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    September 30,
2008.





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  [ 
]





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  (Check one):





Large
accelerated filer   [  ]     
Accelerated filer  [ 
]       Non-Accelerated filer  [ 
]          Small reporting
company [X]


(do
not check if a small


reporting
company)





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


Yes  [
]     No  [X]





Number of
shares of Common Stock, par value $.01 per share, outstanding at the close of
business on October 31, 2008:4,361,658.








COMMUNITY
FINANCIAL CORPORATION








INDEX








PART
      I.
            FINANCIAL
      INFORMATIONItem
      1.
            Consolidated
      Financial StatementsConsolidated
      Balance Sheets at September 30, 2008 (unaudited)
              and
      March 31, 2008
            3Consolidated
      Statements of Operations for the
              Three
      and Six Months Ended September 30, 2008 and 2007
              (unaudited)
            4Consolidated
      Statements of Cash Flows for the
              Six
      Months Ended September 30, 2008 and 2007(Unaudited)
            5Notes
      to Unaudited Interim Consolidated
              Financial
      Statements
            6Item
      2.
            Management's
      Discussion and Analysis of Financial Condition
              and
      Results of Operations
            12Item
      3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            19Item
      4T.
            Controls
      and Procedures
            19PART
      II.
            OTHER
      INFORMATION
            21Signature
      Page
            
            22Exhibit
      Index
            
            23










2







Part I.
Financial Information


Item 1.
Financial Statements





COMMUNITY
      FINANCIAL CORPORATIONCONSOLIDATED
      BALANCE SHEETSSeptember
      30,
            
            
            March
      31,2008
            
            
            2008(Unaudited)ASSETSCash
      (including interest-bearing deposits of
              approximately
      $1,126,157 and $12,762,079)
            
            $
            2,393,379
            
            
            $
            15,998,041SecuritiesHeld
      to maturity
            
            
            2,840,029
            
            
            
            2,940,217Available
      for sale, at fair value
            
            
            689,675
            
            
            
            9,562,410Restricted
      investment in Federal
              Home
      Loan Bank stock, at cost
            
            
            5,480,800
            
            
            
            5,210,800Loans
      receivable, net of allowance for loan
              losses
      of $3,351,059 and $3,214,771
            
            
            458,188,436
            
            
            
            437,173,797Real
      estate owned and repossessed assets
            
            
            2,112,292
            
            
            
            592,609Property
      and equipment, net
            
            
            8,406,535
            
            
            
            7,923,481Accrued
      interest receivableLoans
            
            
            1,979,695
            
            
            
            1,953,550Investments
            
            
            85,444
            
            
            
            125,523Prepaid
      expenses and other assets
            
            
            8,767,912
            
            
            
            9,765,345Total
      Assets
            
            $
            490,944,197
            
            
            $
            491,245,773LIABILITIES
      AND STOCKHOLDERS’ EQUITYLiabilitiesDeposits
            
            $
            351,590,634
            
            
            $
            350,730,834Borrowings
            
            
            104,000,000
            
            
            
            96,000,000Securities
      sold under agreement to repurchase
            
            
            3,010,248
            
            
            
            2,834,412Advance
      payments by borrowers for
              taxes
      and insurance
            
            
            130,184
            
            
            
            150,545Other
      liabilities
            
            
            2,117,759
            
            
            
            2,825,279Total
      Liabilities
            
            
            460,848,825
            
            
            
            452,541,070Stockholders’
      EquityPreferred
      stock $.01 par value,authorized
      3,000,000 shares,
            
            
            ---
            
            
            
            ---none
      outstandingCommon
      stock, $0.01 par value,authorized
      10,000,000 shares,4,361,658
      and 4,335,958
              shares
      outstanding
            
            
            43,617
            
            
            
            43,360Additional
      paid in capital
            
            
            5,562,732
            
            
            
            5,391,704Retained
      earnings
            
            
            24,858,283
            
            
            
            34,992,515Accumulated
      other comprehensive
              (loss)
            
            
            (369,260
            )
            
            
            (1,722,876
            )Total
      Stockholders’ Equity
            
            
            30,095,372
            
            
            
            38,704,703Total
      Liabilities and Stockholders’ Equity
            
            $
            490,944,197
            
            
            $
            491,245,773








See
accompanying notes to unaudited interim consolidated financial
statements.






3








COMMUNITY
      FINANCIAL CORPORATIONCONSOLIDATED
      STATEMENTS OF INCOMEThree
      Months Ended
            
            
            Six
      Months EndedSeptember
      30
            
            
            September
      302008
            
            
            2007
            
            
            2008
            
            
            2007(Unaudited)
            
            
            (Unaudited)INTEREST
      INCOMELoans
            
            $
            7,185,657
            
            
            $
            7,645,088
            
            
            $
            14,338,826
            
            
            $
            15,168,044Investment
      securities
            
            
            32,187
            
            
            
            240,178
            
            
            
            67,020
            
            
            
            480,357Other
            
            
            124,392
            
            
            
            299,253
            
            
            
            416,182
            
            
            
            593,732Total
      interest income
            
            
            7,342,236
            
            
            
            8,184,519
            
            
            
            14,822,028
            
            
            
            16,242,133INTEREST
      EXPENSEDeposits
            
            
            2,617,460
            
            
            
            3,103,551
            
            
            
            5,493,791
            
            
            
            6,049,991Borrowed
      money
            
            
            691,241
            
            
            
            1,252,603
            
            
            
            1,287,864
            
            
            
            2,543,903Total
      interest expense
            
            
            3,308,701
            
            
            
            4,356,154
            
            
            
            6,781,655
            
            
            
            8,593,894NET
      INTEREST INCOME
            
            
            4,033,535
            
            
            
            3,828,365
            
            
            
            8,040,373
            
            
            
            7,648,239PROVISION
      FOR LOAN LOSSES
            
            
            600,544
            
            
            
