UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K


(Mark
One)


ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
Fiscal Year Ended December 31, 2009


or


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


For the
transition period from _________________ to __________________





Commission
File Number: 0-24926





CECIL
      BANCORP, INC.(Exact
      name of Registrant as specified in its
Charter)





Maryland
            
            52-1883546(State
      or other Jurisdiction of
              Incorporation
      or Organization)
            
            (I.R.S.
      Employer
              Identification
      No.)





127
      North Street, PO Box 568, Elkton, Maryland
            
            
            21922-0568





Registrant’s
telephone number, including area code:  (410)
398-1650.




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
$0.01 per share


(Title of
Class)





Indicate
by check mark if 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 if the registrant is not required to file reports pursuant to
Section 13 or 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 whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  o
YES   o
NO




Indicate
by check mark if disclosure of delinquent filers in response 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 a check mark if the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See definitions
of “accelerated filer,” “large accelerated filer,” and “smaller reporting
company” in Rule 12b-2 of the Exchange Act:





Large
      accelerated filer o
            
            Accelerated
      filer oNon-accelerated
      filer o
              (Do
      not check if a smaller reporting company)
            
            Smaller
      reporting company  x





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




As of
March 19, 2010 the registrant had 3,689,346 shares of Common Stock issued and
outstanding. The aggregate market value of shares held by nonaffiliates on such
date was approximately $8.2 million based on the closing sale price of $4.40 per
share of the Registrant’s Common Stock on June 30, 2009. For purposes of this
calculation, it is assumed that the 1,818,414 shares held by directors and
officers of the Registrant are shares held by affiliates.




Documents
Incorporated by Reference:  Part III: Portions of the registrant’s
definitive proxy statement for the 2010 Annual Meeting.




















CECIL BANCORP,
      INC.ANNUAL REPORT ON FORM
      10-Kfor the fiscal year ended
      December 31, 2009INDEXPART
      IPageItem
      1.
            
            Business
            
            3Item
      1A.
            
            Risk
      Factors
            
            15Item
      1B.
            
            Unresolved
      Staff Comments
            
            15Item
      2.
            
            Properties
            
            15Item
      3.
            
            Legal
      Proceedings
            
            16Item
      4.
            
            [Reserved]
            
            16PART
      IIItem
      5.
            
            Market
      for  Registrant’s Common Equity, Related Stockholder Matters and
      Issuer Purchases of Equity Securities
            
            16Item
      6.
            
            Selected
      Financial Data
            
            17Item
      7.
            
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            18Item
      7A.
            
            Quantitative
      and Qualitative Disclosures About Market Risk
            
            34Item
      8.
            
            Financial
      Statements and Supplementary Data
            
            35Item
      9.
            
            Changes
      in and Disagreements with Accountants on Accounting and
              Financial
      Disclosure
            
            68Item
      9A(T).
            
            Controls
      and Procedures
            
            68Item
      9B.
            
            Other
      Information
            
            68PART
      IIIItem
      10.
            
            Directors,
      Executive Officers and Corporate Governance
            
            69Item
      11.
            
            Executive
      Compensation
            
            69Item
      12.
            
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            
            69Item
      13.
            
            Certain
      Relationships and Related Transactions, and Director
      Independence
            
            70Item
      14.
            
            Principal
      Accounting Fees and Services
            
            70PART
      IVItem
      15.
            
            Exhibits,
      Financial Statement Schedules
            
            70Signatures
            
            
            
            73























2


CAUTION
ABOUT FORWARD-LOOKING STATEMENTS





Cecil
Bancorp, Inc. (“Cecil Bancorp” or the “Company”) makes forward-looking
statements in this Form 10-K that are subject to risks and uncertainties. These
forward-looking statements include:





·
            Statements
      of goals, intentions, and
expectations;


·
            Estimates
      of risks and of future costs and
benefits;


·
            Assessments
      of loan quality, probable loan losses, liquidity, off-balance sheet
      arrangements, and interest rate risks;
and


·
            Statements
      of Cecil Bancorp’s ability to achieve financial and other
      goals.





These
forward-looking statements are subject to significant uncertainties because they
are based upon or are affected by:





·
            changes
      in general economic conditions, either nationally or in our market
      areas;


·
            changes
      in the levels of general interest rates, deposit interest rates, our net
      interest margin and funding
sources;


·
            fluctuations
      in the demand for loans, the number of unsold homes and other properties
      and fluctuations in real estate values in our market
  areas;


·
            monetary
      and fiscal policies of the Board of Governors of the Federal Reserve
      System and the U.S. Government and other governmental initiatives
      affecting the financial services
industry;


·
            changes
      in accounting policies and practices, as may be adopted by the financial
      institution regulatory agencies, the Public Company Accounting Oversight
      Board or the Financial Accounting Standards
  Board;


·
            results
      of examinations of the Bank by federal and state banking regulators,
      including the possibility that such regulators may, among other things,
      require us to increase our allowance for loan losses or to write-down
      assets; and


·
            other
      economic, competitive, governmental, regulatory, and technological factors
      affecting our operations, pricing, products and services and the other
      risks described elsewhere in this Form 10-K and in our other filings with
      the SEC.





Because
of these uncertainties, the actual future results may be materially different
from the results indicated by these forward-looking statements. In addition,
Cecil Bancorp’s past results of operations do not necessarily indicate its
future results.





PART
I





Item 1.
Business





General




Cecil
Bancorp, Inc. (the “Company”) is the holding company for Cecil Bank (the
“Bank”). The Company is a financial holding company subject to regulation by the
Board of Governors of the Federal Reserve System (“Federal Reserve”). The Bank
is a Maryland chartered commercial bank, is a member of the Federal Reserve
System and the Federal Home Loan Bank (“FHLB”) of Atlanta, and is an Equal
Housing Lender. Its deposits are insured by the Deposit Insurance Fund (“DIF”)
of the Federal Deposit Insurance Corporation (“FDIC”). The Bank commenced
operations in 1959 as a Federal savings and loan association. On October 1,
2002, the Bank converted from a stock federal savings bank to a Maryland
commercial bank. Its deposits have been federally insured up to applicable
limits, and it has been a member of the FHLB system since 1959.




3


The Bank
conducts it business through its main office in Elkton, Maryland, and branches
in Elkton, North East, Fair Hill, Rising Sun, Cecilton, Aberdeen, Conowingo, and
Havre de Grace, Maryland.




The
Bank’s business strategy is to operate as an independent community-oriented
commercial bank dedicated to real estate, commercial, and consumer lending,
funded primarily by retail deposits. The Bank has sought to implement this
strategy by (1) continuing to emphasize residential mortgage lending through the
origination of adjustable-rate mortgage loans while increasing its construction,
commercial real estate, other commercial, and consumer lending portfolios; (2)
investing in adjustable-rate and short-term liquid investments; (3) controlling
interest rate risk exposure; (4) maintaining asset quality; (5) containing
operating expenses; and (6) maintaining “well capitalized” status. The Company
offers a full range of brokerage and investment services through a relationship
with Waterford Investor Services, Inc.




On
December 23, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital
Purchase Program, the Company sold 11,560 shares of Fixed Rate Cumulative
Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), and a
warrant to purchase 261,538 shares of the Company’s common stock to the United
States Department of the Treasury for an aggregate purchase price of $11.560
million in cash, with $37,000 in offering costs, and net proceeds of $11.523
million. The Preferred Stock and the warrant were issued in a private placement
exempt from registration pursuant to Section 4(2) of the Securities Act of 1933,
as amended.




The
Series A Preferred Stock qualifies as Tier 1 capital and will pay cumulative
dividends at a rate of 5% per annum for the first five years, and 9% per annum
thereafter. The Department of Treasury may permit the Company to redeem the
Series A Preferred Stock in whole or in part at any time after consultation with
the appropriate federal banking agency.  Any partial redemption must
involve at least 25% of the Series A Preferred Stock issued.  Upon
redemption of the Series A Preferred Stock, the Company will have the right to
repurchase the Warrant at its fair market value.




The
warrant has a 10-year term and is immediately exercisable upon its issuance,
with an exercise price, subject to anti-dilution adjustments, equal to $6.63 per
share of common stock. The Treasury has agreed not to exercise voting power with
respect to any shares of common stock issued upon exercise of the
warrant.




In the
event of any liquidation, dissolution or winding up of the affairs of the
Company, whether voluntary or involuntary, holders of the Series A Preferred
Stock shall be entitled to receive for each share of the Series A Preferred
Stock, out of the assets of the Company or proceeds thereof (whether capital or
surplus) available for distribution to stockholders of the Company, subject to
the rights of any creditors of the Company, before any distribution of such
assets or proceeds is made to or set aside for the holders of common stock and
any other stock of the Company ranking junior to the Series A Preferred Stock as
to such distribution, payment in full in an amount equal to the sum of (i) the
liquidation amount of $1,000 per share and (ii) the amount of any accrued and
unpaid dividends, whether or not declared, to the date of payment.




The
Company’s and the Bank’s principal executive office is at 127 North Street,
Elkton, Maryland 21921, and its telephone number is (410) 398-1650. The Company
maintains a website at www.cecilbank.com.




4


REGULATION,
SUPERVISION, AND GOVERNMENTAL POLICY




Following
is a brief summary of certain statutes and regulations that significantly affect
the Company and the Bank. A number of other statutes and regulations affect the
Company and the Bank but are not summarized below.




Holding Company
Regulation. The Company is registered as a holding company under the Bank
Holding Company Act of 1956 and, as such, is subject to supervision and
regulation by the Federal Reserve. As a holding company, the Company is required
to furnish to the Federal Reserve annual and quarterly reports of its operations
and additional information and reports. The Company is also subject to regular
examination by the Federal Reserve.





The Bank
Holding Company Act also limits the investments and activities of bank holding
companies. In general, a bank holding company is prohibited from acquiring
direct or indirect ownership or control of more than 5% of the voting shares of
a company that is not a bank or a bank holding company or from engaging directly
or indirectly in activities other than those of banking, managing or controlling
banks, providing services for its subsidiaries, non-bank activities that are
closely related to banking, and other financially related activities. The
activities of the Company are subject to these legal and regulatory limitations
under the Bank Holding Company Act and Federal Reserve regulations.





The
Federal Reserve has the power to order a holding company or its subsidiaries to
terminate any activity, or to terminate its ownership or control of any
subsidiary, when it has reasonable cause to believe that the continuation of
such activity or such ownership or control constitutes a serious risk to the
financial safety, soundness, or stability of any bank subsidiary of that holding
company.





Under the
Bank Holding Company Act of 1956, a bank holding company must obtain the prior
approval of the Federal Reserve before (1) acquiring direct or indirect
ownership or control of any class of voting securities of any bank or bank
holding company if, after the acquisition, the bank holding company would
directly or indirectly own or control more than 5% of the class; (2) acquiring
all or substantially all of the assets of another bank or bank holding company;
or (3) merging or consolidating with another bank holding company.





Under the
Bank Holding Company Act, any company must obtain approval of the Federal
Reserve prior to acquiring control of the Company or the Bank. For purposes of
the Bank Holding Company Act, “control” is defined as ownership of 25% or more
of any class of voting securities of the Company or the Bank, the ability to
control the election of a majority of the directors, or the exercise of a
controlling influence over management or policies of the Company or the
Bank.





The Bank
Holding Company Act permits the Federal Reserve to approve an application of
bank holding company to acquire control of, or acquire all or substantially all
of the assets of, a bank located in a state other than that holding company’s
home state. The Federal Reserve may not approve the acquisition of a bank that
has not been in existence for the minimum time period (not exceeding five years)
specified by the statutory law of the host state. The Bank Holding Company Act
also prohibits the Federal Reserve from approving an application if the
applicant (and its depository institution affiliates) controls or would control
more than 10% of the insured deposits in the United States or 30% or more of the
deposits in the target bank’s home state or in any state in which the target
bank maintains a branch. The Bank Holding Company Act does not affect the
authority of states to limit the percentage of total insured deposits in the
state which may be held or controlled by a bank or bank holding company to the
extent such limitation does not discriminate against out-of-state banks or bank
holding companies. The State of Maryland allows out-of-state financial
institutions to establish branches in Maryland, subject to certain
limitations.





The
Change in Bank Control Act and the related regulations of the Federal Reserve
require any person or persons acting in concert (except for companies required
to make application under the Holding Company Act), to file a written notice
with the Federal Reserve before the person or persons acquire control of the
Company or the Bank. The Change in Bank Control Act defines “control” as the
direct or indirect power to vote 25% or more of any class of voting securities
or to direct the management or policies of a bank holding company or an insured
bank.


5


The Federal
Reserve has adopted guidelines regarding the capital adequacy of bank holding
companies, which require bank holding companies to maintain specified minimum
ratios of capital to total assets and capital to risk-weighted assets. See
“Regulatory Capital Requirements.”





The
Federal Reserve has the power to prohibit dividends by bank holding companies if
their actions constitute unsafe or unsound practices. The Federal Reserve has
issued a policy statement on the payment of cash dividends by bank holding
companies, which expresses the Federal Reserve’s view that a bank holding
company should pay cash dividends only to the extent that the company’s net
income for the past year is sufficient to cover both the cash dividends and a
rate of earnings retention that is consistent with the company’s capital needs,
asset quality, and overall financial condition.  In a recent
Supervisory Letter, the Federal Reserve staff has stated that, as a general
matter, bank holding companies should eliminate cash dividends if net income
available to shareholders for the past four quarters, net of dividends
previously paid, is not sufficient to fully fund the dividend.





Bank Regulation.The Bank is a member of the Federal Reserve System and is subject to
supervision by the Federal Reserve and the State of Maryland. Deposits of the
Bank are insured by the FDIC to the legal maximum for each insured depositor.
Deposits, reserves, investments, loans, consumer law compliance, issuance of
securities, payment of dividends, establishment of branches, mergers and
acquisitions, corporate activities, changes in control, electronic funds
transfers, responsiveness to community needs, management practices, compensation
policies, and other aspects of operations are subject to regulation by the
appropriate federal and state supervisory authorities. In addition, the Bank is
subject to numerous federal, state and local laws and regulations which set
forth specific restrictions and procedural requirements with respect to
extensions of credit (including to insiders), credit practices, disclosure of
credit terms and discrimination in credit transactions.





The
Federal Reserve regularly examines the operations and condition of the Bank,
including, but not limited to, its capital adequacy, reserves, loans,
investments, and management practices. These examinations are for the protection
of the Bank’s depositors and the federal Deposit Insurance Fund. In addition,
the Bank is required to furnish quarterly and annual reports to the Federal
Reserve. The Federal Reserve’s enforcement authority includes the power to
remove officers and directors and the authority to issue cease-and-desist orders
to prevent a bank from engaging in unsafe or unsound practices or violating laws
or regulations governing its business.





The
Federal Reserve has adopted regulations regarding the capital adequacy, which
require member banks to maintain specified minimum ratios of capital to total
assets and capital to risk-weighted assets. See “Regulatory Capital
Requirements.” Federal Reserve and State regulations limit the amount of
dividends that the Bank may pay to the Company.





The Bank
is subject to restrictions imposed by federal law on extensions of credit to,
and certain other transactions with, the Company and other affiliates, and on
investments in their stock or other securities. These restrictions prevent the
Company and the Bank’s other affiliates from borrowing from the Bank unless the
loans are secured by specified collateral, and require those transactions to
have terms comparable to terms of arms-length transactions with third persons.
In addition, secured loans and other transactions and investments by the Bank
are generally limited in amount as to the Company and as to any other affiliate
to 10% of the Bank’s capital and surplus and as to the Company and all other
affiliates together to an aggregate of 20% of the Bank’s capital and surplus.
Certain exemptions to these limitations apply to extensions of credit and other
transactions between the Bank and its subsidiaries. These regulations and
restrictions may limit the Company’s ability to obtain funds from the Bank for
its cash needs, including funds for acquisitions and for payment of dividends,
interest, and operating expenses.





Under
Federal Reserve regulations, banks must adopt and maintain written policies that
establish appropriate limits and standards for extensions of credit secured by
liens or interests in real estate or are made for the purpose of financing
permanent improvements to real estate. These policies must establish loan
portfolio diversification standards; prudent underwriting standards, including
loan-to-value limits, that are clear and measurable; loan administration
procedures; and documentation, approval, and reporting requirements. A bank’s
real estate lending policy must reflect consideration of the Interagency
Guidelines for Real Estate Lending Policies (the “Interagency Guidelines”)
adopted by the federal bank


6


regulators.
The Interagency Guidelines, among other things, call for internal loan-to-value
limits for real estate loans that are not in excess of the limits specified in
the Guidelines. The Interagency Guidelines state, however, that it may be
appropriate in individual cases to originate or purchase loans with
loan-to-value ratios in excess of the supervisory loan-to-value
limits.





Deposit
Insurance.The Bank’s deposits are insured to applicable limits by the
FDIC.  The maximum deposit insurance amount has been increased from
$100,000 to $250,000 until December 31, 2013.  On October 13, 2008,
the FDIC established a Temporary Liquidity Guarantee Program under which the
FDIC fully guarantees all non-interest-bearing transaction accounts until
December 31, 2009 (the “Transaction Account Guarantee Program”) and all senior
unsecured debt of insured depository institutions or their qualified holding
companies issued between October 14, 2008 and June 30, 2009, with the FDIC’s
guarantee expiring by June 30, 2012 (the “Debt Guarantee
Program”).  Senior unsecured debt would include federal funds
purchased and certificates of deposit standing to the credit of the
bank.  After November 12, 2008, institutions that did not opt out of
the Programs by December 5, 2008 were assessed at the rate of ten basis points
for transaction account balances in excess of $250,000 and at a rate between 50
and 100 basis points of the amount of debt issued.  In May, 2009, the
Debt Guarantee Program issue end date and the guarantee expiration date were
both extended four months to October 31, 2009 and December 31, 2012,
respectively.  Participating holding companies that have not issued
FDIC-guaranteed debt prior to April 1, 2009 must apply to remain in the Debt
Guarantee Program.  Participating institutions will be subject to
surcharges for debt issued after that date.  Effective October 1,
2009, the Transaction Account Guarantee Program was extended until June 30,
2010, with an increased assessment after December 31, 2009.  The
Company opted out of the Debt Guarantee Program.  The Bank did not opt
out of either the Debt Guarantee Program or the Transaction Account Guarantee
Program or its extension.





The FDIC
has adopted a risk-based premium system that provides for quarterly assessments
based on an insured institution’s ranking in one of four risk categories based
on their examination ratings and capital ratios. Well-capitalized institutions
with the CAMELS ratings of 1 or 2 are grouped in Risk Category I and, until
2009, were assessed for deposit insurance at an annual rate of between five and
seven basis points with the assessment rate for an individual institution
determined according to a formula based on a weighted average of the
institution’s individual CAMELS component ratings plus either five financial
ratios or the average ratings of its long-term debt. Institutions in Risk
Categories II, III and IV were assessed at annual rates of 10, 28 and 43 basis
points, respectively.  Insured depository institutions that were in
existence on December 31, 1996 and paid assessments prior to that date (or their
successors) were entitled to a one-time credit against future assessments based
on their past contributions to the predecessor to the Deposit Insurance
Fund.  The Bank used its special assessment credit to offset the cost
of its deposit insurance premium until the fourth quarter of calendar 2007 when
the credit was exhausted.





Pursuant
to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), the FDIC
is authorized to set the reserve ratio for the Deposit Insurance Fund annually
at between 1.15% and 1.5% of estimated insured deposits.  Due to
recent bank failures, the FDIC determined that the reserve ratio was 1.01% as of
June 30, 2008.  In accordance with the Reform Act, as amended by the
Helping Families Save Their Home Act of 2009, the FDIC has established and
implemented a plan to restore the reserve ratio to 1.15% within eight
years.  For the quarter beginning January 1, 2009, the FDIC raised the
base annual assessment rate for institutions in Risk Category I to between 12
and 14 basis points while the base annual assessment rates for institutions in
Risk Categories II, III and IV were increased to 17, 35 and 50 basis points,
respectively.  For the quarter beginning April 1, 2009 the FDIC
set the base annual assessment rate for institutions in Risk Category I to
between 12 and 16 basis points and the base annual assessment rates for
institutions in Risk Categories II, III and IV at 22, 32 and 45 basis points,
respectively.  An institution’s assessment rate could be lowered by as
much as five basis points based on the ratio of its long-term unsecured debt to
deposits or, for smaller institutions based on the ratio of certain amounts of
Tier 1 capital to adjusted assets.  The assessment rate may be
adjusted for Risk Category I institutions that have a high level of brokered
deposits and have experienced higher levels of asset growth (other than through
acquisitions) and could be increased by as much as ten basis points for
institutions in Risk Categories II, III and IV whose ratio of brokered deposits
to deposits exceeds 10%.  Reciprocal deposit arrangements like CDARS®
were treated as brokered deposits for Risk Category II, III and IV institutions
but not for institutions in Risk Category I.  An institution’s base
assessment rate would also be increased if an institution’s ratio of secured
liabilities


7


(including
FHLB advances and repurchase agreements) to deposits exceeds 25%.  The
maximum adjustment for secured liabilities for institutions in Risk Categories
I, II, III and IV would be 8, 11, 16 and 22.5 basis points, respectively,
provided that the adjustment may not increase an institution’s base assessment
rate by more than 50%.





The FDIC
imposed a special assessment equal to five basis points of assets less Tier 1
capital as of June 30, 2009, payable on September 30, 2009, and reserved the
right to impose additional special assessments.  Instead of imposing
additional special assessments during 2009, the FDIC required all insured
depository institutions to prepay their estimated risk-based assessments for the
fourth quarter of 2009, and for all of 2010, 2011 and 2012 on December 30,
2009.  For purposes of estimating the future assessments, each
institution’s base assessment rate in effect on September 30, 2009 was used,
increased by three basis points beginning in 2011, and the assessment base was
increased at a 5% annual growth rate.  The prepaid assessment will be
applied against actual quarterly assessments until exhausted.  Any
funds remaining after June 30, 2013 will be returned to the
institution.  Requiring this prepaid assessment does not preclude the
FDIC from changing assessment rates or from further revising the risk-based
assessment system.





In
addition, all FDIC-insured institutions are required to pay assessments to the
FDIC to fund interest payments on bonds issued by the Financing Corporation
(“FICO”), an agency of the Federal government established to recapitalize the
Federal Savings and Loan Insurance Corporation.  The FICO assessment
rates, which are determined quarterly, averaged .0108% of insured deposits on an
annualized basis in fiscal year 2009.  These assessments will continue
until the FICO bonds mature in 2017.





Regulatory
Capital Requirements.The Federal Reserve has
established guidelines for maintenance of appropriate levels of capital by bank
holding companies and member banks. The regulations impose two sets of capital
adequacy requirements: minimum leverage rules, which require bank holding
companies and banks to maintain a specified minimum ratio of capital to total
assets, and risk-based capital rules, which require the maintenance of specified
minimum ratios of capital to “risk-weighted” assets.





The regulations of the Federal Reserve
in effect at December 31, 2009, do not impose capital ratio requirements on bank
holding companies with assets of less than $500 million as of June 30 of the
prior year that do not engage in a material amount of non-banking activities,
conduct significant off-balance sheet activities or have outstanding a material
amount of debt or equity securities that are registered with the SEC (other than
trust preferred securities). The Company was, therefore, not subject to the
Federal Reserves capital ratio requirements during 2009. The Bank, however, is
fully subject to the Federal Reserve’s capital standards. The regulations of the
Federal Reserve in effect at December 31, 2009, required all member banks to
maintain a minimum leverage ratio of “Tier 1 capital” (as defined in the
risk-based capital guidelines discussed in the following paragraphs) to total
assets of 3.0%. The capital regulations state, however, that only the strongest
bank holding companies and banks, with composite examination ratings of 1 under
the rating system used by the federal bank regulators, would be permitted to
operate at or near this minimum level of capital. All other banks are expected
to maintain a leverage ratio of at least 1% to 2% above the minimum ratio,
depending on the assessment of an individual organization’s capital adequacy by
its primary regulator. A bank experiencing or anticipating significant growth is
expected to maintain capital well above the minimum levels. In addition, the
Federal Reserve has indicated that it also may consider the level of an
organization’s ratio of tangible Tier 1 capital (after deducting all
intangibles) to total assets in making an overall assessment of
capital.





In
general, the risk-based capital rules of the Federal Reserve in effect at
December 31, 2009, required member banks to maintain minimum levels based upon a
weighting of their assets and off-balance sheet obligations according to risk.
The risk-based capital rules have two basic components: a core capital (Tier 1)
requirement and a supplementary capital (Tier 2) requirement. Core capital
consists primarily of common stockholders’ equity, noncumulative perpetual
preferred stock, and minority interests in the equity accounts of consolidated
subsidiaries; less all intangible assets, except for certain mortgage servicing
rights and purchased credit card relationships. Supplementary capital elements
include, subject to certain limitations, the allowance for losses on loans and
leases; perpetual preferred stock that does not qualify as Tier 1 capital;
long-term preferred stock with an original maturity of at least 20 years from
issuance; hybrid capital instruments, including perpetual
debt and mandatory convertible securities; subordinated debt, intermediate-term
preferred stock, and up to 45% of pre-tax net unrealized gains on available for
sale equity securities.


8





The
risk-based capital regulations assign balance sheet assets and credit equivalent
amounts of off-balance sheet obligations to one of four broad risk categories
based principally on the degree of credit risk associated with the obligor. The
assets and off-balance sheet items in the four risk categories are weighted at
0%, 20%, 50%, and 100%. These computations result in the total risk-weighted
assets.





The
risk-based capital regulations require all commercial banks to maintain a
minimum ratio of total capital to total risk-weighted assets of 8%, with at
least 4% as core capital. For the purpose of calculating these ratios: (i)
supplementary capital is limited to no more than 100% of core capital; and (ii)
the aggregate amount of certain types of supplementary capital is limited. In
addition, the risk-based capital regulations limit the allowance for credit
losses that may be included in capital to 1.25% of total risk-weighted
assets.





The
federal bank regulatory agencies have established a joint policy regarding the
evaluation of commercial banks’ capital adequacy for interest rate risk. Under
the policy, the Federal Reserve’s assessment of a bank’s capital adequacy
includes an assessment of the bank’s exposure to adverse changes in interest
rates. The Federal Reserve has determined to rely on its examination process for
such evaluations rather than on standardized measurement systems or formulas.
The Federal Reserve may require banks that are found to have a high level of
interest rate risk exposure or weak interest rate risk management systems to
take corrective actions. Management believes its interest rate risk management
systems and its capital relative to its interest rate risk are
adequate.





Federal
banking regulations also require banks with significant trading assets or
liabilities to maintain supplemental risk-based capital based upon their levels
of market risk. The Bank did not have significant levels of trading assets or
liabilities during 2009, and was not required to maintain such supplemental
capital.





