Item 1. Business
General
Calvin B. Taylor Bankshares, Inc. (Company) was incorporated as a Maryland corporation on October 31, 1995. The Company owns all of the stock of Calvin B. Taylor Banking Company of Berlin, Maryland (Bank). The Bank, which commenced operation in 1890, is a commercial bank incorporated under the laws of the State of Maryland on December 17, 1907, with a main office located in Berlin, Maryland.
Location and Service Area
The Company, through the Bank, is engaged in a general commercial and retail banking business serving individuals, small- to medium-sized businesses, professional organizations, and governmental units. The Bank operates nine branches located throughout Worcester County, Maryland and one branch located in Sussex County, Delaware. The Bank draws most of its customer deposits and conducts most of its lending transactions within the communities in which these branches are located.
Much of the Bank’s service area is located along the shores of the Atlantic Ocean and has grown as both a resort and a retirement community. The principal components of the economy are tourism and agriculture. Berlin has a strong component of health-care related businesses. The tourist businesses of Ocean City, Maryland and Bethany, Delaware and the health-care facilities in Berlin, Maryland (including Berlin Nursing Home and Atlantic General Hospital) are among the largest employers in the counties.
Banking Products and Services
The Bank offers a full range of deposit services including checking, NOW, Money Market, and savings accounts, and time deposits including certificates of deposit. The transaction, savings, and certificate of deposit accounts are tailored to the Bank’s principal market areas at rates competitive to those offered in the area. The Bank also offers Individual Retirement Accounts (IRA), Health Savings Accounts, and Education Savings Accounts. All deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to the maximum amount allowed by law. The Bank solicits these accounts from individuals, businesses, associations and organizations, and governmental authorities. The Bank offers individual customers up to $50 million in FDIC insured deposits through the Certificate of Deposit Account Registry Services® (CDARS).
The Bank also offers a full range of short- to medium-term commercial and personal loans. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements), and purchase of equipment and machinery. Consumer loans include secured and unsecured loans for financing automobiles, home improvements, education, and personal investments. The Bank originates commercial and residential mortgage loans and real estate construction and acquisition loans. These lending activities are subject to a variety of lending limits imposed by state and federal law. The Bank lends to directors and officers of the Company and the Bank under terms comparable to those offered to other borrowers entering into similar loan transactions. The Board of Directors approves all loans to officers and directors and reviews these loans every six months.
Other bank services include cash management services, 24-hour ATM’s, debit cards, safe deposit boxes, travelers’ checks, direct deposit of payroll and social security funds, and automatic drafts for various accounts. The Bank offers bank-by-phone and Internet banking services, including electronic bill-payment, as well as electronic statement delivery to both commercial and retail customers. The Bank’s commercial customers can subscribe to a remote capture service that enables them to electronically capture check images and make on-line deposits. The Bank also offers non-deposit products including retail repurchase agreements.
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Competition
The Company and the Bank face strong competition in all areas of operations. The competition comes from entities operating in Worcester County, Maryland and Sussex County, Delaware and neighboring counties and includes branches of some of the largest banks in Maryland, Delaware, and Virginia. Its most direct competition for deposits historically has come from other commercial banks, savings banks, savings and loan associations, and credit unions operating in its service areas. The Bank also competes for deposits with money market mutual funds and corporate and government securities. The Bank competes for loans with the same banking entities, as well as mortgage banking companies and other institutional lenders. The competition for loans varies from time to time depending on certain factors. These factors include, among others, the general availability of lendable funds and credit, general and local economic conditions, current interest rate levels, conditions in the mortgage market, and other factors which are not readily predictable.
The Bank employs traditional marketing media including local newspapers and radio, to attract new customers. Bank officers, directors, and employees are active in numerous community organizations and participate in community-based events. These activities and referrals by satisfied customers result in new business.
Employees
As of December 31, 2009, the Bank employed 88 full-time equivalent employees. The Company's operations are conducted through the Bank. Consequently, the Company does not have separate employees. None of the employees of the Bank are represented by any collective bargaining unit. The Bank considers its relations with its employees to be good.
SUPERVISION AND REGULATION
The Company and the Bank are subject to state and federal banking laws and regulations which impose specific requirements or restrictions on, and provide for general regulatory oversight with respect to, virtually all aspects of operations. These laws and regulations are generally intended to protect depositors, not stockholders. The following is a summary of certain statutes, rules, and regulations affecting the Company and the Bank. To the extent that the following summary describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions.
Proposed legislative changes and the policies of various regulatory authorities may affect the operations of the Company and the Bank and those effects may be material. The Company is unable to predict the nature or the extent of the effect on its business and earnings that fiscal or monetary policies, economic controls, or new federal or state legislation may have in the future.
The Company
Bank Holding Company Act of 1956
The Company is a bank holding company within the meaning of the federal Bank Holding Company Act of 1956 ( BHCA). Under the BHCA, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and such additional information as the Federal Reserve may require. The Company's and the Bank’s activities are limited to banking, managing or controlling banks, furnishing services to or performing services for its Subsidiary, or engaging in any other activity that the Federal Reserve determines to be so closely related to banking or managing and controlling banks as to be a proper incident thereto.
Investments, Control, and Activities. With certain limited exceptions, the BHCA requires a bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring substantially all the assets of any bank, (ii) acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares), or (iii) merging or consolidating with another bank holding company.
In addition, and subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with regulations thereunder, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company acquiring "control" of a bank holding company, such as the Company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Because the Company's Common Stock is registered under the Securities Exchange Act of 1934, under Federal Reserve regulations, control will be rebuttably presumed to exist if a person acquires at least 10% of the outstanding shares of any class of voting securities of the Company. The regulations provide a procedure for challenge of the rebuttable control presumption.
Under the BHCA, the Company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in non-banking activities, unless the Federal Reserve, by order or regulation, has found those activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
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Source of Strength; Cross-Guarantee. Under Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which the Company might not otherwise do so. The Federal Reserve may require a bank holding company to terminate an activity or relinquish control of a nonbank subsidiary if the Federal Reserve determines that such activity or control poses serious risk to the financial soundness or stability of a subsidiary bank. Further, federal bank regulatory authorities have discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution's financial condition. The Bank may be required to indemnify, or cross-guarantee, the FDIC against losses it incurs with respect to any other bank controlled by the Company, which in effect makes the Company's equity investments in healthy bank subsidiaries available to the FDIC to assist any failing or failed bank subsidiary of the Company.
Gramm-Leach-Bliley Act
In November 1999, the Gramm-Leach-Bliley Act was signed into law. Among other things, the Act repeals the restriction, contained in the Glass-Steagall Act, on banks affiliating with securities firms. The Act permits bank holding companies to engage in a statutorily provided list of financial activities, including insurance and securities underwriting and agency activities, merchant banking, and insurance company portfolio investment activities. The Act also authorizes activities that are "complementary" to financial activities. The Act is intended to grant certain powers to community banks that larger institutions have accumulated on an ad hoc basis. While it is not possible to determine the full effect that the Act has had on the Company and the Bank, one possible consequence of the Act may be increased competition from larger institutions and other types of companies.
Securities Exchange Act of 1934
The Company’s common stock is registered with the Securities and Exchange Commission (SEC) under Section 12(g) of the Securities Exchange Act of 1934 (the Act). The Company is, therefore, subject to periodic and ad hoc information reporting, proxy solicitation rules, restrictions on insider trading, and other requirements of the Act.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act (SOX) of 2002 imposed additional disclosure requirements in the Company’s reports filed with the SEC. SOX defines new standards of independence for insiders, provides guidance for certain Board committees including the composition of those committees, and establishes corporate governance requirements.
The Bank
General. The Bank operates as a state nonmember banking association incorporated under the laws of the State of Maryland. It is subject to examination by the FDIC and the state department of banking regulation for each state in which it has a branch. The States and the FDIC regulate or monitor all areas of the Bank’s operations, including security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuances of securities, payment of dividends, interest rates payable on deposits, interest rates or fees on loans, establishment or closure of branches, corporate reorganizations, maintenance of books and records, and adequacy of staff training to carry on safe lending and deposit gathering practices. The FDIC requires the Bank to maintain certain capital ratios and imposes limitations on the Bank’s aggregate investment in real estate, bank premises, and furniture and fixtures. The Bank is required by the FDIC to prepare quarterly reports on the Bank’s financial condition.
Under provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), all insured institutions must undergo periodic on-site examination by the appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the agency against each institution or affiliate, as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC and the appropriate agency (and state supervisor when applicable). FDICIA also directs the FDIC to develop with other appropriate agencies a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition, or other report of any insured depository institution. FDICIA also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to: (i) internal controls, information systems, and audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset quality.
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Transactions With Affiliates and Insiders
The Bank is subject to Section 23A of the Federal Reserve Act, which places limits on the amount of loans or extensions of credit to, or investment in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. In addition, each covered transaction must meet specific collateral requirements. The Bank is also subject to Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. The Bank is subject to certain restrictions on extensions of credit to executive officers, directors, certain principal stockholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.
Community Reinvestment Act
The Community Reinvestment Act requires that the Bank shall be evaluated by its primary federal regulator with respect to its record in meeting the credit needs of its local community, including low and moderate income neighborhoods, consistent with safe and sound operations. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. The Bank received a satisfactory rating in its most recent evaluation.