            217,225
            
            
            
            752,542
            
            
            
            352,701NET
      INTEREST INCOME AFTER
              PROVISION
      FOR LOAN LOSSES
            
            
            3,432,991
            
            
            
            3,611,140
            
            
            
            7,287,831
            
            
            
            7,295,538NONINTEREST
      INCOME (LOSS)Service
      charges, fees and commissions
            
            
            752,522
            
            
            
            729,418
            
            
            
            1,497,736
            
            
            
            1,466,551Other
            
            
            96,071
            
            
            
            127,317
            
            
            
            190,849
            
            
            
            219,222Securities
      impairment
            
            
            (11,053,341
            )
            
            
            ---
            
            
            
            (11,053,341
            )
            
            
            ---Total
      noninterest income (loss)
            
            
            (10,204,748
            )
            
            
            856,735
            
            
            
            (9,364,756
            )
            
            
            1,685,773NONINTEREST
      EXPENSECompensation
      & benefits
            
            
            1,983,652
            
            
            
            1,837,978
            
            
            
            3,928,904
            
            
            
            3,655,927Occupancy
            
            
            393,533
            
            
            
            358,545
            
            
            
            736,064
            
            
            
            714,463Data
      processing
            
            
            383,391
            
            
            
            359,877
            
            
            
            694,031
            
            
            
            694,069Federal
      insurance premium
            
            
            99,108
            
            
            
            9,578
            
            
            
            169,845
            
            
            
            19,324Advertising
            
            
            113,202
            
            
            
            159,384
            
            
            
            207,524
            
            
            
            219,409Other
            
            
            456,698
            
            
            
            452,654
            
            
            
            940,026
            
            
            
            854,464Total
      noninterest expense
            
            
            3,429,584
            
            
            
            3,178,016
            
            
            
            6,676,394
            
            
            
            6,157,656INCOME
      (LOSS) BEFORE TAXES
            
            
            (10,201,341
            )
            
            
            1,289,859
            
            
            
            (8,753,319
            )
            
            
            2,823,655INCOME
      TAXES
            
            
            288,855
            
            
            
            412,972
            
            
            
            771,461
            
            
            
            917,845NET
      INCOME (LOSS)
            
            $
            (10,490,196
            )
            
            $
            876,887
            
            
            $
            (9,524,780
            )
            
            $
            1,905,810BASIC
      EARNINGS (LOSS) PER SHARE
            
            $
            (2.41
            )
            
            $
            0.20
            
            
            $
            (2.19
            )
            
            $
            0.44DILUTED
      EARNINGS (LOSS) PER SHARE
            
            $
            (2.41
            )
            
            $
            0.20
            
            
            $
            (2.19
            )
            
            $
            0.43DIVIDENDS
      PER SHARE
            
            $
            0.065
            
            
            $
            0.065
            
            
            $
            0.13
            
            
            $
            0.13





See
accompanying notes to unaudited interim consolidated financial
statements.






4






COMMUNITY
      FINANCIAL CORPORATIONCONSOLIDATED
      STATEMENTS OF CASH FLOWSSix
      Months EndedSeptember
      302008
            
            
            2007(Unaudited)
            
            
            (Unaudited)OPERATING
      ACTIVITIESNet
      income (loss)
            
            $
            (9,524,780
            )
            
            $
            1,905,810Adjustments
      to reconcile net income (loss) tonet
      cash provided by operating activitiesProvision
      for loan losses
            
            
            752,542
            
            
            
            352,701Depreciation
            
            
            283,280
            
            
            
            305,184Stock-based
      compensation expense
            
            
            6,826
            
            
            
            ---Amortization
      of premium and accretionof
      discount on securities, net
            
            
            188
            
            
            
            4,084Securities
      impairment
            
            
            11,053,341
            
            
            
            ---(Decrease)
      in net deferred loan fees
            
            
            (70,432
            )
            
            
            (34,737
            )(Decrease)
      in deferred income taxes
            
            
            (94,464
            )
            
            
            (80,072
            )Decrease(increase)
      in other assets
            
            
            997,433
            
            
            
            (961,755
            )(Decrease)
      increase in other liabilities
            
            
            (707,520
            )
            
            
            540,701Net
      cash provided by operating activities
            
            
            2,696,414
            )
            
            
            2,031,916INVESTING
      ACTIVITIESProceeds
      from maturities of held to maturity securities
            
            
            1,700,000
            
            
            
            ---Purchase
      of held to maturity securities
            
            
            (1,600,000
            )
            
            
            ---Net
      increase in loans
            
            
            (22,502,194
            )
            
            
            (16,217,987
            )Purchases
      of property and equipment
            
            
            (748,523
            )
            
            
            (162,865
            )(Purchase)
      of FHLB stock
            
            
            (270,000
            )
            
            
            (315,000
            )(Increase)
      in repossessed assets and real estate owned
            
            
            (1,519,683
            )
            
            
            (132,578
            )Net
      cash absorbed by investing activities
            
            
            (24,940,400
            )
            
            
            (16,828,430
            )FINANCING
      ACTIVITIESDividends
      paid
            
            
            (565,813
            )
            
            
            (558,465
            )Net
      increase in deposits
            
            
            859,800
            
            
            
            12,840,422Proceeds
      from advances and other borrowed money
            
            
            8,175,836
            
            
            
            8,360,215Proceeds
      from issuance of common stock
            
            
            169,501
            
            
            
            9,785Net
      cash provided by financing activities
            
            
            8,639,324
            
            
            
            20,651,957(DECREASE)
      INCREASE IN CASH AND CASH EQUIVALENTS
            
            
            (13,604,662
            )
            
            
            5,855,443CASH
      AND CASH EQUIVALENTS – beginning of period
            
            
            15,998,041
            
            
            
            3,625,796CASH
      AND CASH EQUIVALENTS – end of period
            
            $
            2,393,379
            
            
            $
            9,481,239See
      accompanying notes to unaudited interim consolidated financial
      statements





5


COMMUNITY
FINANCIAL CORPORATION


NOTES TO
UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2008





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 six months ended September 30, 2008 are not necessarily indicative of
the results that may be expected for the year ending March 31,
2009.





