U.S.
Securities and Exchange Commission





Washington,
D.C. 20549


FORM 10-K





Annual
Report pursuant to Section 13 OR 15(d) of the Securities Exchange Act
of 1934 (Fee required)




For the
fiscal year ended December 31, 2007




Commission
file number: 0-23090




Carrollton
      Bancorp(Exact
      Name of Registrant as Specified in its Charter)







Maryland
            
            
            
            
            
            52
      1660951(State
      or Other Jurisdiction of Incorporation or Organization)
            
            (I.R.S.
      Employer Identification No.)344
      N. Charles St.Baltimore,
      MD
            
            
            
            
            
            21201(Address
      of principal executive offices)
            
            
            
            
            
            (Zip
      Code)(410)
      536 4600(Registrant’s
      telephone number,
              including
      area code)







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




None




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




Common
Stock,


par value
$1.00 per share


(Title of
class)




Indicate
by check mark whether the registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act. Yes x No o




Indicate
by check mark whether the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o No x




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




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




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




Large
accelerated filer o Accelerated
filer o Non-accelerated
filer x




Indicate
by check mark if the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No x




The
aggregate market value of the Common Stock, all of which has voting rights, held
by non-affiliates of the registrant upon the closing price of such common equity
as of the last business day of the most recently completed second fiscal
quarterwas
approximately $39.0 million. For the purpose of this calculation, directors and
executive officers of the registrant are considered affiliates.




At
March 20, 2008, the Registrant had 2,635,377 shares of $1.00 par value
common stock outstanding.




DOCUMENTS
INCORPORATED BY REFERENCE




Portions
of the Proxy Statement for Annual Meeting of Shareholders to be held on May 13,
2008, are incorporated by reference in Part III of this
Form 10-K.




1


Table
      of Contents




Part IItem
      1 —
            
            Business
            
            4Item
      1A —
            
            Risk
      Factors
            
            11Item
      2 —
            
            Properties
            
            14Item
      3 —
            
            Legal
      Proceedings
            
            15Item
      4 —
            
            Submission
      of Matters to a Vote of Security Holders
            
            15Part IIItem
      5 —
            
            Market
      for Registrant’s Common Equity, Related Shareholder Matters and Issuer
      Purchases of Equity Securities
            
            16Item
      6 —
            
            Selected
      Financial Data
            
            19Item
      7 —
            
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            20Item
      7A —
            
            Quantitative
      and Qualitative Disclosures About Market Risk
            
            35Item
      8 —
            
            Financial
      Statements and Supplementary Data
            
            36Item
      9—
            
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            
            68Item
      9A(T) —
            
            Controls
      and Procedures
            
            68Item
      9B —
            
            Other
      Information
            
            68Part IIIItem
      10 —
            
            Directors,
      Executive Officers, and Corporate Governance
            
            68Item
      11 —
            
            Executive
      Compensation
            
            68Item
      12 —
            
            Security
      Ownership of Certain Beneficial Owners and Management and
              Related
      Stockholder Matters
            
            69Item
      13 —
            
            Certain
      Relationships and Related Transactions and Director
      Independence
            
            69Item
      14 —
            
            Principal
      Accountant Fees and Services
            
            69Part IVItem
      15 —
            
            Exhibits
      and Financial Statement Schedules
            
            69Signatures
            
            
            
            71





2




Forward-looking
      Statements




This
Annual Report on Form 10-K and certain information incorporated herein by
reference contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended. All statements included or
incorporated by reference in this Annual Report on Form 10-K, other than
statements that are purely historical, are forward-looking statements.
Statements that include the use of terminology such as “anticipates,” “expects,”
“plans”, “believes,” “estimates” and similar expressions also identify
forward-looking statements. The forward-looking statements are based on
Carrollton Bancorp’s current intent, belief and expectations. Forward-looking
statements in this Annual Report on Form 10-K include, but are not limited
to:




Part I.
Item 3. Legal Proceedings:




Statement
regarding the impact on the Company of routine legal proceeding.




Part II.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results
of Operations:




Statements
regarding loan growth in real estate development and construction and commercial
loan portfolios in 2008.




Statement
regarding 2008certificate of deposit
pricing strategy.




Statement
regarding challenges facing management in terms of interest rates, growth in net
interest income and overall management of the net interest margin.




Statements
regarding volatility in mortgage refinancing activity.




Part III.
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk:




Statements
regarding the Company’s ability to limit exposure to interest rate
risk.




Statements
regarding factors that influence demand for real estate loans.




Statements
regarding future revenue improvements.




Statements
regarding the sufficiency of the Company’s allowance for loan
losses.




Part IV.
Item 8. Note 3. Investments:




Statement
regarding anticipated changes in the fair value of securities in relation to
market rates.




These
statements are not guarantees of future performance and are subject to certain
risks and uncertainties that are difficult to predict. Actual results may differ
materially from these forward-looking statements because of interest rate
fluctuations, a deterioration of economic conditions in the Baltimore/
Washington metropolitan area, a downturn in the real estate market, losses from
impaired loans, an increase in nonperforming assets, potential exposure to
environmental laws, changes in federal and state bank laws and regulations, the
highly competitive nature of the banking industry, a loss of key personnel,
changes in accounting standards and other risks described in the Company’s
filings with the Securities and Exchange Commission. Existing and prospective
investors are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this Report. Carrollton Bancorp
undertakes no obligation to update or revise the information contained in this
Annual Report whether as a result of new information, future events or
circumstances or otherwise. Past results of operations may not be indicative of
future results.




3




Part I





Item
      1: Business




General.– Carrollton
Bancorp (the “Company”), a bank holding company registered under the Bank
Holding Company Act of 1956, as amended, was organized on January 11, 1990, and
is headquartered in Baltimore, Maryland. Carrollton Bank (the “Bank”) is a
commercial bank and the principal subsidiary of the Company. The Bank was
chartered by an act of the General Assembly of Maryland (Chapter 727) approved
April 10, 1900. The Bank is engaged in a general commercial and retail banking
business and, as of December 31, 2007,had a total of eleven
branch locations in Maryland with two branch locations in Baltimore City; three
branch locations in Anne Arundel County; five branches in Baltimore County and
one branch in Harford County. The Bank’s wholly owned subsidiaries are
Carrollton Mortgage Services, Inc. (“CMSI”), which is used primarily to
originate and sell residential mortgage loans, Carrollton Financial Services,
Inc. (“CFS”), which provides brokerage services, and Mulberry Street LLC
(“MSLLC”) which is used to dispose of other real estate owned. Carrollton
Community Development Corporation (“CCDC”) is a 96.4% owned subsidiary of the
Bank which promotes, develops and improves the housing and economic conditions
of people in Maryland, particularly the Metropolitan Baltimore
area.




The Bank
also operated a network of ATMs in Maryland, Virginia, and West Virginia
and sponsors national retailers who accept ATM cards for purchases in various
electronic networks. On September 22, 2005, Wal-Mart notified the Bank of its
intention to terminate the agreement for the Bank to provide ATM’s at Wal-Mart,
Sam’s Club, and Wal-Mart Supercenters in Maryland, Virginia, and West Virginia.
The effective date of the termination was January 22, 2006.




The Bank
is an independent, community bank that seeks to provide personal attention and
professional financial services to its customers while offering virtually all of
the banking services of larger competitors. Our customers are primarily
individuals and small and medium-sized businesses. The Bank’s business
philosophy includes offering informed and courteous service, local and timely
decision-making, flexible and reasonable operating procedures and consistently
applied credit policies.




The
executive offices of the Company and the principal office of the Bank are
located at 344 North Charles Street, Baltimore, Maryland 21201, telephone number
(410) 536-4600. The Company files quarterly and annual reports with the
Securities and Exchange Commission (“SEC”) on forms 10-Q and 10-K, respectively,
proxy materials on Schedule 14A and current reports on Form 8-K. The Company
makes available, free of charge, all of these reports, as well as any
amendments, through the Company’s Internet site as soon as is reasonably
practicable after they are filed electronically with the SEC. The address of
that site is http://www.carrolltonbank.com.
To access the SEC reports, click on “About Us” —“SEC Filings”.
The SEC also maintains an internet site that contains reports, proxy materials
and information statements at http://sec.gov. In addition,
the Company will provide paper copies of filings free of charge upon written
request.




Description
of Services.– The Bank provides a broad range of consumer and
commercial banking products and services to individuals, businesses,
professionals and governments. The services and products have been designed in
such a manner as to appeal to consumers and business principals.




The
following is a partial listing of the types of services and products that the
Bank offers:




·
            Commercial
      loans for businesses, including those for working capital purposes,
      equipment purchases and accounts receivable and inventory
      financing.




·
            Commercial
      and residential real estate loans for acquisition, refinancing and
      construction.




·
            Consumer
      loans including automobile loans, home equity loans and lines of
      credit.




·
            Loans
      guaranteed by the United States Small Business
    Administration.




·
            Money
      market deposits, demand deposits, NOW accounts, savings accounts and
      certificates of deposit.




·
            Internet
      banking, including electronic bill
payment




·
            Letters
      of credit and remittance services.




·
            Credit
      and debit card services.




·
            Merchant
      credit card deposit servicing.




·
            Brokerage
      services for stocks, bonds, mutual funds and
  annuities.




·
            A
      24-hour ATM network.




4


·
            After-hours
      depository services.




·
            Safe
      deposit boxes.




·
            Point
      of Sale (POS) services.




·
            Other
      services, such as direct deposit, traveler’s checks and
    IRAs.




Customer
service hours for the Bank are competitive with other institutions in the market
area. The Bank also acts as a reseller of services purchased from third party
vendors for customers requiring services not offered directly by the
Bank.




Lending
Activities.– The Bank makes various types of loans to
borrowers based on, among other things, an evaluation of the borrowers’ net
asset value, cash flow, security and ability to repay. Loans to consumers
include home mortgage loans, home equity lines of credit, home improvement
loans, overdraft lines of credit, and installment loans for automobiles, boats
and recreational vehicles. The Bank also makes loans secured by deposit accounts
and common stocks. The Bank’s commercial loan product line includes commercial
mortgage loans, time and demand loans, lines and letters of credit, and
acquisition, development and construction financing. The Notes to the
Consolidated Financial Statements contained in Part II, Item 8 report the
classification by type of loan for the whole portfolio.




First and
second residential mortgage loans, made principally through the Bank’s
subsidiary, CMSI, enable customers to purchase or refinance residential
properties. These loans are secured by liens on the residential property. All
first mortgage loans with a loan to value ratio greater than 80% have private
mortgage insurance coverage equal to or greater than the amount required under
the Federal National Mortgage Association guidelines. Residential loans are
considered low risk based on the type of collateral (residential property) and
the underwriting standards used.  The Bank experienced $76,426 of
losses and $7,516 in recoveries on residential mortgage loans in
2007.  The Bank experienced no losses and no recoveries on residential
mortgage loans in 2006. The Bank experienced no losses and recoveries of $14,874
in 2005.  There were approximately $1.7 million of residential
mortgage loans delinquent more than 90 days at December 31, 2007.




Home
equity lines of credit are typically second mortgage loans (sometimes first
mortgages) secured by the borrower’s primary residence structured as a revolving
borrowing line with a maximum loan amount. Customers write checks to access the
line. Generally, the Bank has a second lien on the property behind the first
mortgage lien holder. The Bank has a number of different equity loan products
that it offers. Borrowers can choose between fixed rate loans or loans tied to
the prime rate with margins ranging from 0% to 1.5%. The Bank will finance up to
90% of the value of the home in combination with the first mortgage loan
balance, depending on the rate and program. Home equity loans carry a higher
level of risk than first mortgage residential loans because of the second lien
position on the property, and because a higher loan to value ratio is used in
the underwriting of the loan. However, the overall risk of loss on home equity
loans is also considered low due to the underlying values of the collateral. The
Bank experienced losses on home equity loans of $100,455 during 2007 and none
during 2006 and 2005. The Bank experienced no recoveries on home equity loans
during 2007 and 2006 and $7,700 during 2005. There were approximately $249,000
of home equity loans delinquent more than 90 days at December 31, 2007.




Commercial
and investment mortgage loans are first mortgage loans made to individuals or to
businesses to finance acquisitions of plant or earning assets, such as rental
property. These loans are secured by a first mortgage lien on the commercial
property, and may be further secured by other property or other assets depending
on the value of the mortgaged property. In most instances, these loans are
guaranteed personally by the principals. The Bank typically looks for cash flow
from the business at least equal to 115% coverage of the business debt service,
and for income-producing property to be self-supporting, generally, with a
minimum debt service coverage ratio of 120% to 125%. Commercial mortgage loans
carry more risk than residential real estate loans. Commercial mortgage loans
tend to be larger in size, and the properties tend to exhibit more fluctuation
in value. The repayment of the loan is primarily dependent on the success of the
business itself, or the tenants in the case of income producing property.
Economic cycles can affect the success of a business. The Bank experienced
losses on commercial mortgage loans of $220,640 during 2007, $59,120 during 2006
and $0 during 2005. There were no commercial mortgage loans past due more than
90 days at December 31, 2007.




Construction
and land development loans are loans to finance the acquisition and development
of parcels of land and to construct residential housing or commercial property.
The Bank typically will finance 70% to 80% of the discounted future value of
these projects, or 80% of value or 90% of cost, whichever is less, on a
single-family detached home. The loan is collateralized by the project or real
estate itself, and other assets or guarantees of the principals in most cases.
Repayment to the Bank is anticipated from the proceeds of sale of the final
units, or permanent mortgage financing on a residential construction loan for a
single borrower. These types of loans carry a higher degree of risk than a
commercial mortgage loan. Interest rates, buyer preferences, and desired
locations are all subject to change during the period from the time of the loan
commitment to final delivery of the final unit, all of which can change the
economics of the project. In addition, real estate developers to whom these
loans are typically made are subject to the business risk of operating a
business in a competitive environment. The Bank did not experience any losses or
recoveries on construction and land development loans during 2007, 2006 and
2005. There were no construction and land development loans past due more than
90 days at December 31, 2007.




5


Demand
and time loans and lines of credit are loans to businesses for relatively short
periods of time, usually not more than one year. These loans are made for any
valid business purpose. These loans may be secured by assets of the borrower or
guarantor, but may be unsecured based on the personal guarantee of the
principal. If secured, loans may be made for up to 100% of the value of the
collateral. The businesses to which these loans are made are subject to normal
business risk, and cash flows of the business may be subject to economic cycles.
In addition, the value of the collateral may fluctuate. If guaranteed by the
principal, the net worth and assets of the principal may be dissipated by
demands of the business, or due to other factors. The Bank had no losses or
recoveries on demand and time loans in 2007 and 2006.The Bank had losses of
$123,578 and recoveries of $130,904 on time demand and loans in 2005. There were
$3.3 million of demand and time and line of credit loans delinquent more than 90
days at December 31, 2007.




Home
improvement loans are loans made to borrowers to complete improvements to their
homes including such projects as room additions, swimming pool installations or
new roofs. The Bank makes unsecured home improvement loans to a maximum amount
of $15,000. Any loan above that limit is secured by a deed of trust. Borrowers
are required to own their home, and to meet certain income and debt ratio
requirements. The Bank also reviews the credit history of all applicants.
Because they are unsecured or secured by a deed of trust, these loans are more
risky than first mortgage residential lending. This risk is mitigated somewhat
based on the fact that the loans are used to improve the borrower’s home,
typically a borrower’s most significant asset. In addition, the debt-to-income
ratio requirement helps determine the borrower’s current ability to repay the
loan. The Bank had charge-offs of home improvement loans of $249, $11,515 and
$0, in 2007, 2006 and 2005, respectively. There were recoveries of $320, $608,
and $0, in 2007, 2006, and 2005 respectively. There were no home improvement
loans delinquent more than 90 days at December 31, 2007.




The
remainder of the consumer loan portfolio is comprised of installment loans for
automobiles, boats and recreational vehicles (“RV”), overdraft protection lines,
and loans secured by deposit accounts or stocks. The largest portion of this
group is installment loans for automobiles and other vehicles. The Bank will
finance up to 90% of the cost of a new car purchase, or the maximum loan amount
as determined by the National Automobile Dealers Association (NADA) publication
for used cars. The Bank will finance up to 85% of the cost of a new boat or RV,
or the maximum loan amount determined by the NADA Boat/RV Guide for used Boats
and RVs. These loans are secured by the vehicle purchased. Borrowers must meet
certain income and debt ratio requirements, and a credit review is performed on
each applicant. These types of loans are subject to the risk that the value of
the vehicle will decline faster than the amount due on the loan. However, the
income-to-debt ratio requirement helps determine the borrower’s current ability
to repay. The Bank had no losses on automobile loans in 2007 and $6,849 in 2006
and no losses in 2005 and recoveries of $5,598, $1,251, and $0, in 2007, 2006
and 2005, respectively. There were approximately $11,000 of automobile or other
vehicle loans past due more than 90 days at December 31,
2007.




Overdraft
lines and other personal loans are unsecured lending arrangements. These loans
or lines of credit are made to allow customers to easily make purchases of
consumer goods. If the lines are handled as agreed, they will typically be
automatically renewed each year. Because they are unsecured, these loans carry a
higher level of risk than secured lending transactions. The Bank attempts to
mitigate significant risk by establishing fairly low credit limits. Net charge-offs in 2007,
2006, and 2005 were $2,916, $11,662, and $1,927, respectively. There were $1,000
overdraft loans and other personal loans past due more than 90 days at
December 31, 2007.




Loans
secured by savings accounts and stock and bond certificates are secured lending
arrangements. The Bank will advance funds for up to 95% of balances in savings
or certificate of deposit accounts. The Bank will advance funds up to 60% of the
market value of actively traded stock certificates and bonds or 50% of the
market value of listed but not actively traded stocks and bonds. Loans secured
by stocks and bonds are subject to margin calls to maintain the loan to value
ratio. Collateral is not released until the loan is repaid, and the borrower is
generally required to pay interest monthly. There were no losses on loans
secured by savings accounts or stock and bond certificates during 2007, 2006, or
2005. Recoveries on loans secured by stocks and bonds were $437, $0, and $0 in
2007, 2006, and 2005 respectively. There were no loans secured by savings
accounts or stock and bond certificates past due more than 90 days at December
31, 2007.




The Bank
is the principal originator of the loans it makes, at this time. In prior
periods, residential mortgage loans and home equity loans and lines of credit
were predominantly purchased from a network of brokers or other types of
originators with whom the Bank did business. The Bank has sold some loans in the
secondary market and therefore derives a small amount of noninterest income from
serviced loans. These income amounts are not significant to the amounts of
noninterest income derived from other sources.




CMSI
originates adjustable and fixed-rate residential mortgage loans at terms and
conditions and with documentation that permit their sale in the secondary
mortgage market. CMSI’s practice is to immediately sell substantially all
residential mortgage loans in the secondary market with servicing
released.




CCDC was
established in 1995 for the purpose of promoting, developing, and improving the
housing and economic conditions of people in Maryland with particular emphasis
in the Metropolitan Baltimore area. CCDC promotes through loans, investments,
and other transactions, efforts to increase housing for low and moderate-income
individuals.




6




MSLLC was
established in 2004 for the purpose of disposing of real estate
owned.  There was no activity in MSLLC in 2007, 2006, and
2005.




Investment
Activities.– The Company maintains a portfolio of investment
securities to provide liquidity and income. The current portfolio amounts to
about 15% of total assets, and is invested primarily in U.S. government agency
securities, state and municipal bonds, corporate bonds, and mortgage-backed
securities with maturities varying from 2008 to 2031, as well as equity
securities.




Deposit
Services.– The Bank offers a wide range of both personal and
commercial types of deposit accounts and services as a means of gathering funds.
Deposit accounts available include noninterest-bearing demand checking,
interest-bearing checking (NOW accounts), savings, money market, certificates of
deposit, and individual retirement accounts. Deposit accounts carry varying fee
structures depending on the level of services desired by the customer. Interest
rates vary depending on the balance in the account maintained by the customer.
Commercial deposit customers may also choose an overnight investment account
which automatically invests excess balances available in demand accounts on a
daily basis in repurchase agreements. The Bank’s customer base for deposits is
primarily retail in nature. The Bank also offers certificates of deposit over
$100,000 to its retail and commercial customers. The Bank has used deposit
brokers in the past and may do so in the future to meet liquidity needs.




The
Company offers Certificate of Deposit Registry Service (“CDARS”) deposits to its
customers. This is a program which allows customers to deposit more than would
normally be covered by FDIC insurance. CDARS is a nationwide program that allows
participating banks to “swap” customer deposits so that no customer has greater
than the insurable maximum in one bank, but the customer only deals with his/her
own bank.




In
addition to traditional deposit services, the Bank offers telephone banking
services, internet banking services and internet bill paying services to its
customers.  Also, the Bank offers remote deposit capture to its
commercial customers.




Brokerage
Activities.– CFS provides full service brokerage services for
stocks, bonds, mutual funds and annuities. For 2007, commission income totaled
$678,000 and net income was $158,000.




Market.– The
Company considers its core markets to be the communities within the Baltimore
Metropolitan Statistical Area (“Baltimore MSA”), particularly Baltimore City and
the counties of Baltimore, Anne Arundel and Harford. Lending activities are
broader and include areas outside of the Baltimore MSA. CMSI operates in
Delaware, Pennsylvania, Virginia and West Virginia in addition to its core
Maryland operations.




Competition.– The
Bank faces strong competition in all areas of its operations. This competition
comes from entities operating in Baltimore City, Baltimore County, Anne Arundel
County, Harford County, and Carroll County, and includes branches of some of the
largest banks in Maryland. Its most direct competition for deposits historically
has come from other commercial banks, savings banks, savings and loan
associations and credit unions. The Bank also competes for deposits with money
market funds, mutual funds and corporate and government securities. The Bank
competes with the same banking entities for loans, as well as mortgage banking
companies and other institutional lenders. The competition for loans varies from
time to time depending on certain factors, including, among others, the general
availability of lendable funds and credit, general and local economic
conditions, current interest rate levels, conditions in the mortgage market and
other factors which are not readily predictable. Some of the Bank’s competitors
have greater assets and operating capacity than the Bank.




Current
federal law allows the acquisition of banks by bank holding companies
nationwide. Further, federal and Maryland law permit interstate banking. Recent
legislation has broadened the extent to which financial services companies, such
as investment banks and insurance companies, may control commercial banks. As a
consequence of these developments, competition in the Bank’s principal market
may increase, and a further consolidation of financial institutions in Maryland
may occur.




7


Asset
Management.– The Bank makes available several types of loan
services to its customers as described above, depending on customer needs.
Recent emphasis has been made on originating short-term (one year or less),
variable rate commercial loans and variable rate home equity lines of credit,
with the balance of its funds invested in consumer/installment loans and real
estate loans, both commercial and residential. In addition, a portion of the
Bank’s assets is invested in high-grade securities and other investments in
order to provide income, liquidity and safety. Such investments include U.S.
government agency securities, corporate bonds, mortgage-backed securities and
collateralized mortgage obligations, as well as advances of federal funds to
other member banks of the Federal Reserve System. Subject to the effects of
taxes, the Bank also invests in tax-exempt state and municipal securities with a
minimum rating of “A” by a recognized ratings agency. The Bank’s primary source
of funds is customer deposits. The risk of non-repayment (or deferred payment)
of loans is inherent in the business of commercial banking, regardless of the
type of loan or borrower. The Bank’s efforts to expand its loan portfolio to
small and medium-sized businesses may result in the Bank undertaking certain
lending risks which are somewhat different from those involved in loans made to
larger businesses. The Bank’s management evaluates all loan applications and
seeks to minimize the exposure to credit risks through the use of thorough loan
application, approval and monitoring procedures. However, there can be no
assurance that such procedures significantly reduce all risks.




Employees.– As
of December 31, 2007, the Bank and its subsidiaries had 137 full time equivalent
employees, 29 of whom were officers. Each officer generally has responsibility
for one or more loan, banking, customer contact, operations, or subsidiary
functions. Non-officer employees are employed in a variety of administrative
capacities. Management believes that it has a favorable relationship with its
employees.




Critical
accounting policies






The
Company’s financial condition and results of operations are sensitive to
accounting measurements and estimates of matters that are inherently uncertain.
When applying accounting policies in areas that are subjective in nature,
management must use its best judgment to arrive at the carrying value of certain
assets. One of the most critical accounting policies applied is related to the
valuation of the loan portfolio.




A variety
of estimates impact the carrying value of the loan portfolio including the
calculation of the allowance for loan losses, valuation of underlying collateral
and the timing of loan charge-offs.




The
allowance for loan losses is one of the most difficult and subjective judgments.
The allowance is established and maintained at a level that management believes
is adequate to cover losses resulting from the inability of borrowers to make
required payments on loans. Estimates for loan losses are arrived at by
analyzing risks associated with specific loans and the loan portfolio. Current
trends in delinquencies and charge-offs, the views of Bank regulators, changes
in the size and composition of the loan portfolio and peer comparisons are also
factors. The analysis also requires consideration of the economic climate and
direction and change in the interest rate environment, which may impact a
borrower’s ability to pay, legislation impacting the banking industry and
economic conditions specific to the Bank’s service area. Because the calculation
of the allowance for loan losses relies on estimates and judgments relating to
inherently uncertain events, results may differ from our estimates.




Another
critical accounting policy is related to securities. Securities are evaluated
periodically to determine whether a decline in their value is other than
temporary. The term “other than temporary” is not intended to indicate a
permanent decline in value. Rather, it means that the prospects for near term
recovery of value are not necessarily favorable, or that there is a lack of
evidence to support fair values equal to, or greater than, the carrying value of
the investment. Management reviews criteria such as the magnitude and duration
of the decline, as well as the reasons for the decline, to predict whether the
loss in value is other than temporary. Once a decline in value is determined to
be other than temporary, the value of the security is reduced and a
corresponding charge to earnings is recognized.




Supervision
and Regulation






General.– The
Company and Bank are extensively regulated under federal and state law.
Generally, these laws and regulations are intended to protect depositors, not
stockholders. The following is a summary description of certain provisions of
certain laws, which affect the regulation of banks and holding companies. The
discussion is qualified in its entirety by reference to applicable laws and
regulations. Changes in these laws and regulations may have a material effect on
the business and prospects of the Company and the Bank.




As a bank
holding company, the Company is subject to the Bank Holding Company Act of 1956,
as amended (the “BHCA”). The BHCA is administered by the Board of Governors of
the Federal Reserve System (the “Board of Governors”), and the Company is
required to file with the Board of Governors such reports and information as may
be required pursuant to the BHCA. The Board of Governors also may examine the
Company and any of its nonbank subsidiaries. The BCHA requires every bank
holding company to obtain the prior approval of the Board of Governors before:
(i) it or any of its subsidiaries (other than a bank) acquires substantially all
of the assets of any bank; (ii) it acquires ownership or control of any voting
shares of




8


any
bank if after such acquisition it would own or control, directly or indirectly,
more than five percent of the voting shares of such bank; or (iii) it
merges or consolidates with any other bank holding company.




Under the
BHCA, a bank holding company is generally prohibited from engaging in, or
acquiring direct or indirect control of more than five percent (5%) of the
voting shares of any company engaged in non-banking activities. A major
exception to this prohibition is for activities the Board of Governors finds, by
order or regulation, to be so closely related to banking or managing or
controlling banks. Some of the activities that the Board of Governors has
determined by regulation to be properly incident to the business of a bank
holding company are: making or servicing loans and certain types of leases;
engaging in certain investment advisory and discount brokerage activities;
performing certain data processing services; acting in certain circumstances as
a fiduciary or as an investment or financial advisor; ownership of certain types
of savings associations; engaging in certain insurance activities; and making
investments in certain corporations or projects designed primarily to promote
community welfare.




Federal
and State Bank Regulation. The Bank is a Maryland state-chartered bank,
with all the powers of a commercial bank, regulated and examined by the Office
of the Maryland Commissioner of Financial Regulation (the “Commissioner’) and
the Federal Deposit Insurance Corporation (“FDIC”). The Commissioner and the
FDIC have extensive enforcement authority over the institutions they regulate to
prohibit or correct activities which violate law, regulations or written
agreements with the regulator, or which are deemed to constitute unsafe or
unsound practices. Enforcement actions may include the appointment of a
conservator or receiver, the issuance of a cease and desist order, the
termination of deposit insurance, the imposition of civil money penalties on the
institution, its directors, officers, employees and institution-affiliated
parties, and the enforcement of any such mechanisms through restraining orders
or other court actions.




In its
lending activities, the maximum legal rate of interest, fees and charges which a
financial institution may charge on a particular loan depends on a variety of
factors such as the type of borrower, the purpose of the loan, the amount of the
loan and the date the loan is made. Other laws tie the maximum amount, which may
be loaned to any one customer and its related interests to capital levels. The
Bank is also subject to certain restrictions on extensions of credit to
executive officers, directors, principal stockholders or any related interest of
such persons which generally require that such credit extensions be made on
substantially the same terms as are available to third persons dealing with the
Bank and not involve more than the normal risk of repayment.




The
Community Reinvestment Act (“CRA”) requires that in connection with the
examination of financial institutions within their jurisdictions, the FDIC
evaluate the record of the financial institutions in meeting the credit needs of
their local communities, including low and moderate-income neighborhoods,
consistent with the safe and sound operation of these banks. The factors are
also considered by all regulatory agencies in evaluating mergers, acquisitions
and applications to open a branch or facility. As of the date of its most recent
examination report, the Bank has a CRA rating of “Satisfactory.”




Under the
Federal Deposit Insurance Corporation Improvement Act of 1991(“FDICIA”), each
federal banking agency is required to prescribe, by regulation, non-capital
safety and soundness standards for institutions under its authority. The federal
banking agencies, including the FDIC, have adopted standards covering internal
controls, information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation,
fees and benefits. An institution that fails to meet those standards may be
required by the agency to develop a plan acceptable to the agency, which
specifies the steps that the institution will take to meet the standards.
Failure to submit or implement such a plan may subject the institution to
regulatory sanctions. The Bank believes that it meets substantially all
standards which have been adopted. FDICIA also imposed new capital standards on
insured depository institutions described under the caption, “Capital
Requirements.”




Before
establishing new branch offices, the Bank must meet certain minimum capital
stock and surplus requirements. Prior to establishment of the branch, the Bank
must obtain Commissioner and FDIC approval.




Deposit
Insurance. As an FDIC insured institution, deposits of the Bank are
currently insured to a maximum of $100,000 per depositor through the Bank
Insurance Fund (“BIF”).  For traditional and ROTH IRA’s, the federal
deposit insurance limit is $250,000. The FDIC is required to establish the
semi-annual assessments for BIF-insured depository institutions at a rate
determined to be appropriate to maintain or increase the reserve ratio of the
respective deposit insurance funds at or above 1.25 percent of estimated
insured deposits or at such higher percentage that the FDIC determines to be
justified for that year by circumstances raising significant risk of substantial
future losses to the fund. The Bank currently pays a de minimus semi-annual
assessment.




Limits
on Dividends and Other Payment. Both federal and state laws impose
restrictions on the ability of the Bank to pay dividends. The Federal Reserve
Board (“FRB”) has issued a policy statement, which provides that, as a general
matter, insured banks may pay dividends only out of prior operating earnings.
For a Maryland state-chartered bank, dividends may be paid out of undivided
profits or, with the prior approval of the Commissioner, from surplus in excess
of 100% of required capital stock. If, however, the surplus of a Maryland bank
is less than 100% of its required capital stock, cash dividends may not be paid
in excess of 90% of the net earnings. In addition to these specific
restrictions, bank regulatory agencies, in general, also




9


have
the ability to prohibit proposed dividends by a financial institution, which
would otherwise be permitted under applicable regulations if the regulatory body
determines that such distribution would constitute an unsafe or unsound
practice.




