f10k_123112-0424.htm

As of March 1, 2013 the registrant had 7,425,869 shares of Common Stock issued and outstanding. The aggregate market value of shares held by nonaffiliates was approximately $2.6 million based on the closing sale price of $0.70 per share of the registrant’s Common Stock on June 30, 2012. For purposes of this calculation, it is assumed that the 3,716,095 shares held by directors and officers and greater than 10% shareholders of the registrant are shares held by affiliates.

PART I
		Page
Item 1.	Business	3
Item 1A.	Risk Factors	19
Item 1B.	Unresolved Staff Comments	19
Item 2.	Properties	19
Item 3.	Legal Proceedings	20
Item 4.	Mine Safety Disclosures	20

PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	20
Item 6.	Selected Financial Data	21
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	40
Item 8.	Financial Statements and Supplementary Data	41
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	85
Item 9A.	Controls and Procedures	85
Item 9B.	Other Information	85

PART III

Item 10.	Directors, Executive Officers and Corporate Governance	86
Item 11.	Executive Compensation	87
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	87
Item 13.	Certain Relationships and Related Transactions, and Director Independence	87
Item 14.	Principal Accounting Fees and Services	87

PART IV

Item 15.	Exhibits, Financial Statement Schedules	87

Signatures		91

Cecil Bancorp, Inc. is the holding company for Cecil Bank (the “Bank”). The Company is a bank 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 to applicable limits 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.

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 and fixed-rate mortgage loans; (2) investing in adjustable-rate and short-term liquid investments; (3) controlling interest rate risk exposure; (4) improving asset quality; (5) containing operating expenses; and (6) maintaining “well capitalized” status.

Due to our elevated level of problem assets and recurring operating losses, there is substantial doubt about our ability to continue as a going concern. Management is taking steps to improve our financial condition. The consolidated financial statements and the accompanying footnotes have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and does not include any adjustment to reflect the possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result from the outcome of any extraordinary regulatory action, which would affect our ability to continue as a going concern.

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 523,076 shares (after adjusting for the 2-for-1 stock split approved by the Board of Directors in May 2011) 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 Series A 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.

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.

In order to conserve cash in the current uncertain economic environment, the Company’s Board of Directors determined that it was in the best interest of the Company and its stockholders to suspend the payment of dividends on the Series A Preferred Stock beginning with the dividend payable February 15, 2010. We may not declare or pay a dividend or other distribution on our common stock (other than dividends payable solely in common stock), and we generally may not directly or indirectly purchase, redeem or otherwise acquire any shares of common stock unless all accrued and unpaid dividends on the Series A Preferred Stock have been paid in full. Whenever six or more quarterly dividends, whether or

Effective June 29, 2010, the Company and the Bank entered into a written agreement with the Federal Reserve Bank of Richmond (the “Reserve Bank”) and the State of Maryland Commissioner of Financial Regulation (the “Commissioner”) pursuant to which the Company and the Bank have agreed to take various actions. Under the agreement, both the Company and the Bank have agreed to refrain from declaring or paying dividends without prior regulatory approval. The Company has agreed that it will not take any other form of payment representing a reduction in the Bank’s capital or make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without prior regulatory approval. The Company may not incur, increase, or guarantee any debt without prior regulatory approval and has agreed not to purchase or redeem any shares of its stock without prior regulatory approval.

On March 30, 2012, the Company completed the sale of 142,196 shares of Mandatory Convertible Cumulative Junior Preferred Stock, Series B (the “Series B Preferred Stock”) at $17.20 per share in cash for aggregate consideration of approximately $2.5 million, with offering costs of $35,000, and net proceeds of approximately $2.4 million. In April 2012, an additional 22,379 shares were sold for aggregate consideration of approximately $385,000. Total gross proceeds of the offering were $2.8 million, with offering costs of $35,000, and net proceeds of approximately $2.8 million. Upon shareholder approval of the amendment to the Company’s Articles of Incorporation to increase the authorized number of shares of common stock at the 2012 annual meeting, each share of Series B Preferred Stock became convertible into ten shares of common stock.

In the event of any liquidation, dissolution or winding up of the affairs of the Company, whether voluntary or involuntary, holders of the Series B Preferred Stock shall be entitled to receive for each share of the Series B 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 and after payment of liquidation amounts due the holders of Series A Preferred Stock, 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 B Preferred Stock as to such distribution, payment in full in an amount equal to the $17.20 liquidation preference amount per share. To the extent the assets or proceeds available for distribution to stockholders are not sufficient to fully pay the liquidation payments owing to the holders of the Series B Preferred Stock and the holders of any other class or series of our stock ranking equally with the Series B Preferred Stock, the holders of the Series B Preferred Stock and such other stock will share ratably in the distribution.

Each share of the Series B Preferred Stock is convertible at the option of the holder into ten whole shares of common stock plus such number of whole shares that would be obtained by dividing the dollar amount of accrued but unpaid dividends by the conversion price of $1.72. The minimum conversion price will be adjusted proportionately for stock dividends, stock splits and other corporate actions. No fractional shares of common stock will be issued on the conversion of the Series B Preferred Stock. In lieu of fractional shares, holders receive the cash value of such fractional share based on the closing price of the common stock on the date preceding the conversion. Holders may exercise conversion rights by surrendering the certificates representing the shares of Series B Preferred Stock to be converted to the Company with a letter of transmittal specifying the number of shares of Series B Preferred Stock that the holder wishes to convert and the names and addresses in which the shares of common stock are to be issued.

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.

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 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. Under the written agreement, the Company may not pay dividends without the prior written approval of the Federal Reserve.

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. Pursuant to the Written Agreement, the Bank may not pay dividends to the Company without the prior written approval of the Federal Reserve and the Commissioner.

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

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 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.

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 of insured deposits 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.

Starting in 2009, the FDIC significantly raised the assessment rate in order to restore the reserve ratio of the Deposit Insurance Fund to the statutory minimum of 1.15%. 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 increased within certain limits based on its levels of brokered deposits and asset growth.

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. The Bank exhausted its prepaid assessment during 2012.

