UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number: 0-15536

CODORUS VALLEY BANCORP, INC.

(Exact name of registrant as specified in its charter)

Pennsylvania		23-2428543
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

105 Leader Heights Road, P.O. Box 2887, York, Pennsylvania		17405
(Address of principal executive offices)		(Zip code)

717-747-1519

Not Applicable

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. On November 5, 2010, 4,100,408 shares of common stock, par value $2.50, were outstanding.

 

 

Codorus Valley Bancorp, Inc.
Form 10-Q Index

		Page #
PART I — FINANCIAL INFORMATION
Item 1. Financial statements (unaudited):
Consolidated balance sheets			3
Consolidated statements of income			4
Consolidated statements of cash flows			5
Consolidated statements of changes in shareholders’ equity			6
Notes to consolidated financial statements			7
Item 2. Management’s discussion and analysis of financial condition and results of operations			21
Item 3. Quantitative and qualitative disclosures about market risk			36
Item 4. Controls and procedures			36
PART II — OTHER INFORMATION
Item 1. Legal proceedings			36
Item 1A. Risk factors			36
Item 2. Unregistered sales of equity securities and use of proceeds			36
Item 3. Defaults upon senior securities			36
Item 4. Removed and Reserved			36
Item 5. Other information			36
Item 6. Exhibits			37
SIGNATURES			38
Exhibit 3.1
Exhibit 4
Exhibit 4.1
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Codorus Valley Bancorp, Inc.

Consolidated Balance Sheets
Unaudited

		September 30,				December 31,
(dollars in thousands, except share data)		2010				2009
Assets
Interest bearing deposits with banks		$	13,041			$	14,545
Cash and due from banks			9,534				8,634
Federal funds sold			3,000				3,000
Total cash and cash equivalents			25,575				26,179
Securities, available-for-sale			236,543				174,177
Restricted investment in bank stocks, at cost			4,277				4,277
Loans held for sale			4,750				1,266
Loans (net of deferred fees of $635 - 2010 and $766 - 2009)			641,416				645,877
Less-allowance for loan losses			(6,602	)			(7,175	)
Net loans			634,814				638,702
Premises and equipment, net			10,898				11,223
Other assets			34,724				37,007
Total assets		$	951,581			$	892,831
Liabilities
Deposits
Noninterest bearing		$	65,692			$	55,583
Interest bearing			729,439				667,374
Total deposits			795,131				722,957
Short-term borrowings			7,063				8,466
Long-term debt			52,028				73,972
Junior subordinated debt			10,310				10,310
Other liabilities			8,614				5,114
Total liabilities			873,146				820,819
Shareholders’ equity
Preferred stock, par value $2.50 per share; $1,000 liquidation preference, 1,000,000 shares authorized; 16,500 shares issued and outstanding - 2010 and 2009			15,944				15,828
Common stock, par value $2.50 per share; 10,000,000 shares authorized; 4,100,408 shares issued and outstanding - 2010 and 4,074,636 - 2009			10,251				10,187
Additional paid-in capital			37,200				37,004
Retained earnings			10,279				6,592
Accumulated other comprehensive income			4,761				2,401
Total shareholders’ equity			78,435				72,012
Total liabilities and shareholders’ equity		$	951,581			$	892,831

