United
States Securities and Exchange Commission


Washington,D.C.
20549




FORM 10-K




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




or




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




For the
fiscal year ended December 31, 2008




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 o No x




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 herein, 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, a non-accelerated filer or a smaller reporting company. See
definition of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large
accelerated filer o Accelerated
filer o Non-accelerated
filer o (Do
not check box if a smaller reporting company) Smaller reporting company 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 $30.3 million. For the purpose of this calculation, directors and
executive officers of the registrant are considered affiliates.




At
March 3, 2009, the Registrant had 2,564,988 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 12,
2009, are incorporated by reference in Part III of this
Form 10-K.







Table
of Contents




Part IItem
      1 —
            
            Business
            
            2Item
      1A —
            
            Risk
      Factors
            
            10Item
      2 —
            
            Properties
            
            13Item
      3 —
            
            Legal
      Proceedings
            
            14Item
      4 —
            
            Submission
      of Matters to a Vote of Security Holders
            
            14Part IIItem
      5 —
            
            Market
      for Registrant’s Common Equity, Related Shareholder Matters and Issuer
      Purchases of Equity Securities
            
            15Item
      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
            
            36Item
      8 —
            
            Financial
      Statements and Supplementary Data
            
            37Item
      9—
            
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            
            69Item
      9A(T) —
            
            Controls
      and Procedures
            
            69Item
      9B —
            
            Other
      Information
            
            69Part IIIItem
      10 —
            
            Directors,
      Executive Officers and Corporate Governance
            
            69Item
      11 —
            
            Executive
      Compensation
            
            70Item
      12 —
            
            Security
      Ownership of Certain Beneficial Owners and Management and
              Related
      Stockholder Matters
            
            70Item
      13 —
            
            Certain
      Relationships and Related Transactions, and Director
      Independence
            
            70Item
      14 —
            
            Principal
      Accounting Fees and Services
            
            70Part IVItem
      15 —
            
            Exhibits,
      Financial Statement Schedules
            
            70Signatures
            
            
            
            72









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 proceedings.




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 2009.




Statement
regarding 2009 certificate 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.




1




Part I







Item
1: Business




General.– Carrollton
Bancorp, a Maryland corporation (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, 2008,had a total of ten
branch locations in Maryland with two branch locations in Baltimore City; three
branch locations in Anne Arundel County; four 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
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.




On or
around March 23, 2009, the executive offices of the Company and the principal
office of the Bank will be relocated to 7151 Columbia Gateway Drive, Suite A,
Columbia, Maryland 21046, telephone number (410) 312-5400. 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.




Recent Market
Developments.–In response
to the financial crises affecting the banking system and financial markets and
going concern threats to investment banks and other financial institutions, on
October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the
“EESA”) was signed into law. Pursuant to the EESA, the U.S. Treasury was given
the authority to, among other things, purchase up to $700 billion of
mortgages, mortgage-backed securities and certain other financial instruments
from financial institutions for the purpose of stabilizing and providing
liquidity to the U.S. financial markets.




On
October 14, 2008, the Secretary of the Department of the Treasury announced
that the Department of the Treasury will purchase equity stakes in a wide
variety of banks and thrifts. Under the program, known as the Troubled Asset
Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”),
from the $700 billion authorized by the EESA, the Treasury made
$250 billion of capital available to U.S. financial institutions in the
form of preferred stock. In conjunction with the purchase of preferred stock,
the Treasury received, from participating financial institutions, warrants to
purchase common stock with an aggregate market price equal to 15% of the
preferred investment. Participating financial institutions were required to
adopt the Treasury’s standards for executive compensation and corporate
governance for the period during which the Treasury holds equity issued under
the TARP Capital Purchase Program. On February 13, 2009, the Company raised
$9,201,000 through participation in the TARP Capital Purchase
Program.




The
Company issued 9,201 shares of Fixed Rate Cumulative Perpetual Preferred Stock,
Series A, liquidation preference $1,000 per share (the “Series A Preferred
Stock”), and a warrant to purchase 205,379 shares of the Company’s common stock,
par value $1.00 per share.  The warrant is exercisable at $6.72 per
share at any time on or before February 13, 2019.   Treasury has
agreed not to exercise voting power with respect to any shares of common stock
issued upon exercise of the warrant.




On
November 21, 2008, the Board of Directors of the Federal Deposit Insurance
Corporation (“FDIC”) adopted a final rule relating to the Temporary Liquidity
Guarantee Program (“TLG Program”). The TLG Program was announced by the
FDIC on October 14, 2008, preceded by the determination of systemic risk by
the Secretary of the Department of Treasury (after consultation with the
President), as an initiative to counter the system-wide crisis in the nation’s
financial sector. Under the TLG Program the FDIC will (i) guarantee,
through the earlier of maturity or June 30, 2012, certain newly issued
senior unsecured debt issued by participating institutions on or after
October 14, 2008, and before June 30, 2009 and (ii) provide full
FDIC deposit insurance coverage for non-interest bearing transaction deposit
accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5%
interest per annum and Interest on Lawyers Trust Accounts (“IOLTA”) accounts
held at participating FDIC insured institutions through December 31, 2009.
Coverage under the TLG Program was available for the first 30 days
without charge. The fee assessment for coverage of senior unsecured debt ranges
from 50 basis points to 100 basis points per annum, depending on the
initial maturity of the debt. The fee assessment for deposit insurance coverage
is 10 basis


2


points
per quarter on amounts in covered accounts exceeding $250,000. On November 25,
2008, the Company elected to participate in the deposit insurance coverage for
non-interest bearing transaction deposit accounts.  On December 10,
2008, the Company declined to participate in the senior unsecured debt
program.




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.




·
            After-hours
      depository services.




·
            Safe
      deposit boxes.




·
            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 comparatively low risk based on the type of collateral (residential
property) and the underwriting standards used.  The Bank experienced
$423,687 of losses and $4,358 in recoveries on residential mortgage loans in
2008.  The Bank experienced $76,426 of losses and no recoveries on
residential mortgage loans in 2007. The Bank experienced no losses and no
recoveries in 2006.  There were approximately $877,000 of residential
mortgage loans delinquent more than 90 days at December 31, 2008.




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 comparatively low due to the underlying values of the
collateral. The Bank experienced losses on home equity loans of $75,000 during
2008, $100,455 during 2007 and none during 2006. The Bank experienced no
recoveries on home equity loans during 2008, 2007 and 2006.  There
were approximately $199,000 of home equity loans delinquent more than 90 days at
December 31, 2008.




3




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 $518,755 during 2008, $220,640 during
2007, and $59,120 during 2006. The Bank experienced recoveries on commercial and
investment mortgages of $9,643 in 2008, $187 in 2007 and $6,290 in
2006.  There were approximately $2.0 million commercial mortgage loans
past due more than 90 days at December 31, 2008.




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 experienced $1.2 million of
losses and $32,648 in recoveries on construction and land development loans
during 2008.  The Bank did not experience any losses or recoveries on
construction and land development loans during 2007, and 2006. There were
approximately $3.6 million in construction and land development loans past due
more than 90 days at December 31, 2008.




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 2008, 2007 and 2006.  There
were $583,000 of demand and time and line of credit loans delinquent more than
90 days at December 31, 2008.




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 $0, $249, and
$11,515 in 2008, 2007 and 2006, respectively. There were recoveries of $320,
$608 and $0 in 2008, 2007, and 2006, respectively. There were approximately
$3,000 of home improvement loans delinquent more than 90 days at
December 31, 2008.




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 recoveries of $0, $5,598, and $1,251 in 2008, 2007 and 2006,
respectively. There were no automobile or other vehicle loans past due more than
90 days at December 31, 2008.




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 2008,
2007, and 2006 were $24,501, $2,916, and $11,662, respectively. There were
$11,000 overdraft loans and other personal loans past due more than 90 days
at December 31, 2008.




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


4
 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 2008, 2007, or 2006. Recoveries on loans secured by
stocks and bonds were $0, $437, and $0 in 2008, 2007, and 2006 respectively.
There were no loans secured by savings accounts or stock and bond certificates
past due more than 90 days at December 31, 2008.




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.




MSLLC was
established in 2004 for the purpose of disposing of real estate
owned.  At December 31, 2008, there were six properties with a fair
market value of $1.7 million.  There was no activity in MSLLC in 2007
and 2006.




Investment
Activities.– The Company maintains a portfolio of investment
securities to provide liquidity and income. The current portfolio amounts to
about 17% 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 2009 to 2038, 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 2008, commission income totaled
$682,000 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.  All of the Company’s revenue is generated within
the United States.




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.




5




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, 2008, the Bank and its subsidiaries had 137 full time equivalent
employees, 28 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 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


6
 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 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. Congress has temporarily increased FDIC deposit insurance from
$100,000 to $250,000 per depositor through December 31, 2009.  On
January 1, 2010, the standard coverage limit will return to $100,000 for all
deposit categories except IRAs and Certain Retirement Accounts, which will be
insured up to $250,000 per owner.  The Company is participating in the
FDIC’s Temporary Liquidity Guarantee Program.  Consequently, unlimited
deposit insurance coverage is available through December 31, 2009 for
non-interest bearing transaction accounts.  As an FDIC insured
institution, deposits of the Bank are currently insured 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 paid a de minimus semi-annual
assessment in 2008.




In an
effort to restore capitalization levels and to ensure the BIF will adequately
cover projected losses from future bank failures, the FDIC, in October 2008,
proposed a rule to alter the way in which it differentiates for risk in the
risk-based assessment system and to revise deposit insurance assessment rates,
including base assessment rates.  The FDIC proposed raising the
current rates uniformly by 7 basis points for the assessment for the first
quarter of 2009 resulting in annualized assessment rates for Risk
Category 1 institutions ranging from 12 to 14 basis points.
The proposal for first quarter 2009 assessment rates was adopted as a final rule
in December 2008. The FDIC also proposed, effective April 1, 2009,
initial base assessment rates for Risk Category 1 institutions of
10 to 14 basis points. After the effect of potential base-rate
adjustments, the annualized assessment rate for Risk Category 1
institutions would range from 8 to 21 basis points. A final rule
related to this proposal is expected to be issued during the first quarter of
2009. The Company cannot provide any assurance as to the amount of any proposed
increase in its deposit insurance premium rate, should such an increase occur,
as such changes are dependent upon a variety of factors, some of which are
beyond the Company’s control.




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,


7


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 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.




On
February 13, 2009, the Company raised $9,201,000 through the sale of the Series
A Preferred Stock which will qualify as Tier 1 capital.  The Series A
Preferred Stock will pay cumulative dividends at a rate of 5% per annum
until February 15, 2014. Beginning February 16, 2014, the dividend rate will
increase to 9% per annum.   Dividends are payable
quarterly.  The Treasury’s current consent shall be required for any
increase in the common dividends per share until February 13, 2012 unless prior
to such date, the Series A Preferred Stock is redeemed in whole or the Treasury
has transferred all of the Series A Preferred Stock to third
parties.  For as long as the Series A Preferred Stock is outstanding,
no dividend can be paid on the common stock unless all dividends on the Series A
Preferred Stock have been paid.




On and
after February 15, 2012, the Company may, at its option, redeem shares of Series
A Preferred Stock, in whole or in part, at any time and from time to time, for
cash at a per share amount equal to the sum of the liquidation preference per
share plus any accrued and unpaid dividends to but excluding the redemption
date. Prior to February 15, 2012, the Company may redeem shares of Series A
Preferred Stock only if it has received aggregate gross proceeds of not less
than $ 9,201,000 from one or more qualified equity offerings, and the aggregate
redemption price may not exceed the net proceeds received by the Company from
such offerings. The redemption of the Series A Preferred Stock requires prior
regulatory approval.




The
warrant is exercisable at $6.72 per share at any time on or before February 13,
2019. Treasury has agreed not to exercise voting power with respect to any
shares of common stock issued upon exercise of the warrant.




The
Series A Preferred Stock and the warrant were issued in a transaction exempt
from registration pursuant to Section 4(2) of the Securities Act of 1933,
as amended. The Company has agreed to register the Series A Preferred Stock, the
warrant, and the shares of common stock underlying the warrant (the “warrant
shares”) as soon as practicable after the date of the issuance of the Series A
Preferred Stock and the warrant. Neither the Series A Preferred Stock nor the
warrant will be subject to any contractual restrictions on transfer, except that
Treasury may not transfer a portion of the warrant with respect to, or exercise
the warrant for, more than one-half of the warrant shares prior to the earlier
of (a) the date on which the Company has received aggregate gross proceeds of
not less than $9,201,000 from one or more qualified equity offerings and (b)
December 31, 2009.




The
Purchase Agreement also subjects the Company to certain of the executive
compensation limitations included in the EESA. As a condition to the closing of
the transaction, Robert A. Altieri, James M. Uveges, Gary M. Jewell, William D.
Sherman, and Lola B. Stokes (the Company’s Senior Executive Officers, as defined
in the Purchase Agreement) each: (i) voluntarily waived any claim against
the Treasury or the Company for any changes to such Senior Executive Officer’s
compensation or benefits that are required to comply with the regulation issued
by the Treasury under the TARP Capital Purchase Program as published in the
Federal Register on October 20, 2008 and acknowledging that the regulation
may require modification of the compensation, bonus, incentive and other benefit
plans, arrangements and policies and agreements (including so-called “golden
parachute” agreements) as they relate to the period the Treasury holds any
equity or debt securities of the Company acquired through the TARP Capital
Purchase Program; and (ii) entered into an amendment to Messer’s Altieri,
Uveges, Jewell and Mrs. Stokes employment agreements that provide that any
severance payments made to such officers will be reduced, as necessary, so as to
comply with the requirements of the TARP Capital Purchase Program.




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


8


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 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 revised the
BHCA and repealed 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.




9


·
            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.




The
Company’s Business May Be Adversely Affected by Conditions in the Financial
Markets and Economic Conditions Generally




Since
December 2007, the United States has been in a recession. Business activity
across a wide range of industries and regions is greatly reduced and local
governments and many businesses are facing extremely difficult operating
conditions due to the lack of consumer spending and the lack of liquidity in the
credit markets. Unemployment has increased significantly.




Since
mid-2007, and particularly during the second half of 2008, the financial
services industry and the securities markets generally were materially and
adversely affected by significant declines in the values of nearly all asset
classes and by a serious lack of liquidity. This was initially triggered by
declines in home prices and the values of subprime mortgages, but spread to all
mortgage and real estate asset classes, to leveraged bank loans and to nearly
all asset classes, including equities. The global markets have been
characterized by substantially increased volatility and short-selling and an
overall loss of investor confidence, initially in financial institutions, but
more recently in companies in a number of other industries and in the broader
markets.




Market
conditions have also led to the failure or merger of a number of prominent
financial institutions. Financial institution failures or near-failures have
resulted in further losses as a consequence of defaults on securities issued by
them and defaults under contracts entered into with such entities as
counterparties. Furthermore, declining asset values, defaults on mortgages and
consumer loans, and the lack of market and investor confidence, as well as other
factors, have all combined to increase credit default swap spreads, to cause
rating agencies to lower credit ratings, and to otherwise increase the cost and
decrease the availability of liquidity, despite very significant declines in
Federal Reserve borrowing rates and other government actions. Some banks and
other lenders have suffered significant losses and have become reluctant to
lend, even on a secured basis, due to the increased risk of default and the
impact of declining asset values on the value of collateral. The foregoing has
significantly weakened the strength and liquidity of some financial institutions
worldwide. In 2008, the U.S. government, the Federal Reserve and other
regulators have taken numerous steps to increase liquidity and to restore
investor confidence, including investing approximately $200 billion in the
equity of other banking organizations, but asset values have continued to
decline and access to liquidity continues to be very limited.




The
Company’s financial performance generally, and in particular the ability of
borrowers to pay interest on and repay principal of outstanding loans and the
value of collateral securing those loans, is highly dependent upon the business
environment in the markets where the Company operates, in the State of Maryland
and, in particular, the Baltimore, Washington metropolitan region. A favorable
business environment is generally characterized by, among other factors,
economic growth, declining unemployment, efficient capital markets, low
inflation, high business and investor confidence, and strong business earnings.
Unfavorable or uncertain economic and market conditions can be caused by:
declines in economic growth, business activity or investor or business
confidence; rising unemployment, limitations on the availability or increases in
the cost of credit and capital; increases in inflation or interest rates;
natural disasters; or a combination of these or other factors.




Overall,
during 2008, the business environment has been adverse for many households and
businesses in the United States and worldwide. The business environment in
Maryland and the markets in which the Company operates has been less adverse
than in the


10


United
States generally but continues to deteriorate. It is expected that the business
environment in the State of Maryland, the United States and worldwide will
continue to deteriorate for the foreseeable future. There can be no assurance
that these conditions will improve in the near term. Such conditions could
adversely affect the credit quality of the Company’s loans, results of
operations and financial condition.




The
Company’s Profitability Depends Significantly On Economic Conditions In The
State Of Maryland




The
Company’s success depends primarily on the general economic conditions of the
State of Maryland and the specific local markets in which the Company operates.
Unlike larger national or other regional banks that are more geographically
diversified, the Company provides banking and financial services to customers in
the Baltimore, Washington metropolitan area. The local economic conditions in
these areas have a significant impact on the demand for the Company’s products
and services as well as the ability of the Company’s customers to repay loans,
the value of the collateral securing loans and the stability of the Company’s
deposit funding sources. Although economic conditions in the State of Maryland
have experienced less decline than in the United States generally, these
conditions are declining and are expected to continue to decline in the future.
A significant decline in general economic conditions, whether caused by
recession, inflation, unemployment, changes in securities markets, acts of
terrorism, outbreak of hostilities or other international or domestic
occurrences or other factors could impact these local economic conditions and,
in turn, have a material adverse effect on the Company’s financial condition and
results of operations.


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 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


11


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.




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, 2008, approximately 72% 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.




12




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.




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 $5.50 and
$15.08 per share during the 12 months ended December 31, 2008. 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
$2.3 million at December 31, 2008:




Location
              
              Description1740
      East Joppa Road
                Towson,
      MD 21234
              
              Full
      service branch with drive thru, Electronic Banking offices, Auditing
      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 (1)
              
              Full
      service branch with Executive offices, Lending offices and Finance
      offices





13




The
Company leased the following facilities at an aggregate annual rental of
approximately $1.2 million as of December 31, 2008:




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 (1)
                
                Administrative
      and operational offices
                
                April
      30, 20092637-A
      Old Annapolis Road
                  Hanover,
      MD 21076
                
                Full
      service branch
                
                October 1,
      2014Northway
      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, 20091
      Center Square, Suite 201
                  Hanover,
      PA 17331
                
                Mortgage
      subsidiary offices
                
                July
      31, 20097151
      Columbia Gateway Drive
                  Suite
      A
                  Columbia,
      MD  21046 (1)
                
                Executive,
      administrative and operational offices
                
                April
      30, 2029




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




(1)  On
or around March 23, 2009, the Executive, Lending and Finance offices at 344 N.
Charles Street and the administrative and operational offices at 1589 Sulphur
Spring Road will move to 7151 Columbia Gateway Drive, Suite A, Columbia,
Maryland  21046.




Item
3: Legal Proceedings




The
Company is involved in various routine 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, 2008.




14




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, 2008, there were 372 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 2008 and 2007,
and $0.45 in 2006, representing a payout ratio of 137.23% in 2008,63.88% in 2007, and48.98% in 2006. 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
2008, the Company repurchased and retired 276,137 shares of common stock at an
average price of $14.07.  During 2007, the Company repurchased and
retired 16,015 shares of common stock at a price of $16.50 per
share.  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 Paid2008
                    
                    
                    2007
                    
                    
                    Per ShareLow
                    
                    
                    High
                    
                    
                    Low
                    
                    
                    High
                    
                    
                    2008
                    
                    
                    20074th
      Quarter
                    
                    $
                    5.50
                    
                    
                    $
                    9.34
                    
                    
                    $
                    11.25
                    
                    
                    $
                    14.85
                    
                    
                    $
                    0.12
                    
                    
                    $
                    0.123rd
      Quarter
                    
                    
                    8.00
                    
                    
                    
                    14.00
                    
                    
                    
                    12.00
                    
                    
                    
                    16.73
                    
                    
                    
                    0.12
                    
                    
                    
                    0.122nd
      Quarter
                    
                    
                    11.75
                    
                    
                    
                    14.99
                    
                    
                    
                    15.55
                    
                    
                    
                    18.40
                    
                    
                    
                    0.12
                    
                    
                    
                    0.121st
      Quarter
                    
                    
                    12.00
                    
                    
                    
                    15.08
                    
                    
                    
                    16.40
                    
                    
                    
                    18.00
                    
                    
                    
                    0.12
                    
                    
                    
                    0.12$
                    0.48
                    
                    
                    $
                    0.48







As of
December 31, 2008, there were 372 common shareholders of record holding an
aggregate of 2,564,988 shares. The Company believes there to be in excess of 540
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.




On
February 13, 2009, as part of the TARP Capital Purchase Program, the Company
entered into a Letter Agreement, and the related Securities Purchase Agreement -
Standard Terms (collectively, the “Purchase Agreement”), with the United States
Department of the Treasury (“Treasury”), pursuant to which the Company issued
(i) 9,201 shares of Fixed Rate Cumulative Perpetual Preferred Stock,
Series


15


A,
liquidation preference $1,000 per share (the “Series A Preferred Stock”), and
(ii) a warrant to purchase 205,379shares of the Company’s
common stock, par value $1.00 per share, for an aggregate purchase price of
$1,380,147 in cash (the “Warrant”).




The
Series A Preferred Stock will qualify as Tier 1 capital and will pay cumulative
dividends at a rate of 5% per annum until February 15,
2014.  Beginning February 16, 2014, the dividend rate will increase to
9% per annum.  On and after February 15, 2012, the Company may,
at its option, redeem shares of Series A Preferred Stock, in whole or in part,
at any time and from time to time, for cash at a per share amount equal to the
sum of the liquidation preference per share plus any accrued and unpaid
dividends to but excluding the redemption date.  Prior to February 15,
2012, the Company may redeem shares of Series A Preferred Stock only if it has
received aggregate gross proceeds of not less than $9,201,000 from one or more
qualified equity offerings, and the aggregate redemption price may not exceed
the net proceeds received by the Company from such offerings.  The
redemption of the Series A Preferred Stock requires prior regulatory
approval.




