• operating, legal and regulatory risks;

• economic, political and competitive forces affecting banking, securities, asset management and credit services businesses; and

• the risk that management's analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in Item 1A of Part B of this quarterly Form 10-Q Report and Item 1A of the 2007 Annual Report on Form 10-K for the period ended December 31, 2007, and other documents that Codorus Valley files periodically with the Securities and Exchange Commission.
Critical accounting estimates:
Disclosure of Codorus Valley's significant accounting policies is included in Note 1 to the consolidated financial statements of the 2007 Annual Report on Form 10-K for the period ended December 31, 2007. Some of these policies require management to make significant judgments, estimates and assumptions that have a material impact on the carrying value of certain assets and liabilities. Management makes significant estimates in determining the allowance for loan losses. Management considers a variety of factors in establishing this estimate such as current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, financial and managerial strengths of borrowers, adequacy of collateral, if collateral dependent, and present value of future cash flows and other relevant factors. Estimates related to the value of collateral also have a significant impact on whether or not management continues to accrue income on delinquent loans and on the amounts at which foreclosed real estate is recorded on the statement of financial condition. Additional information is contained in Management's Discussion and Analysis regarding critical accounting estimates, including the provision and allowance for loan losses, located on pages 19 and 26 of this Form 10-Q.

Effective January 1, 2008, the Corporation adopted FASB Statement No. 157, which is disclosed in this report under Note 9-Fair Values of Financial Instruments. Statement No. 157 expands disclosures pertaining to the methods used to determine fair values and establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure the fair value of selected assets and liabilities. Also on January 1, 2008, the Corporation adopted the FASB's Emerging Issues Task Force Issue No. 06-4 that pertains to recognizing a liability related to postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The impact of adopting EITF Issue No. 06-4 is disclosed in this report under the Recent Accounting Pronouncements section of Note 2-Significant Accounting Policies.
Management discussed the development and selection of critical accounting estimates and related Management Discussion and Analysis disclosure with the Audit Committee. There were no material changes made to the critical accounting estimates during the periods presented within this report. Three months ended September 30, 2008,
compared to three months ended September 30, 2007
FINANCIAL HIGHLIGHTS
The Corporation earned $1,130,000 or $.28 per share ($.28 diluted), for the three-month period ended September 30, 2008, compared to $1,641,000 or $.42 per share ($.41 diluted), for the same period of 2007. The $511,000 or 31 percent decrease in net income was the result of increases in the provision for loan losses and noninterest expense, and a decrease in net interest income. The Corporation increased the provision for loan losses by $388,000 to support a substantial increase in the loan portfolio and the risk of a prolonged downturn in the US economy. The $261,000 or 6 percent increase in total noninterest expense was due in part to expansion of the Corporation's banking franchise. PeoplesBank, the Corporation's banking subsidiary, recently opened a second full-service financial center in the Hanover, Pennsylvania market, which followed the bank's expansion, in January, to Hunt Valley, Maryland. Increases in assessments by the Federal Deposit Insurance Corporation on the banking industry, miscellaneous services expenses and impaired loan carrying costs also contributed to the increase in total noninterest expense. Net interest income decreased by $215,000 or 4 percent as yields on earning assets declined more rapidly than rates paid on deposits. These decreases in yields and rates paid were due in part to aggressive interest rate cuts by the Federal Reserve Bank to stimulate the struggling US economy. Total noninterest income for the current quarter increased $168,000 or 12 percent primarily as a result of increases in service charges on deposits and gains on the sale of mortgages.