The Bank Secrecy Act and USA Patriot Act
The Bank Secrecy Act of 1970 (BSA) requires financial institutions to assist federal agencies to detect and prevent money laundering by filing and/or maintaining reports of large cash transactions or other suspicious transactions involving cash. BSA is also referred to as anti-money laundering law as it is designed to detect money laundering, tax evasion, or other criminal activities.
In response to the terrorist attacks on September 11, 2001, Congress passed the Patriot Act. The Patriot Act requires that Banks prepare and retain additional records designed to assist the government in an effort to combat terrorism. The Act includes anti-money laundering and financial transparency provisions, and guidelines for verifying customer identification during account opening. The Act promotes cooperation between law enforcement, financial institutions, and financial regulators in identifying persons involved in illegal acts such as money laundering and terrorism.
Other Regulations
Interest and certain other charges collected or contracted for by the Bank are subject to state and federal laws concerning interest rates. The Bank’s loan operations are also subject to certain federal laws applicable to credit transactions, such as the federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers, the Real Estate Settlement Procedures Act requiring lenders to provide disclosures to consumers at various times during an applicable transaction and which outlaws kickbacks that increase the cost of settlement services, the Home Mortgage Disclosure Act of 1975 requiring financial institutions in metropolitan statistical areas to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves, the Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed, or other prohibited bases in extending credit, the Fair Credit Reporting Act of 1978 governing the use and provision of information to credit reporting agencies, the Fair Debt Collection Act governing the manner in which consumer debts may be collected by collection agencies, and the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws. The deposit operations of the Bank are subject to the Truth in Savings Act which governs disclosures of rate and fee information to consumer deposit customers, the Right to Financial Privacy Act which imposes a duty to maintain confidentiality of customers’ financial records and prescribes procedures for complying with administrative subpoenas of financial records, and the Electronic Fund Transfers Act as implemented by the Federal Reserve Board’s Regulation E which governs automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services.
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Deposit Insurance
The FDIC establishes rates for the payment of deposit insurance premiums by federally insured banks and thrifts. The Deposit Insurance Fund (DIF) is maintained for commercial banks and thrifts, with insurance premiums from the industry used to offset losses from insurance payouts when banks and thrifts fail. Since 1993, insured depository institutions like the Bank have paid for deposit insurance under a risk-based premium system. The Federal Deposit Insurance Reform Act of 2005 creates a revised deposit insurance assessment rate structure, effective January 1, 2007. Under this system, assessment rates are based on Risk Categories as determined by a combination of CAMELS component ratings and financial ratios. In addition to the amount paid for deposit insurance, banks are assessed an additional amount to service the interest on the bond obligations of the Financial Corporation (FICO). Any increase in deposit insurance premiums for the Bank will increase the Bank’s operating expenses, and there can be no assurance that such costs can be passed on to the Bank’s customers.
During 2009, as a consequence of recent bank and thrift failures, the DIF fell below target levels. FDIC replenished the fund in mid-2009 by levying a special assessment on insured depository institutions. This special assessment was expensed in the second quarter of 2009. Late in 2009, additional DIF replenishment was achieved by FDIC collecting prepaid insurance premiums from insured depository institutions in an amount calculated to cover premiums for 2010 through 2012. The prepaid amount was paid in December 2009 and will be expensed in the future periods to which it applies.
Dividends
The principal source of the Company's cash revenues comes from dividends received from the Bank. The amount of dividends that may be paid by the Bank to the Company depends on the Bank's earnings and capital position and is limited by federal and state laws, regulations, and policies. The Federal Reserve has stated that bank holding companies should refrain from or limit dividend increases or reduce or eliminate dividends under circumstances in which the bank holding company fails to meet minimum capital requirements or in which earnings are impaired.
The Company's ability to pay any cash dividends to its stockholders in the future will depend primarily on the Bank's ability to pay dividends to the Company. In order to pay dividends to the Company, the Bank must comply with the requirements of all applicable laws and regulations. Under Maryland law, the Bank must pay a cash dividend only from the following, after providing for due or accrued expenses, losses, interest, and taxes: (i) its undivided profits, or (ii) with the prior approval of the Department of Financial Regulation, its surplus in excess of 100% of its required capital stock. Under FDICIA, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. See "Capital Regulations" below. See Item 5 for a discussion of dividends paid by the Company in the past three years.
In addition to the availability of funds from the Bank, the future dividend policy of the Company is subject to the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, financial condition, cash needs, and general business conditions. The amount of dividends that might be declared in the future presently cannot be estimated and it cannot be known whether such dividends would continue for future periods.
Capital Regulations
The federal bank regulatory authorities have adopted risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, account for off-balance sheet exposure, and minimize disincentives for holding liquid assets. The resulting capital ratios represent qualifying capital as a percentage of total risk-weighted assets and off-balance sheet items. The guidelines are minimums, and the regulators have noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimums.
Current guidelines require bank holding companies and federally regulated banks to maintain a minimum ratio of total risk-based capital to risk-weighted assets equal to 8%, of which at least 4% must be Tier 1 capital. Tier 1 capital includes common stockholders' equity before the unrealized gains and losses on securities available for sale, qualifying perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, but excludes goodwill and most other intangibles, and excludes the allowance for loan losses. Tier 2 capital includes the excess of any preferred stock not included in Tier 1 capital, mandatory convertible securities, hybrid capital instruments, subordinated debt and intermediate term-preferred stock, and general reserves for loan losses up to 1.25% of risk-weighted assets. Total capital is the sum of Tier 1 plus Tier 2 capital. The federal bank regulatory authorities have also implemented a leverage ratio, which is Tier 1 capital as a percentage of average total assets less intangibles, to be used as a supplement to the risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base. The minimum required leverage ratio for top-rated institutions is 4%, but most institutions are required to maintain an additional cushion of at least 100 to 200 basis points.
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FDICIA established a new capital-based regulatory scheme designed to promote early intervention for troubled banks and requires the FDIC to choose the least expensive resolution of bank failures. The new capital-based regulatory framework contains five categories for compliance with regulatory capital requirements, including "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." To qualify as a "well capitalized" institution, a bank must have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a total risk-based capital ratio of no less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level. As of December 31, 2008, the Company and the Bank were qualified as "well capitalized." For further discussions, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Capital."
Recent Economic and Legislative Developments
Bank and thrift failures that began making news in late 2008, continued throughout 2009, and are expected to continue in 2010. Securitization of subprime, adjustable rate mortgage loans originated in the United States has been cited as contributing to a global economic recession. Other contributory factors include a pool of investors willing to tolerate the risks attached to high yield mortgage backed securities, complex investment products that were not understood by investors or auditors/examiners, and inadequate oversight. Although neither the Company nor the Bank originated or invested in subprime loans, the economic downturn has affected their ability to invest profitably and the ability of some customers to repay their loans.
The Federal Reserve Open Market Committee reduced the federal funds rate from 4.25% at the beginning of 2008 to a range of 0.00% to 0.25% at the end of 2008. This low rate remained through 2009. Other short-term investments have experienced similar declines. These rate reductions have not yet accomplished their goal of stimulating borrowing and lending activity. The impact on the Company is reduced interest revenues and yields on federal funds sold, debt securities, and certificates of deposit in other banks.
Late in 2008, the Troubled Asset Relief Program (TARP) empowered
U. S. Department of the Treasury to purchase or insure up to $700 billion of "troubled" mortgages and any securities based on those mortgages. These purchases are subject to the Secretary of Treasury’s determination that the action will promote financial market stability. TARP gives Treasury the authority to purchase non-liquid, difficult-to-value assets from banks and other financial institutions. TARP is intended to improve the liquidity of these assets by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses.
Within weeks of the establishment of TARP, Treasury determined that direct asset purchase might not be the most effective use of TARP funds, and announced that some of the funds would be used in the Capital Purchase Program (CaPP). Under CaPP, up to $250 billion in preferred securities could be purchased from major financial institutions on the assumption that stronger equity positions would better equip financial institutions to withstand the impact of troubled asset holdings and would encourage lending. Alternate means for deploying TARP funds and monitoring effectiveness of their distribution are the subject of ongoing debate by policy makers and analysts. The Company and the Bank did not seek this assistance and did not benefit directly from TARP funds.
Late in 2008, to bolster public confidence in the financial system and reduce potential investor losses, deposit insurance levels were raised from $100,000 to $250,000 per depositor in accounts other than certain retirement accounts which are already insured to $250,000. Additional insurance of all noninterest bearing transaction account balances is available to depositors in participating financial institutions. The Company and the Bank elected to participate in the Temporary Liquidity Guarantee Program (TLG), providing this additional insurance. These actions contributed to growth in deposit balances which began in fourth quarter 2008 and continued through 2009, as investors seek the safety of insured deposits in community banks. Deposit insurance premiums increase as a result of higher deposit balances, higher insurance limits, participation in TLG, and higher insurance rates. Management does not expect to pass all of the additional insurance premium costs on to customers.
In the most stable economic times, the Company cannot reliably predict the effect of changing government policies on earnings, or loan and deposit levels. The impact on future results of operation of the Company and the Bank due to turbulent economic times are uncertain. Management expects 2010 to continue the pattern of lower net interest income and higher fees associated with loan collection established in 2009. - 8 -
Item 1A.