Capital
Requirements. The FDIC adopted certain risk-based capital guidelines to
assist in the assessment of the capital adequacy of a banking organization’s
operations for both transactions reported as assets on the balance sheet and
transactions, such as letters of credit and recourse arrangements, which are
recorded as off balance sheet items. Under these guidelines, nominal dollar
amounts of assets and credit equivalent amounts of off balance sheet items are
multiplied by one of several risk adjustment percentages, which range from 0%
for assets with low credit risk, such as certain U.S. Treasury securities, to
100% for assets with relatively high credit risk, such as business
loans.




A banking
organization’s risk-based capital ratios are obtained by dividing its qualifying
capital by its total risk adjusted assets. The regulators measure risk-adjusted
assets, which include off balance sheet items, against both total qualifying
capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and
Tier 1 capital. “Tier 1,” or core capital, includes common equity, perpetual
preferred stock (excluding auction rate issues) and minority interest in equity
accounts of consolidated subsidiaries, less goodwill and other intangibles,
subject to certain exceptions. “Tier 2,” or supplementary capital, includes,
among other things, limited-life preferred stock, hybrid capital instruments,
mandatory convertible securities, qualifying subordinated debt, and the
allowance for loan losses, subject to certain limitations and less required
deductions. The inclusion of elements of Tier 2 capital is subject to certain
other requirements and limitations of the federal banking agencies. Banks
subject to the risk-based capital guidelines are required to maintain a ratio of
Tier 1 capital to risk-weighted assets of at least 4% and a ratio to total
capital to risk-weighted assets of at least 8%. The appropriate regulatory
authority may set higher capital requirements when particular circumstances
warrant.




In
August 1995 and May 1996, the federal banking agencies adopted final
regulations specifying that the agencies will include, in their evaluations of a
bank’s capital adequacy, an assessment of the bank’s interest rate risk (“IRR”)
exposure. The standards for measuring the adequacy and effectiveness of a
banking organization’s interest rate risk management include a measurement of
board of director and senior management oversight, and a determination of
whether a banking organization’s procedures for comprehensive risk management
are appropriate to the circumstances of the specific banking organization. The
Bank has internal IRR models that are used to measure and monitor IRR.
Additionally, the regulatory agencies have been assessing IRR on an informal
basis for several years. For these reasons the addition of IRR evaluation to the
agencies’ capital guidelines has not resulted in significant changes in capital
requirements for the Bank.




Failure
to meet applicable capital guidelines could subject a banking organization to a
variety of enforcement actions, including limitations on its ability to pay
dividends, the issuance by the applicable regulatory authority of a capital
directive to increase capital and, in the case of depository institutions, the
termination of deposit insurance by the FDIC, as well as to the measures
described under the caption, “Federal Deposit Insurance Corporation Improvement
Act of 1991” below, as applicable to undercapitalized institutions. In addition,
future changes in regulations or practices could further reduce the amount of
capital recognized for purposes of capital adequacy. Such a change could affect
the ability of the Bank to grow and could restrict the amount of profits, if
any, available for the payment of dividends to the stockholders.




Federal
Deposit Insurance Corporation Improvement Act of 1991. In December 1991,
Congress enacted FDICIA, which substantially revised the bank regulatory and
funding provisions of the Federal Deposit Insurance Act and made significant
revisions to several other federal banking statutes. FDICIA provides for, among
other things, (i) publicly available annual financial condition and management
reports for financial institutions, including audits by independent accountants,
(ii) the establishment of uniform accounting standards by federal banking
agencies, (iii) the establishment of a “prompt corrective action” system of
regulatory supervision and intervention, based on capitalization levels, with
more scrutiny and restrictions placed on depository institutions with lower
levels of capital, (iv) additional grounds for the appointment of a conservator
or receiver, and (v) restrictions or prohibitions on accepting brokered
deposits, except for institutions which significantly exceed minimum capital
requirements. FDICIA also provides for increased funding of the FDIC insurance
funds and the implementation of risk-based premiums, described further under the
caption “Deposit Insurance.”




A central
feature of FDICIA is the requirement that the federal banking agencies take
“prompt corrective action” with respect to depository institutions that do not
meet minimum capital requirements. Pursuant to FDICIA, the federal bank
regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: “well capitalized,” “adequately
capitalized,” “undercapitalized,” “significantly undercapitalized” and
“critically undercapitalized.” An institution may be deemed by the regulators to
be in a capitalization category that is lower than is indicated by its actual
capital position if, among other things, it receives an unsatisfactory
examination rating with respect to asset quality, management, earnings or
liquidity. The Bank is currently “well capitalized.”




FDICIA
generally prohibits a depository institution from making any capital
distribution (including payment of a cash dividend) if the depository
institution would thereafter be undercapitalized. Undercapitalized depository
institutions are subject to growth limitations and are required to submit
capital restoration plans. If a depository institution fails to submit an
acceptable plan, it is treated as if it is significantly undercapitalized.
Significantly undercapitalized depository institutions may be subject to a
number




10


of
other requirements and restrictions, including orders to sell sufficient voting
stock to become adequately capitalized, requirements to reduce total assets and
stop accepting deposits from correspondent banks. Critically undercapitalized
institutions are subject to the appointment of a receiver or conservator;
generally within 90 days of the date such institution is determined to be
critically undercapitalized.




FDICIA
provides the federal banking agencies with significantly expanded powers to take
enforcement action against institutions, which fail to comply with capital or
other standards. Such action may include the termination of deposit insurance by
the FDIC or the appointment of a receiver or conservator for the institution.
FDICIA also limits the circumstances under which the FDIC is permitted to
provide financial assistance to an insured institution before appointment of a
conservator or receiver.




Financial
Modernization. In November 1999, the Gramm-Leach-Bliley Act (“GLBA”)
was signed into law. Effective in part on March 11, 2000, GLBA revises the
BHCA and repeals the affiliation provisions for the Glass-Steagall Act of 1933,
which, taken together, limited the securities, insurance and other non-banking
activities of any company that controls a FDIC insured institution. Under GLBA,
bank holding companies can elect, subject to certain qualifications, to become a
“financial holding company.” GLBA provides that a financial holding company may
engage in a full range of financial activities, including, insurance and
securities sales and underwriting activities, and real estate development, with
the expedited notice procedures.




Maryland
law generally permits Maryland state-chartered banks, including the Bank, to
engage in the same activities, directly or through an affiliate, as national
banks. GLBA permits certain qualified national banks to form financial
subsidiaries, which have broad authority to engage in all financial activities
except insurance underwriting, insurance investments, real estate investment or
development, or merchant banking. Thus, GLBA has the effect of broadening the
permitted activities of Maryland state-chartered banks.




The
PATRIOT Act






The
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (the “PATRIOT Act”) requires
financial institutions to develop a customer identification plan that includes
procedures to:




·
            Collect
      identifying information about customers opening a deposit or loan
      account




·
            Verify
      customer identity




·
            Maintain
      records of the information used to verify the customer’s
      identity




·
            Determine
      whether the customer appears on any list of suspected terrorists or
      terrorist organizations




Under the
provisions of the PATRIOT Act, the Bank is also required from time to time to
search its customer data base for the names of known or suspected terrorists as
provided by the government.




Due to
the extensive regulation of the commercial banking business in the United
States, the Company is particularly susceptible to changes in federal and state
legislation and regulations.




Governmental
monetary policies and economic controls






The
Company is affected by monetary policies of regulatory agencies, including the
FRB, which regulates the national money supply in order to mitigate recessionary
and inflationary pressures. Among the techniques available to the FRB are:
engaging in open market transactions in U.S. Government securities, changing the
discount rate on bank borrowings, changing reserve requirements against bank
deposits, prohibiting the payment of interest on demand deposits, and imposing
conditions on time and savings deposits. These techniques are used in varying
combinations to influence the overall growth of bank loans, investments and
deposits. Their use may also affect interest rates charged on loans or paid on
deposits. The effect of governmental policies on the earnings of the Company
cannot be predicted. However, the Company’s earnings will be impacted by
movement in interest rates, as discussed in Part II Item 7a. “Quantitative
and Qualitative Disclosure About Market Risk.”




Item
1A: Risk Factors






The risks
and uncertainties described below are not the only ones that we face. Additional
risks and uncertainties that we are unaware of, or that we currently deem
immaterial, also may become important factors that affect us and our business.
If any of these risks were to occur, our business, financial condition or
results of operations could be materially and adversely affected. Also, consider
the other information in this Annual Report on Form 10-K, as well as the
documents incorporated by reference.




Competition
may decrease our growth or profits.






We face
significant competition for banking services in our primary market in which we
operate. Competition in the local banking industries may limit our ability to
attract and retain customers. We may face competition now and in the future from
the




11


following:
other local and regional banking institutions, including larger commercial
banking organizations; savings banks; credit unions; other financial
institutions; and non-bank financial services companies serving the
area.




In
particular, our competitors may possess greater resources that may afford them a
marketplace advantage by enabling them to maintain numerous banking locations
and mount extensive promotional and advertising campaigns. Additionally, banks
and other financial institutions with larger capitalization and financial
intermediaries not subject to bank regulatory restrictions have larger lending
limits, which enable them to serve the credit needs of larger customers. We also
face competition from out-of-state financial intermediaries that have opened
low-end production offices or that solicit deposits in their respective market
areas. If we are unable to attract and retain banking customers we may be unable
to continue our loan growth and level of deposits and our results of operations
and financial condition may otherwise be negatively affected.




In the
past, we have expanded our operations into non-banking activities such as
insurance-related products and brokerage services. We may have difficulty
competing with more established providers of these products and services due to
the intense competition in many of these industries. In addition, we may be
unable to attract and retain non-banking customers due to a lack of market and
product knowledge or other industry specific matters or an inability to attract
and retain qualified, experienced employees. Our failure to attract and retain
customers with respect to these non-banking activities could negatively impact
our future earnings.




Changes
in interest rates and other factors beyond our control may adversely affect our
earnings and financial condition.




Our main
source of income from operations is net interest income, which is equal to the
difference between the interest income received on loans, investment securities
and other interest-earning assets and the interest expense incurred in
connection with deposits, borrowings and other interest-bearing liabilities. As
a result, our net interest income can be affected by changes in market interest
rates. These rates are highly sensitive to many factors beyond our control,
including general economic conditions, both domestic and foreign, and the
monetary and fiscal policies of various governmental and regulatory authorities.
We have adopted asset and liability management policies to try to minimize the
potential adverse effects of changes in interest rates on our net interest
income, primarily by altering the mix and maturity of loans, investments and
funding sources. However, even with these policies in place, we cannot provide
assurance that changes in interest rates will not negatively impact our
operating results.




An
increase in interest rates also could have a negative impact on our business by
reducing the ability of borrowers to repay their current loan obligations, which
could not only result in increased loan defaults, foreclosures and write-offs,
but also necessitate further increases to our allowance for loan losses.
Increases in interest rates also may reduce the demand for loans and, as a
result, the amount of loan and commitment fees. In addition, fluctuations in
interest rates may result in disintermediation, which is the flow of funds away
from depository institutions into direct investments that pay higher rates of
return, and may affect the value of our investment securities and other
interest-earning assets.




We
originate and sell mortgage loans. Changes in interest rates affect demand for
our loan products and the revenue realized on the sale of loans. A decrease in
the volume of loans sold and lower gains on sales of mortgages can decrease our
revenues and net income.




Our
allowance for loan losses may not be adequate to cover our actual loan losses,
which could adversely affect our earnings.




If our
customers default on the repayment of their loans, our profitability could be
adversely affected. A borrower’s default on its obligations under one or more of
our loans may result in lost principal and interest income and increased
operating expenses as a result of the allocation of management time and
resources to the collection and work-out of the loans. If collection efforts are
unsuccessful or acceptable workout arrangements cannot be reached, we may have
to write-off the loans in whole or in part. Although we may acquire any real
estate or other assets that secure the defaulted loans through foreclosure or
other similar remedies, the amount owed under the defaulted loans may exceed the
value of the assets acquired.




Our
management periodically makes a determination of our allowance for loan losses
based on available information, including the quality of our loan portfolio,
economic conditions, and the value of the underlying collateral and the level of
our non-accruing loans. If our assumptions prove to be incorrect, our allowance
may not be sufficient and future additions to the allowance may be necessary
which will result in an expense for the period. If, as a result of general
economic conditions or an increase in nonperforming loans, management determines
that an increase in our allowance for loan losses is necessary, we may incur
additional expenses.




In
addition, as an integral part of their examination process, bank regulatory
agencies periodically review our allowance for loan losses and the value we
attribute to real estate acquired through foreclosure or other similar remedies.
These regulatory agencies may require us to adjust our determination of the
value for these items based on their judgment. These adjustments could
negatively impact our results of operations or financial condition.




12




In the
course of our business, we may acquire, through foreclosure, properties securing
loans that are in default. Particularly in commercial real estate lending, there
is a risk that hazardous substances could be discovered on these properties. In
this event, we might be required to remove these substances from the affected
properties at our sole cost and expense. The cost of this removal could
substantially exceed the value of the affected properties. We may not have
adequate remedies against the prior owners or other responsible parties and
could find it difficult or impossible to sell the affected properties. The
occurrence of one or more of these events could adversely affect our financial
condition or operating results.




Changes
in local economic conditions could adversely affect our
business.






Because
we serve primarily individuals and smaller businesses, the ability of our
customers to repay their loans is impacted by the economic conditions in these
areas. As of December 31, 2007, approximately 74% of our loan portfolio
consisted of commercial loans, defined as commercial and industrial, municipal,
multi-family, commercial real estate and construction loans. Thus, our results
of operations, both in terms of the origination of new loans and the potential
default of existing loans, is heavily dependent upon the strength of local
businesses.




We have
traditionally obtained funds principally through deposits and borrowings. As a
general matter, deposits are a cheaper source of funds than borrowings, because
interest rates paid for deposits are typically less than interest rates charged
for borrowings. If, as a result of competitive pressures, market interest rates,
general economic conditions or other events, the balance of our deposits
decrease relative to our overall banking operations, we may have to rely more
heavily on borrowings as a source of funds in the future. Such an increased
reliance on borrowings could have a negative impact on our results of operations
or financial condition.




Government
regulation significantly affects our business.






Bank
holding companies and state and federally chartered banks operate in a highly
regulated environment and are subject to supervision and examination by federal
and state regulatory agencies. We are subject to the BHCA, as amended, and to
regulation and supervision by the Federal Deposit Insurance Corporation, or
FDIC, and the Office of the Maryland Commissioner. The cost of compliance with
regulatory requirements may adversely affect our results of operations or
financial condition. Federal and state laws and regulations govern numerous
matters including: changes in the ownership or control of banks and bank holding
companies; maintenance of adequate capital and the financial condition of a
financial institution; permissible types, amounts and terms of extensions of
credit and investments; permissible non-banking activities; the level of
reserves against deposits; and restrictions on dividend payments. Regulations
affecting banks and financial services companies undergo continuous change, and
we cannot predict the ultimate effect of these changes, which could have a
material adverse effect on our profitability or financial condition. Federal
economic and monetary policy may also affect our ability to attract deposits and
other funding sources, make loans and investments, and achieve satisfactory
interest spreads.




The FDIC,
and state banking authorities possess cease and desist powers to prevent or
remedy unsafe or unsound practices or violations of law by banks subject to
their regulation, and the FRB possesses similar powers with respect to bank
holding companies. These and other restrictions limit the manner in which we may
conduct our business and obtain financing.




Furthermore,
our banking business is affected not only by general economic conditions, but
also by the monetary policies of the FRB. Changes in monetary or legislative
policies may affect the interest rates we must offer to attract deposits and the
interest rates we can charge on our loans, as well as the manner in which we
offer deposits and make loans. These monetary policies have had, and are
expected to continue to have, significant effects on the operating results of
depository institutions, including our Bank.




Under
regulatory capital adequacy guidelines and other regulatory requirements, we
must meet guidelines that include quantitative measures of assets, liabilities,
and certain off-balance sheet items, subject to qualitative judgments by
regulators about components, risk weightings and other factors. If we fail to
meet these minimum capital guidelines and other regulatory requirements, our
financial condition would be materially and adversely affected. Our failure to
maintain the status of “well capitalized” under our regulatory framework could
affect the confidence of our customers in us, thus compromising our competitive
position. In addition, failure to maintain the status of “well capitalized”
under our regulatory framework or “well managed” under regulatory examination
procedures could compromise our status as a bank holding company and related
eligibility for a streamlined review process for acquisition
proposals.




Changes
in the Federal and State tax laws may negatively impact the financial
performance of the Company






The
Company is subject to changes in tax law that could increase the effective tax
rate payable to the state or federal government.  These law changes
may be retroactive to previous periods and as a result, could negatively affect
the current and future performance of the Company.




13




Technology
failure could adversely affect our operations and profits.






We rely
heavily on communications and information systems to conduct our business. Any
failure or interruptions or breach in security of these systems could result in
failures or disruptions in our customer relationship management, general ledger,
deposits, and servicing or loan origination systems. The occurrence of any
failures or interruptions could result in a loss of customer business and have a
material adverse effect on our results of operations and financial
condition.




The
Company is subject to litigation risk.






In the
normal course of business, the Corporation may become involved in litigation,
the outcome of which may have a direct material impact on our financial position
and daily operations.   Please see Note 16, “Contingencies” for
the current status of existing and threatened litigation.




Changes
in accounting standards or interpretation in new or existing standards could
materially affect the results of the Company.






From time
to time the Financial Accounting Standards Board (“FASB”) and the SEC change
accounting regulations and reporting standards that govern the preparation of
the Company’s financial statements.  In addition, the FASB, SEC, bank
regulators and the outside independent auditors may revise their previous
interpretations regarding existing accounting and regulations and the
application of these accounting standards.  These revisions in their
interpretations are out of the Company’s control and may have a material impact
on the Company’s financial results of operations.




Our
ability to pay dividends is limited by law and contract.






Our
ability to pay dividends to our shareholders largely depends on the Company’s
receipt of dividends from the Bank. The amount of dividends that the Bank may
pay to the Company is limited by federal laws and regulations. We also may
decide to limit the payment of dividends even when we have the legal ability to
pay them in order to maintain earnings for use in our business.




The
market price for our common stock may be volatile.






The
market price for our common stock has fluctuated, ranging between $11.25 and
$18.40 per share during the 12 months ended December 31, 2007. The overall
market and the price of our common stock may continue to be volatile. There may
be a significant impact on the market share of our common stock due to, among
other things:




Variations
in our anticipated or actual operating results or the results of our
competitors;


Changes
in investors’ or analysts’ perceptions of the risks and conditions of
business;


The size
of the public float of our common stock;


Regulatory
developments;


The
announcement of acquisitions or new branch locations by us or our
competitors;


Market
conditions; and


General
economic conditions.




Additionally,
the average daily trading volume for our common stock is low and on various days
throughout the year, there is no activity on the stock. There can be no
assurance that a more active or consistent trading market will develop. As a
result, relatively small trades could have a significant impact on the price of
our stock.




Item
      2: Properties




The
Company owned the following properties, which had a book value of
$2.7 million at December 31, 2007:




Location
            
            Description1740
      East Joppa Road
              Towson,
      MD 21234
            
            Full
      service branch with drive thru, Electronic Banking offices and leased
      office space427
      Crain Highway
              Glen
      Burnie, MD 21061
            
            Full
      service branch with drive-thru531
      South Conkling Street
              Baltimore,
      MD 21224
            
            Full
      service branch with drive-thru344
      N. Charles Street
              Baltimore,
      MD 21201
            
            Full
      service branch with Executive offices, Lending offices and Finance
      offices




14




The
Company leased the following facilities at an aggregate annual rental of
approximately $1.1 million as of December 31, 2007:




Location
            
            Description
            
            Lease
      Expiration Date*1066-70
      Maiden Choice Lane
              Arbutus,
      MD 21229
            
            Full
      service branch
            
            April 30,
      20314738
      Shelbourne Road
              Baltimore,
      MD 21229
            
            Detached
      drive-thru
            
            April 30,
      2031Suites
      101-103 & 120-122
              1589
      Sulphur Spring Road
              Baltimore,
      MD 21227
            
            Administrative
      and operational offices
            
            February 28,
      20192637-A
      Old Annapolis Road
              Hanover,
      MD 21076
            
            Full
      service branch
            
            October 1,
      2014Wilkens
      Beltway Plaza 4658
              Wilkens
      Avenue
              Baltimore,
      MD 21229
            
            Limited-service
      branch
            
            October 21,
      20248157A
      Honeygo Boulevard
              White
      Marsh, MD 21236
            
            Full
      service branch closed January 4, 2008.  Relocated to Perry Hall,
      MarylandNorthway
      Shopping Center
              684
      Old Mill Road
              Millersville,
      MD 21108
            
            Full
      service branch
            
            August 31,
      2014602
      Hoagie Drive
              Bel
      Air, MD 21014
            
            Full
      service branch
            
            November 30,
      204410301
      York Road
              Cockeysville,
      MD 21030
            
            Full
      service branch
            
            December 1,
      20474040
      Schroeder Avenue
              Perry
      Hall, MD  21128
            
            Full
      service branch opened January 7, 2008.  Relocated from White
      Marsh, Maryland
            
            August
      13, 20472300
      York Road
              Timonium,
      MD 21093
            
            Mortgage
      subsidiary offices
            
            January 14,
      2010208
      Hickory Avenue
              Bel
      Air, MD 21014
            
            Mortgage
      subsidiary office closed
            
            March 31,
      20108905
      Harford Road
              Baltimore,
      MD 21234
            
            Mortgage
      subsidiary offices
            
            June 30,
      20081
      Center Square, Suite 201
              Hanover,
      PA 17331
            
            Mortgage
      subsidiary offices
            
            June 29,
      2008





*Expiration
date, assuming the Company exercises all extension options.






Item
      3: Legal Proceedings




The
Company is involved in various legal actions arising from normal business
activities. In management’s opinion, the outcome of these matters, individually
or in the aggregate, will not have a material adverse impact on the results of
operation or financial position of the Company.




Item
      4: Submission of Matters to a Vote of
  Security-Holders




There
were no matters submitted to a vote of the shareholders during the quarter ended
December 31, 2007.




15




Part II







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




Trading
and Dividends






As of
December 31, 2007, there were 380 shareholders of record of the Company.
The Company’s Common Stock has traded on the National Association of Security
Dealers’ Automated Quotation System (“NASDAQ”) National Market Tier of The
NASDAQ Stock Market under the symbol “CRRB.” Currently, there are two
broker-dealers who make a market in the Common Stock.




As a
depository institution whose deposits are insured by the FDIC, the Bank may not
pay dividends or distribute any of its capital assets while it remains in
default on any assessment due to the FDIC. The Bank currently is not in default
under any of its obligations to the FDIC. As a commercial bank under the
Maryland Financial Institution Law, the Bank may declare cash dividends from
undivided profits or, with the prior approval of the Commissioner of Financial
Regulation, out of surplus in excess of 100% of its required capital stock, and
after providing for due or accrued expenses, losses, interest and
taxes.




The
Company and the Bank, in declaring and paying dividends, are also limited
insofar as minimum capital requirements of regulatory authorities must be
maintained. The Company and the Bank currently comply with such capital
requirements.




Dividends
declared per share on the Company’s common stock were $0.48 in 2007, $0.45 in
2006, and $0.40 in 2005, representing a payout ratio of 63.88% in 2007,48.98% in 2006, and45.97% in 2005. The
dividend payout ratio is the result of dividing the amount of dividends paid by
net income.




The
Company implemented a Dividend Reinvestment Plan that provides automatic
reinvestment of dividends in additional shares of Company common
stock.




During
2007, the Company repurchased and retired 16,015 shares of common stock at an
average price of $16.50. In 2006, the Company repurchased and retired 7,518
shares of common stock at a price of $17.14 per share.




The
following table sets forth the high and low sales price and dividends per share
of the Company’s common stock for the periods indicated.




Period
            
            Price Per Share
            
            
            Cash Dividends Paid
              Per Share2007
            
            
            2006
            
            
            2007
            
            
            2006Low
            
            
            High
            
            
            Low
            
            
            High4th
      Quarter
            
            $
            11.25
            
            
            $
            14.85
            
            
            $
            16.99
            
            
            $
            19.45
            
            
            $
            0.12
            
            
            $
            0.123rd
      Quarter
            
            
            12.00
            
            
            
            16.73
            
            
            
            16.11
            
            
            
            18.00
            
            
            
            0.12
            
            
            
            0.112nd
      Quarter
            
            
            15.55
            
            
            
            18.40
            
            
            
            15.64
            
            
            
            18.80
            
            
            
            0.12
            
            
            
            0.111st
      Quarter
            
            
            16.40
            
            
            
            18.00
            
            
            
            14.40
            
            
            
            15.95
            
            
            
            0.12
            
            
            
            0.11$
            0.48
            
            
            $
            0.45







As of
December 31, 2007, there were 380 common shareholders of record holding an
aggregate of 2,834,975 shares. The Company believes there to be in excess of 561
beneficial owners of the Company’s Common Stock.




The
ability of the Company to pay dividends in the future will be dependent on the
earnings, if any, financial condition and business of the Company, as well as
other relevant factors, such as regulatory requirements. No assurance can be
given either that the Company’s future earnings, if any, will be sufficient to
enable it to pay dividends, or that if such earnings are sufficient, that the
Company will not decide to retain such earnings for general working capital and
other funding needs. In addition, the Company is highly dependent on dividends
received from the Bank to enable it to pay dividends to shareholders. No
assurance can be given that the Bank will continue to generate sufficient
earnings to enable it to pay dividends to the Company, or that it will continue
to meet regulatory capital requirements which, if not met, could prohibit
payment of dividends to the Company.




16


Stock
Performance Table






The
Company is required by the SEC to provide a five-year comparison of the
cumulative total shareholder return on our common stock compared with that of a
broad equity market index, and either a published industry index or a
constructed peer group index of the Company.




The
following chart compares the cumulative Shareholder return on the Company’s
common stock from December 31, 2002 to December 31, 2007 with the
cumulative total of the NASDAQ Composite (U.S.), the NASDAQ Bank and SNL
Mid-Atlantic Indices. The comparison assumes $100 was invested on
December 31, 2002 in the Company’s common stock and in each of the
foregoing indices. It also assumes reinvestment of any dividends.




The
Company does not make, nor does it endorse, any predictions as to future stock
performance.




Carrollton
Bancorp









Period EndingIndex
            
            12/31/02
            
            12/31/03
            
            12/31/04
            
            12/31/05
            
            12/31/06
            
            12/31/07Carrollton
      Bancorp
            
            
            100.00
            
            
            
            131.90
            
            
            
            134.76
            
            
            
            116.78
            
            
            
            137.26
            
            
            
            115.23NASDAQ
      Composite
            
            
            100.00
            
            
            
            150.01
            
            
            
            162.89
            
            
            
            165.13
            
            
            
            180.85
            
            
            
            198.60SNL
      Mid-Atlantic Bank Index
            
            
            100.00
            
            
            
            142.18
            
            
            
            150.59
            
            
            
            153.26
            
            
            
            183.94
            
            
            
            139.10




17




The
following table provides information about the Company’s equity securities that
may be issued under all of the Company’s equity compensation plans as of the end
of the most recently completed fiscal year:




Equity
Compensation Plan






Plan Category
            Number of securities to be
              issued upon exercise of
              outstanding options,
              warrants and rights
              (a)
            
            Weighted-average exercise
              price of outstanding options,
              warrants and rights
              (b)
            
            Number of securities remaining
              available for future issuance under
              equity compensation plans
              (excluding securities reflected
              in column (a))
              (c)Equity
      compensation plans approved by security holders
            
            184,555
            
            
            
            $14.64
            
            
            
            496,400Equity
      compensation plans not approved by security holders
            
            N/A
            
            
            
            N/A
            
            
            
            N/ATotal
            
            184,555
            
            
            
            $14.64
            
            
            
            496,400





18




Item
6:Selected
Financial Data




2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Consolidated
      Income Statement Data:Interest
      income
            
            $
            23,676,360
            
            
            $
            23,127,504
            
            
            $
            19,071,379
            
            
            $
            15,500,323
            
            
            $
            15,935,691Interest
      expense
            
            
            9,762,324
            
            
            
            8,737,450
            
            
            
            7,375,083
            
            
            
            5,321,622
            
            
            
            6,639,734Net
      interest income
            
            
            13,914,036
            
            
            
            14,390,054
            
            
            
            11,696,296
            
            
            
            10,178,701
            
            
            
            9,295,957Provision
      for loan losses
            
            
            536,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            243,000Net
      interest income after provision for loan losses
            
            
            13,378,036
            
            
            
            14,390,054
            
            
            
            11,696,296
            
            
            
            10,178,701
            
            
            
            9,052,957Noninterest
      income
            
            
            6,274,142
            
            
            
            8,898,996
            
            
            
            10,718,636
            
            
            
            8,781,151
            
            
            
            8,268,612Noninterest
      expenses
            
            
            16,475,141
            
            
            
            19,381,003
            
            
            
            18,634,124
            
            
            
            17,751,000
            
            
            
            16,058,355Income
      before income taxes
            
            
            3,177,037
            
            
            
            3,908,047
            
            
            
            3,780,808
            
            
            
            1,208,852
            
            
            
            1,263,214Income
      taxes
            
            
            1,050,774
            
            
            
            1,323,268
            
            
            
            1,322,371
            
            
            
            320,488
            
            
            
            338,500Net
      income
            
            $
            2,126,263
            
            
            $
            2,584,779
            
            
            $
            2,458,437
            
            
            $
            888,364
            
            
            $
            924,714Consolidated
      Balance Sheet Data,
              at
      year endAssets
            
            $
            352,848,570
            
            
            $
            349,824,752
            
            
            $
            360,467,146
            
            
            $
            319,123,132
            
            
            $
            302,409,975Gross
      loans
            
            
            261,623,833
            
            
            
            260,001,314
            
            
            
            247,943,073
            
            
            
            219,726,294
            
            
            
            199,296,561Deposits
            
            
            285,638,625
            
            
            
            277,903,801
            
            
            
            271,626,503
            
            
            
            225,846,145
            
            
            
            207,056,100Shareholders’
      equity
            
            
            35,931,300
            
            
            
            34,711,378
            
            
            
            34,640,165
            
            
            
            34,215,280
            
            
            
            34,124,882Per
      Share Data:Number
      of shares of Common Stock outstanding, at year-end
            
            
            2,834,975
            
            
            
            2,806,705
            
            
            
            2,809,698
            
            
            
            2,834,823
            
            
            
            2,828,078Net
      income:Basic
            
            $
            0.75
            
            
            $
            0.92
            
            
            $
            0.87
            
            
            $
            0.31
            
            
            $
            0.33Diluted
            
            
            0.75
            
            
            
            0.90
            
            
            
            0.87
            
            
            
            0.31
            
            
            
            0.32Cash
      dividends declared
            
            
            0.48
            
            
            
            0.45
            
            
            
            0.40
            
            
            
            0.38
            
            
            
            0.36Book
      value, at year end
            
            
            12.67
            
            
            
            12.37
            
            
            
            12.33
            
            
            
            12.07
            
            
            
            12.07Performance
      and capital ratios:Return
      on average assets
            
            
            0.61
            %
            
            
            0.75
            %
            
            
            0.72
            %
            
            
            0.29
            %
            
            
            0.29
            %Return
      on average shareholders’ equity
            
            
            5.97
            %
            
            
            7.55
            %
            
            
            7.12
            %
            
            
            2.61
            %
            
            
            2.71
            %Net
      interest margin (a)
            
            
            4.34
            %
            
            
            4.57
            %
            
            
            3.89
            %
            
            
            3.81
            %
            
            
            3.36
            %Average
      shareholders’ equity to average total assets
            
            
            10.22
            %
            
            
            9.91
            %
            
            
            10.13
            %
            
            
            11.11
            %
            
            
            10.83
            %Year-end
      capital to year-end risk- weighted assets:Tier
      1
            
            
            12.35
            %
            
            
            11.92
            %
            
            
            11.63
            %
            
            
            11.52
            %
            
            
            13.75
            %Total
            
            
            13.63
            %
            
            
            13.20
            %
            
            
            13.51
            %
            
            
            12.74
            %
            
            
            15.51
            %Year-end
      Tier 1 leverage ratio
            
            
            10.03
            %
            
            
            9.74
            %
            
            
            8.96
            %
            
            
            9.41
            %
            
            
            10.35
            %Cash
      dividends declared to net income
            
            
            63.88
            %
            
            
            48.98
            %
            
            
            45.97
            %
            
            
            121.17
            %
            
            
            109.96
            %Asset
      Quality Ratios:Allowance
      for loan losses, at year-end to:Gross
      loans
            
            
            1.25
            %
            
            
            1.20
            %
            
            
            1.35
            %
            
            
            1.59
            %
            
            
            1.83
            %Nonperforming,
      restructured and past-due loans
            
            
            55.28
            %
            
            
            54.93
            %
            
            
            209.50
            %
            
            
            132.05
            %
            
            
            151.37
            %Net
      charge-offs to average gross loans
            
            
            0.15
            %
            
            
            0.08
            %
            
            
            0.06
            %
            
            
            0.08
            %
            
            
            0.09
            %Nonperforming
      assets as a percent of period-end gross loans and foreclosed real
      estate
            
            
            2.26
            %
            
            
            2.19
            %
            
            
            0.64
            %
            
            
            1.20
            %
            
            
            1.26
            %





(a) Net
interest margin is the ratio of net interest income, determined on a fully
taxable equivalent basis (a non-GAAP financial measure), to total average
interest earning assets.