NOTE
2. - STOCK-BASED COMPENSATION PLAN







In
December 2004, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment”
(SFAS 123R). SFAS 123R requires companies to recognize 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 and eliminates the choice to account for employee stock options
under Accounting Principles Board Opinion No. 25, “Accounting for Stock
Issued to Employees” (APB 25). The Company adopted SFAS 123R effective April 1,
2006 using the modified prospective method and as such, results for prior
periods have not been restated. Prior to April 1, 2006, no compensation
expense was recognized for stock option grants as all such grants had an
exercise price not less than fair market value on the date of
grant.




Stock
options of 5,000 shares were granted and $6,826 of stock-based compensation
expense was recognized during the three and six month periods ended September
30, 2008.  There were no stock options granted and no stock-based
compensation expense was recognized during the three and six month periods ended
September 30, 2007.









The
following summarizes the stock option activity for the six months ended
September 30, 2008:





Weighted
            
            IntrinsicWeighted
            
            
            Average
            
            Value
      ofAverage
            
            
            Remaining
            
            UnexercisedExercise
            
            
            Contractual
            
            In-the-MoneyShares
            
            
            Price
            
            
            Term
            
            OptionsOptions
      outstanding, March 31, 2008
            
            
            429,600
            
            
            $
            8.28Granted
            
            
            5,000
            
            
            $
            5.71Exercised
            
            
            (24,700
            )
            
            $
            6.86Forfeited
            
            
            (29,100
            )
            
            $
            7.36Options
      outstanding, September 30, 2008
            
            
            380,200
            
            
            $
            8.41
            
            
            
            4.7Options
      exercisable, September 30, 2008
            
            
            380,200
            
            
            $
            8.41
            
            
            
            4.7
            
            $99,690




The total
intrinsic value of in-the-money options exercised during the six months ended
September 30, 2008 was $370.


6





NOTE
3. - EARNINGS PER SHARE





Basic
earnings per share is based on net income 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. Diluted earnings per share is computed by dividing net earnings 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 EndedSeptember 30, 2008
            
            
            September 30, 2007Weighted
      Average
            
            
            Per
      Share
            
            
            
            
            
            Weighted
      Average
            
            
            Per
      Share(Loss)
            
            
            Shares
            
            
            amount
            
            
            Income
            
            
            Shares
            
            
            AmountBasic
      earnings (loss) per shareIncome
      (loss) available to common stockholders
            
            $
            (10,490,196
            )
            
            
            4,357,684
            
            
            $
            (2.41
            )
            
            $
            876,887
            
            
            
            4,297,120
            
            
            $
            0.20Effect
      of Dilutive SecuritiesOptions
            
            
            ---
            
            
            
            ---
            
            
            
            
            
            
            
            ---
            
            
            
            96,981Diluted
      earnings (loss) per shareIncome
      (loss) available to common stockholders
            
            $
            (10,490,196
            )
            
            
            4,357,684
            
            
            $
            (2.41
            )
            
            $
            876,887
            
            
            
            4,394,101
            
            
            $
            0.20







During
the quarter ended September 30, 2008, no stock options were excluded in the
calculation of earnings per share because they would have been anti-dilutive.
During the quarter ended September 30, 2007, no stock options were excluded in
the calculation of earnings per share because they would have been
anti-dilutive.


7







For
      the Six Months EndedSeptember 30, 2008
            
            
            September 30, 2007Weighted
      Average
            
            
            Per
      Share
            
            
            
            
            
            Weighted
      Average
            
            
            Per
      Share(Loss)
            
            
            Shares
            
            
            amount
            
            
            Income
            
            
            Shares
            
            
            AmountBasic
      earnings (loss) per shareIncome
      (loss) available to
              common
      stockholders
            
            $
            (9,524,780
            )
            
            
            4,350,192
            
            
            $
            (2.19
            )
            
            $
            1,905,810
            
            
            
            4,296,430
            
            
            $
            0.44Effect
      of Dilutive SecuritiesOptions
            
            
            ---
            
            
            
            ---
            
            
            
            
            
            
            
            ---
            
            
            
            119,600Diluted
      earnings (loss) per shareIncome
      (loss) available to
              common
      stockholders
            
            $
            (9,524,780
            )
            
            
            4,350,192
            
            
            $
            (2.19
            )
            
            $
            1,905,810
            
            
            
            4,416,030
            
            
            $
            0.43







NOTE
4. - STOCKHOLDERS' EQUITY





The
following table presents the Bank's regulatory capital levels at September 30,
2008:





Amount
              Required
            
            
            Percent
              Required
            
            
            Actual
              Amount
            
            
            Actual
              Percent
            
            
            Excess
              AmountTangible
      Capital
            
            $
            7,517,000
            
            
            
            1.50
            %
            
            $
            36,551,000
            
            
            
            7.29
            %
            
            $
            29,034,000Core
      Capital
            
            
            20,046,000
            
            
            
            4.00
            
            
            
            36,551,000
            
            
            
            7.29
            
            
            
            16,505,000Risk-based
      Capital
            
            
            34,095,000
            
            
            
            8.00
            
            
            
            39,855,000
            
            
            
            9.35
            
            
            
            5,760,000





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 requires
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.





NOTE
5. - SUPPLEMENTAL INFORMATION - STATEMENT OF CASH FLOWS





Total
interest paid for the six months ended September 30, 2008 and 2007 was
$7,358,584 and $8,357,702, respectively. Total income taxes paid for the six
months ended September 30, 2008 and 2007 was $1,003,776 and $1,107,
191.











