The following discussion compares the Company's financial condition at December 31, 2008 to its financial condition at December 31, 2007 and the results of operations for the years ended December 31, 2008, 2007, and 2006. This discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto appearing in Item 8 of Part II of this report.

RECENT DEVELOPMENTS

Capital Purchase Program

As discussed above, on January 9, 2009 the Company participated in the TARP CPP by issuing 25,000 shares of Series A Preferred Stock and a Warrant covering 172,970 shares of common stock to the Treasury for a total sales price of $25 million. The Warrant may be exercised at any time until January 9, 2019 at an exercise price of $21.68 per share, or an aggregate exercise price of approximately $3.75 million. The Series A Preferred Stock qualifies as Tier 1 capital. The Warrant counts as tangible common equity.

Holders of the Series A Preferred Stock are entitled to receive if, as and when declared by the Board of Directors, out of assets legally available for payment, cumulative cash dividends at a rate per annum of 5% per share on a liquidation amount of $1,000 per share of Series A Preferred Stock with respect to each dividend period from January 9, 2009 to, but excluding, February 15, 2014. From and after February 15, 2014, holders of Series A Preferred Stock are entitled to receive cumulative cash dividends at a rate per annum of 9% per share on a liquidation amount of $1,000 per share with respect to each dividend period thereafter. Under the terms of the Series A Preferred Stock, on and after February 15, 2012, the Company may, at its option, redeem shares of Series A Preferred Stock, in whole or in part, at any time and from time to time, for cash at a per share amount equal to the sum of the liquidation preference per share plus any accrued and unpaid dividends to but excluding the redemption date. The terms of the Series A Preferred Stock further provide that, prior to February 15, 2012, the Company may redeem shares of Series A Preferred Stock only if it has received aggregate gross proceeds of not less than $6.25 million from one or more qualified equity offerings, and the aggregate redemption price may not exceed the net proceeds received by the Company from such offerings. The redemption of the Series A Preferred Stock requires prior regulatory approval.

Until the earlier of (i) January 9, 2012 or (ii) the date on which the Series A Preferred Stock has been redeemed in full or Treasury has transferred all of the Series A Preferred Stock to non-affiliates, the terms of the Series A Preferred Securities prohibit the Company from increasing its quarterly cash dividend paid on common stock above $0.16 per share or repurchasing any shares of common stock or other capital stock or equity securities or trust preferred securities without the consent of the Treasury. Accordingly, the Company's previously-announced common stock repurchase plan has been suspended effective January 9, 2009.

On February 17, 2009, President Obama signed the Recovery Act into law. The Recovery Act permits any institution that receives assistance under TARP (including pursuant to the CPP), after consultation with the appropriate banking regulators, to repay any such assistance at any time notwithstanding any repayment restrictions contained in the instruments defining such assistance. Recent guidance issued by Treasury states that, as a general rule, any partial repayment must equal at least 25% of the outstanding assistance. Treasury may waive this minimum repayment amount. Accordingly, the Company may, at any time and notwithstanding the restrictions on redemption discussed above, and assuming its regulators do not object, repay all of or a portion of (in 25% increments, unless waived by Treasury) the $25 million it received as consideration for the Series A Preferred Stock and the Warrant. If the Company were to repay any assistance, it could also repurchase any or all of the portion of the Warrant that relates to the repayment. Any portion of the Warrant that relates to the repayment that the Company chooses not to repurchase must be liquidated by Treasury, at the current market price.

FDIC Deposit Insurance Fund Restoration Plan Announced

On February 27, 2009, the FDIC announced a proposed rule outlining its plan to implement an emergency special assessment of 20 basis points on all insured depository institutions in order to restore the Deposit Insurance Fund to an acceptable level. The assessment, which would be payable on September 30, 2009, would be in addition to a planned increase in premiums and a change in the way regular premiums are assessed which the FDIC also approved on February 27, 2009. In addition, the proposed rule provides that, after June 30, 2009, if the reserve ratio of the Deposit Insurance Fund is estimated to fall to a level that that the FDIC believes would adversely affect public confidence or to a level which is close to or less than zero at the end of a calendar quarter, then an additional emergency special assessment of up to 10 basis points may be imposed on all insured depository institutions. If this rule is adopted as proposed, it will significantly increase the Banks' FDIC premiums in 2009.