Item 1A. Risk Factors
The Company and the Bank are subject to various types of risk during the normal conduct of business. There has been no material increase in any level of risk incurred by the Company or the Bank during the period covered by this report. Following are descriptions of the significant categories of risk most relevant to the Company.
Credit risk
Credit risk is the risk to the bank’s earnings or capital from the potential of an obligor to fulfill its contractual commitment to the bank. Credit risk is most closely associated with a bank’s lending. It encompasses the potential loss on a particular loan as well as the potential for loss from a group of related loans, i.e., a credit concentration. Credit risk also extends to less traditional bank activities. It includes the credit behind the bank’s investment portfolio.
A primary source of revenue for the Bank is lending, which is also the area of greatest credit risk. To ameliorate credit risk, the Board and management have adopted conservative lending practices. Board approved policies provide underwriting guidance. During the sustained economic downturn which continued through 2009, the Company has suffered historically high levels of delinquencies and loan losses. Management believes that delinquencies and loan losses would have been greater if past lending practices had been less conservative.
Individual loan authorities are low with no individual officer having a secured loan authority over $200,000 or unsecured authority over $100,000. One result of the low individual limits is that the Executive Committee or the full Board approves most mortgage loans and many commercial non-mortgages. The Bank’s product offerings are non-complex and no new loan products have been introduced this year.
Credit risk attributable to concentrations include the coastal geography in which the Bank operates and the hospitality industry associated with the local resorts. There are no significant concentrations related to an individual borrowing relationship.
Interest-rate risk
Interest rate risk is the risk to earnings or capital from the potential movement in interest rates. It is the sensitivity of the bank’s future earnings to interest rate changes. Interest rate risk is generally measured on the basis of duration analysis or gap analysis. Duration analysis measures the degree of risk in a particular instrument or portfolio and gap analysis defines the timing when loss may occur. In a community bank, an adequate interest rate risk measurement can be fairly simplistic.
The Bank controls interest rate risk by keeping both interest-bearing assets and liabilities short-term. As of December 31, 2009, approximately 96.3% of the Bank’s loans are either variable rate or written on demand, and investment securities generally mature within three years. The longest term offered on a customer certificate of deposit is 24 months. This strategy has carried the Bank through rate cycles successfully in the past.
Liquidity Risk
Liquidity risk is the risk to earnings or capital from a bank’s inability to meet its obligations when they come due without incurring unacceptable losses or costs. An example would be: Depositors withdrawing their deposits when the bank does not have the liquid assets to fund the withdrawals while meeting loan-funding obligations.
The Company’s consolidated liquidity ratio was 42.6% in 2009, 40.0% in 2008, and 42.0% in 2007. Based on these liquidity ratios and other available sources of funds, the Company anticipates that it will be able to fund loan demand and meet deposit withdrawal requests through the reduction of overnight investment in federal funds sold, maturity of investment securities, and, if necessary, borrowing against lines of credit with correspondent banks.
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Market Risk: Moderate
Market risk is the risk to earnings or capital from changes in the value of portfolios of financial instruments. For most banks market risk is the risk of a decline in market value of its securities portfolio. Because the value of bank securities is driven primarily by interest rates, market risk and interest-rate risk frequently go hand in hand.
The Bank generally invests in short term investment securities of high quality. Market rates influence the fair market value of the portfolio and, therefore, the carrying value of securities classified as available for sale. The impact on the Bank’s earnings relates to interest-rates and related risk. Management has not identified any investment securities as being other than temporarily impaired.
The regional, national, and international economic recession which deepened throughout 2008 appears to have bottomed in 2009. It has caused borrowers hardships that effect their ability to repay loans, resulting in the Bank experiencing upward moving delinquencies, higher than usual charge-offs, collateral repossessions, and mortgage foreclosures. Additionally, historically low market rates have reduced earnings on investments, including federal funds sold. Due to conservative investment practices, neither the Company nor the Bank has experienced portfolio value declines of significance. The Company and Bank expect the current adverse market conditions to continue to depress earnings for at least another year resulting in slower than usual growth in capital. The Company and the Bank have capital well in excess of the regulatory definition of well-capitalized which management expects to remain at that level.
Transaction Risk
Transaction risk is the risk to earnings or capital arising from problems with service or product delivery. Transaction risk is the risk of a failure in a bank’s operating processes. It is a risk of failure in a bank’s automation, its employee integrity, or its internal controls.
The Company and the Bank are subject to transaction risk. Management believes that a sound system of internal controls along with management and audit oversight control this risk at an acceptable level.
Compliance risk
Compliance risk is the risk to earnings or capital from noncompliance with laws, rules, and regulations. Compliance risk is often the greatest risk a bank faces. Compliance risk weighs heavily in every bank regardless of its size or products.
The Company and the Bank devote significant resources to meeting the challenge of complying with all applicable laws and regulations. Management employs a qualified compliance officer and uses supplementary legal or compliance resources as needed. Additionally, compliance is subject to examination by federal and state bank regulators.
Reputation risk
Reputation risk is the risk to earnings or capital from negative public opinion. Community and customer relations are critical to a bank’s success. A bank’s reputation is extremely important and anything that would impair that reputation is a significant risk.
Management and the Board consider the Bank’s reputation to be one of its most valuable non-financial assets. The Bank has earned a reputation for providing good customer service, exercising safe and sound banking practices, dealing fairly with customers, employees and vendors, and participating as a good neighbor in the community. The maintenance of these qualities requires continued commitment and effort.
Strategic Risk
Strategic risk is the risk to earnings or capital arising from adverse business decisions or improper implementation of those decisions. A bank's strategic plan is the route it is going to follow based on management’s perception of the future. If the plan is wrong or improperly implemented, the bank is at risk.
The Company’s Strategic Plan is general in nature, emphasizing customer service and profitability as its mission and profitability as its primary objective. The Plan mentions basic loan underwriting criteria as a foundation for asset quality. It includes sections on management succession and community involvement. The Plan does not include specific measurable goals or timeframes for goal achievement.
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Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The Company has ten branch locations, all of which are owned by the Company or the Bank. The Bank leases the land on which the East Berlin branch is located. The locations are described as follows:
Office Location Square Footage
Main Office, Berlin 24 North Main Street, 		Berlin, Maryland 21811 24,229
East Berlin Office 10524 Old Ocean City 		Boulevard, Berlin, Maryland 21811 1,500
20th Street 		Office 100 20th Street, 		Ocean City, Maryland 21842 3,100
Ocean Pines Office 11103 Cathell Road, Berlin, 		Maryland 21811 2,420
Mid-Ocean City Office 9105 Coastal Highway, Ocean 		City, Maryland 21842 1,984
North Ocean City Office 14200 Coastal Highway, Ocean 		City, Maryland 21842 2,545
West Ocean City Office 9923 Golf Course Road, Ocean 		City, Maryland 21842 2,496
Pocomoke Office 2140 Old Snow Hill Road, 		Pocomoke, Maryland 21851 2,624
Snow Hill Office 108 West Market Street, Snow 		Hill, Maryland 21863 3,773
Ocean View, Delaware Office 50 Atlantic Avenue, Ocean 		View, Delaware 19970 4,900
The Berlin office is the centralized location for the Company and the Bank. Executive offices, loan processing, proof, bookkeeping, and the computer department are housed there. Most branches have a manager who also serves as a loan officer. All offices participate in normal day-to-day banking operations. The Company operates automated teller machines in all branches and at one non-branch location in a local hospital.
Item 3.
Item 3. Legal Proceedings
(a) There are no material pending legal proceedings to which the Company 		or the Bank or any of their properties are subject.
		(b) No proceedings were terminated during the fourth quarter of the 		fiscal year covered by this report.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of the stockholders of the Company during the fourth quarter of the fiscal year covered by this report.
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PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company's Articles of Incorporation, as amended, authorize it to issue up to 10,000,000 shares of common stock.
As of February 28, 2010 there were approximately 1,012 stockholders of record and 3,000,508 shares of Common Stock issued and outstanding. There is no established public trading market in the stock, and there is no likelihood that a trading market will develop in the near future. Transactions in the common stock are infrequent and are frequently negotiated privately between the persons involved in those transactions.
All outstanding shares of common stock of the Company are entitled to share equally in dividends from funds legally available, when, as, and if declared by the Board of Directors. The Company paid or declared dividends of $.90 per share in 2009, $2.15 per share in 2008, and $.80 per share in 2007. Included in 2008 was a special cash dividend of $1.30 per share which is not expected to be an annual event.
The following table presents information about the Company’s repurchase of its equity securities during the calendar quarter ended on the date of this Form 10-K.
The Company publicly announced on August 14, 2003, that it would repurchase up to 10% of its outstanding equity stock at that time, which equated to a total of 324,000 common shares available for repurchase. As of January 1, 2005, and again on May 18, 2007, this plan was renewed by public announcement, making up to 10% of the Company’s outstanding equity stock available for repurchase at the time of each renewal. On January 13, 2010, as part of its capital planning, the Board of Directors voted to suspend until June 30, 2010, the stock buy-back program.
There is no expiration date for this program. No other stock repurchase plan or program existed or exists simultaneously, nor has any other plan or program expired during the period covered by this table. Common shares repurchased under this plan are retired. Through December 31, 2009, 239,492 shares have been retired under this program.
