Attached files

file filename
EX-32 - COMMUNITY FINANCIAL CORP /VA/ex-32.htm
EX-23 - COMMUNITY FINANCIAL CORP /VA/ex-23.htm
EX-31.2 - COMMUNITY FINANCIAL CORP /VA/ex31-2.htm
EX-99.1 - COMMUNITY FINANCIAL CORP /VA/ex99-1.htm
EX-31.1 - COMMUNITY FINANCIAL CORP /VA/ex31-1.htm
EX-99.2 - COMMUNITY FINANCIAL CORP /VA/ex99-2.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
−−−−−−−−−−−
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED:   MARCH 31, 2011
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-18265.
−−−−−−−−−−−
COMMUNITY FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)

Virginia
 
54-1532044
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
     
38 North Central Avenue, Staunton, Virginia
 
24401
(Address of principal executive offices)
 
(Zip Code)

 
Registrant’s telephone number:  (540) 886-0796
 
Securities Registered Pursuant to Section 12(b) of the Act:
 
 
Title of each class
 
Name of each exchange on which registered
 
Common Stock, par value $.01 per share
 
NASDAQ Capital Market

Securities Registered Pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes     No X
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes     No X
 
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 past twelve months (or for such shorter period that the Registrant  was required to file such reports), and (2) has been subject to such requirements for the past 90 days. Yes X  No___
 
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 (§ 229.405 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____    No____
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
 

 
 
 
 

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
 
 
Large accelerated filer  o
 
Accelerated filer  o
 
Non-accelerated filer  o
 
Smaller reporting company x
 
(Do not check if a smaller reporting company)
   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).Yes  o No x
 
As of May 31, 2011, there were issued and outstanding 4,361,658 shares of the Registrant’s common stock. The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the price at which the common equity was last sold as of September 30, 2010, was approximately $16.0 million.  (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the Issuer that such person is an affiliate of the Registrant.)
 
DOCUMENTS INCORPORATED BY REFERENCE
 
PART III of Form 10-K—Portions of the Proxy Statement for the 2011 Annual Meeting of Stockholders.
 


 
 
 
 

 
TABLE OF CONTENTS
Page
 
CAUTIONARY STATEMENT REGARDING FORWARDING LOOKING STATEMENTS
1
   
PART I
2
   
ITEM 1.  BUSINESS
2
   
      General
2
      Our Operating Strategy
4
      Lending Activities
5
      Loan Originations, Purchases and Sales
13
      Asset Quality
14
      Investment Activities
18
      Sources of Funds
19
      Borrowings
21
      Subsidiary Activities
22
      Competition
22
      Regulation
23
      Federal and State Taxation
30
      Executive Officers
30
      Employees
31
   
ITEM 1A. RISK FACTORS
31
   
ITEM  1B.  UNRESOLVED STAFF COMMENTS
31
   
ITEM  2.  PROPERTIES
32
   
ITEM 3.  LEGAL PROCEEDINGS
33
   
ITEM 4.  (REMOVED AND RESERVED)
33
   
PART II
33
   
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
 
     MATTERS AND  ISSUER PURCHASES OF EQUITY SECURITIES
33
   
ITEM 6.  SELECTED FINANCIAL DATA
34
   
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
 
     AND RESULTS OF OPERATIONS
35
   
      Executive Overview
35
      Critical Accounting Policies
36
      Asset/Liability Management
37
      Average Balances, Interest Rates and Yields
39
      Rate/Volume Analysis
40
      Financial Condition
40
      Results of Operations
41
      Liquidity and Capital Resources
43
      Contractual Obligations and Off-Balance Sheet Arrangements
44
      Impact of Inflation and Changing Prices
44
      Recent Accounting Pronouncements
45
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
45
   
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
45
   
      Index to Financial Statements
46
      Report of Independent Registered Public Accounting Firm
47

 
ii
 
 


 
      Consolidated Balance Sheets at March 31, 2011 and 2010
48
      Consolidated Statements of Operations for the years
 
           ended March 31, 2011, 2010 and 2009
49
      Consolidated Statements of Stockholders’ Equity for the years ended March 31, 2011,
 
           2010 and 2009
51
      Consolidated Statements of Cash Flows for the years ended March 31, 2011, 2010 and 2009
52
      Summary of Accounting Policies
54
      Notes to Consolidated Financial Statements
63
   
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
 
     AND FINANCIAL DISCLOSURE
98
   
ITEM 9A.  CONTROLS AND PROCEDURES
98
   
ITEM 9B.  OTHER INFORMATION
99
   
PART III
99
   
ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE
99
   
ITEM 11.  EXECUTIVE COMPENSATION
100
   
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     AND RELATED STOCKHOLDER MATTERS
100
   
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
 
     INDEPENDENCE
100
   
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
100
   
PART IV
101
   
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
102
   
SIGNATURES
102
   
INDEX TO EXHIBITS
103


 
iii
 
 

CAUTIONARY STATEMENT REGARDING FORWARDING LOOKING STATEMENTS
 
This document, including information incorporated by reference, contains, and future filings by Community Financial Corporation on Form 10-K, Form 10-Q and Form 8-K and future oral and written statements by Community Financial Corporation and its management may contain, forward-looking statements about Community Financial Corporation which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, statements with respect to anticipated future operating and financial performance, including revenue creation, lending origination, operating efficiencies, loan sales, charge-offs and loan loss provisions, growth opportunities, interest rates, cost savings and funding advantages. These forward-looking statements are based on currently available competitive, financial and economic data and management's views and assumptions regarding future events. These forward-looking statements are inherently uncertain and investors must recognize that actual results may differ from those expressed or implied in the forward-looking statements. Accordingly, Community Financial Corporation cautions readers not to place undue reliance on any forward-looking statements.
 
Words such as may, could, should, would, believe, anticipate, estimate, expect, intend, plan and similar expressions are intended to identify these forward-looking statements. The important factors discussed below, as well as other factors discussed elsewhere in this document and factors identified in our filings with the Securities and Exchange Commission and those presented elsewhere by our management from time to time, could cause actual results to differ materially from those indicated by the forward-looking statements made in this document. Among the factors that could cause our actual results to differ from these forward-looking statements are:
 
 
·
the strength of the United States economy in general and the strength of the local economies in which we conduct our operations;
 
 
·
general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, a deterioration in the credit quality of our loans and other assets;
 
 
·
the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;
 
 
·
fluctuations in deposit flows, loan demand, and/or real estate values, which may adversely affect our business;
 
 
·
the credit risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses;
 
 
·
results of examinations of Community Bank by its primary regulator, the Office of Thrift Supervision, including the possibility that the Office of Thrift Supervision may, among other things, require Community Bank to increase its allowance for loan losses;
 
 
·
changes due to the scheduled change in Community Bank’s primary regulator to the Office of the Comptroller of the Currency;
 
 
·
our ability to access cost-effective funding;
 
 
·
financial market, monetary and interest rate fluctuations, particularly the relative relationship of short-term interest rates to long-term interest rates;
 
 
 
1
 
 
 
 
 
 
·
the timely development of and acceptance of new products and services of Community Financial Corporation and Community Bank, and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services;
 
 
·
the impact of changes in financial services laws and regulations (including laws concerning taxes, accounting standards, banking, securities and insurance); legislative or regulatory changes may adversely affect the business in which we are engaged;
 
 
·
our success in gaining regulatory approval of our products and services and branching locations, when required;
 
 
·
the impact of technological changes;
 
 
·
changes in consumer spending and saving habits; and
 
 
·
our success at managing the risks involved in the foregoing.
 
We do not intend to update our forward-looking information and statements, whether written or oral, to reflect change.  All forward-looking statements attributable to us are expressly qualified by these cautionary statements.
 
PART I
 
ITEM 1.  BUSINESS
 
General
 
Community Financial Corporation is a Virginia corporation, which owns Community Bank.  Community Bank was organized in 1928 as a Virginia-chartered building and loan association, converted to a federally-chartered savings and loan association in 1955 and to a federally-chartered savings bank in 1983.  In 1988, Community Bank converted to the stock form of organization through the sale and issuance of shares of our common stock.  References in this document to we, us, our, the Corporation, the Company and the Bank refer to Community Financial and/or Community Bank as the context requires.
 
Our principal asset is the outstanding stock of Community Bank, our wholly owned subsidiary. Our common stock trades on The Nasdaq Stock Market under the symbol “CFFC.”
 
Community Financial Corporation and Community Bank are subject to comprehensive regulation, examination and supervision by the Office of Thrift Supervision, Department of the Treasury and by the Federal Deposit Insurance Corporation.  Community Bank’s primary regulator will change during the 2012 fiscal year to the Office of the Comptroller of the Currency. The Bank is a member of the Federal Home Loan Bank (“FHLB”) System and our deposits are backed by the full faith and credit of the United States Government and are insured to the maximum extent permitted by the Federal Deposit Insurance Corporation. At March 31, 2011, we had $530.1 million in assets, deposits of $379.0 million and stockholders' equity of $49.8 million. Our primary business consists of attracting deposits from the general public and originating real estate loans and other types of investments through our offices located in Staunton, Waynesboro, Stuart Drafts, Raphine, Verona, Lexington, Harrisonburg, Buena Vista and Virginia Beach, Virginia.
 
Like all financial institutions our operations are materially affected by general economic conditions, the monetary and fiscal policies of the federal government and the policies of the various regulatory authorities, including the Office of Thrift Supervision and the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). Our results of operations are largely dependent upon
 
 
 
2
 
 
 
 
our net interest income, which is the difference between the interest we receive on our loan portfolio and our investment securities portfolio, and the interest we pay on our deposit accounts and borrowings.
 
Dramatic declines in the housing market over the past three years, with decreasing home prices and increasing delinquencies and foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions.  General downward economic trends, reduced availability of commercial credit, and increasing unemployment and under-employment have negatively impacted the credit performance of commercial and consumer credit as well, resulting in additional write-downs for many financial institutions.  Concerns over the stability of the financial markets and the economy also have resulted in decreased lending by many financial institutions to their customers and to each other.  This market turmoil and tightening of credit has led to increased delinquencies and foreclosures, lack of customer confidence, increased market volatility and widespread reduction in general business activity.  Some financial institutions have experienced decreased access to deposits or borrowings.  The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets has and may continue to adversely affect our business, results of operations and stock price.
 
Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our loan portfolio is more complex under these difficult market and economic conditions.  We expect to face increased regulation and government oversight as a result of these downward trends.  This increased government action may increase our costs and limit our ability to pursue certain business opportunities.  
 
We do not expect these difficult conditions to improve in the near future.  A worsening of these conditions would likely exacerbate the adverse effects of these difficult market and economic conditions on us, our customers and the other financial institutions in our market.  As a result, we may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds. We also may be required to pay even higher FDIC premiums than the recently increased level, because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the FDIC insurance fund and reduce the FDIC’s ratio of reserves to insured deposits.
 
As previously mentioned, we are subject to extensive regulation, supervision and examination by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation.  These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on a bank’s operations, reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed.  The laws and regulations governing our business are subject to frequent change.  Any change in these regulations and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums could have a material impact on our operations including the scheduled change of our primary regulator to the Comptroller of the Currency.
 
In response to the financial crisis of 2008 and early 2009, Congress has taken actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the Federal Deposit Insurance Corporation has taken actions to increase insurance coverage on deposit accounts.  In addition, there have been proposals made by members of Congress and others that would reduce the amount delinquent borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral.
 
The potential exists for additional federal or state laws and regulations, or changes in policy, affecting lending and funding practices and liquidity standards.  Moreover, bank regulatory agencies have been active in responding to concerns and trends identified in examinations, and have issued many formal enforcement orders requiring capital ratios in excess of regulatory requirements.  Bank regulatory agencies, such as the Office of Thrift Supervision and the Federal Deposit Insurance Corporation, govern the activities in which we may engage, primarily for the protection of depositors, and not for the
 
 
 
3
 
 
 
 
protection or benefit of potential investors.  New laws and regulations may increase our costs of regulatory compliance and of doing business, and otherwise affect our operations.  New laws and regulations also may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability.
 
Congress passed the Dodd-Frank financial reform legislation.  This legislation will have a significant impact on the regulation and operations of financial institutions and their holding companies.  The legislation provides for the elimination of the Office of Thrift Supervision, our primary regulator, and will subject Community Financial to regulatory capital requirements.  The legislation also created a new consumer financial protection agency that will issue and enforce consumer protection initiatives governing financial products and services.  Any legislative or regulatory changes in the future could adversely affect our operations and financial condition.
 
Our main office is located at 38 North Central Avenue, Staunton, Virginia 24401. Our telephone number is (540) 886-0796.  This annual report on Form 10-K, as well as other public information that we file with the Securities and Exchange Commission, is also available on our website at www.cbnk.com and on the Securities and Exchange Commission’s website at www.sec.gov.
 
Our Operating Strategy
 
Our goal is to operate and grow a profitable community-oriented financial institution, and to maximize stockholder value by:
 
 
·
retaining our community-oriented focus to meet the financial needs of the communities we serve;
 
 
·
enhancing our focus on core deposits, including savings and checking accounts;
 
 
·
improving asset quality;
 
 
·
selectively emphasizing products and services to provide diversification of revenue sources and to capture our customer’s full relationship.  We intend to continue to expand our business by cross selling our loan and deposit products and services to our customers;
 
 
·
growing, when economic conditions are suitable, and diversifying our loan portfolio by emphasizing the origination of commercial and multi-family real estate loans, one- to four-family residential mortgage loans, construction loans, secured business loans and consumer loans;
 
 
·
expanding our banking network by opening de novo branches and by selectively acquiring branch offices, although currently we do not have any specific expansion plans;
 
 
·
controlling operating expenses while continuing to provide quality personal service to our customers; and
 
 
·
utilizing borrowings as needed to fund growth and enhance profitability.
 
Market Area

Our primary market area includes the counties of Shenandoah, Rockingham, Page, Highland, Augusta, Albemarle, Bath, Rockbridge, Nelson, and the Hampton Roads area in Virginia.  Our headquarters are located in Historic Downtown Staunton, Virginia in Augusta County.  We conduct our business through our headquarters and 10 branch offices located in Staunton (2), Waynesboro, Stuart Drafts, Raphine, Verona, Lexington, Harrisonburg, Buena Vista and Virginia Beach (2), Virginia. 
 