8


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 and unrealized gains
and losses on securities available for sale. The following tables set forth the
components of comprehensive income for the six-month periods ended September 30,
2008 and 2007:





Six
      months Ended September 302008
            
            
            2007Net
      Income
            
            $
            (9,524,780
            )
            
            $
            1,905,810Other
      comprehensive income (loss), net of tax:Unrealized
      holding (losses) on available for sale securities
              arising
      during the period, net of deferred tax of $829,636
            
            
            (9,699,725
            )
            
            
            (674,560
            )Adjustments
      for realized securities losses, net of tax of $0
            
            
            11,053,341
            
            
            
            ---Total
      other comprehensive income (loss), net of tax
            
            
            1,353,616
            
            
            
            (674,560
            )Total
      comprehensive income (loss)
            
            $
            (8,171,164
            )
            
            $
            1,231,250








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 EndedSeptember
      302008
            
            
            2007Service
      cost
            
            $
            87,669
            
            
            $
            77,336Interest
      cost
            
            
            53,010
            
            
            
            44,055Expected
      return on plan assets
            
            
            (64,175
            )
            
            
            (43,935
            )Recognized
      net actuarial loss
            
            
            4,888
            
            
            
            6,608$
            81,392
            
            
            $
            84,064











9








Six
      Months EndedSeptember
      302008
            
            
            2007Service
      cost
            
            $
            175,338
            
            
            $
            154,672Interest
      cost
            
            
            106,020
            
            
            
            88,110Expected
      return on plan assets
            
            
            (128,350
            )
            
            
            (87,870
            )Recognized
      net actuarial loss
            
            
            9,776
            
            
            
            13,216$
            162,784
            
            
            $
            168,128







As
disclosed in the Company’s Form 10-K for the year ended March 31, 2008, a
contribution of $492,000 to its pension plan is expected during the current
fiscal year. As of September 30, 2008, no contributions have been made. The
Company anticipates making all required contributions prior to March 31,
2009.








NOTE
8. – SECURITIES





Information
pertaining to securities with gross unrealized losses at September 30, 2008,
aggregated by investment category and length of time that individual securities
have been in a continuous loss position, follows:





Less
      Than Twelve Months
            
            
            Over
      Twelve MonthsGross
            
            
            Estimated
              Market
              Value
            
            
            Gross
              Unrealized
              Losses
            
            
            Estimated
              Market
              ValueUnrealized
              LossesHeld
      to MaturityUnited States government
      andagency
obligations
            
            $
            8,010
            
            
            $
            1,591,990
            
            
            $
            -
            
            
            $
            -State and municipal
      obligations
            
            
            -
            
            
            
            -
            
            
            
            1,367
            
            
            
            198,6628,010
            
            
            
            1,591,990
            
            
            
            1,367
            
            
            
            198,662Available
      for SaleEquity securities
            
            
            -
            
            
            
            -
            
            
            
            37,098
            
            
            
            602,750$
            8,010
            
            
            $
            1,591,990
            
            
            $
            38,465
            
            
            $
            801,412





At
September 30, 2008, 5 debt securities had unrealized losses with aggregate
depreciation of 0.52% from the Company’s amortized cost basis.  These
unrealized losses related principally to government agencies.  In
analyzing an issuer’s financial condition, management considers whether the
securities are issued by the federal government or its agencies and whether
downgrades by bond debt rating agencies have occurred.  As management
has the ability and intent to hold these debt securities until maturity or for a
period of time sufficient to allow for any anticipated recovery in fair value,
no declines are deemed to be other than temporary.





At
September 30, 2008, 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. One of the preferred stock issues is the Freddie Mac
preferred series


10


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, 2009.





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) the intent and ability
of the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value.







NOTE 9 - FAIR VALUE
MEASUREMENTS




SFAS No. 157,Fair Value
Measurements, defines fair
value, establishes a framework for measuring fair value, establishes a
three-level valuation hierarchy for disclosure of fair value measurement and
enhances 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
      asset 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.




Impaired
loans




SFAS No. 157 applies to loans measured
for impairment using the practical expedients permitted by SFAS No. 114,Accounting by
Creditors for Impairment of a Loan, 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.




Other real
estate owned




Certain assets such as other real estate
owned (OREO) are measured atthe lesser of cost andfair value less cost to sell. We believe
that the fair value component in its valuation follows the provisions of SFAS
No. 157.







NOTE 10 – SUBSEQUENT
EVENTS





Subsequent
to the September 30, 2008 quarter the Emergency Economic Stabilization Act was
passed by Congress and signed by the President which permitted the OTTI loss to
be deducted as an ordinary loss. This will result in a tax benefit in the
December 31, 2008 quarter of approximately $4.2 million.


11


The
Company is evaluating the provisions of the Capital Purchase Program under the
Emergency Stabilization Act of 2008 that would permit the sale of preferred
capital stock to the U S Treasury (UST). The Company anticipates that it will
make application to the UST under this program.








11. Loans
      Receivable, NetLoans
      receivable are summarized as follows:September
      30, 2008
            
            
            March
      31, 2008Residential
      real estate
            
            $
            132,396,154
            
            
            $
            122,604,826Commercial
      real estate
            
            
            148,295,837
            
            
            
            150,059,098Construction
            
            
            64,148,108
            
            
            
            53,891,019Commercial
      business
            
            
            46,972,534
            
            
            
            41,577,858Consumer
            
            
            84,775,487
            
            
            
            84,671,436476,588,120
            
            
            
            452,804,237Less:Loans in process
            
            
            16,176,032
            
            
            
            13,599,373Deferred loan (costs),
      net
            
            
            (1,127,407
            )
            
            
            (1,183,704
            )Allowance for loan
      losses
            
            
            3,351,059
            
            
            
            3,214,77118,399,684
            
            
            
            15,630,440$
            458,188,436
            
            
            $
            437,173,797





Loans
serviced for others amounted to approximately $312,447 at September 30, 2008,
and $390,094 at


March 31,
2008.  The loans are not included in the accompanying consolidated
balance sheets.