The
Warrant is exercisable in whole or in part, from time to time, at $6.72 per
share at any time on or before February 13, 2019. The number of shares of common
stock issuable upon exercise of the Warrant and the exercise price per share
will be adjusted if specific events occur.  Treasury has agreed not to
exercise voting power with respect to any shares of common stock issued upon
exercise of the Warrant.




Pursuant
to the terms of the Purchase Agreement, prior to the earlier of (i) February 13,
2012 or (ii) the date on which the Series A Preferred Stock has been redeemed in
full or Treasury has transferred all of the Series A Preferred Stock to
non-affiliates, the Company cannot increase its quarterly cash dividend above
$0.08 or repurchase any shares of its common stock or other capital stock or
equity securities or trust preferred securities without the consent of
Treasury.




In
addition, pursuant to the Articles Supplementary relating to the Series A
Preferred Stock, so long as any shares of Series A Preferred Stock remain
outstanding, the Company may not declare or pay any dividends or distributions
on the Company’s common stock or any class or series of the Company’s equity
securities ranking junior, as to dividends and upon liquidation, to the Series A
Preferred Stock (“Junior Stock”) (other than dividends payable solely in shares
of common stock) or on any other class or series of the Company’s equity
securities ranking, as to dividends and upon liquidation, on a parity with the
Series A Preferred Stock (“Parity Stock”), and may not repurchase or redeem any
common stock, Junior Stock or Parity Stock, unless all accrued and unpaid
dividends for past dividend periods, including the latest completed dividend
period, have been paid or have been declared and a sufficient sum has been set
aside for the benefit of the holders of the Series A Preferred
Stock.




The
repurchase restrictions described above do not apply in certain limited
circumstances, including the repurchase of common stock in connection with the
administration of any employee benefit plan in the ordinary course of business
and consistent with past practice, but only to offset the increase in the number
of diluted shares outstanding resulting from the grant, vesting or exercise of
equity-based compensation.




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, 2003, to December 31, 2008, 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, 2003, 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.









Period EndingIndex
            
            12/31/03
            
            12/31/04
            
            12/31/05
            
            12/31/06
            
            12/31/07
            
            12/31/08Carrollton
      Bancorp
            
            
            100.00
            
            
            
            102.17
            
            
            
            88.54
            
            
            
            104.06
            
            
            
            87.36
            
            
            
            38.03NASDAQ
      Composite
            
            
            100.00
            
            
            
            108.59
            
            
            
            110.08
            
            
            
            120.56
            
            
            
            132.39
            
            
            
            78.72SNL
      Mid-Atlantic Bank
            
            
            100.00
            
            
            
            105.91
            
            
            
            107.79
            
            
            
            129.37
            
            
            
            97.83
            
            
            
            53.89







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
            
            156,385
            
            
            
            $14.23
            
            
            
            492,800Equity
      compensation plans not approved by security holders
            
            N/A
            
            
            
            N/A
            
            
            
            N/ATotal
            
            156,385
            
            
            
            $14.23
            
            
            
            492,800




18




Item
6:Selected
Financial Data




2008
                          
                          2007
                          
                          2006
                          
                          2005
                          
                          2004Consolidated
      Income Statement Data:Interest
      income
                          
                          $
                          22,406,600
                          
                          $
                          23,676,360
                          
                          $
                          23,127,504
                          
                          $
                          19,071,379
                          
                          $
                          15,500,323Interest
      expense
                          
                          
                          8,457,182
                          
                          
                          9,762,324
                          
                          
                          8,737,450
                          
                          
                          7,375,083
                          
                          
                          5,321,622Net
      interest income
                          
                          
                          13,949,418
                          
                          
                          13,914,036
                          
                          
                          14,390,054
                          
                          
                          11,696,296
                          
                          
                          10,178,701Provision
      for loan losses
                          
                          
                          2,096,000
                          
                          
                          536,000
                          
                          
                          —
                          
                          
                          —
                          
                          
                          —Net
      interest income after provision for loan losses
                          
                          
                          11,853,418
                          
                          
                          13,378,036
                          
                          
                          14,390,054
                          
                          
                          11,696,296
                          
                          
                          10,178,701Noninterest
      income
                          
                          
                          6,585,694
                          
                          
                          6,274,142
                          
                          
                          8,898,996
                          
                          
                          10,718,636
                          
                          
                          8,781,151Noninterest
      expenses
                          
                          
                          17,468,064
                          
                          
                          16,475,141
                          
                          
                          19,381,003
                          
                          
                          18,634,124
                          
                          
                          17,751,000Income
      before income taxes
                          
                          
                          971,048
                          
                          
                          3,177,037
                          
                          
                          3,908,047
                          
                          
                          3,780,808
                          
                          
                          1,208,852Income
      taxes
                          
                          
                          124,197
                          
                          
                          1,050,774
                          
                          
                          1,323,268
                          
                          
                          1,322,371
                          
                          
                          320,488Net
      income
                          
                          $
                          846,851
                          
                          $
                          2,126,263
                          
                          $
                          2,584,779
                          
                          $
                          2,458,437
                          
                          $
                          888,364Consolidated
      Balance Sheet Data,
                            at
      year endAssets
                          
                          $
                          404,181,184
                          
                          $
                          352,848,570
                          
                          $
                          349,824,752
                          
                          $
                          360,467,146
                          
                          $
                          319,123,132Gross
      loans
                          
                          
                          283,693,156
                          
                          
                          261,623,833
                          
                          
                          260,001,314
                          
                          
                          247,943,073
                          
                          
                          219,726,294Deposits
                          
                          
                          292,353,276
                          
                          
                          285,638,625
                          
                          
                          277,903,801
                          
                          
                          271,626,503
                          
                          
                          225,846,145Shareholders’
      equity
                          
                          
                          27,390,693
                          
                          
                          35,931,300
                          
                          
                          34,711,378
                          
                          
                          34,640,165
                          
                          
                          34,215,280Per
      Share Data:Number
      of shares of Common Stock outstanding, at year-end
                          
                          
                          2,564,988
                          
                          
                          2,834,975
                          
                          
                          2,806,705
                          
                          
                          2,809,698
                          
                          
                          2,834,823Net
      income:Basic
                          
                          $
                          0.32
                          
                          $
                          0.75
                          
                          $
                          0.92
                          
                          $
                          0.87
                          
                          $
                          0.31Diluted
                          
                          
                          0.32
                          
                          
                          0.75
                          
                          
                          0.90
                          
                          
                          0.87
                          
                          
                          0.31Cash
      dividends declared
                          
                          
                          0.48
                          
                          
                          0.48
                          
                          
                          0.45
                          
                          
                          0.40
                          
                          
                          0.38Book
      value, at year end
                          
                          
                          10.68
                          
                          
                          12.67
                          
                          
                          12.37
                          
                          
                          12.33
                          
                          
                          12.07Performance
      and capital ratios:Return
      on average assets
                          
                          
                          0.22
                          %
                          
                          0.61
                          %
                          
                          0.75
                          %
                          
                          0.72
                          %
                          
                          0.29
                          %Return
      on average shareholders’ equity
                          
                          
                          2.62
                          %
                          
                          5.97
                          %
                          
                          7.55
                          %
                          
                          7.12
                          %
                          
                          2.61
                          %Net
      interest margin (a)
                          
                          
                          3.93
                          %
                          
                          4.34
                          %
                          
                          4.57
                          %
                          
                          3.89
                          %
                          
                          3.81
                          %Average
      shareholders’ equity to average total assets
                          
                          
                          8.54
                          %
                          
                          10.22
                          %
                          
                          9.91
                          %
                          
                          10.13
                          %
                          
                          11.11
                          %Year-end
      capital to year-end risk- weighted assets:Tier
      1
                          
                          
                          9.84
                          %
                          
                          12.35
                          %
                          
                          11.92
                          %
                          
                          11.63
                          %
                          
                          11.52
                          %Total
                          
                          
                          10.91
                          %
                          
                          13.63
                          %
                          
                          13.20
                          %
                          
                          13.51
                          %
                          
                          12.74
                          %Year-end
      Tier 1 leverage ratio
                          
                          
                          6.78
                          %
                          
                          10.03
                          %
                          
                          9.74
                          %
                          
                          8.96
                          %
                          
                          9.41
                          %Cash
      dividends declared to net income
                          
                          
                          147.46
                          %
                          
                          63.88
                          %
                          
                          48.98
                          %
                          
                          45.97
                          %
                          
                          121.17
                          %Asset
      Quality Ratios:Allowance
      for loan losses, at year-end to:Gross
      loans
                          
                          
                          1.12
                          %
                          
                          1.25
                          %
                          
                          1.20
                          %
                          
                          1.35
                          %
                          
                          1.59
                          %Nonperforming,
      restructured and past-due loans
                          
                          
                          39.67
                          %
                          
                          55.28
                          %
                          
                          54.93
                          %
                          
                          209.50
                          %
                          
                          132.05
                          %Net
      charge-offs to average gross loans
                          
                          
                          0.82
                          %
                          
                          0.15
                          %
                          
                          0.08
                          %
                          
                          0.06
                          %
                          
                          0.08
                          %Nonperforming
      assets as a percent of period-end gross loans and foreclosed real
      estate
                          
                          
                          3.42
                          %
                          
                          2.26
                          %
                          
                          2.19
                          %
                          
                          0.64
                          %
                          
                          1.20
                          %







(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
2009.




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 ten 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.




Total
assets for the year ended December 31, 2008 compared to December 31, 2007
reflect a 15% increase to $404.2 million.  Gross loans, including
loans held for sale, increased 13% or $36.2 million from $269.2 million at
December 31, 2007, to $305.4 million at December 31,
2008.  Investments increased 26% or $14.0 million to $66.8 million at
December 31, 2008.  Total deposits increased 2% or $6.7 million to
$292.4 million while borrowings increased 168% or $49.9
million.  During the same period, stockholders’ equity decreased $8.5
million or 24% to $27.4 million or 6.78% of total assets compared to 10.2% at
December 31, 2007.  The decrease was due primarily to the repurchase
of 276,137 shares for $3.9 million, dividends paid of $1.2 million, and a
decrease in accumulated other comprehensive income of $4.3 million, all of which
was partially offset by net income of $847,000.




Net
income for the year ended December 31, 2008, totaled $847,000 compared to $2.1
million for the prior year, a $1.3 million or 60% decrease.  The
decrease was due to the $1.6 million increase in the provision for loan losses
and the $538,000 pretax charge to close the Wilkens Plaza drive thru
branch.  The increase in the provision for loan losses was due to an
increase in the level of nonperforming assets, which required additional
allocations to the allowance for credit losses.




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 Act of 2002 (“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 $2.3 million from the sale of equity
securities.




Comparing
the year ended December 31, 2008, and 2007, net interest income remained
relatively flat at $13.0 million.  The reduction in rates by the
Federal Reserve during the year contributed to the reduction in the Company’s
net interest margin from 4.34% for the year ended December 31, 2007 to 3.93% for
the year ended December 31, 2008.  The 41 basis points decrease in the
net interest margin was substantially offset by the $34.2 million increase in
average earning assets.




20




The
Company recorded a provision for loan losses of $2.1 million for the year ended
December 31, 2008, compared to $536,000 in 2007.  The increase in the
provision for loan losses was due to the increase in nonperforming loans and
other loan risk factors.  Nonperforming assets increased from $5.9
million at December 31, 2007 to $9.8 million at December 31,
2009.  The allowance for loan losses represented 1.12% of outstanding
loans at December 31, 2008.




For the
year ended December 31, 2008, noninterest income was $6.6 million compared to
$6.3 million for the year ended December 31, 2007, an increase of $312,000 or
5%.  The increase was due to the $244,000 gain on the sale and call of
securities purchased at a discount partially offset by the write down of equity
securities, and a $263,000 or 12% increase in the fees and commissions earned by
CMSI.  These increases were partially offset by a $126,000 or 13%
decrease in service charges, a $53,000 or 3% decrease in Point of Sale revenue
and ATM fees and a $21,000 or 4% decrease in other fees and
commissions.




Noninterest
expenses were $17.5 million for the year ended December 31, 2008, compared to
$16.5 million for the year ended December 31, 2007, a $993,000 or 6% increase.
The increase resulted from a one-time pre-tax charge of $538,000 to close the
Wilkens Plaza drive thru branch, a $238,000 increase in OREO expenses, a
$257,000 increase in occupancy expense caused by opening of our new Cockeysville
branch and relocating our White Marsh branch to Perry Hall and normal lease
escalation charges, and a $506,000 or 37% increase in employee benefits, in
particular medical expenses.  These increases in expenses were offset
by a $281,000 reduction in salary expenses due to fewer employees and a $159,000
or 15% decrease in professional services related to consulting fees for
compliance with SOX in 2007.




The
Company paid dividends of $0.48 per share to shareholders during
2008.




21


Results
of Operations




Summary




The
Company reported net income for 2008 of $847,000 or $0.32 per diluted share,
representing a 60.2% decrease from 2007 net income of $2.1 millionor $0.75 per
share.




Loans
held for sale increased $14.1 million or 186.3% due to the increase in
refinancings of residential mortgages due to the reduction in rates by the
Federal Reserve during the year.




The loan
portfolio net of the Allowance for Loan Losses increased 8.6%to $280.5 million
as a result of the Company’s continuing efforts to align the loan portfolio to
be in line with typical commercial banks. Interest income on loans, including
loans held for sale, decreased 9.8%due to the reduction in
the yield on average loans, including loans held for sale, from 7.66% for the
year ended December 31, 2007 to 6.64% for the year ended December 31,
2008.  The 102 basis points decrease in the yield was partially offset
by the $11.3 million increase in average gross loans and loans held for
sale.




The
deposit portfolio increased 2.4% to $292.4 million, with the majority of
the growth derived from certificates of deposit.  Partially affecting
these increases were decreases in noninterest bearing deposits, money market
accounts and savings accounts.  Borrowings from the Federal Home Loan
Bank of Atlanta (“FHLBA”) increased $50.2 million to fund the growth in loans
and investments.  Total interest expense decreased during 2008 due to
the reduction in the yield on total interest bearing liabilities from 3.73% for
the year ended December 31, 2007, to 2.86% for the year ended December 31,
2008.  The 87 basis point decrease in the yield was partially offset
by the $33.4 million increase in average total interest bearing
liabilities.  Noninterest income increased 5.0% or $312,000 in 2008
compared to 2007.  The increase was due to the $224,000 gain in the
sale and call of securities purchased at a discount partially offset by the
write down of equity securities, and a $263,000 or 11.5% increase in the fees
and commissions earned by CMSI.  These increases were partially offset
by a $126,000 or 13.3% decrease in service charges, a $53,000 or 2.8% decrease
in Point of Sale revenue and ATM fees and a $21,000 or 4.3% decrease in other
fees and commissions.




Noninterest
expense increased 6.0% or $993,000 in 2008 compared to 2007.  The
increase resulted from a one-time pre-tax charge of $538,000 to close the
Wilkens Plaza drive thru branch, a $238,000 increase in OREO expenses, a
$257,000 increase in occupancy expense caused by opening of our new Cockeysville
branch and relocating of our White Marsh branch to Perry Hall and normal lease
escalation charges, and a $506,000 or 37.1% increase in employee benefits, in
particular medical expenses.  These increases in expenses were offset
by a $281,000 or 3.9% reduction in salary expenses due to fewer employees and a
$159,000 or 14.8% decrease in professional services related to consulting fees
for compliance with SOX in 2007.




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.




22







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.




23




Average
Balances, Interest, and Yields




2008
                                  
                                  2007
                                  
                                  2006Average
                                    Balance
                                  
                                  Interest
                                  
                                  Yield
                                  
                                  Average
                                    Balance
                                  
                                  Interest
                                  
                                  Yield
                                  
                                  Average
                                    Balance
                                  
                                  Interest
                                  
                                  YieldAssetsFederal
      funds sold, Federal Reserve Bank and Federal Home Loan Bank
      deposit
                                  
                                  $    7,511,540
                                  
                                  $    
        65,861
                                  
                                  
                                  0.88
                                  %
                                  
                                  $  
       3,737,413
                                  
                                  $  
        181,635
                                  
                                  
                                  4.86
                                  %
                                  
                                  $    7,839,525
                                  
                                  $    
      382,625
                                  
                                  
                                  4.88
                                  %Federal
      Home Loan Bank stock
                                  
                                  2,968,299
                                  
                                  108,686
                                  
                                  
                                  3.66
                                  
                                  
                                  1,544,464
                                  
                                  99,223
                                  
                                  
                                  6.42
                                  
                                  
                                  1,742,153
                                  
                                  99,046
                                  
                                  
                                  5.69Investment
      securities: (a)U.S.
      government agency
                                  
                                  23,311,111
                                  
                                  1,317,296
                                  
                                  
                                  5.65
                                  
                                  
                                  16,043,046
                                  
                                  902,454
                                  
                                  
                                  5.63
                                  
                                  
                                  15,316,293
                                  
                                  788,538
                                  
                                  
                                  5.15State
      and municipal
                                  
                                  8,543,619
                                  
                                  525,509
                                  
                                  
                                  6.15
                                  
                                  
                                  9,233,678
                                  
                                  572,591
                                  
                                  
                                  6.20
                                  
                                  
                                  8,734,211
                                  
                                  544,815
                                  
                                  
                                  6.24Mortgage-backed
      securities
                                  
                                  27,211,120
                                  
                                  1,495,541
                                  
                                  
                                  5.50
                                  
                                  
                                  19,650,335
                                  
                                  1,067,144
                                  
                                  
                                  5.43
                                  
                                  
                                  21,554,754
                                  
                                  1,170,089
                                  
                                  
                                  5.43Corporate
      bonds
                                  
                                  9,033,034
                                  
                                  423,755
                                  
                                  
                                  4.69
                                  
                                  
                                  5,877,246
                                  
                                  391,199
                                  
                                  
                                  6.66
                                  
                                  
                                  4,089,963
                                  
                                  270,840
                                  
                                  
                                  6.62Other
                                  
                                  1,512,580
                                  
                                  74,775
                                  
                                  
                                  4.94
                                  
                                  
                                  1,140,856
                                  
                                  53,199
                                  
                                  
                                  4.66
                                  
                                  
                                  1,154,060
                                  
                                  49,212
                                  
                                  
                                  4.2669,611,464
                                  
                                  3,836,876
                                  
                                  
                                  5.51
                                  
                                  
                                  51,945,161
                                  
                                  2,986,587
                                  
                                  
                                  5.75
                                  
                                  
                                  50,849,281
                                  
                                  2,823,494
                                  
                                  
                                  5.55Loans:Demand
      and time
                                  
                                  66,488,316
                                  
                                  3,972,570
                                  
                                  
                                  5.97
                                  
                                  
                                  73,606,674
                                  
                                  5,844,340
                                  
                                  
                                  7.94
                                  
                                  
                                  73,339,911
                                  
                                  5,862,743
                                  
                                  
                                  7.99Residential
      mortgage (b)
                                  
                                  90,110,476
                                  
                                  5,874,216
                                  
                                  
                                  6.52
                                  
                                  
                                  77,543,499
                                  
                                  5,704,170
                                  
                                  
                                  7.36
                                  
                                  
                                  72,131,409
                                  
                                  3,926,413
                                  
                                  
                                  5.44Commercial
      mortgage and construction
                                  
                                  123,220,972
                                  
                                  8,712,560
                                  
                                  
                                  7.07
                                  
                                  
                                  116,904,123
                                  
                                  8,988,319
                                  
                                  
                                  7.69
                                  
                                  
                                  110,899,759
                                  
                                  8,544,541
                                  
                                  
                                  7.70Installment
                                  
                                  1,236,740
                                  
                                  89,834
                                  
                                  
                                  7.26
                                  
                                  
                                  1,238,724
                                  
                                  100,692
                                  
                                  
                                  8.13
                                  
                                  
                                  1,504,253
                                  
                                  80,978
                                  
                                  
                                  5.38Lease
      financing
                                  
                                  147,300
                                  
                                  8,761
                                  
                                  
                                  5.95
                                  
                                  
                                  595,593
                                  
                                  39,494
                                  
                                  
                                  6.63
                                  
                                  
                                  1,429,551
                                  
                                  80,889
                                  
                                  
                                  5.66281,203,804
                                  
                                  18,657,941
                                  
                                  
                                  6.64
                                  
                                  
                                  269,888,613
                                  
                                  20,677,015
                                  
                                  
                                  7.66
                                  
                                  
                                  259,304,883
                                  
                                  20,044,135
                                  
                                  
                                  7.73Total
      interest-earning assets
                                  
                                  361,295,107
                                  
                                  22,669,364
                                  
                                  
                                  6.27
                                  
                                  
                                  327,115,651
                                  
                                  23,944,460
                                  
                                  
                                  7.32
                                  
                                  
                                  319,735,842
                                  
                                  23,349,301
                                  
                                  
                                  7.30Noninterest-bearing
      cash
                                  
                                  3,116,830
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  8,649,236
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  14,651,700Premises
      and equipment
                                  
                                  7,223,167
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  6,533,050
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  5,432,452Other
      assets
                                  
                                  10,382,790
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  8,170,747
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  7,993,335Allowance
      for loan losses
                                  
                                  (3,161,028
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  (3,108,760
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  (3,287,376Unrealized
      gains (losses) on available for sale securities, net
                                  
                                  (827,068
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,133,365
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,065,683$378,029,798
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $348,493,289
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $345,591,636Liabilities
      and Shareholders’ EquityInterest-bearing
      deposits:Savings
      and NOW
                                  
                                  $ 
      52,315,578
                                  
                                  122,459
                                  
                                  
                                  0.23
                                  %
                                  
                                  $  55,719,609
                                  
                                  131,760
                                  
                                  
                                  0.24
                                  %
                                  
                                  $  62,309,713
                                  
                                  147,770
                                  
                                  
                                  0.24
                                  %Money
      market
                                  
                                  46,737,845
                                  
                                  1,021,124
                                  
                                  
                                  2.18
                                  
                                  
                                  56,986,611
                                  
                                  2,248,253
                                  
                                  
                                  3.95
                                  
                                  
                                  51,303,354
                                  
                                  1,936,266
                                  
                                  
                                  3.77Certificates
      of deposit
                                  
                                  130,592,612
                                  
                                  5,472,535
                                  
                                  
                                  4.19
                                  
                                  
                                  117,106,699
                                  
                                  5,700,452
                                  
                                  
                                  4.87
                                  
                                  
                                  101,071,899
                                  
                                  4,521,369
                                  
                                  
                                  4.47229,646,035
                                  
                                  6,616,118
                                  
                                  
                                  2.88
                                  
                                  
                                  229,812,919
                                  
                                  8,080,465
                                  
                                  
                                  3.52
                                  
                                  
                                  214,684,966
                                  
                                  6,605,404
                                  
                                  
                                  3.08Borrowed
      funds
                                  
                                  65,789,689
                                  
                                  1,841,064
                                  
                                  
                                  2.80
                                  
                                  
                                  32,222,600
                                  
                                  1,681,860
                                  
                                  
                                  5.22
                                  
                                  
                                  38,900,240
                                  
                                  2,132,046
                                  
                                  
                                  5.48Total
      interest-bearing liabilities
                                  
                                  295,435,724
                                  
                                  8,457,182
                                  
                                  
                                  2.86
                                  
                                  
                                  262,035,519
                                  
                                  9,762,325
                                  
                                  
                                  3.73
                                  
                                  
                                  253,585,206
                                  
                                  8,737,451
                                  
                                  
                                  3.45Noninterest-bearing
      deposits
                                  
                                  48,754,626
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  49,584,706
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  56,441,180Other
      liabilities
                                  
                                  1,569,676
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,261,192
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,312,259Shareholders’
      equity
                                  
                                  32,269,772
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  35,611,872
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  34,252,991Total
      liabilities and shareholders’ equity
                                  
                                  $378,029,798
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $348,493,289
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $345,591,636Net
      interest margin
                                  
                                  $361,295,107
                                  
                                  $14,212,182
                                  
                                  
                                  3.93
                                  %
                                  
                                  $327,115,651
                                  
                                  $14,182,135
                                  
                                  
                                  4.34
                                  %
                                  
                                  $319,735,842
                                  
                                  $14,611,850
                                  
                                  
                                  4.57
                                  %


(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 8.25% for 2008 and 7% for 2007
      and 2006 (or a combined federal and state rate of 39.445% for 2008 and
      38.62% for 2007 and 2006) 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.




