• the possibility of a prolonged economic downturn;

• 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 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 2008 Annual Report on Form 10-K for the period ended December 31, 2008. 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 balance sheet. 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 18 and 25 of this Form 10-Q.

Declines in the fair value of available-for-sale and held-to-maturity securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
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 March 31, 2009,
compared to three months ended March 31, 2008
FINANCIAL HIGHLIGHTS
The Corporation earned net income available to common shareholders of $740,000 or $0.18 per share ($0.18 diluted) for the three-month period ended March 31, 2009, compared to $1,523,000 or $0.39 per share ($0.38 diluted), for the same period of 2008. The $783,000 or 51 percent decrease in net income available to common shareholders for the current quarter was the result of a decrease in net interest income and increases in operating expenses and provision for loan losses.
Net interest income for the first quarter of 2009 was constrained by a decline in net interest margin, defined as net interest income as a percentage of average earnings assets on a tax equivalent basis. The historic low levels of Wall Street Journal Prime and LIBOR rates continue to depress yields on floating rate loans that are priced off of these indices. The increase in operating expenses was primarily the result of adding three new financial centers during 2008, increases in deposit insurance costs due in part to increased assessment rates levied on the commercial banking industry by the Federal Deposit Insurance Corporation, and a non-recurring cost of $242,000 to restructure employee benefit plans. Restructuring the benefit plans resulted in a federal income tax benefit so that the overall transaction had an insignificant impact on net income. The increase in the provision for loan losses for the current period reflected growth in the Company's loan portfolio and heightened risk associated with the economic recession at the local and national levels. Net income as a percentage of average shareholders' equity (ROE) was 5.70 percent for the first three months (annualized) of 2009, compared to 12.49 percent for the same period of 2008. Net income as a percentage of average total assets (ROA) was 0.50 percent for the first three months (annualized) of 2009, compared to 1.02 percent for the same period of 2008. The decrease in both ratios for 2009 reflected the decrease in earnings. The ROE ratio was further depressed as a result of a $16.5 million capital addition described later in this report. The efficiency ratio (noninterest expense as a percentage of net interest income plus noninterest income on a tax equivalent basis) was 82.1 percent for the first quarter of 2009, compared to 66.3 percent for the same quarter of 2008. The increase in the efficiency ratio reflected the impact of the one-time cost of restructuring employee benefit plans in the current period and increased costs associated with corporate expansion during 2008. On March 31, 2009, nonperforming assets as a percentage of total loans and foreclosed real estate were 2.92 percent, compared to 2.24 percent at March 31, 2008. Information regarding nonperforming assets is provided in the Risk Management section of this report, including Table 3-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 March 31, 2009. An analysis of the allowance is provided in Table 4-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 March 31, 2009. The increase in the capital ratios since year-end 2008 reflects the issuance of $16.5 million of perpetual preferred stock, which qualifies as Tier 1 capital, to the U.S. Department of the Treasury under its Capital Purchase Program, described more fully in Note 6-Shareholders' Equity. 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 March 31, 2009, was $5,096,000, a decrease of $345,000 or 6 percent below the first quarter of 2008 due primarily to a decline in net interest margin, which more than offset an increase in the volume of assets. The net interest margin was 2.97 percent for the first quarter of 2009, compared to 4.07 percent for the first quarter of 2008.
For the first three months of 2009, total interest income decreased $108,000 or 1 percent, compared to 2008 due primarily to lower yields on earning assets, particularly loan yields indexed to the Wall Street Journal Prime and LIBOR rates, which are at historic lows. Increases in the level of liquidity and nonperforming assets also dampened interest income for the current quarter. The first quarter of 2008 included the recovery of interest income and fees from two delinquent commercial loans, which had a positive impact on yield and net interest margin. Approximately $179,000 of the interest income recovery in 2008 pertained to amounts due from 2007. Earning assets averaged $721 million and yielded 5.33 percent (tax equivalent basis) for the first quarter of 2009, compared to $554 million and 6.94%, respectively, for 2008. The $167 million or 30 percent increase in average earning assets was primarily the result of strong growth in the commercial loan and investment securities portfolios. Investment securities were purchased during the current quarter as part of a leverage strategy, which is discussed in the Investment Securities section of this report. The leverage strategy is expected to make a positive contribution to net interest income in future periods; however, the 2 percent tax-equivalent margin spread from this strategy is expected to constrain the Corporation's net interest margin.
For the first three months of 2009, total interest expense increased $237,000 or 6 percent, compared to 2008 due to a larger volume of interest bearing liabilities. Total interest bearing liabilities averaged $652 million at an average rate of 2.61 percent for the current quarter, compared to $502 million and 3.17 percent, respectively, for 2008. The $150 million or 30 percent increase in interest bearing liabilities was primarily driven by increases in the volume of time deposits and long-term debt. Federally insured bank deposits continue to provide safe haven to our clients who are increasingly concerned about the economic recession, volatile capital markets and rising unemployment. The addition of three financial centers in 2008 and competitive pricing also contributed to the increase in deposit volumes. The increase in long-term debt during the current quarter provided the financing for a leverage strategy, which is discussed in the Long-term Debt section of this report. Provision for loan losses
For quarter ended March 31, 2009, the provision for loan losses was $244,000, compared to $150,000 for the first quarter of 2008. The current period provision reflected growth in the Corporation's loan portfolio, an increase in nonperforming loans and heightened risk associated with the economic recession at the local and national levels.