Year
      Ended
            
            September
      30, 2008
            
            
            March
      31, 2008Balance
      at beginning of year
            
            $
            3,214,771
            
            
            $
            3,078,397Provision
      for loan loss
            
            
            732,542
            
            
            
            624,717Loans
      charged-off
            
            
            (676,408
            )
            
            
            (623,055
            )Recoveries
      of loans previously charged-off
            
            
            80,154
            
            
            
            134,712Balance
      at end of year
            
            $
            3,351,059
            
            
            $
            3,214,771





Impaired
loans without a valuation allowance totaled $29,851 as of September 30, 2008,
and $47,768 as of
March 31, 2008.





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 $2,413,292 at
      September 30, 2008 and $1,026,298 at March 31, 2008.  If
      interest on these loans had been accrued, such income would have
      approximated $71,998 for the six months ended September 30, 2008 and
      $44,880 for the year ended March 31,
2008.


12


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 (loss) for the six months ended September 30, 2008 decreased $11,431,000
or 599.82% to ($9,525,000) compared to $1,906,000 for the six months ended
September 30, 2008.  Net income for the six months decreased due
primarily to an Other Than Temporary Impairment (OTTI) adjustment on our FHLMC
and FNMA Available for Sale securities of $11,053,000, provision for loan loss
increase, and increases in noninterest expense resulting from higher expenses
associated with compensation and federal insurance premiums. Net income for the
six months ended September 30, 2008 excluding the OTTI would have been
$1,528,000.





Net
income (loss) for the three months ended September 30, 2008 decreased
$11,367,000 or 1,296.3% to ($10,490,000) compared to $877,000 for the three
months ended September 30, 2008.  Net income for the quarter ended
September 30, 2008 decreased due primarily to an Other Than Temporary Impairment
charge on our FHLMC and FNMA Available for Sale securities of $11,053,000, an
increase in the provision for loan loss, and increases in noninterest expense
resulting from higher expenses associated with compensation and federal
insurance premiums. Net income for the quarter ended September 30, 2008
excluding the OTTI would have been $563,000.





Subsequent
to the September 30, 2008 quarter, the Emergency Economic Stabilization Act was
passed by Congress and signed by the President which permitted the OTTI loss to
be deducted as an ordinary loss for income tax purposes. This will result in a
tax benefit in the December 31, 2008 quarter of approximately $4.2
million.





Net
interest income for the quarter ended September 30, 2008 increased $205,000, or
5.4%, to $4.0 million compared to the quarter ended September 30, 2007. 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 factor contributing to the increase in
net interest income for the quarter ended September 30, 2008 was the growth in
interest-earning assets, primarily loans, and lower rates 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 preferred owned
by the Bank. We had no purchases of investment securities during the three
months ended September 30, 2008 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 $323.1 million in adjustable rate loans or
70.5% 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.
The primary source of funding for increases in assets during the September 30,
2008 quarter was borrowed funds. Deposits were down due primarily to the
seasonal nature of non-interest bearing transaction accounts. 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. During the September 30, 2008 quarter, we experienced
increased competition for time deposits primarily from financial institutions
which reported reduced capital as the result of losses related to subprime
lending. These institutions’ sources of funding have been reduced due to their
reduced capital positions. 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


13


interest
rate changes. Management will continue to monitor the level of deposits and
borrowings in relation to the current interest rate environment.







Growth in
our loan portfolio so far this fiscal year has exceeded our expectations. Growth
in the Bank's loan portfolio for the September 30, 2008 quarter was primarily in
construction, residential first mortgage and home equity loans and lines, offset
by a decrease in commercial real estate  loans. We anticipate that
future loan growth will be primarily in commercial real estate.  At
September 30, 2008, our assets totaled $490.9 million, including net loans
receivable of $458.2 million, compared to total assets of $491.2 million,
including net loans receivable of $437.2 million, at March 31,
2008.  Construction loans totaled $64.1 million or 13.5%, residential
first mortgage loans were $132.4 million or 27.8% and home equity loans and
lines were $38.0 million or 8.0% of our total loan portfolio at September 30,
2008 compared to construction loans of $53.9 million or 11.9%, residential first
mortgage loans of $122.6 or 27.1%, and home equity loans and lines of $32.8
million or 7.2% at March 31, 2008.






At
September 30, 2008, non-performing assets totaled approximately $4.5 million or
..92% of assets compared to $1.6 million or .33% of assets at March 31, 2008. Our
allowance for loan losses to non-performing assets was 74.0% and to total loans
was .73% at September 30, 2008.




During
our fiscal year 2008, we evaluated the benefits of the increased yields on our
credit card portfolio with 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
September 30, 2007 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.  General downward economic
trends, reduced availability of commercial credit and increasing unemployment
have negatively impacted the credit performance of commercial and consumer
credit, resulting in additional write-downs.  Concerns over the
stability of the financial markets and the economy have resulted in decreased
lending by 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.  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 recently enacted Emergency Economic
Stabilization Act of 2008 (“EESA”) authorizes 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 is 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 has allocated $250 billion towards the
TARP Capital Purchase Program (“CPP”).  Under the
CPP,


14


Treasury
will purchase debt or equity securities from participating
institutions.  The TARP also will include direct purchases or
guarantees of troubled asset of financial institutions.  The Company
anticipates it will make application to the Treasury Department to participate
in this program.





