Executive Overview

Community Financial Corporation is a Virginia corporation. Certain of the information presented herein relates to Community Bank, a wholly owned subsidiary of Community Financial. Community Financial and Community Bank, like all thrift institutions and their holding companies, are subject to comprehensive regulation, examination and supervision by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation.

The following information is intended to provide investors a better understanding of our financial position and the operating results of Community Financial Corporation and its subsidiary, Community Bank. This discussion is primarily from management's perspective and may not contain all information that is of importance to the reader. Accordingly, the information should be considered in the context of the consolidated financial statements and other related information contained herein.

Our net income is primarily dependent on the difference or spread between the average yield earned on loans and investments and the average rate paid on deposits and borrowings, as well as the relative amounts of such assets and liabilities. The interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Like other financial institutions, we are subject to interest rate risk to the degree that our interest bearing liabilities, primarily deposits and borrowings with short and medium term maturities, mature or reprice more rapidly, or on a different basis, than interest earning assets, primarily loans with longer term maturities than deposits and borrowings. While having liabilities that mature or reprice more frequently on average than assets may be beneficial in times of declining interest rates, such an asset/liability structure may result in lower net income or net losses during periods of rising interest rates, unless offset by other noninterest income. Our net income is also affected by, among other things, fee income, asset quality, provision for loan losses, operating expenses and income taxes.

The primary factor contributing to our net loss for the fiscal year was the securities impairment related to our Fannie Mae and Freddie Mac preferred stock. Additionally we experienced an increase in our provision for loan losses related to the current recessionary economic environment.

The primary factors contributing to the increase in net interest income for the fiscal year ended March 31, 2009 was the growth in interest-earning assets, primarily loans, and an increase in the interest rate spread. The increased interest rate spread is primarily attributable to a reduction in the cost of our interest-bearing liabilities due to aggressive rate reductions by the Federal Reserve during the prior fiscal year. The aggressive rate reductions in the prior fiscal year resulted in a timing difference in the repricing of assets and liabilities. We will monitor the impact a change in interest rates may have on both the growth in interest-earning assets and our interest rate spread. The pace and extent of future interest rate changes will impact our loan growth and interest rate spread, as well as interest rate adjustments on certain adjustable rate loans that are subject to caps.

Utilization of brokered deposits and management's emphasis on increasing low and no interest bearing transaction accounts has impacted the composition of our interest-bearing liabilities. Deposits were the primary source of funding during the fiscal year ended March 31, 2009. We acquired lower cost brokered deposits and low interest bearing transaction accounts during the fiscal year to fund the growth in our loans. While we have the capacity to continue to utilize borrowings to meet funding needs, management recognizes the practical long-term limitations of such a funding strategy. Management is also cognizant of the potential for compression in our net interest margin related to the need to acquire funds and the pace of interest rate changes. Management will continue to monitor the level of deposits and borrowings in relation to the current interest rate environment.

Critical Accounting Policies

General. Our financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The financial information contained within our financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Allowance for Loan Losses. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standard ("SFAS") No.5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market, and the loan balance.

The allowance for loan losses is maintained at a level considered by management to be adequate to absorb future loan losses currently inherent in the loan portfolio. Management's assessment of the adequacy of the allowance is based upon type and volume of the loan portfolio, past loan loss experience, existing and anticipated economic conditions, and other factors which deserve current recognition in estimating future loan losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Additions to the allowance are charged to operations. Subsequent recoveries, if any, are credited to the allowance. Loans are charged-off partially or wholly at the time management determines collectibility is not probable. Management's assessment of the adequacy of the allowance is subject to evaluation and adjustment by our regulators.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers special mention and non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

Asset/Liability Management

Management believes it is important to manage the relationship between interest rates and the effect on our net portfolio value. This approach calculates the difference between the present value of expected cash flows from assets and the present value of expected cash flows from liabilities, as well as cash flows from off-balance sheet contracts. Management of our assets and liabilities is done within the context of the marketplace, but also within limits established by the board of directors on the amount of change in net portfolio value which is acceptable given certain interest rate changes.