The
Federal Reserve has established regulations that classify banks by capital
levels and provide for the Federal Reserve to take various “prompt corrective
actions” to resolve the problems of any bank that fails to satisfy the capital
standards. Under these regulations, a well-capitalized bank is one that is not
subject to any regulatory order or directive to meet any specific capital level
and that has a total risk-based capital ratio of 10% or more, a Tier 1
risk-based capital ratio of 6% or more, and a leverage ratio of 5% or more. An
adequately capitalized bank is one that does not qualify as well-capitalized but
meets or exceeds the following capital requirements: a total risk-based capital
ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of
either (i) 4% or (ii) 3% if the bank has the highest composite examination
rating. A bank that does not meet these standards is categorized as
undercapitalized, significantly undercapitalized, or critically
undercapitalized, depending on its capital levels. A bank that falls within any
of the three undercapitalized categories established by the prompt corrective
action regulation is subject to severe regulatory sanctions. As of December 31,
2009, the Bank was well capitalized as defined in the Federal Reserve’s
regulations.





For
additional information regarding the Company’s and the Bank’s compliance with
their respective regulatory capital requirements, see Note 13, “Regulatory
Matters,” to the consolidated financial statements.





Supervision and
Regulation of Mortgage Banking Operations.The Company’s mortgage banking
business is subject to the rules and regulations of the U.S. Department of
Housing and Urban Development (“HUD”), the Federal Housing Administration
(“FHA”), the Veterans’ Administration (“VA”), and FNMA with respect to
originating, processing, selling, and servicing mortgage loans. Those rules and
regulations, among other things, prohibit discrimination and establish
underwriting guidelines, which include provisions for inspections and
appraisals, require credit reports on prospective borrowers, and fix maximum
loan amounts. Lenders such as the Company are required annually to submit to
FNMA, FHA and VA audited financial statements, and each regulatory entity has
its own financial requirements. The Company’s affairs are also subject to
examination by the Federal Reserve, FNMA, FHA and VA at all times to assure
compliance with the applicable regulations, policies, and procedures. Mortgage
origination activities are subject to, among others, the Equal Credit
Opportunity Act, Federal Truth-in-Lending Act, Fair Housing Act, Fair Credit
Reporting Act, the National Flood Insurance Act and the Real Estate Settlement
Procedures Act and related regulations that prohibit discrimination and require
the disclosure of certain basic information to mortgagors concerning credit
terms and settlement costs. The Company’s


9


mortgage
banking operations also are affected by various state and local laws and
regulations and the requirements of various private mortgage
investors.





Markets




The
Company’s primary market area comprises Cecil and Harford Counties in
northeastern Maryland.




The
Bank’s executive office, two branches, and financial and loan centers are in
Elkton, Maryland, and additional Cecil County branches are located in North
East, Fair Hill, Rising Sun, Cecilton, and Conowingo, Maryland. Elkton is the
county seat, and has a population of approximately 12,000. The population of the
Cecil County is approximately 86,000. Cecil County is located in the extreme
northeast of the Chesapeake Bay, at the crux of four states - Maryland,
Delaware, Pennsylvania, and New Jersey. Elkton is located about 50 miles from
Philadelphia and Baltimore. One-fifth of the U.S. population resides within 300
miles of the County. Interstate I-95, the main north-south East Coast artery,
bisects the County. In addition, the four lane U.S. 40 parallels the Interstate.
Cecil County has over 200 miles of waterfront between five rivers and the
Chesapeake Bay. Key employers include companies such as Air Products, ATK,
DuPont, General Electric, W.L. Gore & Associates, IKEA and Terumo Medical,
as well as State, County and Local Governments.




The Bank
also operates one branch in Aberdeen and two banking offices in Havre de Grace,
Maryland, in Harford County. Harford County is twenty-three miles from Baltimore
and twenty miles from Wilmington, Delaware. The county is a major transportation
link; Interstate 95 and mainlines for CSX Railroad and Conrail run through the
County. The County’s major industrial centers along the I-95 Corridor are
Aberdeen, Belcamp, Edgewood and Havre de Grace. Major private sector employers
in the county include Battelle, CACI, Clorox Products Manufacturing, Custom
Direct, Computer Sciences Corporation, Cytec Engineered Materials, EAI (a
subsidiary of SAIC), EG&G/Lear Siegler, EPS, Frito-Lay, Independent Can,
MITRE Corporation, Northrop Grumman, Nutramax Laboratories, Rite Aid, SafeNet,
SAIC, Saks Fifth Avenue, Smiths Detection, SURVICE Engineering, and Upper
Chesapeake Health. The U.S. Army Aberdeen Proving Ground is the major government
employer in the county.


Loans
and Mortgage Backed Securities




One to Four
Family Residential Real Estate Lending.The Bank offers conventional
mortgage loans on one- to four-family residential dwellings. Most loans are
originated in amounts up to $350,000, on single-family properties located in the
Bank’s primary market area. The Bank makes conventional mortgage loans, as well
as loans guaranteed under the Rural Development Program of the Department of
Agriculture (USDA Housing Loans). The Bank’s mortgage loan originations are
generally for terms of 15, 20 and 30 years, amortized on a monthly basis with
interest and principal due each month. Residential real estate loans often
remain outstanding for significantly shorter periods than their contractual
terms as borrowers may refinance or prepay loans at their option, without
penalty. Conventional residential mortgage loans granted by the Bank customarily
contain “due-on-sale” clauses that permit the Bank to accelerate the
indebtedness of the loan upon transfer of ownership of the mortgaged property.
The Bank uses standard Federal Home Loan Mortgage Corporation (“FHLMC”)
documents, to allow for the sale of loans in the secondary mortgage market. The
Bank’s lending policies generally limit the maximum loan-to-value ratio on
mortgage loans secured by owner-occupied properties to 95% of the lesser of the
appraised value or purchase price of the property, with the condition that
private mortgage insurance is required on loans with a loan-to-value ratio in
excess of 80%. Loans originated under Rural Development programs have
loan-to-value ratios of up to 100% due to the guarantees provided by those
agencies. The substantial majority of loans in the Bank’s loan portfolio have
loan-to-value ratios of 80% or less.




The Bank
offers adjustable-rate mortgage loans with terms of up to 40 years.
Adjustable-rate loans offered by the Bank include loans which reprice every one,
three or five years and provide for an interest rate which is based on the
interest rate paid on U.S. Treasury securities of a corresponding term. All
newly originated residential adjustable rate mortgage loans have interest rate
adjustments limited to three percentage points annually with no interest rate
ceiling over




10


the life
of the loan. New loans also have an interest rate floor imbedded within the
promissory note. Previously originated loans contain a limit on rate adjustments
of two percentage points annually and six percentage points over the life of the
loan.




The Bank
retains all adjustable-rate mortgages it originates, which are designed to
reduce the Bank’s exposure to changes in interest rates. The retention of
adjustable-rate mortgage loans in the Bank’s loan portfolio helps reduce the
Bank’s exposure to increases in interest rates. However, there are
unquantifiable credit risks resulting from potential increased costs to the
borrower as a result of repricing of adjustable-rate mortgage loans. It is
possible that during periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans may increase due to the upward adjustment of
interest cost to the borrower.




The Bank
also originates conventional fixed-rate mortgages with terms of 15, 20, 30 or 40
years. The Bank has originated all fixed-rate mortgage loans in recent years for
sale in the secondary mortgage market, and a substantial majority of all
fixed-rate loans originated since 1990 have been sold, primarily to the FHLMC,
with servicing retained by the Bank. Management assesses its fixed rate loan
originations on an ongoing basis to determine whether the Bank’s portfolio
position warrants the loans being sold or held in the Bank’s
portfolio.




During
the year ended December 31, 2009, the Bank originated $3,988,000 in
adjustable-rate mortgage loans and $17,558,000 in fixed-rate mortgage loans. The
Bank also offers second mortgage loans. These loans are secured by a junior lien
on residential real estate. The total of first and second liens may not exceed a
90% loan to value ratio. Loans have terms of 5, 10 and 15 years and have fixed
rates. The Bank offers home equity lines of credit, which are secured by a
junior lien on residential real estate. Customers are approved for a line of
credit that provides for an interest rate, which varies monthly, and customers
pay 2% of the balance per month.




Construction and
Land Loans.The Bank’s construction lending has primarily involved
lending for construction of single-family residences, although the Bank does
lend funds for the construction of commercial properties and multi-family real
estate. All loans for the construction of speculative sale homes have a loan
value ratio of not more than 80%. The Bank has financed the construction of
non-residential properties on a case by case basis. Loan proceeds are disbursed
during the construction phase according to a draw schedule based on the stage of
completion. Construction projects are inspected by contracted inspectors or bank
personnel. Construction loans are underwritten on the basis of the estimated
value of the property as completed.





The Bank
also, from time to time, originates loans secured by raw land. Land loans
granted to individuals have a term of up to 10 years and interest rates adjust
every one, three or five years. Land loans granted to developers have terms of
up to three years. The substantial majority of land loans have a loan-to-value
ratio not exceeding 75%. Loans involving construction financing and loans on raw
land have a higher level of risk than loans for the purchase of existing homes
since collateral values, land values, development costs and construction costs
can only be estimated at the time the loan is approved. The Bank has sought to
minimize its risk in construction lending and in lending for the purchase of raw
land by offering such financing primarily to builders and developers to whom the
Bank has loaned funds in the past and to persons who have previous experience in
such projects. The Bank also limits construction lending and loans on raw land
to its market area, with which management is familiar, except in conjunction
with participated loans.





Multi-Family and
Commercial Real Estate Lending.The Bank originates loans on multi-family
residential and commercial properties in its market area. Loans secured by
multi-family and commercial real estate generally are larger and involve greater
risks than one- to four-family residential mortgage loans. Because payments on
loans secured by such properties are often dependent on successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Bank seeks to minimize these risks in a variety of ways, including limiting
the size and loan-to-value ratios of its multi-family and commercial real estate
loans. The Bank’s permanent multi-family and commercial real estate loans are
typically secured by retail or wholesale establishments, motels/hotels, service
industries and industrial or warehouse facilities. Multi-family and commercial
real estate loans generally have terms of 20 to 40 years, are either tied to the
prime rate or have interest rate


11


adjustments
every one, three or five years. These adjustable rate loans have no interest
rate change limitations, either annually or over the life of the loan. The loans
are also subject to imbedded interest rate floors with no interest rate ceiling
over the life of the loan. Multi-family and commercial mortgages are generally
made in amounts not exceeding 80% of the lesser of the appraised value or
purchase price of the property. Interest rates on commercial real estate loans
are negotiated on a loan-by-loan basis.





Commercial
Business Loans.The Bank offers commercial business loans and both
secured and unsecured loans and letters of credit, or lines of credit for
businesses located in its primary market area. Most business loans have a one
year term, while lines of credit can remain open for longer periods. All owners,
partners, and officers must sign the loan agreement. The security for a business
loan depends on the amount borrowed, the business involved, and the strength of
the borrower’s firm. Commercial business lending entails significant risk, as
the payments on such loans may depend upon the successful operation or
management of the business involved. Although the Bank attempts to limit its
risk of loss on such loans by limiting the amount and the term, and by requiring
personal guarantees of principals of the business (when additional guarantees
are deemed necessary by management), the risk of loss on commercial business
loans is substantially greater than the risk of loss from residential real
estate lending.





Consumer Lending.Consumer loans generally involve more risk than first mortgage loans.
Repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of damage, loss, or
depreciation, and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, loan
collections are dependent on the borrower’s continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Further, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
that can be recovered. These loans may also give rise to claims and defenses by
a borrower against the Bank, and a borrower may be able to assert against the
Bank claims and defenses that it has against the seller of the underlying
collateral.





The
Bank’s consumer loans consist of automobile loans, deposit account loans, home
improvement loans, and other consumer loans. Consumer loans are generally
offered for terms of up to five years at fixed interest rates. Management
expects to continue to promote consumer loans as part of its strategy to provide
a wide range of personal financial services to its customers and as a means to
increase the yield on the Bank’s loan portfolio. The Bank makes loans for
automobiles and recreational vehicles, both new and used, directly to the
borrowers. The loans can be for up to the lesser of 100% of the purchase price
or the retail value listed by the National Automobile Dealers Association. The
terms of the loans are determined by the condition of the collateral. Collision
insurance policies are required on all these loans, unless the borrower has
substantial other assets and income. The Bank makes deposit account loans for up
to 90% of the amount of the depositor’s account balance. The maximum amount of
the loan takes into consideration the amount of interest due. The term of the
loan is either interest due monthly on demand, or a term loan not to exceed 5
years. The interest rate is 2% higher than the rate being paid on the deposit
account. The Bank also makes other consumer loans, which may or may not be
secured. The term of the loans usually depends on the collateral. Unsecured
loans usually do not exceed $100,000 and have a term of no longer than 12
months. Consumer loans are generally originated at higher interest rates than
residential mortgage loans but also tend to have a higher risk than residential
loans due to the loan being unsecured or secured by rapidly depreciable
assets.





Loan Solicitation
and Processing.The Bank’s lending activities are subject to written,
non-discriminatory underwriting standards and loan origination procedures
outlined in loan policies established by its board of directors. Detailed loan
applications are obtained to determine the borrower’s ability to repay, and the
more significant items on these applications are verified through the use of
credit reports, financial statements, and confirmations. Property valuations
required by policy are performed by independent outside appraisers approved by
the board of directors. With certain limited exceptions, the maximum amount that
the Bank may lend to any borrower (including certain related entities of the
borrower) at any one time may not exceed 15% of the unimpaired capital and
surplus of the institution, plus an additional 10% of unimpaired capital and
surplus for loans fully secured by readily marketable collateral. Under these
limits, at December 31, 2009, the Bank’s loans to one borrower cannot exceed
$10,088,000.


12








Loan Originations
and Sales. Loan originations are derived from a number of sources.
Residential mortgage loan originations primarily come from walk-in customers and
referrals by realtors, depositors, and borrowers. Applications are taken at all
offices, but are processed by the Bank and submitted for approval, as noted
above. The Bank has not purchased loans in the secondary mortgage market. All
fixed-rate loans are originated according to FHLMC guidelines and, depending on
market conditions, may be sold to FHLMC after origination. The Bank retains
servicing on all loans sold to FHLMC.





Interest Rates
and Loan Fees.Interest rates charged by the Bank on mortgage loans are
primarily determined by competitive loan rates offered in its market area.
Mortgage loan interest rates reflect factors such as general market interest
rate levels, the supply of money available to the financial institutions
industry and the demand for such loans. These factors are in turn affected by
general economic conditions, the monetary policies of the Federal government,
including the Board of Governors of the Federal Reserve System (the “Federal
Reserve”), and general supply of money in the economy. In addition to interest
earned on loans, the Bank receives fees in connection with loan commitments and
originations, loan modifications, late payments and for miscellaneous services
related to its loans. Income from these activities varies from period to period
with the volume and type of loans originated, which in turn is dependent on
prevailing mortgage interest rates and their effect on the demand for loans in
the markets served by the Bank. The Bank also receives servicing fees on the
loan amount of the loans that it services. At December 31, 2009, the Bank was
servicing $38.3 million in loans for other financial institutions. For the years
ended December 31, 2009 and 2008, the Bank recognized gross servicing income of
$131,000 and $100,000, respectively, and total loan fee income of $783,000 and
$571,000, respectively.





Mortgage-Backed
Securities.The Bank maintains a portfolio of mortgage-backed securities
in the form of Government National Mortgage Association (“GNMA”) and FHLMC
participation certificates. GNMA certificates are guaranteed as to principal and
interest by the full faith and credit of the United States, while FHLMC
certificates are guaranteed by the agency. Mortgage-backed securities generally
entitle the Bank to receive a pro rata portion of the cash flows from an
identified pool of mortgages. Although mortgage-backed securities yield from 30
to 100 basis points less than the loans that are exchanged for such securities,
they present substantially lower credit risk and are more liquid than individual
mortgage loans and may be used to collateralize obligations of the Bank. Because
the Bank receives regular payments of principal and interest from its
mortgage-backed securities, these investments provide more consistent cash-flows
than investments in other debt securities, which generally only pay principal at
maturity.





Mortgage-backed
securities, however, entail certain unique risks. In a declining rate
environment, accelerated prepayments of loans underlying these securities expose
the Bank to the risk that they will be unable to obtain comparable yields upon
reinvestment of the proceeds. In the event the mortgage-backed security has been
funded with an interest-bearing liability with a maturity comparable to the
original estimated life of the mortgage-backed security, the Bank’s interest
rate spread could be adversely affected. Conversely, in a rising interest rate
environment, the Bank may experience a lower than estimated rate of repayment on
the underlying mortgages, effectively extending the estimated life of the
mortgage-backed security and exposing the Bank to the risk that it may be
required to fund the asset with a liability bearing a higher rate of interest.
The Bank seeks to minimize the effect of extension risk by focusing on
investments in adjustable-rate and/or relatively short-term (seven years or
shorter maturity) mortgage-backed securities. At December 31, 2009, the Bank had
no mortgage derivative products that met the definition of high risk mortgage
securities.





Deposits
and Borrowings





Deposits.
Deposits are attracted principally from the Bank’s market area through the
offering of a variety of deposit instruments, including savings accounts and
certificates of deposit ranging in term from 91 days to 60 months, as well as
regular checking, NOW, passbook and money market deposit accounts. Deposit
account terms vary, principally on the basis of the minimum balance required,
the time periods the funds must remain on deposit, and the interest rate. The
Bank also offers individual retirement accounts (“IRAs”). The Bank’s policies
are designed primarily to attract deposits from local residents. To supplement
local market deposits, the Bank has access to the national CD market through
deposit brokers, including the Certificate of Deposit Account Registry Service
(“CDARS”) of Promontory Interfinancial Network


13


and
Finance 500, Inc. The Bank may use this market to meet liquidity needs. At
December 31, 2009, the Bank had no one-way buy certificates of deposit that were
obtained through the CDARS network or Finance 500, Inc. Because CDARS and
Finance 500, Inc. deposits are considered brokered deposits, the Bank would not
be able to accept or renew these deposits without FDIC permission if the Bank
were less than well capitalized. Interest rates, maturity terms, service fees
and withdrawal penalties are established by the Bank on a periodic basis.
Determination of rates and terms are predicated upon funds acquisition and
liquidity requirements, rates paid by competitors, growth goals and federal
regulations.





Borrowings.Deposits historically have been the primary source of funds for the
Bank’s lending and investment activities and for its general business
activities. The Bank is authorized, however, to use advances from the FHLB of
Atlanta to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. Advances from the FHLB typically are secured by the
Bank’s stock in the FHLB or pledged assets. The Bank utilized advances from FHLB
during the year. The FHLB of Atlanta functions as a central reserve bank
providing credit for member financial institutions. As a member, the Bank is
required to own capital stock in the FHLB and is authorized to apply for
advances on the security of such stock and certain of its loans and other assets
(principally, securities which are obligations of, or guaranteed by, the United
States) provided certain standards related to creditworthiness have been
met.





Competition




The
Company offers a wide range of lending and deposit services in its market area.
In addition, the Company offers a full range of brokerage and investment
services through its relationship with Waterford Investor Services, Inc. The
Company experiences substantial competition both in attracting and retaining
deposits, in making loans, and in providing investment, insurance, and other
services. Management believes the Bank is able to compete effectively in its
primary market area.




The
primary factors in competing for loans are interest rates, loan origination
fees, and the range of services offered by lenders. Competitors for loan
originations include other commercial banks, savings associations, mortgage
bankers, mortgage brokers, and insurance companies. The Bank’s principal
competitors for deposits are other financial institutions, including other
banks, savings associations, and credit unions located in the Bank’s primary
market area of Cecil and Harford Counties in Maryland or doing business in the
market area through the internet, by mail, or by telephone. Competition among
these institutions is based primarily on interest rates and other terms offered,
service charges imposed on deposit accounts, the quality of services rendered,
and the convenience of banking facilities. Additional competition for
depositors’ funds comes from U.S. Government securities, private issuers of debt
obligations and suppliers of other investment alternatives for depositors, such
as securities firms. Competition from credit unions has intensified in recent
years as historical federal limits on membership have been relaxed. Because
federal law subsidizes credit unions by giving them a general exemption from
federal income taxes, credit unions have a significant cost advantage over banks
and savings associations, which are fully subject to federal income taxes.
Credit unions may use this advantage to offer rates that are highly competitive
with those offered by banks and thrifts.




The
banking business in Maryland generally, and the Bank’s primary service area
specifically, is highly competitive with respect to both loans and deposits. The
Bank competes with many larger banking organizations that have offices over a
wide geographic area. These larger institutions have certain inherent
advantages, such as the ability to finance wide-ranging advertising campaigns
and promotions and to allocate their investment assets to regions offering the
highest yield and demand. They also offer services, such as international
banking, that are not offered directly by the Bank (but are available indirectly
through correspondent institutions), and, by virtue of their larger total
capitalization, such banks have substantially higher legal lending limits, which
are based on bank capital, than does the Bank. The Bank can arrange loans in
excess of its lending limit, or in excess of the level of risk it desires to
take, by arranging participations  with
other banks. Other entities, both governmental and in private industry, raise
capital through the issuance and sale of debt and equity securities and
indirectly compete with the Bank in the acquisition of deposits.  In
addition to competing with other commercial banks, savings associations, and
credit unions, commercial banks such as the Bank compete with nonbank
institutions for funds. For instance, yields on corporate and government debt
and




14


equity
securities affect the ability of commercial banks to attract and hold deposits.
Commercial banks also compete for available funds with mutual funds. These
mutual funds have provided substantial competition to banks for deposits, and it
is anticipated they will continue to do so in the future.




Based on
data compiled by the FDIC as of June 30, 2009 (the latest date for which such
information is available), the Bank had the second largest share of FDIC-insured
deposits in Cecil County with approximately 31% and the 14th
largest share of FDIC-insured deposits in Harford County with approximately 2%.
This data does not reflect deposits held by credit unions with which the Bank
also competes.


Employees




As of
December 31, 2009, the Company and the Bank employed 91 persons. None of the
Company’s or the Bank’s employees is represented by a union or covered under a
collective bargaining agreement. Management of the Company and the Bank consider
their employee relations to be excellent.




Item 1A.  Risk
Factors.




Not
applicable.




Item
1B.  Unresolved Staff Comments.




Not
applicable.




Item
2.  Properties




Following
are the locations of the Bank at December 31, 2009. The Company has no other
locations.


Popular
      Name
            LocationMain
      Office
            127
      North Street, Elkton, MD  21921Cecil
      Financial Center*
            135
      North Street, Elkton, MD  21921Elkton
      Drive Thru Office
            200
      North Street, Elkton, MD  21921Corporate
      Center
            118
      North Street, Elkton, MD  21921North
      East*
            108
      North East Plaza, North East, MD 21901Fair
      Hill
            4434
      Telegraph Road, Elkton, MD 21921Rising
      Sun*
            56
      Rising Sun Towne Centre, Rising Sun,
MD  21911Turkey
      Point
            1223
      Turkey Point Road, North East, MD 21901Cecilton
            122
      West Main Street, Cecilton, MD 21913Crossroads*
            114
      E. Pulaski Hwy, Elkton, MD  21921Aberdeen
            3
      W. Bel Air Avenue, Aberdeen, MD  21001Conowingo
            390
      Conowingo Road, Conowingo, MD  21918Downtown
      Havre de Grace
            303-307
      St John Street, Havre de Grace, MD 21078Route
      40 Havre de Grace
            1609
      Pulaski Highway, Havre de Grace, MD
21078


*Leased.


15


Item
3.  Legal Proceedings





In the
normal course of business, Cecil Bancorp is subject to various pending and
threatened legal actions. The relief or damages sought in some of these actions
may be substantial. After reviewing pending and threatened actions with counsel,
management considers that the outcome of such actions will not have a material
adverse effect on Cecil Bancorp’s financial position; however, the Bank is not
able to predict whether the outcome of such actions may or may not have a
material adverse effect on results of operations in a particular future period
as the timing and amount of any resolution of such actions and relationship to
the future results of operations are not known.





Item
4.  [Reserved]




PART
II





Item 5.  Market
for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities





Common
shares of Cecil Bancorp are traded over the counter under the symbol CECB, with
quotations available on the OTC Bulletin Board. Stockholders received quarterly
cash dividends totaling $0.075 per share in 2009 and $0.10 in
2008.  The ratio of dividends per share to diluted net income per
common share was -8.4% in 2009, compared to 20.4% for 2008. The dividend amount
is established by the Board of Directors each quarter. In making its decision on
dividends, the Board considers operating results, financial condition, capital
adequacy, regulatory requirements, shareholder returns and other factors. Until
the third anniversary of the issuance of the Series A Preferred Stock to the
Treasury Department or its earlier redemption or transfer by the Treasury
Department to an unaffiliated holder, the Company may not increase the dividend
on the common stock or repurchase any shares of common stock without the consent
of the Treasury Department.





In order
to conserve capital in the current uncertain economic environment, the Company’s
Board of Directors determined at its meeting held January 19, 2010 that it was
in the best interests of the Company and its stockholders not to declare a
dividend on its common stock for the first quarter of 2010 and not to declare
the dividend payable February 15, 2010 on its Fixed Rate Cumulative Perpetual
Preferred Stock, Series A.  In addition, the Company has given notice
of its intention to defer interest payments on the subordinated debentures
underlying its two outstanding issues of trust preferred securities as permitted
by the indentures therefor.  During the period during which the
Company defers payments on its subordinated debentures, it will be prohibited
under the indentures from declaring or paying dividends on its capital
stock.  The Company will be prohibited from declaring or paying
dividends on its common stock while dividends on its Fixed Rate Cumulative
Perpetual Preferred Stock, Series A are in arrears.  No determination
has been made as to whether or when the Company will resume the payment of
dividends on its common or preferred stock or interest payments on its
subordinated debentures.  Any such future payments will depend on a
variety of factors including, but not limited to, the Company’s capital needs,
operating results, tax considerations, statutory and regulatory limitations and
economic considerations.





The
number of common shareholders of record was approximately 619 as of March 19,
2010, excluding stockholders who hold in nominee or “street name.”