The Dodd-Frank Act requires the FDIC to take such steps as necessary to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020. In setting the assessments, the FDIC is required to offset the effect of the higher reserve ratio against insured depository institutions with total consolidated assets of less than $10 billion. The Dodd-Frank Act also broadens the base for FDIC insurance assessments so that assessments will be based on the average consolidated total assets less average tangible equity capital of a financial institution rather than on its

The FDIC has adopted new assessment regulations that redefine the assessment base as average consolidated assets less average tangible equity. Insured banks with more than $1.0 billion in assets must calculate quarterly average assets based on daily balances while smaller banks and newly chartered banks may use weekly averages. Average assets are reduced by goodwill and other intangible assets. Average tangible equity equals Tier 1 capital. For institutions with more than $1.0 billion in assets, average tangible equity is calculated on a weekly basis, while smaller institutions may use the quarter-end balance. The base assessment rate for insured institutions in Risk Category I ranges between 5 to 9 basis points and for institutions in Risk Categories II, III, and IV, the assessment rates are 14, 23, and 35 basis points, respectively. An institution’s assessment rate is reduced based on the amount of its outstanding unsecured long-term debt and for institutions in Risk Categories II, III, and IV may be increased based on their brokered deposits. Risk Categories are eliminated for institutions with more than $10 billion in assets, which will be assessed at a rate between 5 and 35 basis points.

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 .008% of insured deposits on an annualized basis in fiscal year 2012. These assessments will continue until the FICO bonds mature in 2017.

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, 2012 impose capital ratio requirements on bank holding companies with assets of more than $500 million as of June 30 of the prior year. The Company, therefore, became subject to the Federal Reserve’s capital ratio requirements during 2010. Beginning September 30, 2011, the Company is no longer subject to the capital requirements on a consolidated basis since total assets have not exceeded $500 million for four consecutive quarters. The Bank continues to be subject to the Federal Reserve’s capital standards. The regulations of the Federal Reserve in effect at December 31, 2012, 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, 2012, 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;

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.

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, 2012, the Bank was well capitalized as defined in the Federal Reserve’s regulations.

The federal banking agencies have recently issued a series of proposed rulemakings to conform their regulatory capital rules with the international regulatory standards agreed to by the Basel Committee on Banking Supervision in the accord often referred to as “Basel III”. The proposed revisions would establish new higher capital ratio requirements, tighten the definitions of capital, impose new operating restrictions on banking organizations with insufficient capital buffers and increase the risk weighting of certain assets including residential mortgages. The proposed new capital requirements would apply to all banks and savings associations, bank holding companies with more than $500 million in assets and all savings and loan holding companies regardless of asset size. The following discussion summarizes the

New and Higher Capital Requirements. The proposed regulations would establish a new capital measure called “Common Equity Tier 1 Capital” which would consist of common stock instruments and related surplus (net of treasury stock), retained earnings, accumulated other comprehensive income and, subject to certain adjustments, minority common equity interests in subsidiaries. Unlike the current rules which exclude unrealized gains and losses on available-for-sale debt securities from regulatory capital, the proposed rules would generally require accumulated other comprehensive income to flow through to regulatory capital. Depository institutions and their holding companies would be required to maintain Common Equity Tier 1 Capital equal to 4.5% of risk-weighted assets by 2015.

The proposed regulations would increase the required ratio of Tier 1 Capital to risk-weighted assets from the current 4% to 6% by 2015. Tier 1 Capital would consist of Common Equity Tier 1 Capital plus Additional Tier 1 Capital elements which would include non-cumulative perpetual preferred stock. Neither cumulative preferred stock (other than cumulative preferred stock issued to the U.S. Treasury under the TARP Capital Purchase Program or the Small Business Lending Fund) nor trust preferred would qualify as Additional Tier 1 Capital. These elements, however, could be included in Tier 2 Capital which could also include qualifying subordinated debt. The proposed regulations would also require a minimum Tier 1 leverage ratio of 4% for all institutions eliminating the 3% option for institutions with the highest supervisory ratings. The minimum required ratio of total capital to risk-weighted assets would remain at 8%.

Capital Buffer Requirement. In addition to higher capital requirements, depository institutions and their holding companies would be required to maintain a capital buffer of at least 2.5% of risk-weighted assets over and above the minimum risk-based capital requirements. Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement would be phased in over four years beginning in 2016. The capital buffer requirement effectively raises the minimum required risk-based capital ratios to 7% Common Equity Tier 1 Capital, 8.5% Tier 1 Capital and 10.5% Total Capital on a fully phased-in basis.

Changes to Prompt Corrective Action Capital Categories. The Prompt Corrective Action rules would be amended to incorporate a Common Equity Tier 1 Capital requirement and to raise the capital requirements for certain capital categories. In order to be adequately capitalized for purposes of the prompt corrective action rules, a banking organization would be required to have at least an 8% Total Risk-Based Capital Ratio, a 6% Tier 1 Risk-Based Capital Ratio, a 4.5% Common Equity Tier 1 Risk Based Capital Ratio and a 4% Tier 1 Leverage Ratio. To be well capitalized, a banking organization would be required to have at least a 10% Total Risk-Based Capital Ratio, an 8% Tier 1 Risk-Based Capital Ratio, a 6.5% Common Equity Tier 1 Risk Based Capital Ratio and a 5% Tier 1 Leverage Ratio.