Presented in the following table, as of March 31, 2009 and 2008, is an analysis of our interest rate risk as measured by changes in net portfolio value for instantaneous and sustained parallel shifts in the yield curve and compared to our board policy limits. Information is presented in accordance with Office of Thrift Supervision regulations and based on its assumptions. The Board limits have been established with consideration of the dollar impact of various rate changes and our strong capital position. The Board limit has been established as a minimum percentage of the Company's net portfolio value. Our net portfolio values at March 31, 2009 were within the parameters set by the Board of Directors. As illustrated in the table, net portfolio value is not significantly impacted by rising or falling rates as of the date indicated.

                                      March 31, 2009            March 31, 2008
  Change in       Board Limit         $          NPV as          $         NPV as %
Interest Rate      NPV as %         Change        % of        Change          of
(Basis Points)     of Assets        in NPV       Assets       in NPV        Assets
                               (Dollars in Thousands)
     +200              7             (4,234 )       10.3 %     (4,538 )         9.0 %
     +100              8             (1,852 )       10.6       (2,192 )         9.4
     -0-               9                  -         10.9            -           9.8
     -100              8                840         11.1          899           9.9
     -200              7                  -            -        1,647          10.0

Generally, management strives to maintain a neutral position regarding interest rate risk. In the current interest rate environment, our customers are interested in obtaining long-term credit products and short-term savings products. Management has taken action to counter this trend. A significant effort has been made to reduce the duration and average life of our interest-earning assets. As of March 31, 2009, approximately 73.0% of our gross loan portfolio consisted of loans which reprice during the life of the loan. We emphasize adjustable-rate mortgage loans and have increased our portfolio of short-term consumer loans. Longer term fixed-rate mortgage loans, 15 to 30 years, are generally referred to other organizations.

On the deposit side, management has worked to reduce the impact of interest rate changes by emphasizing non-interest bearing or low interest deposit products and maintaining competitive pricing on longer term certificates of deposit. We have also used Federal Home Loan Bank advances to provide funding for loan originations and to provide liquidity as needed.

In managing our asset/liability mix depending on the relationship between long- and short-term interest rates, market conditions, and consumer preference, we may place somewhat greater emphasis on maximizing our net interest income than on strictly matching the interest rate sensitivity of our assets and liabilities. We believe the increased net income that may result from an acceptable mismatch in the actual maturity or repricing of our asset and liability portfolio can provide sufficient returns to justify the increased exposure to sudden and unexpected increases in interest rates which may result from such a mismatch. We have established limits, which may change from time to time, on the level of acceptable interest rate risk. There can be no assurance, however, that in the event of an adverse change in interest rates, our efforts to limit interest rate risk will be successful.

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could likely deviate significantly from those assumed in calculating the information in the table above. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. We consider all of these factors in monitoring our exposure to interest rate risk.

Average Balances, Interest Rates and Yields

     The following table sets forth certain information relating to categories
of our interest-earning assets and interest-bearing liabilities for the periods
indicated. All average balances are computed on a daily basis. Non-accruing
loans have been included in the table as loans carrying a zero yield. The yields
have not been adjusted for tax preferences.

                                                                                 Year Ended March 31,
                                                2009                                     2008                                     2007
                                 Average                     Yield/       Average                     Yield/       Average                     Yield/
                                 Balance      Interest        Cost        Balance      Interest        Cost        Balance      Interest        Cost
                                                                                (Dollars in Thousands)
Interest-Earning Assets
Loans                           $ 458,265     $  28,129         6.14 %   $ 417,897     $  30,248         7.24 %   $ 377,894     $  27,268         7.22 %
Investment securities and
other investments                  20,172           563         2.79 %      41,064         1,996         4.86 %      44,321         2,151         4.85 %
Total interest-earning assets     478,437        28,692         6.00 %     458,961        32,244         7.03 %     422,215        29,419         6.97 %
Non-interest earning assets        18,953                                   20,959                                   20,261
Total Assets                    $ 497,390                                $ 479,920                                $ 442,476