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements of Income
Unaudited

		Three months ended								Nine months ended
		September 30,								September 30,
(dollars in thousands, except per share data)		2010				2009				2010				2009
Interest income
Loans, including fees		$	9,748			$	8,945			$	28,395			$	25,578
Investment securities:
Taxable			826				837				2,454				2,514
Tax-exempt			617				585				1,785				1,484
Dividends			2				2				6				11
Other			25				13				53				47
Total interest income			11,218				10,382				32,693				29,634
Interest expense
Deposits			2,884				3,711				8,494				11,077
Federal funds purchased and other short-term borrowings			23				—				65				27
Long-term and junior subordinated debt			391				520				1,288				1,591
Total interest expense			3,298				4,231				9,847				12,695
Net interest income			7,920				6,151				22,846				16,939
Provision for loan losses			560				600				1,910				2,483
Net interest income after provision for loan losses			7,360				5,551				20,936				14,456
Noninterest income
Trust and investment services fees			348				347				1,067				961
Income from mutual fund, annuity and insurance sales			329				312				1,091				1,016
Service charges on deposit accounts			632				592				1,843				1,698
Income from bank owned life insurance			161				162				480				480
Other income			147				144				433				446
Gains on sales of loans held for sale			177				191				538				761
Gains on sales of securities			—				—				108				291
Total noninterest income			1,794				1,748				5,560				5,653
Noninterest expense
Personnel			3,393				3,199				9,812				9,702
Occupancy of premises, net			465				413				1,459				1,341
Furniture and equipment			405				427				1,264				1,263
Postage, stationery and supplies			112				104				389				353
Professional and legal			121				121				365				304
Marketing and advertising			179				235				529				475
FDIC insurance			331				278				955				1,154
Debit card processing			156				131				436				383
Charitable donations			43				7				399				214
Telephone			140				132				412				387
Foreclosed real estate including (gains) losses on sales			765				310				1,749				415
Impaired loan carrying costs			199				117				782				250
Other			632				674				1,716				1,834
Total noninterest expense			6,941				6,148				20,267				18,075
Income before income taxes (benefit)			2,213				1,151				6,229				2,034
Provision (benefit) for income taxes			433				75				1,113				(298	)
Net income			1,780				1,076				5,116				2,332
Preferred stock dividends and discount accretion			245				245				735				712
Net income available to common shareholders		$	1,535			$	831			$	4,381			$	1,620
Net income per common share, basic and diluted		$	0.37			$	0.21			$	1.07			$	0.40

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements of Cash Flows
Unaudited

		Nine months ended
		September 30,
(dollars in thousands)		2010				2009
Cash flows from operating activities
Net income		$	5,116			$	2,332
Adjustments to reconcile net income to net cash provided by operations:
Depreciation			1,030				1,047
Provision for loan losses			1,910				2,483
Provision for losses on foreclosed real estate			722				189
Deferred federal income tax expense (benefit)			299				(103	)
Amortization of investment in real estate partnership			421				406
Increase in cash surrender value of life insurance investment			(480	)			(480	)
Originations of loans held for sale			(33,456	)			(64,025	)
Proceeds from sales of loans held for sale			30,350				66,232
Gains on sales of loans held for sale			(538	)			(761	)
Gains on sales of securities available-for-sale			(108	)			(291	)
Gains on sales of held for sale assets			(35	)			—
Gains on sales of foreclosed real estate			(110	)			—
Stock-based compensation expense			87				136
Increase in accrued interest receivable			(126	)			(942	)
Decrease (increase) in other assets			968				(1,455	)
(Decrease) increase in accrued interest payable			(19	)			100
Increase (decrease) in other liabilities			3,525				(59	)
Other, net			799				456
Net cash provided by operating activities			10,355				5,265
Cash flows from investing activities
Securities, available-for-sale
Purchases			(89,850	)			(131,440	)
Maturities, repayments and calls			25,561				18,332
Sales			4,845				8,947
Net increase in restricted investment in bank stock			—				(1,570	)
Net increase in loans made to customers			(6,284	)			(63,979	)
Purchases of premises and equipment			(713	)			(682	)
Proceeds from sales of foreclosed real estate			7,802				—
Investment in life insurance			(7	)			(6	)
Net cash used in investing activities			(58,646	)			(170,398	)
Cash flows from financing activities
Net increase in demand and savings deposits			49,081				58,799
Net increase in time deposits			23,093				56,047
Net decrease in short-term borrowings			(1,403	)			(18,283	)
Proceeds from issuance of long-term debt			—				66,000
Repayment of long-term debt			(21,944	)			(15,906	)
Cash dividends paid to preferred shareholders			(619	)			(495	)
Cash dividends paid to common shareholders			(694	)			(926	)
Net proceeds from issuance of preferred stock and common stock warrants			—				16,461
Issuance of common stock			173				219
Net cash provided by financing activities			47,687				161,916
Net decrease in cash and cash equivalents			(604	)			(3,217	)
Cash and cash equivalents at beginning of year			26,179				14,875
Cash and cash equivalents at end of period		$	25,575			$	11,658