24




Net
interest income on a tax-equivalent basis was substantially the same at
$14.2 million for the years ended December 31, 2008, and
2007.  The decrease in the net interest margin of 41 basis points from
4.34% for the year ended December 31, 2007, to 3.93% for the year ended December
31, 2008, was partially offset by a $34.2 million increase in average
interest-earning assets during 2008 compared to 2007.




The $11.3
million or 4.2% increase in average loans outstanding is attributed to the
Company’s active business development efforts in its residential, commercial
real estate, and construction and land development loan portfolio and general
economic conditions of the Company’s primary service market. The yield on loans
decreased to 6.64% in 2008 compared to 7.66% for 2007 as the Federal Open Market
Committee (“FOMC”) lowered rates in 2008. The yield on investment securities
decreased to 5.51% in 2008 from 5.75% in 2007.  Total interest-earning
assets increased $34.2 million or 10.4% while the yield decreased 105 basis
points.  Total interest-bearing liabilities increased $33.4 million or
12.7% while the yield decreased 87 basis points.  Interest-bearing
deposits were substantially the same at $229.6 million while borrowings
increased $33.6 million or 104.2% to fund loan and investment
growth.  The net impact was a slight increase in tax-equivalent net
interest income for the year ended December 31, 2008, compared to
2007.




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 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.




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
2008 and 2007:




2008
      Compared to 2007
                                                        
                                                        2007 Compared to 2006Change Due to Variance In
                                                        
                                                        Change Due to Variance InRate(b)
                                                        
                                                        Volume(b)
                                                        
                                                        Total
                                                        
                                                        Rates(b)
                                                        
                                                        Volume(b)
                                                        
                                                        TotalInterest
      incomeFederal
      funds sold and interest-bearing deposits with other banks
                                                        
                                                        $    (299,194
                                                        )
                                                        $    183,419
                                                        
                                                        $    (115,775
                                                        )
                                                        $         (778
                                                        )
                                                        $ (200,213
                                                        )
                                                        $
          (200,991
                                                        )Investment
      securities and FHLB stock
                                                        
                                                        (241,556
                                                        )
                                                        1,101,308
                                                        
                                                        859,752
                                                        
                                                        113,357
                                                        
                                                        49,913
                                                        
                                                        163,270Loans (a)
                                                        
                                                        (2,885,965
                                                        )
                                                        866,892
                                                        
                                                        (2,019,073
                                                        )
                                                        (185,237
                                                        )
                                                        818,117
                                                        
                                                        632,880Total
      interest earned
                                                        
                                                        (3,426,715
                                                        )
                                                        2,151,619
                                                        
                                                        (1,275,096
                                                        )
                                                        (72,658
                                                        )
                                                        667,817
                                                        
                                                        595,159Interest
      expenseDeposits
                                                        
                                                        (1,458,479
                                                        )
                                                        (5,868
                                                        )
                                                        (1,464,347
                                                        )
                                                        1,009,606
                                                        
                                                        465,455
                                                        
                                                        1,475,061Borrowings
                                                        
                                                        (1,592,830
                                                        )
                                                        1,752,034
                                                        
                                                        159,204
                                                        
                                                        (84,198
                                                        )
                                                        (365,989
                                                        )
                                                        (450,187
                                                        )Total
      interest expense
                                                        
                                                        (3,051,309
                                                        )
                                                        1,746,166
                                                        
                                                        (1,305,143
                                                        )
                                                        925,408
                                                        
                                                        99,466
                                                        
                                                        1,024,874Net
      interest income
                                                        
                                                        $    (375,406
                                                        )
                                                        $    405,453
                                                        
                                                        $       30,047
                                                        
                                                        $  (998,066
                                                        )
                                                        $ 
      568,351
                                                        
                                                        $     (429,715
                                                        )







(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.




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 and the unprecedented state
of the economy, the Company has experienced an increase in its delinquency rate
and charge off rate. The Company recorded a provision for loan losses of $2.1
million in 2008, $536,000 in 2007, and none for the year ended December 31,
2006. Nonaccrual, restructured and delinquent loans over 90 days to total
loans increased to 3.42% at the end of 2008 compared to 2.26% in 2007. The ratio
of net loan losses to average loans increased in 2008 to 0.74% compared to 0.15%
for 2007.  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.




25




Noninterest
Income




Noninterest
income increased from $6.3 million during 2007 to $6.6 million in 2008, an
increase of $312,000 or 5.0%. The increase was due to the $244,000 gain on the
sale and call of securities purchased at a discount partially offset by the
write down of equity securities, and a $263,000 or 11.5% increase in the fees
and commissions earned by CMSI.  These increases were partially offset
by a $126,000 or 13.3% decrease in service charges, a $53,000 or 2.8% decrease
in Point of Sale revenue and ATM fees and a $21,000 or4.3% decrease in other
fees and commissions.




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. The fees from the
ATMs represent approximately 4% 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 82% of total electronic banking revenue. Fees
from check cards comprise the remaining 14% of electronic banking
revenue.




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
$17.5 million for the year ended December 31, 2008 compared to $16.5 million for
the year ended December 31, 2007, a $993,000 or 6.0%
increase.The increase resulted from a one-time pre-tax charge
of $538,000 to close the Wilkens Plaza drive thru branch, a $238,000 increase in
OREO expenses, a $257,000 or 12.4% increase in occupancy expense resulting from
the opening of our new Cockeysville branch and relocating of our White Marsh
branch to Perry Hall and normal lease escalation charges, and a $506,000 or
37.1% increase in employee benefits, in particular medical
expenses.  These increases in expenses were offset by a $281,000 or
3.9% reduction in salary expenses due to fewer employees and a $159,000 or 14.8%
decrease in professional services related to consulting fees for compliance with
SOX in 2007.




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. These decreases were partially offset by
the $225,000 or 3% increase in salaries, the $269,000 or 15% increase in
occupancy costs, the $671,000 or 129% increase in professional fees, and the
$183,000 or 5% 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 $671,000 increase in professional fees 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.  The $183,000 increase in other operating expenses
was due primarily to 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.




Income
Tax Provision




Income
tax expense was $124,000 in 2008, $1.1 million in 2007 and $1.3 million in
2006. The effective tax rate was 12.8% in 2008, 33.1% in 2007, and 33.9% in
2006. The effective tax rates fluctuate from year to year due to changes in the
mix of tax-exempt loans, investments and life insurance policies as a percentage
of total loans and investments. In 2008, tax exempt interest was a substantial
percentage of income before income taxes which resulted in a significantly lower
effective tax rate.  During 2007 and 2006, the Company purchased
additional tax exempt securities, which reduced the effective tax
rates.




26




Financial
Condition




Summary




Total
assets of the Company increased by 14.6% to $404.2 million at
December 31, 2008 from $352.8 million at December 31, 2007.
Investment securities increased 26.5% to $66.8 million at December 31,
2008. Gross loans, excluding loans held for sale, increased by 8.4% to
$283.7 million at December 31, 2008 compared to $261.6 million at
the end of 2007. Interest-earning assets increased $53.3 million to
$383.2 million and were 94.8% of total assets at December 31,
2008.




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:




2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004Available
      for SaleU.S.
      Government agency
            
            $
            18,334,178
            
            
            $
            11,688,457
            
            
            $
            9,637,760
            
            
            $
            10,740,335
            
            
            $
            19,913,790Mortgage-backed
      securities
            
            
            24,969,846
            
            
            
            11,441,115
            
            
            
            12,725,553
            
            
            
            8,490,125
            
            
            
            8,447,886State
      and municipal bonds
            
            
            6,890,713
            
            
            
            4,904,648
            
            
            
            5,724,959
            
            
            
            3,689,859
            
            
            
            4,137,433Corporate
      bonds
            
            
            4,133,642
            
            
            
            4,788,589
            
            
            
            5,621,529
            
            
            
            1,514,471
            
            
            
            3,036,920Subtotal
            
            
            54,328,379
            
            
            
            32,822,809
            
            
            
            33,709,801
            
            
            
            24,434,790
            
            
            
            35,536,029Equity
      securities
            
            
            2,065,486
            
            
            
            1,966,123
            
            
            
            2,224,846
            
            
            
            4,660,213
            
            
            
            6,952,463Total
      available for sale
            
            
            56,393,865
            
            
            
            34,788,932
            
            
            
            35,934,647
            
            
            
            29,095,003
            
            
            
            42,488,492Held
      to MaturityU.S.
      Government agency
            
            
            —
            
            
            
            6,460,305
            
            
            
            6,456,069
            
            
            
            5,000,000
            
            
            
            —Mortgage-backed
      securities
            
            
            5,966,091
            
            
            
            7,130,202
            
            
            
            8,761,200
            
            
            
            9,575,713
            
            
            
            —State
      and municipal bonds
            
            
            3,912,836
            
            
            
            3,912,769
            
            
            
            3,912,704
            
            
            
            3,912,692
            
            
            
            —Equity
      securities
            
            
            495,361
            
            
            
            500,000
            
            
            
            —
            
            
            
            —
            
            
            
            —Total
      held to maturity
            
            
            10,374,288
            
            
            
            18,003,276
            
            
            
            19,129,973
            
            
            
            18,488,405
            
            
            
            —Total
      investment securities
            
            $
            66,768,153
            
            
            $
            52,792,208
            
            
            $
            55,064,620
            
            
            $
            47,583,408
            
            
            $
            42,488,492







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, 2008:




Available for Sale
                        
                        Held to MaturityMaturing
                        
                        Amortized
                          Cost
                        
                        Fair
                          Value
                        
                        Yield
                        
                        Amortized
                          Cost
                        
                        Fair
                          Value
                        
                        YieldWithin
      one year
                        
                        $   
       867,126
                        
                        $    
      875,152
                        
                        
                        3.49
                        %
                        
                        $              —
                        
                        $             —
                        
                        
                        —
                        %Over
      one to five years
                        
                        4,625,219
                        
                        4,534,807
                        
                        
                        6.19
                        
                        
                        —
                        
                        —
                        
                        
                        —Over
      five to ten years
                        
                        5,346,104
                        
                        5,356,638
                        
                        
                        5.16
                        
                        
                        3,912,836
                        
                        3,892,560
                        
                        
                        5.53Over
      ten years
                        
                        23,962,298
                        
                        18,591,936
                        
                        
                        4.78
                        
                        
                        495,361
                        
                        130,745
                        
                        
                        3.0534,800,747
                        
                        29,358,533
                        
                        
                        
                        
                        
                        4,408,197
                        
                        4,023,305Mortgage-backed
      securities
                        
                        24,688,564
                        
                        24,969,846
                        
                        
                        5.81
                        
                        
                        5,966,091
                        
                        6,108,552
                        
                        
                        4.73Equity
      securities
                        
                        1,608,495
                        
                        2,065,486
                        
                        
                        3.31
                        
                        
                        —
                        
                        —
                        
                        
                        —$61,097,806
                        
                        $56,393,865
                        
                        
                        
                        
                        
                        $10,374,288
                        
                        $10,131,857







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.




Investment
securities increased $14.0 million to $66.8 million at
December 31, 2008 compared to $52.8 million at December 31,
2007.




27




Loans




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




2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004Real
      Estate:Residential
            
            $
            77,278,004
            
            
            $
            66,259,210
            
            
            $
            55,057,625
            
            
            $
            53,148,211
            
            
            $
            55,242,018Commercial
            
            
            136,006,919
            
            
            
            111,474,356
            
            
            
            120,397,988
            
            
            
            97,909,115
            
            
            
            94,858,597Construction
      and land development
            
            
            30,955,304
            
            
            
            35,206,622
            
            
            
            29,996,306
            
            
            
            37,415,478
            
            
            
            17,774,874Demand
      and time
            
            
            37,691,638
            
            
            
            46,406,977
            
            
            
            51,549,802
            
            
            
            56,118,527
            
            
            
            46,168,587Lease
      financing
            
            
            29,772
            
            
            
            287,519
            
            
            
            969,113
            
            
            
            1,936,482
            
            
            
            3,598,003Installment
            
            
            1,731,519
            
            
            
            1,989,149
            
            
            
            2,030,480
            
            
            
            1,415,260
            
            
            
            2,084,215283,693,156
            
            
            
            261,623,833
            
            
            
            260,001,314
            
            
            
            247,943,073
            
            
            
            219,726,294Allowance
      for loan losses
            
            
            (3,179,741
            )
            
            
            (3,270,425
            )
            
            
            (3,131,021
            )
            
            
            (3,337,163
            )
            
            
            (3,485,076
            )Loans,
      net
            
            $
            280,513,415
            
            
            $
            258,353,408
            
            
            $
            256,870,293
            
            
            $
            244,605,910
            
            
            $
            216,241,218







Gross
loans, excluding loans held for sale, increased $22.1 million or 8.4% from
$261.6 million at December 31, 2007 to $283.7 million at
December 31, 2008.  The increase was in residential lending and
commercial real estate lending while construction and land development and
demand and time loans decreased. Commercial loans amounted to
$204.7 million at December 31, 2008 and were 72% of total loans.
Consumer loans amounted to $79.0 million and were 28% of total
loans.




The
following table shows the contractual maturities and interest rate sensitivities
of the Company’s loans at December 31, 2008. 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
            
            $
            1,172,069
            
            
            $
            26,457,598
            
            
            $
            1,689,138
            
            
            $
            5,226,649
            
            
            $
            38,215,532
            
            
            $
            4,517,018
            
            
            $
            77,278,004Commercial
            
            
            16,316,296
            
            
            
            15,158,345
            
            
            
            62,372,217
            
            
            
            9,660,125
            
            
            
            31,003,845
            
            
            
            1,496,091
            
            
            
            136,006,919Construction
      and land development
            
            
            8,365,351
            
            
            
            13,725,235
            
            
            
            4,602,797
            
            
            
            2,432,179
            
            
            
            1,829,742
            
            
            
            —
            
            
            
            30,955,304Demand
      and time
            
            
            3,100,464
            
            
            
            25,581,635
            
            
            
            7,513,265
            
            
            
            399,577
            
            
            
            1,096,697
            
            
            
            —
            
            
            
            37,691,638Lease
      financing
            
            
            29,772
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            29,772Installment
            
            
            490,596
            
            
            
            656,583
            
            
            
            222,767
            
            
            
            —
            
            
            
            173,789
            
            
            
            187,784
            
            
            
            1,731,519$
            29,474,548
            
            
            $
            81,579,396
            
            
            $
            76,400,184
            
            
            $
            17,718,530
            
            
            $
            72,319,605
            
            
            $
            6,200,893
            
            
            $
            283,693,156







The
following table provides information concerning nonperforming assets and past
due loans at December 31, 2008:




2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004Nonaccrual
      loans (a)
            
            $
            5,027,767
            
            
            $
            4,819,139
            
            
            $
            3,699,397
            
            
            $
            1,413,925
            
            
            $
            615,394Restructured
      loans
            
            
            771,216
            
            
            
            178,003
            
            
            
            180,686
            
            
            
            —
            
            
            
            455,864Foreclosed
      real estate
            
            
            1,736,018
            
            
            
            —
            
            
            
            1,383,163
            
            
            
            —
            
            
            
            —$
            7,535,001
            
            
            $
            4,997,142
            
            
            $
            5,263,246
            
            
            $
            1,413,925
            
            
            $
            1,071,258Accruing
      loans past-due 90 days or more
            
            $
            2,216,728
            
            
            $
            918,986
            
            
            $
            436,599
            
            
            $
            179,012
            
            
            $
            1,567,919







(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.




28




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 $290,127, $901,582, and $534,639 as of
December 31, 2008, 2007 and 2006, 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 $1.6 million, $1.4 million, and
$2.0 million as of December 31, 2008, 2007 and 2006,
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, 2004 through 2008, 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.




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.




29




Years ended December 31Description
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004Balance
      at beginning of year
            
            $
            3,270,425
            
            
            $
            3,131,021
            
            
            $
            3,337,163
            
            
            $
            3,485,076
            
            
            $
            3,648,245Charge-offs:Demand
      and time
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            123,578
            
            
            
            192,440Lease
      financing
            
            
            73,821
            
            
            
            25,778
            
            
            
            154,747
            
            
            
            168,823
            
            
            
            —Real
      estate:Residential
            
            
            498,687
            
            
            
            176,881
            
            
            
            —
            
            
            
            —
            
            
            
            7,746Commercial
            
            
            518,755
            
            
            
            220,640
            
            
            
            59,120
            
            
            
            —
            
            
            
            —Construction
            
            
            1,174,879
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Installment
            
            
            2,335
            
            
            
            19,153
            
            
            
            41,967
            
            
            
            22,640
            
            
            
            76,9362,268,477
            
            
            
            442,452
            
            
            
            255,834
            
            
            
            315,041
            
            
            
            277,122Recoveries:Demand
      and time
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            130,904
            
            
            
            67,111Lease
      financing
            
            
            8,309
            
            
            
            14,138
            
            
            
            16,530
            
            
            
            3,980
            
            
            
            —Real
      estate:Residential
            
            
            4,358
            
            
            
            —
            
            
            
            —
            
            
            
            14,874
            
            
            
            8,087Commercial
            
            
            9,643
            
            
            
            187
            
            
            
            6,290
            
            
            
            —
            
            
            
            —Construction
            
            
            32,648
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Installment
            
            
            26,835
            
            
            
            31,531
            
            
            
            26,872
            
            
            
            17,370
            
            
            
            38,75581,793
            
            
            
            45,856
            
            
            
            49,692
            
            
            
            167,128
            
            
            
            113,953Net
      charge-offs
            
            
            2,186,684
            
            
            
            396,596
            
            
            
            206,142
            
            
            
            147,913
            
            
            
            163,169Provision
      charged to operations
            
            
            2,096,000
            
            
            
            536,000
            
            
            
            —
            
            
            
            —
            
            
            
            —Balance
      at end of the year
            
            $
            3,179,741
            
            
            $
            3,270,425
            
            
            $
            3,131,021
            
            
            $
            3,337,163
            
            
            $
            3,485,076Ratio
      of net charge-offs to average loans outstanding
            
            
            0.82
            %
            
            
            0.15
            %
            
            
            0.08
            %
            
            
            0.06
            %
            
            
            0.08
            %




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.




Portfolio
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004Demand
      and time and lease financing
            
            $
            235,573
            
            
            $
            807,582
            
            
            $
            922,612
            
            
            $
            474,059
            
            
            $
            589,053Real
      estate:Residential
            
            
            702,297
            
            
            
            1,258,314
            
            
            
            409,684
            
            
            
            718,028
            
            
            
            587,292Commercial
            
            
            1,100,933
            
            
            
            687,797
            
            
            
            923,453
            
            
            
            679,002
            
            
            
            1,034,546Construction
      and land development
            
            
            193,471
            
            
            
            217,225
            
            
            
            230,072
            
            
            
            382,204
            
            
            
            342,114Installment
            
            
            81,642
            
            
            
            39,164
            
            
            
            49,399
            
            
            
            143,318
            
            
            
            149,271Unallocated
            
            
            865,640
            
            
            
            260,343
            
            
            
            595,801
            
            
            
            940,552
            
            
            
            782,800$
            3,179,741
            
            
            $
            3,270,425
            
            
            $
            3,131,021
            
            
            $
            3,337,163
            
            
            $
            3,485,076




30




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




Portfolio
                      
                      2008
                      
                      
                      2007
                      
                      
                      2006
                      
                      
                      2005
                      
                      
                      2004Demand
      and time and lease financing
                      
                      13.3
                      %
                      
                      17.8
                      %
                      
                      20.2
                      %
                      
                      23.4
                      %
                      
                      22.7
                      %Real
      estate:Residential
                      
                      27.2
                      
                      
                      25.3
                      
                      
                      21.2
                      
                      
                      21.4
                      
                      
                      25.1Commercial
                      
                      48.0
                      
                      
                      42.6
                      
                      
                      46.3
                      
                      
                      39.6
                      
                      
                      43.2Construction
      and land development
                      
                      10.9
                      
                      
                      13.5
                      
                      
                      11.5
                      
                      
                      15.1
                      
                      
                      8.1Installment
                      
                      0.6
                      
                      
                      0.8
                      
                      
                      0.8
                      
                      
                      0.5
                      
                      
                      0.9100.0
                      %
                      
                      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, 2008 the allowance for loan losses was $3.2 million, a 2.8%
decrease from the end of 2007. The ratio of the allowance to total loans was
1.12% at December 31, 2008 and 1.25% at December 31, 2007. The ratio of net loan
losses to average loans outstanding for 2008 was 0.82% compared to 0.15% for
2007. The ratio of nonaccrual loans, restructured loans and loans delinquent
more than 90 days to total loans and foreclosed real estate increased to 3.42%
at December 31, 2008 from 2.26% at the end of 2007. The ratio of real
estate loans to total loans increased to 86.1% at the end of 2008 from 81.4% at
the end of 2007.