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Item 6.
Item 6. Selected Financial Data
The following table presents selected financial data for the five years ended December 31, 2009.
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Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation
The following discussion of the Company's financial condition and results of operations should be read in conjunction with the Company's financial statements and related notes and other statistical information included in this report.
Critical Accounting Policies
The Company’s financial condition and results of operations are sensitive to accounting measurements and estimates of inherently uncertain matters. When applying accounting policies in areas that are subjective in nature, management uses its best judgment to arrive at the carrying value of certain assets. One of the most critical accounting policies applied is related to the valuation of the loan portfolio.
The allowance for loan losses (ALLL) represents management’s best estimate of inherent probable losses in the loan portfolio as of the balance sheet date. It is one of the most difficult and subjective judgments. The adequacy of the allowance for loan losses is evaluated no less than quarterly. The determination of the balance of the allowance for loan losses is based on management’s judgments about the credit quality of the loan portfolio as of the review date. It should be sufficient to absorb losses in the loan portfolio as determined by management’s consideration of factors including an analysis of historical losses, specific reserves for non-performing or past due loans, delinquency trends, portfolio composition (including segment growth or shifting of balances between segments, products and processes, and concentrations of credit, both regional and by relationship), lending staff experience and changes, critical documentation and policy exceptions, risk rating analysis, interest rates and the competitive environment, economic conditions in the Bank’s service area, and results of independent reviews, including audits and regulatory examinations.
Overview
Consolidated income of the Company is derived primarily from operations of the Bank. Net income for 2009 was $5,109,609 compared to $6,059,217 for 2008, and $7,296,587 for 2007. The Company had a return on average equity of 7.11% and return on average assets of 1.32% for 2009, compared to returns on average equity of 8.22% and 10.05%, and returns on average assets of 1.65% and 1.96%, for 2008 and 2007, respectively.
Results of Operations
The Company’s net income of $5,109,609, or $1.69 per share, for the year ended December 31, 2009, was a decrease of $949,608 (15.67%) from net income of $6,059,217, or $1.97 per share, for the year ended December 31, 2008. Contributing to this decrease was a $618,834 (3.87%) decrease in net interest income, a $232,474 (37.65%) increase in the provision for loan losses, a $48,564 (2.38%) decrease in noninterest revenue, and a $561,304 (7.06%) increase in noninterest expense, offset by a $511,568 (15.11%) reduction in income tax expense. These factors are discussed further in the following pages.
The Company’s net income of $6,059,217, or $1.97 per share, for the year ended December 31, 2008, was a decrease of $1,237,370 (16.96%) from net income of 7,296,587, or $2.33 per share, for the year ended December 31, 2007. Contributing to this decrease was a $1,053,933 (6.19%) decrease in net interest income, a $617,526 increase in the provision for loan losses, a $390,177 (5.16%) increase in noninterest expense, offset by a $720,012 reduction in income tax expense.
The Company’s net income of $1,108,094 or $.37 per share, for the quarter ended December 31, 2009, was a modest increase of $20,155 (1.85%) from the net income of $1,087,939 or $.36 per share, for the quarter ended December 31, 2008. A lower quarterly provision for loan loss, the primary reason for the decrease, resulted from management’s assessment of the quality of the loan portfolio at the reporting date. See "Loan Quality and the Allowance for Loan Losses" for additional related disclosure and discussion.
The Company’s net income of $1,087,939 or $.36 per share, for the quarter ended December 31, 2008, was a decrease of $563,477 (34.12%) from the net income of $1,651,416 or $.53 per share, for the quarter ended December 31, 2007. An increased provision for loan loss, the primary reason for the decrease, resulted from management’s assessment of the quality of the loan portfolio at the reporting date. See "Loan Quality and the Allowance for Loan Losses" for additional related disclosure and discussion.
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Net Interest Income
The primary source of income for the Company is net interest income, which is the difference between revenue on interest-earning assets, such as investment securities and loans, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The level of net interest income is determined primarily by the average balances of interest-earning assets and the Company’s funding sources, and the rate spreads between interest-earning assets and funding sources. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, and increases or decreases in the average rates earned and paid on such assets and liabilities. The volume of interest-earning assets and interest-bearing liabilities is affected by the ability to manage the earning-asset portfolio, which includes loans, and the availability of particular sources of funds, such as noninterest-bearing deposits.
The key performance measure for net interest income is the "net margin on interest-earning assets," or net interest income divided by average interest-earning assets. The Company's net interest margin for 2009 on a non-GAAP tax-equivalent basis was 4.38%, compared to 4.77% and 5.07% for 2008 and 2007, respectively. Because most of the Bank’s loans are written with a demand feature, the income of the Bank should not change dramatically as interest rates change. Management of the Company expects to maintain the net margin on interest-earning assets. The net margin may decline, however, if competition increases, loan demand decreases, or the cost of funds rises faster than the return on loans and securities. Although such expectations are based on management's judgment, actual results will depend on a number of factors that cannot be predicted with certainty, and fulfillment of management's expectations cannot be assured.
The following tables present information including average balances of interest-earning assets and interest-bearing liabilities, the amount of related interest income and interest expense, and the resulting yields by category of interest-earning asset and interest-bearing liability. In these tables, dividends and interest on tax-exempt securities and loans are reported on a fully taxable equivalent basis, which is a non-GAAP measure as defined in SEC Regulation G and Item 10 of SEC Regulation S-K. Management believes that these measures provide better yield comparability as a tool for managing net interest income.
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In the preceding table, the variance that is both rate and volume related is reported with the rate variance.
Composition of Loan Portfolio
Because loans are expected to produce higher yields than investment securities and other interest-earning assets (assuming that loan losses are not excessive), the absolute volume of loans and the volume as a percentage of total earning assets is an important determinant of net interest margin. Average loans, net of the allowance for loan losses, were $241,370,000, $238,636,000, and $235,014,000, during 2009, 2008, and 2007, respectively, which constituted 67.36%, 69.65%, and 68.66%, of average interest-earning assets for the periods. The Company’s ratio of net loans to deposits was 76.78%, 82.55%, and 82.40%, at December 31, 2009, 2008, and 2007, respectively. Average net loans to average deposits were 78.67%, 83.09%, and 80.02%, for 2009, 2008, and 2007. The decrease in the average loan to deposit ratio from 2008 to 2009 is attributable to 1.15% growth in the average loan portfolio relative to 6.82% growth in average deposits during 2009. The increase in the average loan to deposit ratio from 2007 to 2008 is attributable to 1.54% growth in the average loan portfolio measure against a 2.21% reduction in average deposits during 2008.
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The Company extends loans primarily to customers located in and near Worcester County, Maryland and Sussex County, Delaware. Although the portfolio is diversified, its performance may be influenced by regional economic conditions. The Company has a substantial portion of its loans in real estate and performance will be influenced by the real estate market in the region. Additionally, the coastal geography is subject to catastrophic storms. The local agricultural and fishing community is subject to adverse weather conditions throughout their productive seasons. There is no adverse weather condition at the time of the valuation.
As of December 31, 2009, the Bank had approximately $39.8 million in secured and unsecured loans and unfunded lines to borrowers in the hospitality industry, including hotels, motels, and other rentals. Ocean City MD, the state’s only ocean resort, is located in the Bank’s market area. During summer months, Ocean City becomes Maryland’s second largest city through a seasonal population growth averaging 250,000. If tourism in the resort area falls off due to the current recession, this industry may encounter cash flow challenges. Management is monitoring this situation.
Through 2006, the Bank experienced rapid growth in construction, land development and land loans as a result of a robust real estate market and favorable competitive conditions. While this type of loan may generally be considered to be more risky than other real estate secured loans, the Bank did not deviate from its conservative underwriting practices relative to these transactions. While increasing the outstanding balances in this type of credit, the Bank did not incur any more than its historically low level of risk. This is consistent with the Company’s philosophy that safe and sound practice, coupled with high earnings, are higher priorities than asset growth. The Bank has not engaged in risky lending practices such as subprime mortgages, high loan-to-value lending, teaser rate lending, or a high volume of loans on condominiums.
From mid-2007 through 2009, general economic conditions have caused a widespread decline in real estate values and an increase in time to market many properties. The Bank’s conservative underwriting practices have somewhat insulated it from the adverse portfolio effects in the banking industry that are currently receiving public attention. Further, management monitors fluctuations in the value of real estate held as collateral and, if deemed necessary, obtains additional collateral to limit the Bank’s loss exposure. As economic conditions continued to deteriorate through 2009, the adverse effects on many of the Bank’s customers have become apparent in increased loan delinquencies. The Bank experienced higher than usual loan losses and nonaccrual classifications of loans during 2008 and 2009. Management believes that loan delinquency and losses are trailing indicators of economic weakness. As of December 31, 2009, the economy has not strengthened significantly leading management to expect continued challenges to borrowers and, subsequently, delinquencies and losses to the Bank.
The following table sets forth the composition of the Company's loan portfolio for each of the five most recent year ends.
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The following table sets forth the maturity distribution, classified according to sensitivity to changes in interest rates, for selected components of the Company's loan portfolio as of December 31, 2009.
As of December 31, 2009, $231,662,182 or 96.25% of total loans were either variable rate loans or loans written on demand.