 
 
4
 
 
 
 
 
The state’s economy is likely to experience sustained high levels of unemployment throughout 2011 and may not return to pre-recession levels of unemployment until after 2014.

Harrisonburg-Rockingham County has a population of approximately 122,858.  Major employment sectors include services, healthcare, manufacturing, trade, government, and construction.  The largest employers headquartered here include James Madison University, Rockingham Memorial Hospital, Pilgrim’s Pride Corp., R.R. Donnelly & Sons Co., and Merck & Co., Inc.

The Staunton-Waynesboro-Augusta County area has a population of approximately 116,299.  Major employment sectors include manufacturing, healthcare, retail trade, hospitality, and educational services.  Major employment sectors include services, manufacturing, trade, government, and construction.  The largest employers headquartered here include Augusta Medical Center, McKee Foods Corporation, Hershey Chocolate of VA, Target Mid-Atlantic Distribution Center, Hollister, and McQuay International.

Lexington-Buena Vista-Rockbridge County has a population of approximately 35,740.  Major employment sectors include services, government, manufacturing, trade, and construction.  The largest employers headquartered here include Lees Carpets, Washington & Lee University, Stonewall Jackson Hospital, Wal-Mart, Inc., and Virginia Military Institute.

The Virginia Beach and Hampton Roads region has a combined population of approximately 1.5 million.  The military has a large presence in this region.  Major employment sectors include food service, employment service, agricultural & engineering services, physicians offices (medical), and services to buildings/dwellings. The largest employers headquartered here include Northrop Grumman, Newport News, Sentara Healthcare, Virginia Beach City Public School, Norfolk Naval Shipyard and Riverside Health System.

Lending Activities
 
General.  We concentrate our lending activities on first mortgage conventional loans secured by residential properties, commercial and multi-family real estate with an emphasis on multi-family housing and, to a lesser extent, construction loans secured by commercial and multi-family real estate and one- to four-family residential properties, and commercial business loans. Additionally, we make consumer loans in order to increase the diversification and decrease the interest rate sensitivity of our loan portfolio, and to increase interest income as these loans typically carry higher interest rates than residential mortgage loans. During fiscal 2011, we substantially curtailed our construction lending due to the lingering effects of the recession. Substantially all of our loans are originated within our market area which includes Shenandoah, Rockingham, Page, Highland, Augusta, Albemarle, Bath, Rockbridge and Nelson Counties, and the Hampton Roads area in Virginia.
 
Residential loan originations come primarily from walk-in customers, real estate brokers and builders. Commercial and multi-family real estate loan originations are obtained through broker referrals, direct solicitation of developers and continued business from customers. All completed loan applications are reviewed by our salaried loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment and credit history of the applicant and any related business interests. If commercial or multi-family real estate is involved, information is also obtained concerning cash flow after debt service. The quality of loans is analyzed based on our experience and on guidelines with respect to credit underwriting as well as the guidelines issued by Freddie Mac and Fannie Mae and other purchasers of loans, depending on the type of loans involved. All real estate is appraised by independent fee appraisers who have been pre-approved by our Board of Directors.
 
 
 
5
 
 
 
 
 
Our loan commitments are approved at different levels, depending on the size and type of the loan being sought. Our Board of Directors has authorized different loan limits for individual loan officers depending on the types of loans being approved.  Individual loan officer limits for one- to four-family real estate loans range from $125,000 to $300,000 and for commercial real estate loans range from $100,000 to $175,000.  One- to four-family real estate loans not exceeding $350,000 and commercial real estate loans not exceeding $225,000 may be approved by the President of the Bank.  One- to four-family real estate loans not exceeding $950,000 and commercial real estate loans not exceeding $875,000 may be approved by one member of senior management and two other officers.  Any loan not exceeding $1,000,000 may be approved by the Bank’s loan committee.  All loans in excess of $1,000,000 must be approved by the Board of Directors.  Individual loan officer limits for unsecured consumer and commercial business loans range from $10,000 to $50,000 and for secured consumer and commercial business loans range from $25,000 to $175,000. Consumer and commercial business loans up to $375,000 on a secured basis and $150,000 on an unsecured basis require the approval of one member of senior management and two other officers. Consumer and commercial business loans in excess of individual loan officer or collective senior management loan authority must be approved by a majority of our Loan Committee or Board of Directors.
 
 The aggregate amount of loans that the Bank is permitted to make to any one borrower, including related entities, and the aggregate amount that the Bank may invest in any one real estate project, with certain exceptions, is limited to the greater of 15% of our unimpaired capital and surplus or $500,000. At March 31, 2011, the maximum amount which we could have loaned to one borrower and the borrower’s related entities or invested in any one project was approximately $8.3 million. At March 31, 2011, we had only 16 borrowers, or groups of related borrowers, with an aggregate outstanding loan balance in excess of $3.0 million, with the largest being a $5.9 million relationship, consisting of  one unsecured business loan, 2 secured business loans and one commercial real estate loan.  All of these loans in excess of $3.0 million were performing in accordance with their payment terms. We also had 21 other borrowers, or groups of related borrowers, with an aggregate outstanding loan balance at March 31, 2011 of between $2.0 million and $3.0 million, all of which were performing in accordance with their payment terms at March 31, 2011.
 
Loan Portfolio Composition.  The following table sets forth the composition of our total loan portfolio in dollars and percentages as of the dates indicated.
 
   
March 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in Thousands)
 
Real Estate Loans:
                                                           
     Residential                                   
  $ 148,199       30.10 %   $ 144,951       27.59 %   $ 140,064       28.17 %   $ 122,605       27.08 %   $ 118,044       28.59 %
     Commercial                                   
    181,822       36.94       171,805       32.71       154,781       31.14       150,059       33.14       119,354       28.91  
     Construction                                   
    27,453       5.58       63,807       12.14       62,887       12.65       53,891       11.90       48,857       11.83  
        Total real estate
    357,474       72.62       380,563       72.44       357,732       71.96       326,555       72.12       286,255       69.33  
Consumer Loans:
                                                                               
     Home equity                                   
    46,930       9.53       48,061       9.14       41,653       8.37       32,780       7.24       30,806       7.46  
     Automobile                                   
    31,286       6.36       35,533       6.77       37,411       7.53       44,961       9.93       50,992       12.34  
     Other                                   
    7,436       1.51       7,819       1.49       6,906       1.39       6,930       1.53       7,171       1.74  
        Total consumer
    85,652       17.40       91,413       17.40       85,970       17.29       84,671       18.70       88,969       21.54  
Commercial business
    49,085       9.98       53,402       10.16       53,436       10.75       41,578       9.18       37,691       9.13  
        Total loans receivable
    492,211       100.00 %     525,378       100.00 %     497,138       100.00 %     452,804       100.00 %     412,915       100.00 %
Less:
                                                                               
     Undisbursed loans in
          process                                   
    6,803               16,158               15,222               13,599               11,884          
     Deferred (costs) and
          unearned discounts
    (731 )             (959 )             (990 )             (1,184 )             (1,299 )        
     Allowance for losses
    7,846               8,053               5,956               3,215               3,078          
   Total loans receivable, net
  $ 478,293             $ 502,126             $ 476,950             $ 437,174             $ 399,252          
                                                                                 
                                                                                 

 
6
 
 


The following table shows the composition of our loan portfolio by fixed and adjustable-rate, at the dates indicated.
 
   
March 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in Thousands)
 
Fixed-Rate Loans:
                                                           
Real Estate:
                                                           
  Residential
  $ 19,252       3.91 %   $ 20,170       3.84 %   $ 29,204       5.87 %   $ 22,146       4.89 %   $ 24,657       5.97 %
  Commercial
    35,646       7.24       33,447       6.37       31,919       6.42       22,592       4.99       15,097       3.66  
  Construction(1)
    537       0.11       7,473       1.42       3,528       0.71       6,870       1.52       --       0.00  
   Total real estate loans
    55,435       11.26       61,090       11.63       64,651       13.00       51,608       11.40       39,754       9.63  
  Home equity
    2,780       0.56       4,222       0.80       5,437       1.09       5,692       1.26       4,972       1.20  
  Automobile
    31,150       6.33       35,460       6.76       37,300       7.51       44,843       9.90       50,895       12.32  
  Other
    6,077       1.23       5,969       1.14       5,718       1.15       5,872       1.30       5,619       1.36  
   Total consumer loans
    40,007       8.12       45,651       8.70       48,455       9.75       56,407       12.46       61,486       14.88  
Commercial business
    15,044       3.06       17,150       3.26       21,234       4.27       19,912       4.40       17,721       4.29  
   Total fixed-rate loans
    110,486       22.44       123,891       23.59       134,340       27.02       127,927       28.26       118,961       28.80  
Adjustable-Rate loans:
                                                                               
Real Estate:
                                                                               
  Residential
    128,947       26.19       124,781       23.75       110,860       22.30       100,459       22.19       93,387       22.62  
  Commercial
    146,176       29.70       138,358       26.34       122,862       24.72       127,467       28.15       104,257       25.25  
  Construction(2)
    26,916       5.47       56,334       10.72       59,359       11.94       47,021       10.38       48,857       11.83  
   Total real estate loans
    302,039       61.36       319,473       60.81       293,0811       58.96       274,9471       60.72       246,5011       59.70  
  Home equity
    44,150       8.97       43,839       8.34       36,216       7.28       27,088       5.98       25,834       6.26  
  Automobile
    136       0.03       73       0.01       111       0.02       118       0.03       97       0.02  
  Other
    1,359       0.28       1,850       0.35       1,188       0.24       1,058       0.23       1,552       0.38  
  Total consumer loans
    45,645       9.28       45,762       8.70       37,515       7.54       28,264       6.24       27,483       6.66  
  Commercial Business
    34,041       6.92       36,252       6.90       32,202       6.48       21,666       4.78       19,970       4.84  
   Total adjustable-rate
         loans
    381,725       77.56       401,487       76.41       362,798       72.98       324,877       71.74       293,954       71.20  
   Total loans receivable
  $ 492,211       100.00 %   $ 525,378       100.00 %   $ 497,138       100.00 %   $ 452,804       100.00 %   $ 412,915       100.00 %
_______________________
(1)
Includes residential real estate construction loans of $0, $3.2 million, $1.9 million, $247,000 and $0, and commercial real estate construction loans of $537,000, $4.3 million, $1.6 million, $6.6 million and $0 at March 31, 2011, 2010, 2009, 2008 and 2007 respectively.
(2)
Includes residential real estate construction loans of $19.3 million, $39.3 million, $45.2 million, $43.3 million and $47.2 million, and commercial real estate construction loans of $7.6 million, $17.0 million, $14.2 million, $3.7 million and $1.7 million at March 31, 2011, 2010, 2009, 2008 and 2007, respectively.
 
 
 

 
 
7
 
 

 
 
 
Loan Maturity and Repricing.  The following schedule illustrates the contractual maturity of our real estate construction and commercial business loan portfolios as of March 31, 2011, before net items.  Loans that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due.  The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
 
   
Real Estate Construction
or Development
   
Commercial
Business
   
Total
 
   
(Dollars in Thousands)
 
Due during periods
ending March 31,
                 
                   
2012
  $ 25,554     $ 29,275     $ 54,829  
2013 to 2016
    1,899       18,901       20,800  
After 2016
    --       909       909  
                         
   Totals
  $ 27,453     $ 49,085     $ 76,538  

The total amount of loans in the above table due after March 31, 2012, which have fixed interest rates is $11.8 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $9.9 million.
 
One- to Four-Family Residential Real Estate Lending. We originate loans secured by one- to four-family residences, substantially all of which are located in our market areas. We evaluate both the borrower’s ability to make principal and interest payments and the value of the property that will secure the loan. Although federal law permits us to make loans in amounts of up to 100% of the appraised value of the underlying real estate, we generally make one- to four-family residential real estate loans in amounts of 80% or less of the appraised value.  In certain instances, we will lend up to 90% of the appraised value of the underlying real estate and require the borrower to purchase private mortgage insurance in an amount sufficient to reduce our exposure to 80% or less.
 
In order to manage our exposure to changes in interest rates, in the past we originated only a limited amount of 30-year and 15-year fixed-rate, one to four-family residential mortgage loans for our portfolio.  For the year ended March 31, 2011, 84.2% of all one to four-family residential loans we originated had adjustable interest rates. At March 31, 2011, only $19.3 million, or 3.9%, of our total loans receivable, before net items, consisted of fixed-rate residential mortgage loans. As part of our asset liability management strategy, we have not originated fixed rate residential loans with terms of 15 years or more for our portfolio for approximately nine years.
 
To compete with other lenders in our market area, we make one, three and five year adjustable-rate mortgage (“ARM”) loans at interest rates which, for the initial period, may be below the index rate which would otherwise apply to these loans. Borrowers are qualified, however, at the fully indexed interest rate. Our one- to four-family residential ARM loans primarily have interest rates that adjust annually after the initial fixed period based on a stated interest margin over the yields on one year U.S. Treasury Bills.  Although our one- to four-family ARM loans primarily adjust annually after the initial period, we currently offer residential ARM loans which adjust every three and five years generally in accordance with the rates based on a stated margin over the yields on the applicable U.S. Treasury Bills. At March 31, 2011 we had the following loans that adjust on an annual basis after the initial period, $23.3 million that adjust after three years, $58.4 million after five years, $416,000 after seven years and $6.7 million after ten years. An additional $1.7 million loans adjust every five years.  We do not currently offer residential ARM loans with an initial adjust period greater than five years. Our ARM loans generally limit interest rate increases to 2% each rate adjustment period and have an established ceiling rate at the time
 
 
 
8
 
 
 
 
the loans are made of up to 6% over the original interest rate.  At March 31, 2011, residential ARM loans totaled $128.9 million, representing 87.0% of our total residential real estate loans and 26.2% of our total loans receivable, before net items. ARM loans generally pose different credit risks than fixed-rate loans primarily because during periods of rising interest rates, the risk of defaults on ARM loans may increase due to the upward adjustment of interest costs to borrowers.
 
