATEMENTS OF CASH FLOWSNine
      Months EndedDecember
      312009
              
              2008(Unaudited)
              
              (Unaudited)OPERATING
      ACTIVITIESNet
      income (loss)
              $2,673,237
              
              $(5,285,756
              )Adjustments
      to reconcile net income (loss) tonet
      cash provided by operating activitiesProvision
      for loan losses
              2,299,395
              
              1,646,225Depreciation
              459,776
              
              434,304Stock-based
      compensation expense
              ---
              
              6,826Amortization
      of premium and accretionof
      discount on securities, net
              10
              
              197Net
      other-than-temporary impairment losses
              ---
              
              11,535,709Increase
      in net deferred loan fees
              150,086
              
              151,789Deferred
      income tax benefit
              (500,858
              )
              (4,522,992
              )(Increase)decrease
      in other assets
              (3,235,117
              )
              96,048(Decrease)
      in other liabilities
              (945,083
              )
              (4,153
              )Net
      cash provided by operating activities
              901,446
              
              4,058,197INVESTING
      ACTIVITIESProceeds
      from maturities of held to maturity securities
              500,000
              
              2,790,000Purchase
      of held to maturity securities
              (300,000
              )
              (2,100,000
              )Proceeds
      from sale of available for  sale securities
              102,197
              )
              ---Net
      increase in loans
              (21,816,881
              )
              (33,391,277
              )Purchases
      of property and equipment
              (916,726
              )
              (887,641
              )(Purchase)
      of FHLB stock
              (945,000
              )
              (180,000
              )(Increase)
      in repossessed assets and real estate owned
              (1,134,996
              )
              (1,118,394
              )Net
      cash absorbed by investing activities
              (25,011,406
              )
              (34,887,312
              )FINANCING
      ACTIVITIESDividends
      paid
              (474,114
              )
              (565,813
              )Net
      increase in deposits
              36,627,648
              
              6,672,278(Repayment)
      proceeds from advances and
                other borrowed money
              (9,129,814
              )
              1,994,341Proceeds
      from issuance of common stock
              ---
              
              169,501Proceeds
      from issuance of preferred stock
              ---
              
              12,643,000Net
      cash provided by financing activities
              27,023,720
              
              20,913,307(DECREASE)
      INCREASE IN CASH AND
                CASH
      EQUIVALENTS
              2,913,760
              
              (9,915,808
              )CASH
      AND CASH EQUIVALENTS – beginning of period
              2,482,182
              
              15,998,041CASH
      AND CASH EQUIVALENTS – end of period
              $ 5,395,942
              
              $ 6,082,233See
      accompanying notes to unaudited interim consolidated financial
      statements






5







COMMUNITY
FINANCIAL CORPORATION


NOTES TO
UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS


DECEMBER
31, 2009





NOTE
1. - BASIS OF PRESENTATION





The
accompanying unaudited interim consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Regulation S-X.  Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements.





The
accompanying consolidated financial statements include the accounts of Community
Financial Corporation ("Community" or the "Company") and its wholly-owned
subsidiary, Community Bank (the "Bank").  All significant intercompany
balances and transactions have been eliminated in consolidation.





In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for fair presentation have been included. Operating results
for the nine months ended December 31, 2009 are not necessarily indicative of
the results that may be expected for the year ending March 31,
2010.





The
Company made application to the Treasury Department to participate in the TARP
program and received an investment by the Treasury Department of $12,643,000 in
the form of preferred stock during the year ended March 31, 2009.  The
Company also issued to the U.S. Treasury a warrant to purchase 351,194 shares of
common stock at $5.40 per share.





Subsequent
events have been evaluated through February 12, 2009, the same date on which
these financial statements were issued.





NOTE
2. - STOCK-BASED COMPENSATION PLAN




The
Company recognizes the cost of employee services received in exchange for awards
of equity instruments, such as stock options and restricted stock, based on the
fair value of those awards at the date of grant.




There
were no stock options granted and no stock-based compensation expense was
recognized during the three and nine month periods ended  December 31,
2008 and 2009.




The
following summarizes the stock option activity for the three months ended
December 31, 2009:





Weighted
            IntrinsicWeighted
            Average
            Value
      ofAverage
            Remaining
            UnexercisedExercise
            Contractual
            In-the-MoneyShares
            
            Price
            Term
            OptionsOptions
      outstanding, March 31, 2009
            380,200
            
            $8.41Granted
            ---
            
            ---Exercised
            ---
            
            ---Forfeited
            (43,000
            )
            6.36Options
      outstanding, December 31, 2009
            337,200
            
            $8.55
            3.6Options
      exercisable, December 31, 2009
            337,200
            
            $8.55
            3.6
            0




There
were no options exercised during the nine months ended December 31,
2009.











6


NOTE
3. - EARNINGS PER SHARE





Basic
earnings per share is based on net income available to common stockholders
divided by the weighted average number of common shares outstanding during the
period.  Diluted earnings per share shows the dilutive effect of
additional common shares issuable under stock option plans and warrants. Diluted
earnings per share is computed by dividing net income available to common
stockholders  by the weighted average number of common shares and
common share equivalents outstanding. Basic and diluted earnings per share are
computed in the following table.





For the Three Months EndedDecember 31, 2009
            
            
            December 31, 2008Weighted
              Average
            
            
            Per
              Share
            
            
            
            
            
            Weighted
              Average
            
            
            Per
              ShareIncome
            
            
            Shares
            
            
            Amount
            
            
            Income
            
            
            Shares
            
            
            AmountBasic
      earnings  per share:Income
      available to common stockholders
            
            $
            643,341
            
            
            
            4,361,658
            
            
            $
            0.15
            
            
            $
            4,235,003
            
            
            
            4,361,658
            
            
            $
            0.97Diluted
      earnings per share:Effect
      of Dilutive SecuritiesOptions
      and Warrants
            
            
            ---
            
            
            
            ---
            
            
            
            
            
            
            
            ---
            
            
            
            4,100Income
      available to common stockholders
            
            $
            643,341
            
            
            
            4,361,658
            
            
            $
            0.15
            
            
            $
            4,235,003
            
            
            
            4,365,758
            
            
            $
            0.97




During
the quarter ended December 31, 2009,337,200 stock options
and 351,194 warrants were excluded in the calculation of earnings per share
because they would have been anti-dilutive. During the quarter ended December
31, 2008, 292,000 stock options were excluded in the calculation of earnings per
share because they would have been anti-dilutive.







For the Nine Months EndedDecember 31, 2009
            
            
            December 31, 2008Weighted
              Average
            
            
            Per
              Share
            
            
            
            
            
            Weighted
              Average
            
            
            Per
              ShareIncome
            
            
            Shares
            
            
            Amount
            
            
            Income
            
            
            Shares
            
            
            AmountBasic
      earnings(loss) per share:Income
      (loss) available to common stockholders
            
            $
            2,108,647
            
            
            
            4,361,658
            
            
            $
            0.48
            
            
            $
            (5,289,777
            )
            
            
            4,354,028
            
            
            $
            (1.21
            )Diluted
      earnings (loss) per share:Effect
      of Dilutive SecuritiesOptions
      and Warrants
            
            
            ---
            
            
            
            ---
            
            
            
            
            
            
            
            ---
            
            
            
            ---Income
      (loss) available to common stockholders
            
            $
            2,108,647
            
            
            
            4,361,658
            
            
            $
            0.48
            
            
            $
            (5,289,777
            )
            
            
            4,354,028
            
            
            $
            (1.21
            )







7







NOTE
4. - STOCKHOLDERS' EQUITY





The
following table presents the Bank's regulatory capital levels at December 31,
2009:





Amount
              Required
            Percent
              Required
            Actual
              Amount
            Actual
              Percent
            Excess
              AmountTangible
      Capital
            $
      8,116,000
            1.50%
            $46,581,000
            8.61%
            $38,465,000Core
      Capital
            21,643,000
            4.00
            46,581,000
            8.61
            24,938,000Risk-based
      Capital
            37,164,000
            8.00
            50,764,000
            10.93
            13,600,000





The
Company’s primary source of funds for the payment of dividends to its
stockholders is dividends from the Bank. Capital distributions by OTS-regulated
savings banks, such as the Bank, are limited by regulation ("Capital
Distribution Regulation").  Capital distributions are defined to
include, in part, dividends, stock repurchases and cash-out
mergers.  The Capital Distribution Regulation permits a savings bank
to make capital distributions during a calendar year equal to net income for the
current year plus the previous two years net income, less capital distributions
paid over the same period. Any distributions in excess of that amount require
prior OTS approval. The Capital Distribution Regulation requires that savings
banks in holding company structures provide the applicable OTS Regional Director
with a 30-day advance written notice of all proposed capital distributions
whether or not advance approval is required by the regulation. The OTS may
object to capital distributions if the bank is not meeting its regulatory
capital requirements, the distribution raises safety and soundness concerns or
is otherwise in violation of law. Issuance of preferred stock under the TARP
Capital Purchase Plan restricts the Company from increasing its dividend
distribution to stockholders without approval from the OTS.