The Company has the following commitments, lines of credit, and letters of credit outstanding as of December 31, 2009, 2008, and 2007, respectively.
		 Construction and land development loans
		 $ 10,231,711
		 $ 15,218,812
		 $ 12,582,162
		 Other loan commitments
		 19,038,506
		 22,245,089
		 20,941,323
		 Standby letters of credit
		 1,907,736
		 1,921,878
		 1,582,050
		 Total
		 $ 31,177,953
		 $ 39,385,779
		 $ 35,105,535
Loan commitments are agreements to lend to customers as long as there is no violation of any conditions to the contracts. Loan commitments generally have interest at current market rates, fixed expiration dates, and may require the payment of a fee. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Loan commitments and letters of credit are made on the same terms, including collateral, as outstanding loans. The Company's exposure to loss in the event of nonperformance by the borrower is represented by the contract amount of the commitment.
Loan Quality and the Allowance for Loan Losses
The allowance for loan losses represents an amount which management believes to be adequate to absorb identified and inherent losses in the loan portfolio as of the balance sheet date. Valuation of the allowance is completed no less than quarterly. The determination of the allowance is inherently subjective as it relies on estimates of potential loss related to specific loans, the effects of portfolio trends, and other internal and external factors.
The ALLL consists of (i) formula-based reserves comprised of potential losses in the balance of the loan portfolio segmented into homogeneous pools, (ii) specific reserves comprised of potential losses on loans that management has identified as impaired, and (iii) unallocated reserves. Unallocated reserves are not associated with a specific portfolio segment or a specific loan, but may be appropriate if properly supported and in accordance with GAAP. Management anticipates having low levels of unallocated reserves in future years, as discussed in conjunction with the table titled Allocation of the Allowance for Loan losses, below.
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The Company evaluates loan portfolio risk for the purpose of establishing an adequate allowance for loan losses. In determining an adequate level for the formula-based portion of the ALLL, management considers historical loss experience for major types of loans. Homogenous categories of loans were evaluated based on loss experience in the most recent five years, applied to the current portfolio. This formulation gives weight to portfolio size and loss experience for categories of real-estate secured loans (i.e. real estate - construction and real estate - mortgage), other loans to commercial borrowers, and other consumer loans. However, historical data may not be an accurate predictor of loss potential in the current loan portfolio.
Management also evaluates trends in delinquencies, the composition of the portfolio, concentrations of credit, and changes in lending products, processes, or staffing. Management further considers external factors such as the interest rate environment, competition, current local and national economic trends, and the results of recent independent reviews by auditors and banking regulators. The continuing protracted slow-down in the real-estate market has affected both the price and time to market residential and commercial properties. Management closely monitors such trends and the potential effect on the Company. The impact of the current adverse economic conditions is reflected in historically high losses and provisions for loan loss in 2008 and 2009.
Management has also adopted a risk rating system which gives weight to collateral status (secured vs. unsecured), and to the absence or improper execution of critical contract or collateral documents. Unsecured loans and those loans with critical documentation exceptions, as defined by management, are considered to have greater loss exposure. Management incorporates these factors in the formula-based portion of the ALLL. Additionally, consideration is given to those segments of the loan portfolio which management deems to pose the greatest likelihood of loss. In an economic downturn, such as the region has experienced from late 2007 through 2009, management believes there is increased likelihood of loss in unsecured loans - commercial and consumer, and in secured consumer loans. Reserves for these segments of the portfolio are included in the formula-based portion of the ALLL.
As the real estate market continues to languish, management continually evaluates the adequacy of collateral on loans where it appears the borrower is having difficulty servicing their debt, taking additional available collateral if prudent. The Bank foreclosed on mortgages during 2009 and expects more foreclosures in 2010. Foreclosure may result in loan losses, costs to hold real estate acquired in foreclosure, and losses on the sale of real estate acquired in foreclosure. Management is unable to estimate the financial consequence of future foreclosure activity.
In determining an adequate level for the specific reserve portion of the ALLL, management reviews the current portfolio giving consideration to problem loans. The allowance may include reserves for specific loans identified as impaired during management's loan review or the Company’s independent loan review or internal audit functions. For significant problem loans, management's review consists of evaluation of the financial strengths of the borrowers and guarantors, the related collateral, and the effects of economic conditions. Management prepares a Watch List of troubled loans for review by the Board of Directors at their monthly meeting.
The provision for loan losses is a charge to earnings in the current period to replenish the allowance and maintain it at a level management has determined to be adequate. The allowance is increased by current period provisions and by recoveries of amounts previously charged-off. The allowance is decreased when loans are charged-off as losses, which occurs when they are deemed to be uncollectible. Adjustments are made to bring the balance in the allowance to the level established by application of management’s allowance methodology, and may result in an increase or decrease to expense. A provision for loan losses of $850,000 was recorded in 2009, and $617,526 was recorded in 2008. No provision for loan losses was made in 2007, 2006, or 2005.
Management considers the December 31, 2009 allowance appropriate and adequate to absorb identified and inherent losses in the loan portfolio. As of December 31, 2009, management has identified one loan with balance of $447,214 which is anticipated to be charged-off within the next 12 months. The loan is still in collection, however, with substantial principal reduction anticipated. Management has provided for a loss of 50% of the outstanding balance in the ALLL as of year end. There can be no assurance that charge-offs in future periods will not exceed the allowance for loan loss or that additional increases in the loan loss allowance will not be required.
The following is a schedule of transactions in the allowance for loan losses for each of the five most recent years ended December 31. The Bank experienced net recoveries in 2005 and net charge-offs in the other four years presented. Management did not detect any meaningful trend in the year-to-year relationship of net recoveries to net charge-offs from 2005 through 2007. Rather, these were natural swings of activity in a loan portfolio that had historically experienced minimal losses. The increased losses in 2008 and 2009 and the increased level of the ALLL as a percentage of the gross loan portfolio, reflect the impact on the Bank’s borrowers, of local, regional, national and global economies troubled by job losses, higher energy prices, lower real estate values, and prolonged recessionary conditions.
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The following table details the allocation of the allowance for loan losses to major categories of loans and the percentage of loans in each category relative to total loans at the five most recent year-ends. The loan portfolio is divided into homogeneous categories of loans for the purpose of calculating formula-based reserves. The categories of real estate - construction and real estate - mortgage loans share similar risks of potential collateral deterioration or devaluation. However, these loans tend to be more adequately secured than those commercial and consumer loans that are not real estate secured. Prior to 2009, the Bank had not incurred a mortgage loan loss since 1997, and therefore no reserves were allocated to the real estate - construction or real estate - mortgage portions of the loan portfolio in determining the ALLL for 2007, 2006, or 2005. In 2008, reserves of $475,098 were provided related to impaired real estate loans. Non-real estate secured loans, commercial and consumer, generally pose a greater risk of loss due to erosion of the borrower’s ability to repay the loan in a timely manner. Collateral on these loans is generally, although not always, less reliable than real estate as a source of recovery if default occurs. The Bank’s loan losses in the 2008, 2007, 2006, and 2005 were consumer and commercial loans which were unsecured or secured with collateral other than real estate. In 2009, $731,191 or 74.70% of total loan losses, were real estate secured. Management attributes this historically high level of loss to the current economic downturn and an accompanying erosion of real estate values.
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Unallocated reserves are not associated with a specific portfolio segment or a specific loan, but may be appropriate if properly supported and in accordance with GAAP. Because no portion of the ALLL is calculated on a total loan portfolio basis, management anticipates having low levels of unallocated reserves in future periods. The unallocated portion in the preceding table appears higher in years prior to 2007, the year in which management adopted a revised methodology. Management believes that the ALLL reflected in this table for years prior to 2007 does not materially differ from the balance that would have been calculated at each of those year-ends had current methodology been applied then.
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The accrual of interest on a loan is discontinued when principal or interest is ninety days past due or when the loan is determined to be impaired, unless collateral is sufficient to discharge the debt in full and the loan is in process of collection. When a loan is placed in nonaccruing status, any interest previously accrued but unpaid, is reversed from interest income. Interest payments received on nonaccrual loans may be recorded as cash basis income, or as a reduction of principal, depending on management’s judgment on a loan by loan basis. Accrual of interest may be restored when all principal and interest are current and management believes that future payments will be received in accordance with the loan agreement.
Nonperforming loans are loans past due 90 or more days and still accruing plus nonaccrual loans. Nonperforming assets are comprised of nonperforming loans combined with other real estate owned, which is real estate acquired in foreclosure and held for sale. The composition of nonperforming assets is presented in following table.