Funding
Sources




Deposits




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




2008
                                                                                                    
                                                                                                    2007
                                                                                                    
                                                                                                    
                                                                                                    2006Average
                                                                                                      Balance
                                                                                                    
                                                                                                    Average
      Rate
                                                                                                    
                                                                                                    Average
                                                                                                      Balance
                                                                                                    
                                                                                                    Average
      Rate
                                                                                                    
                                                                                                    
                                                                                                    Average
                                                                                                      Balance
                                                                                                    
                                                                                                    Average
      RateNoninterest-bearing
      deposits
                                                                                                    $  48,754,626
                                                                                                    
                                                                                                    
                                                                                                    —
                                                                                                    %
                                                                                                    
                                                                                                    $  49,584,706
                                                                                                    
                                                                                                    
                                                                                                    —
                                                                                                    %
                                                                                                    
                                                                                                    
                                                                                                    $56,441,180
                                                                                                    
                                                                                                    
                                                                                                    —
                                                                                                    %Interest-bearing
      deposits:NOW
      accounts
                                                                                                    26,840,775
                                                                                                    
                                                                                                    
                                                                                                    .21
                                                                                                    
                                                                                                    
                                                                                                    29,273,381
                                                                                                    
                                                                                                    
                                                                                                    0.21
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    32,038,917
                                                                                                    
                                                                                                    
                                                                                                    0.21Savings
      accounts
                                                                                                    25,474,803
                                                                                                    
                                                                                                    
                                                                                                    .26
                                                                                                    
                                                                                                    
                                                                                                    26,446,228
                                                                                                    
                                                                                                    
                                                                                                    0.27
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    30,270,796
                                                                                                    
                                                                                                    
                                                                                                    0.27Money
      market accounts
                                                                                                    46,737,845
                                                                                                    
                                                                                                    
                                                                                                    2.18
                                                                                                    
                                                                                                    
                                                                                                    56,986,611
                                                                                                    
                                                                                                    
                                                                                                    3.95
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    51,303,354
                                                                                                    
                                                                                                    
                                                                                                    3.77Certificates
      of deposit
                                                                                                    130,592,612
                                                                                                    
                                                                                                    
                                                                                                    4.19
                                                                                                    
                                                                                                    
                                                                                                    117,106,699
                                                                                                    
                                                                                                    
                                                                                                    4.87
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    101,071,899
                                                                                                    
                                                                                                    
                                                                                                    4.47$278,400,661
                                                                                                    
                                                                                                    
                                                                                                    2.38
                                                                                                    %
                                                                                                    
                                                                                                    $279,397,625
                                                                                                    
                                                                                                    
                                                                                                    2.89
                                                                                                    %
                                                                                                    
                                                                                                    
                                                                                                    $271,126,146
                                                                                                    
                                                                                                    
                                                                                                    2.44
                                                                                                    %







The
following table provides the maturities of certificates of deposit of the
Company in amounts of $100,000 or more at December 31, 2008:




Maturing
      in:3
      months or less
            
            $
            6,642,951Over
      3 months through 6 months
            
            
            3,154,269Over
      6 months through 12 months
            
            
            23,366,570Over
      12 months
            
            
            14,120,612$
            47,284,402







Total
deposits at December 31, 2008 increased by $6.7 million to $292.4 million from
the end of 2007. Interest bearing accounts increased by $11 million and
noninterest-bearing deposits decreased by $4.3 million.




The
Company began offering CDARS deposits to its customers during 2004. This program
allows for customers who wish to invest more than the amounts that would
normally be covered by FDIC insurance with the Bank. The program is nationwide
and 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, 2008, the Bank had approximately
$21.5 million in CDARS deposits, an increase of $7.9 million from
December 31, 2007.




31




Borrowed
Funds




Borrowed
funds consist of securities sold under repurchase agreements, federal funds
purchased and borrowings from the FHLB. 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.




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




December
      31:
                
                2008
                
                
                2007
                
                
                2006Due
      2007, 5.50% to 5.51%
                
                $
                —
                
                
                $
                —
                
                
                $
                17,000,000Due
      2008, 5.19% to 5.51%
                
                
                —
                
                
                
                15,000,000
                
                
                
                5,000,000Due
      2009, 0.48% to 2.33%.
                
                
                21,600,000
                
                
                
                —
                
                
                
                —Due
      2010, 0.59% to 3.57%
                
                
                15,500,000
                
                
                
                —
                
                
                
                —Due
      2011, 3.00% to 4.04%
                
                
                15,900,000
                
                
                
                —
                
                
                
                —Due
      2012, 3.18% to 3.52%
                
                
                9,000,000
                
                
                
                —
                
                
                
                —Due
      2013, 3.26% to 4.33%
                
                
                3,230,000
                
                
                
                —
                
                
                
                —$
                65,230,000
                
                
                $
                15,000,000
                
                
                $
                22,000,000Federal
      funds purchased and securities sold under repurchase
      agreements
                
                $
                14,210,755
                
                
                $
                14,589,152
                
                
                $
                13,405,463Weighted
      average interest rate at year-end:Advances
      from the FHLB
                
                
                2.30
                %
                
                
                5.03
                %
                
                
                5.43
                %Federal
      funds purchased and securities sold under repurchase
      agreements
                
                
                0.003
                %
                
                
                4.03
                %
                
                
                4.86
                %Maximum
      outstanding at any month-end:Advances
      from the FHLB
                
                $
                82,550,000
                
                
                $
                30,000,000
                
                
                $
                40,000,000Federal
      funds purchased and securities sold under repurchase
      agreements
                
                $
                15,697,045
                
                
                
                19,427,144
                
                
                
                13,405,463Average
      balance outstanding during the year:Advances
      from the FHLB
                
                $
                51,812,650
                
                
                $
                19,753,973
                
                
                $
                24,603,287Federal
      funds purchased and securities sold under repurchase
      agreements
                
                $
                13,404,970
                
                
                
                11,914,984
                
                
                
                9,040,071Weighted
      average interest rate during the year:Advances
      from the FHLB
                
                
                3.07
                %
                
                
                5.58
                %
                
                
                5.38
                %Federal
      funds purchased and securities sold under repurchase
      agreements
                
                
                1.76
                %
                
                
                4.67
                %
                
                
                4.66
                %




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%.




The
Company may borrow under available unsecured federal funds line 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, 2008 and 2007.  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.




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, 2008 and 2007. 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.




32




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
            2008
            2008
            2007
            2007Leverage
      ratio
            4
            %
            8.17
            %
            7.37
            %
            
            
            10.03
            %
            
            
            9.72
            %Risk-based
      capital:Tier
      1 (Core)
            4
            %
            9.84
            %
            9.41
            %
            
            
            12.35
            %
            
            
            12.20
            %Total
            8
            %
            10.91
            %
            10.45
            %
            
            
            13.63
            %
            
            
            13.31
            %







Total
shareholders’ equity decreased 23.8% or $8.5 million to $27.4 million at
December 31, 2008. The decrease was due primarily to the repurchase of 276,137
shares for $3.9 million, dividends paid of $1.2 million, and a decrease in
accumulated other comprehensive income of $4.3 million, all of which was
partially offset by net income of $847,000.  The decrease in
accumulated other comprehensive income was due to the decrease in the fair
market value of the available for sale securities, the loss on the frozen
defined benefit pension plan partially offset by the increase in the fair market
value of the effective cash flow hedge.  Under regulatory
requirements, amounts reported as accumulated other comprehensive income/loss
related to these items do not increase or reduce regulatory capital and are not
included in the calculation of risk-based capital and leverage
ratios.




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 $37.3 million
or 9.2% of total assets at December 31, 2008.




The
borrowing requirements of customers include commitments to extend credit and the
unused portion of lines of credit, which totaled $111.0 million at December 31,
2008. Of this total, management places a high probability of required funding
within one year on approximately $60.5 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 external sources of funds through the Federal Reserve Bank
(“FRB”) and FHLB, which can be drawn upon when required.  There is a
line of credit totaling approximately $64 million with the Federal Home Loan
Bank of Atlanta (the “FHLB”) based on qualifying loans pledged as
collateral.  Also the Company can pledge securities at the FRB and
FHLB and borrow approximately 97% of the fair market value of the securities. In
addition, the Company had $33.7 million of securities pledged at the FHLB under
which the Company’s subsidiary, Carrollton Bank, could have borrowed
approximately $32.7 million.  Also, Carrollton Bank has $8.2 million
of securities pledged at FRB under which it could have borrowed approximately
$8.0 million.  Approximately $2.6 million of securities have not been
pledged against any borrowings. Outstanding borrowings at the FHLB were $65.2
million at December 31, 2008. Additionally, the Company has an unsecured federal
funds line of credit of $5.0 million and a $10.0 secured federal funds line of
credit with other institutions. The secured federal funds line of credit with
another institution would require Carrollton Bank to transfer securities pledged
at the FHLB or FRB to this institution before Carrollton Bank could borrow
against this line. There was no balance outstanding under these lines at
December 31, 2008. These lines bear interest at the current federal funds
rate of the correspondent bank.




Capital
Expenditures




Capital
expenditures were approximately $489,000 in 2008, $2.3 million in 2007 and
$801,000 in 2006.  The capital expenditures in 2008 related to
renovations at a couple of branches and purchases of equipment, including
computer equipment. 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 are projected to be approximately $1.2 million for fiscal year 2009
for renovations at one of the Company’s branch locations, purchases of several
ATM’s, purchase of hardware, software, cubicles, filing cabinets and storage for
the new corporate headquarters.




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.




33




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, 2008, 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 U.S. 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, 2008. 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, 2008 in which assets and liabilities
reprice:




(Dollars
      in thousands)
                                                                                  
                                                                                  0 to 90
                                                                                    days
                                                                                  
                                                                                  91 to 365
      days
                                                                                  
                                                                                  1 to 2
      years
                                                                                  
                                                                                  3 to 5
                                                                                    years
                                                                                  
                                                                                  
                                                                                  > 5
                                                                                    yearsAssets:Short
      term investments
                                                                                  $
                                                                                  3,665
                                                                                  
                                                                                  $
                                                                                  —
                                                                                  
                                                                                  $
                                                                                  —
                                                                                  
                                                                                  $
                                                                                  —
                                                                                  
                                                                                  $
                                                                                  —Investment
      securities
                                                                                  
                                                                                  2,987
                                                                                  
                                                                                  
                                                                                  19,924
                                                                                  
                                                                                  
                                                                                  31,220
                                                                                  
                                                                                  
                                                                                  8,659
                                                                                  
                                                                                  
                                                                                  3,978Loans
      held for sale
                                                                                  
                                                                                  21,701
                                                                                  
                                                                                  
                                                                                  —
                                                                                  
                                                                                  
                                                                                  —
                                                                                  
                                                                                  
                                                                                  —
                                                                                  
                                                                                  
                                                                                  —Loans:Residential
      real estate
                                                                                  
                                                                                  17,649
                                                                                  
                                                                                  
                                                                                  42,767
                                                                                  
                                                                                  
                                                                                  10,739
                                                                                  
                                                                                  
                                                                                  4,552
                                                                                  
                                                                                  
                                                                                  1,571Commercial
      real estate
                                                                                  
                                                                                  16,463
                                                                                  
                                                                                  
                                                                                  44,031
                                                                                  
                                                                                  
                                                                                  24,218
                                                                                  
                                                                                  
                                                                                  40,883
                                                                                  
                                                                                  
                                                                                  10,412Construction
      and land development
                                                                                  
                                                                                  7,032
                                                                                  
                                                                                  
                                                                                  15,020
                                                                                  
                                                                                  
                                                                                  1,947
                                                                                  
                                                                                  
                                                                                  4,562
                                                                                  
                                                                                  
                                                                                  2,394Demand
      and time
                                                                                  
                                                                                  4,729
                                                                                  
                                                                                  
                                                                                  24,969
                                                                                  
                                                                                  
                                                                                  2,190
                                                                                  
                                                                                  
                                                                                  4,724
                                                                                  
                                                                                  
                                                                                  1,080Lease
      financing
                                                                                  
                                                                                  28
                                                                                  
                                                                                  
                                                                                  2
                                                                                  
                                                                                  
                                                                                  —
                                                                                  
                                                                                  
                                                                                  —
                                                                                  
                                                                                  
                                                                                  —Installment
                                                                                  
                                                                                  103
                                                                                  
                                                                                  
                                                                                  864
                                                                                  
                                                                                  
                                                                                  98
                                                                                  
                                                                                  
                                                                                  65
                                                                                  
                                                                                  
                                                                                  602$
                                                                                  74,357
                                                                                  
                                                                                  $
                                                                                  147,577
                                                                                  
                                                                                  $
                                                                                  70,412
                                                                                  
                                                                                  $
                                                                                  63,445
                                                                                  
                                                                                  $
                                                                                  20,037Liabilities:Deposits
                                                                                  $
                                                                                  66,059
                                                                                  
                                                                                  $
                                                                                  81,577
                                                                                  
                                                                                  $
                                                                                  42,396
                                                                                  
                                                                                  $
                                                                                  4,293
                                                                                  
                                                                                  $
                                                                                  98,028Borrowings
                                                                                  
                                                                                  40,311
                                                                                  
                                                                                  
                                                                                  500
                                                                                  
                                                                                  
                                                                                  10,500
                                                                                  
                                                                                  
                                                                                  28,130
                                                                                  
                                                                                  
                                                                                  —$
                                                                                  106,370
                                                                                  
                                                                                  $
                                                                                  82,077
                                                                                  
                                                                                  $
                                                                                  2,896
                                                                                  
                                                                                  $
                                                                                  32,423
                                                                                  
                                                                                  $
                                                                                  98,028Gap
      positionPeriod
                                                                                  $
                                                                                  (32,013
                                                                                  )
                                                                                  $
                                                                                  65,500
                                                                                  
                                                                                  $
                                                                                  17,516
                                                                                  
                                                                                  $
                                                                                  31,022
                                                                                  
                                                                                  $
                                                                                  (77,991
                                                                                  )%
      of assets
                                                                                  
                                                                                  (7.92
                                                                                  %)
                                                                                  
                                                                                  16.21
                                                                                  %
                                                                                  
                                                                                  4.33
                                                                                  %
                                                                                  
                                                                                  7.68
                                                                                  %
                                                                                  
                                                                                  (19.30
                                                                                  %)Cumulative
                                                                                  $
                                                                                  (32,013
                                                                                  )
                                                                                  $
                                                                                  33.487
                                                                                  
                                                                                  $
                                                                                  51,003
                                                                                  
                                                                                  $
                                                                                  82,025
                                                                                  
                                                                                  $
                                                                                  4,034%
      of assets
                                                                                  
                                                                                  (7.92
                                                                                  %)
                                                                                  
                                                                                  8.29
                                                                                  %
                                                                                  
                                                                                  12.62
                                                                                  %
                                                                                  
                                                                                  20.29
                                                                                  %
                                                                                  
                                                                                  1.00
                                                                                  %Cumulative
      risk sensitive assets to risk sensitive liabilities
                                                                                  
                                                                                  69.91
                                                                                  %
                                                                                  
                                                                                  117.77
                                                                                  %
                                                                                  
                                                                                  121.13
                                                                                  %
                                                                                  
                                                                                  129.96
                                                                                  %
                                                                                  
                                                                                  101.09
                                                                                  %







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 2008, 2007, and 2006.




34




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, 2008:




Loan
      commitments
            $
            31,395,464Unused
      lines of credit
            
            79,654,394Letters
      of credit
            
            2,604,489







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, 2008.




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
                                
                                $
                                65,230
                                
                                $
                                21,600
                                
                                $ 40,400
                                
                                $
                                3,230
                                
                                
                                
                                —Federal
      fund purchased and securities sold under agreement to
      repurchase
                                
                                
                                14,211
                                
                                
                                14,211
                                
                                —
                                
                                
                                —
                                
                                
                                
                                —Operating
      lease obligations
                                
                                
                                13,430
                                
                                
                                1,179
                                
                                2,154
                                
                                
                                1,835
                                
                                
                                
                                8,262Purchase
      obligations(1)
                                
                                
                                4,942
                                
                                
                                569
                                
                                1,190
                                
                                
                                1,262
                                
                                
                                
                                1,921Total
                                
                                $
                                97,813
                                
                                $
                                37,559
                                
                                $ 43,744
                                
                                $
                                6,327
                                
                                
                                $
                                10,183







(1)
            Represents
      payments required under contract, based on average monthly charges for
      2008 and assuming a growth rate of 3%, with the Company’s current data
      processing service provider that expires in October
  2016.




New
Accounting Pronouncements




In May
2008, the Financial Accounting Standards Board, or FASB, issued FSP APB14-1,
Accounting for Convertible
Debt Instruments That May Be Settled In Cash upon Conversion (Including Partial
Cash Settlement), which applies to all convertible debt instruments that
have a “net settlement feature”, which means instruments that by their terms may
be settled either wholly or partially in cash upon conversion.  Under
FSP APB 14-1, the liability and equity components of convertible debt
instruments that may be settled wholly or partially in cash upon conversion must
be accounted for separately in a manner reflective of their issuer’s
nonconvertible debt borrowing rate.  Previous guidance provided for
accounting of this type of convertible debt instruments entirely as
debt.  FSP APB 14-1 is effective for financial statements issued for
fiscal years beginning after December 15, 2008 and interim periods within those
fiscal years. The adoption of this statement will have no affect on
the  Company’s financial statements.




SFAS
No. 160, Noncontrolling
Interest in Consolidated Financial Statements, an amendment of ARB
Statement No. 51. SFAS 160 amends Accounting Research Bulletin (“ARB”)
No. 51, Consolidated
Financial Statements, to establish accounting and reporting standards for
the non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 clarifies that a non-controlling interest in a
subsidiary, which is sometimes referred to as minority interest, is an ownership
interest in the consolidated entity that should be reported as a component of
equity in the consolidated financial statements. Among other requirements,
SFAS 160 requires consolidated net income to be reported at amounts that
include the amounts attributable to both the parent and the non-controlling
interest. It also requires disclosure, on the face of the consolidated income
statement, of the amounts of consolidated net income attributable to the parent
and to the non-controlling interest. SFAS 160 is effective for the Company
on January 1, 2009 and is not expected to have a significant impact on the
Company’s financial statements.




35




In March
2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133, which enhances the
disclosure requirements related to derivative instruments and hedging activity
to provide greater transparency about (i) how and why an entity uses
derivative instruments, (ii) how derivative instruments and related hedge
items are accounted for under SFAS 133 and its related interpretations, and
(iii) how derivative instruments and related hedged items affect an
entity’s financial position, results of operations and cash flows. To meet those
objectives, SFAS 161 requires qualitative disclosures about objectives and
strategies for using derivatives, quantitative disclosures about fair value
amounts of gains and losses on derivative instruments and disclosures about
credit-risk-related contingent features in derivative agreements. SFAS 161
is effective for the Company on January 1, 2009 and is not expected to have
a significant impact on the Company’s financial statements.




SFAS
No. 162, “The Hierarchy of Generally Accepted Accounting Principles.”
SFAS 162 identifies the sources of accounting principles and the framework
for selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with
generally accepted accounting principles (“GAAP”) in the United States (the GAAP
hierarchy). The hierarchical guidance provided by SFAS 162 did not have a
significant impact on the Company’s financial statements.




FSP
No. 132(R)-1 “Employers’ Disclosures about Postretirement Benefit Plan
Assets.” FSP 132(R)-1 provides guidance related to an employer’s
disclosures about plan assets of defined benefit pension or other post-
retirement benefit plans. Under FSP 132(R)-1, disclosures should provide
users of financial statements with an understanding of how investment allocation
decisions are made, the factors that are pertinent to an understanding of
investment policies and strategies, the major categories of plan assets, the
inputs and valuation techniques used to measure the fair value of plan assets,
the effect of fair value measurements using significant unobservable inputs on
changes in plan assets for the period and significant concentrations of risk
within plan assets. The disclosures required by FSP 132(R)-1 will be
included in the Company’s financial statements beginning with the financial
statements for the year-ending December 31, 2009.




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.