All one- to four-family real estate mortgage loans originated by us contain a “due-on-sale” clause that allows us to declare the unpaid principal balance due and payable upon the sale of the mortgaged property. It is our policy to enforce these due-on-sale clauses concerning fixed-rated loans and to permit assumptions of ARM loans, for a fee, by qualified borrowers.
 
We require, in connection with the origination of residential real estate loans, title opinions and fire and casualty insurance coverage, as well as flood insurance where appropriate, to protect our interests. The cost of this insurance coverage is paid by the borrower. We generally do not require escrows for taxes and insurance.
 
Commercial Real Estate and Construction Lending. We have originated and, in the past have purchased, commercial real estate loans and loan participations. We also make commercial and residential real estate construction loans. Our commercial real estate loans are secured by various types of collateral, including raw land, multi-family residential buildings, hotels and motels, convenience stores, commercial and industrial buildings, shopping centers and churches. At March 31, 2011, commercial real estate and construction loans aggregated $209.3 million or 42.5% of our total loans receivable, before net items, with $173.1 million of these loans having adjustable interest rates and $36.2 million having fixed interest rates. Our commercial real estate and construction loans are secured primarily by properties located in our market areas.
 
Our commercial real estate loans are generally made at interest rates that adjust annually based on yields for one-year U.S. Treasury securities, with a 2% annual cap on rate adjustments and a 6% cap on interest rates over the life of the loan. Typically, we charge origination fees ranging from 1% to 2% on these loans. Commercial real estate loans made by us are fully amortizing with maturities ranging from five to 30 years.  Our construction loans are generally for a term of 12 months or less with interest only due monthly. Construction loans are generally made with permanent financing to be provided by us, although not required. Construction loans to builders may be made on a basis where a buyer has contracted to buy the house or the construction may be on a speculative basis. Limits are set by us as to the number of each type of construction loan for each builder, whether speculative or pre-sold, dependent on the determination made by us during the underwriting process.
 
In our underwriting of commercial real estate and construction loans, we may lend, under federal regulations, up to 100% of the security property’s appraised value, although the loan to original appraised value ratio on such properties is generally 80% or less. Our commercial real estate and construction loan underwriting  requires an examination of debt service coverage ratios, the borrower’s creditworthiness and prior credit history and reputation, and we generally require personal guarantees or endorsements of borrowers. We also carefully consider the location of the security property.
 
At March 31, 2011, we had commercial real estate loans totaling $181.8 million, including 159 commercial real estate loans (or multiple loans to one borrower) in excess of $1.0 million with an aggregate balance of  $108.6 million.  The largest loan or lending relationship to a single borrower was for $5.2 million, which consisted of two loans both secured by commercial real estate. Loans secured by commercial and industrial buildings increased from $43.0 million at March 31, 2010 to $52.7 million at March 31, 2011, accounting for the increase in our commercial real estate loan portfolio.
 
 
 
9
 
 
 
 
 
The following table presents information as to our commercial real estate and commercial construction lending portfolio as of March 31, 2011, by type of project.
 
   
Number
of loans
   
Principal
Balance
 
   
(Dollars in Thousands)
 
Permanent financing:
           
  Multi-family residential buildings
    38     $ 16,707  
  Hotel and motel
    20       21,008  
  Commercial and industrial buildings
    115       52,708  
  Raw land
    179       43,979  
  Church
    13       3,420  
  Restaurant
    16       4,333  
  Warehouse
    30       11,648  
  Retail Store
    82       22,282  
  School/Recreational
    12       5,783  
Commercial construction
    8       6,134  
       Total
    513     $ 188,002  

At March 31, 2011, we had 8 commercial construction loans totaling $6.1 million, the largest one having an outstanding balance of $1.9 million.  All commercial construction loans are performing in accordance with their payment terms. Our commercial construction loans are generally made for a one year term or less, with a requirement that the borrower have a commitment for permanent financing prior to funding the construction loan. Our construction loans generally provide for a fixed rate of interest at or above the prevailing prime rate. Such loans are generally secured by the personal guarantees of the borrowers and by first mortgages on the projects.
 
A large portion of our commercial real estate portfolio consists of loans secured by raw land.  The Company originates loans to local real estate developers with whom it has established relationships for the purpose of developing residential subdivisions (i.e., installing roads, sewers, water and other utilities), as well as loans to individuals to purchase building lots.  Land development loans are secured by a lien on the property and made for a period usually not to exceed twelve months with an interest rate that adjusts with the prime rate, and are made with loan-to-value ratios not exceeding 80%. Monthly interest payments are required during the term of the loan. Subdivision loans are structured so that we are repaid in full upon the sale by the borrower of approximately 90% of the subdivision lots. All of our land loans are secured by property located in our primary market area.  We also generally obtain personal guarantees from financially capable parties based on a review of personal financial statements.
 
Loans secured by undeveloped land or improved lots involve greater risks than one- to four- family residential mortgage loans because these loans are advanced upon the predicted future value of the developed property. If the estimate of the future value proves to be inaccurate, in the event of default and foreclosure, the Company may be confronted with a property the value of which is insufficient to assure full repayment. Loans on raw land may run the risk of adverse zoning changes, environmental or other restrictions on future use.  At March 31, 2011, we had $338,000 of non-performing raw land loans.
 
We also make construction loans to individuals for the construction of their residences as well as to builders and developers for the construction of non-residential properties, one- to four-family residences and the development of one- to four-family lots in Virginia. These construction loans are generally for a term of 12 months or less with interest only due monthly. Construction loans are generally made with permanent financing to be provided by us, although not required. Construction loans to builders may be made on a basis where a buyer has contracted to buy the house or the construction may
 
 
 
10
 
 
 
 
be on a speculative basis. Limits are set by us as to the number of each type of construction loan for each builder, whether speculative or pre-sold, dependent on the determination made by us during the underwriting process.  At March 31, 2011, we had $21.3 million or 4.3% of our total loans receivable, before net items, in 89 residential construction loans, the largest of which was $775,000, compared to $42.1 million or 8.0% at March 31, 2010.  Residential construction loans totaled approximately 77.7% of the total construction loan portfolio.  Unfunded commitments on residential construction loans totaled $4.8 million at March 31, 2011.  All residential construction loans were performing in accordance with their payment terms.
 
Commercial real estate and construction lending is generally considered to involve a higher level of credit risk than one- to four-family residential lending due to the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions on real estate developers and managers. Our risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s sale value upon completion of the project and the estimated cost of the project. If the estimated cost of construction or development proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project with value which is insufficient to assure full repayment. Because we usually provide loans to a developer for the entire estimated cost of the project, defaults in repayment generally do not occur during the construction period and it is therefore difficult to identify problem loans at an early stage. When loan payments become due, borrowers may experience cash flow from the project which is not adequate to service total debt. This cash flow shortage can result in the failure to make loan payments. In such cases, we may be compelled to modify the terms of the loan. In addition, the nature of these loans is such that they are generally less predictable and more difficult to evaluate and monitor. We have reduced our non-owner occupied commercial real estate loans from $168.0 million and 316% of risk based capital at March 31, 2010 to $148.9 million and 270% of risk based capital at March 31, 2011.
 
Consumer Lending. We offer a variety of secured consumer loans, including new and used automobile loans, home equity loans and lines of credit, and deposit account, installment and demand loans.  We also offer unsecured loans.  We originate our consumer loans primarily in our market areas.  At March 31, 2011, our consumer loans totaled $85.7 million or 17.4% of our total loans receivable, before net items. With the exception of $39.0 million of home equity loans and lines of credit at March 31, 2011, our consumer loans primarily have fixed interest rates and generally have terms ranging from 90 days to six years.
 
The largest component of our consumer loans is home equity loans and lines of credit. At March 31, 2011, our home equity loans and lines of credit totaled $46.9 million and comprised 9.5% of our total loan portfolio, before net items, including $39.0 million of home equity lines of credit.  Home equity loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 90% of the value of the property securing the loan. The amount of the line of credit also may not exceed 90% of the value of the property securing the loan.  Home equity lines of credit generally are originated with an adjustable rate of interest, based on the prime rate of interest.  Home equity lines of credit have a 20 year term and amounts may be re-borrowed after payment at any time during the life of the loan.  At March 31, 2011, unfunded commitments on these lines of credit totaled $18.2 million.
 
 We originate automobile loans on a direct and indirect basis.  Automobile loans totaled $31.3 million at March 31, 2011, or 6.4% of our total loan portfolio, before net items, with $7.1 million in direct loans and $24.2 million in indirect loans.  Our automobile loan portfolio decreased from $35.5 million at March 31, 2010 to $31.3 million at March 31, 2011, or 11.8%.  The decrease in automobile loans is attributable to a slower economic environment and increased competition.  The bulk of our indirect lending comes from relationships with approximately 40 car dealerships under an arrangement providing
 
 
 
11
 
 
 
 
a premium for the amount over our interest rate to the referring dealer, with approximately half of these loans originated through four dealerships located in our market area.  Indirect lending is highly competitive; however, our ability to provide same day funding makes our product competitive.  Automobile loans may be written for a term of up to six years and have fixed rates of interest.  Loan-to-value ratios are up to 110% of the manufacturer's suggested retail price for new direct auto loans and 125% of the manufacturer's invoice for new indirect auto loans.  For used car loans we use the same loan-to-value ratios based on National Automobile Dealers Association ("NADA") retail value for direct loans and NADA trade-in value for indirect loans.
 
The automobile loans are generally evenly divided between new and used vehicles. The automobile loans are primarily without recourse to the dealer, but the Bank may require either full or partial recourse to the dealer under certain circumstances. If the customer’s credit history or the loan to value of the vehicle warrants, the Bank may require full or partial recourse to the dealer.
 
We follow our internal underwriting guidelines in evaluating direct automobile loans, including credit scoring.  Indirect automobile loans are underwritten by a third party on our behalf, using substantially similar guidelines to our internal guidelines.  However, because these loans are originated through a third party and not directly by us, they present greater risks than other types of lending activities.  At March 31, 2011, we had $75,000 in non-performing automobile loans, which included $14,000 in indirect automobile loans.
 
The underwriting standards employed by us for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security in relation to the proposed loan amount.
 
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured, such as credit card receivables, or secured by rapidly depreciable assets such as automobiles.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loan such as us, and a borrower may be able to assert against such assignee claims and defenses which it has against the seller of the underlying collateral. We add general provisions to our loan loss allowance, in amounts determined in accordance with industry standards, at the time the loans are originated. Consumer loan delinquencies often increase over time as the loans age. The level of non-performing assets in our consumer loan portfolio decreased from $2.3 million at March 31, 2010 to $455,000 at March 31, 2011due primarily to dispositions and charge-offs. There can be no assurance that delinquencies will not increase in the future.
 
Commercial Business Lending. At March 31, 2011, our commercial business loans totaled $49.1 million, or 10.0%, of our total loans receivable, before net items. We offer commercial business loans to service existing customers, to consolidate our banking relationships with these customers, and to further our asset/liability management goals.  Our commercial business lending activities encompass
 
 
 
12
 
 
 
 
loans with a variety of purposes and security, including but not limited to business secured and unsecured lines of credit, business automobiles, equipment and accounts receivable.  We recognize the generally increased credit risk associated with commercial business lending. Our commercial business lending practice emphasizes credit file documentation and analysis of the borrower’s character, management capabilities, capacity to repay the loan, the adequacy of the borrower’s capital and collateral. An analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis.
 
Unlike residential mortgage loans which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be dependent upon the success of the business itself. Our commercial business loans almost always include personal guarantees and are usually, but not always, secured by business assets.  However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
 
Loan Originations
 
Federal regulations authorize us to make real estate loans anywhere in the United States. At March 31, 2011, substantially all of our real estate loans were secured by real estate located in our market area.
 
We originate both fixed-rate and adjustable-rate loans.  Our ability to originate loans, however, is dependent upon customer demand for loans in our market areas.  Demand is affected by competition and the interest rate environment.
 
Loans purchased must conform to our underwriting guidelines. We have not purchased any loans during the last six fiscal years and sold $3.2 million in loans during the last fiscal year.  Management believes that purchases of loans and loan participations are generally desirable only when local mortgage demand is less than the supply of funds available for local mortgage origination.
 
During the past few years, we, like many other financial institutions, have experienced significant prepayments on loans due to the low interest rate environment prevailing in the United States.  In periods of economic uncertainty, the ability of financial institutions, including us, to originate or purchase large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in interest income.
 
 
 
13
 
 
 
 
 
The following table shows our loan origination and repayment activities for the periods indicated.
 
   
Year Ended March 31,
 
   
2011
   
2010
   
2009
 
Origination by Type:
                 
Adjustable Rate:
                 
  Real estate   - 1-4 family residential
  $ 23,801     $ 38,657     $ 41,441  
                     - commercial
    29,580       31,675       25,814  
                     - construction
    7,238       15,733       30,740  
  Non-real estate  - consumer
    354       580       522  
                          - commercial business
    2,254       6,717       7,695  
      Total adjustable rate
    63,227       93,362       106,212  
Fixed Rate:
                       
  Real estate -  1-4 family residential
    4,469       3,170       7,757  
                      - commercial
    6,944       9,711       10,329  
                      - construction
    ---       3,032       2,608  
  Non-real estate  - consumer
    16,683       18,948       15,711  
                          - commercial business
    5,753       5,379       9,449  
      Total fixed rate
    33,849       40,240       45,854  
Sales and Repayments:
                       
Sales
    3,220       ---       ---  
Principal repayments
    127,023       105,362       107,732  
      Total reductions
    130,243       105,362       107,732  
Increase/(Decrease) in other items, net
    (9,334 )     3,064       4,558  
      Net increase/(decrease)
  $ (23,833 )   $ 25,176     $ 39,776  

Asset Quality
 
Delinquent Loans.  When a borrower fails to make a required payment on a loan, we attempt to cause the deficiency to be cured by contacting the borrower, generally within 15 days of the loan becoming delinquent. A notice is mailed to the borrower after a payment is 15 days past due and again when the loan is 30 days past due. For most loans, if the delinquency is not cured within 30 days we issue a notice of intent to foreclose on the property and if the delinquency is not cured within 60 days, we may institute foreclosure action. If foreclosed on, real property is sold at a public sale and may be purchased by us.
 