Additional Deductions from Capital. Banking organizations would be required to deduct goodwill and other intangible assets (other than certain mortgage servicing assets), net of associated deferred tax liabilities, from Common Equity Tier 1 Capital. Deferred tax assets arising from temporary timing differences that could not be realized through net operating loss carrybacks would continue to be deducted if they exceed 10% of Common Equity Tier 1 Capital. Deferred tax assets that could be realized through NOL carrybacks would not be deducted but would be subject to 100% risk weighting. Defined benefit pension fund assets, net of any associated deferred tax liability, would be deducted from Common Equity Tier 1 Capital unless the banking organization has unrestricted and unfettered access to such assets. Reciprocal cross-holdings in the capital instruments of any other financial institution would now be deducted from capital, not just holdings in other depository institutions. For this purpose, financial institutions are broadly defined to include securities and commodities firms, hedge and private equity funds and non-depository lenders. Banking organizations would also be required to deduct non-significant investments (less than 10% of outstanding stock) in other financial institutions to the extent these exceed 10% of Common Equity Tier 1 Capital subject to a 15% of Common Equity Tier 1 Capital cap. Greater than 10% investments must be deducted if they exceed 10% of Common Equity Tier 1 Capital. If the aggregate amount of certain items excluded from capital deduction due to a 10% threshold exceeds 17.65% of Common Equity Tier 1 Capital, the excess must be deducted. Savings associations would continue to be required to

Changes in Risk-Weightings. The proposed regulations would apply a 250% risk-weighting to mortgage servicing rights, deferred tax assets that cannot be realized through NOL carrybacks and significant (greater than 10%) investments in other financial institutions. The proposed rules would also significantly change the risk-weighting for residential mortgages. Current capital rules assign a 50% risk-weighting to “qualifying mortgage loans” which generally consist of residential first mortgages with an 80% loan-to-value ratio (or which carry mortgage insurance that reduces the bank’s exposure to 80%) that are not more than 90 days past due. All other mortgage loans have a 100% risk weight. Under the proposed regulations, one-to-four family residential mortgage loans would be divided into two broad risk categories with their risk-weighting determined by their loan-to-value ratio without regard to mortgage insurance. Prudently underwritten 30-year residential mortgages providing for regular periodic payments that do not result in negative amortization or balloon payments or allow payment deferrals and caps on annual and lifetime interest rate adjustments and which are not more than 90 days past due would be assigned a risk weighting from 35% for loans with a 60% or lower loan-to-value ratio to 100% for loans over 90%. Residential mortgage loans in this category with a loan-to-value ratio greater than 60% but not more than 80% would continue to carry a 50% risk weighting. All other residential mortgage loans would be risk-weighted between 100% to 200%. The proposal also creates a new 150% risk-weighting category for “high volatility commercial real estate loans” which are credit facilities for the acquisition, construction or development of real property other than one- to four-family residential properties or commercial real projects where: (i) the loan-to-value ratio is not in excess of interagency real estate lending standards; and (ii) the borrower has contributed capital equal to not less than 15% of the real estate’s “as completed” value before the loan was made.

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

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 one banking office 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.

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 30 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 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, or 30 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.

lien on residential real estate. The total of first and second liens may not exceed a 90% loan to value ratio. Second mortgage 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.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) prohibits lenders from making residential mortgages unless the lender makes a reasonable and good faith determination that the borrower has a reasonable ability to repay the mortgage loan according to its terms. A borrower may recover statutory damages equal to all finance charges and fees paid within three years of a violation of the ability-to-repay rule an may raise a violation as a defense to foreclosure at any time. As authorized by the Dodd-Frank Act, the Consumer Financial Protection Bureau (“CFPB”) has adopted regulations defining “qualified mortgages” that would be presumed to comply with the Dodd-Frank Act’s ability-to-repay rules. Under the CFPB regulations, qualified mortgages must satisfy the following criteria: (i) no negative amortization, interest-only payments, balloon payments, or a term greater than 30 years; (ii) no points or fees in excess of 3% of the loan amount for loans over $100,000; (iii) borrower’s income and assets are verified and documented; and (iv) the borrower’s debt-to-income ratio may not exceed 43%. Qualified mortgages are conclusively presumed to comply with the ability-to-repay rule unless the mortgage is a “higher cost” mortgage, in which case the presumption is rebuttable. The CFPB rule offers a temporary exemption for mortgage loans eligible for resale to FNMA or FHLMC or eligible for insurance by FHA, VA, or USDA. The CFPB rules are scheduled to take effect on January 10, 2014.

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 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. During 2011, the Bank began making loans under the Small Business Administration (“SBA”) Section 7(a) program, under which the SBA guarantees up to 75% of loans of up to $5 million for the purchase or expansion of small businesses. The Bank may sell the guaranteed portion of SBA loans into the secondary market and retain the unguaranteed portion in its portfolio. Pursuant to the written agreement with the Reserve Bank and the Commissioner, the Bank has adopted a plan for monitoring the risks of its commercial real estate loan portfolio which includes the reduction of certain concentrations in the portfolio.

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 published 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, 2012, the Bank’s loans to one borrower cannot exceed $6,237,000.

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, 2012, the Bank was servicing $43.7 million in loans for other financial institutions. For the years ended December 31, 2012 and 2011, the Bank recognized gross servicing income of $209,000 and $214,000, respectively, and total loan fee income of $619,000 and $896,000, respectively.

Mortgage-Backed Securities. The Bank maintains a portfolio of mortgage-backed securities in the form of Government National Mortgage Association (“GNMA”), FNMA, and FHLMC participation certificates. GNMA certificates are guaranteed as to principal and interest by the full faith and credit of the United States, while FNMA and FHLMC certificates are guaranteed by the agencies. Since FNMA and FHLMC has been place in receivership, however, their obligations are effectively guaranteed by the U.S. Treasury. 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 it 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.

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 and businesses. 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 and Finance 500, Inc. The Bank may use this market to meet liquidity needs. At December 31, 2012, 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. The Bank may also draw on a secured line of credit with the Community Bankers’ Bank.

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 wealth management and 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 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.

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

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.

In order to conserve capital in the current uncertain economic environment, the Company’s Board of Directors determined that it was in the best interests of the Company and its stockholders not to declare a dividend on its common stock beginning in 2010 and not to declare the dividends payable beginning in 2010 on its Series A Preferred Stock. Additionally, the Company has not declared any dividends on its Series B Preferred Stock since its issuance in March 2012. 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 Series A and Series B Preferred Stock 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.