PERFORMANCE OVERVIEW

The Company recorded a decline in net income for 2008 when compared to 2007. Net income for the year ended December 31, 2008 was $11.47 million, compared to $13.45 million and $13.55 million for the years ended December 31, 2007 and 2006, respectively. Basic earnings per share for 2008 was $1.37, a decrease of 14.9% from 2007. Basic earnings per share was $1.61 and $1.62 for 2007 and 2006, respectively. Diluted earnings per share for 2008 was also $1.37, a decrease of 14.4% when compared to 2007. Diluted earnings per share was $1.60 and $1.61 for 2007 and 2006, respectively.

Return on average assets was 1.13% for 2008, compared to 1.42% for 2007 and 1.52% for 2006. Return on stockholders' equity for 2008 was 9.22%, compared to 11.79% for 2007 and 12.66% for 2006. Comparing the year ended December 31, 2008 to the year ended December 31, 2007, average assets increased 6.7% to $1.011 billion, average loans increased 15.0% to $837.7 million, average deposits increased 6.0% to $815.7 million, and average stockholders' equity increased 9.1% to $124.4 million.

CRITICAL ACCOUNTING POLICIES

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

The most significant accounting policies that the Company follows are presented in Note 1 to the Consolidated Financial Statements. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policy with respect to the allowance for credit losses to be the accounting area that requires the most subjective or complex judgments, and, as such, could be most subject to revision as new information becomes available. Accordingly, the allowance for credit losses is considered to be a critical accounting policy, as discussed below.

The allowance for credit losses represents management's estimate of credit losses inherent in the loan portfolio as of the balance sheet date. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheets. Note 1 to the Consolidated Financial Statements describes the methodology used to determine the allowance for credit losses and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in the Provision for Credit Losses and Risk Management section of this discussion.

RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS

Note 1 to the Consolidated Financial Statements discusses new accounting
policies that the Company adopted during 2008 and the expected impact of accounting policies recently issued or proposed but not yet required to be adopted. To the extent the adoption of new accounting standards materially affects our financial condition, results of operations or liquidity, the impacts are discussed in the applicable section(s) of this discussion and Notes to the Consolidated Financial Statements.

RESULTS OF OPERATIONS

Net Interest Income and Net Interest Margin

During 2008, the FRB reduced the fed funds rate by 400 basis points. The FRB began its current reductions in the fed funds rate by decreasing rates 100 basis points in 2007. The New York Prime rate, the primary index used for variable rate loans, declined by 400 basis points during 2008 and 100 basis points during 2007. These rate changes had a significant impact on our overall yields earned and rates paid.

Net interest income remains the most significant component of our earnings. It is the excess of interest and fees earned on loans, investment securities, and federal funds sold over interest owed on deposits and borrowings. Tax equivalent net interest income for 2008 was $40.3 million, representing a 2.7% decrease from 2007. Tax equivalent net interest income for 2007 was $41.4 million, a 5.6% increase over 2006. A decrease in yields on earning assets was the reason for the decline in 2008; the increase in the volume of earning assets was not enough to offset the decrease in yields. An increase in the volume of earning assets was the reason for the growth in 2007. The tax equivalent yield on earning assets was 6.49% for 2008, compared to 7.34% and 6.98% for 2007 and 2006, respectively. Average earning assets increased to $954.0 million during 2008, compared to $893.0 million and $835.5 million for 2007 and 2006, respectively.

The rate paid for interest bearing liabilities was 2.81% for the year ended December 31, 2008, representing a decrease of 55 basis points from the 3.36% paid for the year ended December 31, 2007. Conversely, in 2007, the overall rate paid for interest bearing liabilities increased 50 basis points when compared to the rate paid for the year ended December 31, 2006.

The following table sets forth the major components of net interest income, on a tax equivalent basis, for the years ended December 31, 2008, 2007, and 2006.