A more detailed analysis of the factors and trends affecting corporate earnings follows.
INCOME STATEMENT ANALYSIS
Net interest income
Net interest income for the three-month period ended September 30, 2008, was $5,134,000, a decrease of $215,000 or 4 percent compared to the third quarter of 2007. Earning assets for the current quarter averaged $599 million and yielded 6.20 percent (tax equivalent basis), compared to $542 million and 7.50 percent, respectively, for the third quarter of 2007. While the volume of average earning assets, principally business loans, increased in the current quarter, yields decreased. Yields on floating rate instruments in particular were adversely affected by aggressive interest rate cuts by the Federal Reserve Bank in its effort to stimulate the US economy. The Federal Reserve Bank lowered interest rates a total of 3.25 percent from September 2007 to April 2008. In addition to a decrease in interest income from loans, loan fees also decreased. Loan fees totaled $184,000 for the third quarter of 2008, compared to $619,000 for the third quarter of 2007. The prior period included $329,000 in loan fees from a single business loan account that did not recur in the current quarter. Total interest bearing deposits for the current quarter averaged $503 million at an average rate of 2.91 percent, compared to $447 million and 3.73 percent, respectively, for the third quarter of 2007. During the current quarter, deposit customers continued to replace floating rate money market and time deposits, in response to the low level of short-term market interest rates, with relatively higher yielding fixed rate time deposits to increase their return. The net interest margin, on a taxable equivalent basis, was 3.52 percent for the third quarter of 2008, compared to 3.69 percent for the second quarter of 2008 and 4.03 percent for the third quarter of 2007. Provision for loan losses
A $353,000 provision expense for loan losses was recorded for the third quarter of 2008, compared to a $35,000 recovery (credit) for the same quarter in 2007. The current quarter's loan loss provision bolstered the allowance to support strong the growth in the Company's business loan portfolio and the risk of a prolonged downturn in the US economy.
Noninterest income
The following table presents the components of total noninterest income for the third quarter of 2008, compared to the third quarter of 2007.

Table 1 - Noninterest income

                                           Three months ended                    Change
                                             September 30,                 Increase (Decrease)
(dollars in thousands)                    2008            2007             $                %

Trust and investment services fees     $      307       $     317      $      (10 )             (3 )%
Service charges on deposit accounts           592             499              93               19
Income from mutual fund, annuity
and insurance sales                           390             410             (20 )             (5 )
Income from bank owned life
insurance                                      73              71               2                3
Other income                                  121             102              19               19
Gain on sales of mortgages                    135              51              84              165
Gain (loss) on sales of securities              0               0               0               nm

Total noninterest income               $    1,618       $   1,450      $      168               12 %

nm - not meaningful
The discussion that follows addresses changes in selected categories of noninterest income.
Service charges on deposit accounts-The $93,000 or 19 percent increase in service charges on deposit accounts for the third quarter of 2008, compared to the same quarter of 2007 was the result of increases in overdraft and debit card fees related to an increase in the number of deposit accounts and increased transaction volumes.
Gain on sales of mortgages-The $84,000 or 165 percent increase in gains on sales of mortgages for the third quarter of 2008, compared to the same quarter of 2007, was the result of an increase in the sales staff and the volume of sales.

Noninterest expense
The following table presents the components of total noninterest expense for the third quarter of 2008, compared to the third quarter of 2007.

Table 2 - Noninterest expense

                                        Three months ended                 Change
                                           September 30,             Increase (Decrease)
   (dollars in thousands)                2008          2007           $               %

   Personnel                          $    2,744      $ 2,741     $       3               0 %
   Occupancy of premises, net                367          314            53              17
   Furniture and equipment                   349          347             2               1
   Postage, stationery and supplies          117          101            16              16
   Professional and legal                     85          105           (20 )           (19 )
   Marketing and advertising                 249          247             2               1
   Other                                   1,012          807           205              25

   Total noninterest expense          $    4,923      $ 4,662     $     261               6 %