19


Item
7: Management’s Discussion and Analysis of Financial Condition and
Results of Operations




Forward-Looking
Statements






This
Annual Report on Form 10-K and certain information incorporated herein by
reference contain forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. All statements included or incorporated by
reference in this Annual Report on Form 10-K, other than statements that are
purely historical, are forward-looking statements. Statements that include the
use of terminology such as “anticipates,” “expects,” “intends,” “plans,”
“believes,” “estimates” and similar expressions also identify forward-looking
statements. The forward-looking statements are based on the Company’s current
intent, belief and expectations. Forward-looking statements in this Annual
Report on Form 10-K include, but are not limited to statements of the
Company’s plans, strategies, objectives, intentions, including, among other
statements, statements involving the Company’s projected loan and deposit
growth, loan collateral values, collectibility of loans, anticipated changes in
other operating income, payroll and branching expenses, branch, office and
product expansion of the Company and its subsidiary, and liquidity and capital
levels.




These
statements are not guarantees of future performance and are subject to certain
risks and uncertainties that are difficult to predict. Actual results may differ
materially from these forward-looking statements because of interest rate
fluctuations, a deterioration of economic conditions in the Baltimore-Washington
metropolitan area, a downturn in the real estate market, losses from impaired
loans, an increase in nonperforming assets, potential exposure to environmental
laws, changes in federal and state bank laws and regulations, the highly
competitive nature of the banking industry, a loss of key personnel, changes in
accounting standards and other risks described in the Company’s filings with the
SEC. Existing and prospective investors are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of today’s
date. The Company undertakes no obligation to update or revise the information
contained in this Annual Report whether as a result of new information, future
events or circumstances or otherwise. Past results of operations may not be
indicative of future results. Readers should carefully review the risk factors
described in other documents the Company files from time to time with the SEC,
including the Quarterly Reports on Form 10-Q to be filed by the Company in
2008.




Business
and Overview






The
Company is a bank holding company headquartered in Baltimore, Maryland with one
wholly-owned subsidiary, the Bank. The Bank has four subsidiaries, CMSI, CFS,
and MSLLC which are wholly owned, and CCDC, which is 96.4% owned.




The Bank
is engaged in a general commercial and retail banking business with eleven
branch locations. CMSI is in the business of originating residential mortgage
loans and has two branch locations. CFS provides brokerage services to customers
and MSLLC manages and disposes of real estate acquired through foreclosures.
CCDC promotes, develops and improves the housing and economic conditions of
people in Maryland.




The Bank
sponsors national retailers who accept ATM cards for purchases in various
electronic networks. Effective January 22, 2006, the agreement with
Wal-Mart for the Bank to provide ATMs at Wal-Mart, Sam’s Club, and Wal-Mart
Supercenters in Maryland, Virginia and West Virginia was
terminated.




During
2007, total assets increased $3.0 million to $352.8 million due to the $1.5
million or 0.6% increase in loans that were funded primarily by the increase in
deposits. The increase in cash and cash equivalents was used to pay off $7.0
million of Federal Home Loan Bank of Atlanta (FHLBA) advances.




Net
income for the year ended December 31, 2007 totaled $2.1 million compared
to $2.6 million for the prior year, an 18% decrease.   The
Company’s earnings performance for the year ended December 31, 2007 was impacted
by the decision to stop servicing money service businesses (MSB) as of September
2006, hiring consultants to assist in documenting internal controls for
compliance with Sarbanes-Oxley (SOX), the increase in the provision for loan
losses, and legal fees and related expenses for non-accrual loans.




The
earnings for the year ended December 31, 2006 included a before tax charge of
approximately $1.8 million ($1.2 million after tax) representing the loss from a
check kiting scheme by one of the Bank’s commercial customers. The earnings also
included a charge of approximately $2.3 million representing a prepayment
penalty for restructuring a $35 million FHLBA advance at a fixed rate of 6.84%
maturing February 2, 2010. This charge was substantially offset by a gain
of approximately $2.2 million from the sale of equity securities. The earnings
for the year ended December 31, 2005 included security gains of $840,000
from the sale of equity securities, a $506,000 charge representing a penalty for
the prepayment of a $5 million FHLBA advance at 7.26% maturing May 24,
2010, and the write down and cost of disposal of ATMS totaling $563,000 related
to the termination of the Wal-Mart agreement. Wal-Mart terminated the agreement
for Carrollton Bank to provide automated teller machines (ATMs) at Wal-Mart,
Sam’s Club and Wal-Mart Supercenters in Maryland, Virginia and West
Virginia.




Comparing
the year ended December 31, 2007 and 2006, net interest income decreased by
$476,000 or 3% due to the Company’s net interest margin declining 23 basis
points to 4.34% in 2007 compared to 4.57% in 2006.  This was a result
of deposit and borrowing costs increasing more rapidly than yields on interest
earning assets through September 2007.  Since September 2007, the
Federal Open Market Committee (FOMC) reduced rates 1% through December 31,
2007.  The decrease in net interest income from the decrease in the
net interest margin was partially offset by the $7.4 million increase in average
interest earning assets.




20




The
Company recorded a provision for loan losses of $563,000 for the year ended
December 31, 2007, and none in 2006.




For the
year ended December 31, 2007, noninterest income was $6.3 million compared to
$8.9 million for the year ended December 31, 2006, a decrease of $2.6 million or
30%.  The decrease was due primarily to the $2.2 million gain on the
sale of securities in 2006, a $171,000 or 15% decrease in service charges, a
$181,000 or 7% decrease in the fees and commissions earned by CMSI and a
$169,000 or 8% decrease on Point of Sale revenue and ATM fees.




Noninterest
expenses were $16.5 million for the year ended December 31, 2007 compared to
$19.4 million for the year ended December 31, 2006, a $2.9 million or 15%
decrease.    The decrease was due to the $1.8 million charge
from the check kiting scheme in 2006, the $2.3 million prepayment penalty for
restructuring the FHLB advance in 2006 partially offset by the $225,000 or 3%
increase in salaries, the $269,000 or 15% increase in occupancy costs and the
$855,000 or 20% increase in other operating expenses.  The $225,000
increase in salaries was due to additional personnel for the new branch opened
in May 2007 and normal salary increases partially offset by the elimination of
personnel.  The $269,000 increase in occupancy costs was due to normal
lease escalation charges, the new branch rent started in March 2007, and a
significant increase in a 30-year branch lease that renewed in April
2006.  The $855,000 increase was due to $202,000 in consulting fees
for compliance with SOX, increased legal fees and related costs due to a
significant commercial loan to one borrower and increased nonaccrual loans and a
$155,000 write down and cost to dispose of a real estate owned property in
2007compared to a recovery of legal fees and related expenses on the payoff of a
delinquent loan in 2006.




The Company opened
its newest retail branch in Perry Hall, Maryland on January 7,
2008.  Simultaneously, the White Marsh branch was closed on January 4,
2008.




Based
upon current earnings and encouraging prospects for future earnings, the Company
paid dividends of $0.48 per share to shareholders during 2007.


21


Results
      of Operations




Summary






The
Company reported net income for 2007 of $2.1 million or $0.75 per diluted
share, representing an 18% decrease from 2006 net income of $2.6 millionor $0.90 per
share.




The loan
portfolio net of the Allowance for Loan Losses andincluding loans held for
sale increased 0.6%to
$265.9 million  as a result of the Company’s continuing efforts
to align the loan portfolio to be in line with typical commercial banks. Loans
held for sale were substantially the same at $7.5 million due to the slow down
in the residential housing market. Interest income on loans, including loans
held for sale, increased 3.2%due to average loans,
including loans held for sale, increasing $10.6 million and partially offset by
loans repricing to lower rates in the fourth quarter of 2007.




The
deposit portfolio increased 2.8% to $285.6 million, with the majority of
the growth derived from money market accounts and certificates of
deposit.  Partially affecting these increases were decreases in
noninterest bearing deposits and savings accounts. Interest expense increased
during 2007, due to an $8.3 million increase in average interest-bearing
deposits and the yield on interest-bearing deposits increasing 44 basis
points.




Noninterest
income decreased 29.5% or $2.6 million in 2007 compared to 2006, due primarily
to a $2.2 million gain on the sale of securities in 2006, a 15.3% or $171,000
decrease in service charges, a 7.3% or $181,000 decrease in the fees and
commissions earned by CMSI and an 8.1% or $166,000 decrease on Point of Sale
revenue and ATM fees.




Noninterest
expense decreased 15.0% or $2.9 million in 2007 compared to 2006. The decrease
was due to the $1.8 million charge from the check kiting scheme by one of the
Bank’s commercial customers and the $2.3 million prepayment penalty for
restructuring a FHLBA advance in 2006 partially offset by the $225.000 or 3%
increase in salaries, the $269,000 or 15% increase in occupancy costs and the
$855,000 or 20% increase in other operating expenses.  The $225,000
increase in salaries was due to additional personnel for the new branch opened
in May 2007 and normal salary increases partially offset by the elimination of
personnel.  The $269,000 increase in occupancy costs was due to normal
lease escalation charges, the new branch rent started in March 2007, and a
significant increase in a 30-year branch lease that renewed in April
2006.  The $855,000 increase was due to $202,000 in consulting fees
for compliance with SOX, increased legal fees and related costs due to a
significant commercial loan to one borrower and increased nonaccrual loans and a
$155,000 write down and cost to dispose of a real estate owned property in 2007
compared to a recovery of legal fees and related expenses on the payoff of a
delinquent loan in 2006.




The
Company reported net income for 2006 of $2.6 million or $0.90 per diluted
share, representing a 5% increase from 2005 net income of $2.5 millionor $0.87 per
share.




The loan
portfolio net of the Allowance for Loan Losses andincluding loans held for
sale, increased 2.3%to $264.4 million,
as a result of the Company’s continuing efforts to align the loan portfolio to
be in line with typical commercial banks. Loans held for sale decreased 45.6% to
$7.5 million due to the slow down in the residential housing market. Interest
income on loans, including loans held for sale, increased 19.1%due to average loans,
including loans held for sale, increasing $14.9 million and loans repricing to
higher rates.




The
deposit portfolio increased 2.3% to $277.9 million, with the majority of
the growth derived from money market accounts and certificates of
deposit.  Partially affecting these increases were decreases in
noninterest bearing deposits and savings accounts. Interest expense increased
during 2006, due primarily to a $24.7 million increase in average
interest-bearing deposits and the yield on interest-bearing deposits increasing
96 basis points.




Noninterest
income decreased 17.0% in 2006 compared to 2005, due primarily to a $3.0 million
decrease in ATM and Point of Sale revenue relating to the termination of the
Wal-Mart ATM agreement and partially offset by the $1.3 million increase in the
gain on the sale of securities.




Noninterest
expense increased 4.0% in 2006 compared to 2005. The increase was due to the
$1.8 million charge from the check kiting scheme by one of the Bank’s commercial
customers and the $1.7 million increase in the prepayment penalty for
restructuring a FHLBA advance partially offset by the elimination of personnel,
transaction fees, and other operating expenses as well as a write down of
$563,000 in 2005 related to the termination of the Wal-Mart ATM
agreement.




Net
Interest Income






Net
interest income, the amount by which interest income on interest-earning assets
exceeds interest expense on interest-bearing liabilities, is the most
significant component of the Company’s earnings. Net interest income is a
function of several factors, including changes in the volume and mix of
interest-earning assets and funding sources, and market interest rates. While
management policies influence these factors, external forces, including customer
needs and demands, competition, the economic policies of the federal government
and the monetary policies of the FRB, are also important.




The
following table sets forth, for the periods indicated, information regarding the
average balances of interest-earning assets and interest-bearing liabilities,
the amount of interest income and interest expense and the resulting yields on
average interest-earning assets and rates paid on average interest-bearing
liabilities. Average balances are also provided for noninterest-earning assets
and noninterest-bearing liabilities.




22


Average
Balances, Interest, and Yields






2007
            
            
            2006
            
            
            2005Average
              Balance
            
            Interest
            
            Yield
            
            
            Average
              Balance
            
            
            Interest
            
            Yield
            
            
            Average
              Balance
            
            
            Interest
            
            YieldAssetsFederal
      funds sold and Federal Home Loan Bank deposit
            $
            3,737,413
            
            $  181,635
            
            
            4.86
            %
            
            $
            7,839,525
            
            $
            382,625
            
            
            4.88
            %
            
            $
            19,067,206
            
            $
            623,910
            
            
            3.27
            %Federal
      Home Loan Bank stock
            
            1,544,464
            
            99,223
            
            
            6.42
            
            
            
            1,742,153
            
            
            99,046
            
            
            5.69
            
            
            
            2,643,019
            
            
            109,616
            
            
            4.15Investment
      securities: (a)U.S.
      government agency
            
            16,043,046
            
            902,454
            
            
            5.63
            
            
            
            15,316,293
            
            
            788,538
            
            
            5.15
            
            
            
            20,306,719
            
            
            560,887
            
            
            2.76State
      and municipal
            
            9,233,678
            
            572,591
            
            
            6.20
            
            
            
            8,734,211
            
            
            544,815
            
            
            6.24
            
            
            
            4,027,933
            
            
            264,620
            
            
            6.57Mortgage-backed
      securities
            
            19,650,335
            
            1,067,144
            
            
            5.43
            
            
            
            21,554,754
            
            
            1,170,089
            
            
            5.43
            
            
            
            11,089,402
            
            
            611,055
            
            
            5.51Corporate
      bonds
            
            5,877,246
            
            391,199
            
            
            6.66
            
            
            
            4,089,963
            
            
            270,840
            
            
            6.62
            
            
            
            1,277,192
            
            
            70,749
            
            
            5.54Other
            
            1,140,856
            
            53,199
            
            
            4.66
            
            
            
            1,154,060
            
            
            49,212
            
            
            4.26
            
            
            
            1,877,280
            
            
            135,232
            
            
            7.2051,945,161
            
            2,986,587
            
            
            5.75
            
            
            
            50,849,281
            
            
            2,823,494
            
            
            5.55
            
            
            
            38,578,526
            
            
            1,642,543
            
            
            4.26Loans:Demand
      and time
            
            73,606,674
            
            5,844,340
            
            
            7.94
            
            
            
            73,339,911
            
            
            5,862,743
            
            
            7.99
            
            
            
            67,134,231
            
            
            3,554,951
            
            
            5.30Residential
      mortgage (b)
            
            77,543,499
            
            5,704,170
            
            
            7.36
            
            
            
            72,131,409
            
            
            3,926,413
            
            
            5.44
            
            
            
            74,654,896
            
            
            4,613,621
            
            
            6.18Commercial
      mortgage and construction
            
            116,904,123
            
            8,988,319
            
            
            7.69
            
            
            
            110,899,759
            
            
            8,544,541
            
            
            7.70
            
            
            
            97,985,886
            
            
            8,298,411
            
            
            8.47Installment
            
            1,238,724
            
            100,692
            
            
            8.13
            
            
            
            1,504,253
            
            
            80,978
            
            
            5.38
            
            
            
            1,813,896
            
            
            154,258
            
            
            8.50Lease
      financing
            
            595,593
            
            39,494
            
            
            6.63
            
            
            
            1,429,551
            
            
            80,889
            
            
            5.66
            
            
            
            2,782,231
            
            
            214,524
            
            
            7.71269,888,613
            
            20,677,015
            
            
            7.66
            
            
            
            259,304,883
            
            
            20,044,135
            
            
            7.73
            
            
            
            244,371,140
            
            
            16,835,765
            
            
            6.89Total
      interest-earning assets
            
            327,115,651
            
            23,944,460
            
            
            7.32
            
            
            
            319,735,842
            
            
            23,349,301
            
            
            7.30
            
            
            
            304,659,891
            
            
            19,211,834
            
            
            6.31Noninterest-bearing
      cash
            
            8,649,236
            
            
            
            
            
            
            
            
            14,651,700
            
            
            
            
            
            
            
            
            
            26,624,448Premises
      and equipment
            
            6,533,050
            
            
            
            
            
            
            
            
            5,432,452
            
            
            
            
            
            
            
            
            
            5,694,687Other
      assets
            
            8,170,747
            
            
            
            
            
            
            
            
            7,993,335
            
            
            
            
            
            
            
            
            
            4,034,529Allowance
      for loan losses
            
            (3,108,760
            )
            
            
            
            
            
            
            
            (3,287,376
            
            
            
            
            
            
            
            
            
            (3,472,722
            )Unrealized
      gains on available for sale securities, net
            
            1,133,365
            
            
            
            
            
            
            
            
            1,065,683
            
            
            
            
            
            
            
            
            
            3,412,785$
            348,493,289
            
            
            
            
            
            
            
            $
            345,591,636
            
            
            
            
            
            
            
            
            $
            340,953,618Liabilities
      and Shareholders’ EquityInterest-bearing
      deposits:Savings
      and NOW
            
            55,719,609
            
            131,760
            
            
            0.24
            %
            
            $
            62,309,713
            
            
            147,770
            
            
            0.24
            %
            
            $
            67,931,566
            
            
            162,865
            
            
            0.24
            %Money
      market
            
            56,986,611
            
            2,248,253
            
            
            3.95
            
            
            
            51,303,354
            
            
            1,936,266
            
            
            3.77
            
            
            
            40,658,604
            
            
            998,161
            
            
            2.45Certificates
      of deposit
            
            117,106,699
            
            5,700,452
            
            
            4.87
            
            
            
            101,071,899
            
            
            4,521,369
            
            
            4.47
            
            
            
            81,412,306
            
            
            2,861,697
            
            
            3.52229,812,919
            
            8,080,465
            
            
            3.52
            
            
            
            214,684,966
            
            
            6,605,404
            
            
            3.08
            
            
            
            190,002,476
            
            
            4,022,723
            
            
            2.12Borrowed
      funds
            
            32,222,600
            
            1,681,860
            
            
            5.22
            
            
            
            38,900,240
            
            
            2,132,046
            
            
            5.48
            
            
            
            54,879,637
            
            
            3,352,360
            
            
            6.11Total
      interest-bearing liabilities
            
            262,035,519
            
            9,762,325
            
            
            3.73
            
            
            
            253,585,206
            
            
            8,737,451
            
            
            3.45
            
            
            
            244,882,113
            
            
            7,375,083
            
            
            3.01Noninterest-bearing
      deposits
            
            49,584,706
            
            
            
            
            
            
            
            
            56,441,180
            
            
            
            
            
            
            
            
            
            59,645,770Other
      liabilities
            
            1,261,192
            
            
            
            
            
            
            
            
            1,312,259
            
            
            
            
            
            
            
            
            
            1,885,164Shareholders’
      equity
            
            35,611,872
            
            
            
            
            
            
            
            
            34,252,991
            
            
            
            
            
            
            
            
            
            34,540,571Total
      liabilities and shareholders’ equity
            $
            348,493,289
            
            
            
            
            
            
            
            $
            345,591,636
            
            
            
            
            
            
            
            
            $
            340,953,618Net
      interest margin
            $
            327,115,651
            
            $14,182,135
            
            
            4.34
            %
            
            $
            319,735,842
            
            $
            14,611,850
            
            
            4.57
            %
            
            $
            304,659,891
            
            $
            11,836,751
            
            
            3.89
            %




(a) 
Interest on investments and loans is presented on a fully taxable equivalent
basis (a non-GAAP financial measure), using the federal income tax rates of 34%
and, where applicable, the state rate of 7% (or a combined federal and state
rate of 38.62%) to increase tax exempt interest income to a taxable equivalent
basis. This is a non-GAAP measure that management believes is useful when
comparing annual results.




(b) 
Loans held for sale are included in residential mortgage
loans.




(c) 
Net interest margin is the ratio of net interest income, determined on a fully
taxable-equivalent basis, to total average interest earning
assets.








23


Net
interest income on a tax-equivalent basis decreased to $14.2 million for
the year ended December 31, 2007 compared to $14.6 million for 2006.
The decrease in tax-equivalent net interest income during 2007 was due to the
decrease in the net interest margin of 23 basis points partially offset by a
$10.6 million increase in average interest-earning assets during 2007
compared to 2006.




The $10.6
million or 4.1% increase in average loans outstanding is attributed to the
Company’s active business development efforts in its residential and
construction and land development loan portfolio and general economic conditions
of the Company’s primary service market. The yield on loans decreased to 7.66%
in 2007 compared to 7.73% for 2006 as the Federal Open Market Committee (FOMC)
began lowering rates in September 2007. The yield on investment securities
increased to 5.75% in 2007 from 5.55% in 2006. The net impact was a $430,000 or
2.9% decrease in tax-equivalent interest income for the year ended
December 31, 2007 compared to 2006.




Net
interest income on a tax-equivalent basis increased to $14.6 million for
the year ended December 31, 2006 compared to $11.8 million for 2005.
The increase in tax-equivalent net interest income during 2006 was due to a
$15.1 million increase in average interest-earning assets during 2006
compared to 2005 and an increase in the yield on interest-earning assets of 99
basis points.




The $14.9
million or 6.1% increase in average loans outstanding is attributed to the
Company’s active business development efforts in its commercial loan portfolio
and general economic conditions of the Company’s primary service market. The
yield on loans increased to 7.73% in 2006 compared to 6.89% for 2005 as lower
yielding loans repriced during the year to higher rates. The yield on investment
securities also increased to 5.55% in 2006 from 4.26% in 2005. The net impact
was a $4.1 million or 21.5% increase in tax-equivalent interest income for
the year ended December 31, 2006 compared to 2005.




Interest
expense increased $1.0 million to $9.8 million in 2007 from
$8.7 million in 2006. Interest expense on deposits increased primarily due
to a change in the deposit mix, with an increase in the amount of
interest-bearing deposits and the cost of interest-bearing deposits increased
from 3.08% in 2006 to 3.52% in 2007.  Interest expense on borrowed
funds decreased due to a $6.7 million decrease in average borrowed funds
and the cost of average borrowed funds decreasing to 5.22% for the year ended
December 31, 2007 compared to 5.48% for the same period in
2006.




The
following table and the related discussions of interest income and interest
expense provide further analysis of the changes in net interest income during
2007 and 2006:




2007 Compared to 2006
            
            2006 Compared to 2005Change Due to Variance In
            
            Change Due to Variance In


Rate(b)
            
            
            Volume(b)
            
            
            Total
            
            
            Rates(b)
            
            
            Volume(b)
            
            
            TotalInterest
      incomeFederal
      funds sold and interest-bearing deposits with other banks
            
            $
            (778
            )
            
            $
            (200,213
            )
            
            $
            (200,991
            )
            
            $
            126,216
            
            
            $
            (367,145
            )
            
            $
            (240,929
            )Investment
      securities and FHLB stock
            
            
            113,357
            
            
            
            49,913
            
            
            
            163,270
            
            
            
            682,785
            
            
            
            485,348
            
            
            
            1,168,133Loans (a)
            
            
            (185,237
            )
            
            
            818,117
            
            
            
            632,880
            
            
            
            2,181,328
            
            
            
            1,028,935
            
            
            
            3,210,263Total
      interest earned
            
            
            (72,658
            )
            
            
            667,817
            
            
            
            595,159
            
            
            
            2,990,329
            
            
            
            1,147,138
            
            
            
            4,137,467Interest
      expenseDeposits
            
            
            1,009,606
            
            
            
            465,455
            
            
            
            1,475,061
            
            
            
            2,060,511
            
            
            
            523,269
            
            
            
            2,583,780Borrowings
            
            
            (84,198
            )
            
            
            (365,989
            )
            
            
            (450,187
            )
            
            
            (245,070
            )
            
            
            (976,341
            )
            
            
            (1,221,411
            )Total
      interest expense
            
            
            925,408
            
            
            
            99,466
            
            
            
            1,024,874
            
            
            
            1,815,440
            
            
            
            (453,072
            )
            
            
            1,362,368Net
      interest income
            
            $
            (998,066
            )
            
            $
            568,351
            
            
            $
            (429,715
            )
            
            $
            1,174,889
            
            
            $
            1,600,210
            
            
            $
            2,775,099




(a) 
Interest on investments and loans is presented on a fully taxable equivalent
basis (a non-GAAP financial measure), using regular income tax
rates.




(b) 
The change in interest income and expense due to variance in both rate and
volume has been allocated to the change due to variance in
rate.






24


Provision
for Loan Losses




On a
monthly basis, management of the Company reviews all loan portfolios to
determine trends and monitor asset quality. For consumer loan portfolios, this
review generally consists of reviewing delinquency levels on an aggregate basis
with timely follow-up on accounts that become delinquent. In commercial loan
portfolios, delinquency information is monitored and periodic reviews of
business and property leasing operations are performed on an individual loan
basis to determine potential collection and repayment problems.




Due to
the slow down in the housing and real estate market, the Company has experienced
an increase in its delinquency rate and charge off rate. The Company recorded a
provision for loan losses of $536,000 in 2007 and none for the years ended
December 31, 2006 and 2005. Nonaccrual, restructured and delinquent loans
over 90 days to total loans increased to 2.26% at the end of 2007 compared
to 2.19% in 2006. The ratio of net loan losses to average loans increased in
2007 to 0.15% compared to 0.08% for 2006.  Nonaccrual, restructured,
and delinquent loans over 90 days to total loans increased to 2.19% at the
end of 2006 compared to 0.64% in 2005. The ratio of net loan losses to average
loans increased in 2006 to 0.08% compared to 0.06% for 2005.


Noninterest
Income




Noninterest
income decreased from $8.9 million during 2006 to $6.3 million in 2007 due
primarily to the $2.2 million gain on the sale of securities in 2006. The
$181,000 decrease in net gains and fees on sales of mortgage loans corresponded
to a decrease in the fees received on mortgage loans sold during the year due to
a slow down in the residential housing market. The $166,000 decrease in
electronic banking was due to a reduction in the number of Point of Sale
transactions in 2007 compared to 2006.  The $171,000 decrease in
service charges was due to the decision to stop servicing money service
businesses (MSB) as of September 2006, and was partially offset by fee increases
effective January 2007.  In 2006, sales of available-for-sale
securities generated $2.2 million in gains compared to $840,000 in
2005.




Electronic
banking income is comprised of three sources: national point of sale (“POS”)
sponsorships, ATM fees, and check card fees. Through December 31, 2005, the
Company maintained ATMs in Wal-Mart stores in Maryland, Virginia and West
Virginia, as well as at its branches. Effective January 22, 2006, the
agreement with Wal-Mart for the Bank to provide ATM services at its locations in
Maryland, Virginia and West Virginia was terminated. The fees from the
ATMs represent approximately 6% of total electronic banking revenue in
2007. The Company sponsors merchants who accept ATM cards for purchases within
various networks (i.e. STAR, PULSE, and NYCE). This national POS sponsorship
income represents approximately 74% of total electronic banking revenue. Fees
from check cards comprise the remaining 13% of electronic banking
revenue.  Service charge fees for one customer comprise the remaining
7% of electronic banking fees.  The majority of these fees were one
time fees.




The
Company offers a variety of financial planning and investment options to
customers, through its subsidiary, CFS, and recognizes commission income as
these services are provided.




Noninterest
Expenses




Noninterest
expense consists primarily of costs associated with personnel, occupancy and
equipment, data processing, marketing and professional fees. Noninterest
expenses were $16.5 million for the year ended December 31, 2007 compared to
$19.4 million for the year ended December 31, 2006, a $2.9 million or 15%
decrease.  The decrease was due to the $1.8 million charge from the
check kiting scheme in 2006, the $2.3 million prepayment penalty for
restructuring the FHLB advance in 2006 partially offset by the $225,000 or 3%
increase in salaries, the $269,000 or 15% increase in occupancy costs and the
$855,000 or 20% increase in other operating expenses.  The $225,000
increase in salaries was due to additional personnel for the new branch opened
in May 2007 and normal salary increases partially offset by the elimination of
personnel.  The $269,000 increase in occupancy costs was due to normal
lease escalation charges, the new branch rent started in March 2007, and a
significant increase in a 30-year branch lease that expired April
2006.  The $855,000 increase was due to $202,000 in consulting fees
for compliance with SOX, increased legal fees and related costs due to a
significant commercial loan to one borrower and increased nonaccrual loans and a
$155,000 write down and cost to dispose of a real estate owned property in 2007
compared to a recovery of legal fess and related expenses on the payoff of a
delinquent loan in 2006.




The
Company’s noninterest expense for the year ended December 31, 2006 totaled
$19.4 million, representing an increase of $747,000, or 4.0%, as compared
to 2005. The increase was due to the $1.8 million charge from the check kiting
scheme by one of the Bank’s commercial customers and the $1.7 million increase
in the prepayment penalty for restructuring a FHLBA advance partially offset by
the elimination of personnel, transaction fees, other operating expenses as well
as a write down of $563,000 in 2005 related to the termination of the Wal-Mart
agreement.




Income
Tax Provision




Income
tax expense was $1.1 million in 2007 and $1.3 million in 2006 and 2005. The
effective tax rate was 33.1% in 2007, 33.9% in 2006 and 35.0% in 2005. The
effective tax rates fluctuate from year to year due to changes in the mix of
tax-exempt loans and investments as a percentage of total loans and investments.
During 2007 and 2006, the Company purchased additional tax exempt securities,
which reduced the effective tax rates.