NOTE
5. - SUPPLEMENTAL INFORMATION - STATEMENT OF CASH FLOWS





Total
interest paid for the nine months ended December 31, 2009 and 2008 was
$8,096,977 and $10,478,874, respectively. Total income taxes paid for the nine
months ended December 31, 2009 and 2008 was $2,005,751 and
$1,474,213.





NOTE
6. - COMPREHENSIVE INCOME





Comprehensive
income is defined as "the change in equity (net assets) of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners."
Comprehensive income for the Company includes net income, unrealized gains and
losses on securities available for sale and pension liability adjustments. The
following table sets forth the components of comprehensive income for the
nine-month periods ended December 31, 2009 and 2008:





Nine
      months Ended December 312009
            
            2008Net
      Income (loss)
            $2,673,237
            
            ($5,285,756)Other
      comprehensive income (loss), net of tax:Unrealized
      holding gains (losses) on available for sale securities
              arising during the period, net of deferred tax of
    $3,553,934
            ---
            
            (5,798,524)Adjustments
      for realized securities losses, net of tax of $4,383,569
            ---
            
            7,152,140Total
      other comprehensive income (loss), net of tax
            ---
            
            (1,353,616)Total
      comprehensive income (loss)
            $2,673,237
            
            ($3,932,140)








8







NOTE
7. – DEFINED BENEFIT PENSION PLAN





The
Company has a non-contributory defined benefit pension plan for which the
components of net periodic benefit cost are as follows:





Three
      Months EndedDecember
      312009
            
            2008Service
      cost
            $  84,954
            
            $  87,669Interest
      cost
            58,964
            
            53,010Expected
      return on plan assets
            (61,538
            )
            (64,175
            )Recognized
      net actuarial loss
            4,984
            
            4,888$  87,364
            
            $  81,392







Nine
      Months EndedDecember
      312009
            
            2008Service
      cost
            $  254,862
            
            $  263,007Interest
      cost
            176,892
            
            159,030Expected
      return on plan assets
            (184,614
            )
            (192,525
            )Recognized
      net actuarial loss
            14,952
            
            14,664$  262,092
            
            $ 244,176







The
Company anticipates making a contribution of $450,000 for the fiscal year ended
March 31, 2010 during the June 30, 2010 quarter. As of December 31, 2009, no
contributions have been made. The Company anticipates making all required
contributions prior to June 30, 2010.





NOTE
8. – SECURITIES





Due to
the conservatorship of Fannie Mae and Freddie Mac in September, 2008 and the
related restrictions on its outstanding preferred stock (including the
elimination of dividends), the Company recorded an other than temporary
impairment (OTTI) non-cash charge with respect to the Fannie Mae and Freddie Mac
preferred stock it owns of $11,053,000 for the quarter ended September 30, 2008
and an additional OTTI charge of $482,000 in the December 31, 2008 quarter. The
Company recorded a tax related benefit of $4,384,000 for the two OTTI non-cash
charges for the quarter ended December 31, 2008. One of the preferred stock
issues is the Freddie Mac preferred series L with a par value of $50 per share.
The dividend rate of this issue resets every five years based on the five year
treasury rate. The next dividend reset date for this security is December 31,
2014.





Management
evaluates securities for other than temporary impairment at least on a quarterly
basis, and more frequently when economic or market concerns warrant such
evaluation.  Consideration is given to (1) the length of time and the
extent to which the fair value has been less than cost, (2) the financial
condition and near-term prospects of the issuer, and (3) whether the Company
intends to sell the investments or it is more likely than not that the Company
will be required to sell the investments before recovery of their amortized cost
basis.


9




NOTE
9 - FAIR VALUE MEASUREMENTS




Generally
accepted accounting principles, define fair value, establish a framework for
measuring fair value, establish a three-level valuation hierarchy for disclosure
of fair value measurement and enhance disclosure requirements for fair value
measurements. The valuation hierarchy is based upon the transparency of inputs
to the valuation of an asset or liability as of the measurement date. The three
levels are defined as follow:







·Level
      1
            Inputs
      to the valuation methodology are quoted prices (unadjusted) for identical
      assets or liabilities in active markets.·Level
      2
            Inputs
      to the valuation methodology include quoted prices for similar assets and
      liabilities in active markets, and inputs that are observable for the
      assets or liability, either directly or indirectly, for substantially the
      full term of the financial instrument.·Level
      3
            Inputs
      to the valuation methodology are unobservable and significant to the fair
      value measurement.









Following
is a description of the valuation methodologies used for instruments measured at
fair value, as well as the general classification of such instruments pursuant
to the valuation hierarchy:




Securities




Where
quoted prices are available in an active market, securities are classified
within level 1 of the valuation hierarchy. Level 1 securities would include
highly liquid government bonds, mortgage products and exchange traded equities.
If quoted market prices are not available, then fair values are estimated by
using pricing models, quoted prices of securities with similar characteristics,
or discounted cash flow. Level 2 securities would include U.S. agency
securities, mortgage-backed agency securities, obligations of states and
political subdivisions and certain corporate, asset backed and other securities.
In certain cases where there is limited activity or less transparency around
inputs to the valuation, securities are classified within level 3 of the
valuation hierarchy.  Currently, all of the Company’s securities are
considered to be Level 2 securities.







The
following table presents the balances of financial assets and liabilities
measured at fair value on a recurring basis as of December 31,
2009:





Fair Value Measurements at December 31, 2009
      UsingQuoted
      Pricesin
      Active
            
            SignificantMarkets
      for
            
            Other
            
            SignificantBalance
      as of
            
            Identical
            
            Observable
            
            UnobservableDecember
      31,
            
            Assets
            
            Inputs
            
            InputsDescription
            
            2009
            
            (Level 1)
            
            (Level 2)
            
            (Level 3)AssetsAvailable-for-sale
      securities
            
            $164,347
            
            $-
            
            $164,347
            
            $-





Certain
financial assets are measured at fair value on a nonrecurring basis in
accordance with generally accepted accounting principles. Adjustments to the
fair value of these assets usually result from the application of
lower-of-cost-or-market accounting or write-downs of individual
assets.


The
following describes the valuation techniques used by the Corporation to measure
certain financial assets recorded at fair value on a nonrecurring basis in the
financial statements:


10




Impaired
loans




Generally
accepted accounting principles apply to loans measured for impairment
using  practical expedients, including impaired loans measured at an
observable market price (if available), or at the fair value of the loan’s
collateral (if the loan is collateral dependent). Fair value of the loan’s
collateral, when the loan is dependent on collateral, is determined by
appraisals or independent valuation which is then adjusted for the cost related
to liquidation of the collateral.







The
following table summarizes the Corporation’s financial assets that were measured
at fair value on a nonrecurring basis during the period.





Carrying Value at December 31,
      2009Quoted
      Pricesin
      Active
            
            SignificantMarkets
      for
            
            Other
            
            SignificantBalance
      as of
            
            Identical
            
            Observable
            
            UnobservableDecember
      31,
            
            Assets
            
            Inputs
            
            InputsDescription
            
            2009
            
            (Level 1)
            
            (Level 2)
            
            (Level 3)AssetsImpaired
      loans net ofvaluation
      allowance
            
            $7,102,694
            
            $-
            
            $-
            
            $7,102,694




Other real estate
owned




Certain
assets such as other real estate owned (OREO) are measured at the lesser of cost
and fair value less cost to sell.







The
following table summarizes the Corporation’s nonfinancial assets that were
measured at fair value on a nonrecurring basis during the period.





Carrying Value at December 31,
      2009Quoted
      Pricesin
      Active
            
            SignificantMarkets
      for
            
            Other
            
            SignificantBalance
      as of
            
            Identical
            
            Observable
            
            UnobservableDecember
      31,
            
            Assets
            
            Inputs
            
            InputsDescription
            
            2009
            
            (Level 1)
            
            (Level 2)
            
            (Level 3)AssetsOther
      real estate
            
            $2,535,188
            
            $-
            
            $-
            
            $2,535,188





The
accounting standard excludes certain financial instruments and all non-financial
instruments from its disclosure requirements.  Accordingly, the
aggregate fair value amounts presented may not necessarily represent the
underlying fair value of the Corporation.





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





Cash and cash
equivalents





For those
short-term investments, the carrying amount is a reasonable estimate of fair
value.






11






Securities





Fair
values for securities, excluding Federal Home Loan Bank (“FHLB”) stock, are
based on quoted market prices or dealer quotes.  If a quoted market
price is not available, fair value is estimated using quoted market prices for
similar securities.  The carrying value of Federal Home Loan Bank
stock approximates fair value based on the redemption provisions of the Federal
Home Loan Bank. The Corporation’s investment in Federal Home loan Bank stock
totaled $6.2 million at December 31, 2009. FHLB stock is generally viewed as a
long term investment and as a restricted investment security which is carried at
cost, because there is no market for the stock other than the FHLB’s or member
institutions. Therefore, when evaluating FHLB stock for impairment, its value is
based on ultimate recoverability of the par value rather than by recognizing
temporary declines in value. Despite the FHLB’s temporary suspension of
repurchases of excess capital stock in 2009, the Corporation does not consider
this investment to be other than temporarily impaired at December 31, 2009 and
no impairment has been recognized.