Quarterly
Stock Information (1)


2009
            
            2008Stock
      Price Range
            
            Per
      Share
            
            Stock
      Price Range
            
            Per
      ShareQuarter
            
            Low
            
            High
            
            Dividend
            
            Low
            
            High
            
            Dividend1st
      Quarter
            
            $
            4.00
            
            $
            6.75
            
            $
            0.025
            
            $
            8.27
            
            $
            9.90
            
            $
            0.0252nd
      Quarter
            
            
            4.35
            
            
            6.00
            
            
            0.025
            
            
            8.22
            
            
            9.05
            
            
            0.0253rd
      Quarter
            
            
            3.75
            
            
            4.50
            
            
            0.025
            
            
            6.45
            
            
            8.25
            
            
            0.0254th
      Quarter
            
            
            2.75
            
            
            4.90
            
            
            0.000
            
            
            4.85
            
            
            7.25
            
            
            0.025Total
            
            
            
            
            
            
            
            $
            0.075
            
            
            
            
            
            
            
            $
            0.100


(1)   Quotations
reflect inter-dealer price, without retail mark-up, mark-down or commissions,
and may not represent actual transactions.


16


Item 6.  Selected
Financial Data





Five Year
Summary of Selected Financial Data





(Dollars
      in thousands, except per share data)
            
            2009
            
            2008
            
            2007
            
            2006
            
            2005RESULTS
      OF OPERATIONS:Interest
      Income
            
            $
            30,296
            
            $
            29,451
            
            $
            28,244
            
            $
            21,646
            
            $
            14,987Interest
      Expense
            
            
            12,428
            
            
            14,313
            
            
            14,346
            
            
            10,167
            
            
            5,679Net
      Interest Income
            
            
            17,868
            
            
            15,138
            
            
            13,898
            
            
            11,479
            
            
            9,308Provision
      for Loan Losses
            
            
            10,640
            
            
            3,405
            
            
            935
            
            
            665
            
            
            625Net
      Interest Income after Provision for Loan
      Losses
            
            
            7,228
            
            
            11,733
            
            
            12,963
            
            
            10,814
            
            
            8,683Noninterest
      Income
            
            
            2,169
            
            
            1,138
            
            
            1,500
            
            
            1,261
            
            
            1,115Noninterest
      Expenses
            
            
            13,159
            
            
            10,015
            
            
            9,004
            
            
            7,847
            
            
            6,543(Loss)
      Income before Income Taxes
            
            
            (3,762
            )
            
            2,856
            
            
            5,459
            
            
            4,228
            
            
            3,255Income
      Tax (Benefit) Expense
            
            
            (1,282
            )
            
            1,005
            
            
            2,059
            
            
            1,520
            
            
            1,193Net
      (Loss) Income
            
            
            (2,480
            )
            
            1,851
            
            
            3,400
            
            
            2,708
            
            
            2,062Preferred
      Stock Dividends
            
            
            (791
            )
            
            -
            
            
            -
            
            
            -
            
            
            -Net
      (Loss) Income Available to Common Stockholders
            
            
            (3,271
            )
            
            1,851
            
            
            3,400
            
            
            2,708
            
            
            2,062PER
      SHARE DATA: (1)Basic
      Net (Loss) Income Per Common Share
            
            $
            (.89
            )
            $
            .50
            
            $
            .92
            
            $
            .74
            
            $
            .60Diluted
      Net (Loss) Income Per Common Share
            
            
            (.89
            )
            
            .49
            
            
            .92
            
            
            .74
            
            
            .60Dividends
      Declared Per Common Share
            
            
            .075
            
            
            .10
            
            
            .10
            
            
            .10
            
            
            .10Book
      Value (at year end) (2)
            
            
            7.06
            
            
            7.83
            
            
            7.41
            
            
            6.60
            
            
            6.21Tangible
      Book Value (at year end) (2), (3)
            
            
            6.95
            
            
            7.15
            
            
            6.75
            
            
            5.95
            
            
            5.55FINANCIAL
      CONDITION (at year end):Assets
            
            $
            509,819
            
            $
            492,397
            
            $
            401,432
            
            $
            347,451
            
            $
            267,125Loans,
      net
            
            
            424,047
            
            
            401,749
            
            
            355,595
            
            
            310,083
            
            
            233,307Investment
      Securities
            
            
            6,413
            
            
            12,012
            
            
            5,219
            
            
            6,271
            
            
            5,922Deposits
            
            
            382,338
            
            
            364,551
            
            
            267,032
            
            
            270,604
            
            
            198,207Stockholders’
      Equity
            
            
            36,979
            
            
            40,392
            
            
            27,242
            
            
            24,273
            
            
            21,942PERFORMANCE
      RATIOS (for the year):Return
      on Average Assets
            
            
            -.49
            %
            
            .42
            %
            
            .92
            %
            
            .91
            %
            
            .89
            %Return
      on Average Equity
            
            
            -6.30
            
            
            6.47
            
            
            13.28
            
            
            11.70
            
            
            10.54Net
      Interest Margin
            
            
            3.90
            
            
            3.78
            
            
            4.05
            
            
            4.18
            
            
            4.36Efficiency
      Ratio (4)
            
            
            65.67
            
            
            61.53
            
            
            58.48
            
            
            61.59
            
            
            62.77Dividend
      Payout Ratio
            
            
            -8.46
            
            
            20.41
            
            
            10.87
            
            
            13.51
            
            
            16.67CAPITAL
      AND CREDIT QUALITY RATIOS:Average
      Equity to Average Assets
            
            
            7.85
            %
            
            6.56
            %
            
            6.92
            %
            
            7.81
            %
            
            8.45
            %Allowance
      for Loan Losses to Loans
            
            
            3.27
            
            
            1.55
            
            
            .87
            
            
            .71
            
            
            .74Nonperforming
      Assets to Total Assets
            
            
            9.66
            
            
            2.70
            
            
            1.42
            
            
            .46
            
            
            1.21Net
      Charge-offs to Average Loans
            
            
            .63
            
            
            .05
            
            
            .01
            
            
            .07
            
            
            .04





(1) All
per share amounts have been adjusted to give retroactive effect for the 1% stock
dividends approved by the Board of Directors in December 2005, March 2006, May
2006, and August 2006, and the two-for-one stock split approved by the Board of
Directors in March 2007.


(2) Book
value is computed using the amount allocated to common stockholders, that is
total stockholders’ equity, less the Series A Preferred Stock.


(3) Total
stockholders’ equity less the Series A Preferred Stock, net of goodwill and
other intangible assets, divided by the number of shares of common stock
outstanding at year end.


(4) The
Efficiency Ratio equals noninterest expenses as a percentage of net interest
income plus noninterest income.


17





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





You
should read this Management’s Discussion and Analysis of the Company’s
consolidated financial condition and results of operations in conjunction with
the Company’s consolidated financial statements and the accompanying
notes.





Summary





Cecil
Bancorp, Inc. (the “Company”) is the holding company for Cecil Bank (the
“Bank”). The Bank is a community-oriented commercial bank chartered under the
laws of the State of Maryland and is a member of the Federal Reserve System. The
Bank commenced operations in 1959 as a Federal savings and loan association and
converted to a Maryland commercial bank in 2002. The Bank conducts its business
through its main office in Elkton, Maryland, and branches in Elkton, North East,
Fair Hill, Rising Sun, Cecilton, Aberdeen, Conowingo, and Havre de Grace,
Maryland. Cecil Service Corporation, a subsidiary of the Bank, acts as leasing
agent for the leased branches. The Bank offers a full range of brokerage and
investment services through a relationship with Waterford Investor Services,
Inc. The Bank’s business strategy is to operate as an independent
community-oriented financial institution funded primarily by retail
deposits.





Consolidated
Average Balances, Yields and Costs (1)





2009
            
            
            2008
            
            
            2007(Dollars
      in thousands)
            Average
              Balance
            
            Interest
            
            Yield/
              Cost
            
            
            Average
              Balance
            
            Interest
            
            Yield/
              Cost
            
            
            Average
              Balance
            
            Interest
            
            Yield/
              CostAssets:Loans
      (2)
            $
            415,281
            
            $
            30,082
            
            7.24
            %
            
            $
            382,779
            
            $
            28,951
            
            7.56
            %
            
            $
            331,021
            
            $
            27,677
            
            8.36
            %Investment
      securities
            
            3,904
            
            
            134
            
            3.43
            
            
            
            5,697
            
            
            249
            
            4.37
            
            
            
            5,674
            
            
            284
            
            5.01Other
      earning assets
            
            39,024
            
            
            80
            
            0.21
            
            
            
            12,096
            
            
            251
            
            2.08
            
            
            
            6,845
            
            
            283
            
            4.12Total
      earning assets
            
            458,209
            
            
            30,296
            
            6.61
            
            
            
            400,572
            
            
            29,451
            
            7.35
            
            
            
            343,540
            
            
            28,244
            
            8.22Other
      assets
            
            43,149
            
            
            
            
            
            
            
            
            35,196
            
            
            
            
            
            
            
            
            26,442Total
      assets
            $
            501,358
            
            
            
            
            
            
            
            $
            435,768
            
            
            
            
            
            
            
            $
            369,982Liabilities
      and Stockholders’ Equity:Deposits
            $
            373,003
            
            
            8,836
            
            2.37
            %
            
            $
            301,982
            
            
            10,311
            
            3.41
            
            
            $
            280,899
            
            
            11,213
            
            3.99
            %FHLB
      advances
            
            63,721
            
            
            2,470
            
            3.88
            
            
            
            80,637
            
            
            2,865
            
            3.55
            
            
            
            42,043
            
            
            2,012
            
            4.79Fed
      funds purchased
            
            132
            
            
            1
            
            0.96
            
            
            
            433
            
            
            13
            
            3.10
            
            
            
            0
            
            
            0
            
            0.00Junior
      subordinated debentures
            
            17,000
            
            
            1,121
            
            6.59
            
            
            
            17,000
            
            
            1,124
            
            6.61
            
            
            
            17,000
            
            
            1,121
            
            6.59Total
      interest-bearing liabilities
            
            453,856
            
            
            12,428
            
            2.74
            
            
            
            400,052
            
            
            14,313
            
            3.58
            
            
            
            339,942
            
            
            14,346
            
            4.22Net
      interest income and
              spread
            
            
            
            $
            17,868
            
            3.87
            %
            
            
            
            
            $
            15,138
            
            3.77
            %
            
            
            
            
            $
            13,898
            
            4.00
            %Noninterest-bearing
      liabilities
            
            8,168
            
            
            
            
            
            
            
            
            7,117
            
            
            
            
            
            
            
            
            4,436Total
      liabilities
            
            462,024
            
            
            
            
            
            
            
            
            407,169
            
            
            
            
            
            
            
            
            344,378Stockholders’
      equity
            
            39,334
            
            
            
            
            
            
            
            
            28,599
            
            
            
            
            
            
            
            
            25,604Total
      liabilities and
              stockholders’
      equity
            $
            501,358
            
            
            
            
            
            
            
            $
            435,768
            
            
            
            
            
            
            
            $
            369,982Net
      Interest Margin
            
            
            
            
            
            
            3.90
            %
            
            
            
            
            
            
            
            3.78
            %
            
            
            
            
            
            
            
            4.05
            %Average
      interest earning assets to interest bearing liabilities
            
            
            
            
            
            
            100.96
            %
            
            
            
            
            
            
            
            100.13
            %
            
            
            
            
            
            
            
            101.06
            %


(1)      No
tax equivalent adjustments were made.


(2)      Non-accrual
loans are included in the average balances.







18


Comparison
of Results of Operations





Net loss
was $2.5 million for the year ended December 31, 2009, a decrease of $4.3
million, or 234.0%, from net income of $1.9 million for 2008. The decrease in
net income is primarily the result of a $7.2 million, or 212.5%, increase in the
provision for loan losses and a $3.1 million, or 31.4%, increase in noninterest
expense, partially offset by a $2.7 million (18.0%) increase in net interest
income, a $1.0 million, or 90.6%, increase in noninterest income, and a $2.3
million (227.6%) decrease in income tax expense. Net loss available to common
stockholders was $3.3 million for the year ended December 31, 2009, a decrease
of $5.1 million, or 276.7%, from net income available to common stockholders of
$1.9 million for 2008.  Basic and diluted loss per common share for
2009 were both $0.89, down $1.39 and $1.38, respectively, or approximately
278.0% and 281.6%, from corresponding 2008 basic and diluted earnings per common
share amounts of $0.50 and $0.49, respectively. The return on average assets and
return on average equity were -0.49% and -6.30%, respectively, for the year
ended December 31, 2009. This compares to a return on average assets and the
return on average equity of 0.42% and 6.47%, respectively, for
2008.





Net
interest income, the Company’s primary source of income, increased $2.7 million,
or 18.0%, to $17.9 million for the year ended December 31, 2009, from $15.1
million for the year ended December 31, 2008 primarily due to an increase in
average earning assets and widening margins. Average interest earning assets
increased $57.6 million, or 14.4%, while average interest bearing liabilities
increased $53.8 million, or 13.5%, improving the ratio of average interest
earning assets to average interest bearing liabilities to 100.96% from
100.13%.  The weighted average yield on interest-earning assets
decreased 74 basis points to 6.61% for the year ended December 31, 2009 from
7.35% for the year ended December 31, 2008. The weighted average rate paid on
interest bearing liabilities decreased 84 basis points to 2.74% for the year
ended December 31, 2009 from 3.58% for the year ended December 31, 2008. The net
interest spread increased to 3.87% for 2009 from 3.77% for 2008 and the net
interest margin increased to 3.90% for 2009 from 3.78% for 2008 as the average
cost of interest bearing liabilities declined at a faster rate than the yield on
interest earning assets.





Interest
and fees on loans receivable increased by $1.1 million, or 3.9%, to $30.1
million for the year ended December 31, 2009 from $29.0 million for the year
ended December 31, 2008. The increase is attributable to an increase in the
average balance outstanding partially offset by a decline in the average yield
earned. The average balance outstanding increased $32.5 million, or 8.5%, to
$415.3 million for the year ended December 31, 2009 from $382.8 million for the
year ended December 31, 2008. The weighted average yield decreased to 7.24% for
the year ended December 31, 2009 from 7.56% for the year ended December 31,
2008.





Interest
on investment securities decreased by $115,000, or 46.2%, to $134,000 for the
year ended December 31, 2009 from $249,000 for the year ended December 31, 2008.
The decrease is attributable to decreases in the weighted average yield and the
average balance outstanding. The average balance outstanding decreased $1.8
million for the year ended December 31, 2009 as compared to the year ended
December 31, 2008. The weighted average yield decreased to 3.43% for the year
ended December 31, 2009 from 4.37% for the year ended December 31,
2008.





Other
earning assets consist of Federal Home Loan Bank stock, Federal Reserve Bank
stock, and interest bearing deposits with other banks. Dividends on Federal Home
Loan and Federal Reserve Bank stock decreased $148,000, or 77.5%, to $43,000 for
the year ended December 31, 2009 from $191,000 for the year ended December 31,
2008 as a result of the discontinuation of dividends by FHLB for much of 2009,
as well as decreases in the average balance and the weighted average yield. The
average balance outstanding decreased $351,000, or 7.5%, to $4.3 million for the
year ended December 31, 2009 from $4.7 million for the year ended December 31,
2008. The weighted average yield decreased to 1.00% for the year ended December
31, 2009 from 4.09% for the year ended December 31, 2008. Interest on the
interest bearing deposits with other banks decreased $23,000 to $37,000 for the
year ended December 31, 2009 from $60,000 for the year ended December 31, 2008
as a result of a decrease in the weighted average yield, partially offset by an
increase in the average balance outstanding. The weighted average yield
decreased to 0.11% for the year ended December 31, 2009 from 0.81% for the year
ended December 31, 2008. The average balance outstanding increased $27.3
million, or 367.2%, to $34.7 million for the year ended December 31, 2009 from
$7.4 million for the year ended December 31, 2008.


19


Interest
expense on deposits decreased $1.5 million, or 14.3%, to $8.8 million for the
year ended December 31, 2009 from $10.3 million for the year ended December 31,
2008. The decrease was the result of a decrease in the average cost of funds
partially offset by an increase in the average balance. The weighted average
rate decreased to 2.37% for the year ended December 31, 2009 from 3.41% for the
year ended December 31, 2008. The average balance outstanding increased $71.0
million, or 23.5%, to $373.0 million for the year ended December 31, 2009 from
$302.0 million for the year ended December 31, 2008. Interest expense on
advances from the Federal Home Loan Bank of Atlanta decreased $395,000, or
13.8%, to $2.5 million for the year ended December 31, 2009 from $2.9 million
for the year ended December 31, 2008. The average balance outstanding decreased
$16.9 million, or 21.0%, to $63.7 million for the year ended December 31, 2009
from $80.6 million for the year ended December 31, 2008. The weighted average
rate increased to 3.88% for the year ended December 31, 2009 from 3.55% for the
year ended December 31, 2008. Interest expense on fed funds purchased decreased
92.3% to $1,000 for the year ended December 31, 2009 from $13,000 for the year
ended December 31, 2008. The average balance outstanding during the period
decreased $301,000, or 69.5%, to $132,000 for the year ended December 31, 2009
from $433,000 for the same period in 2008.  The weighted average rate
decreased to 0.96% for the year ended December 31, 2009 from 3.10% for the year
ended December 31, 2008. Interest expense on junior subordinated debentures was
approximately the same at $1.1 million, as the average balance remained the same
and the interest rate decreased by only 2 basis points.





Effect
of Volume and Rate Changes on Net Interest Income





2009
      vs. 2008
            
            
            
            2008
      vs. 2007Increase
            
            Due
      to Change
            
            
            
            Increase
            
            Due
      to Changeor
            
            In
      Average *
            
            
            
            or
            
            In
      Average *(In
      thousands)
            
            (Decrease)
            
            Volume
            
            Rate
            
            
            
            (Decrease)
            
            Volume
            
            RateInterest
      income from earning assets:Loans
            
            $
            1,131
            
            $
            2,389
            
            $
            (1,258
            )
            
            
            $
            1,274
            
            $
            4,071
            
            $
            (2,797
            )Investment
    securities
            
            
            (115
            )
            
            (68
            )
            
            (47
            )
            
            
            
            (35
            )
            
            1
            
            
            (36
            )Other
      interest-earning assets
            
            
            (171
            )
            
            200
            
            
            (371
            )
            
            
            
            (32
            )
            
            152
            
            
            (184
            )Total Interest
      Income
            
            
            845
            
            
            3,987
            
            
            (3,142
            )
            
            
            
            1,207
            
            
            4,386
            
            
            (3,179
            )Interest
      expense:Interest bearing
      deposits
            
            
            (1,475
            )
            
            2,102
            
            
            (3,577
            )
            
            
            
            (902
            )
            
            800
            
            
            (1,702
            )FHLB
      advances
            
            
            (395
            )
            
            (639
            )
            
            244
            
            
            
            
            853
            
            
            1,475
            
            
            (622
            )Fed
      funds purchased
            
            
            (12
            )
            
            (6
            )
            
            (6
            )
            
            
            
            13
            
            
            13
            
            
            0Junior
      subordinated debentures
            
            
            (3
            )
            
            0
            
            
            (3
            )
            
            
            
            3
            
            
            0
            
            
            3Total Interest
      Income
            
            
            (1,885
            )
            
            1,760
            
            
            (3,645
            )
            
            
            
            (33
            )
            
            2,329
            
            
            (2,362
            )Net Interest
      Income
            
            $
            2,730
            
            $
            2,227
            
            $
            503
            
            
            
            $
            1,240
            
            $
            2,057
            
            $
            (817
            )





________________


*    Variances
are computed line-by-line and do not add to the totals shown. Changes in
rate-volume (changes in rate multiplied by the changes in volume) are allocated
between changes in rate and changes in volume in proportion to the relative
contribution of each.





The
allowance for loan losses is increased by provisions charged to expense.
Charge-offs of loan amounts determined by management to be uncollectible
decrease the allowance, and recoveries of previous charge-offs are added to the
allowance. The Company recognizes provisions for loan losses in amounts
necessary to maintain the allowance for loan losses at an appropriate level,
based upon management’s reviews of probable losses inherent in the loan
portfolio. The provision for loan losses increased $7.2 million to $10.6 million
for the year ended December 31, 2009 from $3.4 million for the year ended
December 31, 2008 as a result of this analysis. (See “Allowance for Loan
Losses.”)





Noninterest
income increased $1.0 million, or 90.6%, to $2.2 million for the year ended
December 31, 2009 from $1.1 million for the year ended December 31, 2008.
Deposit account fees increased $14,000, or 2.2%, to $664,000 for the year ended
December 31, 2009 from $650,000 for the year ended December 31, 2008 due to
growth in the portfolio. ATM fees increased $20,000 to $397,000 for the year
ended December 31, 2009 from $377,000 for the year ended December 31, 2008. This
increase is attributable to increased surcharge fees resulting from increases in
cardholder usage. Commission income decreased $47,000 to $8,000 for the year
ended December 31, 2009 from $55,000 for the year ended


20


December
31, 2008 due to a decrease in investment activity in the current economy. There
was a $277,000 gain on the sale of other real estate owned during the year ended
December 31, 2009 as compared to an $11,000 gain on the sale of other real
estate owned during the year ended December 31, 2008.  Gain on the
sale of loans of $502,000 for the year ended December 31, 2009 was an increase
of $329,000, or 190.2%, over the total of $173,000 for the year ended December
31, 2008. The Company did not show any gains or losses on investments for the
year ended December 31, 2009, as compared to a loss of $618,000 on investments,
consisting of a $125,000 loss on the sale of the AMF Intermediate Mortgage Fund
and an additional $493,000 other than temporary impairment loss on its
investments in Triangle Capital Corporation and the AMF Ultra Short Mortgage,
Intermediate Mortgage, and Short U.S. Government Funds, for the year ended
December 31, 2008.  Income from bank owned life insurance decreased by
$171,000, or 67.1%, to $84,000 for the year ended December 31, 2009 from
$255,000 for the year ended December 31, 2008 due to a decrease in the crediting
rates paid by the carriers.





Noninterest
expense increased $3.1 million, or 31.4%, to $13.2 million for the year ended
December 31, 2009 from $10.0 million for the year ended December 31, 2008
primarily due to a $2.2 million goodwill impairment charge. The Company
experienced a decrease in salaries and employee benefits of $83,000, or 1.4%, to
$6.1 million for the year ended December 31, 2009 from $6.1 million for the year
ended December 31, 2008.  Occupancy expense increased $15,000, or
2.2%, to $704,000 for the year ended December 31, 2009 from $689,000 for the
year ended December 31, 2008.  Professional fees increased $261,000,
or 150.0%, to $435,000 for the year ended December 31, 2009 from $174,000 for
the year ended December 31, 2008 primarily due to increased legal fees
associated with the collection of delinquent loans. The FDIC insurance premium
expense increased by $489,000, or 160.9%, to $793,000 for the year ended
December 31, 2009 from $304,000 for the year ended December 31, 2008 partially
due to the significant increase in deposits over the
period.  Additionally, beginning in January 2009, the FDIC doubled the
assessment rate for most insured institutions and imposed a special assessment
equal to 5 basis points of assets less Tier 1 capital.  The Company
recorded goodwill impairment of $2.2 million for the year ended December 31,
2009 as compared to zero for the year ended December 31, 2008.  The
Company performed its regular annual test for goodwill impairment as of
September 30, 2009, at which time it was determined that goodwill was not
impaired.  Primarily due to the further decline in our market
capitalization during the fourth quarter, we performed an impairment test as of
December 31, 2009.  During this test, we determined that goodwill was
100% impaired and we therefore recorded an impairment charge of $2.2
million.  Other expenses increased $287,000, or 20.4%, to $1.7 million
for the year ended December 31, 2009 from $1.4 million for the year ended
December 31, 2008, primarily as a result of an increase in other real estate
owned expense due to an increase in the number of properties, as well as
valuation adjustments resulting from the unstable real estate
market.





Income
tax benefit for the year ended December 31, 2009 was $1.3 million as compared to
expense of $1.0 million for the year ended December 31, 2008, which equates to
effective rates of 34.1% and 35.2%, respectively.


21





Comparison
of Financial Condition





The
Company’s assets increased by $17.4 million, or 3.5%, to $509.8 million at
December 31, 2009 from $492.4 million at December 31, 2008 primarily due to
growth in loans. The gross loans receivable portfolio increased by $30.3
million, or 7.4%, to $438.4 million at December 31, 2009 from $408.1 million at
December 31, 2008. The increase in loans is due to the Company’s growth strategy
and the marketing efforts of the business development and loan departments.
During the period, we realized a $29.6 million (20.7%) increase in commercial
real estate loans and a $3.3 million (20.6%) increase in commercial business
loans, partially offset by a $2.9 million (2.8%) decrease in construction loans.
The allowance for loan losses increased by $8.0 million, or 127.3%, to $14.4
million at December 31, 2009 from $6.3 million at December 31, 2008. The
allowance for loan losses is increased by provisions charged to expense.
Charge-offs of loan amounts determined by management to be uncollectible
decrease the allowance, and recoveries of previous charge-offs are added to the
allowance. (See “Allowance for Loan Losses” below.)  Cash and cash
equivalents decreased $6.0 million to $35.5 million at December 31, 2009 from
$41.4 million at December 31, 2008 primarily due to an increase in the loan
portfolio, partially offset by an increase in the deposit portfolio and a
decrease in the investment portfolio.





Investment
securities available-for-sale decreased by $10.0 million to $1.7 million at
December 31, 2009 from $11.7 million at December 31, 2008 due to a maturity in
the first quarter of 2009 that was not replaced.  Investment
securities held-to-maturity increased by $4.4 million to $4.7 million at
December 31, 2009 from $300,000 at December 31, 2008 due to the purchase of
several mortgage backed securities during the fourth quarter. Restricted
investment securities, which consist of Federal Home Loan and Federal Reserve
Bank stock, increased by $478,000, or 12.2%, to $4.4 million at December 31,
2009 from $3.9 million at December 31, 2008 due to an increase in the Bank’s
additional paid in capital, which requires a purchase of FRB stock as mandated
by the Federal Reserve Bank of Richmond. Other real estate owned increased $1.8
million, or 61.6%, to $4.6 million at December 31, 2009 from $2.8 million at
December 31, 2008 due to the acquisition of additional properties in
satisfaction of loans receivable.  Goodwill decreased by $2.2 million,
or 100%, to zero at December 31, 2009 from $2.2 million at December 31, 2008 due
to due to management’s determination of full impairment.  Other
intangible assets, consisting entirely of mortgage servicing rights, increased
by $78,000, or 23.7%, to $407,000 at December 31, 2009 from $329,000 at December
31, 2008. Other assets increased $6.8 million, or 116.6%, to $12.7 million at
December 31, 2009 from $5.9 million at December 31, 2008, primarily due to an
increase of $4.5 million in the Company’s deferred tax asset and the $2.1
millionprepaid FDIC
insurance premium at December 31, 2009.  In order to increase the
funds available to the Deposit Insurance Fund, the FDIC required all insured
depository institutions to prepay their federal deposit insurance assessments
through 2012.  The prepayment was due December 30, 2009 and was based
on the institution’s assessment base and assessment rate as of September 30,
2009 assuming a 5% annual growth in deposits and three basis point increase in
the assessment rate during years 2011 and 2012.