36


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, 2008 and 2007, 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, 2008. 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, 2008 and 2007, and the results of their
operations and their cash flows for each of the three years ended
December 31, 2008, 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 3,
2009




37




Consolidated
Balance Sheets




December 31,2008
            
            
            2007AssetsCash
      and due from banks
            
            $
            6,110,122
            
            
            $
            9,382,800Federal
      funds sold and Federal Home Loan Bank deposit
            
            
            4,052,166
            
            
            
            7,544,181Federal
      Home Loan Bank stock, at cost
            
            
            3,575,700
            
            
            
            1,305,100Investment
      securitiesAvailable
      for sale
            
            
            56,393,865
            
            
            
            34,788,932Held
      to maturity
            
            
            10,374,288
            
            
            
            18,003,276Loans
      held for sale
            
            
            21,701,287
            
            
            
            7,579,765Loans,
      less allowance for loan losses of $3,179,741 and
$3,270,425
            
            
            280,513,415
            
            
            
            258,353,408Premises
      and equipment
            
            
            7,012,193
            
            
            
            7,198,208Accrued
      interest receivable
            
            
            1,797,241
            
            
            
            1,733,672Bank
      owned life insurance
            
            
            4,593,182
            
            
            
            4,435,024Deferred
      income taxes
            
            
            3,416,895
            
            
            
            762,606Other
      real estate owned
            
            
            1,736,018
            
            
            
            —Other
      assets
            
            
            2,904,812
            
            
            
            1,762,083$
            404,181,184
            
            
            $
            352,849,055Liabilities
      and Shareholders’ EquityDepositsNoninterest-bearing
            
            $
            45,324,537
            
            
            $
            49,619,610Interest-bearing
            
            
            247,028,739
            
            
            
            236,019,015Total
      deposits
            
            
            292,353,276
            
            
            
            285,638,625Federal
      funds purchased and securities sold under agreements to
      repurchase
            
            
            14,210,755
            
            
            
            14,589,152Advances
      from the Federal Home Loan Bank
            
            
            65,230,000
            
            
            
            15,000,000Accrued
      interest payable
            
            
            288,410
            
            
            
            221,285Accrued
      pension plan
            
            
            1,968,896
            
            
            
            —Other
      liabilities
            
            
            2,739,154
            
            
            
            1,468,693376,790,491
            
            
            
            316,917,755Shareholders’
      equityCommon
      stock, par $1.00 per share; authorized 10,000,000 shares; issued and
      outstanding 2,564,988 in 2008 and 2,834,975 in 2007
            
            
            2,564,988
            
            
            
            2,834,975Additional
      paid-in capital
            
            
            15,255,971
            
            
            
            18,781,650Retained
      earnings
            
            
            13,252,272
            
            
            
            13,654,180Accumulated
      other comprehensive income (loss)
            
            
            (3,682,538
            )
            
            
            660,49527,390,693
            
            
            
            35,931,300$
            404,181,184
            
            
            $
            352,849,055




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




38




Consolidated
Statements of Income




Years Ended December 31,2008
            
            
            2007
            
            
            2006Interest
      incomeInterest
      and fees on loans
            
            $
            18,657,887
            
            
            $
            20,676,380
            
            
            $
            20,041,704Interest
      and dividends on securitiesTaxable
      interest income
            
            
            3,163,838
            
            
            
            2,297,626
            
            
            
            2,197,049Nontaxable
      interest income
            
            
            345,093
            
            
            
            376,199
            
            
            
            357,867Dividends
            
            
            174,494
            
            
            
            145,477
            
            
            
            148,259Interest
      on federal funds sold and other interest income
            
            
            65,288
            
            
            
            180,678
            
            
            
            382,625Total
      interest income
            
            
            22,406,600
            
            
            
            23,676,360
            
            
            
            23,127,504Interest
      expenseDeposits
            
            
            6,628,576
            
            
            
            8,102,417
            
            
            
            6,624,327Borrowings
            
            
            1,828,606
            
            
            
            1,659,907
            
            
            
            2,113,123Total
      interest expense
            
            
            8,457,182
            
            
            
            9,762,324
            
            
            
            8,737,450Net
      interest income
            
            
            13,949,418
            
            
            
            13,914,036
            
            
            
            14,390,054Provision
      for loan losses
            
            
            2,096,000
            
            
            
            536,000
            
            
            
            —Net
      interest income after provision for loan losses
            
            
            11,853,418
            
            
            
            13,378,036
            
            
            
            14,390,054Noninterest
      incomeService
      charges on deposit accounts
            
            
            823,978
            
            
            
            950,217
            
            
            
            1,121,271Brokerage
      commissions
            
            
            681,658
            
            
            
            677,647
            
            
            
            647,301Electronic
      Banking fees
            
            
            1,826,574
            
            
            
            1,879,650
            
            
            
            2,045,618Mortgage
      banking fees and gains
            
            
            2,548,417
            
            
            
            2,284,988
            
            
            
            2,465,814Other
      fees and commissions
            
            
            461,031
            
            
            
            481,640
            
            
            
            461,841Gains
      on security sales
            
            
            244,036
            
            
            
            —
            
            
            
            2,157,151Total
      noninterest income
            
            
            6,585,694
            
            
            
            6,274,142
            
            
            
            8,898,996Noninterest
      expensesSalaries
            
            
            6,946,000
            
            
            
            7,226,753
            
            
            
            7,001,847Employee
      benefits
            
            
            1,869,560
            
            
            
            1,363,985
            
            
            
            1,500,820Occupancy
            
            
            2,320,978
            
            
            
            2,064,352
            
            
            
            1,794,873Furniture
      and equipment
            
            
            636,784
            
            
            
            600,654
            
            
            
            633,004Professional
      services
            
            
            910,521
            
            
            
            1,192,628
            
            
            
            521,231Lease
      buyout - branch
            
            
            538,000
            
            
            
            —
            
            
            
            —Prepayment
      penalty
            
            
            —
            
            
            
            —
            
            
            
            2,251,971Check
      kiting loss
            
            
            —
            
            
            
            —
            
            
            
            1,833,733(Recovery)
      Impairment of ATM network
            
            
            —
            
            
            
            —
            
            
            
            (106,221
            )Other
      noninterest expenses
            
            
            4,246,221
            
            
            
            4,026,769
            
            
            
            3,949,745Total
      noninterest expenses
            
            
            17,468,064
            
            
            
            16,475,141
            
            
            
            19,381,003Income
      before income taxes
            
            
            971,048
            
            
            
            3,177,037
            
            
            
            3,908,047Income
      taxes
            
            
            124,197
            
            
            
            1,050,774
            
            
            
            1,323,268Net
      income
            
            $
            846,851
            
            
            $
            2,126,263
            
            
            $
            2,584,779Net
      income per share — basic
            
            $
            0.32
            
            
            $
            0.75
            
            
            $
            0.92Net
      income per share — diluted
            
            $
            0.32
            
            
            $
            0.75
            
            
            $
            0.90





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




39


Consolidated
Statements of Changes in Shareholders’ Equityyears ended December 31, 2008,
2007 and 2006




Common
              Stock
            
            Additional
      Paid-In Capital
            
            Retained
      Earnings
            
            Accumulated
              Other
              Comprehensive
      Income (Loss)
            
            Comprehensive
      Income (Loss)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
            
            
            —
            
            
            —
            
            —
            
            
            (1,156,725
            )
            
            
            (1,156,725
            )Adjustment
      to initially apply SFAS 158, net of tax effects of $306
            
            
            —
            
            
            —
            
            —
            
            
            484
            
            
            
            484Cash
      flow hedging derivative
            
            
            —
            
            
            —
            
            —
            
            
            (35,092
            )
            
            
            (35,092
            )Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
      1,393,446Shares
      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
            
            
            —
            
            
            —
            
            —
            
            
            (121,312
            )
            
            
            (121,312
            )SFAS
      158, net of tax effects of $17,785
            
            
            —
            
            
            —
            
            —
            
            
            26,819
            
            
            
            26,819Cash
      flow hedging derivative
            
            
            —
            
            
            —
            
            —
            
            
            108,913
            
            
            
            108,913Comprehensive
      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
            
            
            660,495Net
      Income
            
            
            —
            
            
            —
            
            846,851
            
            
            —
            
            
            
            $    846,851Changes
      in net unrealized gains (losses) on available for sale securities, net of
      tax
            
            
            —
            
            
            —
            
            —
            
            
            (3,407,842
            )
            
            
            (3,407,842
            )SFAS
      158, net of tax effects of $776,631
            
            
            —
            
            
            —
            
            —
            
            
            (1,219,569
            )
            
            
            (1,219.569
            )Cash
      flow hedging derivative
            
            
            —
            
            
            —
            
            —
            
            
            284,378
            
            
            
            284,378Comprehensive
      income (loss)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $(3,496,182
            )Shares
      acquired and cancelled
            
            
            (276,137
            )
            
            (3,607,733
            )
            —
            
            
            —Stock
      options exercised including tax benefit of $1,833
            
            
            2,550
            
            
            27,939
            
            —
            
            
            —Issuance
      of stock under 2007 Equity Plan
            
            
            3,600
            
            
            46,800
            
            —
            
            
            —Stock
      based compensation
            
            
            —
            
            
            7,315Cash
      dividends, $0.48 per share
            
            
            
            
            
            
            
            (1,248,759
            )Balance,
      December 31, 2008
            
            
            $2,564,988
            
            
            $15,255,971
            
            $13,252,272
            
            
            $(3,682,538
            )




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




40




Consolidated
Statements of Cash Flows




Years Ended December 31,2008
              
              
              2007
              
              
              2006Cash
      Flows from Operating Activities:Net
      income
              
              $
              846,851
              
              
              $
              2,126,263
              
              
              $
              2,584,779adjustments
      to reconcile net income to net cash provided by (used in) Operating
      Activities:Provision
      for loan losses
              
              
              2,096,000
              
              
              
              536,000
              
              
              
              —Deprecation
      and amortization
              
              
              869,301
              
              
              
              847,924
              
              
              
              763,749Deferred
      income taxes
              
              
              (1,382,057
              )
              
              
              139,538
              
              
              
              60,631Amortization
      of premiums and discounts
              
              
              (98,525
              )
              
              
              (57,828
              )
              
              
              (57,411
              )Gains
      on disposal of securities
              
              
              (348,318
              )
              
              
              —
              
              
              
              (2,157,176
              )Write
      down of equity securities
              
              
              104,282
              
              
              
              —
              
              
              
              —(Recovery)
      impairment of ATM network
              
              
              —
              
              
              
              —
              
              
              
              (106,221
              )Loans
      held for sale made, net of principal sold
              
              
              (14,121,522
              )
              
              
              (90,475
              )
              
              
              6,277,819Gains
      on sale of premises and equipment
              
              
              —
              
              
              
              (5,592
              )
              
              
              —Write
      down of foreclosed real estate
              
              
              167,000
              
              
              
              —
              
              
              
              —(Gain)
      loss on sale of foreclosed real estate
              
              
              (18,981
              )
              
              
              127,906
              
              
              
              —Stock
      based compensation expense
              
              
              7,315
              
              
              
              17,841
              
              
              
              13,447Stock
      issued under 2007 Equity Plan
              
              
              50,400
              
              
              
              58,500
              
              
              
              —(Increase)
      decrease in:Accrued
      interest receivable
              
              
              (63,569
              )
              
              
              (20,019
              )
              
              
              (294,824
              )Prepaid
      income taxes
              
              
              (649,190
              )
              
              
              —
              
              
              
              256,482Cash
      surrender value of bank owned life insurance
              
              
              (158,158
              )
              
              
              (155,194
              )
              
              
              (156,286
              )Other
      assets
              
              
              (751,410
              )
              
              
              (478,693
              )
              
              
              226,026Increase
      (decrease) in:Accrued
      interest payable
              
              
              67,125
              
              
              
              6,720
              
              
              
              (367,298
              )Deferred
      loan origination fees
              
              
              (88,255
              )
              
              
              (184,808
              )
              
              
              (33,566
              )Income
      taxes payable
              
              
              —
              
              
              
              (154,935
              )
              
              
              —Accrued
      pension plan liability
              
              
              1,968,896
              
              
              
              —
              
              
              
              —Other
      liabilities
              
              
              1,344,650
              
              
              
              34,083
              
              
              
              1,313Net
      cash provided by (used in) operating activities
              
              
              (10,158,165
              )
              
              
              2,747,231
              
              
              
              7,011,464Cash
      flows from investing activities:Proceeds
      from sales of securities available for sale
              
              
              5,369,929
              
              
              
              —
              
              
              
              2,766,852Proceeds
      from maturities of securities available for sale
              
              
              2,772,957
              
              
              
              6,973,048
              
              
              
              3,554,884Proceeds
      from maturities of securities held to maturity
              
              
              7,689,223
              
              
              
              1,159,552
              
              
              
              1,353,243Redemption
      (purchase) of Federal Home Loan Bank stock, net
              
              
              (2,270,600
              )
              
              
              399,400
              
              
              
              727,100Purchase
      of securities available for sale
              
              
              (35,080,758
              )
              
              
              (6,000,000
              )
              
              
              (15,030,741
              )Purchase
      of securities held to maturity
              
              
              —
              
              
              
              —
              
              
              
              (1,952,570
              )Loans
      made, net of principal collected
              
              
              (25,412,696
              )
              
              
              (579,049
              )
              
              
              (12,230,817
              )Purchase
      of premises and equipment
              
              
              (499.605
              )
              
              
              (2,338,287
              )
              
              
              (801,823
              )Purchase
      of foreclosed real estate
              
              
              (922,573
              )
              
              
              —
              
              
              
              —Proceeds
      from sale of premises and equipment
              
              
              —
              
              
              
              20,909
              
              
              
              —Proceeds
      from sale of foreclosed real estate
              
              
              283,481
              
              
              
              —
              
              
              
              —Net
      cash (used in) investing activities
              
              
              (48,070.642
              )
              
              
              (364,427
              )
              
              
              (21,613,872
              )Cash
      flows from financing activities:Net
      increase (decrease) in time deposits
              
              
              23,356,996
              
              
              
              13,519,929
              
              
              
              25,486,897Net
      increase (decrease) in other deposits
              
              
              (16,642,345
              )
              
              
              (5,785,105
              )
              
              
              (19,209,599
              )Advances
      (payment) of Federal Home Loan Bank advance
              
              
              50,230,000
              
              
              
              (7,000,000
              )
              
              
              (18,000,000
              )Net
      increase (decrease) in other borrowed funds
              
              
              (378,397
              )
              
              
              1,183,689
              
              
              
              2,192,991Common
      stock repurchase and retirement
              
              
              (3,883,870
              )
              
              
              (264,271
              )
              
              
              (128,850
              )Stock
      options exercised
              
              
              28,606
              
              
              
              592,709
              
              
              
              52,219Income
      tax benefit from exercise of stock options
              
              
              1,883
              
              
              
              32,790
              
              
              
              7,014Dividends
      paid
              
              
              (1,248,759
              )
              
              
              (1,358,330
              )
              
              
              (1,266,063
              )Net
      cash provided by (used in) financing activities
              
              
              51,464,114
              
              
              
              921,411
              
              
              
              (10,865,391
              )Net
      increase (decrease) in cash and cash equivalents
              
              
              (6,764,693
              )
              
              
              3,304,215
              
              
              
              (25,467,799
              )Cash
      and cash equivalents at beginning of year
              
              
              16,926,981
              
              
              
              13,622,766
              
              
              
              39,090,565Cash
      and cash equivalents at end of year
              
              $
              10,162,288
              
              
              $
              16,926,981
              
              
              $
              13,622,766Supplemental
      information:Interest
      paid on deposits and borrowings
              
              $
              8,390,057
              
              
              $
              9,755,604
              
              
              $
              9,104,758Income
      taxes paid
              
              $
              872,387
              
              
              $
              1,205,709
              
              
              $
              837,661Noncash
      activity:Transfer
      of loans to foreclosed real estate
              
              $
              1,244,945
              
              
              $
              —
              
              
              $
              1,383,163Foreclosed
      real estate financed
              
              $
              —
              
              
              $
              1,327,175
              
              
              $
              —




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




41




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 2008. 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.




Fair
Value




Effective
January 1, 2008, the Company adopted Statement of Financial Accounting Standard
No. 157, Fair Value Measurements, or SFAS 157, which establishes a framework for
measuring fair value and requires enhanced disclosures about fair value
measurements.  In accordance with Financial Accounting Standards Board
Staff Position (“FSP”) No. SFAS 157-2, “Effective Date of FASB
Statement No. 157,” the Company will delay application of SFAS 157 for
non-financial assets and non-financial liabilities, until January 1, 2009.
SFAS 157 defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles and expands disclosures about
fair value measurements. The application of SFAS 157 in situations where
the market for a financial asset is not active was clarified by the issuance of
FSP No. SFAS 157-3, “Determining the Fair Value of a Financial
Asset When the Market for That Asset Is Not Active,” in October 2008. FSP
No. SFAS 157-3 became effective immediately and required the use of
level 3 inputs for the five TRUP CDOs securities.




SFAS
157 clarifies that fair value is an exit price, representing the amount that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants.  SFAS 157 also requires
disclosure about how fair value is determined for assets and liabilities and
establishes a hierarchy for which these assets and liabilities must be
grouped,




42




1.
Summary of Significant Accounting Policies (Continued)




based on
significant levels of inputs.  See Note 20 for more information,
including a listing of our assets and liabilities required to be measured at
fair value on a recurring basis and where they are classified within the
hierarchy as of December 31, 2008.




In
February 2007, the FASB issued Statement No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.”  The standard provides
companies with an option to report selected financial assets and liabilities at
fair value and establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities.  The new
standard was effective for the Company on January 1, 2008.  The
Company did not elect the fair value option for any financial assets or
financial liabilities as of January 1, 2008.




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.




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.




43


1.
Summary of Significant Accounting Policies (Continued)




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, 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 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 the economic and market conditions on borrowers.
Loan losses are charged against the Allowance when management believes the
uncollectibility of the loan is confirmed. Subsequent recoveries, if any, are
credited to the Allowance.




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.




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, 2008 and 2007 was $184,761 and $307,936,
respectively. Amortization expense was $123,170 for 2008, 2007, and 2006,
respectively.




44







1.
Summary of Significant Accounting Policies (Continued)




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 the Financial Accounting Standards Board (“FASB”)
Statement 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 U.S. 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 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 SFAS No. 158, Employees Accounting for Defined
Benefit Pension and Other Post Retirement Plans 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
2008 and 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 FASB Statement No. 123
(R), Share-Based Payment,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




45




1.
Summary of Significant Accounting Policies (Continued)




Principles
Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and
related Interpretations, as permitted by FASB Statement No. 123, Accounting for
Stock-Based Compensation. 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 123 (R) 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 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 123 (R). 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 $7,315 and $17,841 during 2008 and 2007. As
of December 31, 2008, there was $2,123 of unrecognized compensation expense
related to nonvested stock options, which will be recognized over the remaining
vesting period.




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, 2008 and 2007,
the required reserve balances were $1.6 million and $1.2 million, respectively.
The Company sells federal funds on an unsecured basis to its correspondent
banks. Average balances sold were $2.5 million in 2008 and
$3.5 million in 2007.




3.
Investment Securities




Investment
securities are summarized as follows:




Amortized
              cost
            
            
            Unrealized
              gains
            
            
            Unrealized
              losses
            
            
            Fair
              valueDecember 31,
      2008Available
      for saleU.S.
      government agency
            
            $
            18,103,498
            
            
            $
            230,681
            
            
            $
            —
            
            
            $
            18,334,178Mortgage-backed
      securities
            
            
            24,688,564
            
            
            
            859,292
            
            
            
            578,010
            
            
            
            24,969,846State
      and municipal
            
            
            7,033,219
            
            
            
            20,282
            
            
            
            162,788
            
            
            
            6,890,713Corporate
      bonds
            
            
            9,664,031
            
            
            
            —
            
            
            
            5,530,389
            
            
            
            4,133,64259,489,312
            
            
            
            1,110,255
            
            
            
            6,271,187
            
            
            
            54,328,379Equity
      securities
            
            
            1,608,495
            
            
            
            539,982
            
            
            
            82,991
            
            
            
            2,065,486$
            61,097,807
            
            
            $
            1,650,237
            
            
            $
            6,354,178
            
            
            $
            56,393,865Held
      to maturityU.S.
      government agency
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —Mortgage-backed
      securities
            
            
            5,966,091
            
            
            
            144,174
            
            
            
            1,714
            
            
            
            6,108,552State
      and municipal
            
            
            3,912,836
            
            
            
            —
            
            
            
            20,277
            
            
            
            3,892,560Corporate
      bonds
            
            
            495,361
            
            
            
            —
            
            
            
            364,616
            
            
            
            130,745$
            10,374,288
            
            
            $
            144,174
            
            
            $
            386,607
            
            
            $
            10,131,857




46




3.
Investment Securities (Continued)




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
                                      
                                      
                                      —
                                      
                                      
                                      3,946,010Corporate
      bonds
                                      500,000
                                      
                                      —
                                      
                                      
                                      (56,250
                                      )
                                      
                                      443,750$18,003,276
                                      
                                      $      87,479
                                      
                                      $
                                      (93,158
                                      )
                                      
                                      $17,997,197




Information
related to unrealized losses in the portfolio as of December 31, 2008
follows:




Less than 12 months
                                                    
                                                    12 months or longer
                                                    
                                                    TotalFair
                                                      Value
                                                    
                                                    Unrealized
                                                      Losses
                                                    
                                                    Fair
                                                      Value
                                                    
                                                    Unrealized
                                                      Losses
                                                    
                                                    Fair
                                                      Value
                                                    
                                                    Unrealized
                                                      LossesMortgage-backed
      securities
                                                    
                                                    $2,816,406
                                                    
                                                    $
                                                    (481,503
                                                    )
                                                    
                                                    $  2,684,751
                                                    
                                                    $
                                                    (98,221
                                                    )
                                                    
                                                    $  5,501,157
                                                    
                                                    $
                                                    (579,724
                                                    )State
      and municipal
                                                    
                                                    —
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    8,991,576
                                                    
                                                    
                                                    (183,065
                                                    )
                                                    
                                                    8,991,576
                                                    
                                                    
                                                    (183,065
                                                    )Corporate
      bonds
                                                    
                                                    2,594,407
                                                    
                                                    $
                                                    (5,769,254
                                                    )
                                                    
                                                    1,669,980
                                                    
                                                    
                                                    (125,751
                                                    )
                                                    
                                                    4,264,387
                                                    
                                                    
                                                    (5,895,005
                                                    )Equity
      securities
                                                    
                                                    —
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    396,816
                                                    
                                                    
                                                    (82,991
                                                    )
                                                    
                                                    396,816
                                                    
                                                    
                                                    (82,991
                                                    )$5,410,813
                                                    
                                                    $
                                                    (6,250,757
                                                    )
                                                    
                                                    $13,743,123
                                                    
                                                    $
                                                    (490,028
                                                    )
                                                    
                                                    $19,153,936
                                                    
                                                    $
                                                    (6,740,785
                                                    )







Contractual
maturities of debt securities at December 31, 2008 and 2007 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, 2008Available for sale
                
                
                Held to maturityMaturing
                
                Amortized
                  Cost
                
                
                Fair
                  Value
                
                
                Amortized
                  Cost
                
                
                Fair
                  ValueWithin
      one year
                
                $
                867,126
                
                
                $
                875,152
                
                
                $
                —
                
                
                $
                —Over
      one to five years
                
                
                4,625,219
                
                
                
                4,534,807
                
                
                
                —
                
                
                
                —Over
      five to ten years
                
                
                5,346,104
                
                
                
                5,356,638
                
                
                
                3,912,836
                
                
                
                3,892,560Over
      ten years
                
                
                23,962,298
                
                
                
                18,591,936
                
                
                
                495,361
                
                
                
                130,745Mortgage-backed
      securities
                
                
                24,688,564
                
                
                
                24,969,846
                
                
                
                5,966,091
                
                
                
                6,108,552$
                59,489,312
                
                
                $
                54,328,379
                
                
                $
                10,374,288
                
                
                $
                10,131,857




47




3.
Investment Securities (Continued)




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







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, 2008, the Company owned five collateralized debt obligation
securities that are backed by trust preferred securities issued by banks,
thrifts, and insurance companies (“TRUP CDOs”).  The market for these
securities at December 31, 2008 was not active and markets for similar
securities were also not active.  The inactivity was evidenced first
by a significant widening of the bid-ask spread in the brokered markets in which
TRUP CDOs trade and then by a significant decrease in the volume of trades
relative to historical levels.  The new issue market is also inactive
as no new TRUP CDOs have been issued since 2007.  There are currently
very few market participants who are willing or able to transact for these
securities.