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity
Unaudited

																		Accumulated
										Additional								Other
		Preferred				Common				Paid-in				Retained				Comprehensive
(dollars in thousands, except share data)		Stock				Stock				Capital				Earnings				Income				Total
For the nine months ended September 30, 2010
Balance, January 1, 2010		$	15,828			$	10,187			$	37,004			$	6,592			$	2,401			$	72,012
Comprehensive income:
Net income															5,116								5,116
Other comprehensive income, net of tax:
Unrealized gains on securities, net																			2,360				2,360
Total comprehensive income																							7,476
Preferred stock discount accretion			116												(116	)							—
Common stock cash dividends ($0.17 per share)															(694	)							(694	)
Preferred stock dividends															(619	)							(619	)
Stock-based compensation											87												87
Issuance of common stock:
17,759 shares under dividend reinvestment and stock purchase plan							44				92												136
7,932 shares under employee stock purchase plan							20				17												37
Balance, September 30, 2010		$	15,944			$	10,251			$	37,200			$	10,279			$	4,761			$	78,435
For the nine months ended September 30, 2009
Balance, January 1, 2009		$	—			$	10,043			$	35,877			$	5,057			$	1,204			$	52,181
Comprehensive income:
Net income															2,332								2,332
Other comprehensive income, net of tax:
Unrealized gains on securities, net																			2,639				2,639
Total comprehensive income																							4,971
Preferred stock and common stock warrants issued, net of issuance costs of $39			15,678								783												16,461
Preferred stock discount accretion			112												(112	)							—
Common stock cash dividends ($0.23 per share)															(926	)							(926	)
Preferred stock dividends															(495	)							(495	)
Stock-based compensation											136												136
Issuance of common stock:
23,164 shares under dividend reinvestment and stock purchase plan							58				120												178
7,581 shares under employee stock purchase plan							19				22												41
13,667 shares of stock-based compensation awards							34				(34	)											—
Balance, September 30, 2009		$	15,790			$	10,154			$	36,904			$	5,856			$	3,843			$	72,547

See accompanying notes.

Notes to Consolidated Financial Statements (Unaudited)

Note 1—Basis of Presentation

The accompanying consolidated balance sheet at December 31, 2009 has been derived from audited financial statements and the unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q, and FASB Accounting Standards Codification (ASC) 270. Accordingly, the interim financial statements do not include all of the financial information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the interim consolidated financial statements include all adjustments necessary to present fairly the financial condition and results of operations for the reported periods, and are of a normal and recurring nature.

These statements should be read in conjunction with the notes to the audited consolidated financial statements contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2009.

The consolidated financial statements include the accounts of Codorus Valley Bancorp, Inc. and its wholly owned bank subsidiary, PeoplesBank, A Codorus Valley Company (PeoplesBank), and its wholly owned nonbank subsidiary, SYC Realty Company, Inc. (collectively referred to as Codorus Valley or the Corporation). PeoplesBank has five wholly owned subsidiaries, Codorus Valley Financial Advisors, Inc. and SYC Settlement Services, Inc. and three subsidiaries whose purpose is to temporarily hold foreclosed properties pending eventual liquidation. All significant intercompany account balances and transactions have been eliminated in consolidation. The combined results of operations of the nonbank subsidiaries are not material to the consolidated financial statements.

The results of operations for the nine-month period ended September 30, 2010 are not necessarily indicative of the results to be expected for the full year.

In accordance with FASB ASC 855, the Corporation evaluated the events and transactions that occurred after the balance sheet date of September 30, 2010, but before the financial statements were issued for potential recognition or disclosure. In preparing these financial statements, the Corporation evaluated the events and transactions that occurred from September 30, 2010 through the date these financial statements were issued.

Note 2—Significant Accounting Policies

Per Share Computations

The weighted average number of shares of common stock outstanding used for basic and diluted calculations are provided below:

		Three months ended								Nine months ended
		September 30,								September 30,
(in thousands, except per share data)		2010				2009				2010				2009
Net income available to common shareholders		$	1,535			$	831			$	4,381			$	1,620
Weighted average shares outstanding (basic)			4,097				4,051				4,086				4,036
Effect of dilutive stock options			9				0				4				0
Weighted average shares outstanding (diluted)			4,106				4,051				4,090				4,036
Basic and diluted earnings per common share		$	0.37			$	0.21			$	1.07			$	0.40
Anti-dilutive stock options and common stock warrants excluded from the computation of earnings per share			421				498				427				498

Comprehensive Income

Accounting principles generally accepted in the United States of America require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. The components of other comprehensive income and related tax effects are presented in the following table:

		Three months ended								Nine months ended
		September 30,								September 30,
(dollars in thousands)		2010				2009				2010				2009
Unrealized holding gains arising during the period		$	958			$	4,604			$	3,684			$	4,289
Reclassification adjustment for gains included in income			—				—				(108	)			(291	)
Net unrealized gains			958				4,604				3,576				3,998
Tax effect			(326	)			(1,565	)			(1,216	)			(1,359	)
Net of tax amount		$	632			$	3,039			$	2,360			$	2,639

Cash Flow Information

For purposes of the statements of cash flows, the Corporation considers interest bearing deposits with banks, cash and due from banks, and federal funds sold to be cash and cash equivalents. Noncash items for the nine-month period ended September 30, 2010 consisted of the transfer of loans to foreclosed real estate in the amount of $8,291,000 and the transfer of loans held for sale to investment in the amount of $160,000. Comparatively, for the nine-month period ended September 30, 2009 noncash transfers included the transfer of loans to foreclosed real estate in the amount of $2,992,000 and the transfer of loans held for sale to investment in the amount of $3,585,000.