Personnel-Personnel expense, comprised of wages, payroll taxes and employee benefits for the third quarter of 2008 was flat compared to the same quarter of 2007. The prior period included a $200,000 wage expense allocation for an annual companywide performance bonus based on projected 2007 core earnings. No comparable performance bonus accrual was recorded for the current period. On an adjusted basis, the $203,000 or 8 percent increase in personnel expense was due to staff additions to support planned corporate growth.
Occupancy of premises, net-The $53,000 or 17 percent increase in occupancy expense for the third quarter of 2008, compared to the same quarter of 2007, was due primarily to the addition of the Hunt Valley office in Maryland in January 2008.
Other-The $205,000 or 25 percent increase in other expense for the third quarter of 2008, compared to the same quarter of 2007 was due in part to increases in the following expenses: an insurance assessment imposed on the industry by the Federal Deposit Insurance Corporation, miscellaneous services, and impaired loan carrying costs.
Income taxes
The provision for income tax was $346,000 for the third quarter of 2008, compared to $531,000 for the same period in 2007. The $185,000 decrease in the tax provision was the result of a 32 percent decrease in pretax income. Codorus Valley's effective federal income tax rate was 21 percent and 25 percent, respectively, for quarters ended September 30, 2008, and 2007. The Company's marginal tax rate was 34 percent for both periods.

Nine months ended September 30, 2008,
compared to nine months ended September 30, 2007
FINANCIAL HIGHLIGHTS
The Corporation earned $3,624,000 or $.92 per share ($.91 diluted) for the nine-month period ended September 30, 2008, compared to $5,037,000 or $1.30 per share ($1.27 diluted), for the same period of 2007. The $1,413,000 or 28 percent decrease in net income was primarily the result of a $2,332,000 pre-tax ($1,539,000 after-tax) increase in the provision for loan losses. The current period provision and allowance were primarily increased to support strong loan growth in the Corporation's loan portfolio and the risk of a prolonged downturn in the US economy and secondarily to replenish the allowance for loan losses for a previously disclosed loan loss of $481,000 in the second quarter of 2008. In contrast, during 2007 the Corporation recognized the positive financial impact of a one-time $839,000 pre-tax recovery ($554,000 after-tax) of loan losses that were incurred by PeoplesBank during 2002-2003. Due to the adequacy of the Corporation's allowance for loan losses in 2007, the full amount of the recovery was recorded as a reduction to the loan loss provision at that time. On a comparable basis, net income for the nine-month period ended September 30, 2008, decreased $859,000 or 19 percent, compared to the same period in 2007, as adjusted ($5,037,000 of reported 2007 earnings less $554,000 for the after-tax effect of the loan recovery).
Net income for the 2008 period was also constrained by net interest margin compression as yields on earning assets declined more rapidly than rates paid on deposits due in part to aggressive interest rate cuts by the Federal Reserve Bank to stimulate the struggling US economy. Operating costs increased for the current period primarily as a result of corporate expansion and increased Federal Deposit Insurance Corporation deposit premiums. PeoplesBank recently opened a second full-service financial center in the Hanover, Pennsylvania market, which followed the Bank's expansion, in January, to Hunt Valley, Maryland. A second Maryland banking office, located in the Bel Air area, is scheduled to open in November 2008.
On September 30, 2008, total assets were $650 million, representing a $60 million or 10 percent increase above September 30, 2007. Asset growth occurred primarily in business and home equity loan portfolios, which were funded by strong deposit growth, principally time deposits. Net income as a percentage of average shareholders' equity (ROE) was 9.72 percent for the first nine months (annualized) of 2008, compared to 14.94 percent for the same period of 2007. Net income as a percentage of average total assets (ROA) was 0.78 percent for the first nine months (annualized) of 2008, compared to 1.18 percent for the same period of 2007. The efficiency ratio (noninterest expense as a percentage of net interest income plus noninterest income) was 68.5 percent for the first nine months of 2008, compared to 67.3 percent for the same period of 2007.
On September 30, 2008, the nonperforming assets ratio was 1.93 percent, compared to 1.02 percent for September 30, 2007. Information regarding nonperforming assets is provided in the Risk Management section of this report, including Table 5-Nonperforming Assets. Based on a recent evaluation of probable loan losses and the current loan portfolio, management believes that the allowance is adequate to support losses inherent in the loan portfolio on September 30, 2008. An analysis of the allowance is provided in Table 6-Analysis of Allowance for Loan Losses.
Throughout the current period, Codorus Valley maintained a capital level well above minimum regulatory quantitative requirements. Currently, there are three federal regulatory definitions of capital that take the form of minimum ratios. Note 5-Regulatory Matters, shows that the Corporation and PeoplesBank were well capitalized on September 30, 2008. Management is presently evaluating the Capital Purchase Program recently announced by the US Department of the Treasury. More information about this program is provided within the Shareholders' Equity and Capital Adequacy section of this report.