Loans
receivable





For
variable-rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying values.  Fair values
for certain mortgage loans (e.g., one-to four-family residential), credit card
loans, and other consumer loans are based on quoted market prices of similar
loans sold in conjunction with securitization transactions, adjusted for
differences in loan characteristics.  Fair values for other loans
(e.g., commercial real estate and investment property mortgage loans, commercial
and industrial loans) are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality.  Fair values for non-performing loans are
estimated using discounted cash flow analyses or underlying collateral values,
where applicable.





Deposit
liabilities





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





Borrowings





For
advances that mature within one year of the balance sheet date, carrying value
is considered a reasonable estimate of fair value.  The fair values of
all other advances are estimated using discounted cash flow analysis based on
the Corporation's current incremental borrowing rate for similar types of
advances.





Securities sold under
agreements to repurchase





Securities
sold under agreements to repurchase are treated as short-term borrowings and the
carrying value approximates fair value.





Accrued
interest





The
carrying amounts of accrued interest approximate fair value.






12





Off-balance sheet
instruments





The fair
value of commitments to extend credit is estimated using the fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreements and the present credit worthiness of the
counterparties.  For fixed-rate loan commitments, fair value also
considers the difference between current levels of interest rates and the
committed rates.  The fair value of standby letters of credit is based
on fees currently charged for similar agreements or on the estimated cost to
terminate them or otherwise settle the obligations with the counterparties at
the reporting date.  At December 31, 2009 and 2008, the fair value of
loan commitments and standby letters of credit were deemed
immaterial.





The
estimated fair values of the Corporation’s financial instruments are as
follows:





December
      31, 2009
            March
      31, 2009Carrying
            Fair
            Carrying
            Fair(In
      Thousands)
            Amount
            Value
            Amount
            ValueFinancial
      assetsCash and cash
      equivalents
            $     5,396
            $     5,396
            $  2,482
            $  2,482Securities
            1,664
            1,668
            1,907
            1,919Federal Home Loan Bank stock,
      restricted
            6,184
            6,184
            5,239
            5,239Loans, net
            496,656
            506,900
            476,950
            487,788Accrued interest
      receivable
            2,029
            2,029
            1,976
            1,976Financial
      liabilitiesDeposits
            $402,133
            $405,431
            $365,506
            $373,896Borrowings
            86,500
            86,704
            95,000
            95,164Securities sold under agreements
      to repurchase
            846
            846
            1,476
            1,476Accrued interest
      payable
            164
            164
            1,894
            1,894





Note
      10  Loans Receivable, Net  Loans
      receivable are summarized as follows:December
      31, 2009
              
              
              March
      31, 2009Residential
      real estate
              
              $
              141,313,836
              
              
              $
              140,063,979Commercial
      real estate
              
              
              165,935,994
              
              
              
              154,781,353Construction
              
              
              74,968,783
              
              
              
              62,887,605Commercial
      business
              
              
              52,528,497
              
              
              
              53,436,237Consumer
              
              
              91,490,920
              
              
              
              85,968,679526,238,030
              
              
              
              497,137,853Less:Loans in process
              
              
              23,357,661
              
              
              
              15,221,797Deferred loan (costs),
      net
              
              
              (884,147
              )
              
              
              (990,170
              )Allowance for loan
      losses
              
              
              7,108,827
              
              
              
              5,955,84729,582,341
              
              
              
              20,187,474$
              496,655,689
              
              
              $
              476,950,379





Loans
serviced for others amounted to approximately $242,688 at December 31, 2009, and
$294,357 at


March 31,
2009.  The loans are not included in the accompanying consolidated
balance sheets.


13





Allowance for loan losses is
summarized as follows:





Nine
      Months Ended
              December
      31, 2009
            
            
            Year
      Ended
              March
      31, 2009Balance
      at beginning of year
            
            $
            5,955,847
            
            
            $
            3,214,771Provision
      for loan loss
            
            
            2,299,395
            
            
            
            4,285,389Loans
      charged-off
            
            
            (1,267,052
            )
            
            
            (1,682,067
            )Recoveries
      of loans previously charged-off
            
            
            120,637
            
            
            
            137,754Balance
      at end of period
            
            $
            7,108,827
            
            
            $
            5,955,847





Impaired
loans with a valuation allowance of $2,782,469 totaled $9,201,366 at December
31, 2009 and impaired loans of $9,792,151 had a valuation allowance of
$1,873,646 at March 31, 2009.





Impaired
loans without a valuation allowance totaled $0 and $28,598 as of December 31,
2009, and March 31, 2009, respectively.





No
additional funds are committed to be advanced in connection with impaired loans.
There were no loans past due 90 days and still accruing interest.





Nonaccrual
loans excluded from impaired loan disclosure amounted to $3,800,559 at December
31, 2009 and $3,050,662 at March 31, 2009.  If interest on nonaccrual
loans had been accrued, such income would have approximately $575,377 for the
nine months ended December 31, 2009 and $222,629 for the year ended March 31,
2009.


14


Item
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND


RESULTS OF OPERATIONS.





EXECUTIVE
SUMMARY





The
following information is intended to provide investors a better understanding of
the financial position and the operating results of Community Financial
Corporation (“Community” or the “Company” and its subsidiary, Community Bank
(the “Bank”). The following is primarily from management’s perspective and may
not contain all information that is of importance to the reader. Accordingly,
the information should be considered in the context of the consolidated
financial statements and other related information contained
herein.





Net
income for the nine months ended December 31, 2009 increased $7,959,000 to
$2,673,000 compared to ($5,286,000) for the nine months ended December 31,
2008.  Net income for the nine months increased due primarily to the
absence of an Other Than Temporary Impairment (OTTI) adjustment in the current
period compared to an OTTI adjustment on our FHLMC and FNMA Available for Sale
securities of $11,535,000, a tax benefit of $4,384,000 related to the (OTTI)
adjustment, and a net interest income increase of $2.6 million, or 21.6%,
partially offset by increases in the provision for loan losses and in
noninterest expense resulting from higher expenses associated with compensation
and federal deposit insurance premiums. Net income for the nine months ended
December 31, 2008 excluding the OTTI would have been $1,865,000. Net income for
the quarter ended December 31, 2009 decreased $3,408,000 to $832,000 compared to
$4,239,000 for the quarter ended December 31, 2008.  Net income for
the quarter ending December 31, 2009 decreased due primarily to the absence of
the tax benefit of $4,384,000 for the Other Than Temporary Impairment (OTTI)
charge on our Freddie Mac and Fannie Mae Available for Sale securities of
$11,053,000 recognized in September 2008 and $482,000 in December 2008,
partially offset by a net interest income increase of $1.0 million, or
25.9%.  Net income for the quarter ended December 31, 2008 excluding
the OTTI would have been $337,000.





Net
interest income for the quarter ended December 31, 2009 increased $1.0 million,
or 25.9%, to $5.1 million compared to the quarter ended December 31, 2008. Net
interest income, which is the difference between the interest income we earn on
our interest-earning assets, such as loans and investment securities, and the
interest we pay on interest-bearing liabilities, which are primarily deposits
and borrowings, was impacted by both the change in our volume of interest
earning assets and the interest rate spread between interest-earning assets and
interest-bearing liabilities. The primary factors contributing to the increase
in net interest income for the quarter ended December 31, 2009 was the growth in
interest-earning assets, primarily loans, and lower rates paid on
interest-bearing liabilities. The increase in net interest income for the
current quarter was limited due to the elimination of dividends on the Freddie
Mac and Fannie Mae preferred stock and Federal Home Loan Bank common stock owned
by the Bank. We did not purchase any investment securities during the three
months ended December 31, 2009 and anticipate limited securities purchases
during the remainder of the current fiscal year.





Management
will continue to monitor asset growth to manage the level of regulatory capital
and funds acquisition. We continue to monitor the impact changing interest rates
may have on both the growth in interest-earning assets and our interest rate
spread. The Bank has approximately $359.9 million in adjustable rate loans, or
73.8% of total loans, which reprice in five years or less, many of which are
subject to annual and lifetime interest rate limits. The pace and extent of
future interest rate changes will impact the Company’s interest rate spread as
well as limitations on interest rate adjustments on certain adjustable rate
loans.





Funding
for the growth in interest-earning assets combined with a falling interest rate
environment has impacted the composition of our interest-bearing liabilities.
Deposits were up due to increases in interest








15








transaction
accounts and time deposits.  Management plans to remain competitive in
our deposit pricing and anticipates that deposit growth will be the primary
source of funding for asset growth during the remainder of the current fiscal
year. Due to relative pricing advantages, we have utilized brokered deposits and
borrowings during the December 31, 2009 quarter. During the December 31, 2009
quarter, we experienced continuing competition for time deposits. Management is
cognizant of the potential for additional compression in the Bank’s margin
related to the need to acquire funds and the pace of interest rate changes.
Management will continue to monitor the level of deposits and borrowings in
relation to the current interest rate environment.