25




Financial
Condition




Summary




Total
assets of the Company increased by 0.9% to $352.8 million at
December 31, 2007 from $349.8 million at December 31, 2006.
Investment securities decreased 4.1% to $52.8 million at December 31,
2007. Gross loans, excluding loans held for sale, increased by 0.6% to
$261.6 million at December 31, 2007 compared to $260.0 million at
the end of 2006. Interest-earning assets increased $2.8 million to
$329.9 million and were 93.5% of total assets at December 31,
2007.




Investment
Securities






The
investment portfolio consists of investment securities held to maturity and
securities available for sale. Investment securities held to maturity are those
securities that the Company has the positive intent and ability to hold to
maturity and are carried at amortized cost. Securities available for sale are
those securities that the Company intends to hold for an indefinite period of
time but not necessarily until maturity. These securities are carried at fair
value and may be sold as part of an asset/liability management strategy,
liquidity management, interest rate risk management, regulatory capital
management or other similar factors.




The
components of the investment portfolio were as follows at
December 31:




2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Available
      for SaleU.S.
      Government agency
            
            $
            11,688,457
            
            
            $
            9,637,760
            
            
            $
            10,740,335
            
            
            $
            19,913,790
            
            
            $
            34,566,285Mortgage-backed
      securities
            
            
            11,441,115
            
            
            
            12,725,553
            
            
            
            8,490,125
            
            
            
            8,447,886
            
            
            
            9,628,267State
      and municipal bonds
            
            
            4,904,648
            
            
            
            5,724,959
            
            
            
            3,689,859
            
            
            
            4,137,433
            
            
            
            5,197,716Corporate
      bonds
            
            
            4,788,589
            
            
            
            5,621,529
            
            
            
            1,514,471
            
            
            
            3,036,920
            
            
            
            6,820,340Subtotal
            
            
            32,822,809
            
            
            
            33,709,801
            
            
            
            24,434,790
            
            
            
            35,536,029
            
            
            
            56,212,608Equity
      securities
            
            
            1,966,123
            
            
            
            2,224,846
            
            
            
            4,660,213
            
            
            
            6,952,463
            
            
            
            6,246,349Total
      available for sale
            
            
            34,788,932
            
            
            
            35,934,647
            
            
            
            29,095,003
            
            
            
            42,488,492
            
            
            
            62,458,957Held
      to MaturityU.S.
      Government agency
            
            
            6,460,305
            
            
            
            6,456,069
            
            
            
            5,000,000
            
            
            
            —
            
            
            
            —Mortgage-backed
      securities
            
            
            7,130,202
            
            
            
            8,761,200
            
            
            
            9,575,713
            
            
            
            —
            
            
            
            —State
      and municipal bonds
            
            
            3,912,769
            
            
            
            3,912,704
            
            
            
            3,912,692
            
            
            
            —
            
            
            
            —Equity
      securities
            
            
            500,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            25,000Total
      held to maturity
            
            
            18,003,276
            
            
            
            19,129,973
            
            
            
            18,488,405
            
            
            
            —
            
            
            
            25,000Total
      investment securities
            
            $
            52,792,208
            
            
            $
            55,064,620
            
            
            $
            47,583,408
            
            
            $
            42,488,492
            
            
            $
            62,483,957







Note:
Investments classified as available for sale are carried at fair value whereas
investments classified as held to maturity are carried at amortized
cost.




The
following table shows the maturity of the investment portfolio at
December 31, 2007:




Available for Sale
            
            
            Held to MaturityMaturing
            
            Amortized
              Cost
            
            
            Fair
              Value
            
            Yield
            
            
            Amortized
              Cost
            
            
            Fair
              Value
            
            YieldWithin
      one year
            $
            5,503,111
            
            $
            5,050,273
            
            
            6.56
            %
            
            $
            500,000
            
            $
            443,750
            
            
            6.74
            %Over
      one to five years
            
            2,984,706
            
            
            3,010,030
            
            
            5.60
            
            
            
            —
            
            
            —
            
            
            —Over
      five to ten years
            
            3,435,926
            
            
            3,575,687
            
            
            5.80
            
            
            
            9,962,551
            
            
            10,031,598
            
            
            5.32Over
      ten years
            
            9,488,234
            
            
            9,745,704
            
            
            4.93
            
            
            
            410,523
            
            
            415,278
            
            
            5.7421,411,977
            
            
            21,381,694
            
            
            
            
            
            
            10,873,074
            
            
            10,890,626Mortgage-backed
      securities
            
            11,324,751
            
            
            11,441,115
            
            
            5.78
            
            
            
            7,130,202
            
            
            7,106,972
            
            
            4.74Equity
      securities
            
            1,140,856
            
            
            1,966,123
            
            
            4.66
            
            
            
            —
            
            
            —
            
            
            —$
            33,877,584
            
            $
            34,788,932
            
            
            
            
            
            $
            18,003,276
            
            $
            17,997,598







The
investment portfolio consists primarily of U. S. Government agency securities,
mortgage-backed securities, corporate bonds, state and municipal obligations,
and equity securities. The income from state and municipal obligations is exempt
from federal income tax. Certain agency securities are exempt from state income
taxes. The Company uses its investment portfolio as a source of both liquidity
and earnings.




26




Investment
securities decreased $2.3 million to $52.8 million at
December 31, 2007 compared to $55.1 million at December 31, 2006.
The decrease was due to the maturity of a $2.0 million agency security and
monthly principal payments.




Loans






The
following table represents a breakdown of loan balances at
December 31:




2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Real
      Estate:Residential
            
            $
            66,259,210
            
            
            $
            55,057,625
            
            
            $
            53,148,211
            
            
            $
            55,242,018
            
            
            $
            57,586,028Commercial
            
            
            111,474,356
            
            
            
            120,397,988
            
            
            
            97,909,115
            
            
            
            94,858,597
            
            
            
            82,856,038Construction
      and land development
            
            
            35,206,622
            
            
            
            29,996,306
            
            
            
            37,415,478
            
            
            
            17,774,874
            
            
            
            16,275,828Demand
      and time
            
            
            46,406,977
            
            
            
            51,549,802
            
            
            
            56,118,527
            
            
            
            46,168,587
            
            
            
            35,978,633Lease
      financing
            
            
            287,519
            
            
            
            969,113
            
            
            
            1,936,482
            
            
            
            3,598,003
            
            
            
            4,449,408Installment
            
            
            1,989,149
            
            
            
            2,030,480
            
            
            
            1,415,260
            
            
            
            2,084,215
            
            
            
            2,150,626261,623,833
            
            
            
            260,001,314
            
            
            
            247,943,073
            
            
            
            219,726,294
            
            
            
            199,296,561Allowance
      for loan losses
            
            
            3,270,425
            
            
            
            3,131,021
            
            
            
            3,337,163
            
            
            
            3,485,076
            
            
            
            3,648,245Loans,
      net
            
            $
            258,353,408
            
            
            $
            256,870,293
            
            
            $
            244,605,910
            
            
            $
            216,241,218
            
            
            $
            195,648,316







Gross
loans, excluding loans held for sale, increased $1.6 million or 0.6% from
$260.0 million as of December 31, 2006 to $261.6 million as of
December 31, 2007.   The increase was primarily in
residential lending while commercial lending, including commercial construction
and land development, decreased slightly. Commercial loans amounted to
$193.4 million at December 31, 2007 and were 74% of total loans.
Consumer loans amounted to $68.2 million and were 26% of total
loans.




The
following table shows the contractual maturities and interest rate sensitivities
of the Company’s loans at December 31, 2007. Some loans may include
contractual installment payments that are not reflected in the table until final
maturity. In addition, the Company’s experience indicates that a significant
number of loans will be extended or repaid prior to contractual maturity.
Consequently, the table is not intended to be a forecast of future cash
repayments.




MaturingIn one year or less
            
            After 1 through 5 years
            
            After 5 yearsFixed
            
            Variable
            
            Fixed
            
            Variable
            
            Fixed
            
            Variable
            
            TotalReal
      Estate:Residential
            
            $  1,357,659
            
            $              —
            
            $
      1,200,989
            
            $              —
            
            $27,872,355
            
            $35,828,207
            
            $  66,259,210Commercial
            
            16,949,002
            
            5,517,525
            
            59,072,096
            
            1,293,075
            
            26,769,816
            
            1,872,842
            
            111,474,356Construction
      and land development
            
            8,147,002
            
            11,581,660
            
            1,715,914
            
            5,354,212
            
            8,407,834
            
            —
            
            35,206,622Demand
      and time
            
            1,800,044
            
            30,537,636
            
            10,675,374
            
            754,420
            
            2,066,134
            
            573,369
            
            46,406,977Lease
      financing
            
            122,790
            
            —
            
            164,729
            
            —
            
            —
            
            —
            
            287,519Installment
            
            761,245
            
            16,489
            
            269,253
            
            500,914
            
            184,896
            
            256,352
            
            1,989,149$29,137,742
            
            $47,653,310
            
            $73,098,355
            
            $7,902,621
            
            $65,301,035
            
            $38,530,770
            
            $261,623,833







The
following table provides information concerning nonperforming assets and past
due loans at December 31, 2007:




2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Nonaccrual
      loans (a)
            
            $
            4,819,139
            
            
            $
            3,699,397
            
            
            $
            1,413,925
            
            
            $
            615,394
            
            
            $
            712,116Restructured
      loans
            
            
            178,003
            
            
            
            180,686
            
            
            
            —
            
            
            
            455,864
            
            
            
            661,974Foreclosed
      real estate
            
            
            —
            
            
            
            1,383,163
            
            
            
            —
            
            
            
            —
            
            
            
            100,000$
            4,997,142
            
            
            $
            5,263,246
            
            
            $
            1,413,925
            
            
            $
            1,071,258
            
            
            $
            1,474,090Accruing
      loans past-due 90 days or more
            
            $
            918,986
            
            
            $
            436,599
            
            
            $
            179,012
            
            
            $
            1,567,919
            
            
            $
            1,036,018







(a) Loans
are placed in nonaccrual status when they are past-due 90 days as to either
principal or interest or when, in the opinion of management, the collection of
all interest and/or principal is in doubt. A loan remains in nonaccrual status
until the loan is current as to payment of both principal and interest and the
borrower demonstrated the ability to pay and remain current. Management may
grant a waiver from nonaccrual status for a 90-day past-due loan that is both
well secured and in the process of collection.




27


Allowance
for Loan Losses






An
allowance for loan losses is maintained to absorb losses in the existing loan
portfolio. The allowance is a function of specific loan allowances, general loan
allowances based on historical loan loss experience and current trends, and
allowances based on general economic conditions that affect the collectibility
of the loan portfolio. These can include, but are not limited to exposure to an
industry experiencing problems, changes in the nature or volume of the portfolio
and delinquency and nonaccrual trends. The portfolio review and calculation of
the allowance is performed by management on a continuing basis.




The
specific allowance is based on regular analysis of the loan portfolio and is
determined by analysis of collateral value, cash flow and guarantor capacity, as
applicable. The specific allowance was $901,582, $534,639, and $77,744 as of
December 31, 2007, 2006 and 2005, respectively.




The
general allowance is calculated using internal loan grading results and
appropriate allowance factors on approximately ten classes of loans. This
process is reviewed on a regular basis. The allowance factors may be revised
whenever necessary to address current credit quality trends or risks associated
with particular loan types. Historic trend analysis is utilized to obtain the
factors to be applied. The general allowance was $1.4 million, $2.0 million, and
$2.3 million as of December 31, 2007, 2006 and 2005,
respectively.




Allocation
of a portion of the allowance does not preclude its availability to absorb
losses in other categories. An unallocated reserve is maintained to recognize
the imprecision in estimating and measuring loss when evaluating the allowance
for individual loans or pools of loans.




During
the years ended December 31, 2003 through 2007, the unallocated portion of
the allowance for loan losses has fluctuated with the specific and general
allowances so that the total allowance for loan losses would be at a level that
management believes is the best estimate of probable future loan losses at the
balance sheet date. The specific allowance may fluctuate from period to period
if the balance of what management considers problem loans changes. The general
allowance will fluctuate with changes in the mix of the Company’s loan
portfolio, economic conditions, or specific industry conditions. The
requirements of the Company’s federal regulators are a consideration in
determining the required total allowance. Due to the level of the unallocated
allowance, management did not make any provision for loan losses in 2006 and
2005.




Management
believes that it has adequately assessed the risk of loss in the loan portfolios
based on a subjective evaluation and has provided an allowance which is
appropriate based on that assessment. Because the allowance is an estimate based
on current conditions, any change in the economic conditions of the Company’s
market area or change within a borrower’s business could result in a revised
evaluation, which could alter the Company’s earnings.




28




The
following charts show the level of loan losses recorded by the Company for the
past five years, management’s allocation of the allowance for loan losses by
type of loan as of the end of each year, and other statistical information. The
allocation of the allowance reflects management’s analysis of economic risk
potential by type of loan, and is not intended as a forecast of loan
losses.




Years ended December 31Description
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Balance
      at beginning of year
            
            $
            3,131,021
            
            
            $
            3,337,163
            
            
            $
            3,485,076
            
            
            $
            3,648,245
            
            
            $
            3,578,762Charge-offs:Demand
      and time
            
            
            —
            
            
            
            —
            
            
            
            123,578
            
            
            
            192,440
            
            
            
            200,173Lease
      financing
            
            
            25,778
            
            
            
            154,747
            
            
            
            168,823
            
            
            
            —
            
            
            
            —Real
      estate:Residential
            
            
            176,881
            
            
            
            —
            
            
            
            —
            
            
            
            7,746
            
            
            
            16,898Commercial
            
            
            220,640
            
            
            
            59,120
            
            
            
            —
            
            
            
            —
            
            
            
            —Construction
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Installment
            
            
            19,153
            
            
            
            41,967
            
            
            
            22,640
            
            
            
            76,936
            
            
            
            47,957442,452
            
            
            
            255,834
            
            
            
            315,041
            
            
            
            277,122
            
            
            
            265,028Recoveries:Demand
      and time
            
            
            —
            
            
            
            —
            
            
            
            130,904
            
            
            
            67,111
            
            
            
            58,034Lease
      financing
            
            
            14,138
            
            
            
            16,530
            
            
            
            3,980
            
            
            
            —
            
            
            
            —Real
      estate:Residential
            
            
            —
            
            
            
            —
            
            
            
            14,874
            
            
            
            8,087
            
            
            
            —Commercial
            
            
            187
            
            
            
            6,290
            
            
            
            —
            
            
            
            —
            
            
            
            —Construction
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Installment
            
            
            31,531
            
            
            
            26,872
            
            
            
            17,370
            
            
            
            38,755
            
            
            
            33,47745,856
            
            
            
            49,692
            
            
            
            167,128
            
            
            
            113,953
            
            
            
            91,511Net
      charge-offs
            
            
            396,596
            
            
            
            206,142
            
            
            
            147,913
            
            
            
            163,169
            
            
            
            173,517Provision
      charged to operations
            
            
            536,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            243,000Balance
      at end of the year
            
            $
            3,270,425
            
            
            $
            3,131,021
            
            
            $
            3,337,163
            
            
            $
            3,485,076
            
            
            $
            3,648,245Ratio
      of net charge-offs to average loans outstanding
            
            
            0.15
            %
            
            
            0.08
            %
            
            
            0.06
            %
            
            
            0.08
            %
            
            
            0.09
            %







A
breakdown of the allowance for loan losses is provided in the table below;
however, management does not believe that the allowance can be segregated by
category with precision. The breakdown of the allowance is based primarily on
those factors discussed previously in evaluating the allowance as a whole. Since
all of those factors are subject to change, the breakdown is not necessarily
indicative of the category of actual or realized credit losses.






29




The table
below provides a percentage breakdown of the loan portfolio by category to total
loans at December 31:




Portfolio
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Demand
      and time and lease financing
            
            
            17.8
            %
            
            
            20.2
            %
            
            
            23.4
            %
            
            
            22.7
            %
            
            
            20.2
            %Real
      estate:Residential
            
            
            25.3
            
            
            
            21.2
            
            
            
            21.4
            
            
            
            25.1
            
            
            
            28.9Commercial
            
            
            42.6
            
            
            
            46.3
            
            
            
            39.6
            
            
            
            43.2
            
            
            
            41.6Construction
      and land development
            
            
            13.5
            
            
            
            11.5
            
            
            
            15.1
            
            
            
            8.1
            
            
            
            8.2Installment
            
            
            0.8
            
            
            
            0.8
            
            
            
            0.5
            
            
            
            0.9
            
            
            
            1.1100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %







All loan
allowances are subject to regulatory examinations and determinations as to the
appropriateness of the methodology and adequacy on an annual basis.




At
December 31, 2007 the allowance for loan losses was $3.3 million, a 4.5%
increase from the end of 2006. The ratio of the allowance to total loans was
1.25% at December 31, 2007 and 1.20% at December 31, 2006. The ratio of net loan
losses to average loans outstanding for 2007 was 0.15% compared to 0.08% for
2006. The ratio of nonaccrual loans, restructured loans and loans delinquent
more than 90 days to total loans increased to 2.26% at December 31, 2007
from 2.19% at the end of 2006. The ratio of real estate loans to total loans
increased to 81.4% at the end of 2007 from 79.0% at the end of
2006.




Funding
Sources






Deposits






The
following table sets forth the average deposit balances and average rates paid
on deposits during the years ended December 31:




2007
            2006
            2005Average
              Balance
            
            Average
              Rate
            Average
              Balance
            
            Average
              Rate
            Average
              Balance
            
            Average
              RateNoninterest-bearing
      deposits
            $
      49,584,706
            
            
            —
            %
            $
      56,441,180
            
            
            —
            %
            $
      59,645,770
            
            
            —
            %Interest-bearing
      deposits:NOW
      accounts
            29,273,381
            
            
            0.21
            
            32,038,917
            
            
            0.21
            
            34,384,963
            
            
            0.21Savings
      accounts
            26,446,228
            
            
            0.27
            
            30,270,796
            
            
            0.27
            
            33,546,603
            
            
            0.27Money
      market accounts
            56,986,611
            
            
            3.95
            
            51,303,354
            
            
            3.77
            
            40,658,604
            
            
            2.45Certificates
      of deposit
            117,106,699
            
            
            4.87
            
            101,071,899
            
            
            4.47
            
            81,412,306
            
            
            3.52$279,397,625
            
            
            2.89
            
            $271,126,146
            
            
            2.44
            
            $249,648,246
            
            
            1.61







The
following table provides the maturities of certificates of deposit of the
Company in amounts of $100,000 or more at December 31, 2007:




Maturing
      in:3
      months or less
            
            $ 
      7,392,278Over
      3 months through 6 months
            
            7,523,621Over
      6 months through 12 months
            
            18,573,278Over
      12 months
            
            3,376,182$36,865,359







Total
deposits at December 31, 2007 increased by $7.7 million to $285.6 million from
the end of 2006. Interest bearing accounts increased by $8.2 million and
noninterest-bearing deposits decreased by $6.9 million.




The
Company began offering CDARS deposits to its customers during 2004. This program
allows for customers that wish to invest more than the amounts that would
normally be covered by FDIC insurance with the Bank. The program is a nationwide
one that allows participating banks to “swap” customer deposits so that no
customer has greater than the insurable maximum in one bank, but the customer
only deals with his/her own bank. As of December 31, 2007, the Bank had
approximately $13.6 million in CDARS deposits, an increase of $4.4 million from
December 31, 2006.




30




Borrowed
Funds






Borrowed
funds consist of securities sold under repurchase agreements, federal funds
purchased and borrowings from the FHLB and notes payable-U.S. Treasury.
Securities sold under repurchase agreements are securities sold to the Bank’s
customers under a continuing “roll-over” contract and mature in one business
day. The underlying securities sold are federal agency securities that are
segregated from the Company’s other investment securities. Federal funds
purchased are unsecured, overnight borrowings from other financial institutions.
Notes payable-U.S. Treasury are U.S. Treasury and Federal Treasury Tax and Loan
deposits accepted by the Bank from its customers to be remitted to the Federal
Reserve on a periodic basis.




Information
with respect to borrowings is as follows at and for the years ended
December 31:




Maturity Date
            
            2007
            
            
            2006
            
            
            2005Amount
      outstanding at year-end:Federal
      Home Loan Bank
            March 26,
      2008
            
            $
            5,000,000
            
            
            $
            5,000,000
            
            
            $
            5,000,000Federal
      Home Loan Bank
            May
      7, 2008
            
            
            5,000,000
            
            
            
            —
            
            
            
            —Federal
      Home Loan Bank
            June
      27, 2008
            
            
            5,000,000
            
            
            
            —
            
            
            
            —Federal
      Home Loan Bank
            February
      2, 2010
            
            
            —
            
            
            
            —
            
            
            
            35,000,000Federal
      Home Loan Bank
            Daily
      Rate Credit
            
            
            —
            
            
            
            17,000,000
            
            
            
            —$
            15,000,000
            
            
            $
            22,000,000
            
            
            $
            40,000,000Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            $
            14,589,152
            
            
            $
            13,405,463
            
            
            $
            9,280,348Notes-payable —
      U.S. Treasury
            
            
            
            —
            
            
            
            —
            
            
            $
            1,932,124Weighted
      average interest rate at year-end:Advances
      from the FHLB
            
            
            
            5.03
            %
            
            
            5.43
            %
            
            
            6.67
            %Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            
            4.03
            %
            
            
            4.86
            %
            
            
            3.59
            %Notes
      payable — U.S. Treasury
            
            
            
            —
            
            
            
            —
            
            
            
            4.17
            %Maximum
      outstanding at any month-end:Advances
      from the FHLB
            
            
            $
            30,000,000
            
            
            $
            40,000,000
            
            
            $
            45,000,000Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            
            19,427,144
            
            
            
            13,405,463
            
            
            
            11,742,108Notes
      payable — U.S. Treasury
            
            
            
            —
            
            
            
            1,432,463
            
            
            
            1,958,750Average
      balance outstanding during the year:Advances
      from the FHLB
            
            
            $
            19,753,973
            
            
            $
            24,603,287
            
            
            $
            44,876,712Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            
            11,914,984
            
            
            
            9,040,071
            
            
            
            8,986,714Notes
      payable — U.S. Treasury
            
            
            
            —
            
            
            
            185,067
            
            
            
            1,016,211Weighted
      average interest rate during the year:Advances
      from the FHLB
            
            
            
            5.58
            %
            
            
            5.38
            %
            
            
            6.84
            %Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            
            4.67
            %
            
            
            4.66
            %
            
            
            2.66
            %Notes
      payable — U.S. Treasury
            
            
            
            —
            
            
            
            4.18
            %
            
            
            3.06
            %







Debt
retirement expense of $2.3 million was incurred in 2006 due to the restructuring
of a $35.0 million FHLBA advance that had a maturity date of February 2, 2010
and an interest rate of 6.84%. Debt retirement expense of $505,839 was incurred
in 2005 due to the prepayment of a $5.0 million FHLB advance that had a maturity
date of May 24, 2010 and an interest rate of 7.26%.




The
Company may borrow under available unsecured federal funds lines of credit of $5
million and a secured federal funds line of credit of $10 million with other
institutions. There was no balance outstanding under these lines at December 31,
2007 and 2006. These lines bear interest at the current federal funds rate of
the correspondent bank.




Capital






Bank
holding companies and banks are required by the FRB and FDIC to maintain minimum
levels of Tier 1 (or Core) and Tier 2 capital measured as a percentage of assets
on a risk-weighted basis. Capital is primarily represented by shareholders’
equity, adjusted for the allowance for loan losses and certain issues of
preferred stock, convertible securities, and subordinated debt, depending on the
capital level being measured. Assets and certain off-balance sheet transactions
are assigned to one of five different risk-weighting factors for purposes of
determining the risk-adjusted asset base. The minimum levels of Tier 1 and Tier
2 capital to risk-adjusted assets are 4% and 8%, respectively, under the
regulations.




31




In
addition, the FRB and the FDIC require that bank holding companies and banks
maintain a minimum level of Tier 1 (or Core) capital to average total assets
excluding intangibles for the current quarter. This measure is known as the
leverage ratio. The current regulatory minimum for the leverage ratio for
institutions to be considered adequately capitalized is 4%, but could be
required to be maintained at a higher level based on the regulator’s assessment
of an institution’s risk profile. The following chart shows the regulatory
capital levels for the Company and Bank at December 31, 2007 and 2006. The
Company’s subsidiary bank also exceeded the FDIC required minimum capital levels
at those dates by a substantial margin. Based on the levels of capital, the
Company and the Bank are well capitalized.




The
following table shows the Company’s and the Bank’s capital ratios as of
December 31:




Carrollton Bancorp
            Carrollton
      Bank
            Carrollton
      Bancorp
            Carrollton BankMinimum
            2007
            2007
            2006
            2006Leverage
      ratio
            
            4
            %
            
            10.03
            %
            
            9.72
            %
            
            
            9.74
            %
            
            
            9.30
            %Risk-based
      capital:Tier
      1 (Core)
            
            4
            %
            
            12.35
            %
            
            12.20
            %
            
            
            11.92
            %
            
            
            11.48
            %Total
            
            8
            %
            
            13.63
            %
            
            13.31
            %
            
            
            13.20
            %
            
            
            12.60
            %







Total
shareholders’ equity increased 3.4% to $35.9 million at December 31, 2007.
Earnings of the Company of $2.1 million for the year ended
December 31, 2007, the proceeds and the tax benefit from the exercise of
stock options of $593,000 and SFAS 158 increase in the funded status, net of
taxes of $17,785, were offset by dividends of $1.4 million, repurchase of shares
totaling $264,000, and the reduction in unrealized gains on available for sale
securities of $13,000.




Liquidity
and Capital Expenditures






Liquidity






Liquidity
describes the ability of the Company to meet financial obligations, including
lending commitments and contingencies that arise during the normal course of
business. Liquidity is primarily needed to meet the borrowing and deposit
withdrawal requirements of the customers of the Company, as well as to meet
current and planned expenditures.




The
Company’s liquidity is derived primarily from its deposit base and equity
capital. Liquidity is provided through the Company’s portfolios of cash and
interest-bearing deposits in other banks, federal funds sold, loans held for
sale, unpledged investment securities held to maturity due within one year, and
unpledged securities available for sale. Such assets totaled $57.9 million
or 16.4% of total assets at December 31, 2007.




The
borrowing requirements of customers include commitments to extend credit and the
unused portion of lines of credit, which totaled $127.7 million at December 31,
2007. Of this total, management places a high probability of required funding
within one year on approximately $70.0 million. The amount remaining is unused
home equity lines and other consumer lines on which management places low
probability of funding.




The
Company also has established lines of credit totaling $59.6 million with the
FHLBA as an additional source of liquidity. At December 31, 2007, the Company
had $15.0 million outstanding with the FHLBA and had $44.6 million collateral
available to borrow under the line of credit. In addition, the Company had $25.4
million of unpledged securities that could be pledged against borrowings from
the FHLBA or other institutions.  Additionally, the Company has
available unsecured federal funds lines of credit of $5.0 million and a secured
federal funds line of credit of $10.0 million with other institutions. There was
no balance outstanding under these lines at December 31, 2007. The lines
bear interest at the current federal funds rate of the correspondent
bank.




Capital
Expenditures






Capital
expenditures were approximately $2.3 million in 2007, $901,000 in 2006, and
$902,000 in 2005. The capital expenditures in 2007 were principally due to
completing the construction of the Cockeysville branch and construction of a new
branch in Perry Hall which opened in January 2008.  Capital
expenditures in 2006 were due to renovations at a couple of branches and partial
construction of a new branch in Cockeysville expected to open in the second
quarter of 2007. Capital expenditures in 2005 were due to renovations at several
branches and normal business activity.




Capital
expenditures are projected to be approximately $400,000 for fiscal year 2008 for
renovations at one of the Company’s branch locations and purchases of furniture
and equipment, including computer equipment.




32




Market
Risk and Interest Rate Sensitivity






The
Company’s interest rate risk represents the level of exposure it has to
fluctuations in interest rates and is primarily measured as the change in
earnings and the theoretical market value of equity that results from changes in
interest rates. The Asset/Liability Management Committee of the Board of
Directors (the “ALCO”) oversees the Company’s management of interest rate risk.
The objective of the management of interest rate risk is to optimize net
interest income during volatile as well as stable interest rate environments
while maintaining a balance between the maturity and repricing characteristics
of assets and liabilities that is consistent with the Company’s liquidity, asset
and earnings growth, and capital adequacy goals.




Due to
changes in interest rates, the level of income for a financial institution can
be affected by the repricing characteristics of its assets and liabilities. At
December 31, 2007, the Company is in an asset sensitive position. Management
continuously takes steps to reduce higher costing fixed rate funding
instruments, while increasing assets that are more fluid in their repricing. An
asset sensitive position, theoretically, is favorable in a rising rate
environment since more assets than liabilities will reprice in a given time
frame as interest rates rise. Management works to maintain a consistent spread
between yields on assets and costs of deposits and borrowings, regardless of the
direction of interest rates.




In order
to partially offset a reduction in interest income in a declining interest rate
environment, on December 14, 2005, the Bank purchased a $10.0 million
notional amount interest rate Floor with a minimum interest rate (strike rate)
of 7.0% based on the US prime rate. The term of the Floor is five years. The
Floor will reduce the variability of cash flow from a pool of variable rate
loans should the rate index of the loans fall below the predetermined strike
rate of the hedge (7%).




The
following chart shows the static gap position for interest sensitive assets and
liabilities of the Company as of December 31, 2007. The chart is as of a
point in time, and reflects only the contractual terms of the loan or deposit
accounts in assigning assets and liabilities to the various repricing periods
except that deposit accounts with no contractual maturity, such as money market,
NOW and savings accounts, have been allocated evenly over a five-year period. In
addition, the maturities of investments shown in the gap table will differ from
contractual maturities due to anticipated calls of certain securities based on
current interest rates. While this chart indicates the opportunity to reprice
assets and liabilities within certain time frames, it does not reflect the fact
that interest rate changes occur in disproportionate increments for various
assets and liabilities.