The
market values for these securities (and any securities other than those issued
or guaranteed by the U.S. Treasury) are very depressed relative to historical
levels.  For example, the yield on spreads for the broad market of
investment grade and high yield corporate bonds reached all time wide levels
versus U.S. Treasuries at the end of November 2008 and remain near those levels
today.  Thus, in today’s market, a low market price for a particular
bond may only provide evidence of stress in the credit markets in general versus
being an indicator of credit problems with a particular issuer.




Given
conditions in the debt markets today and the absence of observable transactions
in the secondary and new issue markets, we determined:




·
            The
      few observable transactions and market quotations that are available are
      not reliable for purposes of determining fair value at December, 31,
      2008;




·
            An
      income valuation approach technique (present value technique) that
      maximizes the use of relevant observable inputs and minimizes the use of
      unobservable inputs will be equally or more representative of fair value
      than the market approach valuation technique used at prior measurement
      dates; and




·
            Our
      TRUP CDOs will be classified within Level 3 of the fair value hierarchy
      because we determined that significant adjustments are required to
      determine fair value at the measurement
date.




Our TRUP
CDO valuations were prepared by an independent third party.  Their
approach to determining fair value involved these steps:




1.
            The
      credit quality of the collateral is estimated using average probability of
      default values for each issuer (adjusted for rating
    levels).




2.
            The
      default probabilities also considered the potential for correlation among
      issuers within the same industry (e.g. banks with other
      banks).




3.
            The
      loss given default was assumed to be 95% (i.e. a 5%
    recovery).




4.
            The
      cash flows were forecast for the underlying collateral and applied to each
      CDO tranche to determine the resulting distribution among the
      securities.




5.
            The
      expected cash flows were discounted to calculate the present value of the
      security.




6.
            The
      calculations were modeled in several thousand scenarios using a Monte
      Carlo engine and the average price was used for valuation
      purposes.




48




3.
Investment Securities (Continued)




7.
            The
      effective discount rates on an overall basis range from 7% to 31% and are
      highly dependent upon the credit quality of the collateral, the relative
      position of the tranche in the capital structure of the TRUP CDO and the
      prepayment assumptions.




During
2008, the Company wrote down two equity securities for $104,282.  At
December 31, 2008, seven marketable equity securities had unrealized losses of
approximately $83,000 from the Company’s cost basis.  At December 31,
2007, five marketable equity securities had unrealized losses of approximately
$40,000 from the Company’s cost basis.  No credit issues in the
remaining equity securities 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, 2008 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.




At
December 31, 2008 and 2007, securities with an amortized cost of $64.5 million
(fair value of $59.7 million) and $16.6 million (fair value of $16.5 million),
respectively, were pledged as collateral for government deposits, securities
sold under repurchase agreements, advances from the Federal Home Loan Bank, and
borrowings from the FRB.  At December 31, 2008, there were no
borrowings against the securities pledged at the FRB.




In 2008,
the Company realized gross gains on sales of or call of securities purchased at
a discount of $347,510.  These gains were partially offset by the
$104,282 write down of equity securities.  There were no sales of
securities in 2007.  In 2006 the Company realized gross gains on sales
of securities of $2.2 million. There were no realized losses in
2006.  Income taxes on net security gains in 2008 and 2006 were
$31,000 and $730,000, respectively.




4.
Loans




Major
classifications of loans at December 31 are as follows:




2008
              
              
              2007Real
      estate:Residential
              
              $
              77,278,004
              
              
              $
              66,259,210Commercial
              
              
              136,006,919
              
              
              
              111,474,356Construction
      and land development
              
              
              30,955,304
              
              
              
              35,206,622Demand
      and time
              
              
              37,691,638
              
              
              
              46,406,977Lease
      financing
              
              
              29,772
              
              
              
              287,519Installment
              
              
              1,731,519
              
              
              
              1,989,149283,693,156
              
              
              
              261,623,833Allowance
      for loan losses
              
              
              (3,179,741
              )
              
              
              (3,270,425
              )Loans,
      net
              
              $
              280,513,415
              
              
              $
              258,353,408




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:




2008
              
              
              2007Repricing
      or maturing within one year
              
              $
              111,053,944
              
              
              $
              111,657,455Maturing
      over one to five years
              
              
              94,118,714
              
              
              
              84,060,030Maturing
      over five years
              
              
              78,520,498
              
              
              
              65,906,348$
              283,693,156
              
              
              $
              261,623,833





49




4.
Loans (Continued)




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




2008
            
            
            2007Deferred
      origination costs and premiums
            
            $
            904,499
            
            
            $
            738,614Deferred
      origination fees and unearned discounts
            
            
            (947,080
            )
            
            
            (869,450
            )Net
      deferred fees
            
            $
            (42,581
            )
            
            $
            (130,836
            )







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




2008
            
            
            2007
            
            
            2006Beginning
      balance
            
            $
            3,270,425
            
            
            $
            3,131,021
            
            
            $
            3,337,163Provision
      charged to operations
            
            
            2,096,000
            
            
            
            536,000
            
            
            
            —Recoveries
            
            
            81,793
            
            
            
            45,856
            
            
            
            49,6925,448,218
            
            
            
            3,712,877
            
            
            
            3,386,855Loans
      charged off
            
            
            2,268,477
            
            
            
            442,452
            
            
            
            255,834Ending
      balance
            
            $
            3,179,741
            
            
            $
            3,270,425
            
            
            $
            3,131,021







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




2008
            
            
            2007
            
            
            2006Nonaccrual
      loans
            
            $
            5,027,767
            
            
            $
            4,819,139
            
            
            $
            3,699,397Restructured
      loans
            
            
            771,216
            
            
            
            178,003
            
            
            
            180,686Foreclosed
      real estate
            
            
            1,736,018
            
            
            
            —
            
            
            
            1,383,163Total
      nonperforming assets
            
            $
            7,535,001
            
            
            $
            4,997,142
            
            
            $
            5,263,246Accruing
      loans past-due 90 days or more
            
            $
            2,216,728
            
            
            $
            918,986
            
            
            $
            436,599Unrecorded
      interest on nonaccrual loans
            
            $
            296,553
            
            
            $
            458,797
            
            
            $
            76,044Interest
      income recognized on nonaccrual loans
            
            $
            281,237
            
            
            $
            88,384
            
            
            $
            300,650







At
December 31, 2008, the Company had eleven impaired loans totaling approximately
$1,554,000, all of which had been classified as non-accrual.  The
valuation allowance for impaired loans was $290,127 at December 31,
2008.




The
average balance of impaired loans amounted to approximately $3.6 million in
2008. During 2008, the Company received total payments on impaired loans of $1.9
million. Of this amount, $133,000 was recorded as interest income for 2008. The
remainder was applied to reduce principal.




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.




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.




At
December 31, 2006 there were no impaired loans.




Loans
with a balance of approximately $109.9 million and $97.3 million were pledged as
collateral to the Federal Home Loan Bank of Atlanta as of December 31, 2008 and
2007, respectively. At December 31, 2008 and 2007, the Company serviced loans
for others totaling $498,000 and $727,000, respectively.




50




5.
Credit Commitments




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




2008
            
            
            2007
            
            
            2006Loan
      commitmentsMortgage
      loans
            
            $
            4,847,310
            
            
            $
            4,347,755
            
            
            $
            4,122,697Construction
      and land development
            
            
            23,864,454
            
            
            
            17,688,330
            
            
            
            29,501,299Commercial
      loans
            
            
            2,683,700
            
            
            
            21,303,360
            
            
            
            6,840,000$
            31,395,464
            
            
            $
            43,339,445
            
            
            $
            40,463,996Unused
      lines of creditHome
      equity lines
            
            $
            40,965,247
            
            
            $
            43,371,236
            
            
            $
            46,199,911Commercial
      lines
            
            
            37,517,960
            
            
            
            39,801,481
            
            
            
            44,279,428Unsecured
      consumer lines
            
            
            1,171,187
            
            
            
            1,144,641
            
            
            
            1,084,048$
            79,654,394
            
            
            $
            84,317,358
            
            
            $
            91,563,387Letters
      of credit
            
            $
            2,604,489
            
            
            $
            2,546,445
            
            
            $
            2,223,755




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.




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,
2008, 2007 and 2006, transactions in related party loans were as
follows:




2008
            
            
            2007
            
            
            2006Beginning
      balance
            
            $
            4,423,636
            
            
            $
            7,976,614
            
            
            $
            1,894,784Additions
            
            
            693,468
            
            
            
            629,259
            
            
            
            7,918,876Repayments
            
            
            (2,328,636
            )
            
            
            (4,182,237
            )
            
            
            (1,837,046
            )Ending
      balance
            
            $
            2,788,468
            
            
            $
            4,423,636
            
            
            $
            7,976,614




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, 2008, 2007, and
2006, amounts paid to the law firm in connection with those services
were  approximately $381,000, $358,000, and $195,000,
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, 2008, 2007, and 2006, amounts paid to the insurance brokerage for
insurance premiums were approximately $214,000, $112,000, and $282,000,
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 2008, 2007 or 2006.




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 $126,562 in
2008, $1.5 million in 2007, and $356,000 in 2006 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


51




6.
Related Party Transactions (Continued)




unrelated
parties.  Balances of executive officers and directors on deposits as
of December 31, 2008 and 2007 were $2.7 million and $2.0 million,
respectively.




7.
Premises and Equipment




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




2008
            
            
            2007Land
      and improvements
            
            $
            909,544
            
            
            $
            909,544Buildings
            
            
            4,671,416
            
            
            
            4,607,893Leasehold
      improvements
            
            
            3,494,431
            
            
            
            3,686,903Equipment
      and fixtures
            
            
            4,938,751
            
            
            
            4,939,40914,014,142
            
            
            
            14,143,749Accumulated
      depreciation and amortization
            
            
            (7,001,949
            )
            
            
            (6,945,541
            )$
            7,012,193
            
            
            $
            7,198,208







Depreciation
and amortization of premises and equipment was $675,409, $663,135, and $611,658,
for 2008, 2007, and 2006, respectively. Amortization of software was $60,507,
$61,616, and $108,364 for 2008, 2007, and 2006, respectively.




8.
Deposits




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




2008
            
            
            2007NOW
      and Super NOW
            
            $
            27,887,068
            
            
            $
            27,832,670Money
      market
            
            
            42,314,448
            
            
            
            54,090,422Savings
            
            
            24,909,807
            
            
            
            25,535,502Certificates
      of deposit of $100,000 or more
            
            
            47,284,402
            
            
            
            36,865,359Other
      time deposits
            
            
            104,633,014
            
            
            
            91,695,062$
            247,028,739
            
            
            $
            236,019,015




Time
deposits mature as follows:




December 31,2008
                
                
                2007Maturing
      within one year
                
                $
                104,464,421
                
                
                $
                109,844,363Maturing
      over one to two years
                
                
                39,495,278
                
                
                
                12,620,414Maturing
      over two to three years
                
                
                5,281,316
                
                
                
                4,313,494Maturing
      over three to four years
                
                
                1,595,778
                
                
                
                801,961Maturing
      over four to five years
                
                
                1,080,623
                
                
                
                980,189$
                151,917,416
                
                
                $
                128,560,421




9.
Borrowed Funds




Borrowed
funds consist of securities sold under repurchase agreements, federal funds
purchased, and borrowings from the FHLB. 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.




52




9.
Borrowed Funds (Continued)




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




Federal
      Home Loan Bank BorrowingsDecember
      31,
                              
                              2008
                              
                              
                              2007Due
      2008, 5.19% to 5.51%
                              
                              $
                              —
                              
                              
                              $
                              15,000,000Due
      2009, 0.48% to 2.33%
                              
                              
                              21,600,000
                              
                              
                              
                              —Due
      2010, 0.59% to 3.57%
                              
                              
                              15,500,000
                              
                              
                              
                              —Due
      2011, 3.00% to 4.04%
                              
                              
                              15,900,000
                              
                              
                              
                              —Due
      2012, 3.18% to 3.52%
                              
                              
                              9,000,000
                              
                              
                              
                              —Due
      2013, 3.26% to 4.33%
                              
                              
                              3,230,000
                              
                              
                              
                              —$
                              65,230,000
                              
                              
                              $
                              15,000,000Federal
      funds purchased and securities sold under repurchase
      agreements
                              
                              $
                              14,210,755
                              
                              
                              $
                              14,589,152Weighted
      average interest rate at year-end:Advances
      from the FHLB
                              
                              
                              2.30
                              %
                              
                              
                              5.03
                              %Federal
      funds purchased and securities sold under repurchase
      agreements
                              
                              
                              0.003
                              %
                              
                              
                              4.03
                              %Maximum
      outstanding at any month-end:Advances
      from the FHLB
                              
                              $
                              82,550,000
                              
                              
                              $
                              30,000,000Federal
      funds purchased and securities sold under repurchase
      agreements
                              
                              $
                              15,697,045
                              
                              
                              $
                              19,427,144Average
      balance outstanding during the year:Advances
      from the FHLB
                              
                              $
                              51,812,650
                              
                              
                              $
                              19,753,973Federal
      funds purchased and securities sold under repurchase
      agreements
                              
                              $
                              13,404,970
                              
                              
                              $
                              11,914,984Weighted
      average interest rate during the year:Advances
      from the FHLB
                              
                              
                              3.07
                              %
                              
                              
                              5.58
                              %Federal
      funds purchased and securities sold under repurchase
      agreements
                              
                              
                              1.76
                              %
                              
                              
                              4.67
                              %







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%.




The
Company also has external sources of funds through the Federal Reserve Bank
(“FRB”) and FHLB, which can be drawn upon when required.  There is a
line of credit totaling approximately $64 million with the Federal Home Loan
Bank of Atlanta (the “FHLB”) based on qualifying loans pledged as
collateral.  Also the Company can pledge securities at the FRB and
FHLB and borrow approximately 97% of the fair market value of the securities. In
addition, the Company had $33.7 million of securities pledged at the FHLB under
which the Company’s subsidiary, Carrollton Bank, could have borrowed
approximately $32.7 million.  Also, Carrollton Bank has $8.2 million
of securities pledged at FRB under which it could have borrowed approximately
$8.0 million.  Approximately $2.6 million of securities have not been
pledged against any borrowings. Outstanding borrowings at the FHLB were $65.2
million at December 31, 2008. Additionally, the Company has an unsecured federal
funds line of credit of $5.0 million and a $10.0 secured federal funds line of
credit with other institutions. The secured federal funds line of credit with
the another institution would require Carrollton Bank to transfer securities
pledged at the FHLB or FRB to this institution before Carrollton Bank could
borrow against the line.  There was no balance outstanding under these
lines at December 31, 2008. These lines bear interest at the current
federal funds rate of the correspondent bank.




53




10.
Other Noninterest Expenses




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




2008
            
            
            2007
            
            
            2006Data
      processing services
            
            $
            853,868
            
            
            $
            847,231
            
            
            $
            815,056Loan
      expenses
            
            
            438,591
            
            
            
            290,286
            
            
            
            195,844Marketing
            
            
            340,514
            
            
            
            320,916
            
            
            
            303,903Directors’
      fees
            
            
            307,850
            
            
            
            352,550
            
            
            
            238,850Employee-related
      expenses
            
            
            305,074
            
            
            
            412,885
            
            
            
            384,128Loss
      on the sale of other real estate owned and related
expenses
            
            
            268,743
            
            
            
            —
            
            
            
            —Liability
      insurance
            
            
            158,687
            
            
            
            172,041
            
            
            
            205,516Printing,
      stationary, and supplies
            
            
            157,830
            
            
            
            166,373
            
            
            
            202,541Software
      maintenance
            
            
            144,120
            
            
            
            110,455
            
            
            
            51,306Telephone
            
            
            141,536
            
            
            
            125,558
            
            
            
            162,808Carrier
      service
            
            
            134,957
            
            
            
            196,240
            
            
            
            210,703Deposit
      premium amortization
            
            
            123,174
            
            
            
            123,174
            
            
            
            123,180Postage
      and freight
            
            
            118,684
            
            
            
            141,918
            
            
            
            164,606FDIC
      Assessment
            
            
            92,424
            
            
            
            32,557
            
            
            
            33,013Contributions
            
            
            88,348
            
            
            
            30,358
            
            
            
            59,324ATM
      services
            
            
            81,069
            
            
            
            63,959
            
            
            
            77,704Shareholder
      expense
            
            
            76,527
            
            
            
            94,974
            
            
            
            111,768Software
      amortization
            
            
            60,507
            
            
            
            61,615
            
            
            
            108,364Coin/Currency
      service
            
            
            9,626
            
            
            
            17,637
            
            
            
            103,480Other
            
            
            344,092
            
            
            
            466,042
            
            
            
            397,651$
            4,246,221
            
            
            $
            4,026,769
            
            
            $
            3,949,745







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 2008 and 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.




54




11.
Stock Options (Continued)




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




2008
                
                2007
                
                2006Shares
                
                Option Price Range
                
                Shares
                
                Option Price Range
                
                Shares
                
                Option Price RangeOutstanding
      at beginning of year
                
                184,555
                
                
                
                
                
                229,030
                
                
                
                
                
                227,130Granted
                
                —
                
                
                
                
                
                630
                
                
                $17.25
                
                
                12,430
                
                
                $15.35
      to $17.16Exercised
                
                (2,550
                )
                
                $10.94
      to $12.67
                
                
                (40,685
                )
                
                $
      9.71 to  $18.10
                
                
                (4,525
                )
                
                $10.94
      to $15.36Expired/Canceled
                
                (25,620
                )
                
                $16.70
      to $18.10
                
                
                (4,420
                )
                
                $14.50
      to $17.79
                
                
                (6,005
                )
                
                $10.94
      to $16.02Outstanding
      at end of year
                
                156,385
                
                
                $9.71
      to $18.03
                
                
                184,555
                
                
                $  9.71
      to $18.10
                
                
                229,030
                
                
                $9.71
      to $18.10Exercisable
      at December 31
                
                151,848
                
                
                
                
                
                173,732
                
                
                
                
                
                209,670Aggregate
      intrinsic value at year end
                
                $0.00
                
                
                
                
                
                $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 $7,315 and $17,841 during 2008
and 2007. As of December 31, 2008, 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, 2008 and 2007 was
approximately $5,000 and $86,000, respectively.