(Dollars in thousands, except per share data)	2012			2011			2010			2009			2008
RESULTS OF OPERATIONS:
Interest Income	$	18,723		$	21,359		$	27,467		$	30,296		$	29,451
Interest Expense		6,350			7,834			10,335			12,428			14,313
Net Interest Income		12,373			13,525			17,132			17,868			15,138
Provision for Loan Losses		7,514			6,958			5,340			10,640			3,405
Net Interest Income after Provision for Loan Losses		4,859			6,567			11,792			7,228			11,733
Noninterest Income		2,646			1,368			2,065			2,169			1,138
Noninterest Expenses		19,943			15,455			12,096			13,159			10,015
(Loss) Income before Income Taxes		(12,438	)		(7,520	)		1,761			(3,762	)		2,856
Income Tax Expense (Benefit)		7,895			(2,815	)		649			(1,282	)		1,005
Net (Loss) Income		(20,333	)		(4,705	)		1,112			(2,480	)		1,851
Preferred Stock Dividends and Discount Accretion		(945	)		(725	)		(715	)		(791	)		-
Net (Loss) Income Available to Common Stockholders		(21,278	)		(5,430	)		397			(3,271	)		1,851

PER COMMON SHARE DATA: (1)
Basic Net (Loss) Income Per Common Share	$	(2.87	)	$	(.73	)	$	.06		$	(.45	)	$	.25
Diluted Net (Loss) Income Per Common Share		(2.87	)		(.73	)		.06			(.45	)		.25
Dividends Declared Per Common Share		.00			.00			.00			.0375			.05
Book Value (at year end) (2)		0.00			2.84			3.59			3.53			3.92
Tangible Book Value (at year end) (2), (3)		(0.06	)		2.78			3.53			3.48			3.58

FINANCIAL CONDITION (at year end):
Assets	$	439,821		$	463,671		$	487,195		$	509,819		$	492,397
Loans, net		296,454			317,850			364,842			424,047			401,749
Investment Securities		37,391			33,401			11,648			6,413			12,012
Deposits		341,219			339,075			358,138			382,338			364,551
Stockholders’ Equity		14,151			32,315			37,608			36,979			40,392

PERFORMANCE RATIOS (for the year):
Return on Average Assets		-4.44	%		-.99	%		.22	%		-.49	%		.42	%
Return on Average Equity		-71.08			-13.18			2.93			-6.30			6.47
Net Interest Margin		3.23			3.46			3.90			3.90			3.78
Efficiency Ratio (4)		132.79			103.77			63.01			65.67			61.53
Dividend Payout Ratio		0.00			0.00			0.00			-8.46			20.41

CAPITAL AND CREDIT QUALITY RATIOS:
Average Equity to Average Assets		6.24	%		7.53	%		7.57	%		7.85	%		6.56	%
Allowance for Loan Losses to Loans		3.36			3.76			3.97			3.27			1.55
Nonperforming Assets to Total Assets		20.48			20.39			17.59			9.66			2.70
Net Charge-offs to Average Loans		3.07			2.81			1.14			.63			.05

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’s business strategy is to operate as an independent community-oriented financial institution funded primarily by retail deposits.

	2012							2011							2010
(Dollars in thousands)	Average Balance		Interest		Yield/ Cost			Average Balance		Interest		Yield/ Cost			Average Balance		Interest		Yield/ Cost
Assets:
Loans (2)	$	313,879	$	18,155		5.78	%	$	342,723	$	20,935		6.11	%	$	405,432	$	27,131		6.69	%
Investment securities		33,562		386		1.15			20,959		300		1.43			9,039		229		2.53
Other earning assets		36,068		182		0.50			27,310		124		0.45			25,126		107		0.42
Total earning assets		383,509		18,723		4.88			390,992		21,359		5.46			439,597		27,467		6.25
Other assets		74,656							83,346							61,918
Total assets	$	458,165						$	474,338						$	501,515
Liabilities and Stockholders’ Equity:
Deposits	$	342,473		3,737		1.09	%	$	346,046		4,480		1.29	%	$	372,794		6,681		1.79	%
FHLB advances		57,085		2,142		3.75			63,506		2,462		3.88			63,577		2,464		3.88
Junior subordinated debentures		17,000		452		2.66			17,000		833		4.90			17,000		1,147		6.74
Other borrowed funds		1,168		19		1.68			1,169		59		5.06			890		43		4.87
Total interest- bearing liabilities		417,726		6,350		1.52			427,721		7,834		1.83			454,261		10,335		2.28
Net interest income and spread			$	12,373		3.36	%			$	13,525		3.63	%			$	17,132		3.97	%
Noninterest- bearing liabilities		11,832							10,916							9,307
Total liabilities		429,558							438,637							463,568
Stockholders’ equity		28,607							35,701							37,947
Total liabilities and stockholders’ equity	$	458,165						$	474,338						$	501,515

Net Interest \ Margin						3.23	%						3.46	%						3.90	%
Average interest earning assets to interest bearing liabilities						91.81	%						91.41	%						96.77	%

Net loss was $20.3 million for the year ended December 31, 2012, an increase of $15.6 million from the $4.7 million loss for 2011. The increase in net loss is primarily the result of a $10.7 million, or 380.5%, increase in income tax expense, a $1.2 million, or 8.5%, decrease in net interest income, a $4.5 million, or 29.0%, increase in noninterest expense, partially offset by a $1.3 million, or 93.4%, increase in noninterest income. Net loss available to common stockholders was $21.3 million for the year ended December 31, 2012, an increase of $15.9 million from net loss available to common stockholders of $5.4 million for 2011. Net loss available to common stockholders includes preferred stock dividends and discount accretion totaling $945,000 and $725,000, respectively, for the years ended December 31, 2012 and 2011. Basic and diluted loss per common share for 2012 were both $2.87, up $2.14 from corresponding 2011 basic and diluted loss per common share amounts of $0.73. The return on average assets and return on average equity were -4.44% and -71.08%, respectively, for the year ended December 31, 2012. This compares to a return on average assets and return on average equity of -0.99% and -13.18%, respectively, for 2011.

Net interest income, the Company’s primary source of income, decreased $1.1 million, or 8.5%, to $12.4 million for the year ended December 31, 2012, from $13.5 million for the year ended December 31, 2011 primarily due to a decline in the weighted average yield earned on earning assets. Average interest-earning assets decreased $7.5 million, or 1.9%. The weighted average yield on interest-earning assets decreased 58 basis points to 4.88% for the year ended December 31, 2012 from 5.46% for the year ended December 31, 2011. The weighted average rate paid on interest-bearing liabilities decreased 31 basis points to 1.52% for the year ended December 31, 2012 from 1.83% for the year ended December 31, 2011. The net interest spread decreased to 3.36% for 2012 from 3.63% for 2011 and the net interest margin decreased to 3.23% for 2012 from 3.46% for 2011.