Period
from December 31, 2007 in which assets and liabilities
reprice:


0 to 90
                days
              
              
              91 to 365
                days
              
              
              1 to 2
                years
              
              
              3 to 5
                years
              
              
              > 5
                yearsAssets:Short
      term investments
              
              $
              6,872
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —Investment
      securities
              
              
              10,737
              
              
              
              3,946
              
              
              
              10,458
              
              
              
              14,742
              
              
              
              12,249Loans
      held for sale
              
              
              7,580
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Loans:Residential
      real estate
              
              
              27,612
              
              
              
              10,062
              
              
              
              11,621
              
              
              
              11,371
              
              
              
              5,530Commercial
      real estate
              
              
              11,379
              
              
              
              19,359
              
              
              
              17,267
              
              
              
              44,113
              
              
              
              19,355Construction
      and land development
              
              
              19,891
              
              
              
              5,250
              
              
              
              142
              
              
              
              1,580
              
              
              
              8,408Demand
      and time
              
              
              28,785
              
              
              
              207
              
              
              
              4,004
              
              
              
              7,078
              
              
              
              6,332Lease
      financing
              
              
              24
              
              
              
              101
              
              
              
              118
              
              
              
              8
              
              
              
              37Installment
              
              
              568
              
              
              
              219
              
              
              
              56
              
              
              
              224
              
              
              
              922$
              113,448
              
              
              $
              39,144
              
              
              $
              43,666
              
              
              $
              79,116
              
              
              $
              52,833Liabilities:Deposits
              
              $
              87,413
              
              
              $
              79,534
              
              
              $
              10,659
              
              
              $
              5,587
              
              
              $
              102,494Borrowings
              
              
              24,589
              
              
              
              5,000
              
              
              
              —
              
              
              
              —
              
              
              
              —$
              112,002
              
              
              $
              84,534
              
              
              $
              10,659
              
              
              $
              5,587
              
              
              $
              102,494Gap
      positionPeriod
              
              $
              1,446
              
              
              $
              (45,390
              )
              
              $
              33,007
              
              
              $
              73,529
              
              
              $
              (49,661
              )%
      of assets
              
              
              0.41
              %
              
              
              (12.86
              )%
              
              
              9.36
              %
              
              
              20.84
              %
              
              
              (14.08
              )%Cumulative
              
              $
              1,446
              
              
              $
              (43,944
              )
              
              $
              (10,937
              )
              
              $
              62,592
              
              
              $
              12,931%
      of assets
              
              
              0.41
              %
              
              
              (12.45
              )%
              
              
              (3.10
              )%
              
              
              17.74
              %
              
              
              3.66
              %Cumulative
      risk sensitive assets to risk sensitive liabilities
              
              
              101.29
              %
              
              
              77.64
              %
              
              
              94.72
              %
              
              
              129.42
              %
              
              
              104.10
              %




33


Inflation






Inflation
may be expected to have an impact on the Company’s operating costs and thus on
net income. A prolonged period of inflation could cause interest rates, wages,
and other costs to increase and could adversely affect the Company’s results of
operations unless the fees charged by the Company could be increased
correspondingly. However, the Company believes that the impact of inflation was
not material for 2007, 2006, and 2005.




Off-Balance
Sheet Arrangements






The
Company enters into off-balance sheet arrangements in the normal course of
business. These arrangements consist primarily of commitments to extend credit,
lines of credit and letters of credit. In addition, the Company has certain
operating lease obligations.




Credit
commitments are agreements to lend to a customer as long as there is no
violation of any condition to the contract. Loan commitments generally have
interest rates fixed at current market amounts, fixed expiration dates, and may
require payment of a fee. Lines of credit generally have variable interest
rates. Such lines do not represent future cash requirements because it is
unlikely that all customers will draw upon their lines in full at any time.
Letters of credit are commitments issued to guarantee the performance of a
customer to a third party.




The
Company’s exposure to credit loss in the event of nonperformance by the borrower
is the contract amount of the commitment. Loan commitments, lines of credit, and
letters of credit are made on the same terms, including collateral, as
outstanding loans. The Company is not aware of any accounting loss it would
incur by funding its commitments.




Outstanding
loan commitments, unused lines of credit and letters of credit were as follows
at December 31, 2007:




Loan
      commitments
            
            $
            43,339,445Unused
      lines of credit
            
            
            84,317,358Letters
      of credit
            
            
            2,546,445







Contractual
      Obligations




The
Company enters into contractual obligations in the normal course of business.
Among these obligations are short and long-term FHLBA advances, operating leases
related to branch and administrative facilities, a long term contract with a
data processing provider and purchase contracts related to construction of a new
branch office. Payments required under these obligations are set forth in the
table below as of December 31, 2007.




Contractual Obligations (Dollars in thousands)
            
            
            Total
            
            
            
            Less than
              1 year
            
            
            
            One to
              three
              years
            
            
            
            Three to
              five
              years
            
            
            
            
            More than
              five
              yearsFederal
      Home Loan Bank
            
            $
            15,000
            
            
            $
            15,000
            
            
            $
            —
            
            
            $
            —
            
            
            
            $
            —Federal
      fund purchased and securities sold under agreement to
      repurchase
            
            
            14,589
            
            
            
            14,589
            
            
            
            —
            
            
            
            —
            
            
            
            
            —Operating
      lease obligations
            
            
            11,458
            
            
            
            1,010
            
            
            
            1,746
            
            
            
            1,338
            
            
            
            
            7,364Purchase
      obligations(1)
            
            
            1,068
            
            
            
            318
            
            
            
            666
            
            
            
            84
            
            
            
            
            —Total
            
            $
            42,115
            
            
            $
            30,917
            
            
            $
            2,412
            
            
            $
            1,422
            
            
            
            $
            7,364





(1)
Represents payments required under contract, based on average monthly charges
for 2007 and assuming a growth rate of 3%, with the Company’s current data
processing service provider that expires in March 2011.






New
Accounting Pronouncements






In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”.This Statement defines fair value, establishes a framework for measuring
fair value, and expands disclosures about fair value measurements. It clarifies
that fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants in
the market in which the reporting entity transacts. This Statement does not
require any new fair value measurements, but rather, it provides enhanced
guidance to other pronouncements that require or permit assets or liabilities to
be measured at fair value. In February 2008, the FASB agreed to defer the
effective date to fiscal years beginning after November 15, 2008 for certain
nonfinancial assets and nonfinancial liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring
basis.  For these financial and nonfinancial assets and liabilities
that are remeasured at least annually, this statement is effective for fiscal
years beginning after November 15, 2007.




34




In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities.  This statement is effective for
fiscal years beginning after November 15, 2007.  The Company will not
elect the fair value option for any of its financial assets or financial
liabilities.




Item
7A: Quantitative and Qualitative Disclosures About Market
Risk






For
information regarding the market risk of the Company’s financial instruments,
see “Market Risk and Interest Rate Sensitivity” in Management’s Discussion and
Analysis of Financial Condition and Results of Operations in Item 7.  35


Item
      8: Financial Statements and Supplementary
Data




Report
      of Independent Registered Public Accounting
Firm




To the
Board of Directors and Shareholders


Carrollton
Bancorp


Baltimore,
Maryland




We have
audited the accompanying consolidated balance sheets of Carrollton Bancorp and
Subsidiary as of December 31, 2007 and 2006, and the related consolidated
statements of income, changes in shareholders’ equity, and cash flows for each
of the three years in the three year period ended December 31, 2007. These
consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits.




We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform an audit of the
Company’s internal control over financial reporting. Our audits included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Carrollton Bancorp and
Subsidiary as of December 31, 2007 and 2006, and the results of their
operations and their cash flows for each of the three years ended
December 31, 2007, in conformity with accounting principles generally
accepted in the United States of America.




As
discussed in Note 1 to the financial statements, effective January 1, 2006,
the Bank adopted the provisions of Statement of Financial Accounting Standard
No. 123R, Share Based
Payment,and effective December 31, 2006, Statement of Financial
Accounting Standards, No. 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans — an amendment of FASB
Statement No. 87, 88, 106, and 132(R).




Rowles &
Company, LLP, Certified Public Accountants









Baltimore,
Maryland


March 22,
2008




36


Consolidated
      Balance Sheets




December 31,2007
            
            
            2006AssetsCash
      and due from banks
            
            $
            9,382,800
            
            
            $
            9,632,763Federal
      funds sold and Federal Home Loan Bank deposit
            
            
            7,544,181
            
            
            
            3,990,003Federal
      Home Loan Bank stock, at cost
            
            
            1,305,100
            
            
            
            1,704,500Investment
      securitiesAvailable
      for sale
            
            
            34,788,932
            
            
            
            35,934,647Held
      to maturity
            
            
            18,003,276
            
            
            
            19,129,973Loans
      held for sale
            
            
            7,579,765
            
            
            
            7,489,290Loans,
      less allowance for loan losses of $3,270,425 and
$3,131,021
            
            
            258,353,408
            
            
            
            256,870,293Premises
      and equipment
            
            
            7,198,208
            
            
            
            5,599,988Accrued
      interest receivable
            
            
            1,733,672
            
            
            
            1,713,653Bank
      owned life insurance
            
            
            4,435,024
            
            
            
            4,279,830Other
      real estate owned
            
            
            —
            
            
            
            1,383,163Other
      assets
            
            
            2,524,689
            
            
            
            2,096,649$
            352,849,055
            
            
            $
            349,824,752Liabilities
      and Shareholders’ EquityDepositsNoninterest-bearing
            
            $
            49,619,610
            
            
            $
            50,069,560Interest-bearing
            
            
            236,019,015
            
            
            
            227,834,241Total
      deposits
            
            
            285,638,625
            
            
            
            277,903,801Federal
      funds purchased and securities sold under agreements to
      repurchase
            
            
            14,589,152
            
            
            
            13,405,463Advances
      from the Federal Home Loan Bank
            
            
            15,000,000
            
            
            
            22,000,000Accrued
      interest payable
            
            
            221,285
            
            
            
            214,565Other
      liabilities
            
            
            1,468,693
            
            
            
            1,589,545316,917,755
            
            
            
            315,113,374Shareholders’
      equityCommon
      stock, par $1.00 per share; authorized 10,000,000 shares; issued and
      outstanding 2,834,975 in 2007 and 2,806,705 in 2006
            
            
            2,834,975
            
            
            
            2,806,705Additional
      paid-in capital
            
            
            18,781,650
            
            
            
            18,372,351Retained
      earnings
            
            
            13,654,180
            
            
            
            12,886,247Accumulated
      other comprehensive income
            
            
            660,495
            
            
            
            646,07535,931,300
            
            
            
            34,711,378$
            352,849,055
            
            
            $
            349,824,752







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






37





Consolidated
      Statements of Income




Years Ended December 31,2007
            
            
            2006
            
            
            2005Interest
      incomeInterest
      and fees on loans
            
            $
            20,676,380
            
            
            $
            20,041,704
            
            
            $
            16,826,955Interest
      and dividends on securitiesTaxable
      interest income
            
            
            2,297,626
            
            
            
            2,197,049
            
            
            
            1,201,016Nontaxable
      interest income
            
            
            376,199
            
            
            
            357,867
            
            
            
            174,649Dividends
            
            
            145,477
            
            
            
            148,259
            
            
            
            244,849Interest
      on federal funds sold and other interest income
            
            
            180,678
            
            
            
            382,625
            
            
            
            623,910Total
      interest income
            
            
            23,676,360
            
            
            
            23,127,504
            
            
            
            19,071,379Interest
      expenseDeposits
            
            
            8,102,417
            
            
            
            6,624,327
            
            
            
            4,022,723Borrowings
            
            
            1,659,907
            
            
            
            2,113,123
            
            
            
            3,352,360Total
      interest expense
            
            
            9,762,324
            
            
            
            8,737,450
            
            
            
            7,375,083Net
      interest income
            
            
            13,914,036
            
            
            
            14,390,054
            
            
            
            11,696,296Provision
      for loan losses
            
            
            536,000
            
            
            
            —
            
            
            
            —Net
      interest income after provision for loan losses
            
            
            13,378,036
            
            
            
            14,390,054
            
            
            
            11,696,296Noninterest
      incomeService
      charges on deposit accounts
            
            
            950,217
            
            
            
            1,121,271
            
            
            
            1,082,568Brokerage
      commissions
            
            
            677,647
            
            
            
            647,301
            
            
            
            667,510Electronic
      Banking fees
            
            
            1,879,650
            
            
            
            2,045,618
            
            
            
            4,975,646Mortgage
      banking fees and gains
            
            
            2,284,988
            
            
            
            2,465,814
            
            
            
            2,705,785Other
      fees and commissions
            
            
            481,640
            
            
            
            461,841
            
            
            
            447,268Gains
      on security sales
            
            
            —
            
            
            
            2,157,151
            
            
            
            839,859Total
      noninterest income
            
            
            6,274,142
            
            
            
            8,898,996
            
            
            
            10,718,636Noninterest
      expensesSalaries
            
            
            7,226,753
            
            
            
            7,001,847
            
            
            
            7,444,463Employee
      benefits
            
            
            1,363,985
            
            
            
            1,500,820
            
            
            
            1,344,092Occupancy
            
            
            2,064,352
            
            
            
            1,794,873
            
            
            
            1,848,168Furniture
      and equipment
            
            
            600,654
            
            
            
            633,004
            
            
            
            1,211,349Prepayment
      penalty
            
            
            —
            
            
            
            2,251,971
            
            
            
            505,839Check
      kiting loss
            
            
            —
            
            
            
            1,833,733
            
            
            
            —(Recovery)
      Impairment of ATM network
            
            
            —
            
            
            
            (106,221
            )
            
            
            563,400Other
      noninterest expenses
            
            
            5,219,397
            
            
            
            4,470,976
            
            
            
            5,716,813Total
      noninterest expenses
            
            
            16,475,141
            
            
            
            19,381,003
            
            
            
            18,634,124Income
      before income taxes
            
            
            3,177,037
            
            
            
            3,908,047
            
            
            
            3,780,808Income
      taxes
            
            
            1,050,774
            
            
            
            1,323,268
            
            
            
            1,322,371Net
      income
            
            $
            2,126,263
            
            
            $
            2,584,779
            
            
            $
            2,458,437Net
      income per share — basic
            
            $
            0.75
            
            
            $
            0.92
            
            
            $
            0.87Net
      income per share — diluted
            
            $
            0.75
            
            
            $
            0.90
            
            
            $
            0.87





The
accompanying notes are an integral part of these consolidated financial
statements.
  38


Consolidated
      Statements of Changes in Shareholders’ Equity
              years
      ended December 31, 2007, 2006 and
2005




Common
      Stock
            
            
            Additional
              Paid-In
              Capital
            
            
            Retained
              Earnings
            
            
            Accumulated
              Other
              Comprehensive
              Income
            
            
            Comprehensive
              IncomeBalance,
      December 31, 2004
            
            $
            2,834,823
            
            
            $
            18,774,448
            
            
            $
            10,239,356
            
            
            $
            2,366,653Net
      Income
            
            
            —
            
            
            
            —
            
            
            
            2,458,437
            
            
            
            —
            
            
            $
            2,458,437Changes
      in net unrealized gains (losses) on available for sale securities, net of
      tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (529,245
            )
            
            
            (529,245
            )Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,929,192Shares
      acquired and cancelled
            
            
            (42,500
            )
            
            
            (556,750
            )
            
            
            —
            
            
            
            —Stock
      options exercised including tax benefit of $18,166
            
            
            17,375
            
            
            
            207,830
            
            
            
            —
            
            
            
            —Cash
      dividends, $0.40 per share
            
            
            —
            
            
            
            —
            
            
            
            (1,130,262
            )
            
            
            —Balance,
      December 31, 2005
            
            
            2,809,698
            
            
            
            18,425,528
            
            
            
            11,567,531
            
            
            
            1,837,408Net
      Income
            
            
            —
            
            
            
            —
            
            
            
            2,584,779
            
            
            
            
            
            
            $
            2,584,779Changes
      in net unrealized gains (losses) on available for sale securities, net of
      tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,191,817
            )
            
            
            (1,191,817
            )Adjustment
      to initially apply SFAS 158, net of tax effects of $306
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            484
            
            
            
            —Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,392,962Shares
      acquired and cancelled
            
            
            (7,518
            )
            
            
            (121,332
            )
            
            
            —
            
            
            
            —Stock
      options exercised including tax benefit of $7,014
            
            
            4,525
            
            
            
            54,708
            
            
            
            —
            
            
            
            —Stock
      based compensation
            
            
            —
            
            
            
            13,447
            
            
            
            —
            
            
            
            —Cash
      dividends $0.45 per share
            
            
            —
            
            
            
            
            
            
            
            (1,266,063
            )Balance,
      December 31, 2006
            
            
            2,806,705
            
            
            
            18,372,351
            
            
            
            12,886,247
            
            
            
            646,075Net
      Income
            
            
            —
            
            
            
            —
            
            
            
            2,126,263
            
            
            
            
            
            
            $
            2,126,263Changes
      in net unrealized gains (losses) on available for sale securities, net of
      tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (12,884
            )
            
            
            (12,884
            )SFAS
      158, net of tax effects of $17,785
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            27,304
            
            
            
            27,304Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            $
            2,140,683Shares
      acquired and cancelled
            
            
            (16,015
            )
            
            
            (248,256
            )
            
            
            —
            
            
            
            —Stock
      options exercised including tax benefit of $32,790
            
            
            40,685
            
            
            
            584,814
            
            
            
            —
            
            
            
            —Issuance
      of stock under 2007 Equity Plan
            
            
            3,600
            
            
            
            54,900
            
            
            
            —
            
            
            
            —Stock
      based compensation
            
            
            —
            
            
            
            17,841
            
            
            
            —
            
            
            
            —Cash
      dividends, $0.48 per share
            
            
            —
            
            
            
            —
            
            
            
            (1,358,330
            )
            
            
            —Balance,
      December 31, 2007
            
            $
            2,834,975
            
            
            $
            18,781,650
            
            
            $
            13,654,180
            
            
            $
            660,495




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







39




Consolidated
      Statements of Cash Flows




Years Ended December 31,2007
            
            
            2006
            
            
            2005Cash
      Flows from Operating Activities:Net
      income
            
            $
            2,126,263
            
            
            $
            2,584,779
            
            
            $
            2,458,437Adjustments
      to reconcile net income to net cash provided
              by
      (used in) operating activites:Provision
      for loan losses
            
            
            536,000
            
            
            
            —
            
            
            
            —Deprecation
      and amortization
            
            
            847,924
            
            
            
            763,749
            
            
            
            937,570Deferred
      income taxes
            
            
            139,538
            
            
            
            60,631
            
            
            
            153,209Amortization
      of premiums and discounts
            
            
            (57,828
            )
            
            
            (57,411
            )
            
            
            80,719Gains
      on disposal of securities
            
            
            —
            
            
            
            (2,157,176
            )
            
            
            (839,859
            )(Recovery)
      impairment of ATM network
            
            
            —
            
            
            
            (106,221
            )
            
            
            563,400Loans
      held for sale made, net of principal sold
            
            
            (90,475
            )
            
            
            6,277,819
            
            
            
            (3,547,380
            )Gains
      on sale of premises and equipment
            
            
            (5,592
            )
            
            
            —
            
            
            
            (6,246
            )Loss
      on sale of foreclosed real estate
            
            
            127,906
            
            
            
            —
            
            
            
            —Stock
      based compensation expense
            
            
            17,841
            
            
            
            13,447
            
            
            
            —Stock
      issued under 2007 Equity Plan
            
            
            58,500
            
            
            
            —
            
            
            
            —(Increase)
      decrease in:Accrued
      interest receivable
            
            
            (20,019
            )
            
            
            (294,824
            )
            
            
            (123,110
            )Prepaid
      income taxes
            
            
            —
            
            
            
            256,482
            
            
            
            (61,871
            )Cash
      surrender value of bank owned life insurance
            
            
            (155,194
            )
            
            
            (156,286
            )
            
            
            (70,896
            )Other
      assets
            
            
            (478,693
            )
            
            
            226,026
            
            
            
            582,001Increase
      (decrease) in:Accrued
      interest payable
            
            
            6,720
            
            
            
            (367,298
            )
            
            
            88,684Deferred
      loan origination fees
            
            
            (184,808
            )
            
            
            (33,566
            )
            
            
            144,907Income
      taxes payable
            
            
            (154,935
            )
            
            
            —
            
            
            
            —Other
      liabilities
            
            
            34,083
            
            
            
            1,313
            
            
            
            622,669Net
      cash provided by (used in) operating activities
            
            
            2,747,231
            
            
            
            7,011,464
            
            
            
            982,234Cash
      flows from investing activities:Proceeds
      from sales of securities available for sale
            
            
            —
            
            
            
            2,766,852
            
            
            
            2,461,757Proceeds
      from maturities of securities available for sale
            
            
            6,973,048
            
            
            
            3,554,884
            
            
            
            19,174,448Proceeds
      from maturities of securities held to maturity
            
            
            1,159,552
            
            
            
            1,353,243
            
            
            
            541,881Redemption
      (purchase) of Federal Home Loan Bank stock, net
            
            
            399,400
            
            
            
            727,100
            
            
            
            191,300Purchase
      of securities available for sale
            
            
            (6,000,000
            )
            
            
            (15,030,741
            )
            
            
            (8,354,638
            )Purchase
      of securities held to maturity
            
            
            —
            
            
            
            (1,952,570
            )
            
            
            (19,021,466
            )Loans
      made, net of principal collected
            
            
            (579,049
            )
            
            
            (12,230,817
            )
            
            
            (28,509,599
            )Purchase
      of premises and equipment
            
            
            (2,338,287
            )
            
            
            (801,823
            )
            
            
            (902,943
            )Proceeds
      from sale of premises and equipment
            
            
            20,909
            
            
            
            —
            
            
            
            15,189Net
      cash (used in) investing activities
            
            
            (364,427
            )
            
            
            (21,613,872
            )
            
            
            (34,404,071
            )Cash
      flows from financing activities:Net
      increase (decrease) in time deposits
            
            
            13,519,929
            
            
            
            25,486,897
            
            
            
            20,085,651Net
      increase (decrease) in other deposits
            
            
            (5,785,105
            )
            
            
            (19,209,599
            )
            
            
            25,694,707Payment
      of Federal Home Loan Bank advance
            
            
            (7,000,000
            )
            
            
            (18,000,000
            )
            
            
            (5,000,000
            )Net
      increase (decrease) in other borrowed funds
            
            
            1,183,689
            
            
            
            2,192,991
            
            
            
            (956,193
            )Common
      stock repurchase and retirement
            
            
            (264,271
            )
            
            
            (128,850
            )
            
            
            (599,250
            )Stock
      options exercised
            
            
            592,709
            
            
            
            52,219
            
            
            
            207,039Income
      tax benefit from exercise of stock options
            
            
            32,790
            
            
            
            7,014
            
            
            
            18,166Dividends
      paid
            
            
            (1,358,330
            )
            
            
            (1,266,063
            )
            
            
            (1,130,262
            )Net
      cash provided by (used in) financing activities
            
            
            921,411
            
            
            
            (10,865,391
            )
            
            
            38,319,858Net
      increase (decrease) in cash and cash equivalents
            
            
            3,304,215
            
            
            
            (25,467,799
            )
            
            
            4,898,021Cash
      and cash equivalents at beginning of year
            
            
            13,622,766
            
            
            
            39,090,565
            
            
            
            34,192,544Cash
      and cash equivalents at end of year
            
            $
            16,926,981
            
            
            $
            13,622,766
            
            
            $
            39,090,565Supplemental
      information:Interest
      paid on deposits and borrowings
            
            $
            9,755,604
            
            
            $
            9,104,758
            
            
            $
            7,286,399Income
      taxes paid
            
            $
            1,205,709
            
            
            $
            837,661
            
            
            $
            1,525,204Noncash
      activity:Transfer
      of loans to foreclosed real estate
            
            $
            —
            
            
            $
            1,383,163
            
            
            $
            —Foreclosed
      real estate financed
            
            $
            1,327,175
            
            
            $
            —
            
            
            $
            —





The
accompanying notes are an integral part of these consolidated financial
statements.
  40


Notes
      to Consolidated Financial
Statements




1.
      Summary of Significant Accounting
Policies




The
accounting and reporting policies of Carrollton Bancorp and subsidiary (the
“Company”) conform to U.S. generally accepted accounting principles. The
following is a description of the more significant of these
policies.




Organization




The
Company was formed January 11, 1990 and is a Maryland corporation chartered as a
bank holding company. The Company holds all the issued and outstanding shares of
common stock of Carrollton Bank (the “Bank”). The Bank is a Maryland company
that engages in general commercial banking operations. Deposits in the Bank are
insured, subject to regulatory limitations, by the Federal Deposit Insurance
Corporation (the “FDIC”).




The Bank
provides commercial and brokerage services to individuals and small and
medium-sized businesses. Services offered by the Bank include a variety of loans
and a broad spectrum of commercial and consumer financial services.




Basis
      of Presentation




The
consolidated financial statements are prepared in conformity with U.S. generally
accepted accounting principles and include all accounts of the Company and its
wholly-owned subsidiary, Carrollton Bank. All significant intercompany accounts
and transactions have been eliminated in the consolidated financial statements.
Certain amounts for prior years have been reclassified to conform to the
presentation for 2007. These reclassifications have no effect on stockholders’
equity or net income as previously reported.




Use
      of Estimates




The
preparation of the financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
judgments that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.




Material
estimates that are particularly susceptible to significant change in the
near-term relate to the determination of the allowance for loan losses (the
“Allowance”), and other than temporary impairment of investment securities. In
connection with the determination of the Allowance, management prepares fair
value analyses and obtains independent appraisals as necessary. Management
believes that the Allowance is sufficient to address the losses inherent in the
current loan portfolio. While management uses available information to recognize
losses on loans, future additions to the Allowance may be necessary based on
changes in economic conditions. In addition, various regulatory agencies, as an
integral part of their examination processes, periodically review the Bank’s
Allowance. Such agencies may require the Bank to recognize additions to the
Allowance based on their judgments about information available to them at the
time of their examinations.




Securities
are evaluated periodically to determine whether a decline in their value is
other than temporary. The term “other than temporary” is not intended to
indicate a permanent decline in value. Rather, it means that the prospects for
near term recovery of value are not necessarily favorable, or that there is a
lack of evidence to support fair values equal to, or greater than, the carrying
value of the investment. Management reviews criteria such as the magnitude and
duration of the decline, as well as the reasons for the decline, to predict
whether the loss in value is other than temporary. Once a decline in value is
determined to be other than temporary, the value of the security is reduced and
a corresponding charge to earnings is recognized.




Cash
      and Cash Equivalents




For
purposes of the Consolidated Statements of Cash Flows, cash and cash equivalents
include cash and due from banks, federal funds sold and interest-bearing
deposits with banks.




Federal
funds sold are carried at cost, which approximates fair value, and are generally
sold for one-day periods.




Federal
      Home Loan Bank Stock




Federal
Home Loan Bank stock is carried at cost, which approximates fair
value.




Investment
      Securities Available for Sale




Securities
available for sale are acquired as part of the Company’s asset/liability
management strategy and may be sold in response to changes in interest rates,
loan demand, changes in prepayment risk and other factors. Securities available
for sale are recorded at their fair value. Unrealized holding gains or losses,
net of the related tax effect, are excluded from earnings and reported as an
item of other comprehensive income until realized. The carrying values of
securities available for sale are adjusted for premium amortization to the
earlier of the maturity or expected call date and discount accretion to the
maturity date. Realized gains and losses, using the specific identification
method, are included as a separate component of noninterest income. Related
interest and dividends are included in interest income. Declines in the fair
value of individual available for sale securities below their cost that are
other than temporary result in
write-downs of the individual securities to their fair value. Factors affecting
the determination of whether an other-than-temporary impairment has occurred
include a downgrading of the security by a rating agency, a significant
deterioration in the financial condition of the issuer, or that management would
not have the intent and ability to hold a security for a period of time
sufficient to allow for any anticipated recovery in fair value.


41




1.
      Summary of Significant Accounting Policies (Continued)




Equity
securities represent the stock of various financial institutions.




Investment
      Securities Held to Maturity




Investment
securities held to maturity are those securities which the Company has the
ability and positive intent to hold until maturity. Securities so classified at
the time of purchase are recorded at cost. Carrying values of securities held to
maturity are adjusted for premium amortization to the earlier of the maturity or
expected call date and discount accretion to the maturity date. Declines in the
fair value of individual held to maturity securities below their cost, that are
other than temporary, result in write-downs of the individual securities to
their fair value. Factors affecting the determination of whether an
other-than-temporary impairment has occurred include a downgrading of the
security by the rating agency, a significant deterioration in the financial
condition of the issuer, or that management would not have the ability to hold a
security for a period of time sufficient to allow for any anticipated recovery
in fair value.




Loans
      Held for Sale




Residential
mortgage loans originated for sale are carried at the lower of cost or market,
which may be indicated by the committed sale price, determined on an individual
basis.




Loans
      Receivable




Loans are
stated at the amount of unpaid principal adjusted for deferred origination fees
and costs and the allowance for loan losses. Deferred origination fees and costs
are recognized as an adjustment of the related loan yield using the interest
method. The Company determines the delinquency status of loans based on
contractual loan terms. Loans are generally placed in nonaccrual status when
they are past-due 90 days as to either principal or interest or when, in the
opinion of management, the collection of all interest and/or principal is in
doubt. A loan remains in nonaccrual status until the loan is current as to
payment of both principal and interest and the borrower demonstrates the ability
to pay and remain current. Management may grant a waiver from nonaccrual status
for a 90-day past-due loan that is both well secured and in the process of
collection.




A loan is
considered to be impaired when, based on current information and events, it is
probable that the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. A loan is not considered impaired
during a period of delay in payment if the Company expects to collect all
amounts due, including interest past-due. The Company generally considers a
period of delay in payment to include delinquency up to
90 days.




In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 114,
Accounting by Creditors for
Impairment of a Loan (“SFAS No. 114”), the Company measures impaired
loans: (i) at the present value of expected cash flows discounted at the loan’s
effective interest rate; (ii) at the observable market price; or (iii) at the
fair value of the collateral if the loan is collateral dependent. If the measure
of the impaired loan is less than the recorded investment in the loan, an
impairment is recognized through a valuation allowance and corresponding
provision for loan losses.




SFAS
No. 114 does not apply to larger groups of smaller-balance homogeneous
loans such as consumer installment loans. These loans are collectively evaluated
for impairment. The Company’s impaired loans are, therefore, comprised primarily
of commercial loans, including commercial mortgage loans, and real estate
development and construction loans. In addition, impaired loans are generally
loans which management has placed in nonaccrual status. The Company recognizes
interest income for impaired loans consistent with its method for nonaccrual
loans. Specifically, interest payments received are normally applied to
principal. An impaired loan is charged off when the loan, or a portion thereof,
is considered uncollectible.




The
Company provides for loan losses through the establishment of the Allowance by
provisions charged against earnings. The Company’s objective is to ensure that
the Allowance is adequate to cover probable loan losses inherent in the loan
portfolio at the date of each balance sheet. Management considers a number of
factors in estimating the required level of the Allowance. These factors
include: historical loss experience in the loan portfolios; the levels and
trends in past-due and nonaccrual loans; the status of nonaccrual loans and
other loans identified as having the potential for further deterioration; credit
risk and industry concentrations; trends in loan volume; the effects of any
changes in lending policies and procedures or underwriting standards; and, a
continuing evaluation of the economic environment. The Company’s estimate of the
required Allowance is subject to revision as these factors change and is
sensitive to the effects of economic and market conditions on borrowers. Loan
losses are charged against the Allowance when management believes the
uncollectibility of the loan balance is
confirmed. Subsequent recoveries, if any, are credited to the
Allowance.




42




1.
      Summary of Significant Accounting Policies (Continued)




Other
      Real Estate Owned (OREO)




OREO is
comprised of properties acquired in partial or total satisfaction of problem
loans. The properties are recorded at the lower of cost or estimated fair value
less selling costs. Losses incurred at the time of acquisition of the property
are charged to the allowance for loan losses. Subsequent write-downs are
included in noninterest expense along with operating income and expenses of such
properties and gains or losses realized upon disposition.




Premises
      and Equipment




Premises
and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation and amortization are charged to noninterest expenses. Depreciation
generally is computed on the straight-line basis over the estimated useful lives
of the assets, which generally range from three to ten years for furniture and
equipment, three to five years for computer software and hardware, and ten to
forty years for buildings and leasehold improvements. Leasehold improvements are
generally amortized over the terms of the related leases or the lives of the
assets, whichever is shorter. The costs of significant purchases, renewals and
betterments are capitalized, while the costs of ordinary maintenance and repairs
are expensed as incurred and included in noninterest expense.