A summary
of information about stock options outstanding is as follows at
December 31, 2008:




Weighted
      Average
                                                                                        Exercise
      Price
                                                                                      
                                                                                      Shares
                                                                                      
                                                                                      Weighted
      Average
                                                                                        Remaining
      Life
                                                                                        (Years)
                                                                                      
                                                                                      Shares
      Underlying
                                                                                        Options
      Currently
                                                                                        Exercisable$ 
      9.71
                                                                                      
                                                                                      
                                                                                      1,890
                                                                                      
                                                                                      
                                                                                      2.33
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,89010.94
                                                                                      
                                                                                      
                                                                                      17,850
                                                                                      
                                                                                      
                                                                                      2.42
                                                                                      
                                                                                      
                                                                                      
                                                                                      17,85012.11
                                                                                      
                                                                                      
                                                                                      3,150
                                                                                      
                                                                                      
                                                                                      3.33
                                                                                      
                                                                                      
                                                                                      
                                                                                      3,15012.14
                                                                                      
                                                                                      
                                                                                      630
                                                                                      
                                                                                      
                                                                                      3.16
                                                                                      
                                                                                      
                                                                                      
                                                                                      63012.67
                                                                                      
                                                                                      
                                                                                      16,350
                                                                                      
                                                                                      
                                                                                      3.58
                                                                                      
                                                                                      
                                                                                      
                                                                                      16,35013.45
                                                                                      
                                                                                      
                                                                                      13,125
                                                                                      
                                                                                      
                                                                                      1.58
                                                                                      
                                                                                      
                                                                                      
                                                                                      13,12513.45
                                                                                      
                                                                                      
                                                                                      1,890
                                                                                      
                                                                                      
                                                                                      1.33
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,89014.45
                                                                                      
                                                                                      
                                                                                      5,880
                                                                                      
                                                                                      
                                                                                      6.29
                                                                                      
                                                                                      
                                                                                      
                                                                                      5,88014.50
                                                                                      
                                                                                      
                                                                                      3,780
                                                                                      
                                                                                      
                                                                                      4.33
                                                                                      
                                                                                      
                                                                                      
                                                                                      3,78014.50
                                                                                      
                                                                                      
                                                                                      29,000
                                                                                      
                                                                                      
                                                                                      6.96
                                                                                      
                                                                                      
                                                                                      
                                                                                      29,00014.85
                                                                                      
                                                                                      
                                                                                      5,000
                                                                                      
                                                                                      
                                                                                      6.43
                                                                                      
                                                                                      
                                                                                      
                                                                                      5,00015.36
                                                                                      
                                                                                      
                                                                                      1,670
                                                                                      
                                                                                      
                                                                                      0.33
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,67015.42
                                                                                      
                                                                                      
                                                                                      23,730
                                                                                      
                                                                                      
                                                                                      0.35
                                                                                      
                                                                                      
                                                                                      
                                                                                      23,73016.02
                                                                                      
                                                                                      
                                                                                      14,000
                                                                                      
                                                                                      
                                                                                      5.58
                                                                                      
                                                                                      
                                                                                      
                                                                                      14,00016.22
                                                                                      
                                                                                      
                                                                                      5,460
                                                                                      
                                                                                      
                                                                                      5.33
                                                                                      
                                                                                      
                                                                                      
                                                                                      5,46016.31
                                                                                      
                                                                                      
                                                                                      6,720
                                                                                      
                                                                                      
                                                                                      7.29
                                                                                      
                                                                                      
                                                                                      
                                                                                      4,48017.16
                                                                                      
                                                                                      
                                                                                      5,000
                                                                                      
                                                                                      
                                                                                      8.00
                                                                                      
                                                                                      
                                                                                      
                                                                                      3,33317.25
                                                                                      
                                                                                      
                                                                                      630
                                                                                      
                                                                                      
                                                                                      8.08
                                                                                      
                                                                                      
                                                                                      
                                                                                      21018.03
                                                                                      
                                                                                      
                                                                                      630
                                                                                      
                                                                                      
                                                                                      7.60
                                                                                      
                                                                                      
                                                                                      
                                                                                      42014.23
                                                                                      
                                                                                      
                                                                                      156,385
                                                                                      
                                                                                      
                                                                                      3.77
                                                                                      
                                                                                      
                                                                                      
                                                                                      151,848




55




11.
Stock Options (Continued)




As of
December 31, 2008, the weighted average exercise price of shares underlying
options currently exercisable was $14.15 per share.




No
options were granted in 2008.  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 and 2006:




2007
            
            
            2006Dividend
      yield
            
            
            3.30
            %
            
            
            2.67
            %Expected
      volatility
            
            
            36.61
            %
            
            
            24.76
            %Risk
      free rate
            
            4.04%
      to 4.87
            %
            
            4.91%
      to 4.99
            %Estimated
      life
            
            6
      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:




2008
            
            
            2007
            
            
            2006Weighted
      average common shares outstanding
            
            
            2,620,441
            
            
            
            2,829,376
            
            
            
            2,812,289Stock
      option adjustment
            
            
            —
            
            
            
            10,861
            
            
            
            58,953Weighted
      average common shares outstanding-diluted
            
            
            2,620,441
            
            
            
            2,840,237
            
            
            
            2,871,242Net
      income (applicable to common stock)
            
            $
            846,851
            
            
            $
            2,126,263
            
            
            $
            2,584,779Basic
      net income per share
            
            $
            0.32
            
            
            $
            0.75
            
            
            $
            0.92Diluted
      net income per share
            
            $
            0.32
            
            
            $
            0.75
            
            
            $
            0.90




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 changes in the net actuarial gain/loss of the Company’s frozen
Defined Benefit Pension 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:




2008
            
            
            2007
            
            
            2006Net
      Income
            
            $
            846,851
            
            
            $
            2,126,263
            
            
            $
            2,584,779Other
      comprehensive income (loss):Net
      unrealized gain (loss) on securities available for sale
            
            
            (5,385,284
            )
            
            
            (197,640
            )
            
            
            326,166Net
      actuarial (loss)gain on defined benefit retirement plan
            
            
            (2,013,985
            )
            
            
            44,299
            
            
            
            (52,862
            )Accumulated
      gain (loss) on effective cash flow hedging derivative
            
            
            471,257
            
            
            
            177,156
            
            
            
            (57,171
            )Less:
      Adjustment for security gains realized in net income
            
            
            (244,036
            )
            
            
            —
            
            
            
            (2,157,151
            )Other
      comprehensive income (loss) before tax
            
            
            (7,172,048
            )
            
            
            23,815
            
            
            
            (1,941,018
            )Income
      taxes (benefit) on comprehensive income
            
            
            (2,829,015
            )
            
            
            9,395
            
            
            
            749,685Other
      comprehensive income (loss) after tax
            
            
            (4,343,033
            )
            
            
            14,420
            
            
            
            (1,191,333
            )Comprehensive
      income (loss)
            
            $
            (3,496,182
            )
            
            $
            2,140,683
            
            
            $
            1,393,446




56




13.
Comprehensive Income (Continued)




The
components of accumulated other comprehensive income, net of tax, as of year-end
were as follows:




2008
                  
                  2007Net
      actuarial (loss) gain on defined benefit post-retirement benefit
      plans
                  
                  $
                  (1,192,265
                  )
                  
                  $
                  27,304Net
      unrealized (loss) gain  on securities available for
      sale
                  
                  
                  (2,848,471
                  )
                  
                  559,371Accumulated
      gain on effective cash flow hedging derivatives
                  
                  
                  358,198
                  
                  
                  
                  73,820$
                  (3,682,538
                  )
                  
                  $
                  660,485




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, 2008, that the Bank meets all capital adequacy requirements to
which it is subject. As of December 31, 2008, the most recent notification
from the 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.




Actual
            
            Minimum Capital Adequacy
            To Be Well CapitalizedAmount
            Ratio
            
            Amount
            
            Ratio
            Amount
            RatioDecember 31,
      2008Total
      Capital (to risk-weighted assets)Consolidated
            $34,230,000
            10.91
            %
            $25,101,000
            
            
            8.0
            %
            $31,377,000
            10.0
            %Carrollton
      Bank
            32,504,000
            10.45
            %
            24,893,000
            
            
            8.0
            %
            31,117,000
            10.0
            %Tier
      1 Capital (to risk-weighted assets)Consolidated
            30,888,000
            9.84
            %
            12,551,000
            
            
            4.0
            %
            18,826,000
            6.0
            %Carrollton
      Bank
            29,280,000
            9.41
            %
            12,447,000
            
            
            4.0
            %
            18,670,000
            6.0
            %Tier
      1 Capital (to average assets)Consolidated
            30,888,000
            8.17
            %
            15,114,000
            
            
            4.0
            %
            18,893,000
            5.0
            %Carrollton
      Bank
            29,280,000
            7.37
            %
            15,045,000
            
            
            4.0
            %
            18,806,000
            5.0
            %December 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
            %




15.
Retirement Plans




In the
year ended December 31, 2006, the Company adopted SFAS No. 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, 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.




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:




2008
              
              
              2007
              
              
              2006Change
      in Benefit Obligation:Benefit
      obligation at beginning of year
              
              $
              8,504,945
              
              
              $
              8,290,339
              
              
              $
              7,944,785Service
      cost
              
              
              —
              
              
              
              —
              
              
              
              —Interest
      cost
              
              
              484,362
              
              
              
              472,592
              
              
              
              469,361Actuarial
      (gain) loss
              
              
              (532,116
              )
              
              
              107,258
              
              
              
              230,830Benefits
      paid
              
              
              (403,716
              )
              
              
              (365,244
              )
              
              
              (354,637
              )Benefit
      obligation at end of year
              
              
              8,053,475
              
              
              
              8,504,945
              
              
              
              8,290,339Change
      in Plan Assets:Fair
      value of plan assets at beginning of year
              
              
              8,550,034
              
              
              
              8,291,129
              
              
              
              7,952,987Actual
      return on plan assets
              
              
              (1,991,902
              )
              
              
              687,533
              
              
              
              767,957Employer
      contribution
              
              
              —
              
              
              
              —
              
              
              
              —Benefits
      paid and administrative expenses
              
              
              (473,553
              )
              
              
              (428,628
              )
              
              
              (429,815
              )Fair
      value of plan assets at end of year
              
              
              6,084,579
              
              
              
              8,550,034
              
              
              
              8,291,129Funded
      status
              
              $
              (1,968,896
              )
              
              $
              45,089
              
              
              $
              790Amounts
      Recognized in the Consolidated Balance Sheets:Prepaid
      benefit cost
              
              $
              —
              
              
              $
              45,089
              
              
              $
              790Other
      liabilities
              
              
              (1,968,896
              )
              
              
              —
              
              
              
              —Net
      amount recognized
              
              $
              (1,968,896
              )
              
              $
              45,089
              
              
              $
              790Amounts
      recognized in accumulated other comprehensive income consist
      of:Net
      loss (gain)
              
              $
              2,233,588
              
              
              $
              (44,299
              )
              
              $
              790Prior
      service cost (credit)
              
              
              —
              
              
              
              —
              
              
              
              —Net
      amount recognized (before tax effect)
              
              $
              2,233,588
              
              
              $
              (44,299
              )
              
              $
              790




58




15.
Retirement Plans(Continued)




2008
            
            
            2007
            
            
            2006Assumptions
      used in Measuring the Projected Benefit Obligation were as Follows for the
      Years Ended December 31:Discount
      rates
            
            
            6.00
            %
            
            
            5.82
            %
            
            
            5.82
            %Rates
      of increase in compensation levels
            
            
            N/A
            
            
            
            N/A
            
            
            
            N/ALong-term
      rate of return on assets
            
            
            5.85
            %
            
            
            5.85
            %
            
            
            8.00
            %Net
      Periodic Pension Expense Includes the Following
Components:Service
      cost
            
            $
            —
            
            
            $
            —
            
            
            $
            —Interest
      cost
            
            
            484,362
            
            
            
            472,592
            
            
            
            469,361Expected
      return on plan assets
            
            
            (489,497
            )
            
            
            (475,074
            )
            
            
            (622,784
            )Net
      periodic pension (benefit)
            
            $
            (5,135
            )
            
            $
            (2,482
            )
            
            $
            (153,423
            )Accumulated
      Benefit Obligation at Year End
            
            $
            8,053,475
            
            
            $
            8,504,945
            
            
            $
            8,290,339 Allocation
of Assets
 Equity
      securities
                          
                          
                          49
                          %
                          
                          
                          59
                          %
                          
                          
                          52
                          %Fixed
      income-guaranteed fund
                          
                          
                          51
                          %
                          
                          
                          41
                          %
                          
                          
                          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.




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




Year
            
            Amount2009
            
            $
            376,0002010
            
            
            383,0002011
            
            
            399,0002012
            
            
            489,0002013
            
            
            487,0002014-2018
            
            
            2,509,000




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 $336,882, $319,236 and
$319,453, for 2008, 2007, and 2006, 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.




59




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.  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:




2008
            
            
            2007
            
            
            2006CurrentFederal
            
            $
            (28,953
            )
            
            $
            999,915
            
            
            $
            1,082,628State
            
            
            (15,120
            )
            
            
            162,767
            
            
            
            180,009(44,073
            )
            
            
            1,162,682
            
            
            
            1,262,637Deferred
            
            
            168,270
            
            
            
            (111,908
            )
            
            
            60,631$
            124,197
            
            
            $
            1,050,774
            
            
            $
            1,323,268




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




2008
              
              
              2007
              
              
              2006Provision
      for loan losses
              
              $
              39,136
              
              
              $
              (75,795
              )
              
              $
              79,612Deferred
      loan origination costs
              
              
              (3,433
              )
              
              
              (1,626
              )
              
              
              (20,427
              )Deferred
      compensation plan
              
              
              (5,981
              )
              
              
              (20,330
              )
              
              
              16,466Depreciation
              
              
              142,665
              
              
              
              (21,286
              )
              
              
              522Discount
      accretion
              
              
              (4,114
              )
              
              
              7,086
              
              
              
              5,178Retirement
      benefits
              
              
              —
              
              
              
              —
              
              
              
              (20,720
              )FHLB
      stock dividends
              
              
              (43
              )
              
              
              43
              
              
              
              —$
              168,270
              
              
              $
              (111,908
              )
              
              $
              60,631




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




2008
            
            
            2007
            
            
            2006Deferred
      tax assetsAllowance
      for loan losses
            
            $
            1,010,685
            
            
            $
            1,049,861
            
            
            $
            974,066Deferred
      compensation plan
            
            
            216,737
            
            
            
            210,756
            
            
            
            190,426Unrealized
      losses on available for sale investment securities
            
            
            1,622,142
            
            
            
            —
            
            
            
            —Prepaid
      retirement benefits
            
            
            776,631
            
            
            
            —
            
            
            
            —Depreciation
            
            
            —
            
            
            
            48,286
            
            
            
            27,0003,626,195
            
            
            
            1,308,903
            
            
            
            1,191,492Deferred
      tax liabilitiesDeferred
      loan origination costs
            
            
            101,586
            
            
            
            105,019
            
            
            
            106,645Unrealized
      gains on available for sale investment securities
            
            
            —
            
            
            
            398,401
            
            
            
            317,406Discount
      accretion
            
            
            11,316
            
            
            
            15,430
            
            
            
            8,344FHLB
      Stock dividends
            
            
            2,019
            
            
            
            2,062
            
            
            
            2,019Depreciation
            
            
            94,379
            
            
            
            —
            
            
            
            —209,300
            
            
            
            520,912
            
            
            
            434,414Net
      deferred tax asset
            
            $
            3,416,895
            
            
            $
            787,991
            
            
            $
            757,078




60




17.
Income Taxes (Continued)




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




2008
                      
                      2007
                      
                      2006Statutory
      federal income tax rate
                      
                      34.0
                      %
                      
                      34.0
                      %
                      
                      34.0
                      %Increase
      (Decrease) resulting from:Tax-exempt
      income
                      
                      (26.8
                      )
                      
                      (4.4
                      )
                      
                      (4.5
                      )State
      income taxes, net of federal income tax benefit
                      
                      3.8
                      
                      
                      3.8
                      
                      
                      3.8Nondeductible
      expense
                      
                      1.8
                      
                      
                      .5
                      
                      
                      0.6Change
      in state rates
                      
                      —
                      
                      
                      (.8
                      )
                      
                      —12.8
                      %
                      
                      33.1
                      %
                      
                      33.9
                      %




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 $1,249,543, $1,129,007, and $937,160, for 2008, 2007, and
2006, respectively.




Lease
obligations will require minimum rental payments as follows:




Period
            
            Minimum rentals2009
            
            $
            1,178,6132010
            
            
            1,186,5672011
            
            
            967,3662012
            
            
            900,5312013
            
            
            934,755Remaining
      years
            
            
            8,261,802$
            13,429,634




61




19.
Parent Company Financial Information




The
balance sheets as of December 31, 2008 and 2007 and statements of income
and cash flows for Carrollton Bancorp (Parent Only) for 2008, 2007 and 2006, are
presented below:




Balance
      Sheets
            
            December 31,2008
            
            
            2007AssetsCash
            
            $
            1,000
            
            
            $
            1,000Interest-bearing
      deposits in subsidiary
            
            
            29,433
            
            
            
            46,475Investment
      in subsidiary
            
            
            25,565,823
            
            
            
            34,276,436Investment
      securities available for sale
            
            
            1,967,720
            
            
            
            1,966,123Other
      assets
            
            
            24,209
            
            
            
            11,557$
            27,588,185
            
            
            $
            36,301,591Liabilities
      and Shareholders’ EquityLiabilities
            
            $
            197,492
            
            
            $
            370,291Shareholders’
      EquityCommon
      Stock
            
            
            2,564,988
            
            
            
            2,834,975Additional
      Paid-in Capital
            
            
            15,255,971
            
            
            
            18,781,650Retained
      earnings
            
            
            13,252,272
            
            
            
            13,654,180Accumulated
      other comprehensive income
            
            
            (3,682,538
            )
            
            
            660,49527,390,693
            
            
            
            35,931,300$
            27,588,185
            
            
            $
            36,301,591




Statements
of Income


Years ended December 31,2008
            
            
            2007
            
            
            2006IncomeDividends
      from subsidiary
            
            $
            5,623,906
            
            
            $
            776,520
            
            
            $
            258,840Interest
      and dividends
            
            
            80,368
            
            
            
            59,721
            
            
            
            73,720Security
      gains (losses)
            
            
            (103,474
            )
            
            
            —
            
            
            
            2,157,1515,600,800
            
            
            
            836,241
            
            
            
            2,489,711Expenses
            
            
            197,630
            
            
            
            314,256
            
            
            
            161,751Income
      before income taxes and equity in undistributed
              net
      income of subsidiary
            
            
            5,403,170
            
            
            
            521,985
            
            
            
            2,327,960Income
      tax expense (benefit)
            
            
            (107,597
            )
            
            
            (112,265
            )
            
            
            785,7905,510,767
            
            
            
            634,250
            
            
            
            1,542,170Equity
      in undistributed net income (loss) of subsidiary
            
            
            (4,663,916
            )
            
            
            1,492,013
            
            
            
            1,042,609Net
      Income
            
            $
            846,851
            
            
            $
            2,126,263
            
            
            $
            2,584,779





62




19.
Parent Company Financial Information (Continued)




Statements
of Cash Flows




Years ended December 31,2008
            
            
            2007
            
            
            2006Cash
      Flows from Operating Activities:Net
      income
            
            $
            846,851
            
            
            $
            2,126,263
            
            
            $
            2,584,779Adjustments
      to Reconcile Net Income to Net Cash Provided by Operating
      Activities:Equity
      in undistributed net (income) loss of subsidiary
            
            
            4,663,916
            
            
            
            (1,492,013
            )
            
            
            (1,042,609
            )Gains
      on disposal of securities
            
            
            (808
            )
            
            
            —
            
            
            
            (2,157,151
            )Write
      down of equity securities
            
            
            104,282
            
            
            
            —
            
            
            
            —Stock
      based compensation expense
            
            
            7,315
            
            
            
            17,841
            
            
            
            13,447Stock
      issued under 2007 Equity Plan
            
            
            50,400
            
            
            
            58,500
            
            
            
            —Decrease
      (increase) in other assets
            
            
            (12,652
            )
            
            
            16,715
            
            
            
            (2,457
            )Increase
      (decrease) in other liabilities
            
            
            (3,092
            )
            
            
            (645,540
            )
            
            
            13,126Net
      cash provided by (used in) operating activities
            
            
            5,656,212
            
            
            
            81,766
            
            
            
            (590,865
            )Cash
      Flows from investing Activities:Purchase
      of securities available for sale
            
            
            (574,160
            )
            
            
            —
            
            
            
            (117,269
            )Proceeds
      from sales of securities available for sale
            
            
            3,046
            
            
            
            —
            
            
            
            2,766,852Net
      cash (used in) provided by investing activities
            
            
            (571,114
            )
            
            
            —
            
            
            
            2,649,583Cash
      Flows from Financing Activities:Dividends
      paid
            
            
            (1,248,759
            )
            
            
            (1,358,330
            )
            
            
            (1,266,063
            )Common
      stock repurchase and retirement
            
            
            (3,883,870
            )
            
            
            (264,271
            )
            
            
            (128,850
            )Stock
      options exercised
            
            
            28,656
            
            
            
            592,709
            
            
            
            52,219Income
      tax benefit from exercise of stock options
            
            
            1,833
            
            
            
            32,790
            
            
            
            7,014Net
      cash used in financing activities
            
            
            (5,102,140
            )
            
            
            (997,102
            )
            
            
            (1,335,680
            )Net
      increase (decrease) in cash
            
            
            (17,042
            )
            
            
            (915,336
            )
            
            
            723,038Cash
      and cash equivalents at beginning of year
            
            
            47,475
            
            
            
            962,811
            
            
            
            239,773Cash
      and cash equivalents at end of year
            
            $
            30,433
            
            
            $
            47,475
            
            
            $
            962,811Noncash
      Activities:Income
      taxes paid, net of cash received from subsidiaries
            
            $
            69,344
            
            
            $
            546,578
            
            
            $
            769,473





63




20.
Fair Value and Financial Instruments




SFAS 157
defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants. A
fair value measurement assumes that the transaction to sell the asset or
transfer the liability occurs in the principal market for the asset or liability
or, in the absence of a principal market, the most advantageous market for the
asset or liability. The price in the principal (or most advantageous) market
used to measure the fair value of the asset or liability shall not be adjusted
for transaction costs. An orderly transaction is a transaction that assumes
exposure to the market for a period prior to the measurement date to allow for
marketing activities that are usual and customary for transactions involving
such assets and liabilities; it is not a forced transaction. Market participants
are buyers and sellers in the principal market that are (i) independent,
(ii) knowledgeable, (iii) able to transact and (iv) willing to
transact.




SFAS 157
requires the use of valuation techniques that are consistent with the market
approach, the income approach and/or the cost approach. The market approach uses
prices and other relevant information generated by market transactions involving
identical or comparable assets and liabilities. The income approach uses
valuation techniques to convert future amounts, such as cash flows or earnings,
to a single present amount on a discounted basis. The cost approach is based on
the amount that currently would be required to replace the service capacity of
an asset (replacement cost). Valuation techniques should be consistently
applied. Inputs to valuation techniques refer to the assumptions that market
participants would use in pricing the asset or liability. Inputs may be
observable, meaning those that reflect the assumptions market participants would
use in pricing the asset or liability developed based on market data obtained
from independent sources, or unobservable, meaning those that reflect the
reporting entity’s own assumptions about the assumptions market participants
would use in pricing the asset or liability developed based on the best
information available in the circumstances. In that regard, SFAS 157
establishes a fair value hierarchy for valuation inputs that gives the highest
priority to quoted prices in active markets for identical assets or liabilities
and the lowest priority to unobservable inputs. The fair value hierarchy is as
follows:




Level 1:  Quoted prices
(unadjusted) or identical assets or liabilities in active markets that the
entity has the ability to access as of the measurement date.




Level 2:  Significant other
observable inputs other than Level 1 prices, such as quoted prices for similar
assets or liabilities, quoted prices in markets that are not active, and other
inputs that are observable or can be corroborated by observable market
data.