Interest and fees on loans receivable decreased by $2.8 million, or 13.3%, to $18.1 million for the year ended December 31, 2012 from $20.9 million for the year ended December 31, 2011. The decrease is attributable to a decrease in the average balance and a decline in the average yield earned. The average balance of loans receivable outstanding decreased $28.8 million, or 8.4%, to $313.9 million for the year ended December 31, 2012 from $342.7 million for the year ended December 31, 2011. The weighted average yield decreased to 5.78% for the year ended December 31, 2012 from 6.11% for the year ended December 31, 2011.

Interest on investment securities increased by $86,000, or 28.7%, to $386,000 for the year ended December 31, 2012 from $300,000 for the year ended December 31, 2011. The increase is attributable to an increase in the average balance outstanding, partially offset by a decrease in the weighted average yield. The average balance outstanding increased $12.6 million, or 60.1%, to $33.6 million for the year ended December 31, 2012 as compared to $21.0 million for the year ended December 31, 2011. The weighted average yield decreased to 1.15% for the year ended December 31, 2012 from 1.43% for the year ended December 31, 2011.

Dividends on Federal Home Loan and Federal Reserve Bank stock increased $52,000, or 76.5%, to $120,000 for the year ended December 31, 2012 from $68,000 for the year ended December 31, 2011 primarily due to an increase in the dividend rate paid by FHLB. The average balance outstanding decreased $166,000, or 3.8%, to $4.2 million for the year ended December 31, 2012 from $4.4 million for the year ended December 31, 2011. The weighted average yield increased to 2.86% for the year ended December 31, 2012 from 1.56% for the year ended December 31, 2011.

Interest expense on deposits decreased $743,000, or 16.6%, to $3.7 million for the year ended December 31, 2012 from $4.5 million for the year ended December 31, 2011. The decrease was the result

of decreases in the average cost of funds and the average balance. The weighted average cost decreased to 1.09% for the year ended December 31, 2012 from 1.29% for the year ended December 31, 2011. The average balance outstanding decreased $3.6 million, or 1.0%, to $342.5 million for the year ended December 31, 2012 from $346.1 million for the year ended December 31, 2011.

Interest expense on junior subordinated debentures decreased $381,000, or 45.7%, to $452,000 for the year ended December 31, 2012 from $833,000 for the year ended December 31, 2011 due to a decline in the weighted average rate. The interest rate on $10.0 million of the junior subordinated debentures began to adjust quarterly on April 1, 2011 to 3-month LIBOR + 1.38%. The interest rate on the remaining $7.0 million of the junior subordinated debentures began to adjust quarterly on March 7, 2012 to 3-month LIBOR + 1.68%. The weighted average cost decreased to 2.66% for the year ended December 31, 2012 from 4.90% for the year ended December 31, 2011. The average balance outstanding remained level at $17.0 million for the years ended December 31, 2012 and 2011.

Interest expense on advances from the Federal Home Loan Bank of Atlanta decreased $320,000, or 13.0%, to $2.1 million for the year ended December 31, 2012 from $2.5 million for the year ended December 31, 2011. The average balance outstanding decreased $6.4 million, or 10.1%, to $57.1 million for the year ended December 31, 2012 from $63.5 million for 2011. The weighted average cost decreased to 3.75% for the year ended December 31, 2012 from 3.88% for the year ended December 31, 2011.

Interest expense on other borrowed funds (consisting of a last-in, first-out loan participation accounted for as a secured borrowing) decreased $40,000 to $19,000 for the year ended December 31, 2012 from $59,000 for the year ended December 31, 2011. The average balance outstanding remained level at $1.2 million for the years ended December 31, 2012 and 2011. The weighted average cost decreased to 1.68% for the year ended December 31, 2012 from 5.06% for the year ended December 31, 2011.

	2012 vs. 2011									2011 vs. 2010
	Increase			Due to Change						Increase			Due to Change
	or			In Average *						or			In Average *
(In thousands)	(Decrease)			Volume			Rate			(Decrease)			Volume			Rate

Interest income from earning assets:
Loans	$	(2,780	)	$	(1,704	)	$	(1,076	)	$	(6,196	)	$	(3,962	)	$	(2,234	)
Investment securities		86			154			(68	)		71			203			(132	)
Other interest-earning assets		58			16			42			17			6			11
Total Interest Income		(2,636	)		(402	)		(2,234	)		(6,108	)		(2,858	)		(3,250	)
Interest expense:
Interest bearing deposits		(743	)		(46	)		(697	)		(2,201	)		(452	)		(1,749	)
FHLB advances		(320	)		(243	)		(77	)		(2	)		(3	)		1
Junior subordinated debentures		(381	)		0			(381	)		(314	)		0			(314	)
Other borrowed funds		(40	)		0			(40	)		16			14			2
Total Interest Expense		(1,484	)		(179	)		(1,305	)		(2,501	)		(577	)		(1,924	)
Net Interest Income	$	(1,152	)	$	(223	)	$	(929	)	$	(3,607	)	$	(2,281	)	$	(1,326	)

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 by $556,000, or 8.0%, to $7.5 million for the year ended December 31, 2012 from $7.0 million for the year ended December 31, 2011 as a result of this analysis. (See “Allowance for Loan Losses.”)