                                 2008                                       2007                                      2006
                  Average       Interest       Yield/        Average      Interest       Yield/        Average      Interest       Yield
(Dollars in
thousands)        Balance           (1)         Rate         Balance          (1)         Rate         Balance          (1)        /Rate
Earning asset
Loans (2) (3)   $   837,739     $  57,041          6.81 %   $ 728,666     $  57,637          7.91 %   $ 664,244     $  50,633         7.62 %
Investment
securities:
Taxable              85,105         3,788          4.45       112,384         5,105          4.54       110,354         4,486         4.07
Tax-exempt           11,031           646          5.86        13,424           786          5.85        13,593           791         5.82
Federal funds
sold                 16,427           308          1.87        21,312         1,108          5.20        28,663         1,459         5.09
Interest
bearing
deposits              3,666            92          2.51        17,086           893          5.23        18,665           939         5.03
Total earning
assets              953,968        61,875          6.49 %     892,972        65,529          7.34 %     835,519        58,308         6.98 %
Cash and due
from banks           14,829                                    16,938                                    20,589
Other assets         50,275                                    44,136                                    42,962
Allowance for
credit losses        (8,270 )                                  (6,898 )                                  (5,653 )
Total assets    $ 1,010,802                                 $ 947,148                                 $ 893,417

Interest
bearing
liabilities
Demand
deposits        $   113,002     $     437          0.39 %   $ 112,553     $   1,069          0.95 %   $ 104,371     $     702         0.67 %
Money market
and savings
deposits            175,376         2,406          1.37       177,256         3,175          1.79       189,699         2,724         1.44
Certificates
of deposit
$100,000 or
more                193,678         7,955          4.11       159,532         7,748          4.86       135,568         5,988         4.42
Other time
deposits            226,201         9,079          4.01       213,823         9,701          4.54       191,234         7,714         4.03
Interest
bearing
deposits            708,257        19,877          2.81       663,164        21,693          3.27       620,872        17,128         2.76
Short-term
borrowings           47,765         1,147          2.40        33,138         1,264          3.81        29,302         1,002         3.42
Long-term
debt                 11,598           531          4.58        21,271         1,148          5.40        17,831           944         5.29
Total
interest
bearing
liabilities         767,620        21,555          2.81 %     717,573        24,105          3.36 %     668,005        19,074         2.86 %

Noninterest
bearing
deposits            107,430                                   106,462                                   110,657
Other
liabilities          11,388                                     9,074                                     7,709
Stockholders'
equity              124,364                                   114,039                                   107,046
Total
liabilities
and
stockholders'
equity          $ 1,010,802                                 $ 947,148                                 $ 893,417

Net interest
spread                          $  40,320          3.68 %                 $  41,424          3.98 %                 $  39,234         4.12 %
Net interest
margin                                             4.23 %                                    4.64 %                                   4.70 %

(1) All amounts are reported on a tax equivalent basis computed using the statutory federal income tax rate of 35% exclusive of the alternative minimum tax rate and nondeductible interest expense. The taxable equivalent adjustment amounts utilized in the above table to compute yields aggregated $401,000 in 2008, $388,000 in 2007, and $337,000 in 2006.
(2) Average loan balances include nonaccrual loans.
(3) Interest income on loans includes amortized loan fees, net of costs, for each category and yields are stated to include all.

On a tax equivalent basis, total interest income was $61.9 million for 2008, compared to $65.5 million for 2007 and $58.3 million for 2006. The Company's largest source of interest income is loans. The tax equivalent yield on loans decreased to 6.81% for 2008, compared to 7.91% for 2007 and 7.62 % for 2006. The $109.0 million increase in average loans was not enough to offset the decrease of 110 basis points in the yield on loans which was the primary reason for the decline in interest income in 2008. An increase in both the volume and yield on loans was the reason for the increase in interest income in 2007. Volume and yields on all other earning assets decreased during 2008. In 2007, volume decreased but yields increased for all other earning assets. During 2008, the overall decrease in yields on earning assets produced $3.7 million less in interest income, $5.8 million of which was due to lower rates net of $2.1 million due to increased volume. In 2007, increased volume and yields on earning assets generated $7.2 million in additional interest income. Of that amount, increased volume generated an additional $4.7 million in interest income, while $2.5 million was attributable to increased yields on earning assets.