		Loans 90 days or more past due and still accruing
		 $ 787,580
		 $ 4,647,792
		 $ 9,100
		 $ 239,620
		 $ 131,717
		Nonaccruing loans
		 1,023,083
		 199,724
		 40,916
		 -
		 -
		 Total nonperforming loans
		 1,810,663
		 4,847,516
		 50,016
		 239,620
		 131,717
		Other real estate owned
		 1,433,000
		 -
		 -
		 -
		 -
		 Total nonperforming assets
		 $ 3,243,663
		 $ 4,847,516
		 $ 50,016
		 $ 239,620
		 $ 131,717
		Interest not accrued on nonaccruing loans
		 $ 46,467
		 $ 6,797
		 $ 1,509
		 $ -
		 $ -
		Interest included in net income on
		 nonaccruing loans
		 $ 30,492
		 $ 12,275
		 $ 2,746
		 $ -
		 $ -
Included in amounts past due 90 days or more and still accruing at December 31, 2008, was a loan with a principal balance of $4,500,000. As of December 31, 2009, this loan was 53 days past due and still accruing as the Bank continued collection efforts. Late in 2008, the Bank was notified that there is a lien on the property securing this loan that is superior to the Bank’s liens. The Bank was not aware of the lien at the time the loan was originated, and the Bank’s settlement agent did not discover the lien during the title examination process. The Bank has filed a claim with the title company that insured its title and lien priority. The Bank believes the title company will indemnify the Bank for any loss resulting from the superior lien, although there is no guarantee that this will be the case. Management reviews the accrual status of this loan quarterly. As of December 31, 2009, there is $33,438 of accrued interest on this loan that was included in interest income in 2009.
Loans are considered impaired when, based on current information, management considers it unlikely that collection of principal and interest payments will be made according to contractual terms. Generally, loans are not reviewed for impairment until the accrual of interest has been discontinued, although management may categorize a performing loan as impaired based on knowledge of the borrower’s financial condition, devaluation of collateral, or other circumstances that are deemed relevant to loan collection. Impaired loans may have specific reserves, or valuation allowances, allocated to them in the ALLL. Estimates of loss reserves on impaired loans are determined based one of two measurement methods: (1) the loan’s observable fair price, or (2) the fair value of collateral, if repayment of the loan is expected to be provided by underlying collateral. Loans determined to be impaired, but for which no specific valuation allowance is made because management believes the loan is secured with adequate collateral or the Bank will not take a loss on such loan, are grouped with other homogeneous loans for evaluation under formula-based criteria described previously.
The following table sets forth principal balances of impaired loans and the related valuation allowances as of December 31, 2009, 2008, and 2007. Management had identified no impaired loans as of December 31, 2006, or 2005.
		Impaired loans with valuation allowances,
		including nonaccruing loans
		 $ 799,834
		 $ 4,328,618
		 $ 595,774
		Valuation allowances on impaired loans
		 $ 258,869
		 $ 605,405
		 $ 138,514
		Impaired loans with no valuation allowances
		 $ 2,102,025
		 $ 4,559,582
		 $ -
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Liquidity and Interest Rate Sensitivity
The primary objective of asset/liability management is to ensure the steady growth of the Company's primary source of earnings, net interest income. Net interest income can fluctuate with significant interest rate movements. To lessen the impact of these margin swings, the balance sheet should be structured so that repricing opportunities exist for both assets and liabilities in roughly equivalent amounts at approximately the same time intervals. Imbalances in these repricing opportunities at any point in time constitute interest rate sensitivity.
Liquidity represents the ability to provide steady sources of funds for loan commitments and investment activities, as well as to provide sufficient funds to cover deposit withdrawals and payment of debt and operating obligations. These funds can be obtained by converting assets to cash or by attracting new deposits. Average liquid assets (cash and amounts due from banks, interest-bearing deposits in other banks, federal funds sold, and investment securities) were 42.56% of average deposits for 2009, compared to 40.00% and 42.03% for 2008 and 2007, respectively.
Average net loans to average deposits were 78.67%, 83.09%, and 80.02%% for 2009, 2008, and 2007. The decrease in the loan to deposit ratio from 2008 to 2009 is attributable to $2,734,000 (1.35%) growth in the average loan portfolio offset by $20,123,000 (7.02%) growth in average deposits during 2009. The increase in the loan to deposit ratio from 2007 to 2008 is attributable to 1.54% growth in the average loan portfolio accompanied by a 2.21% reduction in average deposits during 2008. Funding for loan growth in 2009 was provided by increased deposit balances. This shift has a positive effect on earnings. The increase in loans does not negatively impact the Company’s ability to meet liquidity demands.
As of December 31, 2009, $31,178,540 (39.90%) of total debt securities mature in one year or less, of which, $15,136,254 is classified as "available-for-sale." Federal funds sold provide additional liquidity. Other sources of liquidity include letters of credit, overnight federal funds, and reverse repurchase agreements available from correspondent banks. The total lines and letters of credit available from correspondent banks were $28,000,000 as of December 31, 2009, $27,000,000 as of December 31, 2008, and $21,000,000 as of December 31, 2007.
The following table shows a distribution of investment securities by their contractual maturities and their yields for the various maturity timeframes. In this schedule, investment securities classified as available for sale are presented at fair value and investments classified as held to maturity are presented at amortized cost.
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Interest rate sensitivity refers to the responsiveness of interest-bearing assets and liabilities to changes in market interest rates. The rate-sensitive position, or gap, is the difference in the volume of rate-sensitive assets and liabilities at a given time interval. The general objective of gap management is to actively manage rate-sensitive assets and liabilities to reduce the impact of interest rate fluctuations on the net interest margin. Management generally attempts to maintain a balance between rate-sensitive assets and liabilities as the exposure period is lengthened to minimize the overall interest rate risk to the Company.
Interest rate sensitivity may be controlled on either side of the balance sheet. On the asset side, management exercises some control over maturities. Also, loans are written to provide repricing opportunities on fixed rate notes. The Company's investment portfolio, including federal funds sold, provides the most flexible and fastest control over rate sensitivity since it can generally be restructured more quickly than the loan portfolio.
On the liability side, deposit products are structured to offer incentives to attain the maturity distribution desired. Competitive factors sometimes make control over deposits more difficult and, therefore, less effective as an interest rate sensitivity management tool.
The asset mix of the balance sheet is continually evaluated in terms of several variables: yield, credit quality, appropriate funding sources, and liquidity. Management of the liability mix of the balance sheet focuses on expanding the various funding sources.
As of December 31, 2009, the Company was cumulatively asset-sensitive for all time horizons. For asset-sensitive institutions, if interest rates should decrease, the net interest margins should decline. Since all interest rates and yields do not adjust at the same velocity, the gap is only a general indicator of rate sensitivity.
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Deposits and Other Interest-Bearing Liabilities
Average interest-bearing liabilities increased $18,893,000 (8.67%) to $236,727,000 in 2009, from $217,834,000 in 2008. Average interest-bearing deposits increased $17,183,000 (8.07%) to $230,140,000 in 2009 from $212,957,000 in 2008, while average noninterest-bearing demand deposits increased $2,404,000 (3.24%) to $76,666,000 in 2009 from $74,262,000 in 2008. At December 31, 2009, total deposits were $312,647,619, compared to $292,459,213 at December 31, 2008, an increase of $20,188,406 (6.90%). Throughout 2009, deposit levels have exceeded those of the previous two years during comparable periods. Management attributes this deposit influx to a flight of investors from the troubled stock market to the safety of insured bank deposits, similar to the events of late 2001 through 2004. Higher levels of deposit insurance and the reputation of the Company and the Bank for safe and sound operation are key factors in the deposit increases during 2009.
Average interest-bearing liabilities decreased $414,000 (0.19%) from $218,248,000 in 2007, to $217,834,000 in 2008. Average interest-bearing deposits decreased $934,000 (0.44%) from $213,891,000 in 2007 to $212,957,000 in 2008, while average noninterest-bearing demand deposits decreased $5,545,000 (6.95%) from $79,807,000 in 2007 to $74,262,000 in 2008. At December 31, 2008, total deposits were $292,459,213, compared to $288,943,547 at December 31, 2007, an increase of 1.22%. While annual average deposits were lower in 2008 than in 2007, the Bank experienced an increase in deposits during the last quarter of the year. Based in a summer resort area, it is atypical for the Bank’s deposits to increase in the fourth quarter of the year. Management attributes the deposit influx to a flight of investors from the troubled stock market to the safety of insured bank deposits.
The following table sets forth the deposits of the Company by category as of December 31, 2009, 2008, and 2007, respectively.
Core deposits, which exclude certificates of deposit of $100,000 or more, provide a relatively stable funding source for the Company's loan portfolio and other earning assets. The Company's core deposits increased $15,705,460 during 2009 and $2,001,397 during 2008. Deposits, and particularly core deposits, have been the Company's primary source of funding and have enabled the Company to meet both its short-term and long-term liquidity needs. Management anticipates that while such deposits will continue to be the Company's primary source of funding in the future, continued reductions in deposit levels, if coupled with growth in the Company’s loan portfolio, could require periodic borrowing of funds. In this event, it is likely that Management would liquidate investment securities from the available for sale portfolio or purchase overnight federal funds as needed.
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The maturity distribution of the Company's time deposits of $100,000 or more at December 31, 2009, is shown in the following table.
After six
After three through After
Within three through twelve twelve
months six months months months Total
Time deposits of 		$100,000 or more $ 		19,226,094 $ 		7,212,434 $ 		9,620,913 $ 		5,798,721 $ 		41,858,162
Large certificate of deposit customers tend to be extremely sensitive to interest rate levels, making these deposits less reliable sources of funding for liquidity planning purposes than core deposits. Some financial institutions partially fund their balance sheets using large certificates of deposit obtained through brokers. These brokered deposits are generally expensive and are unreliable as long-term funding sources. Accordingly, the Company does not accept brokered deposits under these conditions. Since 2007, the Bank has been a member of the Certificate of Deposit Account Registry Service (CDARS). This service allows the Bank to offer depositors up to $50 million in FDIC insurance through a network of member banks. While CDARS deposits are considered to be brokered deposits for regulatory reporting, they are not considered volatile as they typically remain in the program until maturity. At December 31, 2009, there were no time deposits issued to customers of other CDARS member banks under the reciprocal program.