Supplemental Benefit Plans

In January 2009, the Corporation incurred 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.

Income Taxes

The provision for income tax for the nine month period ending September 30, 2009 was a credit, or tax benefit, which reflected a low level of pretax income, a significant increase in tax-exempt income, and a federal income tax benefit of $242,000 associated with restructuring employee benefit plans in the first quarter of 2009.

Recent Accounting Pronouncements

The FASB issued ASU 2010-20, “Receivables” (Topic 310) — “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. This ASU requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure. The amendments in this Update apply to all public and nonpublic entities with financing receivables. Financing receivables include loans and trade accounts receivable. However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments. For public companies, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The Corporation is currently reviewing the effect this new pronouncement will have on its consolidated financial statements.

The FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures” (Topic 820) — “Improving Disclosures about Fair Value Measurements.” The amendments in this Update require some new disclosures and clarify some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:

•

A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and

•

In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.

In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:

•

For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and

•

A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

The Corporation adopted the update, except for disclosures about purchases, sales and issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010. The adoption of the Update did not have an effect on the Corporation’s financial position or results of operations.

The FASB issued ASU 2009-16, “Transfers and Servicing” (Topic 860) — “Accounting for Transfers of Financial Assets” — an amendment of FASB Statement 140. The amendments in the Update improve financial reporting by eliminating the exceptions for qualifying special-purpose entities from consolidation guidance and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, the amendments require enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. Comparability and consistency in accounting for transferred financial assets will also be improved through clarifications of the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. The Corporation adopted the update, and it did not have an effect on its financial position or results of operations.

In November 2008, the SEC released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (IASB). Under the proposed roadmap, the Corporation may be required to prepare financial statements in accordance with IFRS as early as 2015. The SEC has indicated it will make a determination in 2011 regarding the mandatory adoption of IFRS. The Corporation is currently assessing the impact that this potential change would have on its consolidated financial statements, and it will continue to monitor the development of the potential implementation of IFRS.

Note 3 — Securities Available-for-Sale

A summary of available-for-sale securities at September 30, 2010 and December 31, 2009 is provided below:

														Estimated
		Amortized				Gross Unrealized								Fair
(dollars in thousands)		Cost				Gains				Losses				Value
September 30, 2010
Debt securities:
U.S. treasury notes		$	8,016			$	163			$	—			$	8,179
U.S. agency			17,031				194				—				17,225
U.S. agency mortgage-backed, residential			114,776				3,103				(137	)			117,742
State and municipal			89,505				3,908				(16	)			93,397
Total debt securities, available-for-sale		$	229,328			$	7,368			$	(153	)		$	236,543
December 31, 2009
Debt securities:
U.S. agency		$	13,526			$	120			$	—			$	13,646
U.S. agency mortgage-backed, residential			82,579				1,715				(34	)			84,260
State and municipal			73,446				2,059				(164	)			75,341
Corporate trust preferred			987				—				(57	)			930
Total debt securities, available-for-sale		$	170,538			$	3,894			$	(255	)		$	174,177

The amortized cost and estimated fair value of debt securities at September 30, 2010 by contractual maturity are shown below. Actual maturities may differ from contractual maturities if call options on select debt issues are exercised in the future. Mortgage-backed securities are included in the maturity categories based on average expected life.

		Available-for-sale
		Amortized				Fair
(dollars in thousands)		Cost				Value
Due in one year or less		$	6,531			$	6,582
Due after one year through five years			150,791				155,874
Due after five years through ten years			67,292				69,247
Due after ten years			4,714				4,840
Total debt securities		$	229,328			$	236,543

Gross gains realized from the sale of available-for-sale securities were $108,000 and $291,000 for the nine months ended September 30, 2010 and 2009, respectively. No gains were realized from the sale of available-for-sale securities in either of the three month periods ended September 30, 2010 or 2009. Realized gains and losses from the sale of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security and are shown net as a separate line item in the income statement. Securities, issued by agencies of the federal government, with a carrying value of $140,536,000 and $84,460,000 on September 30, 2010 and December 31, 2009, respectively, were pledged to secure public and trust deposits, repurchase agreements, other short-term borrowings and Federal Home Loan Bank debt.