Interest expense was $21.6 million for 2008, compared to $24.1 million for 2007 and $19.1 million for 2006. Although overall volume increased, lower rates paid for interest bearing liabilities, primarily deposits, was the main reason for the decrease in interest expense in 2008. An increase in volume and higher rates paid for interest bearing liabilities resulted in an increase in interest expense for 2007 when compared to 2006. The Company incurs the largest amount of interest expense from time deposits. The average rate paid for certificates of deposit of $100,000 or more decreased 75 basis points to 4.11% for 2008 from 4.86% for 2007. The average rate paid for certificates of deposit of $100,000 or more increased 44 basis points in 2007 from 2006. The rate paid for all other time deposits decreased to 4.01% for 2008, compared to 4.54% for 2007. The rate paid for all other time deposits increased 51 basis points in 2007 from 2006. During 2008, the overall decrease in rates on interest bearing liabilities produced $2.5 million less in interest expense, $3.9 million of which was due to lower rates net of $1.4 million due to increased volume. In 2007, increased volume and rates on deposits and other interest bearing liabilities generated $5.0 million in additional interest expense. Of that amount, increased volume generated an additional $2.3 million in interest expense, while $2.7 million was attributable to increased rates.

Average earning assets grew $61.0 million, or 6.8%, for the year ended December 31, 2008, driven primarily by growth in loans. In 2007, average earning assets increased $57.5 million, or 6.9%, when compared to 2006, also mainly due to loan growth. Average loans increased $109.0 million, or 15.0%, totaling $837.7 million for the year ended December 31, 2008, compared to an increase of $64.5 million, or 9.7%, for 2007. For the year ended December 31, 2008, average investment securities decreased $30.0 million and federal funds sold and interest bearing deposits in other banks decreased $18.3 million when compared to 2007. Average investment securities increased $1.9 million and federal funds sold and interest bearing deposits in other banks decreased $8.9 million for 2007 when compared to 2006. As a percentage of total average earning assets, loans and investment securities were 87.8% and 10.1%, respectively, for 2008, compared to 81.6% and 14.1%, respectively, for 2007 and 79.5% and 14.8%, respectively, for 2006.

The following Rate/Volume Variance Analysis identifies the portion of the changes in tax equivalent net interest income attributable to changes in volume of average balances or to changes in the yield on earning assets and rates paid on interest bearing liabilities.

                                2008 over (under) 2007                     2007 over (under) 2006
                          Total               Caused By              Total               Caused By
(Dollars in
thousands)               Variance        Rate         Volume        Variance        Rate         Volume
Interest income from
earning assets:
Loans                   $     (596 )   $  (4,880 )   $   4,284     $    7,004     $   1,878     $   5,126
Taxable investment
securities                  (1,317 )        (111 )      (1,206 )          619           549            70
Tax-exempt investment
securities                    (140 )           1          (141 )           (5 )           5           (10 )
Federal funds sold            (800 )        (455 )        (345 )         (351 )          30          (381 )
Interest bearing
deposits                      (801 )        (320 )        (481 )          (46 )          40           (86 )
Total interest income       (3,654 )      (5,765 )       2,111          7,221         2,502         4,719

Interest expense on
deposits
and borrowed funds:
Interest bearing
demand deposits               (632 )        (636 )           4            367           317            50
Money market and
savings deposits              (769 )        (801 )          32            451           647          (196 )
Time deposits                 (415 )      (1,727 )       1,312          3,747         1,655         2,092
Short-term borrowings         (117 )        (627 )         510            262            52           210
Long-term debt                (617 )        (155 )        (462 )          204            19           185
Total interest
expense                     (2,550 )      (3,946 )       1,396          5,031         2,690         2,341
Net interest income     $   (1,104 )   $  (1,819 )   $     715     $    2,190     $    (188 )   $   2,378

The rate and volume variance for each category has been allocated on a consistent basis between rate and volume variances, based on a percentage of rate, or volume, variance to the sum of the absolute two variances.