The
Bank’s loan portfolio decreased by $3.8 million from September 30, 2009 to
December 31, 2009. This decrease was primarily in residential first mortgages,
commercial business loans and construction loans. We expect our future loan
growth to be slow or moderate due to a slower economy and underwriting changes
to limit funding of speculative construction loans.  We have
experienced reduced construction activity in our market areas while existing
commercial real estate activity continues to be moderate. At December 31, 2009,
our assets totaled $540.9 million, including net loans receivable of $496.7
million, compared to total assets of $512.7 million, including net loans
receivable of $477.0 million, at March 31, 2009.  Commercial real
estate loans were $165.9 million or 31.5%, residential first mortgage loans were
$141.3 million or 26.9%, construction loans totaled $75.0 million or 14.2%,
commercial business loans were $52.5 or 10.0%, and home equity loans and lines
were $47.0 million or 8.9% of our total loan portfolio at December 31, 2009
compared to commercial real estate loans of $154.8 or 31.1%, residential first
mortgage loans of $140.1 or 28.2%, construction loans of $62.9 million or 12.7%,
commercial business loans were $53.4 million or 10.8%, and home equity loans and
lines of $41.7 million or 8.4% at March 31, 2009.




At
December 31, 2009, non-performing assets totaled approximately $15.6 million or
2.89% of assets compared to $9.0 million or 1.75% of assets at March 31, 2009.
Our allowance for loan losses to non-performing assets was 45.57% and to total
loans was 1.41% at December 31, 2009 compared to 66.43% and 1.23%, respectively
at March 31, 2009.  The increase in nonperforming assets consisted of
$5.5 million of nonaccrual loans, which included residential permanent and
construction loans, and commercial real estate, and $1.1 million of real estate
owned and repossessed assets. Due primarily to the slowing economy, we expect an
increase in non-performing assets in the future. Charge-offs of $1,267,000
during the nine month period was primarily related to construction loans,
residential land lots and repossessed vehicles.




During
our fiscal year 2009, we evaluated the benefits of the increased yields on our
credit card portfolio compared to the higher risk and operating costs related to
maintaining and servicing an unsecured credit card portfolio. We believed that
offering a credit card product was important to our existing customer base and
for obtaining new customers. As a result of this evaluation, we entered into an
agent-bank relationship with an unaffiliated non-bank pursuant to which our
customers can obtain credit cards with the Community Bank brand and for which we
earn commissions for new accounts and a percentage of interchange fees, but for
which we incur no liability or credit risk. At the same time, we sold our
existing credit card portfolio to that unaffiliated organization. During the
June 30, 2008 quarter, we sold our credit card portfolio with an approximate
loan balance of $500,000, which resulted in a gain of $37,000.




Dramatic
declines in the housing market, with decreasing home prices and increasing
delinquencies and foreclosures, have negatively impacted the credit performance
of mortgage and construction loans and resulted in significant write-downs of
assets by many financial institutions.  We have experienced stable to
moderate declines in real estate values in our market areas. The Company has
experienced increases in delinquencies for the 2010 fiscal year. Delinquencies
have increased from 3.43% at March 31, 2009 to 5.84% at December 31, 2009.
General downward economic trends, reduced availability of commercial credit and
increasing unemployment have negatively impacted the performance of commercial
and consumer credit, resulting in additional write-downs. While there have been
increases in unemployment and announced layoffs by certain employers in our
markets, there has not been a dramatic or widespread








16








increase
in unemployment to date.  Concerns over the stability of the financial
markets and the economy have resulted in decreased lending by other financial
institutions to their customers and to each other.  This market
turmoil and tightening of credit has led to increased delinquencies, lack of
customer confidence, increased market volatility and widespread reduction in
general business activity.  Other financial institutions have
experienced decreased access to deposits or borrowings.





Our
ability to assess the creditworthiness of customers and to estimate the losses
inherent in our credit exposure is made more difficult and complex under these
difficult market and economic conditions.  We also expect to face
increased regulation and government oversight as a result of these downward
trends.  This increased government action may increase our costs and
limit our ability to pursue certain business opportunities.  We also
may be required to pay even higher FDIC premiums than the recently increased
level, because financial institution failures resulting from the depressed
market conditions have depleted and may continue to deplete the FDIC insurance
fund and reduce the FDIC’s ratio of reserves to insured deposits.





We do not
expect these difficult conditions to improve in the near future.  A
worsening of these conditions would likely exacerbate the adverse effects of
these difficult market and economic conditions on us, our customers and the
other financial institutions in our market.  As a result, we may
experience increases in foreclosures, delinquencies and customer bankruptcies,
as well as more restricted access to funds.





The
Emergency Economic Stabilization Act of 2008 (“EESA”) authorized the U.S.
Department of the Treasury (“Treasury Department”) to purchase from financial
institutions and their holding companies up to $700 billion in mortgage loans,
mortgage-related securities and certain other financial instruments, including
debt and equity securities issued by financial institutions and their holding
companies in a troubled asset relief program (”TARP”).  The purpose of
TARP was to restore confidence and stability to the U.S. banking system and to
encourage financial institutions to increase their lending to customers and to
each other.  The Treasury Department allocated $250 billion towards
the TARP Capital Purchase Program (“CPP”).  Under the CPP, Treasury
purchased debt or equity securities from participating
institutions.  The Company made application to the Treasury Department
to participate in this program and received an investment by the Treasury
Department of $12,643,000 in the form of preferred stock during the December 31,
2008 quarter.  The Company also issued to the U.S. Treasury a warrant
to purchase 351,194 shares of common stock at $5.40 per share. The preferred
shares pay a cumulative dividend of 5% per year for the first five years and 9%
per year thereafter.  The preferred shares are repayable at any time
by the company at 100% of the issue price, subject to the approval of the
Company’s federal regulator.


EESA also
increased FDIC deposit insurance on most accounts from $100,000 to
$250,000.  This increase is in place until the end of 2013 and is not
covered by deposit insurance premiums paid by the banking
industry.  In addition, the FDIC has implemented a temporary program
to guarantee certain unsecured debt of financial institutions and their holding
companies through June 2012.





The
purpose of these legislative and regulatory actions is to stabilize the
volatility in the U.S. banking system.  EESA, TARP and the FDIC’s
regulatory initiatives may not have the desired effect.  If the
volatility in the market and the economy continue or worsen, our business,
financial condition, results of operations, access to funds and the price of our
stock could be materially and adversely impacted.







17


CRITICAL
ACCOUNTING POLICIES




General




The
Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP). The
financial information contained within our statements is, to a significant
extent, financial information that is based on measures of the financial effects
of transactions and events that have already occurred. A variety of factors
could affect the ultimate value that is obtained either when earning income,
recognizing an expense, recovering an asset or relieving a liability. In
addition, GAAP itself may change from one previously acceptable method to
another method. Although the economics of our transactions would be the same,
the timing of events that would impact our transactions could
change.




Allowance
for Loan Losses




The
allowance for loan losses is an estimate of the losses that may be sustained in
our loan portfolio. The allowance is based on generally accepted accounting
principles which require that losses be accrued when they are probable of
occurring and estimable and that losses be accrued based on the differences
between the value of collateral, present value of future cash flows or values
that are observable in the secondary market and the loan balance.




The
allowance for loan losses is maintained at a level considered by management to
be adequate to absorb future loan losses currently inherent in the loan
portfolio.  Management's assessment of the adequacy of the allowance
is based upon type and volume of the loan portfolio, past loan loss experience,
existing and anticipated economic conditions, and other factors which deserve
current recognition in estimating future loan losses.  This evaluation
is inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available. Additions to the
allowance are charged to operations.  Subsequent recoveries, if any,
are credited to the allowance.  Loans are charged-off partially or
wholly at the time management determines collectability is not
probable.  Management's assessment of the adequacy of the allowance is
subject to evaluation and adjustment by the Company's regulators.





The
allowance consists of specific, general and unallocated
components.  The specific component relates to loans that are
classified as doubtful or substandard.  For such loans that are also
classified as impaired, an allowance is established when the discounted cash
flows (or collateral value or observable market price) of the impaired loan is
lower than the carrying value of that loan.  The general component
covers special mention and non-classified loans and is based on historical loss
experience adjusted for qualitative factors.  An unallocated component
is maintained to cover uncertainties that could affect management’s estimate of
probable losses.  The unallocated component of the allowance reflects
the margin of imprecision inherent in the underlying assumptions used in the
methodologies for estimating specific and general losses in the
portfolio.





A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified
as impaired.  Management determines the significance of payment delays
and payment shortfalls on a case-by-case basis, taking into consideration all of
the circumstances surrounding the loan and the borrower, including the length of
the delay, the reasons for the delay, the borrower’s prior payment record, and
the amount of the shortfall in relation to the principal and interest
owed.  Impairment is measured on a loan-by-loan basis for commercial
and construction loans by either the present value of expected future cash flows
discounted at the loan’s effective interest rate, the loan’s obtainable market
price, or the fair value of the collateral if the loan is collateral
dependent.


18


Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment.  Accordingly, the Company does not separately identify
individual consumer and residential loans for impairment disclosures, unless
such loans are the subject of a restructuring agreement.