Noninterest income increased $1.3 million, or 93.4%, to $2.6 million for the year ended December 31, 2012 from $1.4 million for the year ended December 31, 2011, primarily due to increases in gain on sale of loans and other noninterest income. Deposit account fees decreased $82,000, or 14.5%, to $483,000 for the year ended December 31, 2012 from $565,000 for the year ended December 31, 2011. ATM fees increased $18,000, or 4.0%, to $473,000 for the year ended December 31, 2012 from $455,000 for the year ended December 31, 2011. This increase is attributable to increased fees resulting from increases in cardholder usage. Gain on the sale of loans increased $1.1 million, or 269.2%, to $1.5 million for the year ended December 31, 2012 from $409,000 for the year ended December 31, 2011 primarily due to the Bank’s new Small Business Administration loan program, the guaranteed portions of which are sold in the secondary market. There were no gains/losses on investments for the year ended December 31, 2012 as compared to a $50,000 loss on investments in the year ended December 31, 2011. In 2011, we fully reserved against our investment in the debt issued by a private company after the investee began experiencing financial difficulties and it became probable that our investment would not be recovered. Income from bank owned life insurance decreased by $25,000, or 12.1%, to $181,000 for the year ended December 31, 2012 from $206,000 for the year ended December 31, 2011 due to a decrease in the crediting rate paid by the carriers. Other noninterest income increased by $213,000, or 78.3%, to $485,000 for the year ended December 31, 2012 from $272,000 for the year ended December 31, 2011 primarily due to an increase in rental income on other real estate owned.

Noninterest expense increased $4.5 million, or 29.0%, to $19.9 million for the year ended December 31, 2012 from $15.5 million for the year ended December 31, 2011, primarily due to an increase in other real estate owned expenses and valuations. The Company experienced an increase in salaries and employee benefits of $721,000, or 17.1%, to $4.9 million for the year ended December 31, 2012 from $4.2 million for the year ended December 31, 2011 primarily due to an increase in expense for the supplemental executive retirement plan, partially offset by a decline in officer salaries. Occupancy expense decreased $43,000, or 5.7%, to $716,000 for the year ended December 31, 2012 from $759,000 for the year ended December 31, 2011 primarily due to declines in office building repairs and maintenance, utilities, and rent expense on our leased properties. Professional fees increased $149,000, or 10.3%, to $1.6 million for the year ended December 31, 2012 from $1.5 million for the year ended December 31, 2011 primarily due to increased loan review consulting fees and audit and accounting expenses. The FDIC insurance premium expense decreased by $81,000, or 7.3%, to $1.0 million for the year ended December 31, 2012 from $1.1 million for the year ended December 31, 2011. Other real estate owned expenses and valuations increased by $4.9 million, or 143.3%, to $8.2 million for the year ended December 31, 2012 from $3.4 million for the year ended December 31, 2011 primarily due to the valuation of $2.4 million on 24 properties that were sold to one investor, as well as an increase in operating expenses associated with the increase in the number of properties owned. The Bank also continues to be proactive in adjusting the offering prices in an attempt to resolve these nonperforming assets. Loan collection expense decreased by $1.2 million, or 67.6%, to $586,000 for the year ended December 31, 2012 from $1.8 million for the year ended December 31, 2011. Other expenses increased by $133,000, or 9.3%, to $1.6 million for the year ended December 31, 2012 from $1.4 million for the same period in 2011 primarily due to an increase in insurance expense, partially offset by a decline in real estate taxes.

The Company’s assets decreased by $23.9 million, or 5.1%, to $439.8 million at December 31, 2012 from $463.7 million at December 31, 2011 primarily as a result of decreases in loans receivable, deferred tax assets, assets held for sale, and income tax receivable. The funds received from the decline in loans receivable, the sale of assets held for sale, the sale of preferred stock, and the increase in deposits were used to invest in investment securities, repay a maturing advance from the Federal Home Loan Bank of Atlanta, with the excess retained as cash. Cash and cash equivalents increased by $7.4 million, or 21.5%, to $41.8 million at December 31, 2012 from $34.4 million at December 31, 2011 primarily due to the decline in loans receivable, the sale of assets held for sale, the sale of preferred stock, and an increase in deposits, partially offset by the repayment of maturing FHLB advances and the purchase of investment securities. Investment securities available-for-sale increased by $9.8 million, or 41.6%, to $33.5 million at December 31, 2012 from $23.7 million at December 31, 2011. Investment securities held-to-maturity decreased by $5.8 million, or 60.1%, to $3.9 million at December 31, 2012 from $9.7 million at December 31, 2011. In total, there was a net increase of $4.0 million, or 11.9%, in investment securities primarily due to the cash received from the decline in loans receivable.

The gross loans receivable portfolio decreased by $23.5 million, or 7.1%, to $306.8 million at December 31, 2012 from $330.3 million at December 31, 2011. The decrease in loans receivable reflects a tightening of the Bank’s lending standards, diminished loan demand, and the transfer of nonperforming loans to other real estate owned. Management has also sought to shrink the loan portfolio in order to improve capital ratios. During the period, we realized a $5.3 million (8.4%) decline in construction and land development loans, a $20.2 million (18.3%) decrease in 1-4 family residential and home equity loans, an $848,000 (19.0%) increase in multi-family residential loans, a $1.8 million (1.3%) increase in commercial real estate loans, a $30,000 (0.4%) increase in commercial business loans, and a $732,000 (25.3%) decline in consumer loans. The allowance for loan losses decreased by $2.1 million, or 17.0%, to $10.3 million at December 31, 2012 from $12.4 million at December 31, 2011 (see “Allowance for Loan Losses” below).

Other real estate owned increased $2.9 million, or 9.4%, to $33.9 million at December 31, 2012 from $31.0 million at December 31, 2011 due to the acquisition of additional properties in satisfaction of loans receivable. At December 31, 2012, $5.6 million of the other real estate owned balance consists of properties that have been sold. The properties, however, cannot be accounted for as a sale because the Bank provided 100% financing to the purchaser. Once the purchaser contributes the required minimum investment, the sale will be reflected in the financial statements. Deferred tax assets decreased $9.3 million, or 100%, to zero at December 31, 2012 from $9.3 million at December 31, 2011. The Company established a full valuation allowance on its deferred tax assets during the third quarter of 2012, resulting in income tax expense of $9.1 million during the three months ended September 30, 2012. The establishment of the valuation allowance does not preclude the Company from realizing these assets in the future, and the valuation allowance complies with accounting principles generally accepted in the United States. Assets held for sale decreased $5.9 million, or 100%, to zero at December 31, 2012 from $5.9 million at December 31, 2011 due to the settlement on premises held for sale and our investment in Elkton Senior Apartments LLC. Income tax receivable decreased by $1.5 million, or 28.5%, to $3.8 million at December 31, 2012 from $5.3 million at December 31, 2011 primarily due to income tax refunds received during the year. Other assets increased $482,000, or 24.9%, to $2.4 million at December 31, 2012 from $1.9 million at December 31, 2011 primarily due to a receivable from a settlement