Our net interest margin (i.e., tax equivalent net interest income divided by average earning assets) represents the net yield on earning assets. The net interest margin is managed through loan and deposit pricing and asset/liability strategies. The net interest margin was 4.23% for 2008, compared to 4.64% for 2007 and 4.70% for 2006. The main reason for the lower net interest margin in 2008 was decreased yields on earning assets. The increased cost of interest bearing liabilities in 2007 slightly decreased the net interest margin from 2006. The net interest spread, which is the difference between the average yield on earning assets and the rate paid for interest bearing liabilities, was 3.68% for 2008, 3.98% for 2007 and 4.12% for 2006.

Noninterest Income

Noninterest income increased $5.7 million, or 38.6%, in 2008, compared to an increase of $1.8 million, or 14.3%, in 2007. The increases were primarily related to the acquisition of two insurance entities during the fourth quarter of 2007. Service charges on deposit accounts increased $228 thousand in 2008, relatively unchanged from the increase of $235 thousand in 2007. Other service charges and fees increased $834 thousand in 2008 and $677 thousand in 2007. Approximately half of the 2008 increase was from the new insurance entities, 30% was from the trust division, and the remainder was from banking activities. The 2007 increase was the result of an increase in interchange income relating to bank debit and ATM cards ($166 thousand), and fee income generated by the trust division ($303 thousand). Investment securities losses were $15 thousand in 2008, compared to gains of $5 thousand and $3 thousand in 2007 and 2006, respectively. The securities losses in 2008 were from the sale of 10,000 shares of Federal Home Loan Mortgage Corporation (Freddie Mac) preferred stock. The Company also incurred a $371 thousand other than temporary impairment loss on these securities during 2008. Insurance agency commissions income was $12.1 million in 2008, compared to $7.7 million and $6.7 million in 2007 and 2006, respectively. The increase in 2008 and 2007 was primarily due to the two insurance entities acquired in the fourth quarter of 2007. Gains on disposals of premises and equipment were $1.2 million in 2008, compared to losses of $136 thousand in 2007 and gains of $6 thousand in 2006. The gains on disposals in 2008 included the sale of a bank branch to the state of Maryland as part of a road widening project. The branch remains open but management expects to move branch operations to a new facility in the future. During 2008, the Company sold its investment in Delmarva Bank Data Processing Center, Inc., an unconsolidated subsidiary, for a loss of $337 thousand. Other noninterest income decreased $438 thousand in 2008 and increased $114 thousand in 2007. The decrease in 2008 was primarily due to less income generated by the mortgage subsidiary.

The following table summarizes our noninterest income for the years ended December 31:

                              Years Ended                                 Change from Prior Year
                                                                   2008/07                      2007/06
(Dollars in
thousands)         2008          2007          2006         Amount        Percent       Amount        Percent
Service
charges on
deposit
accounts         $   3,600     $   3,372     $   3,137     $     228           6.8 %   $     235            7.5 %
Other service
charges and
fees                 3,029         2,195         1,518           834          38.0           677           44.6
(Losses) gains
on sales of
investment
securities             (15 )           5             3           (20 )      (400.0 )           2           66.7
Other than
temporary
impairment of
securities            (371 )           -             -          (371 )           -             -              -
Insurance
agency
commissions
income              12,090         7,698         6,744         4,392          57.1           954           14.1
Gains (losses)
on disposals
of premises
and equipment        1,247          (136 )           6         1,383       1,016.9          (142 )     (2,366.7 )
Loss on sale
of investment
in
unconsolidated
subsidiary            (337 )           -             -          (337 )           -             -              -
Other
noninterest
income               1,107         1,545         1,431          (438 )       (28.3 )         114            8.0
Total            $  20,350     $  14,679     $  12,839     $   5,671          38.6         1,840           14.3

Noninterest Expense

Total noninterest expense increased $5.8 million or 17.9% in 2008, compared to an increase of $4.0 million or 14.0% in 2007. The increase in 2008 was primarily attributable to the operating costs of the two insurance entities acquired . . .