The following table sets forth information concerning delinquent mortgage and other loans at March 31, 2011. The amounts presented represent the total remaining principal balances of the related loans, rather than the actual payment amounts which are overdue.
 
   
Residential
Real Estate
   
Commercial Real Estate,
Multi-Family and Land
   
Construction
   
Consumer
   
Commercial
Business
   
Total
 
   
Number
   
Amount
   
Number
   
Amount
   
Number
   
Amount
   
Number
   
Amount
   
Number
   
Amount
   
Number
   
Amount
 
   
(Dollars in Thousands)
 
                                                                         
Loans Delinquent for:
                                                                       
30-59 days
    5     $ 755       6     $ 575       --     $ --       57     $ 862       23     $ 743       91     $ 2,935  
60-89 days
    6       718       2       1,755       --       --       17       557       12       609       37       3,639  
90 days and over
    24       3,661       9       1,574       --       --       29       335       17       606       79       6,176  
Total delinquent loans
    35     $ 5,134       17     $ 3,904       --     $ --       103     $ 1,754       52     $ 1,959       207     $ 12,750  
 
 
 
14
 
 
 

 
Risk Elements.  The table below sets forth the amounts and categories of non-performing assets and troubled debt restructurings in our loan portfolio. Non-performing assets include non-accruing loans, accruing loans delinquent 90 days or more as to principal or interest payments and real estate acquired through foreclosure, which include assets acquired in settlement of loans. Typically, a loan becomes nonaccruing when it is 90 days delinquent. All consumer loans more than 120 days delinquent are charged against the allowance for loan losses. Accruing mortgage loans delinquent more than 90 days are loans that we consider to be well secured and in the process of collection. For the years presented, we have no accruing loans 90 days or more delinquent.
 
   
March 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
(Dollars in Thousands)
 
Non-accruing loans:
                             
  Commercial business and consumer
  $ 941     $ 3,998     $ 2,428     $ 137     $ 142  
  Real estate
    5,235       10,566       5,138       889       1,173  
                                         
    Total non-accruing loans
    6,176       14,564       7,566       1,026       1,315  
  Real estate acquired through foreclosure
    10,384       3,182       1,400       593       181  
    Total non-performing assets
  $ 16,560     $ 17,746     $ 8,966     $ 1,619     $ 1,496  
                                         
    Total as a percentage of total assets
    3.12 %     3.24 %     1.75 %     .33 %     .32 %
    Allowance for loan losses
  $ 7,846     $ 8,053     $ 5,956     $ 3,215     $ 3,078  
    Troubled debt restructurings
  $ 21,044     $ 3,713     $ 4,298     $ 2,887     $ 2,963  

Non-performing assets at March 31, 2011 were comprised primarily of non-accruing loans, real estate owned and repossessed automobiles. Real estate acquired through foreclosure consisted of $2.4 million in residential construction, $3.3 million in land, $3.3 million in 1-4 family residences and $1.3 million in commercial real estate.  Based on current market values of the properties securing these loans, management anticipates no significant losses in excess of the reserves for losses previously recorded. Our largest non-accruing loan relationship at March 31, 2011 totaled $975,000 and is located in the Virginia Beach, Virginia area secured by residential real estate. The next largest non-accruing loan relationship was $651,000 secured by commercial real estate.
 
Nonaccrual loans amounted to $6.2 million at March 31, 2011.  If interest on these loans had been accrued, such income would have approximated $325,000 for the year ended March 31, 2011, none of which is included in interest income.
 
Troubled debt restructurings amounted to $21.8 million at March 31, 2011, of which $220,640 is also included in non-performing assets.
 
Other Loans Of Concern.  In addition to the non-performing assets set forth in the table above, as of March 31, 2011, we had approximately $18.3 million of loans with respect to which known information about the possible credit problems of the borrowers or the cash flows of the security properties have caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories.  Although management believes that these loans are adequately secured and no material loss is expected, certain circumstances may cause the borrower to be unable to comply with the present loan repayment terms at some future date. These loans have been considered in management's determination of our allowance for loan losses.
 
In addition to the $18.3 million in loans mentioned above, we have $43.4 million in additional loans which we monitor. These loans are generally performing substantially in accordance with the loan
 
 
 
15
 
 
 
 
terms but exhibit characteristics such as insufficient cash flow or occasional delinquencies which we monitor for deterioration. Of the $43.4 million, $17.6 million is comprised of residential real estate and consumer loans and $25.8 million are commercial real estate and business loans.
 
Classified Assets.  Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the Office of Thrift Supervision to be of lesser quality, as "substandard," "doubtful" or "loss."  An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected.  Assets classified as "doubtful" have all of the weaknesses in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions and values, "highly questionable and improbable."  Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
 
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management.  General allowances represent loss allowances which have been established to recognize the risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets.  When an insured institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount.  An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation, which may order the establishment of additional general or specific loss allowances.
 
We regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations.  On the basis of management’s review of our assets, at March 31, 2011, we had classified $32.4 million of our assets as substandard, $71,000 as doubtful and none as loss. The $32.4 million in classified loans is comprised primarily of residential and commercial real estate loans and commercial business loans.  The $71,000 in doubtful loans is comprised of commercial business loans.
 
Allowance for Losses on Loans and Real Estate.  We provide valuation allowances for anticipated losses on loans and real estate when management determines that a significant decline in the value of the collateral has occurred, as a result of which the value of the collateral is less than the amount of the unpaid principal of the related loan plus estimated costs of acquisition and sale. In addition, we also provide allowances based on the dollar amount and type of collateral securing our loans in order to protect against unanticipated losses. Although management believes that it uses the best information available to make such determinations, future adjustments to allowances may be necessary, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations.  See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Provision for Loan Losses” in Item 7 of this report and Note 2 of the Notes to Consolidated Financial Statements in Item 8 of this report.
 

 
16
 
 

The following table sets forth an analysis of our allowance for loan losses.
 
   
Year Ended March 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
(Dollars in Thousands)
 
Balance at beginning of period
  $ 8,053     $ 5,956     $ 3,215     $ 3,078     $ 2,966  
Provision charged to operations
    8,171       4,031       4,285       625       388  
Charge-offs:
                                       
  Residential real estate
    (1,880 )     (135 )     (72 )     (44 )     ---  
  Commercial Real Estate, Multifamily and Land.
    (2,503 )     (397 )     (488 )     (3 )     ---  
  Construction
    (999 )     (351 )     (100 )     (25 )     ---  
  Home Equity
    (654 )     (578 )     ---       ---       ---  
  Automobile
    (369 )     (429 )     (438 )     (437 )     (279 )
  Other
    (906 )     (130 )     (213 )     (73 )     (76 )
  Commercial Business
    (1,411 )     (86 )     (371 )     (41 )     (2 )
Recoveries:
                                       
  Residential real estate
    43       1       11       ---       ---  
  Commercial Real Estate, Multifamily and Land.
    74       ---       ---       1       ---  
  Construction
    5       20       ---       ---       ---  
  Home Equity
    6       4       ---       ---       ---  
  Automobile
    132       135       116       79       55  
  Other
    13       2       9       10       26  
  Commercial Business
    71       10       2       45       ---  
Net charge-offs
    (8,378 )     (1,934 )     (1,544 )     (488 )     (276 )
Balance at end of period
  $ 7,846     $ 8,053     $ 5,956     $ 3,215     $ 3,078  
Ratio of net charge-offs during the
period to average loans outstanding
during the period
    1.20 %     .39 %     .33 %     .12 %     .07 %
 
The distribution of the allowance for losses on loans at the dates indicated is summarized as follows:
 
   
Residential
   
Commercial
Real Estate,
Multi-Family
and Land
   
Construction
   
Commercial
Business
   
Home
Equity
   
Consumer
   
Total
 
   
(Dollars in Thousands)
 
March 31, 2011:
                                         
Amount of loan loss allowance
  $ 3,670     $ 2,223     $ 549     $ 100     $ 951     $ 353     $ 7,846  
Percent of loans in each
category to total loans
    30.10 %     36.94 %     5.58 %     9.98 %     9.53 %     7.87 %     100.00 %
                                                         
March 31, 2010:
                                                       
Amount of loan loss allowance
  $ 314     $ 2,079     $ 997     $ 3,170     $ 603     $ 890     $ 8,053  
Percent of loans in each
category to total loans
    27.59 %     32.71 %     12.14 %     10.16 %     9.14 %     8.26 %     100.00 %
                                                         
March 31, 2009:
                                                       
Amount of loan loss allowance
  $ 276     $ 1,637     $ 665     $ 2,196     $ 224     $ 958     $ 5,956  
Percent of loans in each
category to total loans
    28.17 %     31.14 %     12.65 %     10.75 %     8.38 %     8.91 %     100.00 %
                                                         
March 31, 2008:
                                                       
Amount of loan loss allowance
  $ 258     $ 981     $ 383     $ 565     $ 130     $ 898     $ 3,215  
Percent of loans in each
category to total loans
    27.08 %     33.14 %     11.90 %     9.18 %     7.24 %     11.46 %     100.00 %
                                                         
March 31, 2007:
                                                       
Amount of loan loss allowance
  $ 238     $ 819     $ 354     $ 530     $ 109     $ 1,028     $ 3,078  
Percent of loans in each
category to total loans
    28.59 %     28.90 %     11.83 %     9.13 %     7.46 %     14.09 %     100.00 %
 
 
 
17
 
 
 
 
 
Investment Activities
 
Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, including callable agency securities, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds.  Subject to various restrictions, federally chartered savings institutions may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.  See "Regulation - Qualified Thrift Lender Test" below for a discussion of additional restrictions on our investment activities.
 
The senior vice president/chief financial officer has the basic responsibility for the management of our investment portfolio, subject to the direction and guidance of the asset/liability management committee.  The senior vice president/chief financial officer considers various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment.  The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.
 
The general objectives of our investment portfolio are to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk.  See also "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" in Item 7 of this Form 10-K.
 
As a member of the Federal Home Loan Bank of Atlanta, we had $5.6 million in stock of the Federal Home Loan Bank of Atlanta at March 31, 2011, and for the year ended March 31, 2011, we received $28,000 in dividends on such stock.
 
The contractual maturities and weighted average yields of our investment securities portfolio, excluding FHLB of Atlanta stock and Freddie Mac stock, are indicated in the following table.
 
   
March 31, 2011
 
   
Within 1
Year or
Less
   
After 1
Year
through 5
Years
   
After 5
Years
through
10 Years
   
Total
Investment
Securities(1)
 
   
Book
Value
   
Book
Value
   
Book
Value
   
Book
Value
   
Market
Value
 
   
(Dollars in Thousands)
 
Federal agency obligations
  $ ---     $ 2,000     $ ---     $ 2,000     $ 1,966  
Other                                        
    198       ---       ---       198       198  
Total Investment Securities
  $ 198     $ 2,000     $ ---     $ 2,198     $ 2,164  
                                         
Weighted Average Yield (2)
    1.13 %     2.36 %     --- %     2.25 %     2.29 %
______________________
(1)
Included in the above table are $2.0 million of securities that are callable in one year or less.
(2)
The weighted average yield is not computed on a tax equivalent basis.

 
18
 
 

The following table sets forth the composition of our available for sale and held to maturity securities portfolios at the dates indicated.  At March 31, 2011, our securities portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our equity capital, excluding those issued by the United States Government or its agencies.  See Note 1 of the Notes to Consolidated Financial Statements in Item 8 of this report for additional information on our investment securities.
 
   
March 31,
 
   
2011
   
2010
   
2009
 
   
Book
Value
   
% of
Total
   
Book
Value
   
% of
Total
   
Book
Value
   
% of
Total
 
   
(Dollars in Thousands)
 
Interest-bearing deposits with banks
  $ 4,119       100.0 %   $ 3,825       100.0 %   $ 512       100.0 %
                                                 
Investment securities:
                                               
  Federal agency obligations
  $ 2,000       25.7 %   $ 1,500       18.9 %   $ 1,500       21.0 %
  State agencies and commercial paper
    ---       ---       ---       ---       200       2.8  
  Other
    198       2.5       198       2.5       ---       ---  
  United States agency equity securities
    39       0.5       73       0.9       207       2.9  
        Subtotal
    2,237       28.7       1,771       22.3       1,907       26.7  
FHLB stock
    5,561       71.3       6,184       77.7       5,239       73.3  
    Total investment securities and
         FHLB stock
  $ 7,798       100.0 %   $ 7,955       100.0 %   $ 7,146       100.0 %
Average remaining life or term
    to repricing (1)
         
4 Years
           
4 Years
           
3 Years
 
____________________
(1)
Excludes Freddie Mac common stock and other marketable equity securities.
 
During fiscal 2011, the market rates paid on investment securities decreased.  During fiscal 2009 through 2011, we made limited investment securities purchases due to the minimal spread between short and long term rates during most of these reporting periods.
 
During fiscal 2009, due to the conservatorship of Fannie Mae and Freddie Mac in September, 2008 and the related restrictions on its outstanding preferred stock (including the elimination of dividends), the Company recorded an other than temporary impairment (OTTI) non-cash charge with respect to the Fannie Mae and Freddie Mac preferred stock it owned of $11,536,000. The Company sold its remaining 57,000 shares of Fannie Mae and Freddie Mac preferred stock during fiscal year 2011.

 
Sources of Funds
 
General.  Deposits have traditionally been the principal source of our funds for use in lending and for other general business purposes. In addition to deposits, we derive funds from loan repayments, cash flows generated from operations, which includes interest credited to our deposit accounts, repurchase agreements entered into with commercial banks and FHLB of Atlanta advances.
 
Contractual loan payments are a relatively stable source of funds, while deposit inflows and outflows and the related cost of such funds have varied widely. Borrowings may be used on a short-term basis to compensate for reductions in deposits or deposit inflows at less than projected levels and may be used on a longer-term basis to support expanded lending activities.
 