The table below shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2010 and December 31, 2009.

		Less than 12 months								12 months or more								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(dollars in thousands)		Value				Losses				Value				Losses				Value				Losses
September 30, 2010
Available-for-sale
Debt securities:
U.S. agency mortgage-backed, residential		$	34,046			$	137			$	—			$	—			$	34,046			$	137
State and municipal			1,440				8				387				8				1,827				16
Total temporarily impaired debt securities		$	35,486			$	145			$	387			$	8			$	35,873			$	153
December 31, 2009
Available-for-sale
Debt securities:
U.S. agency mortgage-backed, residential		$	8,656			$	34			$	—			$	—			$	8,656			$	34
State and municipal			10,607				164				—				—				10,607				164
Corporate trust preferred			—				—				930				57				930				57
Total temporarily impaired debt securities		$	19,263			$	198			$	930			$	57			$	20,193			$	255

At September 30, 2010, the unrealized losses within the less than 12 months category of $145,000 were attributable to nine different securities, primarily U.S. agency securities, and $8,000 in the 12 months or more category was attributed to one municipal security.

In April 2009, the FASB issued FASB ASC Topic 320. This guidance clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. For debt securities, the Corporation must assess whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment. Previously, this assessment required the Corporation to assert it had both the intent and the ability to hold a security for a period of time sufficient to allow for an anticipated recovery in fair value to avoid recognizing an other-than-temporary impairment. This change does not affect the need to forecast recovery of the value of the security through either cash flows or market price.

In instances when a determination is made that an other-than-temporary impairment exists but the Corporation does not intend to sell the debt security and it is unlikely that the Corporation will be required to sell the debt security prior to its anticipated recovery, FASB ASC Topic 320 changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. The other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income. FASB ASC Topic 320 was effective for the Corporation for interim and annual reporting periods ended after June 15, 2009.

Available-for-sale securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers, among other factors: 1) whether the Corporation has the intent to sell its securities prior to market recovery or maturity; 2) whether it is more likely than not that the Corporation will be required to sell its securities prior to market recovery or maturity; 3) default rates/history by security type; 4) third-party securities ratings; 5) third-party guarantees; 6) subordination; 7) payment delinquencies; and 8) current financial news.

We believe that unrealized losses at September 30, 2010 were primarily the result of changes in market interest rates and that we have the ability to hold these investments for a time necessary to recover the amortized cost. To date, the Corporation has collected all interest and principal on its investment securities as scheduled. We believe that collection of the contractual principal and interest is probable and therefore, all impairment is considered to be temporary.

Note 4—Restricted Investment in Bank Stocks

Restricted stock represents required investments in the common stock of correspondent banks. It consists primarily of the common stock of FHLB of Pittsburgh (FHLB) and to a lesser degree Atlantic Central Bankers Bank (ACBB) and is carried at cost as of September 30, 2010 and December 31, 2009. Under the FHLB’s Capital Plan, PeoplesBank is required to maintain a minimum member stock investment, both as a condition of becoming and remaining a member and as a condition of obtaining loans from the FHLB. In December 2008, the FHLB notified member banks that it was suspending dividend payments and the repurchase of capital stock.

We evaluate the restricted stock for impairment in accordance with FASB ASC Topic 942. Our determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as: (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. We believe that no impairment charge was necessary related to the restricted stock during the period ended September 30, 2010.

Note 5—Loans

The composition of the loan portfolio was as follows:

		September 30,				December 31,
(dollars in thousands)		2010				2009
Commercial, financial and agricultural		$	417,474			$	415,404
Real estate — construction and land development			98,672				104,986
Total commercial related loans			516,146				520,390
Real estate — residential and home equity			76,055				73,294
Consumer			49,215				52,193
Total consumer related loans			125,270				125,487
Total loans, net of deferred fees		$	641,416			$	645,877

Note 6— Impaired Commercial Loans

Information regarding impaired commercial loans, comprised of loans classified as nonaccrual, substandard or 90 days past due, at September 30, 2010 and December 31, 2009, is provided below. Commercial loans are predominately real estate collateral dependent. Accordingly, impairment is based on the net realizable value of the collateral relative to recorded investment in the loan.