The Company’s liabilities decreased $5.7 million, or 1.3%, to $425.7 million at December 31, 2012 from $431.4 million at December 31, 2011. Deposits increased $2.1 million, or 0.6%, to $341.2 million at December 31, 2012 from $339.1 million at December 31, 2011. NOW and money market accounts increased by $7.3 million (14.4%), savings accounts decreased by $188,000 (0.9%), certificates of deposit decreased by $6.6 million (2.7%), and checking accounts increased by $1.6 million (6.9%). Other liabilities increased by $2.3 million, or 21.2%, to $12.9 million at December 31, 2012 from $10.6 million at December 31, 2011 primarily due to increases in accrued interest on junior subordinated debentures, accrued dividends on preferred stock, the payable to investors for loans sold with servicing retained, and the supplemental executive retirement plan liability. Advances from the Federal Home Loan Bank of Atlanta declined by $10.0 million, or 15.8%, to $53.5 million at December 31, 2012 from $63.5 million at December 31, 2011 due to the repayment of a fixed rate advance that matured in the second quarter 2012.

The Company’s stockholders’ equity decreased by $18.2 million, or 56.2%, to $14.2 million at December 31, 2012 from $32.3 million at December 31, 2011. This decrease is primarily due to the net loss of $20.3 million, as well as the accrual of preferred stock dividends (included in other liabilities on the balance sheet) totaling $788,000. These decreases were partially offset by $2.8 million in proceeds from the sale of Series B Preferred Stock during the year.

The Bank’s total gross loans declined by $23.5 million, or 7.1%, during 2012. During the period, we realized a $5.3 million (8.4%) decline in construction and land development loans, a $20.2 million (18.3%) decrease in 1-4 family residential and home equity loans, an $848,000 (19.0%) increase in multi-family residential loans, a $1.8 million (1.3%) increase in commercial real estate loans, a $30,000 (0.4%) increase in commercial business loans, and a $732,000 (25.3%) decline in consumer loans. The decline in loans receivable reflects the Bank’s tightened lending standards, diminished loan demand, and the transfer of nonperforming loans to other real estate owned, as well as efforts to shrink the balance sheet in order to improve capital ratios. The following table shows the composition of the loan portfolio at December 31.

(In thousands)	2012			2011			2010			2009			2008
Real estate loans:
Construction and land development	$	57,731		$	62,998		$	81,598		$	105,093		$	108,094
1-4 family residential and home equity		90,406			110,621			117,093			129,847			129,581
Multi-family residential		5,306			4,458			5,123			7,227			6,852
Commercial		143,263			141,438			158,799			172,703			143,126
Total real estate loans		296,706			319,515			362,613			414,870			387,653
Commercial business loans		7,879			7,849			13,513			19,290			15,995
Consumer loans		2,166			2,898			3,793			4,238			4,415
Gross loans		306,751			330,262			379,919			438,398			408,063
Less allowance for loan losses		(10,297	)		(12,412	)		(15,077	)		(14,351	)		(6,314	)
Net loans	$	296,454		$	317,850		$	364,842		$	424,047		$	401,749

	At December 31, 2012
	Remaining Maturities of Selected Credits in Years
(In thousands)	1 or Less		Over 1-5		Over 5		Total
Real estate:
Mortgage	$	85,596	$	178,284	$	17,862	$	281,742
Home equity and second mortgages		5,963		7,123		1,878		14,964
Commercial		3,696		3,948		235		7,879
Consumer		925		982		259		2,166
Total	$	96,180	$	190,337	$	20,234	$	306,751

Rate Terms:
Fixed	$	30,389	$	34,304	$	19,876	$	84,569
Variable or adjustable		65,791		156,033		358		222,182
Total	$	96,180	$	190,337	$	20,234	$	306,751

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 collectability of loans and prior loan loss experience. The allowance is based on 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 determination of a specific allowance, a formula allowance, and an unallocated allowance. During the year ended December 31, 2012, there were no changes in the Bank’s methodology for assessing the appropriateness of the allowance.

The formula allowance is calculated by applying loss factors to corresponding categories of outstanding loans, 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 historical charge-off experience. During regulatory examinations each year,

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 in which the Bank is located 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 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, 2012 was $10.3 million, (3.36% of total loans), a decrease of $2.1 million (17.0%) from the $12.4 million allowance (3.76% of total loans) at December 31, 2011. Net charge-offs for the year ended December 31, 2012 were 3.07% of average loans, as compared to net charge-offs of 2.81% of average loans for 2011. The provision for loan losses required for the years ended December 31, 2012 and 2011 was $7.5 million and $7.0 million, respectively. A summary of activity in the allowance is shown below.

	Years Ended December 31,
(Dollars in thousands)	2012			2011			2010			2009			2008

Balance of allowance, January 1	$	12,412		$	15,077		$	14,351		$	6,314		$	3,109
Loan charge-offs:
Construction and land development		(7,198	)		(2,595	)		(2,431	)		(1,799	)		-
1-4 family residential		(1,906	)		(851	)		(1,235	)		(424	)		(38	)
Multi-family residential		-			-			(866	)		-			(151	)
Commercial real estate		(1,056	)		(5,993	)		-			(845	)		-
Commercial loans		(202	)		(982	)		(100	)		(88	)		(97	)
Consumer		(209	)		(40	)		(94	)		(72	)		(42	)
Total charge-offs		(10,571	)		(10,461	)		(4,726	)		(3,228	)		(328	)
Loan recoveries:
Construction and land development		20			26			-			-			-
1-4 family residential		26			10			56			3			-
Multi-family residential		-			-			-			-			-
Commercial real estate		768			789			25			606			-
Commercial loans		121			-			1			-			110
Consumer		7			13			30			16			18
Total recoveries		942			838			112			625			128
Net charge-offs		(9,629	)		(9,623	)		(4,614	)		(2,603	)		(200	)
Provision for loan losses		7,514			6,958			5,340			10,640			3,405
Balance of allowance, December 31	$	10,297		$	12,412		$	15,077		$	14,351		$	6,314