FINANCIAL
CONDITION





The
Company's total assets increased $28.2 million to $540.9 million at December 31,
2009 from $512.7 million at March 31, 2009 due to increases in loans receivable
of $19.7 million, cash of $2.9 million, real estate owned of $1.1 million and
Federal Home Loan Bank Stock of $945,000. The increase in loans was funded with
increases in savings and interest bearing deposits of $15.3 million,
non-interest bearing deposits of $3.0 million, and increases in time deposits of
$18.4 million at December 31, 2009 from March 31, 2009. FHLB advances decreased
by $8.5 million and other borrowings decreased by
$630,000.  Stockholders’ equity increased $2.2 million to $48.5
million at December 31, 2009, from $46.3 million at March 31, 2009, due to
income for the nine months ended December 31, 2009 of $2.7 million partially
offset by cash dividend payments.





At
December 31, 2009, non-performing assets totaled approximately $15.6 million or
2.89% of assets compared to $9.0 million or 1.75% of assets at March 31,
2009.Non-performing assets at
December 31, 2009 were comprised of repossessed assets of $2.5 million and non
accrual loans of $13.1 million. Included in the total non-performing assets at
December 31, 2009, was one relationship of approximately $4.5 million which
includes $3.3 million of raw land. At December 31, 2009, our allowance for loan
losses to non-performing assets was45.46%and to total loans was
1.41% compared to 66.43% and 1.23%, respectively at March 31, 2009. At December
31, 2009, the percentage of delinquent loans to total loans was 5.84% compared
to 3.43% at March 31, 2009. Our allowance for loan losses to total loans
increased $1,153,000 at December 31, 2009 compared to March 31, 2009 due
primarily to additional specific allowances on the Bank’s nonperforming assets
and due to the growth in our loan portfolio. Based on current market values of
the properties securing these loans, management anticipates no significant
losses in excess of the allowance for losses previously
recorded.  Although management believes that it uses the best
information available to make such determinations, future adjustments to
allowances may be necessary, and net income could be significantly affected, if
circumstances differ substantially from the assumptions used in making the
initial determinations.





As of
December 31, 2009, there were also $15.8 million in loans with respect to which
known information about the possible credit problems of the borrowers or the
cash flows of the security properties have caused management to have doubts as
to the ability of the borrowers to comply with present loan repayment terms and
which may result in the future inclusion of such items in the non-performing
loan categories. These loans are comprised primarily of non-owner occupied
residential real estate loans. No individual loan or relationship in this
category has a balance that exceeds $2.1 million.





19


LIQUIDITY
AND CAPITAL RESOURCES





Our
principal sources of funds are customer deposits, advances from the Federal Home
Loan Bank of Atlanta, amortization and prepayment of loans, and funds provided
from operations. Management maintains investments in liquid assets based upon
its assessment of (i) the need for funds, (ii) expected deposit flows, (iii) the
yields available on short-term liquid assets, (iv) the liquidity of our loan
portfolio and (v) the objectives of our asset/liability management program.
Management believes that the Bank will continue to have adequate liquidity for
the foreseeable future. Cash flow projections are regularly reviewed and updated
to assure that adequate liquidity is provided. As of December 31, 2009, the
Bank’s liquidity ratio (liquid assets as a percentage of net withdrawable
savings and current borrowings) was 2.8%.




The Bank
has a line of credit with the FHLB equal to 26% of the Bank’s assets, subject to
the amount of collateral pledged. Under the terms of its collateral agreement
with the FHLB, the Bank provides a blanket lien covering all of its residential
first mortgage loans, home equity lines of credit, multi-family loans and
commercial loans. In addition, the Bank pledges as collateral its capital stock
in and deposits with the FHLB. Based on the collateral pledged as of December
31, 2009, the total amount of borrowing available under the FHLB line of credit
was approximately $113.9 million. At December 31, 2009, principal obligations to
the FHLB consisted of $6,000,000 in floating-rate, overnight borrowings,
$60,000,000 in fixed-rate short term borrowings, $20,000,000 in fixed-rate
convertible advances and a $4,000,000 letter of credit to the Treasurer of
Virginia for public deposits. The Company had a loan with a bank in the amount
of $500,000 at December 31, 2009.




At
December 31, 2009, we had commitments to purchase or originate $9.1 million of
loans. Certificates of deposit scheduled to mature in one year or less at
December 31, 2009, totaled $246.2 million. Based on our historical experience,
management believes that a significant portion of such deposits will remain with
us. Management further believes that loan repayments and other sources of funds
will be adequate to meet our foreseeable short-term and long-term liquidity
needs. At December 31, 2009, we had brokered or internet time deposits of $28.3
million.





The
Bank’s regulatory capital changed from “adequately capitalized” at September 30,
2008 to “well capitalized” at December 31, 2008 due to the issuance of preferred
stock under the U.S. Treasury Capital Purchase Program. The Companyreceived $12,643,000
from the U.S. Treasury through the sale of 12,643 shares of preferred stock. The
Company also issued to the U.S. Treasury a warrant to purchase 351,194 shares of
common stock at $5.40 per share. The preferred shares pay a cumulative dividend
of 5% per year for the first five years and 9% per year
thereafter.  The preferred shares are repayable at any time by the
Company at 100% of the issue price, subject to the approval of the Company’s
federal regulator.





RESULTS
OF OPERATIONS





Three Months Ended December
31, 2009 and 2008.





General.  Net
income for the three months ended December 31, 2009 decreased $3.4 million or
80.38% to $831,000 from $4.2 million for the three months ended December 31,
2008. Net interest income increased $1.0 million, the provision for loan losses
increased 473,000, non-interest income increased $616,000 and non-interest
expense decreased $83,000 during the three months ended December 31, 2009
compared to the same period in 2008. Return on equity for the three months ended
December 31, 2009 was 6.88% compared to 49.9% for the three month period ended
December 31, 2008. Return on assets was .61% for quarter ended
December 31, 2009 compared to 3.39% for the same period in the previous fiscal
year.





20


Interest Income. Total
interest income decreased by $68,000 to $7.0 million for the three months ended
December 31, 2009, from $7.1 million for the three months ended December 31,
2008, due to lower yields and more loans in non-accrual status partially offset
by higher average loan balances.  The decrease in yields was due to
lower market interest rates generally. The average yield earned on
interest-earning assets was 5.50% for the three months ended December 31, 2009
compared to 5.92% for the three months ended December 31, 2008.





Interest
Expense.  Total interest expense decreased by $1.1 million to
$1.9 million for the quarter ended December 31, 2009, from $3.0 million for the
quarter ended December 31, 2008. Interest on deposits decreased by $910,000 to
$1.7 million for the quarter ended December 31, 2009 from $2.6 million for the
quarter ended December 31, 2008 due to a decrease in the average rate paid,
partially offset by higher average deposit balances. Interest expense on
borrowed money decreased by $206,000 to $224,000 for the quarter ended December
31, 2009 compared to $430,000 for the quarter ended December 31, 2008. A
decrease in the average rate paid on borrowings from 1.65% to 0.97% offset by an
increase in the average balance of borrowings from $99.4 million for the
December 31, 2008 quarter to $103.2 million for the December 31, 2009 quarter
accounted for the decrease. The average rate paid on interest-bearing
liabilities was 1.59% during the three months ended December 31, 2009 compared
to 2.52% for the three months ended December 31, 2008.




Provision for Loan
Losses.  The provision for loan losses increased $473,000 to
$1.4 million for the three months ended December 31, 2009, from $893,000 for the
three months ended December 31, 2008. Charge-offs of $793,000 during the three
month period was primarily related to construction loans, residential land lots,
home equity loans and repossessed vehicles. The amount of the provision for loan
losses for the quarter ended December 31, 2009 was based on management’s
assessment of the inherent risk associated with the increase in our loan
portfolio and the level of our allowance for loan losses. We provide valuation
allowances for anticipated losses on loans and real estate when management
determines that a significant decline in the value of the collateral or cash
flows has occurred, as a result of which the value of the collateral or cash
flows is less than the amount of the unpaid principal of the related loan plus
estimated costs of acquisition and sale. In addition, we also provide allowances
based on the dollar amount and type of collateral securing our loans in order to
protect against unanticipated losses. At December 31, 2009, management believes
its allowance for loan losses was adequate to absorb any probable losses
inherent in the Company’s loan portfolio. Although management believes that it
uses the best information available to make such determinations, future
adjustments to allowances may be necessary, and net income could be
significantly affected, if circumstances differ substantially from the
assumptions used in making the initial determinations.


Noninterest
Income.  Noninterest income increased by $616,000 to $1.0
million for the three months ended December 31, 2009, from $415,000 for the
three months ended December 31, 2008 due primarily to the absence of the Other
Than Temporary Impairment charge on our FHLMC and FNMA available for sale
securities of $482,000 that occurred during the quarter ended December 31, 2008.
Service charges, fees and commissions increased due to an increase in secondary
mortgage fee income.  The Bank has established relationships with
other institutions where the Bank receives fees in return for completed customer
mortgage loan applications for the institution’s approval and funding. We
anticipate these relationships will continue to be a source of fee and service
charge income for the Bank.