The
Company’s liabilities increased $20.8 million, or 4.6%, to $472.8 million at
December 31, 2009 from $452.0 million at December 31, 2008. Deposits increased
$17.8 million, or 4.9%, to $382.3 million at December 31, 2009 from $364.5
million at December 31, 2008. NOW and money market accounts increased by $8.6
million (25.6%), savings accounts increased by $795,000 (4.0%), national
certificates of deposit decreased by $60.2 million (77.0%), local certificates
of deposit increased by $63.4 million (29.7%), and checking accounts increased
by $5.2 million (26.7%). Other liabilities increased $3.2 million, or 47.9%, to
$9.9 million at December 31, 2009 from $6.7 million at December 31, 2008,
primarily due to increases in income taxes payable, the liability to fund the
supplement executive retirement plan, and the liability owed to MoneyGram
Payment Systems to clear official checks written by the Bank.





The
Company’s stockholders’ equity decreased by $3.4 million, or 8.5%, to $37.0
million at December 31, 2009 from $40.4 million at December 31, 2008. This
decrease is primarily due to the net loss of $2.5 million, the payment of
preferred stock dividends to the U.S. Department of the Treasury totaling
$661,000, and the payment of common stock dividends of $0.075 per share, or
$277,000.


22





Loans
Receivable





The
Bank’s total gross loans grew $30.3 million, or 7.4%, during 2009. During the
period, we realized a $29.6 million (20.7%) increase in commercial real estate
loans and a $3.3 million (20.6%) increase in commercial business loans,
partially offset by a $2.9 million (2.8%) decrease in construction loans. The
following table shows the composition of the loan portfolio at December
31.





(In
      thousands)
            
            2009
            
            2008
            
            2007
            
            2006
            
            2005Real
      estate loans:Construction
            
            $
            100,509
            
            $
            103,407
            
            $
            79,150
            
            $
            73,782
            
            $
            16,4141-4
      family residential and home equity
            
            
            129,847
            
            
            129,581
            
            
            125,723
            
            
            109,151
            
            
            86,334Multi-family
      residential
            
            
            7,227
            
            
            6,852
            
            
            7,149
            
            
            6,679
            
            
            4,523Land
            
            
            4,584
            
            
            4,687
            
            
            3,262
            
            
            2,805
            
            
            3,477Commercial
            
            
            172,703
            
            
            143,126
            
            
            126,850
            
            
            102,348
            
            
            45,338Total
      real estate loans
            
            
            414,870
            
            
            387,653
            
            
            342,134
            
            
            294,765
            
            
            156,086Commercial
      business loans
            
            
            19,290
            
            
            15,995
            
            
            10,206
            
            
            10,755
            
            
            67,277Consumer
      loans
            
            
            4,238
            
            
            4,415
            
            
            6,364
            
            
            6,780
            
            
            11,682Gross
      loans
            
            
            438,398
            
            
            408,063
            
            
            358,704
            
            
            312,300
            
            
            235,045Less
      allowance for loan losses
            
            
            (14,351
            )
            
            (6,314
            )
            
            (3,109
            )
            
            (2,217
            )
            
            (1,738
            )Net
      loans
            
            $
            424,047
            
            $
            401,749
            
            $
            355,595
            
            $
            310,083
            
            $
            233,307





Loan
classifications beginning with December 31, 2006 in the preceding table have
been prepared using call report instructions, which generally classify loans
secured by real estate as real estate loans, regardless of the loans’ primary
purpose. Categories for prior years have not been restated, and reflect
classification of commercial purpose loans secured by real estate as commercial
business loans.





The
following table shows the remaining maturities or next repricing date of
outstanding loans at December 31, 2009.





At
      December 31, 2009Remaining
      Maturities of Selected Credits in Years(In
      thousands)
            
            1
      or Less
            
            Over
      1-5
            
            Over
      5
            
            TotalReal
      estate:Mortgage
            
            $
            174,485
            
            $
            203,625
            
            $
            5,639
            
            $
            383,749Home
      equity and second mortgages
            
            
            21,762
            
            
            5,855
            
            
            3,504
            
            
            31,121Commercial
            
            
            12,755
            
            
            5,441
            
            
            1,094
            
            
            19,290Consumer
            
            
            2,106
            
            
            1,661
            
            
            471
            
            
            4,238Total
            
            $
            211,108
            
            $
            216,582
            
            $
            10,708
            
            $
            438,398Rate
      Terms:Fixed
            
            $
            7,623
            
            $
            23,105
            
            $
            10,331
            
            $
            41,059Variable
      or adjustable
            
            
            203,485
            
            
            193,477
            
            
            377
            
            
            397,339Total
            
            $
            211,108
            
            $
            216,582
            
            $
            10,708
            
            $
            438,398





Allowance
for Loan Losses





The Bank
records provisions for loan losses in amounts necessary to maintain the
allowance for loan losses at the level deemed appropriate. The allowance for
loan losses is provided through charges to income in an amount that management
believes will be adequate to absorb losses on existing loans that may become
uncollectible, based upon evaluations of the collectibility of loans and prior
loan loss experience. The allowance is based on a careful, continuous review and
evaluation of the credit portfolio and ongoing, quarterly assessments of the
probable losses inherent in the loan portfolio. The Bank employs a systematic
methodology for assessing the appropriateness of the allowance, which
includes


23


determination
of a specific allowance, a formula allowance, and an unallocated allowance.
During the year ended December 31, 2009, the Bank began calculating the
unallocated allowance by applying a factor derived from the Board of Governors
of the Federal Reserve System’s Principal Economic Indicators, specifically the
charge-off and delinquency rates on loans and leases at commercial
banks.





Specific
allowances are established in cases where management has identified significant
conditions or circumstances related to a credit that management believes
indicate the probability that a loss may be incurred in an amount different from
the amount determined by application of the formula allowance.





The
formula allowance is calculated by applying loss factors to corresponding
categories of outstanding loans and leases, excluding loans for which specific
allocations have been made. Allowances are established for credits that do not
have specific allowances according to the application of these credit loss
factors to groups of loans based upon (a) their credit risk rating, for loans
categorized as substandard or doubtful either by the Bank in its ongoing reviews
or by bank examiners in their periodic examinations, or (b) by type of loans,
for other credits without specific allowances. These factors are set by
management to reflect its assessment of the relative level of risk inherent in
each category of loans, based primarily on the credit risk factors employed by
bank examiners at their most recent periodic examination of the Bank. Bank
regulatory examinations usually occur each year. In these examinations, the
examiners review the credit portfolio, establish credit risk ratings for loans,
identify charge offs, and perform their own calculation of the allowance for
loan losses. Additionally, the Bank engages an independent third party to review
a significant portion of our loan portfolio. The use of these credit risk
factors based primarily upon periodic examinations is intended to provide a
self-correcting mechanism to reduce differences between estimated and actual
observed losses.





The
unallocated allowance is based upon management’s evaluation of current economic
conditions that may affect borrowers’ ability to pay that are not directly
measured in the determination of the specific and formula allowances. Management
has chosen to apply a factor derived from the Board of Governors of the Federal
Reserve System’s Principal Economic Indicators, specifically the charge-off and
delinquency rates on loans and leases at commercial banks.  This
statistical data tracks delinquency ratios on a national level.  While
management does not believe the region that the bank is located in has been hit
as hard as others across the nation, this ratio provides a global perspective on
delinquency trends. Management has identified land acquisition and development
loans, as well as construction speculation loans, as higher risk due to current
economic factors. These loans are being reviewed individually on a quarterly
basis for specific impairment.





Determining
the amount of the allowance for loan losses requires the use of estimates and
assumptions, which is permitted under accounting principles generally accepted
in the United States of America. Actual results could differ significantly from
those estimates. While management uses available information to estimate losses
on loans, future additions to the allowance may be necessary based on changes in
economic conditions. In addition, as noted above, federal and state financial
institution examiners, as an integral part of their examination process,
periodically review the Bank’s allowance for loan losses, and may require the
Bank to recognize additions to the allowance based on their judgments about
information available to them at the time of their examination.





Management
determined that the appropriate allowance for loan losses at December 31, 2009
was $14.3 million, (3.27% of total loans), an increase of $8.0 million, or
127.3%, from the $6.3 million allowance (1.55% of total loans) at December 31,
2008. The allowance was higher than the same period last year due to an increase
in the level of risk in the Company’s real estate loan portfolio, resulting from
the continued slow-down in the real estate market.  The same slow-down
has resulted in delinquencies due to the inability of investors to resell
properties as anticipated.  The Company has also seen an increase in
loan extensions and in modification requests.  The allowance was also
moved higher by management when land acquisition and development loans, as well
as speculative construction loans were reviewed individually for
impairment.  Net charge-offs were 0.63% of average loans in 2009,
while net charge-offs were 0.05% of average loans in 2008. There was one
out-of-area loan that the Company had purchased a participation in that resulted
in a charge-off of $1.2 million, which equates to 36.1% of total
charge-offs.  Charge-offs related to the acquisition of REO properties
resulted in $2.9 million, or 90.0% or charge-offs.  The provision for
loan losses required for 2009 was $10.6


24


million, up $7.2 million (212.5%), from
$3.4 million in 2008.A summary of activity in
the allowance is shown below.





Years
      Ended December 31,(Dollars
      in thousands)
            
            2009
            
            2008
            
            2007
            
            2006
            
            2005Balance
      of allowance, January 1
            
            $
            6,314
            
            $
            3,109
            
            $
            2,217
            
            $
            1,738
            
            $
            1,189Loan
      charge-offs:Real
      estate
            
            
            (3,068
            )
            
            (189
            )
            
            0
            
            
            (35
            )
            
            (5
            )Commercial
      loans
            
            
            (88
            )
            
            (97
            )
            
            (30
            )
            
            (121
            )
            
            (29
            )Consumer
            
            
            (72
            )
            
            (42
            )
            
            (40
            )
            
            (92
            )
            
            (86
            )Total
      charge-offs
            
            
            (3,228
            )
            
            (328
            )
            
            (70
            )
            
            (248
            )
            
            (120
            )Loan
      recoveries:Real
      estate
            
            
            609
            
            
            0
            
            
            0
            
            
            0
            
            
            0Commercial
      loans
            
            
            0
            
            
            110
            
            
            0
            
            
            14
            
            
            0Consumer
            
            
            16
            
            
            18
            
            
            27
            
            
            48
            
            
            44Total
      recoveries
            
            
            625
            
            
            128
            
            
            27
            
            
            62
            
            
            44Net
      charge-offs
            
            
            (2,603
            )
            
            (200
            )
            
            (43
            )
            
            (186
            )
            
            (76
            )Provision
      for loan losses
            
            
            10,640
            
            
            3,405
            
            
            935
            
            
            665
            
            
            625Balance
      of allowance, December 31
            
            $
            14,351
            
            $
            6,314
            
            $
            3,109
            
            $
            2,217
            
            $
            1,738Net
      charge-offs to average loans
            
            
            (0.63
            )%
            
            (0.05
            )%
            
            (0.01
            )%
            
            (0.07
            )%
            
            (0.04
            )%Allowance
      to total loans
            
            
            3.27
            %
            
            1.55
            %
            
            0.87
            %
            
            0.71
            %
            
            0.74
            %





The
following table presents a five year history of the allocation of the allowance
for loan losses, reflecting the methodologies described above, along with the
percentage of total loans in each category.





December
      312009
            
            2008
            
            2007
            
            2006
            
            2005Credit
            
            
            
            
            Credit
            
            
            
            
            Credit
            
            
            
            
            Credit
            
            
            
            
            Credit(Dollars
      in thousands)
            
            Amount
            
            Mix
            
            Amount
            
            Mix
            
            Amount
            
            Mix
            
            Amount
            
            Mix
            
            Amount
            
            MixAmount
      applicable to:Real
      estate loans:Construction
            
            $
            8,346
            
            23
            %
            
            $
            2,756
            
            25
            %
            
            $
            1,744
            
            22
            %
            
            $
            661
            
            9
            %
            
            $
            469
            
            7
            %1-4
      family residential and home equity
            
            
            2,284
            
            30
            
            
            
            200
            
            32
            
            
            
            194
            
            35
            
            
            
            123
            
            29
            
            
            
            118
            
            37Multi-family
      residential
            
            
            47
            
            2
            
            
            
            0
            
            2
            
            
            
            0
            
            2
            
            
            
            0
            
            2
            
            
            
            0
            
            2Land
            
            
            0
            
            1
            
            
            
            63
            
            1
            
            
            
            52
            
            1
            
            
            
            33
            
            1
            
            
            
            98
            
            1Commercial
            
            
            3,243
            
            39
            
            
            
            1,248
            
            35
            
            
            
            931
            
            35
            
            
            
            589
            
            28
            
            
            
            410
            
            19Total
      Real Estate Loans
            
            
            13,920
            
            95
            
            
            
            4,267
            
            95
            
            
            
            2,921
            
            95
            
            
            
            1,406
            
            69
            
            
            
            1,095
            
            66Commercial
      business loans
            
            
            376
            
            4
            
            
            
            1,806
            
            4
            
            
            
            64
            
            3
            
            
            
            659
            
            26
            
            
            
            446
            
            29Consumer
      Loans
            
            
            55
            
            1
            
            
            
            241
            
            1
            
            
            
            124
            
            2
            
            
            
            152
            
            5
            
            
            
            197
            
            5Total
      allowance
            
            $
            14,351
            
            100
            %
            
            $
            6,314
            
            100
            %
            
            $
            3,109
            
            100
            %
            
            $
            2,217
            
            100
            %
            
            $
            1,738
            
            100
            %





25


Nonperforming
      Assets





Management
reviews and identifies loans and investments that require designation as
nonperforming assets. Nonperforming assets are: loans accounted for on a
nonaccrual basis; loans past due by 90 days or more but still accruing;
restructured loans; and other real estate owned (assets acquired in settlement
of loans). The following tables set forth certain information with respect to
nonperforming assets at December 31:





December
      31,(Dollars
      in thousands)
            
            2009
            
            
            
            2008
            
            
            
            2007
            
            
            
            2006
            
            
            
            2005Non-accrual
      loans (1)
            
            $
            32,694
            
            
            
            $
            10,459
            
            
            
            $
            5,065
            
            
            
            $
            1,382
            
            
            
            $
            2,818Loans
      90 days past due and still accruing
            
            
            0
            
            
            
            
            0
            
            
            
            
            0
            
            
            
            
            211
            
            
            
            
            18Restructured
      loans (2)
            
            
            11,959
            
            
            
            
            0
            
            
            
            
            0
            
            
            
            
            0
            
            
            
            
            0Total
      non-performing loans (3)
            
            
            44,653
            
            
            
            
            10,459
            
            
            
            
            5,065
            
            
            
            
            1,593
            
            
            
            
            2,836Other
      real estate owned, net
            
            
            4,594
            
            
            
            
            2,843
            
            
            
            
            655
            
            
            
            
            0
            
            
            
            
            385Total
      non-performing assets
            
            $
            49,247
            
            
            
            $
            13,302
            
            
            
            $
            5,720
            
            
            
            $
            1,593
            
            
            
            $
            3,221Non-performing
      loans to total loans
            
            
            10.19
            %
            
            
            
            2.56
            %
            
            
            
            1.41
            %
            
            
            
            0.51
            %
            
            
            
            1.21
            %Non-performing
      assets to total assets
            
            
            9.66
            %
            
            
            
            2.70
            %
            
            
            
            1.42
            %
            
            
            
            0.46
            %
            
            
            
            1.21
            %Allowance
      for loan losses to non-performing loans
            
            
            32.14
            %
            
            
            
            60.37
            %
            
            
            
            61.38
            %
            
            
            
            139.17
            %
            
            
            
            61.28
            %





(1)Gross interest income that would have been recorded in 2009 if
non-accrual loans had been current and in accordance with their original terms
was $2,894,000, while interest actually recorded on such loans was
$1,237,000.


(2)Gross interest income that would have been recorded in 2009 if
restructured loans had been current and in accordance with their original terms
was $1,328,000, while interest actually recorded on such loans was
$1,227,000.


(3)  Performing
loans considered potential problem loans, as defined and identified by
management, amounted to $37,367,000 at December 31, 2009. Although these are
loans where known information about the borrowers’ possible credit problems
causes management to have doubts as to the borrowers’ ability to comply with the
present loan repayment terms, most are well collateralized and are not believed
to present significant risk of loss. Loans classified for regulatory purposes
not included in nonperforming loans do not, in management’s opinion, represent
or result from trends or uncertainties reasonably expected to materially affect
future operating results, liquidity or capital resources or represent material
credits where known information about the borrowers’ possible credit problems
causes management to have doubts as to the borrowers’ ability to comply with the
loan repayment terms.





Non-performing
loans totaled $44.7 million, or 10.19% of total loans at December 31, 2009,
compared with $10.5 million or 2.56% at December 31,
2008.  Non-performing loans were higher than the same period last year
due to an increase in the level of risk in the Company’s real estate loan
portfolio, resulting from the continued slow-down in the real estate
market.  The same slow-down has resulted in delinquencies due to the
inability of investors to resell properties as anticipated.  The
Company has also seen an increase in loan extensions and in modification
requests.





Investment
Securities





The Bank
maintains a portfolio of investment securities to provide liquidity as well as a
source of earnings. The Bank’s investment securities portfolio consists
primarily of U.S. Government and Agency securities and mortgage-backed and other
securities issued by U.S. government-sponsored enterprises (“GSEs”) including
Freddie Mac and Fannie Mae. The Bank has also invested in various mutual funds
that invest in securities that the Bank is permitted to invest in directly,
including the AMF Intermediate Mortgage, Ultra Short Mortgage, and Short U.S.
Government Funds, which invest in agency and private label mortgage-backed
securities. The Bank has also invested in the equity securities of Triangle
Capital Corporation, a publicly traded business development/small business
investment company that makes debt and equity investments in middle-market
companies in the Southeastern states.As a member of
the


26


Federal
Reserve and FHLB systems, the Bank is also required to invest in the stock of
the Federal Reserve Bank of Richmond and FHLB of Atlanta,
respectively.





The
composition of investment securities at December 31 is shown below.








(Dollars
      in thousands)
            
            2009
            
            2008
            
            2007Available-for-Sale:(1)Mutual
      Funds-AMF Intermediate Mortgage Fund
            
            $
            148
            
            $
            176
            
            $
            630Mutual
      Funds-AMF Ultra Short Mortgage Fund
            
            
            571
            
            
            571
            
            
            753Mutual
      Funds-AMF Short U.S. Government Fund
            
            
            687
            
            
            686
            
            
            758Equity
      Securities
            
            
            229
            
            
            193
            
            
            213FNMA
      Discount Note
            
            
            —
            
            
            9,999
            
            
            —Mortgage-backed
      Securities
            
            
            79
            
            
            87
            
            
            116Total
            
            
            1,714
            
            
            11,712
            
            
            2,470Held-to-Maturity:U.S.
      Government and Agency  (2)
            
            
            500
            
            
            250
            
            
            2,749Mortgage-backed
      Securities
            
            
            4,149
            
            
            —
            
            
            —Other
            
            
            50
            
            
            50
            
            
            —Total
            
            
            4,699
            
            
            300
            
            
            2,749Total
      Investment Securities (3)
            
            $
            6,413
            
            $
            12,012
            
            $
            5,219





(1)  At
estimated fair value.


(2)  Issued
by a U. S. Government Agency or secured by U.S. Government Agency
collateral.


(3)  The
outstanding balance of no single issuer, except for U.S. Government, U.S.
Government Agency, and FNMA securities, exceeded ten percent of stockholders’
equity at December 31, 2009, 2008 or 2007.





Contractual
maturities and weighted average yields for debt securities available-for-sale
and held-to-maturity at December 31, 2009 are presented below. Expected
maturities may differ from contractual maturities because borrowers may have the
right to prepay obligations with or without prepayment penalties.





One
      Year or Less
            
            One
      Year to Five Years
            
            Five
      Years to Ten YearsWeighted
            
            
            
            Weighted
            
            
            
            WeightedAverage
            
            
            
            Average
            
            
            
            Average(Dollars
      in thousands)
            Amount
            
            Yield
            
            Amount
            
            Yield
            
            Amount
            
            YieldAvailable-for-Sale:Mortgage
      Backed Securities
            $
            —
            
            —
            %
            $
            —
            
            —
            %
            $
            —
            
            —
            %Held-to-Maturity:U.S.
      Government and Agency
            
            500
            
            0.25
            
            
            —
            
            —
            
            
            —
            
            —Mortgage
      Backed Securities
            
            —
            
            —
            
            
            3,974
            
            0.07
            
            
            175
            
            3.44Total
      Debt Securities
            $
            500
            
            0.25
            %
            $
            3,974
            
            0.07
            %
            $
            175
            
            3.44
            %





Over
      Ten Years
            
            TotalWeighted
            
            
            
            WeightedAverage
            
            
            
            Average(Dollars
      in thousands)
            Amount
            
            Yield
            
            Amount
            
            YieldAvailable-for-Sale:Mortgage
      Backed Securities
            $
            79
            
            3.36
            %
            $
            79
            
            3.36
            %Held-to-Maturity:U.S.
      Government and Agency
            
            —
            
            —
            
            
            500
            
            0.25Mortgage
      Backed Securities
            
            —
            
            —
            
            
            4,149
            
            0.21Total
      Debt Securities
            $
            79
            
            3.36
            %
            $
            4,728
            
            0.27
            %





27


Deposits





The
following table sets forth the average dollar amount of deposits in the various
types of accounts at December 31:





2009
            
            2008Weighted
            
            
            
            
            
            
            WeightedAverage
            
            Average
            
            %
      of
            
            Average
            
            Average
            
            %
      of(Dollars
      in thousands)
            Balance
            
            Rate
            
            Total
            
            Balance
            
            Rate
            
            TotalNOW
      and Money Market Accounts
            $
            37,907
            
            1.76%
            
            10.16
            %
            $
            31,595
            
            2.27%
            
            10.46
            %Savings
      accounts
            
            21,018
            
            0.59
            
            5.64
            
            
            20,118
            
            0.76
            
            6.66Term
      Certificates
            
            290,725
            
            2.79
            
            77.94
            
            
            228,601
            
            3.71
            
            75.70Checking
      Accounts
            
            23,353
            
            0.00
            
            6.26
            
            
            21,668
            
            0.00
            
            7.18Total
      Deposits
            $
            373,003
            
            
            
            100.00
            %
            $
            301,982
            
            
            
            100.00
            %








2007WeightedAverage
            
            Average
            
            %
      of(Dollars
      in thousands)
            
            Balance
            
            Rate
            
            TotalNOW
      and Money Market Accounts
            
            $
            25,216
            
            1.68%
            
            8.98
            %Savings
      accounts
            
            
            20,603
            
            0.75
            
            7.33Term
      Certificates
            
            
            216,091
            
            4.95
            
            76.93Checking
      Accounts
            
            
            18,989
            
            0.00
            
            6.76Total
      Deposits
            
            $
            280,899
            
            
            
            100.00
            %





28


Borrowings





Year-end
advances from the Federal Home Loan Bank of Atlanta consisted of the following
(dollars in thousands):






2009
              
              2008Maturity
              
              
              
              
              
              
              
              
              MaturityAmount
              
              Date
              
              Rate
              
              Type
              
              Amount
              
              Date
              
              Rate
              
              Type$
              143
              
              2010
              
              3.930
              
              Fixed
              
              $
              286
              
              2010
              
              3.930
              
              Fixed10,000
              
              2012
              
              5.060
              
              Fixed
              
              
              10,000
              
              2012
              
              5.060
              
              Fixed7,500
              
              2017
              
              3.776
              
              Fixed
              
              
              7,500
              
              2017
              
              3.776
              
              Fixed7,500
              
              2017
              
              3.690
              
              Fixed
              
              
              7,500
              
              2017
              
              3.690
              
              Fixed11,000
              
              2017
              
              3.588
              
              Fixed
              
              
              11,000
              
              2017
              
              3.588
              
              Fixed9,500
              
              2017
              
              3.875
              
              Fixed
              
              
              9,500
              
              2017
              
              3.875
              
              Fixed15,000
              
              2017
              
              3.448
              
              Fixed
              
              
              15,000
              
              2017
              
              3.448
              
              Fixed3,000
              
              2017
              
              2.955
              
              Fixed
              
              
              3,000
              
              2017
              
              2.955
              
              Fixed$
              63,643
              
              
              
              
              
              
              
              $
              63,786





2007MaturityAmount
            
            Date
            
            Rate
            
            Type$
            20,570
            
            Demand
            
            Variable
            
            Fixed429
            
            2012
            
            3.930
            
            Fixed10,000
            
            2017
            
            5.060
            
            Fixed7,500
            
            2017
            
            3.776
            
            Fixed7,500
            
            2017
            
            3.690
            
            Fixed11,000
            
            2017
            
            3.588
            
            Fixed9,500
            
            2017
            
            3.875
            
            Fixed15,000
            
            2017
            
            3.448
            
            Fixed3,000
            
            2017
            
            2.955
            
            Fixed$
            84,000











The
following table sets forth information concerning short-term borrowings, which
consisted primarily of advances from the Federal Home Loan Bank of Atlanta
during the periods indicated.





At
      or For the Years
              Ended
      December 31,(Dollars
      in thousands)
            
            2009
            
            2008
            
            2007Average
      outstanding
            
            $
            0
            
            $
            16,371
            
            $
            22,500Maximum
      amount outstanding at any month-end during the year
            
            $
            0
            
            $
            31,349
            
            $
            32,730Weighted
      average interest rate during the year
            
            
            0.00
            %
            
            2.77
            %
            
            5.38
            %Total
      short-term borrowings at year end
            
            $
            0
            
            $
            0
            
            $
            20,570Weighted
      average interest rate at year end
            
            
            0.00
            %
            
            0.00
            %
            
            4.40
            %





29


Interest
Sensitivity





The
ability to maximize net interest income is largely dependent upon the
achievement of a positive interest rate spread (the difference between the
weighted average interest yields earned on interest-earning assets and the
weighted average interest rates paid on interest-bearing liabilities) that can
be sustained during fluctuations in prevailing interest rates. Asset/liability
management functions to maximize profitability within established guidelines for
interest rate risk, liquidity, and capital adequacy. The Bank’s asset/liability
management policies are designed to reduce the impact of changes in interest
rates on its net interest income by achieving a more favorable match between the
maturities or repricing dates of its interest-earning assets and
interest-bearing liabilities. Measurement and monitoring of liquidity, interest
rate risk, and capital adequacy are performed centrally through the
Asset/Liability Management Committee, and reported under guidelines established
by management, the Board of Directors and regulators. Oversight of this process
is provided by the Board of Directors.