A more detailed analysis of the factors and trends affecting corporate earnings follows.
INCOME STATEMENT ANALYSIS
Net interest income
Net interest income for the nine-month period ended September 30, 2008, was $15,677,000, an increase of $613,000 or 4 percent above the same period in 2007 due to a larger volume of earning assets and lower funding costs. The growth in net interest income was constrained by net interest margin compression as the yields on earning assets declined more rapidly than rates paid on deposits. The net interest margin, on a tax equivalent basis, was 3.75 percent for the first nine months of 2008, compared to 3.90 percent for the same period in 2007. The decline in loan yields and deposit rates, particularly floating rate products, reflected a series of aggressive interest rate cuts by the Federal Reserve Bank that began in September 2007 and ended in April 2008 to stimulate the US economy. (Note: During October 2008 the Federal Reserve Bank cut its target federal funds rate two times for a total of 100 basis points. As of October 29, 2008, the target federal funds rate was 1%, which equates to a 4% prime lending rate.)
Earning assets averaged $576 million and yielded 6.48 percent (tax equivalent basis) for the current nine-month period, compared to $532 million and 7.44 percent, respectively, for 2007. The $44 million or 8 percent increase in average earning assets was the result of loan growth primarily in the business loan portfolio and secondarily in the home equity loan portfolio. Total loans averaged $479 million and yielded 6.80 percent (tax equivalent basis) for 2008, compared to $426 million and 7.95 percent, respectively, for 2007. The investment securities portfolio averaged $81 million and yielded 5.36 percent (tax equivalent basis) for 2008, compared to $84 million and 5.45 percent for 2007. Interest income from investment securities decreased as a result of decreases in volume and yield. For the first nine months of 2008, total interest income decreased $1,695,000 or 6 percent, compared to 2007, due primarily to lower yields on floating rate loans and overnight investments, and decreased loan fees.
For the first nine months of 2008, total interest expense decreased $2,308,000 or 16 percent, compared to 2007 due to a decrease in the weighted average rate paid on deposits and borrowings. Total interest bearing liabilities averaged $517 million at an average rate of 3.04 percent, compared to $478 million and 3.93 percent, respectively, for 2007. The $39 million or 8 percent increase in average interest bearing liabilities was driven by an increase in time deposits. Interest expense on deposits for the current period decreased $1,694,000 or 14 percent below the prior year due to lower market interest rates. During the current nine-month period deposit customers continued to replace floating rate money market and time deposits with higher yielding fixed rate time deposits to increase their return. Interest expense on long-term debt decreased for the current period by $648,000 or 39 percent below the prior year due to a decrease in volume, which resulted from a scheduled maturity in 2007 that was not refinanced and the pay-off of two borrowings prior to maturity that also occurred in 2007.
Provision for loan losses
For the nine-month period ended September 30, 2008, the provision for loan losses was $1,413,000, representing a $2,332,000 increase compared to the $919,000 recovery (credit) for the same period in 2007. The current period provision and allowance were primarily increased to support strong loan growth in the Corporation's loan portfolio and the risk of a prolonged downturn in the US economy and secondarily to replenish the allowance for a previously disclosed loan loss in the second quarter of 2008. In contrast, during 2007 the Corporation recognized the positive financial impact of a one-time $839,000 pre-tax recovery ($554,000 after-tax) of loan losses that were incurred by PeoplesBank during 2002-2003. Due to the adequacy of the Corporation's allowance for loan losses in 2007, the full amount of the recovery was recorded as a reduction to the loan loss provision at that time.