Level 3:  Significant
unobservable inputs that reflect a company’s own assumptions about the
assumptions that market participants would use in pricing an asset or
liability.




The Company uses the following methods
and significant assumptions to estimate fair value for financial assets and
financial liabilities:




Securities available for
sale:  The fair value of securities available for sale are determined
by obtaining quoted prices on nationally recognized securities
exchanges.  If quoted market prices are not available, fair value is
determined using quoted market prices for similar securities.  Equity
securities are reported at fair value using Level 1 inputs.




Derivatives:  Derivatives are
reported at fair value utilizing Level 2 inputs.  The Company obtains
dealer quotations to value its interest rate floor.  For purposes of
potential valuation adjustments to its derivative position, the Company
evaluates the credit risk of its counterparty.  Accordingly, the
Company has considered factors such as the likelihood of default by the
counterparty and the remaining contractual life, among other things, in
determining if any fair value adjustment related to credit risk is
required.




Loans held for sale:  The
fair value of loans held for sale is determined, when possible, using quoted
secondary-market prices.  If no such quoted pricing exists, the fair
value of a loan is determined using quoted prices for a similar asset or assets,
adjusted for the specific attributes of that loan.




Impaired loans and other real estate
owned:  Nonrecurring fair value adjustments to loans and other real
estate owned (“OREO”) reflect full or partial write-downs that are based on the
loans or OREO’s observable market price or current appraised value of the
collateral in accordance with SFAS 114, Accounting by Creditors for Impairment
of a Loan.  Since the market for impaired loans and OREO is not
active, loans or OREO subjected to nonrecurring fair value adjustments based on
the current appraised value of the collateral may be classified as Level 2 or
Level 3 depending on the type of asset and the inputs to the
valuation.  When appraisals are used to determine impairment and these
appraisals are based on a market approach incorporating a dollar-per-square-foot
multiple, the related loans or OREO are classified as Level 2.  If the
appraisals require significant adjustments to market-based valuation inputs or
apply an income approach based on unobservable cash flows to measure fair value,
the related loans or OREO subjected to nonrecurring fair value adjustments are
typically classified as Level 3 due to the fact that Level 3 inputs are
significant to the fair value measurement.




64




20.
Fair Value and Financial Instruments (Continued)




Fair
      Value Measuments at December 31, 2008 using:Total
                Quoted
      prices in active markets for identical assets
                    (Level
      1)
                Significant
      other observable inputs
                    (Level
      2)
                Significant
      unobservable inputs
                  (Level
      3)Available
      for sale securities
                $56,393,865
                $2,065,486
                $50,194,738
                $4,133,641Derivative
      asset
                649,792
                —
                649,792
                —







Approximately
$104,000 write down of equity securities was recognized as a reduction of gain
on sales.




Certain other assets are measured at
fair value on a nonrecurring basis.  These adjustments to fair value
usually result from application of lower of cost or fair value accounting or
write-downs of individual assets due to impairment.  For assets
measured at fair value on a nonrecurring basis during 2008 that were still held
in the balance sheet at year end, the following table provides the level of
valuation assumptions used to determine each adjustment and the carrying value
of the related individual assets at year end.









Carrying
      value at December 31, 2008:Total
                Quoted
      prices in active markets for identical assets
                    (Level
      1)
                Significant
      other observable inputs
                    (Level
      2)
                Significant
      unobservable inputs
                    (Level
      3)Loans
      held for sale
                $21,701,287
                $                —
                $21,701,287
                $              —Impaired
      loans
                1,553,548
                —
                1,553,548
                —Other
      real estate owned (OREO)
                1,736,018
                —
                1,736,018
                —







During
2008, the Company recognized losses related to certain assets that are measured
at fair value on a nonrecurring basis (i.e. loans and loans held for
sale).  Approximately $2.3 million of losses related to loans were
recognized as chargeoffs for loan losses and $167,000 write downs of OREO
properties were recognized as other operating expenses.  During 2008,
there were no losses related to loans held for sale accounted for at the lower
of cost or fair value.




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.  Level 3 of the fair
value hierarchy was used to determine fair value of Trust Preferred securities
because the market for these securities at December 31, 2008 was not
active.




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.




65




20.
Fair Value and Financial Instruments (Continued)




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. The
estimated fair value of deposits does not take into account the value of the
Company’s long-term relationships with depositors, commonly known as core
deposit intangibles, which are separate intangible assets, and not considered
financial instruments. Nonetheless, the Company would likely realize a core
deposit premium if its deposit portfolio were sold in the principal market for
such deposits.




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, 2008
              
              
              December 31, 2007Carrying
                amount
              
              
              Fair
                value
              
              
              Carrying
                amount
              
              
              Fair
                valueFinancial
      assetsCash
      and cash equivalents
              
              $
              10,162,288
              
              
              $
              10,162,288
              
              
              $
              16,926,981
              
              
              $
              16,926,981Investment
      securities (total)
              
              
              66,768,153
              
              
              
              66,525,722
              
              
              
              52,792,208
              
              
              
              52,786,529Federal
      Home Loan Bank stock
              
              
              3,575,700
              
              
              
              3,575,700
              
              
              
              1,305,100
              
              
              
              1,305,100Loans
      held for sale
              
              
              21,701,287
              
              
              
              22,363,923
              
              
              
              7,579,765
              
              
              
              7,761,521Loans,
      net
              
              
              280,513,415
              
              
              
              289,078,738
              
              
              
              258,353,408
              
              
              
              264,548,464Financial
      liabilitiesNoninterest-bearing
      deposits
              
              
              45,324,537
              
              
              
              45,324,537
              
              
              
              49,619,610
              
              
              
              49,619,610Interest-bearing
      deposits
              
              
              247,028,739
              
              
              
              250,644,373
              
              
              
              236,019,015
              
              
              
              237,021,786Federal
      funds purchased and securities sold under agreements to
      repurchase
              
              
              14,210,755
              
              
              
              14,210,755
              
              
              
              14,589,152
              
              
              
              14,589,152Advances
      from the Federal Home Loan Bank
              
              
              65,230,000
              
              
              
              66,088,063
              
              
              
              15,000,000
              
              
              
              15,009,000





66




21.
Consolidated Quarterly Results of Operations (Unaudited)




Year Ended December 31, 2008First Quarter
              
              Second Quarter
              
              Third Quarter
              
              Fourth QuarterInterest
      income
              
              $
              5,559,959
              
              
              $
              5,474,229
              
              
              $
              5,684,721
              
              
              $
              5,687,691Interest
      expense
              
              
              2,157,184
              
              
              
              1,930,005
              
              
              
              2,167,677
              
              
              
              2,202,316Net
      interest income
              
              
              3,402,775
              
              
              
              3,544,224
              
              
              
              3,517,044
              
              
              
              3,485,375Provision
      for loan losses
              
              
              99,000
              
              
              
              99,000
              
              
              
              799,000
              
              
              
              1,099,000Other
      noninterest income
              
              
              1,660,186
              
              
              
              1,645,704
              
              
              
              1,642,103
              
              
              
              1,637,701Noninterest
      expenses
              
              
              4,417,019
              
              
              
              4,163,855
              
              
              
              4,364,975
              
              
              
              4,522,215Income
      (loss) before income taxes
              
              
              546,942
              
              
              
              927,073
              
              
              
              (4,828
              )
              
              
              (498,139
              )Income
      taxes (benefit)
              
              
              117,993
              
              
              
              300,155
              
              
              
              (55,557
              )
              
              
              (238,394
              )Net
      income (loss)
              
              $
              428,949
              
              
              $
              626,918
              
              
              $
              50,729
              
              
              $
              (259,745
              )Net
      income (loss) per share — basic
              
              $
              0.16
              
              
              $
              0.24
              
              
              $
              0.02
              
              
              $
              (0.10
              )Cash
      dividends per share
              
              $
              0.12
              
              
              $
              0.12
              
              
              $
              0.12
              
              
              $
              0.12Market
      prices: high
              
              $
              15.08
              
              
              $
              14.99
              
              
              $
              14.00
              
              
              $
              9.34low
              
              $
              12.00
              
              
              $
              11.75
              
              
              $
              8.00
              
              
              $
              5.50




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
                                                            
                                                            
                                                            
                                                            3,375,220Gains
      on security sales
                                                            
                                                            
                                                            
                                                            
                                                            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


67




21.
Consolidated Quarterly Results of Operations (Unaudited)(Continued)




Year Ended December 31, 2006First Quarter
                                                                                        
                                                                                        Second 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


22.
Subsequent Event




On
February 13,  2009, as part of the TARP Capital Purchase Program, the
Company entered into a Letter Agreement, and the related Securities Purchase
Agreement - Standard Terms (collectively, the “Purchase Agreement”), with
the United States Department of the Treasury (“Treasury”), pursuant to which the
Company issued (i) 9,201 shares of Fixed Rate Cumulative Perpetual
Preferred Stock, Series A, liquidation preference $1,000 per share (“Series A
Preferred Stock”), and (ii) a warrant to purchase 205,379 shares of
the Company’s common stock, par value $1.00 per share.




The
Company raised $9,201,000 through the sale of the Series A Preferred Stock which
will qualify as Tier 1 capital. With the full amount of the Treasury’s
investment, on a pro-forma basis, at December 31, 2008, the Company’s Tier I
capital ratio would increase to approximately 12.78% and total risk-based
capital ratio would increase to approximately 13.84%.  The Series A
Preferred Stock will pay cumulative dividends at a rate of 5% per annum
until February 15, 2014. Beginning February 16, 2014, the dividend rate will
increase to 9% per annum.   Dividends are payable
quarterly.




On and
after February 15, 2012, the Company may, at its option, redeem shares of Series
A Preferred Stock, in whole or in part, at any time and from time to time, for
cash at a per share amount equal to the sum of the liquidation preference per
share plus any accrued and unpaid dividends to but excluding the redemption
date. Prior to February 15, 2012, the Company may redeem shares of Series A
Preferred Stock only if it has received aggregate gross proceeds of not less
than $ 9,201,000 from one or more qualified equity offerings, and the aggregate
redemption price may not exceed the net proceeds received by the Company from
such offerings. The redemption of the Series A Preferred Stock requires prior
regulatory approval.




The
warrant is exercisable in whole or in part at $6.72 per share at any time on or
before February 13, 2019. Treasury has agreed not to exercise voting power with
respect to any shares of common stock issued upon exercise of the
warrant.




The
Series A Preferred Stock and the warrant were issued in a transaction exempt
from registration pursuant to Section 4(2) of the Securities Act of 1933,
as amended. The Company has agreed to register the Series A Preferred Stock, the
warrant, and the shares of common stock underlying the warrant (the “warrant
shares”) as soon as practicable after the date of the issuance of the Series A
Preferred Stock and the warrant. Neither the Series A Preferred Stock nor the
warrant will be subject to any contractual restrictions on transfer, except that
Treasury may not transfer a portion of the warrant with respect to, or exercise
the warrant for, more than one-half of the warrant shares prior to the earlier
of (a) the date on which the Company has received aggregate gross proceeds of
not less than $9,201,000 from one or more qualified equity offerings and (b)
December 31, 2009.




The
Purchase Agreement also subjects the Company to certain of the executive
compensation limitations included in the Emergency Economic Stabilization Act of
2008 (the “EESA”). As a condition to the closing of the transaction, Robert A.
Altieri, James M. Uveges, Gary M. Jewell, William D. Sherman, and Lola B. Stokes
(the Company’s Senior Executive Officers, as defined in the Purchase Agreement)
each: (i) voluntarily waived any claim against the Treasury or the Company
for any changes to such Senior Executive Officer’s compensation or benefits that
are required to comply with the regulation issued by the Treasury under the TARP
Capital Purchase Program as published in the Federal Register on
October 20, 2008 and acknowledging that the regulation may require
modification of the compensation, bonus, incentive and other benefit plans,
arrangements and policies and agreements (including so-called “golden parachute”
agreements) as they relate to the period the Treasury holds any equity or debt
securities of the Company acquired through the TARP Capital Purchase Program;
and (ii) entered into an amendment to Messer’s Altieri,
Uveges,  Jewell and Mrs. Stokes employment agreements that provide
that any severance payments made to such officers will be reduced, as necessary,
so as to comply with the requirements of the TARP Capital Purchase
Program.




68




The
Treasury’s current consent shall be required for any increase in the common
dividends per share until February 13, 2012 unless prior to such date, the
Series A preferred stock is redeemed in whole or the Treasury has transferred
all of the Series A Preferred Stock to third parties.




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 2008.




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
objective.




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, 2008 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, 2008 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 2008 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 12, 2009.


69


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 2008 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 12, 2009.




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 12, 2009.




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 12, 2009.




Item
14: Principal Accounting 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 12, 2009.




PART IV




Item
15: Exhibits, Financial Statement Schedules




1.
            Financial
      Statements


Carrollton
Bancorp and Subsidiaries:


Report of
Independent Registered Public Accounting Firm


Consolidated
Balance Sheets as of December 31, 2008, and 2007


Consolidated
Statements of Income for the years ended December 31, 2008, 2007, and
2006


Consolidated
Statements of Changes in Shareholders’ Equity for the years ended
December 31, 2008, 2007, and 2006


Consolidated
Statements of Cash Flows for the years ended December 31, 2008, 2007, and
2006


Notes to
Consolidated Financial Statements


2.
            Financial
      Statement Schedules


None


3.
            Exhibits




Exhibit
              Number
            
            Description3.1(i)
            
            Articles
      of Incorporation of Carrollton Bancorp3.1(ii)
            
            Articles
      of Amendment of Carrollton Bancorp3.1(iii)
            
            Articles
      Supplementary of Carrollton Bancorp3.2(i)
            
            By-Laws
      of Carrollton Bancorp3.2(ii)
            
            Amendment
      No. 1 to Bylaws of Carrollton Bancorp4.1
            
            Form
      of Stock Certificate for Fixed Rate Cumulative Perpetual Preferred Stock,
      Series A(1)4.2
            
            Warrant
      to Purchase 205,379 Shares of Common Stock of Carrollton
      Bancorp(1)10.1
            
            Lease
      dated January 24, 1989, by and between Hill Management
      Services, Inc. and The Carrollton Bank of
    Baltimore.(2)10.2
            
            Lease
      dated July 21, 1989, by and between Hill Management
      Services, Inc. and The Carrollton Bank of
    Baltimore.(2)10.7
            
            Lease
      dated July 19, 1988, by and between Northway Limited Partnership and
      The Carrollton Bank of Baltimore.(2)10.8
            
            Lease
      dated August 11, 1994, by and between KIMCO and Carrollton
      Bank.(3)10.9
            
            Lease
      dated October 11, 1994, by and between Ridgeview Associates Limited
      Partnership and Carrollton Bank.(3)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 Bank





70




Exhibit
                Number
              
              Description10.20
              
              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(4)10.23
              
              Lease
      dated August 13, 2007, by and between Tarragon, Inc. and Carrollton
      Bank10.24
              
              Employment
      agreement with Robert A. Altieri(5)10.25
              
              Employment
      agreement with Lola B. Stokes(6)10.26
              
              Employment
      agreement with James M. Uveges(7)10.27
              
              Lease
      dated September 8, 2008 by and between Gateway 38 LLC and Carrollton
      Bancorp (8)10.28
              
              Letter
      Agreement and related Securities Purchase Agreement - Standard Terms,
      dated February 13, 2009 between Carrollton Bancorp and United States
      Department of the Treasury(1)10.29
              
              Form
      Waiver executed by each of Robert A. Altieri, James M. Uveges, Gary M.
      Jewell, William D. Sherman and Lola B. Stokes(1)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 to the Registrant’s Form 8-K filed 2/17/2009 (File No.:
      000-23090).


(2)
            Incorporated
      by reference from Registration Statement dated January 12, 1990, on
      SEC Form S-4 (1933 Act File No.:
33-33027).


(3)
            Incorporated
      by reference from Annual Report on Form 10-KSB for the fiscal year
      ended December 31, 1994, (1934 Act File No.:
  0-23090).


(4)
            Incorporated
      by reference to the Registrant’s Form 8-K filed 6/19/2007 (File No.:
      000-23090).


(5)
            Incorporated
      by reference to the Registrant’s Form 8-K filed 9/25/2007 (File No.:
      000-23090).


(6)
            Incorporated
      by reference to the Registrant’s Form 8-K filed 10/24/2007 (File No.:
      000-23090).


(7)
            Incorporated
      by reference to the Registrant’s Form 8-K filed 11/8/2007 (File No.:
      000-23090).


(8)
            Incorporated
      by reference to the Registrant’s Form 8-K filed 9/30/2008 (File No.:
      000-23090)




71




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 3,
      2009
            
            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 3,
      2009
            
            By:
            
            /s/
      Robert A. AltieriRobert
      A. AltieriPresident
      and Chief Executive Officer





Principal
Financial and Accounting Officer




March 3,
      2009
                        
                        By:
                        
                        /s/
      James M. UvegesJames
      M. Uveges(Principal
      financial and accounting officer)Senior
      Vice President and Chief Financial OfficerBoard
      of DirectorsMarch 3,
      2009
                        
                        By:
                        
                        /s/
      Robert J. AumillerRobert
      J. AumillerDirectorMarch 3,
      2009
                        
                        By:
                        
                        /s/
      Steven K. BreedenSteven
      K. BreedenDirectorMarch 3,
      2009
                        
                        By:
                        
                        /s/
      Albert R. CounselmanAlbert
      R. CounselmanChairman
      of the BoardMarch 3,
      2009
                        
                        By:
                        
                        /s/
      Harold I. HackermanHarold
      I. HackermanDirectorMarch 3,
      2009
                        
                        By:
                        
                        /s/
      William L. HermannWilliam
      L. HermannDirector





72


March 3,
      2009
                          
                          By:
                          
                          /s/
      David P. HesslerDavid
      P. HesslerDirectorMarch 3,
      2009
                          
                          By:
                          
                          /s/
      Howard S. KleinHoward
      S. KleinDirectorMarch 3,
      2009
                          
                          By:
                          
                          /s/
      Charles E. Moore, Jr.Charles
      E. Moore, Jr.DirectorMarch 3,
      2009
                          
                          By:
                          
                          /s/
      Bonnie L. PhippsBonnie
      PhippsDirectorMarch 3,
      2009
                          
                          By:
                          
                          /s/
      John Paul RogersJohn
      Paul RogersDirectorMarch 3,
      2009
                          
                          By:
                          
                          /s/
      William C. Rogers, IIIWilliam
      C. Rogers, IIIDirector
 March 3,
      2009
                
                By:
                
                /s/
      Francis X. RyanFrancis
      X. RyanDirector
  73
  Exhibit
Index




Exhibit
              Number
            
            Description
            
            Sequentially
              Numbered
      Page3.1(i)
            
            Articles
      of Incorporation of Carrollton Bancorp3.1(ii)
            
            Articles
      of Amendment of Carrollton Bancorp3.1(iii)
            
            Articles
      Supplementary of Carrollton Bancorp3.2(i)
            
            By-Laws
      of Carrollton Bancorp3.2(ii)
            
            Amendment
      No. 1 to Bylaws of Carrollton Bancorp4.1
            
            Form
      of Stock Certificate for Fixed Rate Cumulative Perpetual Preferred
      Stock,
              Series
      A
            
            
            (1)4.2
            
            Warrant
      to Purchase 205,379 Shares of Common Stock of Carrollton
      Bancorp
            
            
            (1)10.1
            
            Lease
      dated January 24, 1989, by and between Hill Management Services, Inc. and
      The Carrollton Bank of Baltimore.
            
            
            (2)10.2
            
            Lease
      dated July 21, 1989, by and between Hill Management Services, Inc. and The
      Carrollton Bank of Baltimore.
            
            
            (2)10.7
            
            Lease
      dated July 19, 1988, by and between Northway Limited Partnership and The
      Carrollton Bank of Baltimore.
            
            
            (2)10.8
            
            Lease
      dated August 11, 1994, by and between KIMCO and Carrollton
      Bank.
            
            
            (3)10.9
            
            Lease
      dated October 11, 1994, by and between Ridgeview Associates Limited
      Partnership and Carrollton Bank.
            
            
            (3)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 Bank10.20
            
            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
            
            
            (4)10.23
            
            Lease
      dated August 13, 2007, by and between Tarragon, Inc. and Carrollton
      Bank10.24
            
            Employment
      agreement with Robert A. Altieri
            
            
            (5)10.25
            
            Employment
      agreement with Lola B. Stokes
            
            
            (6)10.26
            
            Employment
      agreement with James M. Uveges
            
            
            (7)10.27
            
            Lease
      dated September 8, 2008 by and between Gateway 38 LLC and Carrollton
      Bancorp
            
            
            (8)10.28
            
            Letter
      Agreement and related Securities Purchase Agreement - Standard Terms,
      dated February 13, 2009 between Carrollton Bancorp and United States
      Department of the Treasury
            
            
            (1)10.29
            
            Form
      Waiver executed by each of Robert A. Altieri, James M. Uveges, Gary M.
      Jewell, William D. Sherman and Lola B. Stokes
            
            
            (1)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 to the Registrant’s Form 8-K filed February 17, 2009 (File
      No.: 000-23090).




(2)
            Incorporated
      by reference from Registration Statement dated January 12, 1990 on
      SEC Form S-4 (1933 Act File No.:
33-33027).




74


(3)
            Incorporated
      by reference from Annual Report on Form 10-KSB for the fiscal year
      ended December 31, 1994 (1934 Act File No.:
  0-23090).




(4)
            Incorporated
      by reference to the Registrant’s Form 8-K filed June19, 2007 (File No.:
      000-23090)




(5)
            Incorporated
      by reference to the Registrant’s Form 8-K filed September 25, 2007 (File
      No. :  000-23090)




(6)
            Incorporated
      by reference to the Registrant’s Form 8-K filed October 24, 2007 (File No.
      :  000-23090)




(7)
            Incorporated
      by reference to the Registrant’s Form 8-K filed November 8, 2007 (File No.
      :  000-23090)




(8)
            Incorporated
      by reference to the Registrant’s Form 8-K filed September 30, 2008 (File
      No.:  000-23090)