The Bank
has implemented policies by generally emphasizing the origination of one-year,
three-year and five-year adjustable rate mortgage loans, adjustable rate
commercial loans and lines of credit, and short-term consumer loans. Since 1995,
the Bank has, from time to time, originated fixed rate mortgages for sale in the
secondary market. The Bank is currently originating loans for sale in the
secondary market through the Federal Home Loan Mortgage Corporation. Management
has been monitoring the retention of fixed rate loans through its
asset/liability management policy. Management intends to continue to concentrate
on maintaining its interest rate spread in a manner consistent with its lending
policies, which are principally the origination of adjustable-rate mortgages and
commercial loans, and may include an appropriate blend of fixed-rate mortgage
loans in its primary market area.





The
Bank’s net income is largely dependent on its net interest income. The Bank
seeks to maximize its net interest margin within an acceptable level of interest
rate risk. Interest rate risk can be defined as the amount of forecasted net
interest income that may be gained or lost due to favorable or unfavorable
movements in interest rates. Interest rate risk, or sensitivity, arises when the
maturity or repricing characteristics of assets differ significantly from the
maturity or repricing characteristics of liabilities. Net interest income is
also affected by changes in the portion of interest-earning assets that are
funded by interest-bearing liabilities rather than by other sources of funds,
such as noninterest-bearing deposits and stockholders’ equity.





The Bank
attempts to manage interest rate risk while enhancing net interest margin by
adjusting its asset/liability position. At times, depending on the level of
general interest rates, the relationship between long- and short-term interest
rates, market conditions and competitive factors, the Bank may decide to
increase its interest rate risk position somewhat in order to increase its net
interest margin. The Bank monitors interest rate risk and adjusts the
composition of its interest-related assets and liabilities in order to limit its
exposure to changes in interest rates on net interest income over time. The
Bank’s asset/liability committee reviews its interest rate risk position and
profitability, and recommends adjustments. The asset/liability committee also
reviews the securities portfolio, formulates investment strategies, and oversees
the timing and implementation of transactions. Notwithstanding the Bank’s
interest rate risk management activities, the potential for changing interest
rates is an uncertainty that can have an adverse effect on net
income.





The Bank
also analyzes interest rate risk based upon quantitative measures of the
percentage changes in fair value of equity capital (or market value of portfolio
equity) resulting from a hypothetical immediate change (or shock) of plus or
minus 100, 200, and 300 basis points in interest rate levels. Due to the current
interest rate environment, the Company did not perform analysis on decreases of
200 and 300 basis points as of December 31, 2009.  This analysis is
based upon models, which are based upon a number of significant assumptions
regarding reactions of interest rates. At December 31, 2009,
this


30


analysis
indicated that a shock decrease of 100 basis points would decrease the market
value of portfolio equity by 11.5%, while interest rate shock increases of 100,
200 and 300 basis points would decrease the market value of portfolio equity by
10.4%, 8.2%, and 6.9%, respectively. These models also provide an analysis of
interest rate shock effects on net interest income. At December 31, 2009, this
analysis indicated that a shock decrease of 100 basis points would decrease net
interest income by 13.1%. Interest rate shock increases of 100, 200, and 300
basis points would decrease net interest income by 15.5%, 15.0%, and 14.4%,
respectively.





Liquidity





Liquidity
is measured by a financial institution’s ability to raise funds through
deposits, borrowed funds, capital, or the sale of highly marketable assets such
as residential mortgage loans and available for sale investments. Additional
sources of liquidity, including cash flow from the repayment of loans, are also
considered in determining whether liquidity is satisfactory. Liquidity is also
achieved through growth of deposits and liquid assets, and accessibility to the
capital and money markets. These funds are used to meet deposit withdrawals,
maintain reserve requirements, fund loans and operate the
organization.





Cash and
cash equivalents decreased $6.0 million during 2009. This decrease was the
result of $29.5 million in cash used by investing activities, partially offset
by $16.7 million in cash provided by financing activities and $6.8 million in
cash provided by operating activities.





Cash and
cash equivalents increased $35.9 million during 2008. This increase was the
result of $88.0 million in cash provided by financing activities and $6.5
million in cash provided by operating activities, partially offset by $58.6
million in cash used by investing activities.





The Bank
maintains liquid assets that can be invested in specified short-term securities,
and is also permitted to make certain other investments. Liquidity levels may be
increased or decreased depending upon the yields on investment alternatives,
management’s judgment as to the attractiveness of the yields then available in
relation to other opportunities, its expectations of the level of yield that
will be available in the future and its projections as to the short term demand
for funds to be used in the Bank’s loan origination and other activities. The
general objectives of the Bank’s investment policy are to (i) maintain liquidity
levels sufficient to meet the operating needs of the Bank (ii) minimize interest
rate risk by managing the repricing characteristics of the Bank’s assets and
liabilities, (iii) reduce credit risk by investing primarily in U.S. Treasury
and agency securities and (iv) absorb excess liquidity when loan demand is low
and/or deposit growth is high. The Bank’s investment activities are conducted by
senior management (specifically Chief Executive Officer Halsey and Chief
Financial Officer Whitehead) and supervised by the Board of Directors.
Investments are governed by an investment policy adopted by the Board, which
currently provides for maintenance of an investment portfolio for the purposes
of providing earnings, ensuring a minimum liquidity reserve and facilitating the
Bank’s asset/liability management objectives (e.g., limiting the weighted
average terms to maturity or repricing of the Bank’s interest-earning assets).
In accordance with the policy, management has primarily invested in U.S.
Treasury, government and agency securities and mutual funds.





31


The
Bank’s time deposits of $100,000 or more represented 38.0% of total deposits at
December 31, 2009, and are shown by maturity in the table below.





Months
      to Maturity3
      or
            Over
      3
            Over
      6
            Over(Dollars
      in thousands)
            less
            to
      6
            to
      12
            12
            TOTALTime
      deposits-$100 thousand or more
            $38,785
            $35,560
            $66,150
            $4,940
            $145,435





Capital





Capital
adequacy refers to the level of capital required to sustain asset growth and to
absorb losses. The Board of Governors of the Federal Reserve System (“Federal
Reserve”), which is the Company’s and the Bank’s principal federal regulator,
has established requirements for total and tier 1 (core) risk-based capital and
tangible capital. As of June 30, 2008, since the Company had total assets less
than $500 million, the capital adequacy requirements do not apply on a
consolidated basis. At December 31, 2009, the Bank exceeded applicable capital
requirements to be well capitalized, having a total risk based capital ratio of
12.61%, a tier 1 risk-based capital ratio of 8.36%, and a tier 1 leverage ratio
of 7.06%. See Note 13 “Regulatory Matters” in the notes to the consolidated
financial statements.





Off-Balance
Sheet Arrangements





In the
normal course of business, Cecil Bancorp makes use of a number of different
financial instruments to help meet the financial needs of its customers. In
accordance with accounting principles generally accepted in the United States of
America, the full notional amount of these transactions is not recorded in the
accompanying consolidated financial statements and is referred to as off-balance
sheet instruments. These transactions and activities include commitments to
extend credit, standby letters of credit, and lease obligations.





Standby
letters of credit are conditional commitments issued by the Bank to guarantee
the performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers. The Bank holds collateral supporting those
commitments for which collateral is deemed necessary. The issuance of letters of
credit is not a significant activity of the Bank.





Commitments
to extend credit are agreements to lend funds to customers as long as there are
no violations of any condition established in the loan contracts. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer’s credit
worthiness on a case-by-case basis. The amount of collateral obtained, if it is
deemed necessary by the Bank upon extension of credit, is based on credit
evaluation by management. Collateral held varies but may include accounts
receivable, inventory, property, plant and equipment as well as income producing
properties. Management believes that the Bank has adequate resources to fund all
loan commitments.





For
additional information regarding off-balance sheet arrangements, please see Note
16 to the Consolidated Financial Statements.


32


Critical
Accounting Policies





Cecil
Bancorp’s consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
(“GAAP”) and follow general practices within the banking industry. Application
of these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, the financial statements may reflect different
estimates, assumptions, and judgments. Certain policies inherently rely more on
the use of estimates, assumptions, and judgments and as such have a greater
possibility of producing results that could be materially different than
originally reported. Estimates, assumptions, and judgments are necessary when
assets and liabilities are required to be recorded at fair value, when a decline
in the value of an asset not carried on the financial statements at fair value
warrants an impairment write-down or valuation allowance to be established, or
when an asset or liability must be recorded contingent upon a future event.
Carrying assets and liabilities at fair value inherently results in more
financial statement volatility. The fair values and the information used to
record valuation adjustments for certain assets and liabilities are based either
on quoted market prices or are provided by other third-party sources, when
available.





Allowance for
Loan Losses.The allowance for loan losses is an estimate of the losses
that may be sustained in the loan portfolio. The allowance is based on two basic
principles of accounting: (1) ASC Topic 450, “Contingencies”, which requires
that losses be accrued when they are probable of occurring and estimable, and
(2) ASC Topic 310, “Receivables”, which requires that losses be accrued when it
is probable that Cecil Bancorp will not collect all principal and interest
payments according to the loan’s contractual terms.





Management
believes that the allowance is adequate. However, its determination requires
significant judgment, and estimates of probable losses inherent in the credit
portfolio can vary significantly from the amounts actually observed. While
management uses available information to recognize probable losses, future
additions to the allowance may be necessary based on changes in the credits
comprising the portfolio and changes in the financial condition of borrowers,
such as those that may result from changes in economic conditions. In addition,
regulatory agencies, as an integral part of their examination process,
periodically review the credit portfolio and the allowance. Such review may
result in additional provisions based on their judgments of information
available at the time of each examination.





Cecil
Bancorp’s systematic methodology for assessing the appropriateness of the
allowance includes determination of specific, formula, and unallocated
components, as described above under “Allowance for Loan Losses” and in Notes 1
and 4 to the Consolidated Financial Statements. At December 31, 2009, a 10%
decrease or increase in all categories of risk rated credits for which specific
allowances had not been recorded would have resulted in a corresponding decrease
or increase of approximately $420,000 in the recommended allowance, assuming no
change in other elements considered in the methodology.





Other Than
Temporary Impairment of 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


33


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.





As of
December 31, 2009, we concluded that any unrealized losses in the
available-for-sale portfolios were temporary in nature due to market interest
rates and not the underlying credit quality of the issuers of the securities.
Additionally, we have the intent to hold and do not expect to be required to
sell these investments for the time necessary to recover the amortized cost.
Future events that would materially change this conclusion and require a charge
to operations for an impairment loss include a change in the credit quality of
the issuers.





Income Taxes.The Company accounts for income taxes under the asset/liability method.
Deferred tax assets are recognized for the future consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases, as well as operating loss and
tax credit carry-forwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period indicated by the enactment date. A valuation
allowance is established for deferred tax assets when, in the judgment of
management, it is more likely than not that such deferred tax assets will not
become realizable. The judgment about the level of future taxable income is
dependent to a great extent on matters that may, at least in part, be beyond the
Company’s control. It is at least reasonably possible that management’s judgment
about the need for a valuation allowance for deferred tax assets could change in
the near term.





Goodwill and
Other Intangible Assets. The Company accounts for goodwill and other
intangible assets under Statement of Financial Accounting Standards (“SFAS”) No.
142, Goodwill and Other
Intangible Assets. SFAS No. 142 prescribes a two-phase process for
impairment testing of goodwill. The first phase screens for impairment; while
the second phase, if necessary, measures the impairment. We consider the Company
to be a single reporting unit. Accordingly, all of the goodwill is associated
with the entire Company. The Company performs the required impairment analysis
of goodwill annually or on an interim basis if circumstances dictate. Any
reduction of the enterprise fair value below the recorded amount of equity could
require us to write down the value of goodwill or purchased intangibles and
record an expense for an impairment loss.  As of December 31, 2009, we
determined that goodwill was fully impaired and therefore recorded an impairment
loss of $2.2 million.





Impact of
Inflation





The
consolidated financial statements and notes thereto presented herein have been
prepared in accordance with U.S. generally accepted accounting principles, which
generally require the measurement of financial position and operating results in
terms of historical dollars without considering the changes in the relative
purchasing power of money over time due to inflation.  Unlike most
industrial companies, nearly all of the Company’s assets and liabilities are
monetary in nature.  As a result, interest rates have a greater impact
on the Company’s performance than do the effects of general levels of
inflation.  Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and
services.





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





Not
applicable.











34





Item
8.   Financial Statements and Supplementary
Data














INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS








PageREPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
            
            36CONSOLIDATED
      FINANCIAL STATEMENTSBalance
      Sheets
            
            37Statements
      of (Loss) Income
            
            38Statements
      of Changes in Stockholders’ Equity
            
            39Statements
      of Cash Flows
            
            40NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS
            
            42














35











REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

















Board of
Directors and Stockholders


Cecil
Bancorp, Inc.


Elkton,
Maryland








We have audited the accompanying
consolidated balance sheets of Cecil Bancorp, Inc. and subsidiaries (the
“Company”) as of December 31, 2009 and 2008, and the related consolidated
statements of (loss) income, changes in stockholders’ equity, and cash flows for
the years then ended. These 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 the standards of the Public Company Accounting Oversight Board (United
States). 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 its internal control over financial reporting. Our audit
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 consolidated financial statements,
assessing the accounting principles used and significant estimates made by
management, as well as 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 Cecil Bancorp, Inc. and subsidiaries as of December
31, 2009 and 2008, and the results of their operations and cash flows for the
years then ended in conformity with accounting principles generally accepted in
the United States of America.














Baltimore,
Maryland


March 24,
2010





36


CECIL
BANCORP, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


DECEMBER
31, 2009 AND 2008


(dollars
in thousands, except per share data)








ASSETS2009
            
            2008Cash
      and due from banks
            
            $
            8,897
            
            $
            4,627Interest
      bearing deposits with banks
            
            
            26,479
            
            
            36,793Federal
      funds sold
            
            
            88
            
            
            -Total
      cash and cash equivalents
            
            
            35,464
            
            
            41,420Investment
      securities:Securities
      available-for-sale at fair value
            
            
            1,714
            
            
            11,712Securities
      held-to-maturity (fair value of $4,627
              in
      2009 and $300 in 2008)
            
            
            4,699
            
            
            300Restricted
      investment securities – at cost
            
            
            4,396
            
            
            3,918Loans
      receivable
            
            
            438,398
            
            
            408,063Less:
      Allowance for loan losses
            
            
            (14,351
            )
            
            (6,314
            )Net
      loans receivable
            
            
            424,047
            
            
            401,749Other
      real estate owned
            
            
            4,594
            
            
            2,843Premises
      and equipment, net
            
            
            11,910
            
            
            12,071Accrued
      interest receivable
            
            
            2,025
            
            
            2,225Goodwill
            
            
            -
            
            
            2,182Other
      intangible assets
            
            
            407
            
            
            329Bank
      owned life insurance
            
            
            7,871
            
            
            7,787Other
      assets
            
            
            12,692
            
            
            5,861TOTAL
      ASSETS
            
            $
            509,819
            
            $
            492,397LIABILITIES
      AND STOCKHOLDERS’ EQUITYLIABILITIES:Deposits
            
            $
            382,338
            
            $
            364,551Other
      liabilities
            
            
            9,859
            
            
            6,668Junior
      subordinated debentures
            
            
            17,000
            
            
            17,000Advances
      from Federal Home Loan Bank of Atlanta
            
            
            63,643
            
            
            63,786Total
      liabilities
            
            
            472,840
            
            
            452,005STOCKHOLDERS’
      EQUITY:Preferred
      stock, $.01 par value; authorized 1,000,000shares, issued and
      outstanding 11,560 shares, liquidationpreference $1,000
      per share in 2009 and 2008
            
            
            10,916
            
            
            10,786Common
      stock, $.01 par value; authorized 10,000,000shares, issued and
      outstanding 3,689,346 shares in2009 and 3,686,580
      shares in 2008
            
            
            37
            
            
            37Additional
      paid in capital
            
            
            12,252
            
            
            12,234Retained
      earnings
            
            
            13,791
            
            
            17,339Accumulated
      other comprehensive loss
            
            
            (17
            )
            
            (4
            )Total
      stockholders’ equity
            
            
            36,979
            
            
            40,392TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            509,819
            
            $
            492,397








See
accompanying notes to consolidated financial statements.





37


CECIL
BANCORP, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF (LOSS) INCOME


FOR THE
YEARS ENDED DECEMBER 31, 2009 AND 2008


(dollars
in thousands, except per share data)





2009
            
            2008INTEREST
      INCOME:Interest
      and fees on loans
            
            $
            30,082
            
            $
            28,951Interest
      on investment securities
            
            
            134
            
            
            249Dividends
      on FHLB and FRB stock
            
            
            43
            
            
            191Other
      interest-earning assets
            
            
            37
            
            
            60Total
      interest income
            
            
            30,296
            
            
            29,451INTEREST
      EXPENSE:Interest
      expense on deposits
            
            
            8,836
            
            
            10,311Interest
      expense on junior subordinated debentures
            
            
            1,121
            
            
            1,124Interest
      expense on advances from Federal Home Loan Bank of Atlanta
            
            
            2,470
            
            
            2,865Interest
      expense on fed funds purchased
            
            
            1
            
            
            13Total
      interest expense
            
            
            12,428
            
            
            14,313NET
      INTEREST INCOME
            
            
            17,868
            
            
            15,138PROVISION
      FOR LOAN LOSSES
            
            
            10,640
            
            
            3,405NET
      INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
            
            
            7,228
            
            
            11,733NONINTEREST
      INCOME:Deposit
      account fees
            
            
            664
            
            
            650ATM
      fees
            
            
            397
            
            
            377Commission
      income
            
            
            8
            
            
            55Gain
      on sale of other real estate owned
            
            
            277
            
            
            11Gain
      on sale of loans
            
            
            502
            
            
            173Loss
      on investments
            
            
            -
            
            
            (618
            )Income
      from bank owned life insurance
            
            
            84
            
            
            255Other
            
            
            237
            
            
            235Total
      noninterest income
            
            
            2,169
            
            
            1,138NONINTEREST
      EXPENSE:Salaries
      and employee benefits
            
            
            6,060
            
            
            6,143Occupancy
      expense
            
            
            704
            
            
            689Equipment
      and data processing expense
            
            
            1,294
            
            
            1,301Professional
      fees
            
            
            435
            
            
            174FDIC
      deposit insurance premium
            
            
            793
            
            
            304Goodwill
      impairment
            
            
            2,182
            
            
            -Other
            
            
            1,691
            
            
            1,404Total
      noninterest expense
            
            
            13,159
            
            
            10,015(LOSS)
      INCOME BEFORE INCOME TAXES
            
            
            (3,762
            )
            
            2,856INCOME
      TAX (BENEFIT) EXPENSE
            
            
            (1,282
            )
            
            1,005NET
      (LOSS) INCOME
            
            $
            (2,480
            )
            $
            1,851PREFERRED
      STOCK DIVIDENDS
            
            
            (791
            )
            
            -NET
      (LOSS) INCOME AVAILABLE TO COMMON STOCKHOLDERS
            
            $
            (3,271
            )
            $
            1,851(Loss)
      Earnings per common share - basic
            
            $
            (0.89
            )
            $
            0.50(Loss)
      Earnings per common share - diluted
            
            $
            (0.89
            )
            $
            0.49Dividends
      declared per common share
            
            $
            0.075
            
            $
            0.10





See
accompanying notes to consolidated financial statements.


38





CECIL
BANCORP, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


FOR THE
YEARS ENDED DECEMBER 31, 2009 AND 2008


(dollars
in thousands)








AccumulatedAdditional
            
            
            
            Other
            
            TotalPreferred
            
            Common
            
            Paid-In
            
            Retained
            
            Comprehensive
            
            Stockholders’Stock
            
            Stock
            
            Capital
            
            Earnings
            
            Income
      (Loss)
            
            EquityBALANCES
      AT JANUARY 1, 2008
            $
            —
            
            $
            37
            
            $
            11,441
            
            $
            15,856
            
            $
            (92
            )
            $
            27,242Comprehensive
      income:Net
      income
            
            —
            
            
            —
            
            
            —
            
            
            1,851
            
            
            —
            
            
            1,851Other
      comprehensive income, net oftax
      effects of $56 (unrealized losseson
      securities of $762, adjusted fora
      reclassification adjustment for lossesof
      $618)
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            88
            
            
            88Total
      comprehensive income
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1,939Cash
      dividends declared
            
            —
            
            
            —
            
            
            —
            
            
            (368
            )
            
            —
            
            
            (368
            )Stock
      purchased by dividendreinvestment
      plan
            
            —
            
            
            —
            
            
            32
            
            
            —
            
            
            —
            
            
            32Stock
      options exercised
            
            —
            
            
            —
            
            
            24
            
            
            —
            
            
            —
            
            
            24Sale
      of preferred stock, net of issuance
              costs
      of $37
            
            11,523
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            11,523Issuance
      of warrants for 261,538shares
      of common stock
            
            (737
            )
            
            —
            
            
            737
            
            
            —
            
            
            —
            
            
            —BALANCES
      AT DECEMBER 31, 2008
            
            10,786
            
            
            37
            
            
            12,234
            
            
            17,339
            
            
            (4
            )
            
            40,392Comprehensive
      loss:Net
      loss
            
            —
            
            
            —
            
            
            —
            
            
            (2,480
            )
            
            —
            
            
            (2,480
            )Other
      comprehensive loss, net oftax
      effects of $9 (unrealized losseson
      securities of $22)
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (13
            )
            
            (13
            )Total
      comprehensive loss
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (2,493
            )Common
      stock cash dividends declared
            
            —
            
            
            —
            
            
            —
            
            
            (277
            )
            
            —
            
            
            (277
            )Preferred
      stock cash dividends declared
            
            —
            
            
            —
            
            
            —
            
            
            (661
            )
            
            —
            
            
            (661
            )Stock
      purchased by dividendreinvestment
      plan
            
            —
            
            
            —
            
            
            17
            
            
            —
            
            
            —
            
            
            17Restricted
      stock awards
            
            —
            
            
            —
            
            
            1
            
            
            —
            
            
            —
            
            
            1Amortization
      of preferred stock discount
            
            130
            
            
            —
            
            
            —
            
            
            (130
            )
            
            —
            
            
            —BALANCES
      AT DECEMBER 31, 2009
            $
            10,916
            
            $
            37
            
            $
            12,252
            
            $
            13,791
            
            $
            (17
            )
            $
            36,979








See
accompanying notes to consolidated financial statements.


39





CECIL
BANCORP, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR THE
YEARS ENDED DECEMBER 31, 2009 AND 2008


(dollars
in thousands)








2009
            
            2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      (loss) income
            
            $
            (2,480
            )
            $
            1,851Adjustments
      to reconcile net income to net cashprovided by
      operating activities:Depreciation
      and amortization
            
            
            568
            
            
            524Provision
      for loan losses
            
            
            10,640
            
            
            3,405Goodwill
      impairment
            
            
            2,182
            
            
            -Gain
      on sale of loans
            
            
            (502
            )
            
            (173
            )Gain
      on sale of real estate owned
            
            
            (277
            )
            
            (11
            )Loss
      on investments
            
            
            -
            
            
            618Gain
      on disposal of premises and equipment
            
            
            -
            
            
            (3
            )Increase
      in cash surrender value of bank owned life insurance
            
            
            (84
            )
            
            (255
            )Deferred
      income taxes
            
            
            (4,515
            )
            
            (1,865
            )Excess
      servicing rights
            
            
            (184
            )
            
            (127
            )Reinvested
      dividends on investments
            
            
            -
            
            
            (27
            )Originations
      of loans held for sale
            
            
            (15,942
            )
            
            (9,302
            )Proceeds
      from sales of loans held for sale
            
            
            16,009
            
            
            9,383Net
      change in:Accrued
      interest receivable and other assets
            
            
            (1,781
            )
            
            1,474Other
      liabilities
            
            
            3,191
            
            
            1,009Net
      cash provided by operating activities
            
            
            6,825
            
            
            6,501CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of investment securities available-for-sale
            
            
            -
            
            
            (12,094
            )Purchase
      of investment securities held-to-maturity
            
            
            (5,150
            )
            
            (545
            )Proceeds
      from sales, maturities, calls and principal paymentsof
      investment securities available-for-sale
            
            
            10,010
            
            
            2,430Proceeds
      from maturities, calls and principal paymentsof
      investment securities held-to-maturity
            
            
            752
            
            
            3,000Net
      (purchase) redemption of stock in Federal Home Loan Bank
            
            
            (479
            )
            
            832Net
      increase in loans
            
            
            (37,951
            )
            
            (51,965
            )Proceeds
      from sale of real estate owned
            
            
            3,649
            
            
            320Proceeds
      from sale of premises and equipment
            
            
            -
            
            
            5Purchase
      of bank owned life insurance
            
            
            -
            
            
            (779
            )Surrender
      of bank owned life insurance
            
            
            -
            
            
            779Purchases
      of premises and equipment - net
            
            
            (335
            )
            
            (592
            )Net
      cash used by investing activities
            
            
            (29,504
            )
            
            (58,609
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      increase in deposits
            
            
            17,787
            
            
            97,519Net
      decrease in advances from Federal Home Loan Bank:Short-term
            
            
            -
            
            
            (20,570
            )Long-term
            
            
            (143
            )
            
            (143
            )Proceeds
      from issuance of preferred stock, net of issuance costs
            
            
            -
            
            
            11,523Proceeds
      from issuance of common stock
            
            
            17
            
            
            56Payments
      of cash dividends
            
            
            (938
            )
            
            (368
            )Net
      cash provided by financing activities
            
            
            16,723
            
            
            88,017





40


CECIL
BANCORP, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS (CONTINUED)


FOR THE
YEARS ENDED DECEMBER 31, 2009 AND 2008


(dollars
in thousands)





2009
            
            2008(Decrease)
      increase in cash and cash equivalents
            
            $
            (5,956
            )
            $
            35,909Cash
      and cash equivalents at beginning of year
            
            
            41,420
            
            
            5,511Cash
      and cash equivalents at end of year
            
            $
            35,464
            
            $
            41,420Supplemental
      disclosure of cash flows information:Cash
      paid for income taxes
            
            $
            1,540
            
            $
            3,125Cash
      paid for interest
            
            $
            12,675
            
            $
            14,101Supplemental
      disclosure of noncash investing and financing activities:Transfer
      of loans receivable to other real estate owned
            
            $
            5,449
            
            $
            2,496Interest
      capitalized during the period
            
            $
            0
            
            $
            69Sale
      of other real estate owned:Carrying
      value
            
            $
            3,372
            
            $
            309Gain
      on sale
            
            
            277
            
            
            11Cash
      received from sale
            
            $
            3,649
            
            $
            320

















See
accompanying notes to consolidated financial statements.