Interest-Bearing Liabilities
Deposits                        $ 355,599        10,497         2.95 %   $ 337,608        12,354         3.66 %   $ 311,207        10,047         3.23 %
FHLB advances and other
borrowings                         98,293         1,963         2.00 %      98,636         4,624         4.69 %      91,454         4,745         5.19 %
Total interest-bearing
liabilities                       453,892        12,460         2.75 %     436,244        16,978         3.89 %     402,661        14,792         3.67 %
Non-interest bearing
Liabilities                         3,533                                    4,414                                    2,815
Total Liabilities                 457,425                                  440,658                                  405,476
Stockholder's equity               39,965                                   39,262                                   37,000
Total Liabilities and
Stockholders' Equity            $ 497,390                                $ 479,920                                $ 442,476
Net interest income                           $  16,232                                $  15,266                                $  14,627
Interest rate spread                                            3.25 %                                   3.14 %                                   3.30 %
Net interest-earning
assets/net yield on
interest-earning assets         $  24,545                       3.39 %   $  22,717                       3.33 %   $  19,554                       3.46 %
Percentage of
interest-earning assets to
interest-bearing liabilities       105.41 %                                 105.21 %                                 104.86 %

Rate/Volume Analysis

The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected our interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume), and (iii) total changes in rate and volume. The combined effect of changes in both volume and rate, which cannot be separately identified, has been allocated proportionately to the change due to volume and the change due to rate.

                                                       Year Ended March 31,
                                      2009 v. 2008                               2008 v. 2007
                          Increase                                    Increase
                         (Decrease)                    Total         (Decrease)                   Total
                           Due to                     Increase         Due to                    Increase
                           Volume         Rate       (Decrease)        Volume        Rate       (Decrease)
                                                      (Dollars in Thousands)
Interest-Earning
Assets
Loans                   $      2,478    $ (4,597 )  $     (2,119 )  $      2,895    $    85    $      2,980
Investment
securities and other
investments                     (583 )      (850 )        (1,433 )          (158 )        3            (155 )
Total
Interest-earning
assets                  $      1,895    $ (5,447 )  $     (3,552 )  $      2,737    $    88    $      2,825

Interest-Bearing
Liabilities
Deposits                $        531    $ (2,388 )  $     (1,857 )  $        966    $ 1,341    $      2,307
FHLB advances and
other borrowings                  (7 )    (2,654 )        (2,661 )           337       (458 )          (121 )
Total
interest-bearing
liabilities             $        524    $ (5,042 )  $     (4,518 )  $      1,303    $   883    $      2,186
Net interest income                                 $        966                               $        639

Financial Condition

Total assets increased $21.5 million, or 4.2%, to $512.7 million at March 31, 2009, primarily as a result of an increase in loans of $39.8 million, offset by a $10.6 million decrease in investments. The increase in assets was funded by a $14.8 million, or 4.2%, increase in deposits and a $12.6 million preferred stock issue under the Treasury's CPP. The increase in deposits is reflected primarily in increased time deposits of $10.5 million, money market accounts of $2.9 million and a $1.4 million increase in transaction accounts. The change in deposits is related primarily to the increase in brokered deposits of $10.2 million. Management believes the increase in money market deposits is primarily attributable to maintaining competitive pricing. Management attributes the increase in loans receivable primarily to excellent customer service and competitive pricing on both mortgage and consumer loans.

The Hampton Roads region of the Bank experienced loan growth of $11.0 million, primarily real estate loans, for the fiscal year ended 2009. The Shenandoah Valley region of the Bank had loan growth of approximately $28.8 million, primarily commercial real estate loans and construction loans.

Asset quality is an important factor in the successful operation of a financial institution. The loss of interest income and principal that may result from non-performing assets has an adverse effect on earnings, while the resolution of those assets requires the use of capital and managerial resources. At March 31, 2009, non-performing assets, consisting of non-performing loans, foreclosed real estate and repossessed automobiles, totaled $9.0 million, or 1.75% of total assets, compared to $1.6 million or .33% of total assets at March 31, 2008. Non-performing assets at March 31, 2009 were comprised primarily of raw land and commercial business loans 90 days or more and real estate owned. Based on current market values of the collateral securing these loans, management anticipates no significant losses in excess of the reserves for losses previously recorded. Due to an uncertain real estate market and the economy in general, no assurances can be given that our level of non-performing assets will not increase in the future.