EESA also increased FDIC deposit
insurance on most accounts from $100,000 to $250,000.  This increase
is in place until the end of 2009 and is not covered by deposit insurance
premiums paid by the banking industry.  In addition, the FDIC has
implemented two temporary programs to provide deposit insurance for the full
amount of most non-interest bearing transaction accounts through the end of 2009
and to guarantee certain unsecured debt of financial institutions and their
holding companies through June 2012.  Financial institutions have
until December 5, 2008 to opt out of these two programs.  We expect to
participate only in the program that provides unlimited deposit insurance
coverage through December 31, 2009 for noninterest-bearing transaction accounts
(typically business checking accounts) and certain funds swept into
noninterest-bearing savings accounts. Under that program, we will pay a 10 basis
points fee (annualized) on the balance of each covered account in excess of
$250,000, while the extra deposit insurance is in place.  At September
30, 2008, we had $1.5 million in such accounts in excess of
$250,000.





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 recent 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.





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 two basic principles of
accounting: (i) Statement of Financial Accounting Standard ("SFAS") No.5,
Accounting for Contingencies, which requires that losses be accrued when they
are probable of occurring and estimable and (ii) SFAS No. 114, Accounting by
Creditors for Impairment of a Loan, which requires 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 collectibility 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, substandard or special mention.  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 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.


15





A loan is
considered impaired when, based on current information and events, it is
probable that the Corporation 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.




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 decreased $302,000 to $490.9 million at September 30,
2008 from $491.2 million at March 31, 2008 due to decrease in cash of $2.0
million, interest bearing deposits of $11.6 million and securities available for
sale of $8.9 million, offset by an increase in loans receivable of $21.0
million. The increase in loans was funded with an increase in FHLB Advances and
borrowings of $8.2 million and decreases in cash of $2.0 million and interest
bearing deposits of $11.6 million at September 30, 2008 from March 31, 2008.
FHLB Advances increased by $4.0 million and other borrowings increased by $4.2
million.  Stockholders’ equity decreased $8.6 million to $30.1 million
at September 30, 2008, from $38.7 million at March 31, 2008, due to the loss for
the six months of $9.5 million and cash dividend payments, offset by the
elimination of unrealized losses on securities.





At
September 30, 2008, non-performing assets totaled approximately $4.5 million or
..92% of assets compared to $1.6 million or .33% of assets at March 31,
2008.Non-performing assets at
September 30, 2008 were comprised of repossessed assets of $2.1million and non
accrual loans of $2.4 million. Included in the total non-performing assets at
September 30, 2008 was one relationship of approximately $2.1 million which
includes $1.5 million of residential lots. At September 30, 2008, our allowance
for loan losses to non-performing assets was 74.0% and to total loans was .73%
compared to 313.3% and .73%, respectively at March 31, 2008. At September 30,
2008 delinquent loans to total loans was 1.38% compared to .86% at March 31,
2008. 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.





As of
June 30, 2008, there were also $6.1 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 residential real estate
loans. No individual loan in this category has a balance that exceeds
$300,000.





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) our 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 September 30, 2008, the
Bank’s liquidity ratio (liquid assets as a percentage of net withdrawable
savings and current borrowings) was 3.8%.




16


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 September
30, 2008, the total amount of borrowing available under the FHLB line of credit
was approximately $129,590,000. At September 30, 2008, principal obligations to
the FHLB consisted of $72,000,000 in floating-rate, overnight borrowings and
$20,000,000 in fixed-rate convertible advances.




The
Company had a line of credit with a bank in the amount of $5,000,000 at
September 30, 2008 of which $4,000,000 had been drawn on the line.




At
September 30, 2008 we had commitments to purchase or originate $21.7million of loans.
Certificates of deposit scheduled to mature in one year or less at September 30,
2008, totaled $215.1 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
September 30, 2008, we had brokered or internet time deposits of $6.3
million.





The
Bank’s regulatory capital changed from “well capitalized” at June 30, 2008 to
“adequately capitalized” at September 30, 2008 due to the OTTI charge related to
its Fannie Mae and Freddie Mac preferred stock. The Company is considering the
alternatives to regain the “well capitalized” capital status including
participation in the U.S. Treasury Capital Purchase Program. The maximum
available under this program is approximately $12.8 million of preferred
stock.








RESULTS
OF OPERATIONS





Three Months Ended September
30, 2008 and 2007.





General.  Net
income (loss) for the three months ended September 30, 2008 decreased
$11,367,000 or 1,296.3% to ($10,490,000) from $877,000 for the three months
ended September 30, 2007. Net interest income increased $205,000, the provision
for loan losses increased $383,000, non-interest income decreased $11,061,000
and non-interest expense increased $252,000 during the three months ended
September 30, 2008 compared to the same period in 2008. Return on equity for the
three months ended September 30, 2008 was (121.6)% compared to 8.96% for the
three month period ended September 30, 2008. Return on assets was (8.51)% for
quarter ended September 30, 2008 compared to 0.74% for the same period in the
previous fiscal year.





Interest Income. Total
interest income decreased by $842,000 to $7.3 million for the three months ended
September 30, 2008, from $8.2 million for the three months ended September 30,
2008, due to lower yields partially offset by higher average loan
balances.  Investment securities income decreased by $208,000 due to
lower average balances as a result of calls and maturities on securities. Other
interest income decreased due to elimination of dividends on FHLMC common and
preferred stock and a lower yield on FHLB stock.  The decrease in
yields was due to lower market interest rates generally. The average yield
earned on interest-earning assets was 6.39% for the three months ended September
30, 2008 compared to 7.12% for the three months ended September 30,
2007.