Deposits.  We attract both short-term and long-term deposits from the general public by offering a wide assortment of accounts and rates. We have been required by market conditions to rely on short-term accounts and other deposit alternatives that are more responsive to market interest rates than fixed interest rate, fixed-term certificates that were our primary source of deposits in the past. We offer regular savings
 
 
 
19
 
 
 
 
 
accounts, checking accounts, various money market accounts, fixed-rate long-term certificates with varying maturities, $100,000 or more jumbo certificates of deposit and individual retirement accounts. During fiscal 2011, 2010 and 2009 we utilized brokered deposits due to their lower relative costs. At March 31, 2011, we had total brokered deposits of $15.3 million.
 
The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by us at the periods indicated.
 
   
March 31,
 
   
2011
   
2010
   
2009
 
   
(In Thousands)
 
Passbook and statement accounts
  $ 33,997     $ 31,586     $ 27,320  
NOW and Super NOW accounts including non-interest bearing
    75,446       68,844       56,626  
Money market accounts
    43,850       38,466       25,255  
Six-month and 91 day certificates
    7,075       13,195       8,958  
One- to five-year fixed-rate certificates
    218,677       246,329       247,347  
       Total
  $ 379,045     $ 398,420     $ 365,506  

The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and has allowed us to respond with flexibility (by paying rates of interest more closely approximating market rates of interest) to, although not eliminate the threat of, disintermediation (the flow of funds away from depository institutions such as thrift institutions into direct investment vehicles such as government and corporate securities). In addition, we have become much more subject to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. Our ability to attract and maintain deposits, and our cost of funds, has been, and will continue to be, significantly affected by money market conditions.
 
The following table sets forth our deposit flows during the periods indicated.
 
   
Year Ended March 31,
 
   
2011
   
2010
   
2009
 
   
(Dollars in Thousands)
 
Opening balance
  $ 398,420     $ 365,506     $ 350,731  
Net deposits(withdrawals)
    (24,063 )     24,780       6,639  
Interest credited
    4,688       8,134       8,136  
Ending balance
  $ 379,045     $ 398,420     $ 365,506  
Net increase(decrease)
  $ (19,375 )   $ 32,914     $ 14,775  
Percent increase(decrease)
    (4.86 %)     9.01 %     4.21 %

  During fiscal 2009, we experienced an increase in interest-bearing checking accounts due to our continued emphasis on increasing these relationships. During fiscal 2010, the change in deposits was related primarily to the utilization of brokered deposits and our continued emphasis on increasing transaction accounts. During fiscal 2011, the change in deposits was related to the decrease in loans and lower time deposit rates with continued emphasis on transaction accounts. We remained competitive on deposit rates. We may use borrowings from time to time as an alternative source of funds. See “ Borrowings.”
 
 
 
20
 
 
 
 
 
The following table contains information pertaining to the average amount of and the average rate paid on each of the following deposit categories for the periods indicated.
 
   
Year Ended March 31,
 
   
2011
   
2010
   
2009
 
   
Average
Balance
   
Average
Rate Paid
   
Average
Balance
   
Average
Rate Paid
   
Average
Balance
   
Average
Rate Paid
 
   
(Dollars in Thousands)
 
Deposit Category:
                                   
Non-interest bearing demand
    deposits
  $ 27,573       --- %   $ 26,717       --- %   $ 25,514       --- %
Interest bearing demand deposits
    83,901       0.71       66,355       0.95       51,920       1.16  
Savings deposits
    31,993       0.55       29,484       0.92       27,463       1.18  
Time deposits
    243,652       1.70       259,948       2.40       250,702       3.82  
Total deposits
  $ 387,119       1.27 %   $ 382,504       1.87 %   $ 355,599       2.95 %

The following table shows rate information for our certificates of deposit as indicated.
 
    
Less Than
1.00%
      1.00- 2.00%       2.01- 3.00%       3.01- 4.00%    
4.01 and
Greater
   Total  
 
                                             
March 31, 2011
  $ 36,247     $ 151,652     $ 28,448     $ 3,396     $ 6,009     $ 225,752  
March 31, 2010
  $ 22,850     $ 148,275     $ 70,378     $ 5,060     $ 12,961     $ 259,524  
March 31, 2009
  $ 3,185     $ 12,275     $ 63,401     $ 118,149     $ 59,295     $ 256,305  

The following table indicates the amount of the certificates of deposit by time remaining until maturity as of March 31, 2011.
 
   
Maturity
 
   
3 Months
or less
   
Over 3
Months
through
6 Months
   
Over 6
Months
through
12 Months
   
Over 12
Months
   
Total
 
   
(Dollars in Thousands)
 
Certificates of deposit less than $100,000
  $ 29,403     $ 36,051     $ 45,454     $ 30,938     $ 141,846  
Certificates of deposit of $100,000 or more
    21,371       20,112       22,557       19,866       83,906  
       Total certificates of deposit
  $ 50,774     $ 56,163     $ 68,011     $ 50,804     $ 225,752  

Borrowings
 
We generally utilize borrowings to supplement deposits when they are available at a lower overall cost to us or they can be invested at a positive rate of return.  Our borrowings generally consist of advances from the FHLB of Atlanta.  Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB of Atlanta may prescribe the acceptable uses to which these advances may be put, as well as limitations on the size of the advances and repayment provisions.
 
Our borrowings, from time to time, also include securities sold under agreements to repurchase, with mortgage-backed securities or other securities pledged as collateral.  At March 31, 2011, we had $1,445,000 of securities sold under agreements to repurchase which adjust with the federal funds rate. For additional information on our borrowings and securities sold under agreements to repurchase, see Notes 6 and 7 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
 
 
 
21
 
 
 
 
 
The following table sets forth information as to our borrowings and the weighted average interest rate paid on such borrowings at the dates indicated.
 
   
At March 31,
 
   
2011
   
2010
   
2009
 
   
(Dollars in thousands)
 
       
Securities sold under agreements to repurchase
  $ 1,445     $ 846     $ 1,476  
Other borrowings
    ---       250       1,000  
FHLB advances
    97,000       96,000       94,000  
Total Borrowings
  $ 98,445     $ 97,096     $ 96,476  
                         
Weighted average interest rate of borrowings
    0.23 %     0.90 %     1.00 %

Information related to short-term borrowing activity from the Federal Home Loan Bank is as follows:
 
At or for the Year Ended March 31,
 
2011
   
2010
   
2009
 
   
(Dollars in Thousands)
 
Amount outstanding at year end
  $ 97,000     $ 96,000     $ 74,000  
Average interest rate on amount at year end
    0.23 %     0.93 %     0.43 %
                         
Average amount outstanding during the year
  $ 96,345     $ 79,397     $ 72,055  
Average interest rate during the year
    0.71 %     0.37 %     1.69 %
                         
Maximum amount outstanding during the year
  $ 108,000     $ 97,000     $ 94,000  

Subsidiary Activities
 
There are no significant subsidiary activities.
 
Competition
 
Community faces strong competition both in originating real estate loans and in attracting deposits. Competition in originating real estate loans comes primarily from other thrift institutions, commercial banks and mortgage bankers who also make loans secured by real estate located in our market area. We compete for real estate loans principally on the basis of our interest rates and loan fees, the types of loans and the quality of services provided to borrowers.
 
We face substantial competition in attracting deposits from other thrift institutions, commercial banks, money market and mutual funds, credit unions and other investment vehicles. Our ability to attract and retain deposits depends on our ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk and other factors. We compete for these deposits by offering a variety of deposit accounts at competitive rates and convenient business hours.
 
We consider our primary markets for deposits to be Augusta County and Hampton Roads and for mortgage loans to be Augusta and Rockingham Counties and the Hampton Roads area.  We estimate that our market share of savings deposits in Augusta County is approximately 15% and our share of mortgage loans in Augusta and Rockingham Counties is less than 10%. The opening of an office by the Bank in April, 1997 in Virginia Beach, Virginia expanded the Bank’s market area to the Hampton Roads area of Virginia.
 
 
 
22
 
 
 
 
 
Regulation
 
General.  Set forth below is a brief description of certain laws and regulations that are applicable to Community Financial and Community Bank.  The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.  Legislative or regulatory changes in the future could adversely affect our operations and financial condition.
 
The Office of Thrift Supervision has extensive enforcement authority over all savings associations and their holding companies, including Community Financial and Community Bank.  This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions.  In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices.  Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the Office of Thrift Supervision.  Except under certain circumstances, public disclosure of final enforcement actions by the Office of Thrift Supervision is required by law.
 
Recently Enacted Regulatory Reform .  On July 21, 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Dodd-Frank Act imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. In addition, the new law changes the jurisdictions of existing bank regulatory agencies and in particular transfers the regulation of federal savings associations from the Office of Thrift Supervision to the Office of Comptroller of the Currency, effective July 21, 2011. At the same time, responsibility for regulation of savings and loan holding companies will be transferred to the Board of Governors of the Federal Reserve System (Federal Reserve). The new law also establishes an independent federal consumer protection bureau within the Federal Reserve, the Consumer Financial Protection Bureau (CFPB). The following discussion summarizes significant aspects of the new law that may affect Community Bank and Community Financial.  Many regulations implementing these changes have not been promulgated, so we cannot determine the full impact on our business and operations at this time.
 
The following aspects of the Dodd-Frank Act are related to the operations of Community Bank:  
 
 
·
Effective July 21, 2011, the Office of the Comptroller of the Currency will assume the authority and responsibilities of the Office of Thrift Supervision to regulate savings associations under the same laws as the Office of Thrift Supervision (except where modified by the Dodd-Frank Act).  The regulations and policies of the Office of Thrift Supervision for savings associations will continue to apply unless and until the Office of the Comptroller of the Currency modifies them.
 
 
·
Effective July 21, 2011, the Federal Reserve will assume the authority and responsibilities of the Office of Thrift Supervision to regulate savings and loan holding companies under the same laws as the Office of Thrift Supervision (except where modified by the Dodd-Frank Act).  The regulations and policies of the Office of Thrift Supervision for savings and loan holding companies will continue to apply unless and until modified by the Federal Reserve.
 
 
·
The Consumer Financial Protection Bureau will be established within the Federal Reserve, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. Smaller financial institutions, like Community Bank, will be subject to supervision and enforcement by their primary federal banking regulators with respect to federal consumer financial protection laws.
 
 
 
23
 
 
 
 
 
 
·
The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution subsidiaries.
 
 
·
Tier 1 capital treatment for "hybrid" capital items like trust preferred securities is eliminated subject to various grandfathering and transition rules.
 
 
·
The current prohibition on payment of interest on demand deposits is repealed, effective July 21, 2011.
 
 
·
State consumer financial protection law will be preempted only if it would have a discriminatory effect on a federal savings association or is preempted by any other federal law. The Office of the Comptroller of the Currency must make a preemption determination with respect to a state consumer financial protection law on a case-by-case basis with respect to a particular state law or other state law with substantively equivalent terms.
 
 
·
Deposit insurance is permanently increased to $250,000 and unlimited deposit insurance for noninterest-bearing transaction accounts is extended through December 31, 2013.
 
 
·
The Deposit insurance assessment base is the depository institution's total average assets minus the sum of its average tangible equity during the assessment period.
 
The following aspects of the Dodd-Frank Act are related to the operations of Community Financial:
 
 
·
Savings and loan holding companies will be subject to the same capital requirements as bank holding companies five years after enactment. Currently, a bank holding company with less than $500 million in assets is subject to capital requirements on a bank-only basis (except in certain unusual cases).
 
 
·
The Securities and Exchange Commission is authorized to adopt rules requiring public companies to make their proxy materials available to shareholders for nomination of their own candidates for election to the board of directors.
 
 
·
Public companies are required to provide their shareholders with a non-binding vote: (i) at least once every three years on the compensation paid to executive officers, and (ii) at least once every six years on whether they should have a "say on pay" vote every one, two or three years.
 
 
·
A separate, non-binding shareholder vote is required regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments.
 
 
·
Securities exchanges are required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for certain "significant" matters, which include votes on the election of directors, executive compensation matters, and any other matter determined to be significant.
 
 
·
Stock exchanges, which does not include the OTC Bulletin Board, are prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its policy on incentive compensation payable on the basis of financial information reportable under the
 
 
 
24
 
 
 
 
 
 
 
securities laws, and (ii) the recovery from current or former executive officers, following an accounting restatement triggered by material noncompliance with securities law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which the restatement was required that exceeds the amount that would have been paid on the basis of the restated financial information.
 
 
·
Disclosure in annual proxy materials is required concerning the relationship between the executive compensation paid and the financial performance of the issuer.
 
 
·
Smaller reporting companies are exempt from complying with the internal control auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act.
 
Federal Regulation of Savings Associations.  Community Bank, as a federally chartered savings bank, is subject to regulation and oversight by the Office of Thrift Supervision extending to all aspects of its operations.  This regulation of Community Bank is intended for the protection of depositors and the insurance of accounts fund and not for the purpose of protecting shareholders.  Community Bank is required to maintain minimum levels of regulatory capital and is subject to some limitations on the payment of dividends to Community Financial.  See “- Regulatory Capital Requirements” and “- Limitations on Dividends and Other Capital Distributions.”  Community Bank also is subject to regulation and examination by the Federal Deposit Insurance Corporation, which insures the deposits of Community Bank to the maximum extent permitted by law.
 
We are subject to periodic examinations by the Office of Thrift Supervision.  During these examinations, the examiners may require Community Bank to provide for higher general or specific loan loss reserves, which can impact our capital and earnings.  As a federal savings bank, Community Bank is subject to a semi-annual assessment, based upon its total assets, to fund the operations of the Office of Thrift Supervision.
 
The Office of Thrift Supervision has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits.  Any institution regulated by the Office of Thrift Supervision that fails to comply with these standards must submit a compliance plan.
 
Insurance of Accounts and Regulation by the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions.  It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the fund.  The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision an opportunity to take such action.  Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or written agreement with the FDIC.  We are not aware of any practice, condition or violation that might lead to termination of Community Bank’s deposit insurance.

Community Bank is a member of the Deposit Insurance Fund (DIF), which is administered by the FDIC.  Deposits are insured up to the applicable limits by the FDIC, backed by the full faith and credit of the United States Government. The basic deposit insurance limit is $250,000.