Noninterest income
The following table presents the components of total noninterest income for the first quarter of 2009, compared to the first quarter of 2008. Total noninterest income increased $252,000 or 16 percent including the gain from the sale of securities. Excluding this gain, total noninterest income increased $89,000 or 6 percent.

Table 1 - Noninterest income

                                                Three months ended                    Change
                                                     March 31                   Increase (Decrease)
(dollars in thousands)                         2009            2008             $                %

Trust and investment services fees          $      311       $     314      $       (3 )            (1) %
Mutual fund, annuity and insurance sales           346             488            (142 )            (29 )
Service charges on deposit accounts                525             520               5                1
Income from bank owned life insurance              163              67              96              143
Other income                                       148             122              26               21
Gain on sales of mortgages                         167              60             107              178
Gain on sales of securities                        163               0             163              100

Total noninterest income                    $    1,823       $   1,571      $      252               16 %

The discussion that follows addresses changes in selected categories of noninterest income.
Trust and investment services fees-Income from trust operations was generally flat as a result of the depressed capital markets and the impact it had on our fees, which are generally calculated on the market price of assets under management.
Mutual fund, annuity and insurance sales-The $142,000 or 29 percent decrease in income from the sale of mutual funds, annuities and insurance products by Codorus Valley Financial Advisors, a subsidiary of PeoplesBank, was a result of depressed capital markets and the impact it had on the volume of sales and fees. A portion of our fees is calculated on market prices of assets under management. Service charges on deposit accounts-Service charges on deposit accounts were generally flat as deposit clients were more conservative in their spending and money management behavior due to concerns about the recession and job security. Income from bank owned life insurance-The $96,000 or 143 percent increase in income from bank owned life insurance (BOLI) was due to an additional investment of approximately $4 million in November 2008 and an increase in the crediting rates on existing policies that were transferred to new insurance providers. The additional investment in BOLI provided a competitive tax-free return to the Corporation while providing a life insurance benefit to additional members of the management team.
Other income-The $26,000 or 21 percent increase in other income was due primarily to an increase in income from real estate settlement services. Gain on sales of mortgages-The $107,000 or 178 percent increase in gains from the sale of mortgages was the result of an increase in the volume of sales. During the current quarter, the low level of market interest rates on mortgage products, influenced by the Federal Reserve Bank to stimulate the economy, has increased mortgage refinancing activity.

Gain on sales of securities-During the current quarter $163,000 in gains were realized from the sale of five U.S. agency mortgage-backed bonds from the available-for-sale securities portfolio to take advantage of the low interest rate environment. There was no comparable transaction in the first quarter of 2008.
Noninterest expense
The following table presents the components of total noninterest expense for the first quarter of 2009, compared to the first quarter of 2008.