Interest
Expense.  Total interest expense decreased by $1,047,000 to
$3.3 million for the quarter ended September 30, 2008, from $4.4 million for the
quarter ended September 30, 2008. Interest on deposits decreased by $486,000 to
$2.6 million for the quarter ended September 30, 2008 from $3.1 million for the
quarter ended June 30, 2008 due to a decrease in the average rate paid partially
offset by higher average deposit balances. Interest expense on borrowed money
decreased by $561,000 to $691,000 for the quarter ended September 30, 2008
compared to the quarter ended September 30, 2007. A decrease in the average rate
paid on borrowings from 5.23% to 2.65% offset by an increase in the average
balance of borrowings from $97.2 million for the September 30, 2007 quarter to
$104.5 million for the September 30, 2008 quarter accounted for the decrease.
The average rate paid on interest-bearing liabilities was 3.08% during the three
months ended September 30, 2008 compared to 3.99% for the three months ended
September 30, 2007.





Provision for Loan
Losses.  The provision for loan losses increased by $383,000 to
$601,000 for the three months ended September 30, 2008, from $217,000 for the
three months ended September 30, 2007. The amount of the


17


provision
for loan losses for the quarter ended September 30, 2008 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 September 30, 2008,
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 (loss) decreased by $11,061,000 to
($10,205,000) for the three months ended September 30, 2008, from $857,000 for
the three months ended September 30, 2007 due primarily to an Other Than
Temporary Impairment adjustment on our FHLMC and FNMA available for sale
securities of $11,053,000. 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 this relationship will continue to be a source of fee and service
charge income for the Bank.





Noninterest
Expense.  Noninterest expense increased by $252,000 to $3.4
million for the three months ended September 30, 2008 compared to the same
period last year. The increase in noninterest expense resulted primarily from
compensation related expenses due generally to merit increases, additional loan
and retail personnel and federal deposit insurance premiums.




Federal
deposit insurance premiums during the three months ended September 30, 2008
totaled $99,000, compared to $10,000 for the same period in 2007.  These
premiums are expected to increase in 2009 due to recent strains on the Federal
Deposit Insurance Corporation ("FDIC") deposit insurance fund due to the cost of
large bank failures and increase in the number of troubled banks.  The
current rates for FDIC assessments have ranged from 5 to 43 basis points,
depending on the health of the insured institution.  The FDIC has proposed
increasing the current deposit insurance assessment rates uniformly for all
institutions by 7 basis points (to a range from 12 to 50 basis points) for the
first quarter of 2009.  The proposed rule would also alter the way the FDIC
calculates federal deposit insurance assessment rates beginning in the second
quarter of 2009 and thereafter.  The FDIC also proposed that it could
increase assessment rates in the future without formal rulemaking.





Taxes.  Taxes
decreased by $124,000 to $289,000 for the three months ended September 30, 2008,
from $413,000 for the three months ended September 30, 2007. The effective tax
rate increased from 32.0% for the September 30, 2007 quarter to 33.9% for the
September 30, 2008 quarter.





Six Months Ended September
30, 2008 and 2007.





General.  Net
income (loss) for the six months ended September 30, 2008 decreased $7,619,000
or 399.8% compared to $1,906,000 for the six months ended September 30,
2007.  Net income for the six months decreased due primarily to an
Other Than Temporary Impairment adjustment on our FHLMC and FNMA Available for
Sale securities of $11,053,000, an increase in the provision for loan loss and
increases in noninterest expense resulting from higher expenses associated with
compensation and federal insurance premium. Return on equity for the six months
ended September 30, 2008 was (48.53)% compared to 10.49% for the six month
period ended September 30, 2007 Return on assets was (3.88)% for six months
ended September 30, 2008 compared to .87% for the same period in the previous
fiscal year.





Interest
Income.  Total interest income decreased by $1.4 million or
8.7% to $14.8 million for the six months ended September 30, 2008, from $16.2
million for the six months ended September 30, 2007 due to a decrease in loan
yields, a decrease in average investment security balances and 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 7.12% to 6.31% for the same periods.





18


Interest
Expense.  Total interest expense decreased by $1.8 million or
21.1% to $6.8 million for the six months ended September 30, 2008, from the six
months ended September 30, 2007  Interest on deposits decreased to
$5.5 million for the six months ended September 30, 2008, from $6.1 million for
the same period last year due to a decrease in the average rate paid on deposit
balances offset by an increase in the average deposit balances. The rate paid on
deposits decreased from 3.64% for the six months ended September 30, 2007 to
3.14% for the same period in the current fiscal year. Interest expense on
borrowed money decreased to $1.3 months ended September 30, 2007 from $25
million for the six months ended September 30, 2008 due to both a decrease in
the average outstanding balance on borrowings and the average rate on borrowing
balances. The average balance on borrowings decreased from $98.0 months ended
September 30, 2007 $97.1 million for the six months ended September 30, 2008.
The average rate paid on borrowings decreased from 5.19% for the six months
ended September 30, 2007to 2.65% for the six month period ended September 30,
2008.
  provision





Noninterest
Income.  Noninterest income (loss) decreased by $11,051,000 to
($9,365,000) for the six months ended September 30, 2008, from $1,686,000 for
the six months ended September 30, 2007 due primarily to an Other Than Temporary
Impairment adjustment on our FHLMC and FNMA available for sale securities of
$11,053,000.





Noninterest
Expenses.  Noninterest expenses increased $519,000 for the six
months ended September 30, 2008, compared to the same period last
year.  The increase in noninterest expense resulted primarily from
compensation related expenses due generally to merit increases, additional loan
and retail personnel and federal deposit insurance premiums.





Taxes.  Taxes
decreased to $771,000 for the six months ended September 30, 2008, from $918,000
for the six months ended September 30, 2007. The effective tax rate increased to
33.5%  for the September 30, 2008 period from 32.5% for the same
period ended September 30, 2007.







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,
2008.




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,
2008.