Any gain
or loss on the sale of an asset is treated as an adjustment to the basis of its
replacement, if traded in, or as an income or expense item, if sold. Leases are
accounted for as operating leases since none meet the criteria for
capitalization.




Bank
      Owned Life Insurance




The
Company purchased insurance on the lives of certain groups of employees. The
policies accumulate asset values to meet future liabilities. Increases in the
cash surrender value are recorded in noninterest income in the Consolidated
Statements of Income.




Income
      Taxes




The
Company and its subsidiary file a consolidated federal income tax return.
Deferred income taxes are recognized for the tax consequences of temporary
differences between financial statement carrying amounts and the tax basis of
assets and liabilities based on enacted tax rates expected to be in effect when
such amounts are realized or settled.




Intangible
      Assets




A deposit
intangible asset of $1,847,700, relating to a branch acquisition, is being
amortized using the straight-line method over 15 years. The remaining
unamortized balance at December 31, 2007 and 2006 was $307,936 and $431,110,
respectively. Amortization expense was $123,180 for 2007, 2006, and 2005,
respectively.




The
Company capitalizes the value of loan servicing retained on loan sales, and
amortizes the value over the estimated life of the portfolio of loans
serviced.




Intangible
assets are included in “Other assets” on the Consolidated Balance Sheets.
Management evaluates intangible assets for impairment quarterly.




Derivative
      Instruments and Hedging Activities




The
Company accounts for derivative instruments and hedging activities utilizing
guidelines established in FASB Statement No. 133 (“FASB No. 133”), Accounting for Derivative
Instruments and Hedging Activities, as amended. The Company recognizes
all derivatives as either assets or liabilities on the balance sheet and
measures those instruments at fair value. Changes in fair value of derivatives
designated and accounted for as cash flow hedges, to the extent they are
effective as hedges, are recorded in “Other Comprehensive Income,” net of
deferred taxes. Any hedge ineffectiveness would be recognized in the income
statement line item pertaining to the hedged item.




Management
periodically reviews contracts from various functional areas of the Company to
identify potential derivatives embedded within selected contracts. Management
has identified potential embedded derivatives in certain loan commitments for
residential mortgages where the Company has intent to sell to an outside
investor. Due to the short-term nature of these loan commitments and the minimal
historical dollar amount of commitments outstanding, the corresponding impact on
the Company’s financial condition and results of operation has not been
material.




The
Company entered into an interest rate Floor transaction on December 14, 2005.
The Floor has a notional amount of $10.0 million with a minimum interest rate of
7.00% based on US prime rate and was initiated to hedge exposure to the
variability in the future cash flows derived from adjustable rate home equity
loans in a declining interest rate environment. The Floor has a term of five
years. This interest rate Floor is designated a cash flow hedge, as it is
designed to reduce variation in overall changes in cash flow below the above
designated strike level associated with the first Prime based interest payments
received each period on its then existing loans. The interest rate of these
loans




43




1.
      Summary of Significant Accounting Policies (Continued)




will
change whenever the repricing index changes, plus or minus a credit spread
(based on each loan’s underlying credit characteristics), until the maturity of
the interest rate Floor. Should the Prime rate index fall below the strike level
of the Floor prior to maturity, the Floor’s counterparty will pay the Bank the
difference between the strike rate and the rate index multiplied by the notional
value of the Floor multiplied by the number of days in the period divided by 360
days. The fair value of the Floor will be recorded as “Other assets” and changes
in the fair value will be recorded as “Other Comprehensive Income” a component
of shareholders’ equity.




Per
      Share Data




Basic net
income per share is determined by dividing net income by the weighted average
number of common shares outstanding giving retroactive effect to any stock
dividends and splits declared. Diluted earnings per share is determined by
adjusting average shares of common stock outstanding by the potentially dilutive
effects of stock options outstanding. The dilutive effects of stock options are
computed using the treasury stock method.




Comprehensive
      Income




Comprehensive
income includes all changes in shareholders’ equity during a period, except
those relating to investments by and distributions to shareholders. The
Company’s comprehensive income consists of net earnings, unrealized gains and
losses on securities available for sale, changes in the fair value of the Floor
and the adjustment from the adoption of Statement of Financial Accounting
Standards No. 158, “Employees Accounting for Defined Benefit Pension and Other
Post Retirement Plans” (“SFAS No. 158”) as of December 31, 2006 and is presented
in the statements of shareholders’ equity. Accumulated other comprehensive
income is displayed as a separate component of shareholders’
equity.




Stock-based
      Compensation




At the
Company’s annual shareholders meeting on May 15, 2007, the 2007 Equity Plan was
approved.  This Plan provides for the issuance of stock options, stock
appreciation rights (SARs), restricted stock, restricted performance stock,
unrestricted Company stock and performance unit awards to directors, officers
and other eligible employees and makes available 500,000 shares for
issuance.  The Plan provides for automatic annual grants of 300 shares
of unrestricted stock of the Company to each non-employee
director.  Also, in accordance with the 2007 Equity Plan, 300 shares
of unrestricted Common Stock were issued to each non-employee director in May,
2007.  No new grants will be made under the 1998 Long Term Incentive
Plan.  However, incentive stock options issued under the 1998 plan
will remain outstanding until exercised or until the tenth anniversary of the
grant date of such options.




On
January 1, 2006, the Company adopted the provisions of Financial Accounting
Standards Board (“FASB”) Statement No. 123 (R), Share-Based Payment,(“SFAS
No. 123R”), which requires companies to recognize expense related to the fair
value of stock-based compensation. Prior to January 1, 2006, the Company
accounted for stock-based compensation under the recognition and measurement
provisions of Accounting Principle Board (“APB”) Opinion No. 25, Accounting for
Stock Issued to Employees (“APB No. 25”), and related Interpretations, as
permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation
(“SFAS No. 123”). In accordance with APB No. 25, no compensation cost was
required to be recognized for options granted that had an exercise price equal
to the market value of the underlying common stock on the date of the
grant.




The
Company adopted SFAS No. 123R using the modified prospective transition method.
Under this transition method, compensation cost recognized for the year ended
December 31, 2006 includes: a)  compensation cost for all share-based
compensation granted prior to, but not vested as of January 1, 2006, based on
the grant-date fair value estimated in accordance with the original provisions
of SFAS No. 123, and b) compensation cost for all share-based compensation
granted subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS No. 123R. Prior to January
1, 2006, no compensation expense was recognized for stock option grants, as all
such grants had an exercise price equal to the fair market value on the date of
the grant.




In
December 2005, the Company authorized the grant of 42,000 options to officers
and the immediate vesting of such options. All outstanding options to officers
where the exercise price of the option exceeded the fair market value of the
Company’s stock were also approved for accelerated vesting. This resulted in
75,500 options becoming vested in 2005 that would have otherwise vested in
future years.




As a
result of adopting SFAS 123R on January 1, 2006, incremental stock-based
compensation expense recognized was $17,841 and $13,447 during 2007 and 2006. As
of December 31, 2007, there was $9,437 of unrecognized compensation expense
related to nonvested stock options, which will be recognized over the remaining
vesting period.




44




1.
      Summary of Significant Accounting Policies (Continued)




The
following illustrates the effect on the net income and earnings per share if the
Company had applied the fair value method of SFAS No. 123, “Accounting for
Stock-Based Compensation,” prior to January 1, 2006:




2005Net
      Income:As
      reported
            
            $
            2,458,437Additional
      compensation
            
            
            (162,222
            )Income
      tax benefit on additional compensation
            
            
            62,650Pro
      forma
            
            $
            2,358,865Basic
      Earnings Per Share:As
      reported
            
            $
            0.87Pro
      forma
            
            
            0.83Diluted
      Earnings Per Share:As
      reported
            
            
            0.87Pro
      forma
            
            
            0.83







2.
      Cash and Due from Banks




The Bank
is required by the Federal Reserve System to maintain certain reserve balances
based principally on deposit liabilities. At December 31, 2007 and 2006,
the required reserve balances were $1.2 million and $1.4 million, respectively.
The Company sells federal funds on an unsecured basis to its correspondent
banks. Average balances sold were $3.5 million in 2007 and
$6.7 million in 2006.




3.
      Investment Securities




Investment
securities are summarized as follows:




Amortized
                cost
              
              
              Unrealized
                gains
              
              
              Unrealized
                losses
              
              
              Fair
                valueDecember 31,
      2007Available
      for saleU.S.
      government agency
              
              $
              11,293,966
              
              
              $
              394,491
              
              
              $
              —
              
              
              $
              11,688,457Mortgage-backed
      securities
              
              
              11,324,751
              
              
              
              160,986
              
              
              
              (44,622
              )
              
              
              11,441,115State
      and municipal
              
              
              4,874,900
              
              
              
              34,250
              
              
              
              (4,502
              )
              
              
              4,904,648Corporate
      bonds
              
              
              5,243,111
              
              
              
              —
              
              
              
              (454,522
              )
              
              
              4,788,58932,736,728
              
              
              
              589,727
              
              
              
              (503,646
              )
              
              
              32,822,809Equity
      securities
              
              
              1,140,856
              
              
              
              864,905
              
              
              
              (39,638
              )
              
              
              1,966,123$
              33,877,584
              
              
              $
              1,454,632
              
              
              $
              (543,284
              )
              
              $
              34,788,932Held
      to maturityU.S.
      government agency
              
              $
              6,460,305
              
              
              $
              40,160
              
              
              $
              —
              
              
              $
              6,500,465Mortgage-backed
      securities
              
              
              7,130,202
              
              
              
              13,678
              
              
              
              (36,908
              )
              
              
              7,106,972State
      and municipal
              
              
              3,912,769
              
              
              
              33,641
              
              
              
              —
              
              
              
              3,946,410Corporate
      bonds
              
              
              500,000
              
              
              
              —
              
              
              
              (56,250
              )
              
              
              443,750$
              18,003,276
              
              
              $
              87,479
              
              
              $
              (93,158
              )
              
              $
              17,997,597
   45


3.
      Investment Securities (Continued)




Amortized
              cost
            
            
            Unrealized
              gains
            
            Unrealized
              losses
            
            
            Fair
              valueDecember 31,
      2006Available
      for saleU.S.
      government agency
            
            $
            9,642,252
            
            $
            24,405
            
            $
            (28,897
            )
            
            $
            9,637,760Mortgage-backed
      securities
            
            
            12,712,231
            
            
            129,674
            
            
            (116,352
            )
            
            
            12,725,553State
      and municipal
            
            
            5,691,067
            
            
            42,133
            
            
            (8,241
            )
            
            
            5,724,959Corporate
      bonds
            
            
            5,639,276
            
            
            —
            
            
            (17,747
            )
            
            
            5,621,52933,684,826
            
            
            196,212
            
            
            (171,237
            )
            
            
            33,709,801Equity
      securities
            
            
            1,140,856
            
            
            1,090,934
            
            
            (6,944
            )
            
            
            2,224,846$
            34,825,682
            
            $
            1,287,146
            
            $
            (178,181
            )
            
            $
            35,934,647Held
      to maturityU.S.
      government agency
            
            $
            6,456,069
            
            $
            —
            
            $
            (89,979
            )
            
            $
            6,366,090Mortgage-backed
      securities
            
            
            8,761,200
            
            
            —
            
            
            (136,735
            )
            
            
            8,624,465State
      and municipal
            
            
            3,912,704
            
            
            3,528
            
            
            (16,519
            )
            
            
            3,899,713$
            19,129,973
            
            $
            3,528
            
            $
            (243,233
            )
            
            $
            18,890,268







Information
related to unrealized losses in the portfolio as of December 31, 2007
follows:




Less than 12 months
            
            
            12 months or longer
            
            
            TotalFair
              Value
            
            
            Unrealized
              Losses
            
            
            Fair
              Value
            
            
            Unrealized
              Losses
            
            
            Fair
              Value
            
            
            Unrealized
              LossesMortgage-backed
      securities
            
            $
            —
            
            
            $
            —
            
            
            $
            8,984,592
            
            
            $
            (81,530
            )
            
            $
            8,984,592
            
            
            $
            (81,530
            )State
      and municipal
            
            
            —
            
            
            
            —
            
            
            
            1,390,498
            
            
            
            (4,502
            )
            
            
            1,390,498
            
            
            
            (4,502
            )Corporate
      bonds
            
            
            —
            
            
            
            —
            
            
            
            5,232,315
            
            
            
            (510,772
            )
            
            
            5,232,315
            
            
            
            (510,772
            )Equity
      securities
            
            
            —
            
            
            
            —
            
            
            
            93,095
            
            
            
            (39,638
            )
            
            
            93,095
            
            
            
            (39,638
            )$
            —
            
            
            $
            —
            
            
            $
            15,700,500
            
            
            $
            (636,442
            )
            
            $
            15,700,500
            
            
            $
            (636,442
            )







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.




At
December 31, 2007, five marketable equity securities had unrealized losses of
approximately $40,000 from the Company’s cost basis.  At December 31,
2006, five marketable equity securities had unrealized losses of approximately
$6,944 from the Company’s cost basis. At December 31, 2005, one marketable
equity security had an unrealized loss with aggregate depreciation of
approximately $3,900 from the Company’s cost basis.  No credit issues
have been identified that cause management to believe the decline in market
value is other than temporary. In analyzing the issuer’s financial condition,
management considers industry analysis reports, financial performance and
projected target prices of investment analysts within a one-year time frame.
Unrealized losses on marketable equity securities that are in excess of 50% of
cost, and that have been sustained for more than 24 months, are generally
recognized by management as being other than temporary and charged to earnings,
unless evidence exists to support a realizable value equal to or greater than
the Company’s carrying value of the investment.




All
unrealized losses on U.S. government agency, mortgage-backed securities, state
and municipal securities and corporate bonds as of December 31, 2007 are
considered to be temporary losses, because each security will be redeemed at
face value at, or prior to maturity. In most cases, the temporary impairment in
value is caused by market interest rate fluctuations.




46




3.
      Investment Securities (Continued)




Contractual
maturities of debt securities at December 31, 2007 and 2006 are shown
below. Actual maturities may differ from contractual maturities because
borrowers have the right to call or prepay obligations with or without call or
prepayment penalties.




December 31, 2007Available for sale
            
            
            Held to maturityMaturing
            
            Amortized
              Cost
            
            
            Fair
              Value
            
            
            Amortized
              Cost
            
            
            Fair
              ValueWithin
      one year
            
            $
            5,503,111
            
            
            $
            5,050,273
            
            
            $
            500,000
            
            
            $
            443,750Over
      one to five years
            
            
            2,984,706
            
            
            
            3,010,030
            
            
            
            —
            
            
            
            —Over
      five to ten years
            
            
            3,435,926
            
            
            
            3,575,687
            
            
            
            9,962,551
            
            
            
            10,031,598Over
      ten years
            
            
            9,488,234
            
            
            
            9,745,704
            
            
            
            410,523
            
            
            
            415,278Mortgage-backed
      securities
            
            
            11,324,751
            
            
            
            11,441,115
            
            
            
            7,130,202
            
            
            
            7,106,972$
            32,736,728
            
            
            $
            32,822,809
            
            
            $
            18,003,276
            
            
            $
            17,997,598







December 31, 2006Available for sale
            
            
            Held to maturityMaturing
            
            Amortized
              Cost
            
            
            Fair
              Value
            
            
            Amortized
              Cost
            
            
            Fair
              ValueWithin
      one year
            
            $
            2,000,000
            
            
            $
            1,985,620
            
            
            $
            —
            
            
            $
            —Over
      one to five years
            
            
            4,923,172
            
            
            
            4,924,303
            
            
            
            —
            
            
            
            —Over
      five to ten years
            
            
            3,928,823
            
            
            
            3,958,428
            
            
            
            8,414,510
            
            
            
            8,324,424Over
      ten years
            
            
            10,120,600
            
            
            
            10,115,898
            
            
            
            1,954,263
            
            
            
            1,941,379Mortgage-backed
      securities
            
            
            12,712,231
            
            
            
            12,725,553
            
            
            
            8,761,200
            
            
            
            8,624,465$
            33,684,826
            
            
            $
            33,709,802
            
            
            $
            19,129,973
            
            
            $
            18,890,268







At
December 31, 2007 and 2006, securities with an amortized cost of $16.6 million
(fair value of $16.5 million) and $17.9 million (fair value of $17.9 million),
respectively, were pledged as collateral for government deposits, securities
sold under repurchase agreements, and advances from the Federal Home Loan
Bank.




In 2006,
and 2005, the Company realized gross gains on sales of securities of $2.2
million, and $839,859, respectively. There were no realized losses in 2006 or
2005.  There were no sales of securities in 2007.  Income
taxes (benefit) on net security gains (losses) were $730,413 and $293,783 in
2006 and 2005, respectively.




47


4.
      Loans




Major
classifications of loans at December 31 are as follows:




2007
            
            
            2006Real
      estate:Residential
            
            $
            66,259,210
            
            
            $
            55,057,625Commercial
            
            
            111,474,356
            
            
            
            120,397,988Construction
      and land development
            
            
            35,206,622
            
            
            
            29,996,306Demand
      and time
            
            
            46,406,977
            
            
            
            51,549,802Lease
      financing
            
            
            287,519
            
            
            
            969,113Installment
            
            
            1,989,149
            
            
            
            2,030,480261,623,833
            
            
            
            260,001,314Allowance
      for loan losses
            
            
            3,270,425
            
            
            
            3,131,021Loans,
      net
            
            $
            258,353,408
            
            
            $
            256,870,293







The Bank
makes loans to customers located in Maryland, Virginia, Pennsylvania and
Delaware. Although the loan portfolio is diversified, its performance will be
influenced by the regional economy.




The
maturity and rate repricing distribution of the loan portfolio at
December 31 is as follows:




2007
            
            
            2006Repricing
      or maturing within one year
            
            $
            111,657,455
            
            
            $
            77,881,735Maturing
      over one to five years
            
            
            84,060,030
            
            
            
            98,707,890Maturing
      over five years
            
            
            65,906,348
            
            
            
            83,411,689$
            261,623,833
            
            
            $
            260,001,314







Loan
balances have been adjusted by the following deferred amounts as of
December 31:




2007
            
            
            2006Deferred
      origination costs and premiums
            
            $
            738,614
            
            
            $
            538,554Deferred
      origination fees and unearned discounts
            
            
            (869,450
            )
            
            
            (854,549
            )Net
      deferred fees
            
            $
            (130,836
            )
            
            $
            (315,995
            )







Transactions
in the allowance for loan losses for the years ended December 31 were as
follows:




2007
            
            
            2006
            
            
            2005Beginning
      balance
            
            $
            3,131,021
            
            
            $
            3,337,163
            
            
            $
            3,485,076Provision
      charged to operations
            
            
            536,000
            
            
            
            —
            
            
            
            —Recoveries
            
            
            45,856
            
            
            
            49,692
            
            
            
            167,1283,712,877
            
            
            
            3,386,855
            
            
            
            3,652,204Loans
      charged off
            
            
            442,452
            
            
            
            255,834
            
            
            
            315,041Ending
      balance
            
            $
            3,270,425
            
            
            $
            3,131,021
            
            
            $
            3,337,163




48


4.
      Loans (Continued)




Nonperforming
assets and loans past-due 90 days or more but accruing interest were as
follows at December 31:




2007
            
            
            2006
            
            
            2005Nonaccrual
      loans
            
            $
            4,819,139
            
            
            $
            3,699,397
            
            
            $
            1,413,925Restructured
      loans
            
            
            178,003
            
            
            
            180,686
            
            
            
            —Foreclosed
      real estate
            
            
            —
            
            
            
            1,383,163
            
            
            
            —Total
      nonperforming assets
            
            $
            4,997,142
            
            
            $
            5,263,246
            
            
            $
            1,413,925Accruing
      loans past-due 90 days or more
            
            $
            918,986
            
            
            $
            436,599
            
            
            $
            179,012Unrecorded
      interest on nonaccrual loans
            
            $
            458,797
            
            
            $
            76,044
            
            
            $
            111,413Interest
      income recognized on nonaccrual loans
            
            $
            88,384
            
            
            $
            300,650
            
            
            $
            58,718







At
December 31, 2007, the Company had nine impaired loans totaling approximately
$3,640,000, all of which had been classified as non-accrual.  The
valuation allowance for impaired loans was $901,652 at December 31,
2007.  At December 31, 2006 and 2005, there were no impaired
loans.




The
average balance of impaired loans amounted to approximately $3.9 million in
2007. During 2007, the Company received total payments on impaired loans of
$669,083. Of this amount, $52,454 was recorded as interest income for 2007. The
remainder was applied to reduce principal.




Loans
with a balance of approximately $97.3 million and $86.6 million were pledged as
collateral to the Federal Home Loan Bank of Atlanta as of December 31, 2007 and
2006, respectively. At December 31, 2007 and 2006, the Company serviced loans
for others totaling $727,000 and $1.1 million, respectively.




5.
      Credit Commitments




Outstanding
loan commitments, unused lines of credit, and letters of credit were as follows
as of December 31:




2007
            
            
            2006
            
            
            2005Loan
      commitmentsMortgage
      loans
            
            $
            4,347,755
            
            
            $
            4,122,697
            
            
            $
            4,066,223Construction
      and land development
            
            
            17,688,330
            
            
            
            29,501,299
            
            
            
            14,913,344Commercial
      loans
            
            
            21,303,360
            
            
            
            6,840,000
            
            
            
            7,058,000$
            43,339,445
            
            
            $
            40,463,996
            
            
            $
            26,037,567Unused
      lines of creditHome
      equity lines
            
            $
            43,371,236
            
            
            $
            46,199,911
            
            
            $
            52,194,528Commercial
      lines
            
            
            39,801,481
            
            
            
            44,279,428
            
            
            
            26,095,802Unsecured
      consumer lines
            
            
            1,144,641
            
            
            
            1,084,048
            
            
            
            1,410,270$
            84,317,358
            
            
            $
            91,563,387
            
            
            $
            79,700,600Letters
      of credit
            
            $
            2,546,445
            
            
            $
            2,223,755
            
            
            $
            2,606,061







Loan
commitments and lines of credit are agreements to lend to a customer as long as
there is no violation of any condition to the contract. Loan commitments
generally have interest rates fixed at current market amounts, fixed expiration
dates, and may require payment of a fee. Lines of credit generally have variable
interest rates. Such lines do not represent future cash requirements because it
is unlikely that all customers will draw upon their lines in full at any time.
Letters of credit are commitments issued to guarantee the performance of a
customer to a third party.




The
Company’s exposure to credit loss in the event of nonperformance by the borrower
is the contract amount of the commitment. Loan commitments, lines of credit, and
letters of credit are made on the same terms, including collateral, as
outstanding loans. The Company is not aware of any accounting loss it would
incur by funding the above commitments.




49




6.
      Related Party Transactions




The
Company’s executive officers and directors, or other entities, to which they are
related, enter into loan transactions with the Bank in the ordinary course of
business. The terms of these transactions are similar to the terms provided to
other borrowers entering into similar loan transactions and do not involve more
than normal risk of collectibility. During the years ended December 31,
2007, 2006 and 2005, transactions in related party loans were as
follows:




2007
            
            
            2006
            
            
            2005Beginning
      balance
            
            $
            7,976,614
            
            
            $
            1,894,784
            
            
            $
            1,820,717Additions
            
            
            629,259
            
            
            
            7,918,876
            
            
            
            179,452Repayments
            
            
            (4,182,237
            )
            
            
            (1,837,046
            )
            
            
            (105,385
            )Ending
      balance
            
            $
            4,423,636
            
            
            $
            7,976,614
            
            
            $
            1,894,784




A
director of the Company is a partner in a law firm that provides legal services
to the Company and the Bank. During the years ended December 31, 2007, 2006, and
2005, amounts paid to the law firm in connection with those services
were  approximately $358,000, $195,000, and $220,000,
respectively.




A
director of the Company is President of an insurance brokerage through which the
Company and the Bank place various insurance policies. During the years ended
December 31, 2007, 2006, and 2005, amounts paid to the insurance brokerage for
insurance premiums were approximately $112,000, $282,000, and $215,000,
respectively.




A
director of the Company is President of an electrical company through which the
Company and the Bank may contract for electrical services. No such services were
performed in 2007, 2006 or 2005.




A
director of the Company is the Executive Vice President for a commercial real
estate services company, through which the Company and the Bank contracted for
appraisal and management services.  In late 2006 and 2007, contracts
for the construction of two branches were awarded on a competitive bid basis to
a related party.  Contract payments totaling approximately $1.5
million in 2007, $356,000 in 2006, and $169,000 in 2005 were paid to the related
party.




The Bank
routinely enters into deposit relationships with its directors, officers and
employees in the normal course of business.  These deposits bear the
same terms and conditions of those prevailing at the time for comparable
transactions with unrelated parties.  Balances of executive officers
and directors on deposits as of December 31, 2007 and 2006 were $2.0 million and
$3.9 million, respectively.




7.
      Premises and Equipment




A summary
of premises and equipment is as follows as of December 31:




2007
            
            
            2006Land
      and improvements
            
            $
            909,544
            
            
            $
            909,544Buildings
            
            
            4,607,893
            
            
            
            2,995,117Leasehold
      improvements
            
            
            3,686,903
            
            
            
            3,523,947Equipment
      and fixtures
            
            
            4,939,409
            
            
            
            4,521,05214,143,749
            
            
            
            11,949,660Accumulated
      depreciation and amortization
            
            
            (6,945,541
            )
            
            
            (6,349,672
            )$
            7,198,208
            
            
            $
            5,599,988




Depreciation
and amortization of premises and equipment was $663,135, $611,658, and $673,022,
for 2007, 2006, and 2005, respectively. Amortization of software was $61,616,
$108,364, and $141,368 for 2007, 2006, and 2005, respectively.




50




8.
      Deposits




Major
classifications of interest-bearing deposits are as follows as of
December 31:




2007
            
            
            2006NOW
      and Super NOW
            
            $
            27,832,670
            
            
            $
            33,112,772Money
      market
            
            
            54,090,422
            
            
            
            52,072,965Savings
            
            
            25,535,502
            
            
            
            27,608,013Certificates
      of deposit of $100,000 or more
            
            
            36,865,359
            
            
            
            29,567,921Other
      time deposits
            
            
            91,695,062
            
            
            
            85,472,570$
            236,019,015
            
            
            $
            227,834,241







Time
deposits mature as follows:




December 31,2007
            
            
            2006Maturing
      within one year
            
            $
            109,844,363
            
            
            $
            92,053,740Maturing
      over one to two years
            
            
            12,620,414
            
            
            
            13,479,273Maturing
      over two to three years
            
            
            4,313,494
            
            
            
            5,197,865Maturing
      over three to four years
            
            
            801,961
            
            
            
            3,503,735Maturing
      over four to five years
            
            
            980,189
            
            
            
            805,878$
            128,560,421
            
            
            $
            115,040,491







9.
      Borrowed Funds




Borrowed
funds consist of securities sold under repurchase agreements, federal funds
purchased, borrowings from the FHLB and notes payable-U.S. Treasury. Notes
payable-U.S. Treasury are U.S. Treasury and Federal Treasury Tax and Loan
deposits accepted by the Bank from its customers to be remitted to the Federal
Reserve on a periodic basis. Securities sold under repurchase agreements are
securities sold to the Bank’s customers under a continuing “roll-over” contract
and mature in one business day. The underlying securities sold are federal
agency securities that are segregated from the Company’s other investment
securities. Federal funds purchased are unsecured, overnight borrowings from
other financial institutions.




51




9.
      Borrowed Funds (Continued)




Information
with respect to borrowings is as follows at and for the years ended
December 31:




Maturity Date
            
            2007
            
            
            2006
            
            
            2005Amount
      outstanding at year-end:Federal
      Home Loan Bank
            March 26,
      2008
            
            $
            5,000,000
            
            
            $
            5,000,000
            
            
            $
            5,000,000Federal
      Home Loan Bank
            May
      7, 2008
            
            
            5,000,000
            
            
            
            —
            
            
            
            —Federal
      Home Loan Bank
            June
      27, 2008
            
            
            5,000,000
            
            
            
            —
            
            
            
            —Federal
      Home Loan Bank
            February 2,
      2010
            
            
            —
            
            
            
            —
            
            
            
            35,000,000Federal
      Home Loan Bank
            Daily
      Rate Credit
            
            
            —
            
            
            
            17,000,000
            
            
            
            —$
            15,000,000
            
            
            $
            22,000,000
            
            
            $
            40,000,000Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            $
            14,589,152
            
            
            $
            13,405,463
            
            
            $
            9,280,348Notes-payable —
      U.S. Treasury
            
            
            
            —
            
            
            
            —
            
            
            $
            1,932,124Weighted
      average interest rate at year-end:Advances
      from the FHLB
            
            
            
            5.03
            %
            
            
            5.43
            %
            
            
            6.67
            %Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            
            4.03
            %
            
            
            4.86
            %
            
            
            3.59
            %Notes
      payable — U.S. Treasury
            
            
            
            —
            
            
            
            —
            
            
            
            4.17
            %Maximum
      outstanding at any month-end:Advances
      from the FHLB
            
            
            $
            30,000,000
            
            
            $
            40,000,000
            
            
            $
            45,000,000Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            
            19,427,144
            
            
            
            13,405,463
            
            
            
            11,742,108Notes
      payable — U.S. Treasury
            
            
            
            —
            
            
            
            1,432,423
            
            
            
            1,958,750Average
      balance outstanding during the year:Advances
      from the FHLB
            
            
            $
            19,753,973
            
            
            $
            24,603,287
            
            
            $
            44,876,712Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            
            11,914,984
            
            
            
            9,040,071
            
            
            $
            ,986,714Notes
      payable — U.S. Treasury
            
            
            
            —
            
            
            
            185,067
            
            
            
            1,016,211Weighted
      average interest rate during the year:Advances
      from the FHLB
            
            
            
            5.58
            %
            
            
            5.38
            %
            
            
            6.84
            %Federal
      funds purchased and securities sold under repurchase
      agreements
            
            
            
            4.67
            %
            
            
            4.66
            %
            
            
            2.66
            %Notes
      payable — U.S. Treasury
            
            
            
            —
            
            
            
            4.18
            %
            
            
            3.06
            %




Debt
retirement expense of $2.3 million was incurred in 2006 due to the restructuring
of a $35.0 million FHLB advance that had a maturity date of February 2,
2010 and an interest rate of 6.84%. Debt retirement expense of $505,839 was
incurred in 2005 due to the prepayment of a $5.0 million FHLB advance that
had a maturity date of May 24, 2010 and an interest rate of
7.26%.




The
Company also has established lines of credit totaling $59.6 million with the
Federal Home Loan Bank of Atlanta as an additional source of liquidity. At
December 31, 2007, the Company had $15.0 million outstanding with the FHLB and
had $44.6 million collateral available to borrow under the line of credit. In
addition, the Company had $25.4 million of unpledged securities that could be
pledged against borrowings from the FHLB or other institutions.




The
Company has available unsecured federal funds lines of credit of $5 million and
a secured federal funds line of credit of $10 million with other institutions.
There was no balance outstanding under these lines at December 31, 2007 and
2006. These lines bear interest at the current federal funds rate of the
correspondent bank.