Table 2 - Noninterest expense

                                        Three months ended                 Change
                                             March 31               Increase (Decrease)
   (dollars in thousands)                2009          2008            $              %

   Personnel                          $    3,346      $ 2,858     $       488           17 %
   Occupancy of premises, net                480          380             100           26
   Furniture and equipment                   435          350              85           24
   Postage, stationery and supplies          110          109               1            1
   Professional and legal                     84           88              (4 )         (5 )
   Marketing and advertising                 125           72              53           74
   FDIC insurance                            230           55             175          318
   Debit card processing                     122          121               1            1
   Charitable donations                      176          555            (379 )        (68 )
   Other                                     700          209             491          235

   Total noninterest expense          $    5,808      $ 4,797     $     1,011           21 %

The discussion that follows addresses changes in selected categories of noninterest expense.
Personnel-The $488,000 or 17 percent increase in personnel expense, comprised of wages/sales commissions, payroll taxes and employee benefits, resulted from staff additions associated with planned business growth and a non-recurring cost of $242,000 to restructure employee benefit plans. Restructuring the benefit plans resulted in a federal income tax benefit so that the overall transaction had an insignificant impact on net income.
Occupancy of premises, net-The $100,000 or 26 percent increase in occupancy expense, comprised of rent, depreciation, maintenance, insurance, real estate taxes and utilities, increased primarily as a result of expanding the banking franchise. PeoplesBank added three full service financial centers during 2008. Furniture and equipment-The $85,000 or 24 percent increase in furniture and equipment expense was primarily the result of an increase in depreciation expense from capital expenditures that supported franchise expansion and information technology initiatives.
Marketing and advertising-The $53,000 or 74 percent increase in marketing and advertising expenses were due to increased product and image advertising, franchise expansion and normal business growth.
FDIC insurance-The $175,000 or 318 percent increase in Federal Deposit Insurance Corporation (FDIC) insurance premiums was primarily the result of an industry-wide increase in assessment rates and an increase in the volume of deposits upon which the assessment is based. Based on the estimated level of insured deposits and the current 2009 assessment rates, the Corporation expects to incur approximately $950,000 of FDIC insurance premiums for full year 2009.

In addition, the FDIC has adopted an interim rule imposing a special assessment of 20 basis points on total deposits at June 30, 2009, in its effort to replenish the Deposit Insurance Fund. Recently, the U.S. Senate passed a bill that will increase the FDIC's borrowing authority from the U.S. Treasury from $30 billion to $100 billion, allowing the FDIC to reduce its planned special assessment from 20 basis points to 10 basis points. The FDIC is expected to announce its final special assessment decision in late May 2009. Based on the Corporation's deposit base at March 31, 2009, the cost of the special assessment would be approximately $1,300,000 ($858,000 after-tax) under a 20 basis point assessment rate scenario and $650,000 ($429,000 after-tax) under a 10 basis point assessment rate scenario. Planned deposit growth during the second quarter would increase these amounts since the actual assessment date is June 30, 2009. Charitable donations-The level of charitable donations was particularly large in the first quarter of 2008. At that time the Corporation accrued $444,000 for a donation commitment that qualified for a $400,000 (90%) state tax credit for education improvement. The tax credit was used to reduce the Pennsylvania shares tax expense included in other expense.
Other-The $491,000 or 235 percent increase in other expense, which is comprised of many underlying expenses, increased primarily as a result of a $400,000 increase in Pennsylvania shares tax and a $61,000 increase in telephone expense. The shares tax expense for the first quarter of 2008 was unusually low as a result of recognizing a $400,000 tax credit, described above, in charitable donations. The increase in telephone expense reflected conversion to a new carrier during 2008, telecommunication enhancements and corporate growth. In the period ahead, it is probable that noninterest expense will increase as a result of increased FDIC deposit insurance premiums, planned improvements to selected corporate facilities, investment in information technology initiatives, regulatory compliance and normal business growth. Income taxes
The provision for income tax for the first quarter of 2009 was a $96,000 credit (benefit), compared to a $542,000 expense for the same period in 2008. The decrease in income tax was the result of a decrease in pretax income and the recognition of a one-time $242,000 tax benefit associated with restructuring employee benefit plans. For both periods the Corporation's statutory federal income tax rate was 34 percent. The Corporation's effective federal income tax rate was a negative 11 percent for 2009 and 25 percent for 2008. The effective tax rate differs from the statutory tax rate due to the impact of low-income housing credits and tax exempt income including income from bank owned life insurance. The effective tax rate for 2009 decreased primarily as a result of the one-time tax benefit and the decrease in pretax income.
BALANCE SHEET REVIEW
Interest bearing deposits with banks
On March 31, 2009, interest bearing deposits with banks, i.e., overnight investments, was $37 million, compared to $3 million at year-end 2008. The increase in overnight investments primarily resulted from strong deposit growth, which exceeded loan growth.