		September 30,				December 31,
(dollars in thousands)		2010				2009
Impaired loans without a related allowance		$	21,145			$	24,605
Impaired loans with a related allowance			1,478				7,828
Total impaired loans		$	22,623			$	32,433
Allowance for impaired loans		$	410			$	2,401

Note 7—Deposits

The composition of deposits was as follows:

		September 30,				December 31,
(dollars in thousands)		2010				2009
Noninterest bearing demand		$	65,692			$	55,583
NOW			57,224				55,010
Money market			219,497				186,873
Savings			27,642				23,508
Time deposits less than $100,000			252,329				238,594
Time deposits $100,000 or more			172,747				163,389
Total deposits		$	795,131			$	722,957

Note 8—Long-term Debt

PeoplesBank’s obligations to the Federal Home Loan Bank of Pittsburgh (FHLBP) are primarily fixed rate instruments. A summary of long-term debt at September 30, 2010 and December 31, 2009, is provided below:

		September 30,				December 31,
(dollars in thousands)		2010				2009
Obligations of PeoplesBank to FHLBP:
Due February 2010, 1.55%		$	—			$	15,000
Due June 2010, 4.32%			—				6,000
Due January 2011, 2.06%			14,000				14,000
Due January 2011, 4.30%, amortizing			3,451				3,676
Due August 2011, 2.42%			12,000				12,000
Due January 2012, 2.34%			10,000				10,000
Due June 2012, 4.25%, amortizing			664				948
Due December 2012, 1.91%			5,000				5,000
Due May 2013, 3.46%, amortizing			1,507				1,906
Due December 2013, 2.39%			5,000				5,000
			51,622				73,530
Capital lease obligation			406				442
Total long-term debt		$	52,028			$	73,972

Note 9—Regulatory Matters

Codorus Valley and PeoplesBank are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material effect on Codorus Valley’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Codorus Valley and PeoplesBank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators.

Quantitative measures established by regulators to ensure capital adequacy require Codorus Valley and PeoplesBank to maintain minimum ratios, as set forth below, to total and Tier 1 capital as a percentage of risk-weighted assets, and of Tier 1 capital to quarter-to-date average assets (leverage ratio). We believe that Codorus Valley and PeoplesBank were well capitalized on September 30, 2010, based on regulatory capital guidelines.

										Minimum for								Well Capitalized
		Actual								Capital Adequacy								Minimum*
(dollars in thousands)		Amount				Ratio				Amount				Ratio				Amount				Ratio
Codorus Valley Bancorp, Inc. (consolidated)
at September 30, 2010
Capital ratios:
Tier 1 risk based		$	83,379				12.46	%		$	26,761				4.00	%			n/a				n/a
Total risk based			89,981				13.45				53,521				8.00				n/a				n/a
Leverage			83,379				8.98				37,124				4.00				n/a				n/a
at December 31, 2009
Capital ratios:
Tier 1 risk based		$	79,286				11.83	%		$	26,810				4.00	%			n/a				n/a
Total risk based			86,461				12.90				53,620				8.00				n/a				n/a
Leverage			79,286				9.11				34,815				4.00				n/a				n/a
PeoplesBank, A Codorus Valley Company
at September 30, 2010
Capital ratios:
Tier 1 risk based		$	80,274				12.05	%		$	26,645				4.00	%		$	39,967				6.00	%
Total risk based			86,876				13.04				53,289				8.00				66,612				10.00
Leverage			80,274				8.68				36,999				4.00				46,249				5.00
at December 31, 2009
Capital ratios:
Tier 1 risk based		$	74,945				11.25	%		$	26,647				4.00	%		$	39,970				6.00	%
Total risk based			82,120				12.33				53,293				8.00				66,616				10.00
Leverage			74,945				8.66				34,601				4.00				43,251				5.00

Note 10—Shareholders’ Equity

Preferred Stock Issued to the United States Department of the Treasury

In connection with the Emergency Economic Stabilization Act of 2008 (EESA), the U.S. Treasury Department (Treasury) initiated a Capital Purchase Program (CPP) which allowed for qualifying financial institutions to issue preferred stock to the Treasury, subject to certain limitations and terms. The EESA was developed to attract broad participation by strong financial institutions, to stabilize the financial system and increase lending to benefit the national economy and citizens of the United States.