52




10.
      Other Noninterest Expenses




Other
noninterest expenses include the following for the years ended
December 31:




2007
            
            
            2006
            
            
            2005Data
      processing services
            
            $
            847,230
            
            
            $
            815,056
            
            
            $
            807,314Professional
      services
            
            
            1,192,628
            
            
            
            521,231
            
            
            
            226,965Employee-related
      expenses
            
            
            412,881
            
            
            
            384,128
            
            
            
            345,203Marketing
            
            
            320,916
            
            
            
            303,903
            
            
            
            355,921Directors’
      fees
            
            
            352,550
            
            
            
            238,850
            
            
            
            173,050Carrier
      service
            
            
            196,240
            
            
            
            210,703
            
            
            
            496,714Liability
      insurance
            
            
            172,041
            
            
            
            205,516
            
            
            
            214,579Printing,
      stationary, and supplies
            
            
            166,543
            
            
            
            202,541
            
            
            
            257,865Loan
      expenses
            
            
            290,287
            
            
            
            195,844
            
            
            
            354,864Loss
      on the sale of other real estate owned and related
expenses
            
            
            155,481
            
            
            
            —
            
            
            
            —Postage
      and freight
            
            
            141,918
            
            
            
            164,606
            
            
            
            167,681Telephone
            
            
            125,558
            
            
            
            162,808
            
            
            
            189,990Deposit
      premium amortization
            
            
            123,174
            
            
            
            123,174
            
            
            
            123,174Shareholder
      expense
            
            
            94,974
            
            
            
            111,768
            
            
            
            111,273Software
      amortization
            
            
            61,615
            
            
            
            108,364
            
            
            
            141,368Coin/Currency
      service
            
            
            17,637
            
            
            
            103,480
            
            
            
            84,429ATM
      services
            
            
            63,959
            
            
            
            77,704
            
            
            
            1,057,794Bank
      account charges
            
            
            37,830
            
            
            
            51,643
            
            
            
            80,592Other
            
            
            445,935
            
            
            
            489,651
            
            
            
            528,037$
            5,219,397
            
            
            $
            4,470,976
            
            
            $
            5,716,813







11.
      Stock Options




At the
Company’s annual shareholders meeting on May 15, 2007, the 2007 Equity Plan was
approved.  Under this plan, 500,000 shares of the Common Stock of the
Company were reserved for issuance.  Also, in accordance with the 2007
Equity Plan, 300 shares of unrestricted Common Stock were issued to each
non-employee director in May, 2007.  No new grants will be made under
the 1998 Long Term Incentive Plan.  However, incentive stock options
issued under this plan will remain outstanding until exercised or until the
tenth anniversary of the grant date of such options.




The 1998
Long Term Incentive Plan provided for the granting of common stock options to
directors and key employees. In 2004, the shareholders approved increasing the
number of shares available for grant under the Plan from 210,000 shares to
300,000 shares. These stock option awards contained a serial feature whereby one
third of the options granted vest and can be exercised after each year. Option
prices were equal to the estimated fair market value of the common stock at the
date of the grant. Options expire ten years after the date of grant or upon
employee termination if not exercised.




53




11.
      Stock Options (Continued)




Information
with respect to options outstanding is as follows for the years ended
December 31:




2007
            
            
            2006
            
            
            2005Shares
            
            
            Option Price Range
            
            
            Shares
            
            
            Option Price Range
            
            
            Shares
            
            
            Option Price RangeOutstanding
      at beginning of year
            
            
            229,030
            
            
            
            
            
            
            227,130
            
            
            
            
            
            
            193,470Granted
            
            
            630
            
            
            $
            17.25
            
            
            
            12,430
            
            
            $
            15.35
      to $17.16
            
            
            
            53,930
            
            
            $
            14.45 to $14.85Exercised
            
            
            (40,685
            )
            
            $
            9.71
      to $18.10
            
            
            
            (4,525
            )
            
            $
            10.94
      to $15.36
            
            
            
            (17,375
            )
            
            $
            9.71
      to $14.50Expired/Canceled
            
            
            (4,420
            )
            
            $
            14.50
      to $17.79
            
            
            
            (6,005
            )
            
            $
            10.94
      to $16.02
            
            
            
            (2,895
            )
            
            $
            12.67
      to $15.48Outstanding
      at end of year
            
            
            184,555
            
            
            $
            9.71
      to $18.10
            
            
            
            229,030
            
            
            $
            9.71
      to $18.10
            
            
            
            227,130
            
            
            $
            9.71
      to $18.10Exercisable
      at December 31
            
            
            173,732
            
            
            
            
            
            
            
            209,670
            
            
            
            
            
            
            
            213,550Aggregate
      intrinsic value at year end
            
            $
            108,640
            
            
            
            
            
            
            $
            558,473







On
December 15, 2005, the Board of Directors authorized the grant of 42,000 options
to officers and the immediate vesting of such options. All outstanding options
to officers where the exercise price of the option exceeded the fair market
value of the Company’s stock were also approved for accelerated vesting. This
resulted in 75,500 options becoming vested in 2005 that would have otherwise
vested in future years.




As a
result of adopting SFAS 123R on January 1, 2006, incremental
stock-based compensation expense recognized was $17,841 and $13,447 during 2007
and 2006. As of December 31, 2007, there was $9,437 of unrecognized
compensation expense related to nonvested stock options, which will be
recognized over the remaining vesting period. The total intrinsic value of
options excised during the year ended December 31, 2007 and 2006 was
approximately $86,000 and $18,000, respectively.




A summary
of information about stock options outstanding is as follows at
December 31, 2007:




Weighted
              Average
              Exercise
              Price
            
            Shares
            
            Weighted
              Average
              Remaining
              Life
              (Years)
            
            Shares
              Underlying
              Options
              Currently
              Exercisable$ 9.71
            
            
            
            1,890
            
            
            
            3.33
            
            
            
            1,89010.94
            
            
            
            18,900
            
            
            
            3.42
            
            
            
            18,90012.11
            
            
            
            3,150
            
            
            
            4.33
            
            
            
            3,15012.14
            
            
            
            630
            
            
            
            4.16
            
            
            
            63012.67
            
            
            
            17,850
            
            
            
            4.58
            
            
            
            17,85013.45
            
            
            
            13,125
            
            
            
            2.58
            
            
            
            13,12513.45
            
            
            
            1,890
            
            
            
            2.33
            
            
            
            1,89014.45
            
            
            
            5,880
            
            
            
            7.29
            
            
            
            3,92014.50
            
            
            
            3,780
            
            
            
            5.33
            
            
            
            3,78014.50
            
            
            
            29,000
            
            
            
            7.96
            
            
            
            29,00014.85
            
            
            
            5,000
            
            
            
            7.43
            
            
            
            5,00015.36
            
            
            
            1,670
            
            
            
            1.33
            
            
            
            1,67015.42
            
            
            
            23,730
            
            
            
            1.35
            
            
            
            23,73016.02
            
            
            
            14,000
            
            
            
            6.58
            
            
            
            14,00016.22
            
            
            
            5,460
            
            
            
            6.33
            
            
            
            5,46016.31
            
            
            
            6,720
            
            
            
            8.29
            
            
            
            2,240


16.70
                
                
                
                2,100
                
                
                
                0.16
                
                
                
                2,10017.16
                
                
                
                5,000
                
                
                
                9.00
                
                
                
                1,66717.25
                
                
                
                630
                
                
                
                9.08
                
                
                
                —17.79
                
                
                
                21,000
                
                
                
                0.35
                
                
                
                21,00018.03
                
                
                
                630
                
                
                
                8.60
                
                
                
                21018.10
                
                
                
                2,520
                
                
                
                0.33
                
                
                
                2,52014.64
                
                
                
                184,555
                
                
                
                4.11
                
                
                
                173,732












54







11.
      Stock Options (Continued)




As of
December 31, 2007, the weighted average exercise price of shares underlying
options currently exercisable is $14.54 per share.




The value
of each option is estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions used for grants
during the years ended December 31, 2007, 2006 and 2005:




2007
            
            
            2006
            
            
            2005Dividend
      yield
            
            3.30
            %
            
            
            2.67
            %
            
            
            2.67
            %Expected
      volatility
            
            36.61%
            
            
            24.76
            %
            
            
            26.94
            %Risk
      free rate
            
            4.04%
      to 4.87
            %
            
            4.91%
      to 4.99
            %
            
            3.96%
      to 4.47
            %Estimated
      life
            6
      years
            
            
            10
      years
            
            
            10
      years







The
dividend yield is based on estimated future dividend yields. The risk-free rate
for periods within the contractual term of the share option is based on the U.S.
Treasury yield curve in effect at the time of the grant. Expected volatilities
are generally based on historical volatilities.




12.
      Net Income Per Share




The
calculation of net income per common share as restated giving retroactive effect
to any stock dividends and splits is as follows for the years ended
December 31:




2007
            
            
            2006
            
            
            2005Weighted
      average common shares outstanding
            
            
            2,829,376
            
            
            
            2,812,289
            
            
            
            2,827,747Stock
      option adjustment
            
            
            10,861
            
            
            
            58,953
            
            
            
            14,140Weighted
      average common shares outstanding-diluted
            
            
            2,840,237
            
            
            
            2,871,242
            
            
            
            2,841,887Net
      income (applicable to common stock)
            
            $
            2,126,263
            
            
            $
            2,584,779
            
            
            $
            2,458,437Basic
      net income per share
            
            $
            0.75
            
            
            $
            0.92
            
            
            $
            0.87Diluted
      net income per share
            
            $
            0.75
            
            
            $
            0.90
            
            
            $
            0.87




55




13.
      Comprehensive Income




Comprehensive
income is defined as net income plus transactions and other occurrences which
are the result of nonowner changes in equity. For the Company, nonowner equity
changes are comprised of unrealized gains or losses on available for sale
securities, changes in the fair value of the derivative interest rate floor
transaction and the adjustment for the adoption of SFAS 158 related to the
funded status of the defined benefit plan. These items, net of taxes, will be
accumulated with net income in determining comprehensive income. Presented below
is a reconcilement of net income to comprehensive income for the years ended
December 31:




2007
            
            
            2006
            
            
            2005Net
      Income
            
            $
            2,126,263
            
            
            $
            2,584,779
            
            
            $
            2,458,437Other
      comprehensive income:Unrealized
      holding gains (losses) during the period
            
            
            (20,484
            )
            
            
            215,449
            
            
            
            (22,384
            )Retirement
      plan liability adjustment
            
            
            44,299
            
            
            
            —
            
            
            
            —Less:
      Adjustment for security gains realized in net income
            
            
            —
            
            
            
            (2,157,151
            )
            
            
            (839,859
            )Other
      comprehensive income before tax
            
            
            23,815
            
            
            
            (1,941,702
            )
            
            
            (862,243
            )Income
      taxes on comprehensive income
            
            
            9,395
            
            
            
            749,885
            
            
            
            332,998Other
      comprehensive income after tax
            
            
            14,420
            
            
            
            (1,191,817
            )
            
            
            (529,245
            )Comprehensive
      income
            
            $
            2,140,683
            
            
            $
            1,392,962
            
            
            $
            1,929,192







14.
      Capital Standards




The
Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary action taken by regulators that, if undertaken, could have a
direct material effect on the Company’s financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance sheet items as
calculated under regulatory accounting procedures. The Bank’s capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.




Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table below) of total
and Tier 1 capital (as defined) to risk-weighted assets (as defined), and of
Tier 1 capital to average assets (as defined). Management believes, as of
December 31, 2007, that the Bank meets all capital adequacy requirements to
which it is subject. As of December 31, 2007, the most recent notification
from the Federal Reserve Bank and the FDIC categorized the Company and the Bank
as “well capitalized” under the regulatory framework for prompt corrective
action. There are no conditions or events since that notification that
management believes would change the Company’s or the Bank’s
category.




56






14.
      Capital Standards (Continued)




Actual
            
            
            Minimum Capital Adequacy
            
            To Be Well CapitalizedAmount
            Ratio
            
            
            Amount
            
            Ratio
            
            Amount
            RatioDecember 31,
      2007Total
      Capital (to risk-weighted assets)Consolidated
            
            $38,605,000
            13.63
            %
            
            $22,655,000
            
            
            8.0
            %
            
            $28,319,000
            10.0
            %Carrollton
      Bank
            
            37,084,000
            13.31
            %
            
            22,284,000
            
            
            8.0
            %
            
            27,855,000
            10.0
            %Tier
      1 Capital (to risk-weighted assets)Consolidated
            
            34,963,000
            12.35
            %
            
            11,328,000
            
            
            4.0
            %
            
            16,992,000
            6.0
            %Carrollton
      Bank
            
            33,987,000
            12.20
            %
            
            11,142,000
            
            
            4.0
            %
            
            16,713,000
            6.0
            %Tier
      1 Capital (to average assets)Consolidated
            
            34,963,000
            10.03
            %
            
            13,946,000
            
            
            4.0
            %
            
            17,432,000
            5.0
            %Carrollton
      Bank
            
            33,987,000
            9.72
            %
            
            13,980,000
            
            
            4.0
            %
            
            17,475,000
            5.0
            %December 31,
      2006Total
      Capital (to risk-weighted assets)Consolidated
            
            $37,253,000
            13.20
            %
            
            $22,573,000
            
            
            8.0
            %
            
            $28,217,000
            10.0
            %Carrollton
      Bank
            
            35,313,000
            12.60
            %
            
            22,428,000
            
            
            8.0
            %
            
            28,035,000
            10.0
            %Tier
      1 Capital (to risk-weighted assets)Consolidated
            
            33,634,000
            11.92
            %
            
            $11,287,000
            
            
            4.0
            %
            
            16,930,000
            6.0
            %Carrollton
      Bank
            
            32,182,000
            11.48
            %
            
            11,214,000
            
            
            4.0
            %
            
            16,821,000
            6.0
            %Tier
      1 Capital (to average assets)Consolidated
            
            33,634,000
            9.74
            %
            
            $13,824,000
            
            
            4.0
            %
            
            17,280,000
            5.0
            %Carrollton
      Bank
            
            32,182,000
            9.30
            %
            
            13,849,000
            
            
            4.0
            %
            
            17,311,000
            5.0
            %







15.
      Retirement Plans




In the
year ended December 31, 2006, the Company adopted Statement of Financial
Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans” (“SFAS 158”), which requires the
recognition of the funded status of defined benefit postretirement plans and
related disclosures. While it does not impact net income, this resulted in a
one-time adjustment to accumulated other comprehensive income in shareholders’
equity of $484 (net of tax) for the Pension Plan. The Company’s 2005 disclosure
has not been changed as SFAS 158 prohibits retrospective
application.




Effective
December 31, 2004, the Company froze the Defined Benefit Pension Plan.
Participant benefits stopped accruing as of the date of the freeze. No new
participants entered the Plan after December 31, 2004.




57




15.
      Retirement Plans (Continued)




The
following table sets forth the financial status of the Plan as of and for the
years ended December 31:




2007
            
            
            2006
            
            
            2005Change
      in Benefit Obligation:Benefit
      obligation at beginning of year
            
            $
            8,290,339
            
            
            $
            7,944,785
            
            
            $
            7,739,006Service
      cost
            
            
            —
            
            
            
            —
            
            
            
            —Interest
      cost
            
            
            472,592
            
            
            
            469,361
            
            
            
            477,203Actuarial
      loss
            
            
            107,258
            
            
            
            230,830
            
            
            
            61,831Benefits
      paid
            
            
            (365,244
            )
            
            
            (354,637
            )
            
            
            (333,255
            )Benefit
      obligation at end of year
            
            
            8,504,945
            
            
            
            8,290,339
            
            
            
            7,944,785Change
      in Plan Assets:Fair
      value of plan assets at beginning of year
            
            
            8,291,129
            
            
            
            7,952,987
            
            
            
            7,730,718Actual
      return on plan assets
            
            
            687,533
            
            
            
            767,957
            
            
            
            591,608Employer
      contribution
            
            
            —
            
            
            
            —
            
            
            
            —Benefits
      paid and administrative expenses
            
            
            (428,628
            )
            
            
            (429,815
            )
            
            
            (369,339
            )Fair
      value of plan assets at end of year
            
            
            8,550,034
            
            
            
            8,291,129
            
            
            
            7,952,987Funded
      status
            
            $
            45,089
            
            
            $
            790
            
            
            $
            8,202Amounts
      Recognized in the Consolidated Balance Sheets:Prepaid
      benefit cost
            
            $
            45,089
            
            
            $
            790
            
            
            $
            53,652Amounts
      recognized in accumulated other comprehensive income consist
      of:Net(gain)
      loss
            
            $
            (44,299
            )
            
            $
            790
            
            
            $
            —Prior
      service cost (credit)
            
            
            —
            
            
            
            —
            
            
            
            —Net
      amount recognized (before tax effect)
            
            $
            (44,299
            )
            
            $
            790
            
            
            $
            —






2007
            
            
            2006
            
            
            2005Assumptions
      used in Measuring the Projected Benefit Obligation were as Follows for the
      Years Ended December 31:Discount
      rates
            
            
            5.82
            %
            
            
            5.82
            %
            
            
            6.25
            %Rates
      of increase in compensation levels
            
            
            N/A
            
            
            
            N/A
            
            
            
            N/ALong-term
      rate of return on assets
            
            
            5.85
            %
            
            
            8.00
            %
            
            
            8.00
            %Net
      Periodic Pension Expense Includes the Following
Components:Service
      cost
            
            $
            —
            
            
            $
            —
            
            
            $
            —Interest
      cost
            
            
            472,592
            
            
            
            469,361
            
            
            
            477,203Expected
      return on plan assets
            
            
            (475,074
            )
            
            
            (622,784
            )
            
            
            (555,044
            )Net
      periodic pension (benefit)
            
            $
            (2,482
            )
            
            $
            (153,423
            )
            
            $
            (77,841
            )Accumulated
      Benefit Obligation at Year End
            
            $
            8,504,945
            
            
            $
            8,290,339
            
            
            $
            7,944,785Allocation
      of AssetsEquity
      securities
            
            
            59
            %
            
            
            52
            %
            
            
            52
            %Fixed
      income-guaranteed fund
            
            
            41
            %
            
            
            48
            %
            
            
            48
            %100
            %
            
            
            100
            %
            
            
            100
            %







There are
no net transaction obligation (asset), prior service cost (credit) and estimated
net loss (gain) for the Plan that are expected to be amortized from accumulated
other comprehensive income into net periodic benefit cost over the next fiscal
year.




58




15.
      Retirement Plans (Continued)




Benefits
expected to be paid from the Plan are as follows:




Year
            
            Amount2008
            
            $
            370,4002009
            
            
            370,2002010
            
            
            398,5002011
            
            
            414,2002012
            
            
            430,8002013-2017
            
            
            2,574,000




The
Plan’s investment strategy is predicated on its investment objectives and the
risk and return expectations of asset classes appropriate for the Plan.
Investment objectives have been established by considering the Plan’s liquidity
needs and time horizon and the fiduciary standards under ERISA. The asset
allocation strategy is developed to meet the Plan’s long term needs in a manner
designed to control volatility and to reflect the Company’s risk
tolerance.




In
determining the long-term rate of return on pension plan assets assumption, the
target asset allocation is first reviewed. An expected long-term rate of return
is assumed for each asset class, and an underlying inflation rate assumption is
also made. The effects of asset diversification and periodic fund rebalancing
are also considered.




The
Company has a contributory thrift plan qualifying under
Section 401(K) of the Internal Revenue Code. Employees with one year
of service are eligible for participation in the Plan. In conjunction with the
curtailment of the pension plan, the Company expanded the thrift plan to make it
a Safe Harbor Plan. Once an employee has been at the Company for one year, the
Company then contributes 3% of the employee’s salary to the Plan for the
employee’s benefit. The Company also matches 50% of the employee
401(K) contribution up to 6% of employee compensation. Contributions to
this Plan, included in employee benefit expenses, were $319,236, $319,453, and
$292,080, for 2007, 2006, and 2005, respectively.




16.
      Contingencies




The
Company is involved in various legal actions arising from normal business
activities. Management believes that the ultimate liability or risk of loss
resulting from these actions will not materially affect the Company’s financial
position or results of operations.




17.
      Income Taxes




On
January 1, 2007, the Company adopted the Financial Accounting Standards Board
(FASB) Final Interpretation Number 48, “Accounting for Uncertainty in Income
Taxes” (FIN48).  The Company has no adjustments to report with respect
to the effect of adoption of FIN 48.




The
components of income tax expense are as follows for the years ended
December 31:




2007
            
            
            2006
            
            
            2005CurrentFederal
            
            $
            999,915
            
            
            $
            1,082,628
            
            
            $
            989,907State
            
            
            162,767
            
            
            
            180,009
            
            
            
            179,2551,162,682
            
            
            
            1,262,637
            
            
            
            1,169,162Deferred
            
            
            (111,908
            )
            
            
            60,631
            
            
            
            153,209$
            1,050,774
            
            
            $
            1,323,268
            
            
            $
            1,322,371




59




17.
      Income Taxes (Continued)




The
components of the deferred tax benefits were as follows for the years ended
December 31:




2007
            
            
            2006
            
            
            2005Provision
      for loan losses
            
            $
            (75,795
            )
            
            $
            79,612
            
            
            $
            57,124Deferred
      loan origination costs
            
            
            (1,626
            )
            
            
            (20,427
            )
            
            
            (4,812
            )Deferred
      compensation plan
            
            
            (20,330
            )
            
            
            16,466
            
            
            
            (227
            )Depreciation
            
            
            (21,286
            )
            
            
            522
            
            
            
            (120,334
            )Discount
      accretion
            
            
            7,086
            
            
            
            5,178
            
            
            
            (666
            )Retirement
      benefits
            
            
            —
            
            
            
            (20,720
            )
            
            
            30,062FHLB
      stock dividends
            
            
            43
            
            
            
            —
            
            
            
            —Impairment
      loss provisions
            
            
            —
            
            
            
            —
            
            
            
            192,062$
            (111,908
            )
            
            $
            60,631
            
            
            $
            153,209







The
components of the net deferred tax liability were as follows for the years ended
December 31:




2007
            
            
            2006
            
            
            2005Deferred
      tax assetsAllowance
      for loan losses
            
            $
            1,049,861
            
            
            $
            974,066
            
            
            $
            1,053,678Deferred
      compensation plan
            
            
            210,756
            
            
            
            190,426
            
            
            
            206,892Depreciation
            
            
            48,286
            
            
            
            27,000
            
            
            
            27,5221,308,903
            
            
            
            1,191,492
            
            
            
            1,288,092Deferred
      tax liabilitiesPrepaid
      retirement benefits
            
            
            —
            
            
            
            —
            
            
            
            20,720Deferred
      loan origination costs
            
            
            105,019
            
            
            
            106,645
            
            
            
            127,072Unrealized
      gains on available for sale investment securities
            
            
            398,401
            
            
            
            317,406
            
            
            
            1,156,088Discount
      accretion
            
            
            15,430
            
            
            
            8,344
            
            
            
            3,166FHLB
      Stock dividends
            
            
            2,062
            
            
            
            2,019
            
            
            
            2,019520,912
            
            
            
            434,414
            
            
            
            1,309,065Net
      deferred tax asset (liability)
            
            $
            787,991
            
            
            $
            757,078
            
            
            $
            (20,973
            )







The
differences between the federal income tax rate of 34 percent and the
effective tax rate for the Company are reconciled as follows:




2007
            
            2006
            
            2005Statutory
      federal income tax rate
            
            
            34.0
            %
            
            
            34.0
            %
            
            
            34.0
            %Increase
      (Decrease) resulting from:Tax-exempt
      income
            
            
            (4.4
            )
            
            
            (4.5
            )
            
            
            (3.4
            )State
      income taxes, net of federal income tax benefit
            
            
            3.8
            
            
            
            3.8
            
            
            
            4.0Nondeductible
      expense
            
            
            .5
            
            
            
            0.6
            
            
            
            0.4Change
      in state rates
            
            
            (.8
            )
            
            
            —
            
            
            
            —33.1
            %
            
            
            33.9
            %
            
            
            35.0
            %




60




18.
      Lease Commitments




The
Company leases various branch and general office facilities to conduct its
operations. The leases have remaining terms which range from a period of
1 year to 20 years. Most leases contain renewal options which are
generally exercisable at increased rates. Some of the leases provide for
increases in the rental rates at specified times during the lease terms, prior
to the expiration dates.




The
leases generally provide for payment of property taxes, insurance, and
maintenance costs by the Company. The total rental expense for all real property
leases amounted to $1,129,007, $937,160, and $947,957, for 2007, 2006, and 2005,
respectively.




Lease
obligations will require minimum rental payments as follows:




Period
            
            Minimum rentals2008
            
            $
            1,009,6092009
            
            
            880,8562010
            
            
            865,1152011
            
            
            702,5572012
            
            
            636,559Remaining
      years
            
            
            7,363,628$
            11,458,324







19.
      Parent Company Financial
Information




The
balance sheets as of December 31, 2007 and 2006 and statements of income
and cash flows for Carrollton Bancorp (Parent Only) for 2007, 2006, and 2005,
are presented below:




Balance
      Sheets
            
            December 31,2007
            
            
            2006AssetsCash
            
            $
            1,000
            
            
            $
            6,293Interest-bearing
      deposits in subsidiary
            
            
            46,475
            
            
            
            956,518Investment
      in subsidiary
            
            
            34,276,436
            
            
            
            32,593,361Investment
      securities available for sale
            
            
            1,966,123
            
            
            
            2,224,846Other
      assets
            
            
            11,557
            
            
            
            28,270$
            36,301,591
            
            
            $
            35,809,288Liabilities
      and Shareholders’ EquityLiabilities
            
            $
            370,291
            
            
            $
            1,097,910Shareholders’
      EquityCommon
      Stock
            
            
            2,834,975
            
            
            
            2,806,705Additional
      Paid-in Capital
            
            
            18,781,650
            
            
            
            18,372,351Retained
      earnings
            
            
            13,654,180
            
            
            
            12,886,247Accumulated
      other comprehensive income
            
            
            660,495
            
            
            
            646,07535,931,300
            
            
            
            34,711,378$
            36,301,591
            
            
            $
            35,809,288




61




19.
      Parent Company Financial Information (Continued)




Statements
      of Income




Years ended December 31,2007
            
            
            2006
            
            
            2005IncomeDividends
      from subsidiary
            
            $
            776,520
            
            
            $
            258,840
            
            
            $
            608,827Interest
      and dividends
            
            
            59,721
            
            
            
            73,720
            
            
            
            138,592Security
      gains
            
            
            —
            
            
            
            2,157,151
            
            
            
            766,772836,241
            
            
            
            2,489,711
            
            
            
            1,514,191Expenses
            
            
            314,256
            
            
            
            161,751
            
            
            
            163,639Income
      before income taxes and equity in undistributed
              net
      income of subsidiary
            
            
            521,985
            
            
            
            2,327,960
            
            
            
            1,350,552Income
      tax expense (benefit)
            
            
            (112,265
            )
            
            
            785,790
            
            
            
            249,895634,250
            
            
            
            1,542,170
            
            
            
            1,100,657Equity
      in undistributed net income of subsidiary
            
            
            1,492,013
            
            
            
            1,042,609
            
            
            
            1,357,780Net
      Income
            
            $
            2,126,263
            
            
            $
            2,584,779
            
            
            $
            2,458,437







Statements
      of Cash Flows




Years ended December 31,2007
            
            
            2006
            
            
            2005Cash
      Flows from Operating Activities:Net
      income
            
            $
            2,126,263
            
            
            $
            2,584,779
            
            
            $
            2,458,437Adjustments
      to Reconcile Net Income to Net Cash Provided by Operating
      Activities:Equity
      in undistributed net income of subsidiary
            
            
            (1,492,013
            )
            
            
            (1,042,609
            )
            
            
            (1,357,780
            )Gains
      on disposal of securities
            
            
            —
            
            
            
            (2,157,151
            )
            
            
            (766,772
            )Stock
      based compensation expense
            
            
            17,841
            
            
            
            13,447
            
            
            
            —Stock
      issued under 2007 Equity Plan
            
            
            58,500
            
            
            
            —
            
            
            
            —Decrease
      (increase) in other assets
            
            
            16,715
            
            
            
            (2,457
            )
            
            
            (74
            )Increase
      (decrease) in other liabilities
            
            
            (645,540
            )
            
            
            13,126
            
            
            
            309,958Net
      cash provided by (used in) operating activities
            
            
            81,766
            
            
            
            (590,865
            )
            
            
            643,769Cash
      Flows from investing Activities:Purchase
      of securities available for sale
            
            
            —
            
            
            
            (117,269
            )
            
            
            —Proceeds
      from sales of securities available for sale
            
            
            —
            
            
            
            2,766,852
            
            
            
            1,016,133Net
      cash provided by investing activities
            
            
            —
            
            
            
            2,649,583
            
            
            
            1,016,133Cash
      Flows from Financing Activities:Dividends
      paid
            
            
            (1,358,330
            )
            
            
            (1,266,063
            )
            
            
            (1,130,262
            )Common
      stock repurchase and retirement
            
            
            (264,271
            )
            
            
            (128,850
            )
            
            
            (599,250
            )Stock
      options exercised
            
            
            592,709
            
            
            
            52,219
            
            
            
            207,039Income
      tax benefit from exercise of stock options
            
            
            32,790
            
            
            
            7,014
            
            
            
            18,166Net
      cash used in financing activities
            
            
            (997,102
            )
            
            
            (1,335,680
            )
            
            
            (1,504,307
            )Net
      increase (decrease) in cash
            
            
            (915,336
            )
            
            
            723,038
            
            
            
            155,595Cash
      and cash equivalents at beginning of year
            
            
            962,811
            
            
            
            239,773
            
            
            
            84,178Cash
      and cash equivalents at end of year
            
            $
            47,475
            
            
            $
            962,811
            
            
            $
            239,773Noncash
      Activities:Income
      taxes paid, net of cash received from subsidiaries
            
            $
            546,578
            
            
            $
            769,473
            
            
            $
            36,615






62


20.
      Fair Value of Financial Instruments




The
following methods and assumptions were used to estimate the fair value of each
class of financial instrument.




Cash
      and cash equivalents




The
carrying amount of cash and due from banks is a reasonable estimate of fair
value.




Federal
      funds sold and Federal Home Loan Bank
deposit




The
carrying amount of federal funds sold and Federal Home Loan Bank deposit is a
reasonable estimate of fair value.




Investment
      Securities




The fair
values of securities held to maturity and securities available for sale are
based upon quoted market prices or dealer quotes.




Loans
      held for sale




The fair
value of residential mortgage loans originated for sale is estimated by
discounting future cash flows using current rates for which similar loans would
be made to borrowers with similar credit histories.




Loans,
      net




The fair
value of loans receivable is estimated by discounting future cash flows using
current rates for which similar loans would be made to borrowers with similar
credit histories.




Deposit
      liabilities




The fair
value of demand deposits and savings accounts is the amount payable on demand.
The fair value of fixed maturity certificates of deposit is estimated using the
rates currently offered for deposits of similar remaining
maturities.




Federal
      funds purchased and securities sold under agreements to
      repurchase




The
carrying amount of federal funds purchased and securities sold under agreements
to repurchase is a reasonable estimate of fair value.




Advances
      from the FHLB




The fair
value of long-term FHLB advances is estimated by discounting the value of
contractual cash flows using rates currently offered for advances with similar
terms and remaining maturities.