Noninterest revenue
Noninterest revenue for 2009 decreased $48,564 (2.38%) from the previous year. Service charges on deposit accounts decreased by $105,730 (9.67%) due to lower volume of fees for items presented against insufficient funds. ATM and debit card revenue increased $14,963 (2.88%) due to increased card usage. Miscellaneous revenues exceed the previous year by $61,775 (26.70%) which includes a gain of $33,410 on the sale of collectible coins.
Noninterest revenue for 2008 increased $104,254 (5.39%) from the previous year. Service charges on deposit accounts increased by $70,427 (6.89%) due to a mid-year increase in the fee for items presented against insufficient funds, coupled with reductions in fee waivers. ATM and debit card revenue increased $13,713 (2.71%) due to increased card usage. Miscellaneous revenues exceed the previous year by $16,585 (7.72%) which includes an increase of $8,651 (35.98%) in wire transfer fees.
The following table presents the principal components of noninterest revenue for the years ended December 31, 2009, 2008, and 2007, respectively.
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Noninterest Expense
Noninterest expense increased $561,304 (7.06%) from 2008 to 2009. A deposit insurance increase of 452,220 resulted from a special assessment to replenish the Deposit Insurance Funds, depleted by bank failures, plus an increase in insured deposit levels and the expiration of a credit which benefited the Bank in recent years. Expense related to ATM and debit card activities decreased $48,887 (16.04%) based on a contract renegotiation with the Bank’s service provider. Professional fees increased $77,020 (94.33%) as the Bank engaged legal representation for loan collection.
Noninterest expense increased $390,177 (5.16%) from 2007 to 2008. Increased personnel costs of $137,791(3.04%) are attributable to salary increases and related payroll taxes. Occupancy expense increased $53,513 (7.64%), including a $28,404 (20.17%) increase in utilities and a $26,000 (16.36%) increase in real estate taxes. Other operating expense increased $197,896 (10.61%). Significant variances occurred in several areas. Advertising increased $33,489 (18.86%) as the Bank conveyed to the public through the media its safety and soundness in a time of economic turmoil. Expense related to ATM and debit card activities increased $32,258 (11.84%) due to a growing volume of card transactions and the addition of a fraud monitoring system implemented in mid-2008. Annual maintenance contracts for computer software systems increased $20,139 (15.74%) as the Bank offered more products to customers and continued with an equipment replacement program designed to support increasing demands on our processing systems. Correspondent bank fees increased $42,498 (233.92%) due to carrying lower balances at Federal Reserve which results in lower earnings credits. Courier service declined by $23,818 (40.65%) as a result of the conversion in May 2007, to branch-based electronic image capture. Professional fees increased $34,442 (72.96%) as the Bank engaged legal representation for loan collection and to assist with Securities and Exchange Commission compliance.
The following table presents the principal components of noninterest expense for the years ended December 31, 2009, 2008, and 2007, respectively.
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Capital
Under capital guidelines adopted by the Federal Reserve Board and the FDIC, the Company and the Bank are currently required to maintain a minimum risk-based total capital ratio of 8%, with at least 4% being Tier 1 capital. Tier 1 capital consists of common stockholders’ equity, qualifying perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, less certain intangibles. In addition, the Company and the Bank must maintain a minimum Tier 1 leverage ratio (Tier 1 capital to total assets) of at least 4%, but this minimum ratio is increased by 100 to 200 basis points for other than the highest-rated institutions.
At December 31, 2009, 2008, and 2007, the Company and the Bank were well-capitalized, exceeding all minimum requirements, as set forth in the following table.
		Analysis of Capital
		Consolidated
		To be well
		Required
		Company
		Bank
		capitalized
		minimums
		Total risk-based capital ratio
		32.1%
		30.6%
		10.0%
		8.0%
		Tier 1 risk-based capital ratio
		31.6%
		30.3%
		6.0%
		4.0%
		Tier 1 leverage ratio
		17.7%
		16.9%
		5.0%
		4.0%
		Total risk-based capital ratio
		32.5%
		30.8%
		10.0%
		8.0%
		Tier 1 risk-based capital ratio
		31.8%
		30.4%
		6.0%
		4.0%
		Tier 1 leverage ratio
		18.7%
		17.8%
		5.0%
		4.0%
		Total risk-based capital ratio
		33.7%
		32.0%
		10.0%
		8.0%
		Tier 1 risk-based capital ratio
		33.1%
		31.9%
		6.0%
		4.0%
		Tier 1 leverage ratio
		19.5%
		18.6%
		5.0%
		4.0%
Website Access to Securities and Exchange Commission Reports
The Bank maintains an Internet website at
www.taylorbank.com. The Company’s periodic SEC reports, including annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, are accessible through this website. Access to these filings is free of charge. The reports are available as soon as practicable after they are filed electronically with the SEC.
Accounting Rule Changes
On July 1, 2009, the Accounting Standards Codification (ASC) became the Financial Accounting Standards Board’s (FASB) officially recognized source of authoritative U.S. generally accepted accounting principles applicable to all public and non-public non-governmental entities, superseding existing FASB, AICPA, EITF and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies.
The following accounting guidance has been approved by the Financial Accounting Standards Board and would apply to the Company if the Company or the Bank entered into an applicable activity.
FASB ASC Topic 715, "Compensation - Retirement Benefits" provides guidance related to an employer’s disclosures about plan assets of defined benefit pension or other post-retirement benefit plans. Under ASC Topic 715, disclosures should provide users of financial statements with an understanding of how investment allocation decisions are made, the factors that are pertinent to an understanding of investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets. Adoption of the disclosure requirements of ASC topic 715 was effective beginning with the financial statements for the year-ended December 31, 2009 and did not have a significant impact on the Company’s financial statements.
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Accounting Standards Update No. 2009-5, under FASB ASC Topic 820, "Fair Value Measurement and Disclosures," provides authoritative guidance for measuring the fair value of a liability in circumstances in which a quoted price in an active market for the identical liability is not available. In such a case, the reporting company must measure fair value utilizing a valuation technique that uses (i) the quoted price of the identical liability when traded as an asset, (ii) quoted prices for similar liabilities or similar liabilities when traded as assets, or (iii) another valuation technique that is consistent with the existing principles of ASC Topic 820, such as an income approach or market approach. The new authoritative accounting guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The new authoritative accounting guidance under ASC Topic 820 was effective for the Company’s financial statements beginning October 31, 2009, and did not have a significant impact on the Company’s financial statements
FASB ASC Topic 855, "Subsequent Events" establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. ASC Topic 855 defines (i) the period after the balance sheet date during which a reporting entity’s management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures an entity should make about events or transactions that occurred after the balance sheet date. ASC Topic 855 became effective for periods ending after June 15, 2009, and did not have a significant impact on the Company’s financial statements.
FASB ASC Topic 860, "Transfers and Servicing" enhances reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. This new guidance eliminates the concept of a "qualifying special-purpose entity" and changes the requirements for derecognizing financial assets. It also requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. ASC Topic 860 is effective January 1, 2010 and has not had a significant impact on the Company’s financial statements.
The accounting policies adopted by management are consistent with authoritative U.S. generally accepted accounting principles and are consistent with those followed by peer Banks.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Impact of Inflation
Unlike most industrial companies, the assets and liabilities of financial institutions such as the Company and the Bank are primarily monetary in nature. Therefore, interest rates have a more significant effect on the Company's performance than do the effects of changes in the general rate of inflation and change in prices. In addition, interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. As discussed previously, management seeks to manage the relationships between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation. See "Liquidity and Interest Rate Sensitivity" above.
Item 8.
Item 8. Financial Statements and Supplementary Data
In response to this Item, the information included on pages 1 through 22 of the Company's Annual Report to Stockholders for the year ended December 31, 2009, is incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
There have been no changes in or disagreements with accountants on accounting or financial disclosure during the fiscal year covered by this report.
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Item 9A.
Item 9A. Controls and Procedures
Evaluation of disclosure controls and procedures
Disclosure controls and procedures are designed and maintained by the Company to ensure that information required to be disclosed in the Company’s publicly filed reports is recorded, processed, summarized and reported in a timely manner. Such information must be available to management, including the Chief Executive Officer (CEO) and Treasurer, to allow them to make timely decisions about required disclosures. Even a well-designed and maintained control system can provide only reasonable, not absolute, assurance that its objectives are achieved. Inherent limitations in any system of controls include flawed judgment, errors, omissions, or intentional circumvention of controls.
The Company’s management, including the CEO and Treasurer, performed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2009. Based on that evaluation, the Company’s management, including the CEO and Treasurer, has concluded that the Company’s disclosure controls and procedures are effective. The projection of an evaluation of controls to future periods is subject to the risk that procedures may become inadequate due to changes in conditions including the degree of compliance with procedures.