Stockholders' equity increased $7.6 million, or 19.7%, to $46.3 million at March 31, 2009 compared to $38.7 million at March 31, 2008. The increase was the result of the issuance of preferred stock under the Treasury's CPP of $12.6 million, a decrease in the unrealized gain on equity securities of $1.4 million, proceeds from option exercises offset by a $(5.8) million net loss, and dividends paid to stockholders of $664,000.

Results of Operations

Our results of operations depend primarily on the level of our net interest income and noninterest income and the level of our operating expenses. Net interest income depends upon the value of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.

Comparison of Years Ended March 31, 2009 and 2008

General. Net loss for the year ended March 31, 2009 was $(5.8) million or $(1.39) diluted earnings per share compared to $3.8 million income or $0.87 diluted earnings per share for the year ended March 31, 2008. Net income decreased due primarily to securities impairment related to Fannie Mae and Freddie Mac preferred stock and an increase in our provision for loan losses.

Interest Income. Total interest income decreased $3.6 million, or 11.0%, to $28.7 million for the year ended March 31, 2009 as compared to $32.2 million for the year ended March 31, 2008. The decrease in total interest income can be attributed to a decrease in the yield on interest earning assets offset by an increase in the average dollar volume of interest-earning assets, primarily $40.0 million in loans receivable. Average yields on total interest-earning assets decreased 1.03% from 7.03% in fiscal 2008 to 6.00% for the current fiscal year due primarily to an decrease in loans yields in a decreasing rate environment.

Interest Expense. Total interest expense decreased $4.5 million, or 26.6%, to $12.5 million for the year ended March 31, 2009 from $17.0 million for the year ended March 31, 2008. The decrease in total interest expense is attributable to a decrease in the cost of interest-bearing liabilities offset by an increase in the average dollar volume in deposits of $18.0 million. The cost of funds decreased 1.14% from 3.89% for the year ended March 31, 2008 to 2.75% for the current year. The increase in deposit balances was due primarily to increases in time deposits for the current fiscal year.

Provision for Loan Losses. We establish provisions for loan losses, which are charged to earnings, at a level required to reflect credit losses inherent in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers' ability to repay, estimated value of any underlying collateral, peer group data, prevailing economic conditions, and current factors. Large groups of smaller balance homogeneous loans, such as residential real estate, small commercial real estate, home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data. Larger non-homogeneous loans, such as commercial loans for which management has concerns about the borrowers' ability to repay, are evaluated individually, and specific loss allocations are provided for these loans when necessary.

In the current economic environment, management has considered the potential impact of subprime lending in certain areas of the national economy. These circumstances do not appear to have significantly impacted economic conditions in our market areas which to date remain stable. We have experience moderate increases in delinquency and charge-off rates but at levels generally less than our industry during the fiscal year ended March 31, 2009. We have maintained experienced and stable lending personnel during that period. We also evaluated our risk in certain lending areas and reduced our exposure in automobile lending by $7.6 million.

Based on management's evaluation of these factors, the provision for loan losses increased $3.7 million, or 586.0%, to $4.3 million for the fiscal year ended March 31, 2009 from $625,000 for the fiscal year ended March 31, 2008. The increase in the provision for fiscal 2009 was due to an increase in the rate of loan growth and reserves for non-performing assets. We monitor our loan loss allowance on a quarterly basis and make allocations as necessary. Management believes that the level of our loan loss allowance is adequate. As of March 31, 2009, the total allowance for loan losses amounted to $6.0 million. At March 31, 2009, our allowance as a percentage of total loans receivable was 1.25% and as a percentage of total non-performing loans was 78.7%.

Noninterest Income. Noninterest income increased $80,000, or 2.4%, to $3.4 million in fiscal 2009 as compared to $3.3 million for the year ended March 31, 2008. The increase in noninterest income was primarily due to overdraft fees.

. . .