RECENT
ACCOUNTING PRONOUNCEMENTS





In
December 2007, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 141(R), “Business Combinations” (SFAS
141(R)).  The Standard will significantly change the financial
accounting and reporting of business combination transactions.  SFAS
141(R) establishes the criteria for how an acquiring entity in a business
combination recognizes the assets acquired and liabilities assumed in the
transaction; establishes the acquisition date fair value as the measurement
objective for all assets acquired and liabilities assumed; and requires the
acquirer to disclose to investors and other users all of the information they
need to evaluate and understand the nature and financial effect of the business
combination.  Acquisition related costs including finder's fees,
advisory, legal, accounting valuation and other professional and consulting fees
are required to be expensed as incurred.  SFAS 141(R) is effective for
fiscal years beginning after December 15, 2008 and early implementation is not
permitted. The Company does not expect the implementation to have a material
impact on its consolidated financial statements.





In
December 2007, the FASB issued Statement of Financial Accounting Standards
No.160, “Noncontrolling Interests in Consolidated Financial Statements” (SFAS
160).  SFAS 160 establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent’s ownership interest, and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated.  The Statement also establishes reporting requirements
that provide sufficient disclosures to clearly identify and distinguish between
the interests of the parent and the interests of the noncontrolling
owners.  SFAS 160 is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008. Earlier
adoption is prohibited.The
Company does not expect the implementation of SFAS 160 to have a material impact
on its consolidated financial statements.







19







In March
2008, the FASB issued Statement of Financial Accounting Standards No. 161,
“Disclosures about Derivative Instruments and Hedging Activities – an amendment
of FASB Statement No. 133”(SFAS
161).  SFAS 161 changes the disclosure requirements for derivative
instruments and hedging activities.  Entities are required to provide
enhanced disclosures about how and why an entity uses derivative instruments,
how derivative instrumentsand related hedged items are accounted for under
Statement 133 and its related interpretations, and how derivative instruments
and related hedged items affect an entity’s financial position, financial
performance and cash flows.  SFAS 161 is effective for fiscal years
and interim periods beginning after November 15, 2008, with early application
permitted. The Company does not expect the implementation of SFAS 161 to have a
material impact on its consolidated financial statements.





In May
2008, the FASB issued Statement of Financial Accounting Standards No. 162,
“The Hierarchy of Generally Accepted Accounting Principles” (SFAS
162).  This Statement identifies the sources of accounting principles
and the framework for selecting the principles used in the preparation of
financial statements of nongovernmental entities that are presented in
conformity with generally accepted accounting principles in the United
States.  SFAS 162 becomes effective 60 days following the SEC’s
approval of the Public Company Accounting Oversight Board amendments to AU
Section 411.  The Company does not expect the implementation of SFAS
162 to have a material impact on its consolidated financial
statements.





In
February 2008, the FASB issued FASB Staff Position
(FSP) No. 157-2, “Effective Date of FASB Statement No. 157” (FSP
157-2).  FSP FAS 157-2 delays the effective date of SFAS 157, “Fair
Value Measurements,” for nonfinancial assets and nonfinancial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually).  The delay is
intended to allow the FASB and constituents additional time to consider the
effect of various implementation issues that have arisen, or that may arise,
from the application of Statement 157.  FSP 157-2 defers the effective
date of Statement 157 to fiscal years beginning after November 15, 2008,
and interim periods within those fiscal years, for items within the scope of
this FSP.  Examples of items to which the deferral would and would not
apply are listed in the FSP.  The Company does not expect the
implementation of FSP 157-2 to have a material impact on its consolidated
financial statements.





In
October 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active” (FSP
157-3).  FSP 157-3 clarifies the application of SFAS 157, “Fair Value
Measurements,” in a market that is not active and provides an example to
illustrate key considerations in determining the fair value of a financial asset
when the market for that financial asset is not active.  This FSP was
effective upon issuance, including prior periods for which financial statements
have not been issued.




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, 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:


20


·
              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;


·
            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 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.







ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





There
have been no material changes in market risk since March 31, 2008 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,
2008.





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 ofSeptember 30, 2008, 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 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 endedSeptember
30, 2008, that have materially affected, or
arereasonably 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.





21


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





The Company held an annual
meeting of stockholders on July 30, 2008. The following directors were elected
for a three year term at the meeting: Charles F. Andersen and Charles W.
Fairchilds.  The following directors’ term of office continued after
the meeting:, Jane C. Hickok, P. Douglas Richard, Dale C. Smith, Morgan N.
Trimyer, Jr. and James R. Cooke, Jr..





The only matter voted on at the annual
meeting was the election of the following two directors, each for a term of
three years:





For
              
              
              WithheldCharles
      F. Andersen
              
              
              3,450,949
              
              
              
              57,034Charles
      W. Fairchilds
              
              
              3,474,689
              
              
              
              33,294





Item
5.  Other Information




Not
applicable.


Item
6.  Exhibits





See Exhibit Index


22





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:
      November 12, 2008
            By:R.
      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
            
            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
            
            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.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 each of P. Douglas Richard and Chris P. Kyriakides, 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
            
            Amended
      and Restated Employment Agreement by and between Community Bank and Chris
      P. Kyriakides, filed on May 5, 2006 as Exhibit 99.3 to the Registrant’s
      Current Report on Form 8-K (SEC File No. 000-18265), is incorporated
      herein by reference.10.5
            
            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.10.6
            
            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.10.7
            
            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.10.8
            
            Salary
      Continuance Agreements by and between Community Bank and Officers Richard,
      Kyriakides, 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 here by
      reference.10.9
            
            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 here
      by reference.10.10
            
            Registrant’s
      2003 Stock Option and Incentive Plan, filed on September 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.

















10.11
            
            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.10.12
            
            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.10.13
            
            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.10.14
              
              
              10.15
            
            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.
              
              Form
      of Change in Control Agreement by and between Community Financial
      Corporation and John Howeton is filed with this Form 10-Q.11
            
            Statement
      re computation of per share earnings (see Note 12 of the Notes to
      Consolidated Financial Statements included in Item 8 of this Annual Report
      on Form 10-K).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