The FDIC assesses deposit insurance premiums on each insured institution quarterly based on annualized rates for one of four risk categories.  Each institution is assigned to one of four risk categories
 
 
 
25
 
 
 
 
based on its capital, supervisory ratings and other factors.  Well capitalized institutions that are financially sound with only a few minor weaknesses are assigned to Risk Category I.  Risk Categories II, III and IV present progressively greater risks to the DIF.  Under the rules in effect through March 31, 2011, a range of initial base assessment rates applied to each Risk Category, subject to adjustments based on an institution’s unsecured debt, secured liabilities and brokered deposits, such that the total base assessment rates after adjustments ranged from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for Risk Category IV.

As required by the Dodd-Frank Act, the FDIC adopted rules effective April 1, 2011, under which insurance premium assessments are based on an institution's total assets minus its tangible equity (defined as Tier 1 capital) instead of its deposits.  Under these rules, an institution with total assets of less than $10 billion is assigned to a Risk Category as described above, and a range of initial base assessment rates applies to each category, subject to adjustment downward based on unsecured debt issued by the institution and, except for an institution in Risk Category I, adjustment upward if the institution’s brokered deposits exceed 10% of its domestic deposits, to produce total base assessment rates.  Total base assessment rates range from 2.5 to 9 basis points for Risk Category I, 9 to 24 basis points for Risk Category II, 18 to 33 basis points for Risk Category III, and 30 to 45 basis points for Risk Category IV, all subject to further adjustment upward if the institution holds more than a de minimis amount of unsecured debt issued by another FDIC-insured institution. The FDIC may increase or decrease its rates by 2.0 basis points without further rulemaking.  In an emergency, the FDIC may also impose a special assessment.

As a result of a decline in the reserve ratio (the ratio of the DIF to estimated insured deposits) and concerns about expected failure costs and available liquid assets in the DIF, the FDIC adopted a rule requiring each insured institution to prepay on December 30, 2009 the estimated amount of its quarterly assessments for the fourth quarter of 2009 and all quarters through the end of 2012 (in addition to the regular quarterly assessment for the third quarter which was due on December 30, 2009).  The prepaid amount is recorded as an asset with a zero risk weight and the institution will continue to record quarterly expenses for deposit insurance.  For purposes of calculating the prepaid amount, assessments were measured at the institution’s assessment rate as of September 30, 2009, with a uniform increase of 3 basis points effective January 1, 2011, and were based on the institution’s assessment base for the third quarter of 2009, with growth assumed quarterly at annual rate of 5%.  If events cause actual assessments during the prepayment period to vary from the prepaid amount, institutions will pay excess assessments in cash or receive a rebate of prepaid amounts not exhausted after collection of assessments due on June 30, 2013, as applicable.  Collection of the prepayment does not preclude the FDIC from changing assessment rates or revising the risk-based assessment system in the future.  The balance of Community Bank’s prepaid assessment at March 31, 2011 was $1.5 million.

The Dodd-Frank Act establishes 1.35% as the minimum reserve ratio. The FDIC has adopted a plan under which it will meet this ratio by September 30, 2020, the deadline imposed by the Dodd-Frank Act.  The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum reserve ratio to 1.35% from the former statutory minimum of 1.15%.  The FDIC has not yet announced how it will implement this offset.  In addition to the statutory minimum ratio, the FDIC must designate a reserve ratio, known as the designated reserve ratio or DRR, which may exceed the statutory minimum.  The FDIC has established 2.0% as the DRR.

The FDIC has authority to increase insurance assessments.  A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. There can be no prediction as to what insurance assessment rates will be in the future.
 
 
 
26
 
 
 

 
In addition to the assessment for deposit insurance, through 2019, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. This payment is established quarterly and during the four quarters ending March 31, 2011 averaged 1.025 basis points of assessable deposits.

Transactions with Affiliates.  Transactions between Community Bank and its affiliates generally are required to be on terms as favorable to the institution as transactions with non-affiliates, and certain of these transactions, such as loans to an affiliate, are restricted to a percentage of Community Bank's capital.  In addition, Community Bank may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates.  Community Financial is an affiliate of Community Bank.
 
Regulatory Capital Requirements.  To be considered well capitalized, an institution must have a ratio of Tier 1 capital to adjusted total assets of at least 5.0%, a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, and a ratio of total capital to risk-weighted assets of at least 10.0% and not be subject to any agreement, order or directive of the OTS to meet and maintain any specific capital measure.  Tier 1 capital generally consists of common stockholders’ equity, retained earnings and certain noncumulative perpetual preferred stock, plus certain intangibles.  At March 31, 2011, Community Bank had no intangibles in Tier 1 capital.
 
Total capital consists of Tier 1 and Tier 2 capital.  Tier 2 capital generally consists of certain permanent and maturing capital instruments that do no qualify as Tier 1 capital and up to 1.25% of risk-weighted assets in allowance for loan and lease losses.  The amount of Tier 2 capital includable in total capital may not exceed the amount of Tier 1 capital.  Risk-weighted assets are determined by assigning a risk weight ranging from 0% to 100% to all assets and certain off-balance sheet items.
 
To be adequately capitalized, an institution must have a ratio of Tier 1 capital to adjusted total assets of at least 4.0%, a ratio of Tier 1 capital to risk-weighted assets of at least 4.0% and a ratio of total capital to risk-weighted assets of at least 8.0%.  At March 31, 2011, Community Bank was well capitalized.  The Office of Thrift Supervision is authorized to require federal savings banks on a case-by-case basis to maintain an additional amount of total capital to account for concentration of credit risk, level of interest rate risk, equity investments in non-financial companies and the risk of non-traditional activities.
 
The Office of Thrift Supervision is authorized, and under certain circumstances required, to take certain actions against savings banks that are not at least adequately capitalized.  Any such institution must submit a capital restoration plan and until such plan is approved by the Office of Thrift Supervision may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions.  Additional restrictions may apply, including a forced merger, acquisition, or liquidation of the institution.  The Office of Thrift Supervision generally is authorized to reclassify an institution into a lower capital category and impose the restrictions if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition.  The imposition by the Office of Thrift Supervision of any of these measures on Community Bank may have a substantial adverse effect on our operations and profitability.  Regulatory capital is discussed further in Note 11 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
 
Any institution that meets the requirement to be “adequately capitalized” and not the requirements to be “well capitalized” may not accept, renew or rollover brokered deposits without a waiver from the FDIC.  An institution that does not meet the requirements to be “adequately capitalized” may not accept, renew or rollover brokered deposits.  Brokered deposits include deposits solicited by the institution or its employees if the interest rates on such deposits exceed certain thresholds.
 
 
 
27
 
 
 
 
 
Limitations on Dividends and Other Capital Distributions.  Office of Thrift Supervision regulations impose various restrictions on the ability of Community Bank to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account.  Community Bank must file a notice or application with the Office of Thrift Supervision before making any capital distribution.  Community Bank generally may make capital distributions during any calendar year in an amount up to 100% of net income for the year-to-date plus retained net income for the two preceding years, so long as it is well-capitalized after the distribution.  If, however, Community Bank proposes to make a capital distribution when it does not meet (or will not meet following the proposed capital distribution) the requirements to be adequately capitalized or to make a distribution that will exceed these net income limitations, it must obtain Office of Thrift Supervision approval prior to making such distribution.  The Office of Thrift Supervision may object to any distribution based on safety and soundness concerns.
 
Community Financial is not subject to Office of Thrift Supervision regulatory restrictions on the payment of dividends.  Dividends from Community Financial, however, may depend, in part, upon its receipt of dividends from Community Bank. Issuance of preferred stock under the TARP and CPP restricts the Company from increasing its dividend distribution to stockholders without approval from the Office of Thrift Supervision.
 
 
Qualified Thrift Lender Test.  All savings associations, including Community Bank, are required to meet a qualified thrift lender test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (as defined by statute) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings association may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under either test, such assets primarily consist of residential housing related loans and investments. At March 31, 2011, Community Bank met the test and has always met the test since its effective date.
 
Any savings institution that fails to meet the qualified thrift lender test must convert to a national bank, unless it re-qualifies as a qualified thrift lender and thereafter remains a qualified thrift lender.  If an institution that fails the qualified thrift lender test is controlled by a holding company (unless the institution re-qualifies in timely fashion after first failing the test), then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See"-Holding Company Regulation."
 
Community Reinvestment Act.  Under the Community Reinvestment Act, every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Act. The Community Reinvestment Act requires the Office of Thrift Supervision, in connection with the examination of Community Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by Community Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the Office of Thrift Supervision. Community Bank was examined for Community Reinvestment Act compliance in November, 2010 and received a rating of “Satisfactory”.
 
Holding Company Regulation.  Community Financial is a unitary savings and loan holding company subject to regulatory oversight by the Office of Thrift Supervision. As such, we are required to register and file reports with the Office of Thrift Supervision and are subject to regulation and
 
 
 
28
 
 
 
 
examination by the Office of Thrift Supervision. In addition, the Office of Thrift Supervision has enforcement authority over us and our non-savings association subsidiaries, which also permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association.
 
As a unitary savings and loan holding company that acquired Community Bank before May 4, 1999, we generally are not subject to activity restrictions. If we acquire control of one or more additional savings associations as a separate subsidiary, our activities and those of any of our subsidiaries (other than Community Bank or any other insured savings association) would become subject to such restrictions unless such other associations each qualify as a QTL and were acquired in supervisory acquisitions.
 
Federal Securities Laws.  The stock of Community Financial is registered with the SEC under the Securities Exchange Act of 1934, as amended.  Community Financial is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Securities Exchange Act of 1934.
 
The SEC and the NASDAQ have adopted regulations and policies under the Sarbanes-Oxley Act of 2002 that apply to Community Financial as a registered company under the Securities Exchange Act of 1934 and a NASDAQ-traded company.  The stated goals of these Sarbanes-Oxley requirements are to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.  The SEC and NASDAQ Sarbanes-Oxley-related regulations and policies include very specific additional disclosure requirements and corporate governance rules.  The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
 
Captial Purchase Program.  On December 19, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”) of the United States Department of the Treasury (“Treasury”), the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with Treasury, pursuant to which the Company (i) sold to Treasury 12,643 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation preference amount of $1,000 per share, for a purchase price of $12.6 million in cash and (ii) issued to Treasury a ten-year warrant (the “Warrant”) to purchase 351,194 shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), at an exercise price of $5.40 per share.
 
The Series A Preferred Stock qualified as Tier 1 capital and will pay cumulative dividends on the liquidation preference amount on a quarterly basis at a rate of 5% per annum for the first five years, and 9% per annum thereafter.  Subject to the prior approval of the Board of Governors of the Federal Reserve System, the Series A Preferred Stock is redeemable at the option of the Company in whole or in part at a redemption price of 100% of the liquidation preference amount plus any accrued and unpaid dividends.

The enactment of ARRA on February 17, 2009 permits the Company to repay the Treasury without penalty and without the need to raise new capital, subject to the Treasury’s consultation with the recipient’s appropriate regulatory agency.  Additionally, upon repayment the Treasury will liquidate all outstanding warrants at their current market value.

The Series A Preferred Stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”).  In
 
 
 
29
 
 
 
 
 
accordance with the Purchase Agreement, the Company subsequently registered the Series A Preferred Stock, the Warrant and the shares of Common Stock underlying the Warrant under the Securities Act.

Federal and State Taxation
 
Federal Taxation.  Savings associations such as Community Bank that meet certain definitional tests relating to the composition of assets and other conditions prescribed by the Internal Revenue Code of 1986, as amended, had been permitted to establish reserves for bad debts and to make annual additions thereto which could, within specified formula limits, be taken as a deduction in computing taxable income for federal income tax purposes. The amount of the bad debt reserve deduction for “non-qualifying loans” was computed under the experience method. The amount of the bad debt reserve deduction is now actual net charge-offs. As a result, the Bank must recapture as taxable income that portion of the reserve that exceeds the amount that could have been taken under the experience method for post- 1987 tax years. At March 31, 2011, Community Bank’s had no excess reserves to be recaptured.
 
In addition to the regular income tax, corporations, including savings associations such as Community Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation’s regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation’s regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income.
 
To the extent earnings appropriated to a savings association’s bad debt reserves for “qualifying real property loans” and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association’s supplemental reserves for losses on loans (“Excess”), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses).
 
Community Financial and Community Bank file consolidated federal income tax returns on a fiscal year basis. Savings associations, such as the Community Bank, that file federal income tax returns as part of a consolidated group are required by applicable Treasury regulations to reduce their taxable income for purposes of computing the percentage bad debt deduction for losses attributable to activities of the non-savings association members of the consolidated group that are functionally related to the activities of the savings association member.
 
Our federal income tax returns and our consolidated subsidiary for the last three years are open to possible audit by the Internal Revenue Service. In the opinion of management, any examination of still open returns (including returns of subsidiaries and predecessors of, or entities merged into, Community Bank) would not result in a deficiency which could have a material adverse effect on the financial condition of Community Financial and our consolidated subsidiaries.
 
Virginia Taxation.  We conduct our business in Virginia and consequently are subject to the Virginia corporate income tax. The Commonwealth of Virginia imposes a corporate income tax on a basis similar to federal income tax at a rate of 6% on Virginia taxable income.
 
Executive Officers
 
The following information as to the business experience during the past five years is supplied with respect to executive officers of Community Financial. Except as otherwise indicated, the persons named have served as officers of Community Financial since it became the holding company of Community Bank, and all offices and positions described below are also with Community Bank.
 
 
 
30
 
 
 
 
 
Norman C. Smiley, III, age 49,  was appointed President of Community Bank in March, 2008, and effective April 30, 2010, became the President and Chief Executive Officer of Community Financial and Community Bank.  Prior to joining the Company in April 1996, Mr. Smiley was a Branch Manager for First Virginia where he was employed for 14 years.  He is a 1987 graduate of the Virginia Bankers School of Bank Management at the University of Virginia and a 2001 graduate of the American Bankers Association Stonier Graduate School of Banking at Georgetown University.  Mr. Smiley is currently a Board member of the American Frontier Museum and the Staunton Redevelopment Housing Authority. He is a past Board member of the Coordinated Area Transportation System, Big Brothers/Big Sisters, Salvation Army, the Red Cross, the City of Staunton Board of Zoning Appeals and past Elder of the First Presbyterian Church.
 