Noninterest
Expense.  Noninterest expense decreased by $83,000 to $3.4
million for the three months ended December 31, 2009 compared to the same period
last year. The decrease in noninterest expense resulted primarily from reduced
compensation expenses due to the intention not to pay a bonus this fiscal year
and professional fees partially offset by higher federal deposit insurance
premiums and real estate owned expenses.  The increase in real estate
owned expenses is related to the increase in real estate owned properties and
the efforts to dispose of these assets.






21





Federal deposit insurance premiums
during the three months ended December 31, 2009 totaled $165,000, compared to
$58,000 for the same period in 2008. Under FDIC’s current risk-based assessment
rules, assessment rates range from 7 to 77.5 basis points.Rates increase
uniformly by 3 basis points effective January 1, 2011.




In
addition to the regular quarterly assessments, due to losses and projected
losses attributed to failed institutions, the FDIC imposed a special assessment
of 5 basis points on the amount of each depository institution’s assets reduced
by the amount of its Tier 1 capital (not to exceed 10 basis points of its
assessment base for regular quarterly premiums) as of June 30, 2009, which was
collected on September 30, 2009.




As a
result of a decline in the reserve ratio (the ratio of the Deposit Insurance
Fund (“DIF”) to estimated insured deposits) and concerns about expected failure
costs and available liquid assets in the DIF, the FDIC adopted a rule requiring
each insured institution to prepay on December 30, 2009 the estimated amount of
its quarterly assessments for the fourth quarter of 2009 and all quarters
through the end of 2012 (in addition to the regular quarterly assessment for the
third quarter which was due on December 30, 2009).  The prepaid amount
is recorded as an asset with a zero risk weight and the institution will
continue to record quarterly expenses for deposit insurance.  For
purposes of calculating the prepaid amount, assessments are measured at the
institution’s assessment rate as of September 30, 2009, with a uniform increase
of 3 basis points effective January 1, 2011, and are based on the institution’s
assessment base for the third quarter of 2009, with growth assumed quarterly at
an annual rate of 5%.  If events cause actual assessments during the
prepayment period to vary from the prepaid amount, institutions will pay excess
assessments in cash or receive a rebate of prepaid amounts not exhausted after
collection of assessments due on June 13, 2013, as
applicable.  Collection of the prepayment does not preclude the FDIC
from changing assessment rates or revising the risk-based assessment system in
the future.  The rule includes a process for exemption from the
prepayment for institutions whose safety and soundness would be affected
adversely.





FDIC
estimates that the reserve ratio (the ratio of the net worth of the DIF to
estimated insured deposits) will reach the designated reserve ratio of 1.15% by
2017 as required by statute.





Taxes.  Taxes
increased by $4,681,000 to $478,000 for the three months ended December 31,
2009, from a $(4,203,000) tax benefit for the three months ended December 31,
2008. The effective tax rate for the December 31, 2009 quarter was
36.5%.





Nine Months Ended December
31, 2009 and 2008.





General.  Net
income (loss) for the nine months ended December 31, 2009 increased $8.0 million
to $2.7 million from ($5,286,000) for the nine months ended December 31,
2008.  Net income for the nine months increased due primarily to an
Other Than Temporary Impairment adjustment on our FHLMC and FNMA Available for
Sale securities of $11,536,000 (net of a tax benefit of $4,384,000) in the 2008
period, an increase in net interest income, an increase in loan service charges
and was offset by increases in the provision for loan losses and in noninterest
expense resulting from higher expenses associated with compensation and federal
deposit insurance premiums. Return/(Loss) on equity for the nine months ended
December 31, 2009 was 7.46% compared to (18.81)% for the nine month period ended
December 31, 2008. Return/(Loss) on assets was .67% for nine months ended
December 31, 2009 compared to (1.43)% for the same period in the previous fiscal
year.





22





Interest
Income.  Total interest income decreased by $824,000 or 3.8% to
$21.1 million for the nine months ended December 31, 2009, from $21.9 million
for the nine months ended December 31, 2008 due to a decrease in loan yields, an
increase to non-accrual activity, a decrease in average investment security
balances, the elimination of FHLMC common and preferred stock dividends and a
lower dividend rate on the FHLB stock offset by an increase in average loan
balances. The yield on loans and securities decreased from 6.18% to 5.66% for
the same periods.





Interest
Expense.  Total interest expense decreased by $3.4 million or
35.00% to $6.4 million for the nine months ended December 31, 2009, from $9.8
million for the nine months ended December 31, 2008. Interest on deposits
decreased to $5.6 million for the nine months ended December 31, 2009, from $8.1
million for the same period last year due to a decrease in the average rate paid
on deposit balances partially offset by an increase in the average deposit
balances. The rate paid on deposits decreased from 3.05% for the nine months
ended December 31, 2008 to 1.99% for the same period in the current fiscal
year. Interest expense
on borrowed money decreased to $723,000 for the nine months ended December 31,
2009 from $1.7 million for the six months ended December 31, 2008 due to a
decrease in the average rate on borrowing balances offset by an increase in the
average outstanding balance on borrowings. The average balance on borrowings
increased from $99.4 million for the nine months ended December 31, 2008 to
$103.2 million for the nine months ended December 31, 2009. The average rate
paid on borrowings decreased from 2.31% for the nine months ended December 31,
2008 to .93% for the nine month period ended December 31, 2009.





Provision for Loan
Losses.  The provision for loan losses increased by $653,000
for the nine months ended December 31, 2009 from $1,646,000 for the nine months
ended December 31, 2008 based on managements’ review of the inherent risk
associated with the increase in the commercial real estate lending portfolio and
anticipated charge-offs related to certain loans for which we have established
specific reserves.





Noninterest
Income.  Noninterest income (loss) increased by $11.9 million
to $3.0 million for the nine months ended December 31, 2009, from ($9.0) million
for the nine months ended December 31, 2008 due primarily to an Other Than
Temporary Impairment adjustment on our FHLMC and FNMA available for sale
securities of $11.5 million in the prior period.





Noninterest
Expenses.  Noninterest expenses increased $885,000 for the nine
months ended December 31, 2009, compared to the same period last
year.  The increase in noninterest expense resulted primarily from
compensation related expenses due generally to merit increases and an additional
branch location, increased federal deposit insurance premiums and loan
collection expenses.


Taxes.  Taxes
increased to $1.6 million for the nine months ended December 31, 2009, from
$(3.4) million for the nine months ended December 31, 2008. The effective tax
rate was 37.4% for the December 31, 2009 quarter.







OFF
BALANCE SHEET ARRANGEMENTS




There has
not been a significant change in our off balance sheet arrangements from the
information reported in our annual 10-K for the period ended March 31,
2009.






CONTRACTUAL
OBLIGATIONS




There has
not been a significant change in our contractual obligations from the
information reported in our annual 10-K for the period ended March 31,
2009.






23







RECENT
ACCOUNTING PRONOUNCEMENTS





Adoption of New Accounting
Standards







The
Company adopted new guidance impacting Financial Accounting Standards Board
Topic 805: Business
Combinations(Topic 805) on January 1, 2009. This guidance requires
the acquiring entity in a business combination to recognize the full fair value
of assets acquired and liabilities assumed in the transaction (whether a full or
partial acquisition); establishes the acquisition-date fair value as the
measurement objective for all assets acquired and liabilities assumed; requires
expensing of most transaction and restructuring costs; and requires the acquirer
to disclose to investors and other users all of the information needed to
evaluate and understand the nature and financial effect of the business
combination.The
adoption of the new guidance did not have a material impact on the Company’s
consolidated financial statements.




In April
2009, the FASB issued new guidance impacting Topic 805. This guidance addresses
application issues raised by preparers, auditors, and members of the legal
profession on initial recognition and measurement, subsequent measurement and
accounting, and disclosure of assets and liabilities arising from contingencies
in a business combination. This guidance was effective for business combinations
entered into on or after January 1, 2009. This guidance did not have a
material impact on the Company’s consolidated financial statements.




In
December 2008, the FASB issued new guidance impacting FASB Topic 715-20: Compensation Retirement Benefits –
Defined Benefit Plans – General. The objectives of this guidance are to
provide users of the financial statements with more detailed information related
to the major categories of plan assets, the inputs and valuation techniques used
to measure the fair value of plan assets and the effect of fair value
measurements using significant unobservable inputs (Level 3) on changes in plan
assets for the period, as well as how investment allocation decisions are made,
including the factors that are pertinent to an understanding of investment
policies and strategies. The disclosures about plan assets required by this
guidance are included in Note 12 of the Company’s consolidated financial
statements.




In April
2009, the FASB issued new guidance impacting FASB Topic 820: Fair Value Measurements and
Disclosures (Topic 820). This interpretation provides additional guidance
for estimating fair value when the volume and level of activity for the asset or
liability have significantly decreased. This also includes guidance on
identifying circumstances that indicate a transaction is not orderly and
requires additional disclosures of valuation inputs and techniques in interim
periods and defines the major security types that are required to be disclosed.
This guidance was effective for interim and annual periods ending after June 15,
2009, and should be applied prospectively. The adoption of the standard did not
have a material impact on the Company’s consolidated financial
statements.