On January 9, 2009, the Corporation entered into a Securities Purchase Agreement with the Treasury pursuant to which the Corporation sold to the Treasury, for an aggregate purchase price of $16.5 million, 16,500 shares of non-voting cumulative perpetual preferred stock, $1,000 liquidation value, $2.50 par value, and warrants to purchase up to 263,859 shares of common stock, par value $2.50 per share, with an exercise price of $9.38 per share. As a condition under the CPP, without the consent of the Treasury, the Corporation’s share repurchases are limited to purchases in connection with the administration of any employee benefit plan, including purchases to offset share dilution in connection with any such plans. This restriction is effective until January 9, 2012 or until the Treasury no longer owns any of the Corporation’s preferred shares issued under the CPP. The Corporation’s preferred stock is included as a component of Tier 1 capital in accordance with regulatory capital requirements. See Note 9, “Regulatory Matters” for details of the Corporation’s regulatory capital.

The preferred stock ranks senior to the Corporation’s common shares and pays a compounded cumulative dividend at a rate of 5 percent per year for the first five years, and 9 percent per year thereafter. Dividends are payable quarterly on February 15th, May 15th, August 15th and November 15th. The Corporation is prohibited from paying any dividend with respect to shares of common stock or repurchasing or redeeming any shares of the Corporation’s common shares in any quarter unless all accrued and unpaid dividends are paid on the preferred stock for all past dividend periods (including the latest completed dividend period), subject to certain limited exceptions. In addition, without the prior consent of the Treasury, the Corporation is prohibited from declaring or paying any cash dividends on common shares in excess of $0.12 per share, which was the last quarterly cash dividend per share declared prior to October 14, 2008. The CPP also places restrictions on incentive compensation to senior executives. The preferred stock is non-voting, other than class voting rights on matters that could adversely affect the preferred stock, and is generally redeemable at the liquidation value at any time in whole or in part (i.e., a minimum of 25 percent of the issue price) with regulatory permission.

Common Stock Warrants

The 263,859 shares of common stock warrants issued to the Treasury have a term of 10 years (expiring January 9, 2019) and are exercisable at any time, in whole or in part, at an exercise price of $9.38 per share (subject to certain anti-dilution adjustments). The $16.5 million of proceeds was allocated to the preferred stock and the warrants based on their relative fair values at issuance ($15.7 million was allocated to the preferred stock and $783,000 to the warrants). The fair value of the preferred stock was based on a 10 percent assumed market discount rate. The fair value of the stock warrants was calculated by a third-party software model based on many financial assumptions, including market price of the stock, stock price volatility and risk free interest rate. The difference between the initial value allocated to the preferred stock of approximately $15.7 million and the liquidation value of $16.5 million, i.e., the preferred stock discount, will be charged to retained earnings over the first five years of the life of the preferred stock as an adjustment to the dividend yield using the effective yield method.

Note 11—Contingent Liabilities

We are not aware of any material contingent liabilities as of September 30, 2010.

Note 12—Guarantees

Codorus Valley does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are written conditional commitments issued by PeoplesBank to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued, have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $6,718,000 of standby letters of credit outstanding on September 30, 2010, compared to $5,651,000 on December 31, 2009. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payment required under the corresponding letters of credit. The amount of the liability as of September 30, 2010 and December 31, 2009, for guarantees under standby letters of credit issued, was not material. Many of the commitments are expected to expire without being drawn and therefore, generally do not present significant liquidity risk to the Corporation or PeoplesBank.

Note 13—Fair Value Measurements and Fair Values of Financial Instruments

We use our best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts that could be realized in sales transactions on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period end.

Fair value measurement guidance defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. Additional guidance is provided on determining when the volume and level of activity for the asset or liability has significantly decreased and on identifying circumstances when a transaction may not be considered orderly.

Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed, and significant adjustments to the related prices may be necessary to estimate fair value in accordance with fair value measurement and disclosure guidance.

This guidance further clarifies that, when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

Fair value and disclosure guidance establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

For financial assets measured at fair value, the fair value measurements by level within the fair value hierarchy are as follows:

						(Level 1)				(Level 2)				(Level 3)
						Quoted Prices in				Significant Other				Significant Other
						Active Markets for				Observable				Unobservable
(dollars in thousands)		Total				Identical Assets				Inputs				Inputs
September 30, 2010
Measured at fair value on a recurring basis:
Securities, available-for-sale:
U.S. treasury notes		$	8,179			$	8,179			$	—			$	—
Other			228,364				—				228,364				—
Measured at fair value on a nonrecurring basis:
Impaired loans			1,068				—				—				1,068
Other real estate owned			2,576				—				—				2,576
December 31, 2009
Measured at fair value on a recurring basis:
Securities, available-for-sale		$	174,177			$	—			$	174,177			$	—
Measured at fair value on a nonrecurring basis:
Impaired loans			5,427				—				—				5,427
Other real estate owned			668				—				—				668

The following information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments and certain nonfinancial assets at September 30, 2010 and December 31, 2009:

Cash and cash equivalents (carried at cost)

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.