Investment securities
On March 31, 2009, the fair value of the securities available-for-sale portfolio totaled $136 million, compared to $72 million at year-end 2008. The increase in the investment securities portfolio was the result of initiating an $80 million leverage strategy that involves investing in investment grade U.S. agency mortgage-backed bonds (3-4 year average lives) and municipal bonds (5-10 year maturities), which were financed by borrowing from the Federal Home Loan Bank of Pittsburgh. The leverage strategy, when complete in April 2009, is expected to generate a 2 percent tax-equivalent margin spread, which will cover the dividends payable and related costs associated with the recent issuance of preferred stock described in Note 6-Shareholders' Equity. During the first quarter, PeoplesBank took advantage of the low interest rate environment and sold five U.S. agency mortgage-backed bonds totaling $5.3 million yielding approximately 4.55%. The sale generated a $163,000 gain that was recognized into income.
Restricted investment in bank stocks
At March 31, 2009, PeoplesBank held $4,262,000 in restricted common stock, compared to $2,692,000 at year-end 2008. The increase was required to obtain advances from the Federal Home Loan Bank of Pittsburgh (FHLBP) to finance the leverage strategy previously discussed. Investment in restricted stock is a condition to obtaining credit from the FHLBP and the Atlantic Central Bankers Bank (ACBB) organizations. Of the total, $4,187,000 pertained to stock issued by the FHLBP and $75,000 pertained to ACBB. In December 2008, the FHLBP announced the suspension of the payment of dividends on its common stock and its repurchase of capital stock as strategies to preserve its capital. Loans
On March 31, 2009, total loans were $591 million, an increase of $18 million or 3 percent above year-end 2008. The increase was primarily attributable to an increase in commercial loans. The average yield (tax-equivalent basis) earned on total loans was 5.70 percent for the first quarter of 2009, compared to 6.21 percent for the fourth quarter of 2008 and 7.43 percent for the first quarter of 2008. The decline in loan yields, particularly floating rate loans, reflected a series of aggressive interest rate cuts by the Federal Reserve Bank from September 2007 through April 2008 and again during the fourth quarter of 2008 in its continuing efforts to stimulate the recessionary economy. The sharp decreases in LIBOR rates, which are presently at historically low levels, reflect the impact of a global economic crisis and disrupted credit markets. The first quarter of 2008 included the recovery of interest income and fees from two delinquent commercial loans, which had a positive impact on yield. Approximately $179,000 of the interest income recovery in 2008 pertained to amounts due from 2007.
Deposits
On March 31, 2009, total deposits were approximately $650 million, an increase of $52 million or 9 percent above year-end 2008. The increase in deposits, as shown in Note 3-Deposits, occurred primarily in time deposits and secondarily in money market deposits. Federally insured bank deposits continue to provide safe haven to our clients who are increasingly concerned about the economic recession, volatile capital markets and rising unemployment. The addition of three financial centers in 2008 and competitive pricing also contributed to the increase in deposit volumes. The average rate paid on interest-bearing deposits was 2.59 percent for the first quarter of 2009, compared to 2.82 percent for the fourth quarter of 2008 and 3.06 percent for the first quarter of 2008. Long-term debt
On March 31, 2009, long-term debt totaled $85 million, compared to $19 million at year-end 2008. During the current quarter PeoplesBank borrowed approximately $66 million in term debt from the Federal Home Loan Bank of Pittsburgh (FHLBP). Maturities were staggered over three years at an average rate of 2.04 percent. PeoplesBank borrowed from the FHLBP to finance investments in securities. i.e., effect a leverage strategy, to generate sufficient margin spread to cover the costs of the dividends payable on the preferred stock issued in January 2009 as described below in the shareholders' equity and capital adequacy section and in Note 6-Shareholders' Equity. A listing of outstanding long-term debt obligations is provided in Note 4-Long-term Debt.

Shareholders' equity and capital adequacy Shareholders' equity or capital enables Codorus Valley to maintain asset growth and absorb losses. Total shareholders' equity was approximately $69 million on March 31, 2009, an increase of approximately $17 million or 32 percent above December 31, 2008. The increase was caused primarily by the issuance of $16.5 million of preferred stock described below.
As previously disclosed, on January 9, 2009, the Corporation sold 16,500 shares of $1,000 liquidation value ($2.50 par value) nonvoting cumulative perpetual preferred stock to the U.S. Department of the Treasury (Treasury) under the Treasury's voluntary Capital Purchase Program (CPP) and received $16.5 million in capital funds. Codorus Valley, which is well capitalized, plans to use the . . .