R. Jerry Giles, age 62, is our Chief Financial Officer and Senior Vice President, a position he has held since April 1994. Prior to joining the Company in April 1994, Mr. Giles was a Certified Public Accountant in public accounting and the Chief Financial Officer with a savings bank for eleven years.
 
Benny N. Werner, age 62, is our Senior Vice President and Chief Operations Officer, a position he has held since May 1998. Prior to joining the Company, Mr. Werner was employed by Crestar for three years as President-Warrenton area and employed by Jefferson Savings and Loan, Warrenton, Virginia as Senior Vice President of Retail Banking for seventeen years.
 
Lyle A. Moffett, age 42, is our Senior Vice President of Lending, a position he has held since March, 2008. Mr. Moffett joined Community Bank in 1997 and was Vice President and Commercial Loan Officer prior to his current position.

John J. Howerton, age 53, is our Senior Vice President of Retail Banking, a position he has held since September, 2008. Mr. Howerton has been employed in the banking industry since 1982 and prior to joining the Company, Mr. Howerton was the Senior Vice President of Retail Banking with Stellar One.

Clarence W. Keel, age 64, is the Senior Vice President in our Hampton Roads Region, a position he has held since March, 2010. Mr. Keel has been employed in the banking industry since 1971 and prior to joining the Company, Mr. Keel was the Senior Vice President and Manager of Shareholder Services with BB&T Corporation.

Employees
 
At March 31, 2011, we had a total of 162 employees, including 22 hourly employees. None of our employees are represented by any collective bargaining group. Management considers our employee relations to be good.
 

 
ITEM 1A.  RISK FACTORS – Not required by smaller reporting companies.
 

 
ITEM 1B.  UNRESOLVED STAFF COMMENTSNot required by smaller reporting companies.
 

 

 
31
 
 

ITEM  2.  PROPERTIES
 
The following table sets forth information at March 31, 2011, with respect to our retail and operational offices, furniture and equipment.  We believe that our current facilities are adequate to meet our present and foreseeable need
 
Location
Opened
Owned or
Lease
Expiration
 
Gross Square
Footage
   
Net Book Value
at March 31,
2011
 
38 North Central Avenue
Staunton, Virginia
1965
Owned
    17,000       $1,266,000    
2934 West Main Street
Waynesboro, Virginia
1989
Owned
    5,300          513,000  
2658 Stuarts Draft Highway
Stuarts Draft, Virginia
1993
Owned
    3,000          872,000  
621 Nevan Road
Virginia Beach, Virginia
1998
2038
    13,000          785,000  
101 Community Way
Staunton, Virginia
1999
2039
    4,500          591,000  
2134 Raphine Road,
Raphine, Virginia
2001
2011
    2,308            31,000  
21 Dick Huff Lane
Verona, Virginia
2002
Owned
    3,850          927,000  
123 West Frederick Street (1)
Staunton, Virginia
2003
Owned
    22,000       1,531,000  
1201 Lake James Drive
Virginia Beach, Virginia
2005
2012
    3,900          199,000  
463 Hidden Creek Lane
Harrisonburg, Virginia
2005
2011
    2,000            21,000  
102 Walker Street
Lexington, Virginia
2006
2028
    2,200          152,000  
211 West Frederick Street (1)
Staunton, Virginia
2009
Owned
    4,445          281,000  
128 West 21st Street
Buena Vista, Virginia
2009
Owned
    4,100       1,600,000  

(1) Operational offices
 
Our accounting and record-keeping activities are maintained on an in-house computer system. The net book value of our computer equipment at March 31, 2011 was $38,079.
 
 
 
32
 
 
 
 
 
ITEM 3.  LEGAL PROCEEDINGS
 
There are no material pending legal proceedings to which we or our subsidiary is a party or to which any of our property is subject.
 
Item 4.  (Removed and reserved)
 
PART II
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
As of May 31, 2011, there were approximately 455 holders of record of Community Financial common stock.  Community Financial common stock is traded on The Nasdaq Capital Market under the symbol “CFFC.”  The number of shareholders of record does not reflect persons or entities who hold their stock in nominee or “street” name.
 
The following tables present the high, low and closing sales prices of our common stock as reported by the Nasdaq Stock Market during the last two fiscal years and the common dividends declared by us for the stated periods.
 
Fiscal 2011
 
High
   
Low
   
Close
   
Dividend Declared
 
March 2011
  $ 3.65     $ 2.95     $ 3.14     $ .000  
December 2010
    4.28       2.72       3.48       .000  
September 2010
    4.54       3.58       4.07       .000  
June 2010
    5.29       3.69       4.36       .000  
                                 
Fiscal 2010
 
High
   
Low
   
Close
   
Dividend Declared
 
March 2010
  $ 4.48     $ 3.68     $ 4.16     $ .000  
December 2009
    4.94       3.32       4.34       .000  
September 2009
    4.70       3.70       4.16       .000  
June 2009
    6.00       3.50       4.40       .000  

 
The Board of Directors of Community Financial makes dividend payment decisions with consideration of a variety of factors, including earnings, financial condition, market considerations and regulatory restrictions.  Our ability to pay dividends is limited by restrictions imposed by the Virginia Stock Corporation Act, contractually pursuant to our participation in the U.S. Treasury’s CPP and indirectly by the Office of Thrift Supervision.  Restrictions on dividend payments from Community Bank to Community Financial (Community Financials’ primary source of funds for the payment of dividends to its stockholders) are described in Note 10 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
 
The Equity Compensation Plan information contained in Item 12 of this Form 10-K is incorporated herein by reference.  No stock was repurchased by the Company during the fourth quarter of fiscal 2011.  Our ability to repurchase stock is limited as a result of our participation in the U.S. Treasury’s CCP and, indirectly, by the Office of Thrift Supervision.
 



 
33
 
 
 

 
ITEM 6. SELECTED FINANCIAL DATA
 
   
At March 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
(In thousands)
 
Selected Financial Condition Data:
                             
Total assets
  $ 530,080     $ 547,180     $ 512,724     $ 491,246     $ 463,112  
Loans receivable, net
    478,293       502,126       476,950       437,174       399,252  
Investment securities and other earning assets(1)
    11,917       11,780       7,658       30,475       43,703  
Real estate owned, net
    10,384       3,182       1,400       593       181  
Deposits
    379,045       398,420       365,506       350,731       330,538  
Advances and other borrowed money
    98,445       97,096       96,476       98,834       90,740  
Stockholders’ equity
    49,760       49,012       46,337       38,705       38,570  
                                         
   
Year Ended March 31,
 
      2011       2010       2009       2008       2007  
   
(In thousands)
 
Selected Operations Data:
                                       
Total interest income
  $ 27,585     $ 28,198     $ 28,692     $ 32,244     $ 29,419  
Total interest expense
    5,612       8,081       12,460       16,978       14,792  
Net interest income
    21,973       20,117       16,232       15,266       14,627  
Provision for loan losses
    8,170       4,031       4,285       625       388  
Net interest income after provision for loan losses
    13,803       16,086       11,946       14,641       14,239  
Service charges and fees
    3,712       3,300       3,037       3,007       2,816  
Securities impairment
    ---       ---       (11,536 )     ---       ---  
Other noninterest income(2)
    377       550       386       336       369  
Noninterest expenses
    15,527       14,995       13,449       12,292       11,306  
Income (loss) before income taxes
    2,365       4,941       (9,616 )     5,692       6,118  
Income taxes (benefit)
    843       1,349       (3,793 )     1,856       2,027  
Net income (loss)
  $ 1,522     $ 3,592     $ (5,823 )   $ 3,836     $ 4,091  
Amortization of discount on preferred stock
    (121 )     (121 )     (34 )     -       -  
Cumulative dividends on preferred stock
    (632 )     (632 )     (176 )     -       -  
Net income (loss) available to common stockholders
  $ 769     $ 2,839     $ (6,033 )   $ 3,836     $ 4,091  
   
   
At or For the Year Ended March 31,
 
      2011       2010       2009       2008       2007  
Other Data:
                                       
Average interest-earning assets to average
    interest bearing liabilities
    103.41 %     104.24 %     105.41 %     105.21 %     104.86 %
Average interest rate spread during year
    4.34       3.92       3.25       3.14       3.30  
Non-performing assets to total assets
    3.13       3.24       1.75       .33       .32  
Return on assets (ratio of net income to average
    total assets)
    .28       .67       (1.17 )     .80       .92  
Return on equity (ratio of net income to
     average total equity)
    3.04       7.45       (14.57 )     9.77       11.06  
Equity-to-assets ratio (ratio of average
     equity to average assets)
    9.36       9.02       8.03       8.18       8.36  
Allowance for loan losses to loans receivable, net
    1.61       1.58       1.25       .73       .77  
Allowance for loan losses to non-performing loans
    127.04       55.29       78.70       313.30       234.16  
                                         
Per Common Share Data: (3)
                                       
Net income (loss)-diluted
  $ 0.18     $ 0.65     $ (1.39 )   $ 0.87     $ 0.93  
Book value
    8.55       8.34       7.72       8.93       8.98  
Dividends-common
    0.00       0.00       .13       .26       .255  
Dividend payout ratio-common
    --- %     --- %     --- %     29.22 %     26.54 %
Number of full-service offices
    11       11       11       10       10  
____________________
(1)
Includes federal funds sold, securities purchased under resale agreements and overnight deposits.
(2)
Other income includes customer service fees and commissions, gain or loss on disposal of property and other items.
(3)
Per share data for the periods presented has been restated to reflect the 2-for-1 stock split declared on July 26, 2006, as applicable.

 
 
34
 
 
 

 
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
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 decrease in net income for the fiscal year was the increase in the provision for loan losses, partially offset by a 9.2% increase in our net interest income for the current fiscal year compared to the prior fiscal year.
 
The primary factor contributing to the increase in net interest income for the fiscal year ended March 31, 2011 was 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 the repricing of these liabilities during the current low interest rate environment. The aggressive rate reductions in prior fiscal years 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, 2011. We acquired lower cost brokered deposits and low interest bearing transaction accounts during the fiscal year to replace higher cost time deposits.  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.
 
 
 
35
 
 
 
 
 
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) that losses be accrued when they are probable of occurring and estimable and (ii) 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 may be 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.
 
The Corporation uses real estate appraisal, discounted cash flows or other appropriate methods to determine the value of impaired loans. With the use of these methods, the Corporation provides valuation allowances for anticipated losses when management determines that a decline in the value of the collateral or expected cash flows has occurred.  Updated appraisals are obtained periodically and in those instances where management has reason to believe a material change may have occurred in the fair value of the collateral.  Evaluation of impairment requires judgment and estimates and management uses all relevant and timely information available to determine specific reserves on impaired loans, including appraisals and cash flow analysis.  Loans are partially or completely charged off in the period when they are deemed uncollectible in accordance with ASC 310-35.
 
 
 
36
 
 
 

 
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. These loans were included in the allowance calculation as pools of loans in the general component with allocations based on historic charge-offs and qualitative factor adjustments deemed appropriate by management for these types of loans and their nonaccrual status.

In preparing consolidated financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the valuation of real estate owned and the fair value of financial instruments.

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, 2011 and 2010, 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 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, 2011 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, 2011
 
March 31, 2010
Change in
Interest Rate
(Basis Points)
 
Board Limit
NPV as %
of Assets
 
$
Change
in NPV
 
NPV as % of Assets
 
$
Change
in NPV
 
NPV as % of Assets
(Dollars in Thousands)
+200
 
7
 
1,879
 
   12.3%
 
(1,273)
 
    11.3%
+100
 
8
 
   985
 
12.2
 
   (142)
 
11.4
-0-
 
9
 
    ---
 
11.4
 
    ---
 
11.4
-100
 
8
 
  (1,306)  
 
11.7
 
 (1,280)
 
11.2
-200
 
7
 
    ---
 
  ---
 
    ---
 
  ---

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, 2011, approximately 77.6% of our gross loan portfolio consisted of loans which reprice during the life of the loan. Applications are taken and processed for customers seeking longer term fixed-rate mortgage loans, 15 to 30 years, with the loan being closed and retained by other organizations.
 
 
 
37
 
 
 
 
 
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.
 

 

 
38
 
 

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,
 
   
2011
   
2010
   
2009
 
   
Average
Balance
   
Interest
   
Yield/
Cost
   
Average
Balance
   
Interest
   
Yield/
Cost
   
Average
Balance
   
Interest
   
Yield/
Cost
 
   
(Dollars in Thousands)
 
Interest-Earning Assets
                                                     
Loans
  $ 491,753     $ 27,330       5.56 %   $ 494,427     $ 28,009       5.66 %   $ 458,265     $ 28,129       6.14 %
Investment securities and other investments
    9,641       255       2.64 %     9,656       189       1.96 %     20,172       563       2.79 %
  Total interest-earning assets
    501,394       27,585       5.50 %     504,083       28,198       5.59 %     478,437       28,692       6.00 %
Non-interest earning assets
    36,692                       30,674                       18,953                  
  Total Assets
  $ 538,086                     $ 534,757                     $ 497,390                  
                                                                         
Interest-Bearing Liabilities
                                                                       
Deposits
  $ 387,119       4,912       1.27 %   $ 382,504       7,149       1.87 %   $ 355,599       10,497       2.95 %
FHLB advances and other borrowings
    97,741       700       0.72 %     101,072       932       0.92 %     98,293       1,963       2.00 %
  Total interest-bearing liabilities
    484,860       5,612       1.16 %     483,576       8,081       1.67 %     453,892       12,460       2.75 %
Non-interest bearing Liabilities
    3,166                       2,965                       3,533                  
  Total Liabilities
    488,026                       486,541                       457,425                  
Stockholder’s equity
    50,060                       48,216                       39,965                  
  Total Liabilities and Stockholders’ Equity
  $ 538,086                     $ 534,757                     $ 497,390                  
Net interest income
          $ 21,973                     $ 20,117                     $ 16,232          
Interest rate spread
                    4.34 %                     3.92 %                     3.25 %
Net interest-earning assets/net yield on
interest-earning assets
  $ 16,534               4.40 %   $ 20,507               3.99 %   $ 24,545               3.39 %
Percentage of interest-earning assets to
interest-bearing liabilities
    103.41 %                     104.24 %                     105.21 %                



 

 
39
 
 

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,
 
    2011 v. 2010     2010 v. 2009  
   
Increase
(Decrease)
Due to
Volume
   
Rate
   
Total
Increase
(Decrease)
   
Increase
(Decrease)
Due to
Volume
   
Rate
   
Total
Increase
(Decrease)
 
   
(Dollars in Thousands)
 
Interest-Earning Assets
                                       
Loans
  $ (149 )   $ (530 )   $ (679 )   $ 2,049     $ (2,169 )   $ (120 )
Investment securities and other
   investments
    0       66       66       (206 )     (168 )     (374 )
   Total interest-earning assets
  $ (149 )   $ (464 )   $ (613 )   $ 1,843     $ (2,337 )   $ (494 )
                                                 
Interest-Bearing Liabilities
                                               
Deposits
  $ 59     $ (2,296 )   $ (2,237 )   $ 503     $ (3,851 )   $ (3,348 )
FHLB advances and other
   borrowings
    (24 )     (208 )     (232 )     25       (1,056 )     (1,031 )
   Total interest-bearing liabilities
  $ 35     $ (2,504 )   $ (2,469 )   $ 528     $ (4,907 )   $ (4,379 )
Net interest income
                  $ 1,856                     $ 3,885  

Financial Condition  
 
Total assets decreased $17.1 million, or 3.1%, to $530.1 million at March 31, 2011 due primarily to a decrease in loans of $23.8 million, partially offset by increases to cash of $2.5 million and real estate owned of $7.2 million. Deposits decreased $19.4 million, or 4.9%.  The decrease in deposits is reflected primarily in a decrease in time deposits of $33.8 million, partially offset by increases to transaction accounts of $6.6 million, money market accounts of $5.4 million and savings accounts of $2.4 million. Management believes the increase in transaction and money market deposits is primarily attributable to an increased emphasis on customer relationships, service and pricing. Management attributes the decrease in loans receivable primarily to weak economic conditions and related reduced loan demand.
 