41


CECIL
BANCORP, INC. AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


FOR THE
YEARS ENDED DECEMBER 31, 2009 AND 2008





1.           SIGNIFICANT
ACCOUNTING POLICIES





The
accounting and reporting policies of Cecil Bancorp, Inc. (the “Company”) and its
wholly-owned subsidiaries, Cecil Properties, Inc., 1223 Turkey Point Road, LLC,
and Cecil Bank (the “Bank”), together with its subsidiaries, Cecil Financial
Services Corporation, Cecil Service Corporation, and 3106 Emmorton Road, LLC,
conform to accounting principles generally accepted in the United States of
America.





Certain
reclassifications have been made to amounts previously reported to conform to
the classifications made in 2009. The Company has evaluated subsequent events
for potential recognition and/or disclosure through the date the consolidated
financial statements included in this Form 10-K were issued.  The
following is a summary of the more significant accounting policies:





Nature of
Operations





Through
its subsidiary bank, the Company conducts full-service commercial banking.
Services to individuals and businesses include accepting deposits, and extending
real estate, consumer and commercial loans and lines of credit. The Company
primarily operates in the two Maryland counties of Cecil and Harford, and has a
concentration in loans secured by residential and commercial real estate in
these counties.





Policy for
Consolidation





The
consolidated financial statements include the accounts of the Company and its
subsidiaries. Consolidation has resulted in the elimination of all significant
intercompany balances and transactions. The financial statements of the Company
(parent only) include its investment in its subsidiaries under the equity method
of accounting.





Use of
Estimates





The
preparation of the financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and 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 credit losses and
other-than-temporary impairment of investment securities.




Cash and Cash
Equivalents






For
purposes of the consolidated statements of cash flows, highly liquid investments
with original maturities of three months or less are classified as cash and cash
equivalents. Assets categorized in the balance sheet as cash and due from banks
and interest bearing deposits with banks are considered cash and cash
equivalents. Interest bearing deposits with banks generally exceed balances that
are recoverable under FDIC insurance.




42


Investment
Securities





Securities
that the Company has the positive intent and ability to hold to maturity are
classified as held-to-maturity and recorded at amortized cost. Securities are
classified as trading securities if bought and held principally for the purpose
of selling them in the near-term. Trading securities are reported at estimated
fair value, with unrealized gains and losses included in earnings. Securities
not classified as held-to-maturity or trading securities are considered
available-for-sale and are reported at estimated fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component of
stockholders’ equity, net of tax effects, in accumulated other comprehensive
income. The Company designates securities into one of the three categories at
the time of purchase.





Premiums
and discounts on investments are recognized in interest income over the terms of
the securities using methods that approximate the interest method. Declines in
the fair value of held-to-maturity and available-for-sale securities below their
cost that are deemed to be other than temporary are reflected in earnings as
realized losses. In estimating other-than-temporary impairment losses,
management considers (1) the duration and magnitude of the decline in value, (2)
the financial condition of the issuer, and (3) the structure of the security. An
impairment loss is recognized in earnings only when (1) the Company intends to
sell the security, (2) it is more likely than not that the Company will be
required to sell the security before recovery of its amortized cost basis, or
(3) the Company does not expect to recover the entire amortized cost basis of
the investment.  In situations where the Company intends to sell or
when it is more likely than not that we will be required to sell the security,
the entire impairment loss must be recognized in earnings.  In all
other situations, only the portion of the impairment loss representing the
credit loss must be recognized in earnings, with the remaining portion being
recognized in stockholders’ equity as a component of other comprehensive income,
net of deferred taxes.  Gains and losses on the sale of securities are
recorded on the trade date and are determined using the specific identification
method.





Restricted Investment
Securities





Restricted
investment securities consist of Federal Reserve Bank of Richmond (“FRB”) and
Federal Home Loan Bank of Atlanta (“FHLB”) stock which are required by law and
are restricted as to marketability. Because the investment securities are not
marketable, they are reported at cost. The FRB and FHLB perform ongoing reviews
of the Company’s stock level to be sure it meets the minimum requirements. The
FRB requires a minimum stock balance based on the balance of the Bank’s common
stock and surplus. The FHLB required stock balance is based on total assets as
of December 31 of the previous year and total FHLB advances currently
outstanding. As of December 31, 2009 and 2008, the Company met all stock
ownership requirements set forth by the FRB and FHLB.





Loans
Receivable





Loans are
stated at their principal balance outstanding net of any deferred fees and
costs. Interest income on loans is accrued at the contractual rate based on the
principal outstanding. The Company places loans, except for consumer loans, on
nonaccrual when any portion of the principal or interest is ninety days past due
and collateral is insufficient to discharge the debt in full. Interest accrual
may also be discontinued earlier if, in management’s opinion, collection is
unlikely. Generally, consumer installment loans are not placed on nonaccrual,
but are charged off when they are three months past due.





Loans are
considered impaired when, based on current information, it is probable that the
Company will not collect all principal and interest payments according to
contractual terms. Generally, loans are considered impaired once principal or
interest payments become ninety days or more past due and they are placed on
nonaccrual. Management also considers the financial condition of the
borrower,


43


cash
flows of the loan and the value of the related collateral. Impaired loans do not
include large groups of smaller balance homogeneous credits such as residential
real estate and consumer installment loans, which are evaluated collectively for
impairment. Loans specifically reviewed for impairment are not considered
impaired during periods of “minimal delay” in payment (ninety days or less)
provided eventual collection of all amounts due is expected. The impairment of a
loan is measured based on the present value of expected future cash flows
discounted at the loan’s effective interest rate, or the fair value of the
collateral if repayment is expected to be provided by the collateral. Generally,
the Company’s impairment on such loans is measured by reference to the fair
value of the collateral. Interest income generally is not recognized on specific
impaired loans unless the likelihood of further loss is remote. Interest
payments received on such loans are applied as a reduction of the loan principal
balance. Interest income on other nonaccrual loans is recognized only to the
extent of interest payments received.





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. The Company had no loans held for sale as of December 31, 2009 and
2008.





Allowance for Loan
Losses





The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance.





The
allowance for loan losses is evaluated on a regular basis by management and is
based upon management’s periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower’s ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes
available.





The
allowance consists of specific, general and unallocated components. The
components of the allowance for loan losses represent an estimation done
pursuant to either ASC Topic 450 “Contingencies,” or ASC Topic 310
“Receivables.”  The specific component relates to loans that are
classified as either doubtful, substandard or special mention. For such loans
that are also classified as impaired, an allowance is established when the
discounted cash flows (or collateral value or observable market price) of the
impaired loan is lower than the carrying value of that loan. The general
component covers non-classified loans and is based on historical loss experience
adjusted for qualitative factors. The unallocated component is based upon
management’s evaluation of various conditions that are not directly measured in
the determination of the specific and general components. These conditions may
include the nature and volume of the loan portfolio, overall portfolio quality,
and current economic conditions that may affect the borrowers’ ability to repay
the loan.





Premises and
Equipment





Premises
and equipment are stated at cost less accumulated depreciation and amortization.
Premises and equipment, including costs related to developing or obtaining
software for internal use, are depreciated on a straight-line basis over their
useful lives, which range from three to seven years for furniture, fixtures and
equipment to forty years for buildings and building improvements. Leasehold
improvements are amortized over the shorter of their estimated useful economic
lives or the lives of the


44


leases.
Maintenance and repairs are charged to expense as incurred, while improvements
which extend the useful life are capitalized and depreciated over the remaining
life. Interest costs on the original purchase, significant repairs, and
construction expenditures relating to bank premises are capitalized at the
Bank’s average cost of funds and depreciated over the life of the
building.






Other Real Estate
Owned





Other
real estate owned comprises properties acquired in partial or total satisfaction
of problem loans. The properties are recorded at the lower of cost or fair value
at the date acquired. Losses arising at the time of acquisition of such
properties are charged against the allowance for loan losses. Subsequent
write-downs that may be required are added to a valuation reserve. Gains and
losses realized from sales, as well as valuation adjustments, are included in
noninterest income. Expenses of operation are included in noninterest
expense.





Goodwill





Goodwill
represents the excess of the cost of assets acquired in business combinations
accounted for under the purchase method over the fair value of the net assets at
dates of acquisition and is tested annually for impairment.





Mortgage Servicing
Rights





The cost
of mortgage servicing rights is amortized in proportion to, and over the period
of, estimated net servicing revenue. Impairment of mortgage servicing rights is
assessed based on the fair value of those rights. Fair values are estimated
using discounted cash flows based on a current market interest rate. The amount
of impairment recognized is the amount by which the capitalized mortgage
servicing rights exceed their fair value.





When
participating interests in loans sold have an average contractual interest rate,
adjusted for normal servicing fees, that differs from the agreed yield to the
purchaser, gains or losses are recognized equal to the present value of such
differential over the estimated remaining life of such loans. The resulting
“excess servicing receivable” or “deferred servicing revenue” is amortized over
the estimated life using a method approximating the interest
method.





Quoted
market prices are not available for the excess servicing receivables. Thus, the
excess servicing receivables and the amortization thereon are periodically
evaluated in relation to estimated future servicing revenue, taking into
consideration changes in interest rates, current repayment rates, and expected
future cash flows. The Company evaluates the carrying value of the excess
servicing receivables by estimating the future servicing income of the excess
servicing receivables based on management’s best estimate of remaining loan
lives discounted at the original discount rate.





Bank Owned Life
Insurance





The Bank
is the beneficiary of insurance policies on the lives of officers of the Bank.
The Bank has recognized the amount that could be realized under the insurance
policies as an asset in the consolidated balance sheets. Appreciation in the
value of the insurance policies is classified as noninterest
income.





45


Income
Taxes


Income
tax expense is based on the results of operations, adjusted for permanent
differences between items of income or expense reported in the financial
statements and those reported for tax purposes. Under the liability method,
deferred income taxes are determined based on the differences between the
financial statement carrying amounts and the income tax bases of assets and
liabilities and are measured at the enacted tax rates that will be in effect
when these differences reverse. We recognize interest and penalties related to
income tax matters in other noninterest expense.





Advertising





Advertising
costs are expensed as incurred. Advertising expense was $141,000 and $148,000
for the years ended December 31, 2009 and 2008, respectively.





Earnings Per
Share





Basic
earnings per share (EPS) are calculated by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted earnings per share are calculated by adjusting the
denominator of the basic earnings per share computation for the effects of all
dilutive potential common shares outstanding during the period. The dilutive
effects of options, warrants, and their equivalents are computed using the
treasury stock method.





Stock-Based
Compensation





We
account for stock-based compensation under the provisions of FASB ASC Topic 718,
Compensation-Stock
Compensation, which requires the recognition of the cost of employee
services received in exchange for an award of equity instruments in the
financial statements and is measured based on the grant date fair value of the
award.  ASC 718 also requires the stock option compensation expense to
be recognized over the period during which an employee is required to provide
service in exchange for the award (the vesting period).





There
were no options granted or vested during the two years ended December 31, 2009.
In November 2009, the Committee approved the granting of 60,125 restricted stock
awards (“Awards”) with a fair market value of $4.00 per share.





Comprehensive
Income





The
Company reports comprehensive income which includes net income, as well as other
changes in stockholders’ equity that result from transactions and economic
events other than those with stockholders. The Company’s only significant
element of comprehensive income is unrealized gains and losses on
available-for-sale securities.





Transfers of Financial
Assets





The
Company accounts for transfers and servicing of financial assets in accordance
with ASC Topic 860, Transfers
and Servicing. Transfers of financial assets are accounted for as sales
only when control over the assets has been surrendered. Control over transferred
assets is deemed to be surrendered when (1) the assets have been isolated from
the Company, (2) the transferee obtains the right (free of conditions that
constrain it from taking advantage of that right) to pledge or exchange the
transferred assets, and (3) the Company does not maintain effective control over
the transferred assets through an agreement to repurchase them before their
maturity.


46


Segment
Reporting





SFAS 131,
Disclosures about Segments of
an Enterprise and Related Information, requires that an enterprise report
selected information about operating segments in its financial reports issued to
its shareholders. Based on the analysis performed by the Company, management has
determined that the Company only has one operating segment, which is commercial
banking. The chief operating decision-makers use consolidated results to make
operating and strategic decisions, and therefore, are not required to disclose
any additional segment information.





2.           RECENT
ACCOUNTING PRONOUNCEMENTS





In April
2009, the Financial Accounting Standards Board (“FASB”) issued Financial
Statement of Position FAS 115-2 and FAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments” (“FSP FAS 115-2/124-2”), now included
in the Codification as part of FASB ASC 320-10-35. FASB has issued the staff
positions to address concerns regarding (1) determining whether a market is not
active and a transaction is not orderly, (2) recognition and presentation of
other-than-temporary impairments and (3) interim disclosures of fair values of
financial instruments. The staff positions will be effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009. The Company adopted the staff positions
effective for the period ending June 30, 2009, but that adoption did not result
in a material effect on consolidated results of operations.





In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair
Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”), now
included in the Codification as part of FASB ASC 270-10-05. This standard
requires disclosures about fair value of financial instruments in interim and
annual financial statements. The Company adopted this standard effective for the
quarter ending June 30, 2009, but the adoption did not result in a material
effect consolidated financial position or results of operations.





In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS
165”), now included in the Codification as part of FASB ASC 855-10-55. This
standard is intended to establish general standards of accounting for and
disclosures of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. It requires the
disclosure of the date through which an entity has evaluated subsequent events
and the basis for selecting that date, that is, whether that date represents the
date the financial statements were issued or were available to be issued. This
standard is effective for interim or annual financial periods ending after June
15, 2009.





In
June 2009, the FASB issued SFAS No. 166 (not incorporated into the
Codification yet), a revision to SFAS No. 140, “Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities,”and
will require more information about transferred of financial assets and where
companies have continuing exposure to the risks related to transferred financial
assets. SFAS 166 is effective at the start of a company’s first fiscal year
beginning after November 15, 2009, or January 1, 2010 for companies reporting
earnings on a calendar-year basis.





In June
2009, the FASB issued SFAS No. 167 (not incorporated into the Codification yet),
a revision to FASB Interpretation No. 46(R), “Consolidation of Variable Interest
Entities,” and will change how a company determines when an entity that
is insufficiently capitalized or is not controlled through voting (or similar
rights) should be consolidated. Under SFAS No. 167, determining whether a
company is required to consolidate an entity will be based on, among other
things, an entity’s purpose and design and a company’s ability to direct the
activities of the entity that most significantly impact the entity’s economic
performance. SFAS 167 is effective at the start of a company’s first fiscal
year


47


beginning
after November 15, 2009, or January 1, 2010 for companies reporting earnings on
a calendar-year basis.





In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles—a
replacement of FASB Statement No. 162.”The change initiated
by this Statement is now included in the Codification as FASB ASC 105-10-10and establishes the
Financial Accounting Standards
Board (FASB) Accounting Standards Codificationas the source of
authoritative principles and standards recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
conformity with generally accepted accounting principles (GAAP). Rules and interpretive
releases of the Securities and Exchange Commission (SEC) under authority of
federal securities laws are also sources of authoritative GAAP for SEC
registrants. On the effective date of this standard, the Codification superseded
all then-existing non-SEC accounting and reporting standards. All other
non-grandfathered non-SEC accounting literature not included in the Codification
became non-authoritative. This standard is effective for financial statements
issued for interim and annual periods ending after September 15, 2009. In
the FASB’s view, the Codification does not change GAAP, except for those
nonpublic nongovernmental entities that must apply the American Institute of
Certified Public Accountants Technical Inquiry Service Section 5100,
“Revenue Recognition,” paragraphs 38–76, now included as part of FASB ASC Topic
985. The Company adopted FASB ASC Topic 105-10-10 effective for the quarter
ending September 30, 2009. The adoption did not have an impact on the Company’s
financial position or results of operations.







3.           INVESTMENT
SECURITIES





Investment
securities have been classified in the consolidated balance sheets according to
management’s intent and ability to hold the investment.





Investment
securities at December 31, 2009 and 2008 are summarized in the following table
(in thousands).





2009Gross
              
              Gross
              
              EstimatedAmortized
              
              Unrealized
              
              Unrealized
              
              FairCost
              
              Gains
              
              Losses
              
              ValueAvailable-for-saleMutual
      funds - mortgage securities
              $
              747
              
              $
              —
              
              $
              28
              
              $
              719Mutual
      funds - U.S. Government securities
              
              686
              
              
              1
              
              
              —
              
              
              687Equity
      securities
              
              226
              
              
              3
              
              
              —
              
              
              229Mortgage-backed
      securities
              
              83
              
              
              —
              
              
              4
              
              
              79$
              1,742
              
              $
              4
              
              $
              32
              
              $
              1,714Held-to-Maturity:Other
              $
              50
              
              $
              —
              
              
              —
              
              $
              50Mortgage-backed
      securities
              
              4,149
              
              
              2
              
              
              74
              
              
              4,077U.
      S. Treasury securities and obligations
              
              500
              
              
              —
              
              
              —
              
              
              500$
              4,699
              
              $
              2
              
              $
              74
              
              $
              4,627
   48


2008Gross
              
              Gross
              
              EstimatedAmortized
              
              Unrealized
              
              Unrealized
              
              FairCost
              
              Gains
              
              Losses
              
              ValueAvailable-for-saleMutual
      funds - mortgage securities
              $
              747
              
              $
              —
              
              $
              —
              
              $
              747Mutual
      funds - U.S. Government securities
              
              686
              
              
              —
              
              
              —
              
              
              686Equity
      securities
              
              226
              
              
              —
              
              
              33
              
              
              193FNMA
      discount note
              
              9,966
              
              
              33
              
              
              —
              
              
              9,999Mortgage-backed
      securities
              
              93
              
              
              —
              
              
              6
              
              
              87$
              11,718
              
              $
              33
              
              $
              39
              
              $
              11,712Held-to-Maturity:Other
              $
              50
              
              $
              —
              
              $
              —
              
              $
              50U.
      S. Treasury securities and obligations
              
              250
              
              
              —
              
              
              —
              
              
              250$
              300
              
              $
              —
              
              $
              —
              
              $
              300





At
December 31, 2009 and 2008, investment securities with a carrying value of
$500,000 and $250,000, respectively, were pledged to secure deposits of
municipalities. At December 31, 2009, investment securities with a carrying
value of $974,000 were pledged to secure advances from the Federal Home Loan
Bank of Atlanta and investment securities with a carrying value of $3.2 million
were pledged to the Federal Reserve Bank of Richmond.





The tax
effect of the net unrealized holding gains or losses of available-for-sale
securities is included as a component of the net deferred tax asset and the
remaining portion of the holding gain or loss is included as a component of
accumulated other comprehensive income. At December 31, 2009, a deferred tax
asset of $11,000 and accumulated other comprehensive loss of $17,000 relate to
the unrealized holding loss on available-for-sale securities. At December 31,
2008, a deferred tax asset of $2,000 and accumulated other comprehensive loss of
$4,000 relate to the unrealized holding loss on available-for-sale
securities.





The U. S.
Treasury securities and obligations of the U.S. Government and Federal
agencies at December 31, 2009, by contractual maturities, are due within one
year. At December 31, 2009, by contractual maturities, $4.0 million of mortgage
backed securities mature between one and five years, $175,000 matures between
five and ten years, and $79,000 matures after ten years.  Expected
maturities may differ from contractual maturities because borrowers may have the
right to prepay obligations with or without prepayment penalties.





As of
December 31, 2009, unrealized losses (in thousands) on securities were comprised
of the following based on the length of time that the securities have been in a
continuous loss position:








Less
      than 12 Months
            
            More
      than 12 Months
            
            TotalFair
            
            Unrealized
            
            Fair
            
            Unrealized
            
            Fair
            
            UnrealizedValue
            
            Losses
            
            Value
            
            Losses
            
            Value
            
            LossesAvailable-for-Sale:Mutual
      funds – mortgage securities
            
            $
            719
            
            $
            28
            
            $
            —
            
            $
            —
            
            $
            719
            
            $
            28Mortgage-backed
      securities
            
            
            —
            
            
            —
            
            
            79
            
            
            4
            
            
            79
            
            
            4$
            719
            
            $
            28
            
            $
            79
            
            $
            4
            
            $
            798
            
            $
            32





49


Management has the intent
to hold the securities classified as held to maturity in the table above until
they mature, at which time the Company will receive full value for the
securities.  Furthermore, as of December 31, 2009, management does not
have the intent to sell any of the securities classified as available for sale
in the table above and believes that it is more likely than not that the Company
will not have to sell any such securities before a recovery of
cost.  Management does not believe any of the securities are impaired
due to reasons of credit quality.  Accordingly, as of December 31,
2009, management believes the impairments detailed in the table above are
temporary and no impairment loss has been realized in the Company’s consolidated
income statement.





The
Company did not sell any securities or recognize any other than temporary
impairment losses during the year ended December 31, 2009. The Company sold
mutual funds with an amortized cost of $375,000 for $250,000, thereby recording
a realized loss of $125,000 during the year ended December 31, 2008. The Company
also recorded an other than temporary impairment loss of $493,000 on its
investments in mutual funds and equity securities during the year ended December
31, 2008.





4.           LOANS
AND ALLOWANCE FOR LOAN LOSSES





The
Company’s lending activities are predominantly conducted in Cecil and Harford
Counties in the State of Maryland. A summary of loans (in thousands)
follows:





2009
            
            2008Real
      estate loans:1 -
      4 dwelling units and home equity
            
            $
            130,594
            
            $
            130,3115
      or more
            
            
            7,475
            
            
            6,852Nonresidential
            
            
            174,864
            
            
            143,126Land
            
            
            4,584
            
            
            4,687Construction
            
            
            105,616
            
            
            118,571423,133
            
            
            403,547Commercial
      loans
            
            
            19,511
            
            
            15,995Consumer
      loans
            
            
            4,128
            
            
            4,415Gross
      loans
            
            
            446,772
            
            
            423,957Less:Undisbursed
      proceeds on loans in process
            
            
            (7,803
            )
            
            (15,164
            )Deferred
      loan fees and costs
            
            
            (571
            )
            
            (730
            )Loans
      receivable
            
            $
            438,398
            
            $
            408,063





In the
normal course of banking business, loans are made to officers and directors and
their affiliated interests. These loans are made on substantially the same terms
and conditions as those prevailing at the time for comparable transactions with
outsiders and are not considered to involve more then the normal risk of
collectibility. As of December 31, activity in such loans outstanding, both
direct and indirect (including guarantees), to directors, their associates and
policy-making officers were as follows (in thousands):





2009
            
            2008Balance
      at beginning of year
            
            $
            16,162
            
            $
            18,009New
      loans and additional borrowings
            
            
            1,133
            
            
            727Repayments
            
            
            (488
            )
            
            (2,574
            )Balance
      at end of year
            
            $
            16,807
            
            $
            16,162





50


An analysis of the allowance
for loan losses for the years ended December 31, 2009 and 2008 is as follows (in
thousands):








2009
            
            2008Balance
      at beginning of period
            
            $
            6,314
            
            $
            3,109Provision
      charged to operations
            
            
            10,640
            
            
            3,405Charge-offs
            
            
            (3,228
            )
            
            (328
            )Recoveries
            
            
            625
            
            
            128Balance
      at end of period
            
            $
            14,351
            
            $
            6,314





Management
reviews and identifies loans and investments that require designation as
nonperforming assets. Nonperforming assets include loans accounted for on a
non-accrual basis, loans past due by 90 days or more but still accruing,
restructured loans, and other real estate owned. Information (in thousands) with
respect to nonperforming assets at December 31, 2009 and 2008 is as
follows:





2009
            
            2008Non-accrual
      loans
            
            $
            32,694
            
            $
            10,459Restructured
      loans
            
            
            11,959
            
            
            —Loans
      90 days or more past due and still accruing
            
            
            —
            
            
            —Total
      nonperforming loans
            
            
            44,653
            
            
            10,459Other
      real estate owned, net
            
            
            4,594
            
            
            2,843Total
      nonperforming assets
            
            $
            49,247
            
            $
            13,302





Impaired
loans include nonperforming loans and other loans that management has identified
where it is probable that all amounts due will not be collected in accordance
with the contractual terms of the loan. Loans that are returned to accrual
status are no longer considered to be impaired.





Information
with respect to impaired loans at December 31, 2009 and 2008 and for the years
then ended is as follows (in thousands):





2009
            
            2008Impaired
      loans with a valuation allowance
            
            $
            11,159
            
            $
            3,855Impaired
      loans without a valuation allowance
            
            
            21,535
            
            
            6,604Total
      impaired loans
            
            $
            32,694
            
            $
            10,459Allowance
      for loan losses related to impaired loans
            
            $
            5,864
            
            $
            2,434Allowance
      for loan losses related to other thanimpaired
      loans
            
            
            8,487
            
            
            3,880Total
      allowance for loan losses
            
            $
            14,351
            
            $
            6,314Average
      impaired loans for the year
            
            $
            24,416
            
            $
            7,671Interest
      income on impaired loansrecognized
      on the cash basis
            
            $
            1,237
            
            $
            380





51


5. 
           SERVICING





At
December 31, 2009 and 2008, the Bank was servicing loans for others amounting to
approximately $38.3 million and $30.0 million, respectively. Servicing loans for
others generally consists of collecting mortgage payments, maintaining escrow
accounts, disbursing payments to investors and foreclosure processing. Loan
servicing income is recorded upon receipt and includes servicing fees from
investors and certain charges collected from borrowers, such as late payment
fees. Mortgage servicing rights had a carrying value of $407,000 and $329,000 as
of December 31, 2009 and 2008, respectively. Estimated fair value of the
servicing rights approximates carrying value. Amortization expense of servicing
rights was $106,000 and $38,000 for the years ended December 31, 2009 and 2008,
respectively.





The
following table summarizes the activity pertaining to mortgage servicing rights
(in thousands):





2009
            
            2008Balance
      at beginning of period
            
            $
            329
            
            $
            240Mortgage
      servicing rights capitalized
            
            
            184
            
            
            127Mortgage
      servicing rights amortized
            
            
            (106
            )
            
            (38
            )Balance
      at end of period
            
            $
            407
            
            $
            329





6.           PREMISES
AND EQUIPMENT





Premises and equipment are summarized
by major classifications as follows (in thousands):





2009
            
            2008Land
            
            $
            3,036
            
            $
            3,036Buildings
      and improvements
            
            
            9,478
            
            
            9,336Furniture,
      fixtures and equipment
            
            
            2,618
            
            
            2,436Leasehold
      improvements
            
            
            462
            
            
            45015,594
            
            
            15,258Less:
      accumulated depreciation
            
            
            3,684
            
            
            3,187$
            11,910
            
            $
            12,071





Depreciation
expense for the years ended December 31, 2009 and 2008 was $497,000 and
$516,000, respectively.