In April
2009, the FASB issued new guidance impacting FASB Topic 320-10: Investments – Debt and Equity
Securities. This guidance amends GAAP for debt securities to make the
guidance more operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements. This guidance was effective for interim and annual periods ending
after June 15, 2009, with earlier adoption permitted for periods ending after
March 15, 2009. The Company did not have any cumulative effect adjustment
related to the adoption of this guidance




In May
2009, the FASB issued new guidance impacting FASB Topic 855: Subsequent Events. This
update provides guidance on management’s assessment of subsequent events that
occur after the balance sheet date through the date that the financial
statements are issued. This guidance is generally consistent with current
accounting practice. In addition, it requires certain additional disclosures.
This guidance was effective for periods ending after June 15, 2009 and had
no impact on the Company’s consolidated financial statements.






24






In August
2009, the FASB issued new guidance impacting Topic 820. This guidance is
intended to reduce ambiguity in financial reporting when measuring the fair
value of liabilities. This guidance was effective for the first reporting period
(including interim periods) after issuance and had no impact on the Company’s
consolidated financial statements.




In October 2009,
the Securities and Exchange Commission issued Release No. 33-99072, Internal Control over Financial
Reporting in Exchange Act Periodic Reports of Non-Accelerated Filers.
Release No. 33-99072 delays the requirement for non-accelerated filers to
include an attestation report of their independent auditor on internal control
over financial reporting with their annual report until the fiscal year ending
on or after June 15, 2010.







Accounting Standards Not Yet
Effective





In
June 2009, the FASB issued new guidance relating to the accounting for
transfers of financial assets. The new guidance, which was issued as SFAS
No. 166, Accounting for
Transfers of Financial Assets, an amendment to SFAS No. 140, was adopted
into Codification in December 2009 through the issuance of Accounting
Standards Updated (ASU) 2009-16. The new standard provides guidance to improve
the relevance, representational faithfulness, and comparability of the
information that an entity provides in its financial statements about a transfer
of financial assets; the effects of a transfer on its financial position,
financial performance, and cash flows; and a transferor’s continuing
involvement, if any, in transferred financial assets.  The Company
will adopt the new guidance in 2010 and is evaluating the impact it will have,
if any, on its consolidated financial statements.




In June
2009, the FASB issued new guidance relating to the variable interest
entities.  The new guidance, which was issued as SFAS No. 167,
Amendments to FASB
Interpretation No. 46(R), was adopted into Codification in December
2009. The objective of the guidance is to improve financial reporting by
enterprises involved with variable interest entities and to provide more
relevant and reliable information to users of financial statements. SFAS
No. 167 is effective as of January 1, 2010. The Company does not
expect the adoption of the new guidance to have a material impact on its
consolidated financial statements.




In
September 2009, the FASB issued new guidance impacting Topic 820. This creates a
practical expedient to measure the fair value of an alternative investment that
does not have a readily determinable fair value. This guidance also requires
certain additional disclosures. This guidance is effective for interim and
annual periods ending after December 15, 2009. The Company does not expect
the adoption of the new guidance to have a material impact on its consolidated
financial statements.




In
October 2009, the FASB issued ASU 2009-15, Accounting for Own-Share Lending
Arrangements in Contemplation of Convertible Debt Issuance or Other
Financing. ASU 2009-15 amends Subtopic 470-20 to expand accounting and
reporting guidance for own-share lending arrangements issued in contemplation of
convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning
on or after December 15, 2009 and interim periods within those fiscal years for
arrangements outstanding as of the beginning of those fiscal years. The Company
does not expect the adoption of ASU 2009-15 to have a material impact on its
consolidated financial statements.




In
January 2010, the FASB issued ASU 2010-01, Equity (Topic 505): Accounting for
Distributions to Shareholders with Components of Stock and Cash – a consensus of
the FASB Emerging Issues Task Force. ASU 2010-01 clarifies that the stock
portion of a distribution to shareholders that allows them to elect to receive
cash or stock with a potential limitation on the total amount of cash that all
shareholders can elect to receive in the aggregate is considered a share
issuance that is reflected in EPS prospectively and is not a stock
dividend.  ASU 2010-01 is effective for interim and annual periods








25








ending on
or after December 15, 2009 and should be applied on a retrospective
basis.  The Company does not expect the adoption of ASU 2010-01 to
have a material impact on its consolidated financial statements.




In
January 2010, the FASB issued ASU 2010-02, Consolidation (Topic 810):
Accounting and reporting for Decreases in Ownership of a Subsidiary – a Scope
Clarification. ASU 2010-02 amends Subtopic 810-10 to address
implementation issues related to changes in ownership provisions including
clarifying the scope of the decrease in ownership and additional
disclosures.  ASU 2010-02 is effective beginning in the period that an
entity adopts Statement 160.  If an entity has previously adopted
Statement 160, ASU 2010-02 is effective beginning in the first interim or annual
reporting period ending on or after December 15, 2009 and should be applied
retrospectively to the first period Statement 160 was
adopted.   The Company does not expect the adoption of ASU
2010-02 to have a material impact on its consolidated financial
statements.




In
January 2010, the FASB issued ASU 2010-04, Accounting for Various Topics –
Technical Corrections to SEC Paragraphs. ASU 2010-04 makes technical
corrections to existing SEC guidance including the following topics: accounting
for subsequent investments, termination of an interest rate swap, issuance of
financial statements - subsequent events, use of residential method to value
acquired assets other than goodwill, adjustments in assets and liabilities for
holding gains and losses, and selections of discount rate used for measuring
defined benefit obligation. The Company does not expect the adoption of ASU
2010-04 to have a material impact on its consolidated financial
statements.




In
January 2010, the FASB issued ASU 2010-05, Compensation – Stock Compensation
(Topic 718): Escrowed Share Arrangements and the Presumption of
Compensation. ASU 2010-05 updates existing guidance to address the SEC
staff’s views on overcoming the presumption that for certain shareholders
escrowed share arrangements represent compensation.  The Company does
not expect the adoption of ASU 2010-05 to have a material impact on its
consolidated financial statements.




In
January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and
Disclosures (Topic 820): Improving Disclosures about Fair Value
Measurements. ASU 2010-06 amends Subtopic 820-10 to clarify existing
disclosures, require new disclosures, and includes conforming amendments to
guidance on employers’ disclosures about postretirement benefit plan assets. ASU
2010-06 is effective for interim and annual periods beginning after December 15,
2009, except for disclosures about purchases, sales, issuances, and settlements
in the roll forward of activity in Level 3 fair value measurements. Those
disclosures are effective for fiscal years beginning after December 15, 2010 and
for interim periods within those fiscal years.  The Company does not
expect the adoption of ASU 2010-06 to have a material impact on its consolidated
financial statements.




In
February 2010, the FASB issued ASU 2010-08, Technical Corrections to Various
Topics. ASU 2010-08 clarifies guidance on embedded derivatives and
hedging. ASU 2010-08 is effective for interim and annual periods beginning after
December 15, 2009. The Company does not expect the adoption of ASU 2010-08 to
have a material impact on its consolidated financial statements.







Disclosure
Regarding Forward-Looking Statements




This
document, including information incorporated by reference, contains, and future
filings by Community Financial Corporation on Form 10-K, Form 10-Q and Form 8-K
and future oral and written statements by Community Financial Corporation and
its management may contain, forward-looking statements about Community Financial
Corporation which we believe are within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include, without
limitation, statements with respect to anticipated future operating and
financial performance, including revenue creation, lending origination,
operating efficiencies, loan sales, charge-offs and loan loss provisions, growth
opportunities, interest rates, acquisition and divestiture opportunities, and
synergies,








26








efficiencies,
cost savings and funding advantages. These forward-looking statements are based
on currently available competitive, financial and economic data and management's
views and assumptions regarding future events. These forward-looking statements
are inherently uncertain, and investors must recognize that actual results may
differ from those expressed or implied in the forward-looking statements.
Accordingly, Community Financial Corporation cautions readers not to place undue
reliance on any forward-looking statements.




Many of
these forward-looking statements appear in this document in Management's
Discussion and Analysis. Words such as may, could, should, would, believe,
anticipate, estimate, expect, intend, plan and similar expressions are intended
to identify these forward-looking statements. The important factors discussed
below, as well as other factors discussed elsewhere in this document and factors
identified in our filings with the Securities and Exchange Commission and those
presented elsewhere by our management from time to time, could cause actual
results to differ materially from those indicated by the forward-looking
statements made in this document. Among the factors that could cause our actual
results to differ from these forward-looking statements are:




·
            the
      strength of the United States economy in general and the strength of the
      local economies in which we conduct our operations; general economic
      conditions, either nationally or regionally, may be less favorable than
      expected, resulting in, among other things, a deterioration in the credit
      quality of our loans and other assets and a reduction in the value of the
      collateral securing our loans;




·
            the
      effects of, and changes in, trade, monetary and fiscal policies and laws,
      including interest rate policies of the Federal Reserve
    Board;




·
            financial
      market, monetary and interest rate fluctuations, particularly the relative
      relationship of short-term interest rates to long-term interest
      rates;




·
            the
      accuracy of our estimates in evaluating our allowance for loan losses or
      determining the fair value of our
securities;




·
            the
      timely development of and acceptance of new products and services of
      Community Financial Corporation and Community Bank, and the perceived
      overall value of these products and services by users, including the
      features, pricing and quality compared to competitors' products and
      services;




·
            the
      impact of changes in financial services laws and regulations (including
      laws concerning taxes, accounting standards, banking, securities and
      insurance); legislative or regulatory changes may adversely affect the
      business in which we are engaged;




·
            the
      impact of technological changes;




·
            changes
      in consumer spending and saving habits;
and




·
            our
      success at managing the risks involved in the
  foregoing.