Securities, available-for-sale (carried at fair value)

The fair values of securities available-for-sale are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.

Restricted investment in bank stocks (carried at cost)

The carrying amount of restricted investment in bank stocks approximates fair value, and considers the limited marketability of such securities.

Loans held for sale (carried at lower of cost or fair value)

The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan. At September 30, 2010 and December 31, 2009, the fair value of loans held for sale exceeded the cost basis.

Loans (carried at cost)

Generally, for variable and adjustable rate loans that reprice frequently and with no significant change in credit risk, fair value is based on carrying value. Fair values for other loans in the portfolio are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal.

Impaired loans (generally carried at fair value)

Impaired loans are those that are accounted for under FASB ASC Topic 310, in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. A portion of the allowance for loan losses is allocated to impaired loans if the value of the collateral supporting such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to require increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when we believe that the uncollectability of a loan is confirmed. These loans are included as Level 3 fair values, based on the lowest level of input that is significant to the fair value measurements. At September 30, 2010, the fair value of loans with a specific reserve allowance was $1,478,000, net of a valuation allowance of $410,000, compared to $7,828,000, net of a valuation allowance of $2,401,000 at December 31, 2009.

Other Real Estate Owned (carried at lower of cost or fair value)

Other real estate property acquired through foreclosure is initially recorded at fair value of the property at the transfer date less estimated selling cost which becomes the cost basis. Subsequently, other real estate owned is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based upon an independent third-party appraisal of the property or occasionally upon a recent sales offer. While the Corporation has acquired several properties through foreclosure, only a single property had a valuation allowance at September 30, 2010. The carrying value of this property was $2,576,000 ($3,298,000 less $722,000 allowance). At December 31, 2009, the carrying value of other real estate owned with a valuation allowance was $668,000 ($857,000 less $189,000 allowance), which pertained to a single property that was sold in the first quarter of 2010.

Interest receivable and payable (carried at cost)

The carrying amount of interest receivable and interest payable approximates its fair value.

Deposit liabilities (carried at cost)

The fair values disclosed for demand deposits (e.g., noninterest and interest bearing checking, money market and savings accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for variable rate time deposits that reprice frequently are based on carrying value. Fair values for fixed rate time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities of time deposits.

Short-term borrowings (carried at cost)

The carrying amount of short-term borrowings approximates its fair value.

Long-term debt (carried at cost)

Fair values of FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices are obtained from this active market and represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Junior subordinated debt (carried at cost)

The fair value of junior subordinated debt is estimated using discounted cash flow analysis, based on market rates and spread characteristics currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.

Off-balance sheet financial instruments (disclosed at cost)

Fair values for the Corporation’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. These amounts were not considered to be material at September 30, 2010 and December 31, 2009.

The estimated fair values of the Corporation’s financial instruments were as follows at September 30, 2010 and December 31, 2009.

		September 30, 2010								December 31, 2009
						Estimated								Estimated
		Carrying				Fair				Carrying				Fair
(dollars in thousands)		Amount				Value				Amount				Value
Financial assets
Cash and cash equivalents		$	25,575			$	25,575			$	26,179			$	26,179
Securities, available-for-sale			236,543				236,543				174,177				174,177
Restricted investment in bank stocks			4,277				4,277				4,277				4,277
Loans held for sale			4,750				4,838				1,266				1,293
Loans, net			634,814				639,555				638,702				641,250
Interest receivable			3,553				3,553				3,427				3,427
Financial liabilities
Noninterest bearing demand, NOW, money market and savings deposits		$	370,055			$	370,055			$	320,974			$	320,974
Time deposits			425,076				435,500				401,983				406,203
Short-term borrowings			7,063				7,063				8,466				8,466
Long-term debt			52,028				52,829				73,972				74,681
Junior subordinated debt			10,310				3,742				10,310				4,331
Interest payable			733				733				752				752
Off-balance sheet instruments			—				—				—				—