The Bank
leases three of its branch facilities, two automated teller machine facilities,
and one operations building under operating lease agreements which provide for
the payment of utilities and taxes by the lessee. Future minimum payments (in
thousands) for each of the five succeeding years under noncancelable leases
consisted of the following at December 31, 2009:





Year ending
      December 31:2010
            
            $
            1062011
            
            
            932012
            
            
            952013
            
            
            452014
            
            
            29Thereafter
            
            
            22





52


Rent
expense was $145,000 and $144,000 for the years ended December 31, 2009 and
2008, respectively.





7.           GOODWILL





Goodwill
represents the excess of the cost of assets acquired in business combinations
accounted for under the purchase method of accounting over the fair value of the
net assets acquired at the dates of acquisition. As of December 31, 2009, we
determined that goodwill was impaired and therefore recorded an impairment loss
of $2.2 million.  A schedule of goodwill (in thousands) at December 31
is as follows:





2009
              
              2008Gross
      Carrying Amount
              $
              2,816
              
              $
              2,816Accumulated
      Amortization
              
              2,816
              
              
              634Net
      Carrying
      Amount
              $
              0
              
              $
              2,182





8.           DEPOSITS





The
following is a summary of deposits (dollars in thousands) as of December
31:





2009
            
            2008Weighted
            
            
            
            WeightedAverage
            
            
            
            AverageAmount
            
            Rate
            
            Amount
            
            RateNOW
      and Money Market accounts
            
            $
            42,023
            
            1.76%
            
            $
            33,456
            
            2.27%Savings
      accounts
            
            
            20,773
            
            0.59
            
            
            19,978
            
            0.76Term
      certificates
            
            
            294,817
            
            2.79
            
            
            291,608
            
            3.71Checking
      accounts
            
            
            24,725
            
            0.00
            
            
            19,510
            
            0.00$
            382,338
            
            
            
            $
            364,551








A summary
of certificate accounts (dollars in thousands) by maturity as of December 31,
2009 follows:





Three
      months or less
            
            $
            76,804Three
      months to twelve months
            
            
            190,446Twelve
      months to twenty-four months
            
            
            19,196Twenty-four
      months to thirty-six months
            
            
            3,454Thirty-six
      months to forty-eight months
            
            
            2,898Forty-eight
      months to sixty months
            
            
            2,019$
            294,817





During
the fourth quarter of 2008, the Federal Deposit Insurance Corporation
temporarily increased its insurance coverage through December 31, 2009 from
$100,000 to $250,000 for eligible deposits. The Bank is also participating in
the FDIC’s temporary program to insure noninterest bearing transaction accounts,
regardless of the balance.





Term
certificates include certificates of deposit in denominations of $100,000 or
more aggregating approximately $145,435,000 and $93,328,000 as of December 31,
2009 and 2008, respectively.


53


Officers’ and directors’
deposit accounts amounted to approximately $1,247,000 and $2,338,000 at December
31, 2009 and 2008, respectively.





As of
December 31, 2009 and 2008, $251,000 and $49,000, respectively, in overdrawn
demand deposit accounts was reclassified as loans receivable on the consolidated
balance sheet.





9.           ADVANCES
FROM FEDERAL HOME LOAN BANK OF ATLANTA (“FHLB”)





At
December 31, advances from the FHLB consisted of the following (dollars in
thousands):





2009
            
            2008Maturity
            
            
            
            
            
            
            
            
            MaturityAmount
            
            Date
            
            Rate
            
            Type
            
            Amount
            
            Date
            
            Rate
            
            Type$
            143
            
            2010
            
            3.930
            
            Fixed
            
            $
            286
            
            2010
            
            3.930
            
            Fixed10,000
            
            2012
            
            5.060
            
            Fixed
            
            
            10,000
            
            2012
            
            5.060
            
            Fixed7,500
            
            2017
            
            3.776
            
            Fixed
            
            
            7,500
            
            2017
            
            3.776
            
            Fixed7,500
            
            2017
            
            3.690
            
            Fixed
            
            
            7,500
            
            2017
            
            3.690
            
            Fixed11,000
            
            2017
            
            3.588
            
            Fixed
            
            
            11,000
            
            2017
            
            3.588
            
            Fixed9,500
            
            2017
            
            3.875
            
            Fixed
            
            
            9,500
            
            2017
            
            3.875
            
            Fixed15,000
            
            2017
            
            3.448
            
            Fixed
            
            
            15,000
            
            2017
            
            3.448
            
            Fixed3,000
            
            2017
            
            2.955
            
            Fixed
            
            
            3,000
            
            2017
            
            2.955
            
            Fixed$
            63,643
            
            
            
            
            
            
            
            $
            63,786





The Bank
has lines of credit with the FHLB with a total maximum available balance of
$64,186,000. As of December 31, 2009, $543,000 was available to be drawn against
the lines of credit.





Wholly
owned first mortgage loans on 1 - 4 family and multifamily dwelling units,
commercial real estate loans, and second mortgages and home equity lines of
credit with unpaid principal balances of approximately $109,598,000 were pledged
to the FHLB as collateral on advances as of December 31, 2009. Investment
securities with a carrying value of $974,000 and interest bearing deposits with
banks totaling $4,169,000 were also pledged to the FHLB as collateral on
advances as of December 31, 2009.





The Bank
has an unsecured line of credit with the Community Bankers Bank with a total
maximum available balance of $5,000,000. As of December 31, 2009 the maximum
balance was available to be drawn against the line of credit.





10.           JUNIOR
SUBORDINATED DEBENTURES





In March
2006, the Company formed a wholly-owned subsidiary, Cecil Bancorp Capital Trust
I (the “Trust”). On March 23, 2006, the Trust sold $10.0 million of trust
preferred securities in a private placement. The Trust used the proceeds plus
the proceeds from the sale of common securities to the Company to purchase $10.3
million of the Company’s 30-year junior subordinated debentures. The trust
preferred securities and the junior subordinated debentures bear interest at a
fixed rate of 6.51% for five years and then at a variable rate, which resets
quarterly, of 3-month LIBOR plus 1.38%. Interest is cumulative and payable
quarterly in arrears. The trust preferred securities and the junior subordinated
debentures mature March 23, 2036 and are callable at par after five years. The
trust preferred securities, classified on the balance sheet as “junior
subordinated debentures”, qualify as Tier 1 capital for regulatory purposes,
subject to applicable limits. The Company used the proceeds to increase the
regulatory capital of the Bank and for other corporate
purposes.


54


In November 2006, the
Company formed a wholly-owned subsidiary, Cecil Bancorp Capital Trust II (the
“Trust”). On November 30, 2006, the Trust sold $7.0 million of trust preferred
securities in a private placement. The Trust used the proceeds plus the proceeds
from the sale of common securities to the Company to purchase $7.2 million of
the Company’s 30-year junior subordinated debentures. The trust preferred
securities and the junior subordinated debentures bear interest at a fixed rate
of 6.58% for five years and then at a variable rate, which resets quarterly, of
3-month LIBOR plus 1.68%. Interest is cumulative and payable quarterly in
arrears. The trust preferred securities and the junior subordinated debentures
mature March 6, 2037 and are callable at par after five years. The trust
preferred securities, classified on the balance sheet as “junior subordinated
debentures”, qualify as Tier 1 capital for regulatory purposes, subject to
applicable limits. The Company used the proceeds to increase the regulatory
capital of the Bank and for other corporate purposes.





See note
20 to the consolidated financial statements for additional discussion regarding
the payment of interest on these junior subordinated debentures.





11.           INCOME
TAXES





Income
tax (benefit) expense (in thousands) for the years ended December 31 consists
of:





2009
            
            2008Current
      income taxes:Federal
            
            $
            2,559
            
            $
            2,275State
            
            
            674
            
            
            5953,233
            
            
            2,870Deferred
      income taxes:Federal
            
            
            (3,596
            )
            
            (1,477
            )State
            
            
            (919
            )
            
            (388
            )(4,515
            )
            
            (1,865
            )Total
      income tax (benefit) expense
            
            $
            (1,282
            )
            $
            1,005





The tax
effects (in thousands) of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31
are presented below:





2009
            
            2008Deferred
      tax assets:Deferred
      loan origination fees
            
            $
            226
            
            $
            288Loan
      loss allowance
            
            
            5,661
            
            
            2,491Deferred
      compensation
            
            
            2,252
            
            
            1,853Net
      unrealized loss on available-for-sale securities
            
            
            11
            
            
            2State
      net operating loss carry-forwards
            
            
            103
            
            
            97Other
            
            
            968
            
            
            504Total
      gross deferred tax assets
            
            
            9,221
            
            
            5,235Deferred
      tax liabilities:FHLB
      stock dividends
            
            
            28
            
            
            28Mortgage
      servicing rights
            
            
            161
            
            
            130Carrying
      value in excess of tax basis of goodwill
            
            
            (337
            )
            
            448Tax
      accumulated depreciation in excess of book
            
            
            367
            
            
            157Total
      gross deferred tax liabilities
            
            
            219
            
            
            763Net
      deferred tax assets before valuation allowance
            
            
            9,002
            
            
            4,472Valuation
      allowance
            
            
            (103
            )
            
            (97
            )Net
      deferred tax assets
            
            $
            8,899
            
            $
            4,375





55


At December 31, 2009 and
2008, the Company had state net operating loss carry-forwards of approximately
$1,251,000 and $1,173,000, respectively, which, due to the uncertainty of
realization, have a full valuation allowance established. The loss
carry-forwards begin to expire in 2010 through 2029. A two year reconcilement of
the difference between the statutory federal income tax rate and the effective
tax rate for the Company is as follows:








2009
            
            2008Federal
      income tax rate
            
            34.0
            %
            34.0
            %Increase
      (decrease) resulting from:State
      income taxes, net of federalincome
      tax benefit
            
            4.5
            
            4.5Other
            
            (4.4
            )
            (3.3
            )Effective
      tax rate
            
            34.1
            %
            35.2
            %





The
Company files income tax returns in the U.S. federal
jurisdiction.  The Company is no longer subject to U.S. federal income
tax examinations by tax authorities for years before 2006.





12.       STOCKHOLDERS’
EQUITY





The
Company has a dividend reinvestment and stock purchase plan which provides
stockholders with the opportunity to increase their equity ownership by electing
to have cash dividends automatically reinvested in additional shares of common
stock without payment of any brokerage commission or service charge. Pursuant to
the plan, stockholders are also permitted to make optional quarterly cash
purchases of stock, subject to minimum and maximum dollar amounts. The Board has
reserved 60,000 shares for issuance under the plan. During the year ended
December 31, 2009, there were 2,766 shares issued under the plan.





On
December 23, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital
Purchase Program, the Company sold 11,560 shares of fixed rate cumulative
perpetual preferred stock, series A, and a warrant to purchase 261,538 shares of
the Company’s common stock to the United States Department of the Treasury for
an aggregate purchase price of $11.560 million in cash, with $37,000 in offering
costs, and net proceeds of $11.523 million. The preferred stock and the warrant
were issued in a private placement exempt from registration pursuant to Section
4(2) of the Securities Act of 1933, as amended.





The
preferred stock will qualify as Tier 1 capital and will pay cumulative dividends
at a rate of 5% per annum for the first five years, and 9% per annum thereafter.
The Department of Treasury may permit the Company to redeem the Series A
Preferred Stock in whole or in part at any time after consultation with the
appropriate federal banking agency.  Any partial redemption must
involve at least 25% of the Series A Preferred Stock issued.  Upon
redemption of the Series A Preferred Stock, the Company will have the right to
repurchase the Warrant at its fair market value.





The
warrant has a 10-year term and is immediately exercisable upon its issuance,
with an exercise price, subject to anti-dilution adjustments, equal to $6.63 per
share of common stock. The Treasury has agreed not to exercise voting power with
respect to any shares of common stock issued upon exercise of the
warrant.







56


preferred
stock, out of the assets of the Company or proceeds thereof (whether capital or
surplus) available for distribution to stockholders of the Company, subject to
the rights of any creditors of the Company, before any distribution of such
assets or proceeds is made to or set aside for the holders of common stock and
any other stock of the Company ranking junior to the preferred stock as to such
distribution, payment in full in an amount equal to the sum of (i) the
liquidation amount of $1,000 per share and (ii) the amount of any accrued and
unpaid dividends, whether or not declared, to the date of payment.





13.           REGULATORY
MATTERS





The
Federal Reserve has established guidelines for maintenance of appropriate levels
of capital by bank holding companies and member banks. The regulations impose
two sets of capital adequacy requirements: minimum leverage rules, which require
bank holding companies and banks to maintain a specified minimum ratio of
capital to total assets, and risk-based capital rules, which require the
maintenance of specified minimum ratios of capital to “risk-weighted”
assets.





The
regulations of the Federal Reserve in effect at December 31, 2009, do not impose
capital ratio requirements on bank holding companies with assets of less than
$500 million as of June 30 of the prior year. The Company was, therefore, not
subject to the Federal Reserve’s capital ratio requirements during 2009. The
Bank, however, is fully subject to the Federal Reserve’s capital standards. The
regulations of the Federal Reserve in effect at December 31, 2009, required all
member banks to maintain a minimum leverage ratio of “Tier 1 capital” (as
defined in the risk-based capital guidelines discussed in the following
paragraphs) to total assets of 3.0%. The capital regulations state, however,
that only the strongest bank holding companies and banks, with composite
examination ratings of 1 under the rating system used by the federal bank
regulators, would be permitted to operate at or near this minimum level of
capital. All other banks are expected to maintain a leverage ratio of at least
1% to 2% above the minimum ratio, depending on the assessment of an individual
organization’s capital adequacy by its primary regulator. A bank experiencing or
anticipating significant growth is expected to maintain capital well above the
minimum levels. In addition, the Federal Reserve has indicated that it also may
consider the level of an organization’s ratio of tangible Tier 1 capital (after
deducting all intangibles) to total assets in making an overall assessment of
capital.





The
risk-based capital regulations require all commercial banks to maintain a
minimum ratio of total capital to total risk-weighted assets of 8%, with at
least 4% as core capital. For the purpose of calculating these ratios: (i)
supplementary capital is limited to no more than 100% of core capital; and (ii)
the aggregate amount of certain types of supplementary capital is limited. In
addition, the risk-based capital regulations limit the allowance for credit
losses that may be included in capital to 1.25% of total risk-weighted
assets.





The
Federal Reserve has established regulations that classify banks by capital
levels and provide for the Federal Reserve to take various “prompt corrective
actions” to resolve the problems of any bank that fails to satisfy the capital
standards. Under these regulations, a well-capitalized bank is one that is not
subject to any regulatory order or directive to meet any specific capital level
and that has a total risk-based capital ratio of 10% or more, a Tier 1
risk-based capital ratio of 6% or more, and a leverage ratio of 5% or more. An
adequately capitalized bank is one that does not qualify as well-capitalized but
meets or exceeds the following capital requirements: a total risk-based capital
ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of
either (i) 4% or (ii) 3% if the bank has the highest composite examination
rating. A bank that does not meet these standards is categorized as
undercapitalized, significantly undercapitalized, or critically
undercapitalized, depending on its capital levels. A bank that falls within any
of the three


57


undercapitalized
categories established by the prompt corrective action regulation is subject to
severe regulatory sanctions. As of December 31, 2009, the Bank was well
capitalized as defined in the Federal Reserve’s regulations. There are no
subsequent conditions or events that management believes have changed the Bank’s
category. The Bank’s actual capital amounts and ratios are also presented in the
table below.





To
      be WellCapitalized
      UnderPrompt
      Corrective
            
            For
      CapitalActual
            
            Action
      Rules
            
            Adequacy
      PurposesAmount
            
            Ratio
            
            Amount
            
            Ratio
            
            Amount
            
            Ratio(Dollars
      in thousands)As
      of December 31, 2009:Total
      risk-based capital  (to risk-weighted assets)
            
            $53,474
            
            12.61%
            
            $42,408
            
            10.00%
            
            $33,927
            
            8.00%Tier
      1 capital (to risk-weighted assets)
            
            35,461
            
            8.36
            
            25,445
            
            6.00
            
            16,963
            
            4.00Tier
      1 capital (to adjusted total assets)
            
            35,461
            
            7.06
            
            25,101
            
            5.00
            
            20,081
            
            4.00As
      of December 31, 2008:Total
      risk-based capital  (to risk-weighted assets)
            
            $58,692
            
            14.64%
            
            $40,088
            
            10.00%
            
            $32,070
            
            8.00%Tier
      1 capital (to risk-weighted assets)
            
            41,065
            
            10.24
            
            24,053
            
            6.00
            
            16,035
            
            4.00Tier
      1 capital (to adjusted total assets)
            
            41,065
            
            8.64
            
            23,761
            
            5.00
            
            19,009
            
            4.00





14.           OFFICER,
DIRECTOR AND EMPLOYEE BENEFIT PLANS





Employee Stock Ownership
Plan





The Board
of Directors approved a contributory Employee Stock Ownership Plan (ESOP) for
employees who have attained age 21 and completed one year of service with the
Company or its subsidiaries, effective January 1, 1994. The ESOP acquired 38,508
shares of common stock in November 1994 for $385,080 financed by a loan from the
Company. Shares acquired with such loan proceeds are to be held in a suspense
account for allocation among the participants as the loan is repaid. The loan
agreement is secured by a pledge of the common stock owned by the ESOP and
purchased with the proceeds of the loan. The loan was repaid in annual
installments of $38,508 plus interest at prime plus 1% over a ten-year period.
Payments began on December 31, 1995. As of December 31, 2004, the loan had been
paid in full, and thus the related liability and reduction in stockholders’
equity have been eliminated.





The
Company accounts for its ESOP in accordance with Statement of Position 93-6.
Accordingly, the debt of the ESOP was recorded as debt and shares pledged as
collateral were reported as unearned ESOP shares, a reduction of stockholders’
equity. As shares were released from collateral, the Bank recorded compensation
expense in an amount equal to the fair value of the shares, and the shares
became outstanding for earnings per share computations. All shares were released
from collateral as of December 31, 2004, as the loan balance has been paid in
full. Compensation expense is also recognized for dividends on unallocated
shares paid or added to participant accounts. Compensation expense is reduced by
the amount of the annual interest paid by the ESOP to service the loan issued to
acquire the shares of stock. There was no ESOP compensation expense recorded in
2009 or 2008.





Stock-Based Compensation
Plans





In 1995,
the Company formed a Management Recognition Plan (MRP), which was authorized to
acquire 4% of the shares of common stock issued on the date of conversion to a
stock corporation to provide them with a proprietary interest in the Company in
a manner designed to encourage such employees to remain with the Company.
Compensation expense in connection with the MRP was zero for the years ended
December 31, 2009 and 2008, respectively.


58





The
Company adopted stock option plans in 1992 and 1995 for the benefit of
Directors, selected officers, and other key employees. The Plans provide for the
granting of options for the common shares of the Company at the fair market
value at the time the options are granted. The term of each option awarded is to
be determined by a committee of the Board of Directors, but shall not exceed ten
years. The term of an option shall not exceed five years for employees and
directors owning more than 10% of the outstanding common stock at the time the
option is granted. Discretionary stock appreciation rights may be granted in
conjunction with, or independently of, any options granted under the Plans. Upon
exercise of a stock appreciation right, the related option, or portion thereof,
is cancelled.





In
accordance with the stock option plans, a total of 115,676shares of
unissued common stock were reserved for issuance pursuant to incentive stock
options.





The
Company’s 1995 Stock Option Plan has authorized the grant of options to
management personnel for up to 96,442 shares of the Company’s common stock. All
options granted have 10 year terms and vest over a period of 5
years.





The
Company’s stock options have been adjusted to give retroactive effect to the
2-for-1 stock split approved by the Board of Directors in March
2007.





A summary
of the Company’s stock option activity, and related information for the years
ended December 31 is as follows:





2009
            
            2008Weighted-
            
            
            
            Weighted-Average
            
            
            
            AverageShares
            
            Exercise
      Price
            
            Shares
            
            Exercise
      PriceOutstanding
      at beginning of year
            
            12,024
            
            $
            6.00
            
            16,032
            
            $
            6.00Forfeited
      / Expired
            
            (12,024
            )
            
            6.00
            
            —
            
            
            —Granted
            
            —
            
            
            —
            
            —
            
            
            —Exercised
            
            —
            
            
            —
            
            (4,008
            )
            
            6.00Outstanding
      at end of year
            
            —
            
            $
            —
            
            12,024
            
            $
            6.00Options
      exercisable at year end
            
            —
            
            $
            —
            
            12,024
            
            $
            6.00





In 2009, the Company
adopted an Equity Incentive Plan (the “Plan”) that provides that the Board of
Directors or the Compensation Committee of the Board of Directors (the
“Committee”) may grant stock options and restricted stock awards to directors,
officers and employees.  The total number of shares of common stock to
be reserved and available for awards under the Plan is 368,935
shares.





The purpose of the Plan
is to provide incentives and rewards to directors, officers and employees who
contribute to the success and growth of the Company and its subsidiaries or
affiliates, and to assist the Company in attracting and retaining directors,
officers and other key employees with experience and ability in order to aid the
Company in rewarding such individuals who provide substantial services to the
Company or its subsidiaries or affiliates, and who promote the creation of
long-term value for the Company’s shareholders by closely aligning the interests
of participants with those of shareholders.







59


as
incentive stock options (“ISOs”) under Section 422 of the Internal Revenue Code
of 1986, as amended (the “Internal Revenue Code”), options that do not, or cease
to, qualify as incentive stock options under the Internal Revenue Code
(“non-statutory stock options” or “NSOs”) and stock awards (“Stock Awards”)
comprised of shares of Company common stock.  Awards to any individual
Employee under the Plan shall not exceed one-third of the aggregate total number
of Shares reserved for Stock Options or one-third of the aggregate total number
of Shares reserved for Restricted Stock Awards during the Term of the Plan or in
any one year.  The maximum number of shares of the Common Stock that
may be delivered pursuant to Awards under the Plan is 368,935
shares.  Of the 368,935 Plan shares, the Company may issue a maximum
of 276,701 shares (75%) upon the exercise of Stock Options and may grant a
maximum of 92,234 (25%) shares as Restricted Stock Awards.





In
November 2009, the Committee approved the granting of 60,125 restricted stock
awards (“Awards”) with a fair market value of $4.00 per share.  Awards
shall become earned and non-forfeitable at the rate of 20% on the one year
anniversary of the Date of Grant, and 20% annually thereafter, during periods of
continued service as a director or director emeritus of the Company or Cecil
Bank. Awards shall vest immediately upon the death or Disability of the
Participant, or upon a change in control of the Company or the
Bank.





A summary
of the Company’s activity under the plan, and related information for the years
ended December 31 is as follows:





2009
            
            2008Shares
            
            Weighted
      Average Grant  Date Fair Value
            
            Shares
            
            Weighted
      Average Grant Date Fair ValueUnvested
      at beginning of year
            
            —
            
            $
            —
            
            —
            
            $
            —Forfeited
            
            —
            
            
            —
            
            —
            
            
            —Awarded
            
            60,125
            
            
            4.00
            
            —
            
            
            —Released
            
            —
            
            
            —
            
            —
            
            
            —Unvested
      at end of year
            
            60,125
            
            $
            4.00
            
            —
            
            $
            —





The
Company had adopted a Retirement Plan for non-employee directors under which
each participating director would receive monthly benefits upon termination of
service based on a benefits formula. The Company accrued the liability over the
service period for each participating director. All participating directors are
now receiving fixed payments from the liability accrued in accordance with the
Plan. The Plan has been frozen and there are not any current directors covered
by the Plan, thus there is no compensation cost to the Company for the years
ended December 31, 2009 and 2008.





Deferred
Compensation





The Bank
has entered into deferred compensation agreements with some of its executive
officers. Under the agreements, the Bank is obligated to provide annual benefits
for the officers or their beneficiaries, after the officer’s death, disability,
or retirement. The estimated present value of the service cost to be paid is
being accrued over the period from the effective date of the agreements until
the full eligibility dates of the participants. The estimated present value of
the interest cost to be paid is being accrued over the expected life of the
participants based on current life expectancy tables. The expense  60


of
$7,871,000 and $7,787,000 at December 31, 2009 and 2008, respectively, which
were purchased as a method of partially financing the benefits under this
plan.





15.           PROFIT
SHARING PLAN





The Bank
has established a defined contribution 401(k) profit sharing plan for the
benefit of its employees. The Plan covers all full-time employees who meet
certain eligibility requirements as to age and length of service. Contributions
to the 401(k) section of the plan are based on the amounts contributed by
employees. The employees may contribute a percentage of their annual
compensation to the Plan. The Bank makes a discretionary matching contribution
equal to a uniform percentage of the amount of the employees’ contribution. In
applying the matching contribution, only employee salary deductions up to 2%
will be considered. The Bank may also make a discretionary profit sharing
contribution to the Plan as determined by the Board of Directors. For the years
ended December 31, 2009 and 2008, the Bank’s expense related to the Plan was
$54,000 and $189,000, respectively.





16.           FINANCIAL
INSTRUMENTS WITH OFF-BALANCE-SHEET RISK





In the
normal course of business, the Bank has various outstanding credit commitments
which are properly not reflected in the financial statements. These commitments
are made to satisfy the financing needs of the Bank’s clients. The associated
credit risk is controlled by subjecting such activity to the same credit and
quality controls that exist for the Bank’s lending and investing activities. The
commitments involve diverse business and consumer customers and are generally
well collateralized. Management does not anticipate that losses, if any, which
may occur as a result of these commitments, would materially affect the
stockholders’ equity of the Bank. Since a portion of the commitments have some
likelihood of not being exercised, the amounts do not necessarily represent
future cash requirements.





Loan and
credit line commitments, excluding unused portions of home equity lines of
credit, totaled approximately $21,969,000 at December 31, 2009, and $36,221,000
at December 31, 2008. These commitments are contingent upon continuing customer
compliance with the terms of the agreement.





Unused
portions of home equity lines at year-end amounted to approximately $1,511,000
in 2009 and $1,527,000 in 2008. The Bank’s home equity line accounts are secured
by the borrower’s residence.





Irrevocable
letters of credit, totaling $13,199,000 at December 31, 2009 and $15,874,000 at
December 31, 2008, are obligations to make payments under certain conditions to
meet contingencies related to customers’ contractual agreements. They are
primarily used to guarantee a customer’s contractual and/or financial
performance and are seldom exercised.