Commitments
      to extend credit, standby letters of credit and financial guarantees
      written




The
Company charges fees for commitments to extend credit. Interest rates on loans
for which these commitments are extended are normally committed for periods of
less than one month. Fees charged on standby letters of credit and other
financial guarantees are deemed to be immaterial and these guarantees are
expected to be settled at face amount or expire unused. It is impractical to
assign any fair value to these commitments.




December 31, 2007
            
            
            December 31, 2006Carrying
              amount
            
            
            Fair
              value
            
            
            Carrying
              amount
            
            
            Fair
              valueFinancial
      assetsCash
      and cash equivalents
            
            $
            16,926,981
            
            
            $
            16,926,981
            
            
            $
            13,622,766
            
            
            $
            13,622,766Investment
      securities (total)
            
            
            52,792,208
            
            
            
            52,786,529
            
            
            
            55,064,620
            
            
            
            54,824,915Federal
      Home Loan Bank stock
            
            
            1,305,100
            
            
            
            1,305,100
            
            
            
            1,704,500
            
            
            
            1,704,500Loans
      held for sale
            
            
            7,579,765
            
            
            
            7,761,521
            
            
            
            7,489,290
            
            
            
            7,524,363Loans,
      net
            
            
            258,353,408
            
            
            
            264,548,464
            
            
            
            256,870,293
            
            
            
            258,073,223Financial
      liabilitiesNoninterest-bearing
      deposits
            
            
            49,619,610
            
            
            
            49,619,610
            
            
            
            50,069,560
            
            
            
            50,069,560Interest-bearing
      deposits
            
            
            236,019,015
            
            
            
            237,021,786
            
            
            
            227,834,241
            
            
            
            227,711,750Federal
      funds purchased and securities sold under agreements to
      repurchase
            
            
            14,589,152
            
            
            
            14,589,152
            
            
            
            13,405,463
            
            
            
            13,405,463Advances
      from the Federal Home Loan Bank
            
            
            15,000,000
            
            
            
            15,009,000
            
            
            
            22,000,000
            
            
            
            21,995,650






63




21.
      Segment Information




The
Company has reportable segments that are strategic business units offering
complimentary products and services to the core business of banking. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company provides the accounting
for all segments and charges a management fee for this service to the other
segments. The Company has also lent money to various segments with terms similar
to those offered third parties.




The
Commercial/Retail Bank segment provides full service retail and business banking
services, including lending and deposit services, investment activities and
other customary services associated with a bank.




The
Electronic Banking segment provides national point of sale transaction
originations, home banking, and debit card transaction processing.




The
Brokerage segment provides full service brokerage services for stocks, bonds,
mutual funds and annuities.




The
Mortgage Unit segment provides residential mortgage lending products and
services.




Segment
information for the Company for 2007 is as follows:




Commercial/
                Retail Bank
              
              
              
              Electronic
                Banking
              
              
              
              Brokerage
              
              
              
              Mortgage
                Unit
              
              
              
              Segment
                Totals
              
              
              
              Eliminations
              
              
              
              ConsolidatedInterest
      income
              
              $
              23,240,077
              
              
              $
              —
              
              
              $
              —
              
              
              $
              1,109,984
              
              
              $
              24,350,061
              
              
              $
              673,701
              
              
              $
              23,676,360Interest
      expense
              
              
              (10,436,025
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (10,436,025
              )
              
              
              (673,701
              )
              
              
              (9,762,324
              )Net
      interest income
              
              
              12,804,052
              
              
              
              —
              
              
              
              —
              
              
              
              1,109,984
              
              
              
              13,914,036
              
              
              
              —
              
              
              
              13,914,036Provision
      for loan losses
              
              
              (464,000
              )
              
              
              —
              
              
              
              —
              
              
              
              (72,000
              )
              
              
              (536,000
              )
              
              
              
              
              
              
              (536,000
              )Noninterest
      income
              
              
              1,337,346
              
              
              
              1,985,975
              
              
              
              677,647
              
              
              
              2,273,174
              
              
              
              6,274,142
              
              
              
              
              
              
              
              6,274,142Intersegment
      income
              
              
              709,291
              
              
              
              21,067
              
              
              
              419
              
              
              
              (635,125
              )
              
              
              95,652
              
              
              
              (95,652
              )
              
              
              —Noninterest
      expenses
              
              
              (13,173,053
              )
              
              
              (828,714
              
              
              
              (420,867
              )
              
              
              (2,148,159
              )
              
              
              (16,570,793
              )
              
              
              (95,652
              )
              
              
              (16,475,141
              )Income
      before income taxes
              
              
              1,213,636
              
              
              
              1,178,328
              
              
              
              257,199
              
              
              
              527,874
              
              
              
              3,177,037
              
              
              
              —
              
              
              
              3,177,037Income
      taxes
              
              
              (287,197
              )
              
              
              (455,070
              
              
              
              (99,330
              )
              
              
              (209,177
              )
              
              
              (1,050,774
              )
              
              
              —
              
              
              
              (1,050,774
              )Net
      income
              
              $
              926,439
              
              
              $
              723,258
              
              
              $
              157,869
              
              
              $
              318,697
              
              
              $
              2,126,263
              
              
              $
              —
              
              
              $
              2,126,263Segment
      assets
              
              $
              351,498,227
              
              
              $
              81,705
              
              
              $
              106,558
              
              
              $
              13,382,086
              
              
              $
              365,068,576
              
              
              $
              (12,219,521
              )
              
              $
              352,849,055Expenditures
      for segment purchases of premises, equipment and software
              
              $
              2,338,287
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              2,338,287
              
              
              $
              —
              
              
              $
              2,338,287






A
reconciliation of total segment assets to consolidated total assets follows as
of December 31, 2007:




Total
      segment assets
            
            $
            365,068,576Elimination
      of intersegment loans
            
            
            (11,368,034
            )Elimination
      of intersegment deposit accounts
            
            
            (851,487
            )$
            352,849,055




64


21.
      Segment Information(Continued)




Segment
information for the Company for 2006 is as follows




Commercial/
              Retail Bank
            
            
            Electronic
              Banking
            
            
            Brokerage
            
            
            Mortgage
              Unit
            
            
            Segment
              Totals
            
            
            Eliminations
            
            
            Consolidated


Interest
      income
            
            $
            22,680,213
            
            
            $
            —
            
            
            $
            —
            
            
            $
            1,222,566
            
            
            $
            23,902,779
            
            
            $
            (775,275
            )
            
            $
            23,127,504Interest
      expense
            
            
            (9,512,725
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (9,512,725
            )
            
            
            775,275
            
            
            
            8,737,450Net
      interest income
            
            
            13,167,488
            
            
            
            —
            
            
            
            —
            
            
            
            1,222,566
            
            
            
            14,390,054
            
            
            
            —
            
            
            
            14,390,054Provision
      for loan losses
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Noninterest
      income
            
            
            3,779,786
            
            
            
            2,013,943
            
            
            
            647,301
            
            
            
            2,457,966
            
            
            
            8,898,996
            
            
            
            —
            
            
            
            8,898,996Intersegment
      income
            
            
            793,360
            
            
            
            23,285
            
            
            
            1,398
            
            
            
            (724,140
            )
            
            
            93,903
            
            
            
            (93,903
            )
            
            
            —Noninterest
      expenses
            
            
            (16,102,581
            )
            
            
            (701,085
            )
            
            
            (402,917
            )
            
            
            (2,268,323
            )
            
            
            (19,474,906
            )
            
            
            93,903
            
            
            
            19,381,003Income
      before income taxes
            
            
            1,638,053
            
            
            
            1,336,143
            
            
            
            245,782
            
            
            
            688,069
            
            
            
            3,908,047
            
            
            
            —
            
            
            
            3,908,047Income
      taxes
            
            
            (441,533
            )
            
            
            (516,018
            )
            
            
            (93,441
            )
            
            
            (272,276
            )
            
            
            (1,323,268
            )
            
            
            —
            
            
            
            (1,323,268
            )Net
      income
            
            $
            1,196,520
            
            
            $
            820,125
            
            
            $
            152,341
            
            
            $
            415,793
            
            
            $
            2,584,779
            
            
            $
            —
            
            
            $
            2,584,779Segment
      assets
            
            $
            348,578,067
            
            
            $
            15,848
            
            
            $
            26,702
            
            
            $
            17,736,965
            
            
            $
            366,357,582
            
            
            $
            (16,532,830
            )
            
            $
            349,824,752Expenditures
      for segment purchases of premises, equipment and software
            
            $
            885,945
            
            
            $
            —
            
            
            $
            —
            
            
            $
            15,456
            
            
            $
            901,401
            
            
            $
            —
            
            
            $
            901,401












A
reconciliation of total segment assets to consolidated total assets follows as
of December 31, 2006:




Total
      segment assets
            
            $
            366,357,582Elimination
      of intersegment loans
            
            
            (14,934,950
            )Elimination
      of intersegment deposit accounts
            
            
            (1,597,880
            )$
            349,824,752







Segment
information for the Company for 2005 is as follows:




Commercial/
              Retail Bank
            
            
            Electronic
              Banking
            
            
            Brokerage
            
            
            Mortgage
              Unit
            
            
            Segment
              Totals
            
            
            Eliminations
            
            
            Consolidated


Interest
      income
            
            $
            17,177,300
            
            
            $
            —
            
            
            $
            —
            
            
            $
            1,366,403
            
            
            $
            18,543,703
            
            
            $
            527,676
            
            
            $
            19,071,379Interest
      expense
            
            
            (6,741,963
            )
            
            
            (105,444
            )
            
            
            —
            
            
            
            —
            
            
            
            (6,847,407
            )
            
            
            (527,676
            )
            
            
            (7,375,083
            )Net
      interest income
            
            
            10,435,337
            
            
            
            (105,444
            )
            
            
            —
            
            
            
            1,366,403
            
            
            
            11,696,296
            
            
            
            —
            
            
            
            11,696,296Provision
      for loan losses
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Noninterest
      income
            
            
            2,466,304
            
            
            
            4,871,076
            
            
            
            667,510
            
            
            
            2,713,746
            
            
            
            10,718,636
            
            
            
            —
            
            
            
            10,718,636Intersegment
      income
            
            
            598,180
            
            
            
            —
            
            
            
            2,906
            
            
            
            (512,785
            )
            
            
            88,301
            
            
            
            (88,301
            )
            
            
            —Noninterest
      expenses
            
            
            (11,919,891
            )
            
            
            (3,727,831
            )
            
            
            (412,222
            )
            
            
            (2,662,481
            )
            
            
            (18,722,425
            )
            
            
            88,301
            
            
            
            (18,634,124
            )Income
      before income taxes
            
            
            1,579,930
            
            
            
            1,037,801
            
            
            
            258,194
            
            
            
            904,883
            
            
            
            3,780,808
            
            
            
            —
            
            
            
            3,780,808Income
      taxes
            
            
            (472,393
            )
            
            
            (400,798
            )
            
            
            (99,714
            )
            
            
            (349,466
            )
            
            
            (1,322,371
            )
            
            
            —
            
            
            
            (1,322,371
            )Net
      income
            
            $
            1,107,537
            
            
            $
            637,003
            
            
            $
            158,480
            
            
            $
            555,417
            
            
            $
            2,458,437
            
            
            $
            —
            
            
            $
            2,458,437Segment
      assets
            
            $
            358,760,082
            
            
            $
            3,691,629
            
            
            $
            82,512
            
            
            $
            23,749,243
            
            
            $
            386,283,466
            
            
            $
            (25,816,320
            )
            
            $
            360,467,146Expenditures
      for segment purchases of premises, equipment and software
            
            $
            655,832
            
            
            $
            211,910
            
            
            $
            —
            
            
            $
            35,201
            
            
            $
            902,943
            
            
            $
            —
            
            
            $
            902,943







A
reconciliation of total segment assets to consolidated total assets follows as
of December 31, 2005:




Total
      segment assets
            
            $
            386,283,466Elimination
      of intersegment loans
            
            
            (25,065,528
            )Elimination
      of intersegment deposit accounts
            
            
            (750,792
            )$
            360,467,146




65







22.
Consolidated Quartely Results of Operations (Unaudited)




Year Ended December 31,2007First Quarter
            
            Second Quarter
            
            Third Quarter
            
            Fourth QuarterInterest
      income
            
            $
            5,837,298
            
            
            $
            6,028,065
            
            
            $
            6,020,330
            
            
            $
            5,790,667Interest
      expense
            
            
            2,408,583
            
            
            
            2,465,421
            
            
            
            2,472,873
            
            
            
            2,415,447Net
      interest income
            
            
            3,428,715
            
            
            
            3,562,644
            
            
            
            3,547,457
            
            
            
            3,375,220Provision
      for loan losses
            
            
            66,000
            
            
            
            99,000
            
            
            
            99,000
            
            
            
            272,000Other
      noninterest income
            
            
            1,598,570
            
            
            
            1,616,030
            
            
            
            1,563,046
            
            
            
            1,496,496Noninterest
      expenses
            
            
            4,089,425
            
            
            
            4,384,615
            
            
            
            3,864,045
            
            
            
            4,137,056Income
      before income taxes
            
            
            871,860
            
            
            
            695,059
            
            
            
            1,147,458
            
            
            
            462,660Income
      taxes
            
            
            270,968
            
            
            
            242,418
            
            
            
            334,436
            
            
            
            202,952Net
      income
            
            $
            600,892
            
            
            $
            452,641
            
            
            $
            813,022
            
            
            $
            259,708Net
      income per share — basic
            
            $
            0.21
            
            
            $
            0.16
            
            
            $
            0.29
            
            
            $
            0.09Cash
      dividends per share
            
            $
            0.12
            
            
            $
            0.12
            
            
            $
            0.12
            
            
            $
            0.12Market
      prices: high
            
            $
            18.00
            
            
            $
            18.40
            
            
            $
            16.73
            
            
            $
            14.85low
            
            $
            16.40
            
            
            $
            15.55
            
            
            $
            12.00
            
            
            $
            11.25









Year Ended December 31, 2006   First Quarter
              
              
              First Quarter
              
              
              Third Quarter
              
              
              Fourth QuarterInterest
      income
              
              $
              5,566,706
              
              
              $
              5,652,219
              
              
              $
              5,855,415
              
              
              $
              6,053,164Interest
      expense
              
              
              2,082,985
              
              
              
              2,052,221
              
              
              
              2,237,219
              
              
              
              2,365,025Net
      interest income
              
              
              3,483,721
              
              
              
              3,599,998
              
              
              
              3,618,196
              
              
              
              3,688,139Gains
      on security sales
              
              
              2,157,176
              
              
              
              —
              
              
              
              —
              
              
              
              —Other
      noninterest income
              
              
              1,783,075
              
              
              
              1,986,531
              
              
              
              1,555,033
              
              
              
              1,417,182Noninterest
      expenses
              
              
              6,088,968
              
              
              
              5,558,716
              
              
              
              3,859,040
              
              
              
              3,874,280Income
      before income taxes
              
              
              1,335,004
              
              
              
              27,813
              
              
              
              1,314,189
              
              
              
              1,231,041Income
      taxes
              
              
              467,146
              
              
              
              (30,557
              )
              
              
              459,078
              
              
              
              427,601Net
      income
              
              $
              867,858
              
              
              $
              58,370
              
              
              $
              855,111
              
              
              $
              803,440Net
      income per share — basic
              
              $
              0.31
              
              
              $
              0.02
              
              
              $
              0.30
              
              
              $
              0.29Cash
      dividends per share
              
              $
              0.11
              
              
              $
              0.11
              
              
              $
              0.11
              
              
              $
              0.12Market
      prices: high
              
              $
              15.95
              
              
              $
              18.80
              
              
              $
              18.00
              
              
              $
              19.45low
              
              $
              14.40
              
              
              $
              15.64
              
              
              $
              16.11
              
              
              $
              16.99


66




22.
      Consolidated Quarterly Results of Operations (Unaudited) (Continued)Year Ended December 31, 2005


First Quarter
            
            
            Second Quarter
            
            
            
            Third Quarter
            
            
            Fourth QuarterInterest
      income
            $
            4,275,029
            
            $
            4,512,073
            
            
            $
            4,957,555
            
            $
            5,326,722Interest
      expense
            
            (1,555,268
            )
            
            (1,766,890
            )
            
            
            (1,937,526
            )
            
            (2,115,399
            )Net
      interest income
            
            2,719,761
            
            
            2,745,183
            
            
            
            3,020,029
            
            
            3,211,323Gains
      on security sales
            
            73,087
            
            
            —
            
            
            
            766,772
            
            
            —Other
      noninterest income
            
            2,255,502
            
            
            2,649,218
            
            
            
            2,615,235
            
            
            2,358,822Noninterest
      expenses
            
            (4,367,243
            )
            
            (4,435,408
            )
            
            
            (4,736,498
            )
            
            (5,094,975
            )Income
      before income taxes
            
            681,107
            
            
            958,993
            
            
            
            1,665,538
            
            
            475,170Income
      taxes
            
            (268,511
            )
            
            (324,661
            )
            
            
            (629,609
            )
            
            (99,590
            )Net
      income
            $
            412,596
            
            $
            634,332
            
            
            $
            1,035,929
            
            $
            375,580Net
      income per share — basic
            $
            0.15
            
            $
            0.22
            
            
            $
            0.37
            
            $
            0.13Cash
      dividends per share
            $
            0.10
            
            $
            0.10
            
            
            $
            0.10
            
            $
            0.10Market
      prices: high
            $
            17.00
            
            $
            17.00
            
            
            $
            16.29
            
            $
            15.00low
            $
            14.12
            
            $
            14.25
            
            
            $
            13.95
            
            $
            14.00






67




Item
9: Changes in and Disagreements With Accountants On Accounting and




Financial
Disclosure




There
have been no changes in or disagreements with accountants, on accounting and
financial disclosure during 2007.




Item
      9A(T): Controls and Procedures




Evaluation of Disclosure Controls and
Procedures.  We maintain disclosure controls and procedures
that are designed to ensure that information required to be disclosed in
Exchange Act reports is recorded, processed, summarized and reported within the
time periods specified in the rules and forms of the Securities and Exchange
Commission, and that such information is accumulated and communicated to our
management, including the Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required
disclosure.  Management necessarily applied its judgment in assessing
the costs and benefits of such controls and procedures which, by their nature,
can provide only reasonable assurance regarding management’s control
objectives.




We
carried out an evaluation, under the supervision and with the participation of
our management , including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15, as of the end of
the fiscal period covered by this report on Form 10-K.  Based upon
that evaluation, each of our Chief Executive Officer and our Chief Financial
Officer concluded that our disclosure controls and procedures are effective in
timely alerting them to material information relating to us required to be
disclosed in our Exchange Act reports.




Management’s Report on Internal
Control over Financial Reporting.Management is responsible
for establishing and maintaining adequate internal control over financial
reporting as such term is defined in Exchange Act Rules
13a-15(f).  The Company’s internal controls over financial reporting
is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting
principles.  Because of its inherent limitations, internal controls
over financial reporting may not prevent or detect
misstatements.  Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may be inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate.




Under the
supervision and with the participation of the Company’s Chief Executive Officer
and Chief Financial Officer, management conducted an evaluation of the
effectiveness of the Company’s internal control over financial reporting as of
December 31, 2007 based on the framework in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.  Based on this evaluation, management concluded that the
Company’s internal control over financial reporting was effective as of December
31, 2007 under this framework.




This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this annual report.




Changes in Internal Control over
Financial Reporting.  In connection with our evaluation, no
change was identified in our internal controls over financial reporting that
occurred during the fourth quarter of 2007 that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial
reporting.




Item
      9B: Other Information




None.




PART III







Item
      10: Directors, Executive Officers and Corporate
  Governance




The
information required by this Item is incorporated by reference to the
information appearing under the captions “Election of Directors,” “Executive
Officers” and “Section 16(a) Beneficial Ownership Reporting
Compliance” in the Company’s definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on May 13, 2008.




Item
      11: Executive Compensation




The
information required by this Item is incorporated by reference to the
information appearing under the captions “Executive Compensation,” “Outstanding
Equity Awards at 2007 Fiscal Year End,” “Grants of Plan-Based Awards,” “Option
Exercises and Stocks Vested” and “Pension Benefits and Perquisites” in the
Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to
be held on May 13, 2008.




68




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




The
information required by this Item is incorporated by reference to the
information appearing under the caption “Security Ownership of Directors and
Executive Officers” and “Certain Beneficial Owners” in the Company’s definitive
Proxy Statement for the Annual Meeting of Shareholders to be held on
May 13, 2008.




Item
      13: Certain Relationships and Related Transactions and Director
      Independence




The
information required by this Item is hereby incorporated by reference to the
information appearing under the caption “Certain Transactions and Relationships”
in the Company’s definitive Proxy Statement for the Annual Meeting of
Shareholders to be held on May 13, 2008.




Item
      14: Principal Accountant Fees and
Services




The
information required by this Item is hereby incorporated by reference to the
information appearing under the caption “Audit Fees and Services” in the
Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to
be held on May 13, 2008.




PART IV







Item
      15: Exhibits and Financial Statement
Schedules




1.
      Financial Statements


Carrollton
Bancorp and Subsidiaries:


Report of
Independent Registered Public Accounting Firm


Consolidated
Balance Sheets as of December 31, 2007 and 2006


Consolidated
Statements of Income for the years ended December 31, 2007, 2006, and
2005


Consolidated
Statements of Changes in Shareholders’ Equity for the years ended
December 31, 2007, 2006, and 2005


Consolidated
Statements of Cash Flows for the years ended December 31, 2007, 2006, and
2005


Notes to
Consolidated Financial Statements


2. Financial
      Statement Schedules


None


3.
      Exhibits




Exhibit
              Number
            
            Description3(i)
            
            Articles
      of Incorporation of Carrollton Bancorp(1)3(ii)
            
            By-Laws
      of Carrollton Bancorp(1)10.1
            
            Lease
      dated January 24, 1989 by and between Hill Management
      Services, Inc. and The Carrollton Bank of
    Baltimore.(1)10.2
            
            Lease
      dated July 21, 1989 by and between Hill Management
      Services, Inc. and The Carrollton Bank of
    Baltimore.(1)10.7
            
            Lease
      dated July 19, 1988 by and between Northway Limited Partnership and
      The Carrollton Bank of Baltimore.(1)10.8
            
            Lease
      dated August 11, 1994 by and between KIMCO and Carrollton
      Bank.(2)10.9
            
            Lease
      dated October 11, 1994 by and between Ridgeview Associates Limited
      Partnership and Carrollton Bank.(2)10.12
            
            Lease
      dated January 15, 2004 by and between Turf Village Offices and
      Carrollton Bank (2300 York Road, Suite 114, 115,
  116)10.14
            
            Lease
      dated February 15, 2005 by and between Turf Village Offices and
      Carrollton Bank (2300 York Road, Suites 213, 214, 215,
  216)10.15
            
            Lease
      dated February 18, 2005 by and between Broadway 205 Associates, LLP
      and Carrollton Mortgage Services, Inc.10.16
            
            Lease
      dated October 26, 2005 by and between Arthur Lea Stabler and Helen H.
      Stabler and Carrollton Bank10.17
            
            Lease
      dated June 11, 2004 by and between Mario J. Orlando and Matthew J.
      Salafia and Carrollton Mortgage Services, Inc.10.18
            
            Lease
      dated November 4, 2003 by and between Hickory Crossing, LLC and
      Carrollton Bank10.19
            
            Lease
      dated October 31, 1997 between The Avenue at White Marsh, LLC and
      Carrollton Bank10.20
            
            Lease
      dated January 13, 2006 by and between Scotts Corner LLLP and
      Carrollton Bank10.21
            
            Lease
      dated April 27, 2006 by and between Arbutus Shopping Center Limited
      Partnership and Carrollton Bank





69


Exhibit
                Number
              
              Description10.22
              
              Employment
      agreement with Gary M. Jewell(3)10.23
              
              Lease
      dated August 13, 2007 by and between Tarragon, Inc. and Carrollton
      Bank10.24
              
              Employment
      agreement with Robert A. Altieri(4)10.25
              
              Employment
      agreement with Lola B. Stokes(5)10.26
              
              Employment
      agreement with James M. Uveges(6)21.1
              
              Subsidiaries
      of Carrollton Bancorp23.1
              
              Consent
      of Independent Registered Public Accounting Firm by Exchange Act
      Rule 13-a-14(a)31.1
              
              Certification
      by the Principal Executive Officer required by Exchange Act
      Rule 13-a-14(a)31.2
              
              Certification
      by Principal Financial Officer required by Exchange Act
      Rule 13-a-14(a)32.1
              
              Certification
      by the Principal Executive Officer32.2
              
              Certification
      by the Principal Financial
Officer




(1)  
      Incorporated by reference from Registration Statement dated
      January 12, 1990 on SEC Form S-4 (1933 Act File No.:
      33-33027).


(2)  
      Incorporated by reference from Annual Report on Form 10-KSB for the
      fiscal year ended December 31, 1994 (1934 Act File No.:
      0-23090).


(3)  
      Incorporated by reference to the Registrant’s Form 8-K filed 6/19/2007
      (File No.: 000-23090)


(4)  
      Incorporated by reference to the Registrant’s Form 8-K filed 9/25/2007
      (File No.: 000-23090).


(5) 
       Incorporated by reference to the Registrant’s Form 8-K filed
      10/24/2007 (File No.: 000-23090).


(6)  
      Incorporated by reference to the Registrant’s Form 8-K filed 11/8/2007
      (File No.: 000-23090).


70


Signatures




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




CARROLLTON
BANCORP




(Registrant)




March 20,
      2008
            
            By:
            
            /s/
      Robert A. AltieriRobert
      A. AltieriPresident
      and Chief Executive Officer







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




March 20,
      2008
            
            By:
            
            /s/
      Robert A. AltieriRobert
      A. AltieriPresident
      and Chief Executive Officer







Principal
      Financial and Accounting Officer




March 20,
      2008
            
            By:
            
            /s/
      James M. UvegesJames
      M. Uveges(Principal
      financial and accounting officer)Senior
      Vice President and Chief Financial OfficerBoard
      of DirectorsMarch 20,
      2008
            
            By:
            
            /s/
      Robert J. AumillerRobert
      J. AumillerDirectorMarch 20,
      2008
            
            By:
            
            /s/
      Steven K. BreedenSteven
      K. BreedenDirectorMarch 20,
      2008
            
            By:
            
            /s/
      Albert R. CounselmanAlbert
      R. CounselmanChairman
      of the BoardMarch 20,
      2008
            
            By:
            
            /s/
      Harold I. HackermanHarold
      I. HackermanDirectorMarch 20,
      2008
            
            By:
            
            /s/
      William L. HermannWilliam
      L. HermannDirector





71




March 20,
      2008
            
            By:
            
            /s/
      David P. HesslerDavid
      P. HesslerDirectorMarch 20,
      2008
            
            By:
            
            /s/
      Howard S. KleinHoward
      S. KleinDirectorMarch 20,
      2008
            
            By:
            
            /s/
      Ben F. MasonBen
      F. MasonDirectorMarch 20,
      2008
            
            By:
            
            /s/
      Charles E. Moore, Jr.Charles
      E. Moore, Jr.DirectorMarch 20,
      2008
            
            By:
            
            /s/
      John Paul RogersJohn
      Paul RogersDirectorMarch 20,
      2008
            
            By:
            
            /s/
      William C. Rogers, Jr.William
      C. Rogers, Jr.DirectorMarch 20,
      2008
            
            By:
            
            /s/
      Francis X. RyanFrancis
      X. RyanDirector




72


Exhibit
Index




Exhibit
              Number
            
            Description
            
            Sequentially
              Numbered
      Page3(i)
            
            Articles
      of Incorporation of Carrollton Bancorp
            
            
            (1)3(ii)
            
            By-Laws
      of Carrollton Bancorp
            
            
            (1)10.1
            
            Lease
      dated January 24, 1989 by and between Hill Management Services, Inc. and
      The Carrollton Bank of Baltimore.
            
            
            (1)10.2
            
            Lease
      dated July 21, 1989 by and between Hill Management Services, Inc. and The
      Carrollton Bank of Baltimore.
            
            
            (1)10.7
            
            Lease
      dated July 19, 1988 by and between Northway Limited Partnership and The
      Carrollton Bank of Baltimore.
            
            
            (1)10.8
            
            Lease
      dated August 11, 1994 by and between KIMCO and Carrollton
      Bank.
            
            
            (2)10.9
            
            Lease
      dated October 11, 1994 by and between Ridgeview Associates Limited
      Partnership and Carrollton Bank.
            
            
            (2)10.12
            
            Lease
      dated January 15, 2004 by and between Turf Village Offices and Carrollton
      Bank (2300 York Road, Suite 114, 115, 116)10.14
            
            Lease
      dated February 15, 2005 by and between Turf Village Offices and Carrollton
      Bank (2300 York Road, Suites 213, 214, 215, 216)10.15
            
            Lease
      dated February 18, 2005 by and between Broadway 205 Associates, LLP
      and Carrollton Mortgage Services, Inc.10.16
            
            Lease
      dated October 26, 2005 by and between Arthur Lea Stabler and Helen H.
      Stabler and Carrollton Bank10.17
            
            Lease
      dated June 11, 2004 by and between Mario J. Orlando and Matthew J. Salafia
      and Carrollton Mortgage Services, Inc.10.18
            
            Lease
      dated November 4, 2003 by and between Hickory Crossing, LLC and Carrollton
      Bank10.19
            
            Lease
      dated October 31, 1997 between The Avenue at White Marsh, LLC and
      Carrollton Bank10.20
            
            Lease
      dated January 13, 2006 by and between Scotts Corner LLLP and
      Carrollton Bank10.21
            
            Lease
      dated April 27, 2006 by and between Arbutus Shopping Center Limited
      Partnership and Carrollton Bank10.22
            
            Employment
      agreement with Gary M. Jewell
            
            
            (3)10.23
            
            Lease
      dated August 13, 2007 by and between Tarragon, Inc. and Carrollton
      Bank10.24
            
            Employment
      agreement with Robert A. Altieri
            
            
            (4)10.25
            
            Employment
      agreement with Lola B. Stokes
            
            
            (5)10.26
            
            Employment
      agreement with James M. Uveges
            
            
            (6)21.1
            
            Subsidiaries
      of Carrollton Bancorp23.1
            
            Consent
      of Independent Registered Public Accounting Firm required by Exchange Act
      Rule 13-a-14(a)31.1
            
            Certification
      by the Principal Executive Officer required by Exchange Act
      Rule 13a-14(a)31.2
            
            Certification
      by the Principal Financial Officer required by Exchange Act
      Rule 13a-14(a)32.1
            
            Certification
      by the Principal Executive Officer32.2
            
            Certification
      by Principal Financial Officer







(1) 
      Incorporated by reference from Registration Statement dated
      January 12, 1990 on SEC Form S-4 (1933 Act File No.:
      33-33027).




(2) 
      Incorporated by reference from Annual Report on Form 10-KSB for the
      fiscal year ended December 31, 1994
              (1934
      Act File No.: 0-23090).




(3) 
      Incorporated by reference to the Registrant’s Form 8-K filed June19, 2007
      (File No.: 000-23090)




(4)  Incorporated
      by reference to the Registrant’s Form 8-K filed September 25, 2007 (File
      No. :  000-23090)




(5)  Incorporated
      by reference to the Registrant’s Form 8-K filed October 24, 2007 (File No.
      :  000-23090)




(6)  Incorporated
      by reference to the Registrant’s Form 8-K filed November 8, 2007 (File No.
      :  000-23090)