Noninterest income
The following table presents the components of total noninterest income for the first nine months of 2008, compared to the first nine months of 2007. After removing the impact of infrequent gains (losses) from the sale of securities, total noninterest income for the current nine-month period increased $701,000 or 17 percent above 2007.

Table 3 - Noninterest income

                                           Nine months ended                     Change
                                             September 30,                 Increase (Decrease)
(dollars in thousands)                    2008           2007              $                  %

Trust and investment services fees     $      983      $     945      $        38                 4 %
Service charges on deposit accounts         1,675          1,436              239                17
Income from mutual fund, annuity
and insurance sales                         1,374          1,092              282                26
Income from bank owned life
insurance                                     208            204                4                 2
Other income                                  367            324               43                13
Gain on sales of mortgages                    303            208               95                46
Gain (loss) on sales of securities            123             (7 )            130                nm

Total noninterest income               $    5,033      $   4,202      $       831                20 %

nm - not meaningful
The discussion that follows addresses changes in selected categories of noninterest income.
Trust and investment services fees-The $38,000 or 4 percent increase in trust fees for the first nine months of 2008, compared to the same period in 2007 was primarily the result of periodic recognition of estate fees totaling $55,000. Service charges on deposit accounts-The $239,000 or 17 percent increase in service charges on deposit accounts for the first nine months of 2008, compared to the same period in 2007 was the result of increases in overdraft and debit card fees related to an increase in the number of deposit accounts and transaction volumes.
Income from mutual fund, annuity and insurance sales-The $282,000 or 26 percent increase in mutual fund, annuity and insurance income for the first nine months of 2008, compared to the same period in 2007 was the result of increased sales. Gain on sales of mortgages-The $95,000 or 46 percent increase in gains on sales of mortgages for the first nine months of 2008, compared to the same period in 2007 was the result of an increase in the sales staff and the volume of sales. Gain (loss) on sales of securities-During 2008, market interest rates decreased affording the Company an opportunity to realize a $123,000 gain from the sale of investment securities with a carrying value of $6.5 million. There was no comparable sale in the prior year.

Noninterest expense
The following table presents the components of total noninterest expense for the first nine months of 2008, compared to the first nine months of 2007. After removing the impact of an infrequent prepayment penalty in 2007, which is described below under other expense, total noninterest expense for the current nine-month period increased $1,328,000 or 10 percent above 2007.
In the period ahead, it is probable that noninterest expense will continue to increase as a result of expansion of the banking franchise, investment in technology, and increased Federal Deposit Insurance Corporation (FDIC) premiums. PeoplesBank recently opened a second full-service financial center in the Hanover, Pennsylvania market, which followed the Bank's expansion, in January, to Hunt Valley Maryland. A second Maryland banking office, located in the Bel Air area, is scheduled to open in November 2008.
Recently, the FDIC proposed a premium increase for 2009, beginning in the first quarter of next year, which could double the annual $300,000 premium that PeoplesBank is presently paying as a well-managed, well-capitalized bank (FDIC Risk Category I). The increase in premiums is expected to replenish the FDIC's reserve as a result of recent and anticipated bank failures. On a separate note, in October 2008, the FDIC communicated its interim rule on the Temporary Liquidity Guarantee Program (TLGP). The TLGP consists of temporary guarantees by the FDIC of a member bank's newly issued senior unsecured debt and non-interest bearing transaction accounts in excess of $250,000. A member bank can opt out of either or both guarantee components of the TLGP. The FDIC encourages participation in the TLGP and PeoplesBank plans to do so. The proposed FDIC fees under its TLGP are expected to be insignificant.

Table 4 - Noninterest expense

. . .