17.           EARNINGS
PER SHARE





In the
following table, basic earnings per share are derived by dividing net income
available to common stockholders by the weighted-average number of common shares
outstanding, and do not include the effect of any potentially dilutive common
stock equivalents. The diluted earnings per share are derived by dividing net
income by the weighted-average number of shares outstanding, adjusted for the
dilutive effect of outstanding stock options and warrants.  As of
December 31, 2009, the 261,538 shares in the warrant issued to the US Treasury
as part of the Troubled Asset Relief Program Capital Purchase Program were
excluded from the diluted earnings per share calculation because their effect
was anti-dilutive.  As of December 31, 2008, there were no
anti-dilutive options excluded from the earnings per share
calculation.


61








The
calculation of net (loss) income per common share for the years ended December
31 is as follows:





2009
            
            2008BASIC:Net
      (loss) income
            
            $
            (2,480,000
            )
            $
            1,851,000Preferred
      stock dividends
            
            
            (791,000
            )
            
            (19,000
            )Net
      (loss) income available to common stockholders
            
            $
            (3,271,000
            )
            $
            1,832,000Average
      common shares outstanding
            
            
            3,689,063
            
            
            3,681,783Basic
      net (loss) income per share
            
            $
            (0.89
            )
            $
            0.50DILUTED:Net
      (loss) income
            
            $
            (2,480,000
            )
            $
            1,851,000Preferred
      stock dividends
            
            
            (791,000
            )
            
            (19,000
            )Net
      (loss) income available to common stockholders
            
            $
            (3,271,000
            )
            $
            1,832,000Average
      common shares outstanding
            
            
            3,689,063
            
            
            3,681,783Stock
      option adjustment
            
            
            —
            
            
            67,179Average
      common shares outstanding – diluted
            
            
            3,689,063
            
            
            3,748,962Diluted
      net (loss) income per share
            
            $
            (0.89
            )
            $
            0.49








18.           FAIR
VALUE OF FINANCIAL INSTRUMENTS





ASC Topic
825 Disclosure About Fair
Value of Financial Instruments requires that the Company disclose
estimated fair values for both its on and off-balance-sheet financial
instruments. The following methods and assumptions were used to estimate the
fair value of the Company’s financial instruments. Changes in estimates and
assumptions could have a significant impact on these fair values.





Cash and Cash
Equivalents - The fair values of cash and cash equivalents approximate
their carrying values.





Investment Securities
- The fair values of investment securities are based on quoted market prices,
where available. If a quoted market price is not available, fair value is
estimated using quoted market prices of comparable instruments.





Loans - The fair
value of the loan portfolio is estimated by evaluating homogeneous categories of
loans with similar financial and credit risk characteristics. Loans are
segregated by types, such as residential mortgage, commercial real estate and
consumer. Each loan category is further segmented into fixed and adjustable-rate
interest terms.





The fair
values of each loan category are estimated by discounting contractual cash flows
adjusted for estimated prepayments. Assumptions regarding prepayment estimates
and discount rates are judgmentally determined by using available market
information.





Accrued Interest
Receivable - The fair value of the Company’s interest receivable
approximates its carrying value.




Restricted Investment
Securities - The fair value of the Company’s investment in stock of the
FHLB and FRB approximates its carrying value.


62


Deposits - The fair
values of deposits are estimated using a discounted cash flow calculation,
adjusted for estimated decay rates, that applies interest rates currently
offered for funding sources with similar maturities. Assumptions regarding
discount rates and decay estimates are judgmentally determined by using
available market information.





Advances from the
FHLB - The fair value of FHLB advances was estimated by computing the
discounted value of contractual cash flows payable at current interest rates for
obligations with similar remaining terms.





Commitments to Extend
Credit - 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.





The estimated fair values of
financial instruments (in thousands) at December 31, 2009 are as
follows:





Carrying
            
            FairValue
            
            ValueFinancial
      assets:Cash
      and cash equivalents
            
            $
            35,464
            
            $
            35,464Investment
      securities:Available-for-sale
            
            
            1,714
            
            
            1,714Held-to-maturity
            
            
            4,699
            
            
            4,627Loans
      receivable
            
            
            438,398
            
            
            461,041Restricted
      investment securities
            
            
            4,396
            
            
            4,396Accrued
      interest receivable
            
            
            2,025
            
            
            2,025Financial
      liabilities:Deposits
            
            
            382,338
            
            
            380,780Junior
      subordinated debentures
            
            
            17,000
            
            
            16,959Advances
      from FHLB
            
            
            63,643
            
            
            64,004





63





The
estimated fair values of financial instruments (in thousands) at December 31,
2008 are as follows:





Carrying
            
            FairValue
            
            ValueFinancial
      assets:Cash
      and cash equivalents
            
            $
            41,420
            
            $
            41,420Investment
      securities:Available-for-sale
            
            
            11,712
            
            
            11,712Held-to-maturity
            
            
            300
            
            
            300Loans
      receivable
            
            
            408,063
            
            
            436,382Restricted
      investment securities
            
            
            3,918
            
            
            3,918Accrued
      interest receivable
            
            
            2,225
            
            
            2,225Financial
      liabilities:Deposits
            
            
            364,551
            
            
            365,786Junior
      subordinated debentures
            
            
            17,000
            
            
            19,968Advances
      from FHLB
            
            
            63,786
            
            
            64,677





19.           ASSETS
MEASURED AT FAIR VALUE





ASC Topic
820, Fair Value Measurements
and Disclosures, defines fair value as the price that would be received
to sell an asset or paid to transfer a liability (an exit price) in an orderly
transaction between market participants at the measurement date. In addition,
ASC Topic 820 establishes a fair value hierarchy, which prioritizes the inputs
to valuation techniques used to measure fair value into three broad levels.
Level 1 assets are valued based on readily available pricing sources for
transactions involving identical assets. Level 2 assets are valued based on
transactions in less active markets. Valuations are obtained from third parting
pricing services which use observable inputs for comparable assets other than
Level 1 assets. Level 3 assets are valued based on unobservable inputs that are
supported by little or no market activity that are significant to the fair
value. Lastly, ASC Topic 820 requires additional disclosures for each interim
and annual period separately for each major category of assets and liabilities.
The following table shows the value (in thousands) at December 31, 2009 of each
major category of assets measured at fair value on the consolidated balance
sheets, which consists solely of investment securities available-for-sale. The
changes in fair value were reflected as a component of other comprehensive
income and did not affect net income.








Fair
      Value Measurements at Reporting Date UsingQuoted
      PricesIn
      Active
            SignificantMarkets
      for
            Other
            SignificantIdentical
            Observable
            UnobservableCarrying
            Assets
            Inputs
            InputsDescription
            Value
            (Level
      1)
            (Level
      2)
            (Level
      3)Investment
      securities available -
              for-sale
            $1,714
            $1,635
            $79
            $0








We may be
required from time to time to measure certain other financial assets and
liabilities at fair value on a nonrecurring basis. These adjustments to fair
value usually result from application of lower of cost or market accounting or
write-downs of individual assets. For assets measured at fair value on a
nonrecurring basis at December 31, 2009, the following table provides the level
of valuation assumptions


64


used to
determine each adjustment and the carrying value of the assets. For both other
real estate owned and impaired loans, Level 3 assets are valued at the lesser of
the unpaid principal balance of the loan, or the appraised value of the
underlying collateral, as determined by a third party appraiser.








Fair
      Value Measurements at Reporting Date UsingQuoted
      PricesIn
      Active
            SignificantMarkets
      for
            Other
            SignificantIdentical
            Observable
            UnobservableCarrying
            Assets
            Inputs
            InputsDescription
            Value
            (Level
      1)
            (Level
      2)
            (Level
      3)Other
      real estate owned
            $  4,594
            $0
            $0
            $  4,594Impaired
      loans
            $32,694
            $0
            $0
            $32,694








The
following table provides a roll forward of the changes in fair value during the
year ended December 31, 2009 for items included in the Level 3
category:





Other
      RealEstate
            
            ImpairedOwned
            
            LoansBalance
      at December 31, 2008
            
            $
            2,843
            
            $
            10,459Loans
      put on nonaccrual status
            
            
            0
            
            
            31,190Loans
      returned to accrual status
            
            
            0
            
            
            (4,773
            )Valuation
      adjustments
            
            
            (326
            )
            
            0Loans
      transferred to other real estate owned
            
            
            5,449
            
            
            (4,182
            )Other
      real estate owned sold
            
            
            (3,372
            )
            
            0Balance
      at December 31, 2009
            
            $
            4,594
            
            $
            32,694Net
      realized gains included in net income
            
            $
            277
            
            $
            0





20.       SUBSEQUENT
EVENTS





In order
to conserve capital in the current uncertain economic environment, the Company’s
Board of Directors determined at its meeting held January 19, 2010 that it was
in the best interests of the Company and its stockholders not to declare a
dividend on its common stock for the first quarter of 2010 and not to declare
the dividend payable February 15, 2010 on its Fixed Rate Cumulative Perpetual
Preferred Stock, Series A.  In addition, the Company has given notice
of its intention to defer interest payments on the subordinated debentures
underlying its two outstanding issues of trust preferred securities as permitted
by the indentures therefor.  During the period during which the
Company defers payments on its subordinated debentures, it will be prohibited
under the indentures from declaring or paying dividends on its capital
stock.  The Company will be prohibited from declaring or paying
dividends on its common stock while dividends on its Fixed Rate Cumulative
Perpetual Preferred Stock, Series A are in arrears.  No determination
has been made as to whether or when the Company will resume the payment of
dividends on its common or preferred stock or interest payments on its
subordinated debentures.  Any such future payments will depend on a
variety of factors including, but not limited to, the Company’s capital needs,
operating results, tax considerations, statutory and regulatory limitations and
economic considerations.


65


21.           CECIL
BANCORP, INC. - HOLDING COMPANY ONLY FINANCIAL INFORMATION





The
following condensed balance sheets (in thousands) as of December 31, 2009 and
2008 and condensed statements of (loss) income and cash flows (in thousands) for
the years then ended for Cecil Bancorp, Inc. should be read in conjunction with
the consolidated financial statements and notes thereto.








BALANCE
SHEETS





ASSETS





2009
            
            2008Cash
            
            $
            41
            
            $
            1,013Investment
      in subsidiaries
            
            
            41,318
            
            
            43,760Investments
      held-to-maturity
            
            
            50
            
            
            50Notes
      receivable from subsidiaries
            
            
            12,924
            
            
            12,923Premises
      and equipment
            
            
            398
            
            
            398Accrued
      interest receivable from subsidiaries
            
            
            23
            
            
            23Other
      assets
            
            
            197
            
            
            185Total
      assets
            
            $
            54,951
            
            $
            58,352LIABILITIES
      AND STOCKHOLDERS’ EQUITYJunior
      subordinated debentures
            
            $
            17,000
            
            $
            17,000Loans
      payable to subsidiaries
            
            
            200
            
            
            200Other
      liabilities
            
            
            772
            
            
            760Total
      liabilities
            
            
            17,972
            
            
            17,960Stockholders’
      equity:Preferred
      stock, $.01 par value, authorized 1,000,000 shares in
              2009 and 2008,
      issued and outstanding 11,560 shares,
              liquidation
      preference $1,000 per share, in 2009 and 2008
            
            
            10,916
            
            
            10,786Common
      stock, $.01 par value, authorized 10,000,000 shares in 2009
              and 2008, issued
      and outstanding 3,689,346 shares in 2009 and 3,686,580
              shares in
      2008
            
            
            37
            
            
            37Additional
      paid-in capital
            
            
            12,252
            
            
            12,234Retained
      earnings
            
            
            13,791
            
            
            17,339Accumulated
      other comprehensive loss
            
            
            (17
            )
            
            (4
            )Total
      stockholders’ equity
            
            
            36,979
            
            
            40,392Total
      liabilities and stockholders’ equity
            
            $
            54,951
            
            $
            58,352





66


STATEMENTS
OF (LOSS) INCOME





Years
      Ended December 31,2009
            
            2008Income:Interest
      income on notes receivable from subsidiaries
            
            $
            883
            
            $
            882Rental
      income from subsidiaries
            
            
            125
            
            
            125Dividends
      from subsidiaries
            
            
            0
            
            
            360Equity
      in undistributed (loss) earnings of subsidiaries
            
            
            (2,428
            )
            
            1,537Other
      income
            
            
            70
            
            
            83Total
      income
            
            
            (1,350
            )
            
            2,987Operating
      expenses:Compensation
      and benefits
            
            
            20
            
            
            16Interest
      expense on junior subordinated debentures
            
            
            1,121
            
            
            1,124Interest
      expense on loans payable to subsidiaries
            
            
            7
            
            
            10Other
            
            
            9
            
            
            10Total
      operating expenses
            
            
            1,157
            
            
            1,160Net
      (loss) income before income taxes
            
            
            (2,507
            )
            
            1,827Income
      tax benefit
            
            
            27
            
            
            24Net
      (loss) income
            
            $
            (2,480
            )
            $
            1,851





STATEMENTS
OF CASH FLOWS








Years
      Ended December 31,2009
            
            2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      (loss) income
            
            $
            (2,480
            )
            $
            1,851Adjustments
      to reconcile net income to net cash provided by operating
      activities:Equity
      in undistributed loss (earnings) of subsidiaries
            
            
            2,428
            
            
            (1,537
            )Net
      change in other assets and other liabilities
            
            
            1
            
            
            1Net
      cash flows (used) provided by operating activities
            
            
            (51
            )
            
            315CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of investment securities held-to-maturity
            
            
            —
            
            
            (50
            )Net
      cash provided (used) by investing activities
            
            
            —
            
            
            (50
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Dividends
      paid
            
            
            (938
            )
            
            (368
            )Proceeds
      from issuance of preferred stock
            
            
            —
            
            
            11,523Proceeds
      from issuance of common stock
            
            
            17
            
            
            56Investment
      in subsidiaries
            
            
            —
            
            
            (10,683
            )Net
      cash (used) provided by financing activities
            
            
            (921
            )
            
            528NET
      (DECREASE) INCREASE IN CASH
            
            
            (972
            )
            
            793CASH
      AT BEGINNING OF PERIOD
            
            
            1,013
            
            
            220CASH
      AT END OF PERIOD
            
            $
            41
            
            $
            1,013








67


Item 9. Changes in and
Disagreements With Accountants on Accounting and Financial
Disclosure





None





Item 9A(T). Controls and
Procedures.





As
required by SEC rules, the Company’s management evaluated the effectiveness of
the Company’s disclosure controls and procedures as of December 31, 2009. The
Company’s Chief Executive Officer and Chief Financial Officer participated in
the evaluation. Based on the evaluation, the Company’s Chief Executive Officer
and Chief Financial Officer concluded that the Company’s disclosure controls and
procedures were effective as of December 31, 2009 to ensure that information
required to be disclosed by the Company in reports it files under the Securities
Exchange Act of 1934 is processed, summarized and reported within the time
periods specified by the SEC’s rules and forms.





Internal
Control over Financial Reporting





The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting. As required by SEC rules, the
Company’s management evaluated the effectiveness of the Company’s internal
control over financial reporting as defined in SEC Rule 13a-15 as of December
31, 2009. The Company’s Chief Executive Officer and Chief Financial Officer
participated in the evaluation, which was based upon the criteria for effective
internal control over financial reporting included in the “Internal Control –
Integrated Framework” issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this evaluation, the Company’s Chief Executive
Officer and Chief Financial Officer concluded that the Company’s internal
control over financial reporting was effective as of December 31,
2009.





This
annual report does not include an attestation report of the Company’s
independent registered public accounting firm regarding internal control over
financial reporting. Management’s report was not subject to attestation by the
Company’s independent 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.





Fourth
Quarter 2009 Changes in Internal Control over Financial Reporting





No change
occurred during the fourth quarter of 2009 that has materially affected, or is
reasonably likely to materially affect, the Company’s internal control over
financial reporting.





Item 9B. Other
Information.





None.





68


PART
III





Item 10. Directors,
Executive Officers, and Corporate Governance





Other
Executive Officers





Following
are the name, age (as of December 31, 2009), and principal position of executive
officers of the Company and the Bank who are not directors.





Name
            
            Age
            
            TitleBrian
      J. Hale
            
            50
            
            Executive
      Vice President/Chief Operating OfficerSandra
      D. Feltman
            
            60
            
            Sr.
      Vice President/Director of LendingR.
      Lee Whitehead
            
            32
            
            Vice
      President/Chief Financial Officer








Brian J. Haleis Executive
Vice President/Chief Operating Officer of the Bank. Before joining the Bank,
Mr. Hale was employed at County Banking and Trust Company, Elkton, Maryland
for 17 years in various capacities, finally as Assistant Vice President in
charge of loan operations. Since joining the Bank in 1995, Mr. Hale’s
responsibilities as Chief Operating Officer include the administration of all
human resource, lending, savings, and operational activities of the Bank.
Mr. Hale is currently a Director of the United Way of Cecil County.
Mr. Hale resides in North East, Maryland.





Sandra D. Feltmanis Senior
Vice President/Director of Lending of the Bank. Ms. Feltman has previously
served in various capacities since joining the Bank in 1972 and has served in
her present capacity as Director of Lending since 1982. Her responsibilities
include carrying out the Bank’s lending policies and acting as the Community
Reinvestment Act Officer. Ms. Feltman has previously served as the
President and Director of the Greater Elkton Chamber of Commerce as well as a
member in the committee to select a new Elkton Police Chief and the Teacher
Recruitment/Retention Committee. She also participates in various activities for
the Business and Education Partnership Advisory Council. Ms. Feltman is a
member and past chairman of the Finance Committee of the Cecil County Board of
Realtors. Ms. Feltman is also a past director of the Cecil County Home
Builders Association.





R. Lee Whiteheadis Vice
President/Chief Financial Officer of the Bank. Mr. Whitehead has previously
served as accounting manager since joining the Bank in April 2004 before being
appointed Chief Financial Officer in May 2005. In his present capacity,
Mr. Whitehead’s responsibilities include the administration of all
accounting and financial reporting functions. Lee resides in Aberdeen,
Maryland.





Other
information required by this item is incorporated by reference from the
registrant’s definitive proxy statement pursuant to General Instruction G to
Form 10-K.





Item
11.  Executive Compensation





Information
required by this item is incorporated by reference from the registrant’s
definitive proxy statement pursuant to General Instruction G to Form
10-K.





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





Information
required by this item is incorporated by reference from the registrant’s
definitive proxy statement pursuant to General Instruction G to Form
10-K.





69


Item 13. Certain
Relationships and Related Transactions and Director
Independence





Information
required by this item is incorporated by reference from the registrant’s
definitive proxy statement pursuant to General Instruction G to Form
10-K.





Item 14. Principal
Accounting Fees and Services





Information
required by this item is incorporated by reference from the registrant’s
definitive proxy statement pursuant to General Instruction G to Form
10-K.





PART
IV





Item 15. Exhibits, Financial
Statement Schedules





(a)           Documents Filed as Part of
this Report




(1)           Financial
Statements.





The following financial statements are
filed in Item 8 of this report:





Report of
Independent Registered Public Accounting Firm


Consolidated
Balance Sheets as of December 31, 2009 and 2008


Consolidated
Statements of (Loss) Income for the Years Ended December 31, 2009 and
2008


Consolidated
Statements of Changes in Stockholders’ Equity for the Years Ended December 31,
2009 and 2008


Consolidated
Statements of Cash Flows for the Years Ended December 31, 2009 and
2008


Notes to
Consolidated Financial Statements.





(2)           Financial Statement
Schedules. All schedules for which provision is made in the applicable
accounting regulations of the SEC are omitted because of the absence of
conditions under which they are required or because the required information is
included in the consolidated financial statements and related notes
thereto.





(3)  Exhibits. The
following exhibits are filed as a part of this report:





Exhibit
      No.
            Description
            Incorporated
      by Reference to:3.1
            Articles
      of Incorporation of Cecil Bancorp, Inc.
            Exhibit
      3.1 to Quarterly Report on Form 10-Q for the quarter ended June 30,
      20083.2
            Bylaws
      of Cecil  Bancorp, Inc.3.3
            Articles
      Supplementary for Fixed Rate Cumulative Perpetual Preferred Stock,
      Series A
            Exhibit
      3.1 to Current Report on Form 8-K filed December 23,
  2008.4.1
            Form
      of Common Stock Certificate
            Exhibit
      4 to Registration Statement on Form  S-1 (File No.
      33-81374)4.2
            Form
      of Certificate for Fixed Rate Cumulative Perpetual Preferred Stock,
      Series A
            Exhibit
      4.1 to Current Report on Form 8-K filed December 23,
  2008.4.3
            Warrant
      for Purchase of Shares of Common Stock
            Exhibit
      4.2 to Current Report on Form 8-K filed December 23,
  2008.













70


Exhibit
      No.
              Description
              Incorporated
      by Reference to:4.4
              Amended
      and Restated Trust Agreement, dated as of March 23, 2006, among Cecil
      Bancorp, Inc., as depositor, Wilmington Trust Company, as property and
      Delaware Trustee, and Charles F. Sposato, Mary B. Halsey and Jennifer
      Carr, as administrative trustees.
              Not
      filed in accordance with the provisions of Item 601(b)(4)(iii) of
      Regulation S-K. The Registrant agrees to provide a copy of this document
      to the Commission upon request.4.5
              Junior
      Subordinated Indenture, dated as of March 23, 2006 between Cecil Bancorp,
      Inc. and Wilmington Trust Company, as Trustee.
              Not
      filed in accordance with the provisions of Item 601(b)(4)(iii) of
      Regulation S-K. The Registrant agrees to provide a copy of this document
      to the Commission upon request.4.6
              Guarantee
      Agreement, dated as of March 23, 2006, between Cecil Bancorp, Inc., as
      Guarantor, and Wilmington Trust Company, as Guarantee
    Trustee.
              Not
      filed in accordance with the provisions of Item 601(b)(4)(iii) of
      Regulation S-K. The Registrant agrees to provide a copy of this document
      to the Commission upon request.4.7
              Amended
      and Restated Declaration of Trust, dated as of November 30, 2006 by and
      among Wilmington Trust Company, as Delaware and institutional trustee,
      Cecil Bancorp, Inc., as sponsor, and Charles F. Sposato, Mary B. Halsey
      and Jennifer Carr, as administrators.
              Exhibit
      10.3 to Current Report on Form 8-K filed December 4,
  2006.4.8
              Indenture,
      dated as of November 30, 2006, between Cecil Bancorp, Inc. and Wilmington
      Trust Company, as trustee.
              Exhibit
      10.1 to Current Report on Form 8-K filed December 4,
  2006.4.9
              Guarantee
      Agreement, dated as of November 30, 2006, between Cecil Bancorp, Inc., as
      Guarantor, and Wilmington Trust Company, as Guarantee
    Trustee.
              Exhibit
      10.4 to Current Report on Form 8-K filed December 4,
  2006.10.1*
              Cecil
      Federal Savings Bank Retirement Plan for Non-Employee
      Directors
              Exhibit
      10.4 to Annual Report on Form 10-KSB for the year ended December 31, 1994,
      SEC File No. 0-24926.10.2*
              Cecil
      Federal Bank Supplemental Executive Retirement Plan covering Charles F.
      Sposato, Chairman; Mary B. Halsey, President and Chief Executive Officer;
      and Brian J. Hale, Executive Vice President and Chief Operating Officer
      and related agreements with such officers
              Exhibit
      10.1 to the Company’s Quarterly Report on Form 10-QSB for the quarterly
      period ending June 30, 2004
 
 
 71
 Exhibit
      No.
                  Description
                  Incorporated
      by Reference to:10.3
                  Letter
      Agreement, dated December 23, 2008, between Cecil Bancorp, Inc. and United
      States Department of the Treasury, with respect to the issuance and sale
      of the Series A Preferred Stock and the Warrant
                  Exhibit
      10.1 to Current Report on Form 8-K filed December 23,
  2008.10.4*
                  Form
      of Waiver, executed by Ms. Halsey and each of Messrs. Sposato,
      Hale and Whitehead
                  Exhibit
      10.2 to Current Report on Form 8-K filed December 23,
  2008.10.5*
                  Form
      of Letter Agreement, executed by Ms. Halsey and each of
      Messrs. Sposato, Hale and Whitehead
                  Exhibit
      10.3 to Current Report on Form 8-K filed December 23,
  2008.10.6*
                  Incentive
      Compensation Plan
                  Exhibit
      10.10 to Annual Report on Form 10-K for the year ended December 31, 2008,
      SEC File No. 0-24926.10.7*
                  Cecil
      Bancorp, Inc. 2009 Equity Incentive Plan
                  Exhibit
      10.1 to Registration Statement on Form S-8 (File No.
      333-159419).21
                  Subsidiaries23
                  Consent
      of Stegman & Company31
                  Rule
      13a-14(a)/15d-14(a) Certifications32
                  18
      U.S.C. Section 1350 Certifications99
                  EESA
      § 111(b)(4) Certification of Principal Executive Officer and Principal
      Financial Officer
 
 *
Management Contract or Compensatory Plan or
Arrangement.


72


SIGNATURESPursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act
      of 1934, the Registrant has duly caused this Report to be signed on its
      behalf by the undersigned, thereunto duly authorized.CECIL
      BANCORP, INC.Dated:
      March 26, 2010
            
            By:
            /s/
      Mary B. HalseyMary
      B. Halsey
              President
      and Chief Executive OfficerPursuant
      to the requirement of the Securities Exchange Act of 1934, this Report has
      been signed below by the following persons on behalf of the Registrant and
      in the capacities and on the dates
indicated.





By:
            /s/
      Mary B. Halsey
            Date:
            March
      26, 2010Mary
      B. Halsey
              President
      and Chief Executive Officer
              (Principal
      Executive Officer)By:
            /s/
      Robert Lee Whitehead
            Date:
            March
      26, 2010Robert
      Lee Whitehead
              Vice
      President and Chief Financial Officer
              (Principal
      Financial and Accounting Officer)By:
            /s/
      Charles F. Sposato
            Date:
            March
      26, 2010Charles
      F. Sposato
              Chairman
      of the BoardBy:
            /s/
      Matthew G. Bathon
            Date:
            March
      26, 2010Matthew
      G. Bathon
              DirectorBy:
            /s/
      William H. Cole, IV
            Date:
            March
      26, 2010William
      H. Cole, IV
              DirectorBy:
            /s/
      Brian L. Lockhart
            Date:
            March
      26, 2010Brian
      L. Lockhart
              DirectorBy:
            /s/ Mark
      W. Saunders
            Date:
            March
      26, 2010Mark
      W. Saunders
              DirectorBy:
            /s/
      Thomas L. Vaughan, Sr.
            Date:
            March
      26, 2010Thomas
      L. Vaughan, Sr.
              Director