27


ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





There
have been no material changes in market risk since March 31, 2009 year end.
Market risk is discussed as part of management’s discussion and analysis under
asset/liability management in the Company’s annual report for March 31,
2009.








ITEM
4T.  CONTROLS AND PROCEDURES




An
evaluation of our disclosure controls and procedures (as defined in Rule
13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) as of December 31,
2009, was carried out under the supervision and with the participation of the
Company's Chief Executive Officer, Chief Financial Officer and several other
members of the Company's senior management. The Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures in effect as of December 31, 2009, were effective in
ensuring that the information required to be disclosed by the Company in the
reports it files or submits under the Act is: (i) accumulated and communicated
to the Company's management (including the Chief Executive Officer and Chief
Financial Officer) in a timely manner and (ii) recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms. In
addition, there have been no changes in our internal control over financial
reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the
quarter ended December 31, 2009, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




The
Company does not expect that its disclosure controls and procedures and internal
control over financial reporting will prevent all error and all fraud. A control
procedure, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control procedure
are met. Because of the inherent limitations in all control procedures, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls may be circumvented by the individual acts of some
persons, by collusion of two or more people, or by override of the control. The
design of any control procedure also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions; over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
procedure, misstatements due to error or fraud may occur and not be
detected.





28


PART
II.  OTHER INFORMATION





Item
1.  Legal Proceedings





Not Applicable.





Item
1A.  Risk Factors





Not required for smaller reporting
company





Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds





Not Applicable.





Item
3.  Defaults Upon Senior Securities





Not Applicable.





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





Not Applicable.





Item
5.  Other Information





Not
Applicable.





Item
6.  Exhibits





See Exhibit Index


29





SIGNATURES





Pursuant to the requirements 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.





COMMUNITY
      FINANCIAL CORPORATIONDate:
      February 12, 2010
            By:
            /s/ R. Jerry
      GilesR.
      Jerry Giles
              Chief
      Financial Officer
              (Duly
      Authorized Officer)

















EXHIBIT
INDEX




Exhibit
      Number
            
            Document3.1
            
            Amended
      and Restated Articles of Incorporation, filed on July 5, 1996 as an
      exhibit to the Registrant’s Definitive Proxy Statement on Schedule 14A
      (SEC File No. 000-18265), are incorporated herein by
      reference.3.2
            
            Certificate
      of Amendment and Articles of Amendment for the Series A Preferred Stock,
      filed on December 22, 2008, as Exhibit 3.1 to the Registrant’s Current
      Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by
      reference.3.3
            
            Bylaws,
      as amended and restated, filed on December 20, 2007 as Exhibit 3.2 to the
      Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is
      incorporated herein by reference.4.1
            
            Registrant’s
      Specimen Common Stock Certificate, filed on June 29, 1999 as Exhibit 4 to
      the Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal
      year ended March 31, 1999, is incorporated herein by
      reference.4.2
            
            Registrant’s
      Form of Certificate for the Series A Preferred Stock, filed on December
      22, 2008, as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K
      (SEC File No. 000-18265), is incorporated herein by
reference.4.3
            
            Registrant’s
      Form of Warrant for Purchase of Shares of Common Stock, filed on December
      22, 2008, as Exhibit 4.2 to the Registrant’s Current Report on Form 8-K
      (SEC File No. 000-18265), is incorporated herein by
reference.10.1
            
            Amended
      and Restated Employment Agreement by and between Community Bank and P.
      Douglas Richard, filed on May 5, 2006, as Exhibit 99.2 to the Registrant’s
      Current Report on Form 8-K (SEC File No. 000-18265), is incorporated
      herein by reference.10.2
            
            Form
      of Change in Control Agreement by and between Community Financial
      Corporation and  P. Douglas Richard, filed on May 5, 2006 as
      Exhibit 99.4 to the Registrant’s Current Report on Form 8-K (SEC File No.
      000-18265), is incorporated herein by reference.10.3
            
            Registrant’s
      1996 Incentive Plan, filed on July 5, 1996 as an exhibit to the
      Registrant’s Definitive Proxy Statement on Schedule 14A (SEC File No.
      000-18265), is incorporated herein by reference.10.4
            
            Form
      of Change in Control Agreement by and between Community Financial
      Corporation and each of R. Jerry Giles and Benny N. Werner, filed on May
      5, 2006 as Exhibit 99.5 to the Registrant’s Current Report on Form 8-K
      (SEC File No. 000-18265), is incorporated herein by
reference.10.5
            
            Retirement
      Agreements by and between Community Bank and Non-Employee Directors filed
      on June 29, 2004 as an exhibit to the Registrant’s Annual Report on Form
      10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 2004,
      and incorporated here by reference.10.6
            
            Form
      of First Amendment to the Retirement Agreements by and between Community
      Bank and Non-Employee Directors, filed on June 29, 2005 as an exhibit to
      the Registrant’s Annual Report on Form 10-K (SEC File No. 000-18265) for
      the fiscal year ended March 31, 2005, is incorporated here by
      reference.
















10.7
            
            Salary
      Continuation Agreements by and between Community Bank and Officers
      Richard, Giles, Smiley and Werner filed on June 29, 2004 as an exhibit to
      the Registrant’s Annual Report on Form 10-KSB (SEC File No. 000-18265) for
      the fiscal year ended March 31, 2004, and incorporated herein by
      reference.10.8
            
            Form
      of Director Deferred Fee Agreement, as amended, filed on June 29, 2005 as
      an exhibit to the Registrant’s Annual Report on Form 10-K (SEC File No.
      000-18265) for the fiscal year ended March 31, 2005, is incorporated
      herein by reference.10.9
            
            Registrant’s
      2003 Stock Option and Incentive Plan, filed on December 27, 2003 as an
      exhibit to the Registrant’s Definitive Proxy Statement on Schedule 14A
      (SEC File No. 000-18265), is incorporated herein by
reference.10.10
            
            Form
      of Incentive Stock Option Agreement and Non-Qualified Stock Option
      Agreement for Registrant’s 2003 Stock Option and Incentive Plan, filed on
      August 12, 2005 as an exhibit to the Registrant’s Quarterly Report on Form
      10-Q (SEC File No. 000-18265) for the quarter ended June 30, 2005, are
      incorporated herein by reference.10.11
            
            Employment
      Agreement by and between Community Bank and Norman C. Smiley, III, filed
      on June 16, 2008 as Exhibit 10.1 to the Registrant’s Current Report on
      Form 8-K (SEC File No. 000-18265), is incorporated herein by
      reference.10.12
            
            Change
      in Control Agreement by and between Community Financial Corporation and
      Norman C. Smiley, III, filed on June 16, 2008 as an exhibit to the
      Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is
      incorporated herein by reference.10.13
            
            Form
      of Change in Control Agreement by and between Community Financial
      Corporation and Lyle Moffett, filed on July 1, 2008 as Exhibit 10.1 to the
      Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is
      incorporated herein by reference.10.14
            
            Form
      of Change in Control Agreement by and between Community Financial
      Corporation and John Howerton, filed on November 14, 2008 as an exhibit to
      the Registrant’s Report on Form 10-Q (SEC File No. 000-18265), is
      incorporated herein by reference.10.15
            
            Letter
      Agreement, including Schedule A, and Securities Purchase Agreement, dated
      December 19, 2008, between Community Financial Corporation and United
      States Department of the Treasury, with respect to the issuance and sale
      of the Series A Preferred Stock and Warrant, filed on December 22, 2008,
      as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (SEC File
      No. 000-18265), is incorporated herein by reference.10.16
            
            Form
      of Compensation Modification Agreement and Waiver, executed
      by  P. Douglas Richard and Norman C. Smiley, III, filed on
      December 22, 2008, as Exhibit 10.2 to the Registrant’s Current Report on
      Form 8-K (SEC File No. 000-18265), is incorporated herein by
      reference.10.17
            
            Separation
      Agreement and Release between the Registrant, and its wholly owned
      subsidiary, Community Bank, and Chris P. Kyriakides, filed on May 26, 2009
      as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (SEC File
      No. 000-18265), is incorporated herein by reference.11
            
            Statement
      re computation of per share earnings (see Note 3 of the Notes to Unaudited
      Interim Consolidated Financial Statements included in this Current Report
      on Form 10-Q).31.1
            
            Rule
      13(a)-14(a) Certification (Chief Executive Officer)31.2
            
            Rule
      13(a)-14(a) Certification (Chief Financial Officer)32
            
            Section
      1350 Certifications