Net charge-offs to average loans		3.07	%		2.81	%		1.14	%		0.63	%		0.05	%
Allowance to total loans		3.36	%		3.76	%		3.97	%		3.27	%		1.55	%

	2012					2011					2010					2009					2008
			Credit					Credit					Credit					Credit					Credit
(Dollars in thousands)	Amount		Mix			Amount		Mix			Amount		Mix			Amount		Mix			Amount		Mix
Amount applicable to:
Real estate loans:
Construction and land development	$	5,624		19	%	$	4,234		19	%	$	7,268		21	%	$	6,360		24	%	$	2,819		26	%
1-4 family residential and home equity		2,378		29			2,323		34			1,480		31			2,168		30			200		32
Multi-family residential		32		2			14		1			51		1			45		2			0		2
Commercial		1,014		47			4,243		43			4,455		42			3,079		39			1,248		35
Total Real Estate Loans		9,048		97			10,814		97			13,254		95			11,652		95			4,267		95
Commercial business loans		582		2			636		2			637		4			357		4			1,806		4
Consumer Loans		13		1			169		1			174		1			52		1			241		1
Unallocated		654		0			793		0			1,012		0			2,290		0			0		0
Total allowance	$	10,297		100	%	$	12,412		100	%	$	15,077		100	%	$	14,351		100	%	$	6,314		100	%

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 increase in nonperforming assets is due to the continuing slow down in the real estate market. This slow down has resulted in the inability of investors to resell properties as originally anticipated, which has led to an increase in delinquencies. The Company continues to work with these customers, which has also led to an increase in restructured loans. The following table sets forth certain information with respect to nonperforming assets.

	December 31,
(Dollars in thousands)	2012			2011			2010			2009			2008
Non-accrual loans (1)	$	34,537		$	37,815		$	54,420		$	32,694		$	10,459
Loans 90 days past due and still accruing		0			0			0			0			0
Restructured loans (2)		25,581			25,771			13,283			11,959			0
Total non-performing loans (3)		60,118			63,586			67,703			44,653			10,459
Other real estate owned, net		33,871			30,966			17,994			4,594			2,843
Total non-performing assets	$	93,989		$	94,552		$	85,697		$	49,247		$	13,302

Non-performing loans to total loans		19.60	%		19.25	%		17.82	%		10.19	%		2.56	%
Non-performing assets to total assets		21.37	%		20.39	%		17.59	%		9.66	%		2.70	%
Allowance for loan losses to non-performing loans		17.13	%		19.52	%		22.27	%		32.14	%		60.37	%

(3) Performing loans considered potential problem loans, as defined and identified by management, amounted to $41,062,000 at December 31, 2012. 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.

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 also invests in securities backed by pools of SBA-guaranteed loans. 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 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.

(Dollars in thousands)	2012		2011		2010
Available-for-Sale:(1)
Mutual Funds-AMF Intermediate Mortgage Fund	$	136	$	135	$	133
Mutual Funds-AMF Ultra Short Mortgage Fund		573		576		581
Mutual Funds-AMF Short U.S. Government Fund		673		674		676
Equity Securities		482		362		359
SBA securitized loan pools		3,658		4,921		0
Other debt securities		732		3,167		0
Mortgage-backed Securities		27,250		13,821		410
Total		33,504		23,656		2,159

Held-to-Maturity:
U.S. Government and Agency (2)		250		750		750
SBA securitized loan pools		1,389		2,161		0
Other debt securities		500		1,500		0
Mortgage-backed Securities		1,748		5,334		8,689
Other		0		0		50
Total		3,887		9,745		9,489
Total Investment Securities (3)	$	37,391	$	33,401	$	11,648

	One Year or Less					One Year to Five Years					Five Years to Ten Years
			Weighted					Weighted					Weighted
			Average					Average					Average
(Dollars in thousands)	Amount		Yield			Amount		Yield			Amount		Yield
Available-for-Sale:
SBA securitized loan pools	$	—		—	%	$	1,077		3.63	%	$	2,581		0.86	%
Other debt securities		—		—			732		1.69			—		—
Mortgage Backed Securities		—		—			480		1.98			3,865		1.71
Held-to-Maturity:
U.S. Government and Agency		250		0.13			—		—			—		—
SBA securitized loan pools		—		—			1,389		0.91			—		—
Other debt securities		—		—			500		1.00			—		—
Mortgage Backed Securities		459		2.28			1,209		0.45			80		2.79
Total Debt Securities	$	709		1.15	%	$	5,387		1.14	%	$	6,526		1.34	%

	Over Ten Years					Total
			Weighted					Weighted
			Average					Average
(Dollars in thousands)	Amount		Yield			Amount		Yield
Available-for-Sale:
SBA securitized loan pools	$	—		—	%	$	3,658		1.42	%
Other debt securities		—		—			732		1.53
Mortgage Backed Securities		22,905		1.97			27,250		1.88
Held-to-Maturity:
U.S. Government and Agency		—		—			250		0.13
SBA securitized loan pools		—		—			1,389		0.91
Other debt securities		—		—			500		1.09
Mortgage Backed Securities		—		—			1,748		0.53
Total Debt Securities

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
(Address of principal executive office)			(ZIP Code)

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

	2012									2011
	Stock Price Range						Per Share			Stock Price Range						Per Share
Quarter	Low			High			Dividend			Low			High			Dividend
1st Quarter		$	0.35		$	0.75		$	0.000		$	1.00		$	1.75		$	0.000
2nd Quarter			0.64			0.90			0.000			0.55			1.29			0.000
3rd Quarter			0.40			0.90			0.000			0.55			1.01			0.000
4th Quarter			0.38			0.65			0.000			0.30			1.01			0.000
Total								$	0.000								$	0.000