Internal Control Over Financial Reporting
Management Report on Internal Control over Financial Reporting
Calvin B. Taylor Bankshares, Inc. maintains a system of internal control over financial reporting, which is designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation of reliable published financial statements. The system includes an organizational structure and division of responsibility, established policies and procedures including a code of conduct to foster a strong ethical climate, and the careful selection, training and development of our staff. The system contains self-monitoring mechanisms, and an internal auditor monitors the operation of the internal control system and reports findings and recommendations to management and the board of directors. Corrective actions are taken to address control deficiencies and other opportunities for improving the system as they are identified. The board, operating through its audit committee, which is composed entirely of directors who are not officers or employees of the Company, provides oversight to the financial reporting process.
There are inherent limitations in the effectiveness of any system of internal controls, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Furthermore, the effectiveness of an internal control system may vary over time and with circumstances.
The Company assessed its internal control system as of December 31, 2009 in relation to criteria for effective internal control over financial reporting as described in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its assessment, the Company believes that, as of December 31, 2009, its system of internal control over financial reporting met those criteria.
CALVIN B. TAYLOR BANKSHARES, INC.
(Registrant)
Date: March 10, 2010 												By: /s/ Raymond M. 												Thompson
Raymond M. Thompson
Chief Executive Officer
Date: March 10, 2010 By: /s/ Jennifer G. 												Hawkins
Jennifer G. Hawkins
Treasurer / Principal Financial Officer
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Attestation Report of the Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Calvin B. Taylor Bankshares, Inc.
Berlin, Maryland
We have audited Calvin B. Taylor Bankshares, Inc. and Subsidiary’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Calvin B. Taylor Bankshares, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board in the United States of America, the balance sheets and the related statements of income, changes in stockholders’ equity and cash flows of Calvin B. Taylor Bankshares, Inc. and Subsidiary, and our report dated March 5, 2010, expressed an unqualified opinion.
/s/ Rowles & Company, LLP
Baltimore, Maryland
March 5, 2010
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Changes in Internal Controls
During the quarter ended on the date of this report, there were no significant changes in the Company’s internal controls over financial reporting that have had or are reasonably likely to have a material affect on the Company’s internal control over financial reporting. As of December 31, 2009, the Company’s management, including the CEO and Treasurer, has concluded that the Company’s internal controls over financial reporting are effective.
Audit Committee and Financial Expert
The Board of Directors has adopted a written Audit Policy, which serves as a charter for the Audit Committee. The Audit Committee is comprised of seven independent directors, including Chairman James R. Bergey, Jr., CPA who serves as the financial expert. The Audit Committee is scheduled to meet quarterly and held four meetings in 2009.
PART III
Item 10.
Item 10. Directors and Executive Officers and Corporate Governance
The information required by this item is included in the Company's Proxy Statement to be filed in connection with the 2010 Annual Meeting of Stockholders, and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required by this item is included in the Company's Proxy Statement to be filed in connection with the 2010 Annual Meeting of Stockholders, and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is included in the Company's Proxy Statement to be filed in connection with the 2010 Annual Meeting of Stockholders, and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item is included in the Company's Proxy Statement to be filed in connection with the 2010 Annual Meeting of Stockholders, and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this item is included in the Company's Proxy Statement to be filed in connection with the 2010 Annual Meeting of Stockholders, and is incorporated herein by reference.
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PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) Exhibits
(a)(1), (2) Annual Report to Stockholders for the year ended December 31, 2009.
3.1 Articles of Incorporation of the Company, incorporated by reference to Exhibit 3.1 of Registration Statement Form S-4, File No. 33-99762.
3.2 Bylaws of the Company, incorporated by reference to Exhibit 3.2 of Registration Statement Form S-4, File No. 33-99762.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CALVIN B. TAYLOR BANKSHARES, INC.
(Registrant)
Date: March 10, 2010 												By: /s/ Raymond M. 												Thompson
Raymond M. Thompson
Chief Executive Officer
Date: March 10, 2010 By: /s/ Jennifer G. 												Hawkins
Jennifer G. Hawkins
Treasurer / Principal Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
												Date: March 10, 2010 By: /s/ James R. Bergey, Jr.
James R. Bergey, Jr., Director
												Date: March 10, 2010 By: /s/ John H. Burbage, Jr.
John H. Burbage, Jr., Director
												Date: March 10, 2010 By: /s/ Todd E. Burbage
Todd E. Burbage, Director
												Date: March 10, 2010 By: /s/ Charlotte K. Cathell
Charlotte K. Cathell, Director
												Date: March 10, 2010 By: /s/ Reese F. Cropper, Jr.
Reese F. Cropper, Jr.
Chairman of the Board of Directors
Date: March 10, 2010 By: /s/ Reese F. Cropper, III
Reese F. Cropper, III, Director
												Date: March 10, 2010 By: /s/ Hale Harrison
Hale Harrison, Director
												Date: March 10, 2010 By: /s/ Gerald T. Mason
Gerald T. Mason, Director
												Date: March 10, 2010 By: /s/ William H. Mitchell
William H. Mitchell, Director
Vice President
												Date: March 10, 2010 By: /s/ Joseph E. Moore
Joseph E. Moore, Director
												Date: March 10, 2010 By: /s/ Michael L. Quillin, Sr.
Michael L. Quillin, Sr., Director
												Date: March 10, 2010 By: /s/ Raymond M. Thompson
Raymond M. Thompson, Director
President and Chief Executive Officer
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Certification - Pursuant to 18 U.S.C. 1350
Section 906 of the Sarbanes-Oxley Act of 2002
We, the undersigned, certify that to the best of our knowledge, based upon a review of the Annual Report on Form 10-K for the period ended December 31, 2009 of the Registrant (the "Report"):
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) 	of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all material 	respects, the financial condition and results of operations of the 	Registrant.
CALVIN B. TAYLOR BANKSHARES, INC.
(Registrant)
Date: March 10, 2010 												By: /s/ Raymond M. 												Thompson
Raymond M. Thompson
Chief Executive Officer
Date: March 10, 2010 By: /s/ Jennifer G. 												Hawkins
Jennifer G. Hawkins
Treasurer / Principal Financial Officer
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Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Raymond M. Thompson, certify that:
I have reviewed this annual report on Form 10-K of Calvin B. Taylor Bankshares, Inc.;
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such 			disclosure controls and procedures to be designed under our 			supervision, to ensure that material information relating to the 			registrant, including its consolidated subsidiary, is made known to 			us by others within those entities, particularly during the period 			in which this report is being prepared;
b) designed such internal control over financial reporting, or 			caused such internal control over financial reporting to be designed 			under our supervision, to provide reasonable assurance regarding the 			reliability of financial reporting and the preparation of financial 			statements for external purposes in accordance with generally 			accepted accounting principles;
c) evaluated the effectiveness of the registrant’s disclosure 			controls and procedures and presented in this report our conclusions 			about the effectiveness of the disclosure controls and procedures, 			as of the end of the period covered by this report based on such 			evaluations; and
d) disclosed in this report any change in the registrant’s internal 			control over financial reporting that occurred during the 			registrant’s most recent fiscal quarter that has materially 			affected, or is reasonably likely to materially affect, the 			registrant’s internal control over financial reporting; and
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:
a) all significant deficiencies and material weaknesses in the 			design or operation of internal control over financial reporting 			which are reasonably likely to adversely affect the registrant’s 			ability to record, process, summarize and report financial 			information; and
b) any fraud, whether or not material, that involves management or 			other employees who have a significant role in the registrant’s 			internal control over financial reporting.
CALVIN B. TAYLOR BANKSHARES, INC.
(Registrant)
Date: March 10, 2010 												By: /s/ Raymond M. 												Thompson
Raymond M. Thompson
Chief Executive Officer
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Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Jennifer G. Hawkins, certify that:
I have reviewed this annual report on Form 10-K of Calvin B. Taylor Bankshares, Inc.;
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such 			disclosure controls and procedures to be designed under our 			supervision, to ensure that material information relating to the 			registrant, including its consolidated subsidiary, is made known to 			us by others within those entities, particularly during the period 			in which this report is being prepared;
b) designed such internal control over financial reporting, or 			caused such internal control over financial reporting to be designed 			under our supervision, to provide reasonable assurance regarding the 			reliability of financial reporting and the preparation of financial 			statements for external purposes in accordance with generally 			accepted accounting principles;
c) evaluated the effectiveness of the registrant’s disclosure 			controls and procedures and presented in this report our conclusions 			about the effectiveness of the disclosure controls and procedures, 			as of the end of the period covered by this report based on such 			evaluations; and
d) disclosed in this report any change in the registrant’s internal 			control over financial reporting that occurred during the 			registrant’s most recent fiscal quarter that has materially 			affected, or is reasonably likely to materially affect, the 			registrant’s internal control over financial reporting; and
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:
a) all significant deficiencies and material weaknesses in the 			design or operation of internal control over financial reporting 			which are reasonably likely to adversely affect the registrant’s 			ability to record, process, summarize and report financial 			information; and
b) any fraud, whether or not material, that involves management or 			other employees who have a significant role in the registrant’s 			internal control over financial reporting.
CALVIN B. TAYLOR BANKSHARES, INC.
(Registrant)
Date: March 10, 2010 By: /s/ Jennifer G. 												Hawkins
Jennifer G. Hawkins
Treasurer / Principal Financial Officer
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