The Hampton Roads region of the Bank experienced a loan decrease of $21.7 million, primarily commercial and residential real estate loans and construction loans, for the fiscal year ended 2011. The Shenandoah Valley region of the Bank had a loan decrease of approximately $2.1 million, primarily 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, 2011, non-performing assets, consisting of non-performing loans, foreclosed real estate and repossessed automobiles, totaled $16.6 million, or 3.13% of total assets, compared to $17.7 million or 3.24% of total assets at March 31, 2010.   Non-performing assets at March 31, 2011 were comprised primarily of raw land, residential real estate and commercial real estate loans delinquent 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.
 
 
 
40
 
 
 
 
 
Stockholders' equity increased $749,000, or 1.5%, to $49.8 million at March 31, 2011 compared to $49.0 million at March 31, 2010. The increase was the result of earnings for the year ended March 31, 2011 offset by cash dividend payments on preferred stock.
 
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, 2011 and 2010
 
General.  Net income for the year ended March 31, 2011 was $1.5 million or $0.18 diluted earnings per common share compared to $3.6 million or $0.65 diluted earnings per common share for the year ended March 31, 2010. Net income decreased due primarily to an increase in the provision for loan losses, partially offset by an increase in net interest income for the March 31, 2011 fiscal year.
 
Interest Income.  Total interest income decreased $613,000, or 2.2%, to $27.6 million for the year ended March 31, 2011 as compared to $28.2 million for the year ended March 31, 2010. The decrease in total interest income can be attributed to a decrease in the yield on interest earning assets and a decrease in the average dollar volume of loans of $2.7 million.  Average yields on total interest-earning assets decreased nine basis points from 5.59% in fiscal 2010 to 5.50% for the current fiscal year due primarily to a decrease in loans yields in a decreasing rate environment.
 
Interest Expense.  Total interest expense decreased $2.5 million, or 30.6%, to $5.6 million for the year ended March 31, 2011 from $8.1 million for the year ended March 31, 2010. The decrease in total interest expense is attributable to a decrease in the cost of interest-bearing liabilities slightly offset by an increase in the average dollar volume of deposits of $4.6 million. The cost of funds decreased 51 basis points from 1.67% for the year ended March 31, 2010 to 1.16% for the current year. The increase in deposit balances was due primarily to increases in transaction accounts 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 appear to have impacted economic conditions in our market areas to a lesser extent than the national economy. We have experienced increases in delinquency and charge-off rates during the fiscal year ended March 31, 2011. We have maintained experienced and stable lending personnel during that period.
 
 
 
41
 
 
 
 
 
Based on management’s evaluation of these factors, the provision for loan losses increased $4.1 million, or 102.7%, to $8.1 million for the fiscal year ended March 31, 2011 from $4.0 million for the fiscal year ended March 31, 2010. The loan loss allowance for specific impaired loans is dependent primarily on the value of the collateral relative to the outstanding loan balance. 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, 2011, the total allowance for loan losses amounted to $7.9 million.  At March 31, 2011, our allowance as a percentage of total loans receivable was 1.61% and as a percentage of total non-performing loans was 127.1%.
 
Noninterest Income.  Noninterest income increased $239,000, or 6.2%, to $4.1 million in fiscal 2011 as compared to $3.9 million for the year ended March 31, 2010.  The increase was primarily due to secondary market mortgage loan fees, commercial loan fees and overdraft fees.  The decrease in other income is due to the income from the sale of Fannie Mae and Freddie Mac preferred stock in the previous fiscal year.
 
   
Fiscal 2011
   
Fiscal 2010
   
Change
 
                   
Loan fee income
  $ 1,163,409     $ 920,013     $ 243,396  
Deposit fee income
    2,548,391       2,379,771       168,620  
Other
    377,408       550,421       (173,013 )
     Total noninterest income
  $ 4,089,208     $ 3,850,205     $ 239,003  

Noninterest Expense.  Total noninterest expense increased $532,000, or 3.5%, to $15.5 million for the year ended March 31, 2011 from $15.0 million for the year ended March 31, 2010, due primarily to increased compensation expense of $369,000 and an increase in real estate owned expenses of $624,000, partially offset by a decreased deposit insurance expense of $409,000 due to a special assessment in the previous year. The increase in compensation expenses is related to merit pay increases and additional loan and customer service personnel. The increase in other expenses is primarily due to the increase in nonperforming assets and related collection expenses.
 
Taxes.  Total taxes decreased $506,000 to $843,000 during the year ended March 31, 2011 from $1.3 million during fiscal 2010. The effective tax rate for the year ended March 31, 2011 was 35.6%. Income taxes for the March 31, 2010 fiscal year included a historic tax credit of $483,000.
 
Comparison of Years Ended March 31, 2010 and 2009
 
General.  Net income for the year ended March 31, 2010 was $3.6 million or $0.65 diluted earnings per common share compared to $(5.8) million or $(1.39) diluted earnings per common share for the year ended March 31, 2009. Net income increased due primarily to the securities impairment related to Fannie Mae and Freddie Mac preferred stock in the March 31, 2009 fiscal year and an increase in net interest income for the March 31, 2010 fiscal year.
 
Interest Income.  Total interest income decreased $494,000, or 1.7%, to $28.2 million for the year ended March 31, 2010 as compared to $28.7 million for the year ended March 31, 2009. 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 $25.3 million in loans receivable. Average yields on total interest-earning assets decreased 0.41% from 6.00% in fiscal 2009 to 5.59% for the current fiscal year due primarily to a decrease in loans yields in a decreasing rate environment.
 
 
 
42
 
 
 
 
 
Interest Expense.  Total interest expense decreased $4.4 million, or 35.1%, to $8.1 million for the year ended March 31, 2010 from $12.5 million for the year ended March 31, 2009. 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 $26.9 million. The cost of funds decreased 1.08% from 2.75% for the year ended March 31, 2009 to 1.67% for the current year. The increase in deposit balances was due primarily to increases in transaction accounts for the current fiscal year.
 
Provision for Loan Losses.  The provision for loan losses decreased $254,000, or 5.9%, to $4.0 million for the fiscal year ended March 31, 2010 from $4.3 million for the fiscal year ended March 31, 2009. The loan loss allowance for specific impaired loans is dependent primarily on the value of the collateral relative to the outstanding loan balance. 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, 2010, the total allowance for loan losses amounted to $8.1 million.  At March 31, 2010, our allowance as a percentage of total loans receivable was 1.58% and as a percentage of total non-performing loans was 55.29%.
 
Noninterest Income.  Noninterest income increased $427,000, or 12.5%, to $3.9 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 secondary mortgage loan fees. The increase in other income is due to the sale of Fannie Mae and Freddie Mac preferred stock which was Other Than Temporarily Impaired in the previous fiscal year.
 
   
Fiscal 2010
   
Fiscal 2009
   
Change
 
                   
Loan fee income
  $ 920,013     $ 641,952     $ 278,061  
Deposit fee income
    2,379,771       2,394,740       (14,969 )
Other
    550,421       386,158       164,263  
     Total noninterest income
  $ 3,850,205     $ 3,422,850     $ 427,355  

Noninterest Expense.  Total noninterest expense increased $1.5 million, or 11.5%, to $15.0 million for the year ended March 31, 2010 from $13.5 million for the year ended March 31, 2009, due primarily to increased compensation expense of $584,000 and increased deposit insurance expense of $781,000 due to premium increases. The increase in compensation expenses is related to merit pay increases and additional loan personnel. The increase in other expenses is primarily due to the increase in nonperforming assets and related collection expenses.
 
Taxes.  Total taxes increased $5.1 million to $1.3 million during the year ended March 31, 2010 from $(3.8) million during fiscal 2009. The effective tax rate for the year ended March 31, 2010 was 27.3%. Income taxes for the March 31, 2010 fiscal year includes a historic tax credit of $483,000.
 
Liquidity and Capital Resources  
 
Liquidity represents our ability to meet our on-going funding requirements for contractual obligations, the credit needs of customers, withdrawal of customers' deposits and operating expenses. Our principal sources of funds are customer deposits, advances from the Federal Home Loan Bank of Atlanta, amortization and prepayment of loans, proceeds from the sale of loans and funds provided from operations.  Management maintains investments in liquid assets based upon its assessment of (i) our need for funds, (ii) expected deposit flows, (iii) the yields available on short-term liquid assets, (iv) the liquidity of our loan portfolio and (v) the objectives of our asset/liability management program.
 
 
 
43
 
 
 
 
 
Our dominant source of funds during the year ended March 31, 2011 was from deposits which decreased by $19.4 million. Our cash increased $2.5 million from $5.4 million at March 31, 2010 to $7.9 million at March 31, 2011.
 
At March 31, 2011, we had commitments to originate $3.4 million of loans.   Certificates of deposit scheduled to mature in one year or less at March 31, 2011 totaled $175.0 million. Based on our historical experience, management believes that a significant portion of such deposits will remain with us.  Management further believes that loan repayments and other sources of funds will be adequate to meet our foreseeable short- and long-term liquidity needs.
 
The Bank had at March 31, 2011, a line of credit at the Federal Home Loan Bank of Atlanta in the amount of $134.3 million. The Bank had borrowings of $97.0 million in addition to a letter of credit of $4.0 million and a remaining balance available of $33.3 million at March 31, 2011.
 
At March 31, 2011, we had tangible and core capital of 9.32% of adjusted total assets, which was in excess of their respective requirements of 1.5% and 4.0%.   We also had risk-based capital of 12.29% of risk weighted assets, which also exceeded its requirement of 8.0%. The Bank was considered “well capitalized” as of March 31, 2011. Regulatory capital is discussed further in Note 10 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
 
Contractual Obligations and Off-Balance Sheet Arrangements
 
As of March 31, 2011, we have not participated in any unconsolidated entities or financial partnerships, often referred to as structured finance or special entities. We do have significant commitments to fund loans in the ordinary course of business. Such commitments and resulting off-balance sheet risk are further discussed in Note 14 of the Consolidated Financial Statements contained in Item 8 of this report.
 
The following table presents our contractual cash obligations, excluding deposit obligations, as of March 31, 2011.
 
   
Total
   
Less than
1 year
   
1-3
years
   
3-5
years
   
More than
5 years
 
                               
Operating Leases
  $ 620,275     $ 183,723     $ 197,302     $ 87,000     $ 152,250  
Long-Term Debt
    ---       ---       ---       ---       ---  
     Total
  $ 620,275     $ 183,723     $ 197,302     $ 87,000     $ 152,250  

 
Impact of Inflation and Changing Prices  
 
The consolidated financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and results of operations in terms of historical dollars without considering changes in the relative purchasing power of money over time because of inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation.  Interest rates do not necessarily move in the same direction or the same magnitude as the price of goods and services.  In the current interest-rate environment, equity, maturity structure and quality of our assets and liabilities are critical to the maintenance of acceptable performance levels.
 
 
 
44
 
 
 
 
 
Recent Accounting Pronouncements
 
For a discussion of recent accounting pronouncements implemented by us during fiscal 2011 and new pronouncements which will be implemented in the future, see “Summary of Accounting Policies” in our Consolidated Financial Statements contained in Item 8 of this report.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management” in Item 7 of this report.
 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


 
45
 
 
Community Financial Corporation
and Subsidiary

Contents




 

 

 
Report of Independent Registered Public Accounting Firm
47
   
Consolidated Financial Statements
 
 
 
Consolidated Balance Sheets
48
     
 
Consolidated Statements of Operations
49
     
 
Consolidated Statements of Stockholders’ Equity
51
     
 
Consolidated Statements of Cash Flows
52
     
Summary of Accounting Policies
54
   
Notes to Consolidated Financial Statements
63
 
 
 
 
 
 
 
 
 
 

 

 
46
 
 
Certified Public Accountants
        and Consultants




REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders
Community Financial Corporation
Staunton, Virginia

We have audited the accompanying consolidated balance sheets of Community Financial Corporation and Subsidiary as of March 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years ended March 31, 2011, 2010 and 2009. These financial statements are the responsibility of the Corporation's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Corporation is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community Financial Corporation and Subsidiary as of March 31, 2011 and 2010, and the results of their operations and their cash flows for the years ended March 31, 2011, 2010 and 2009 in conformity with U.S. generally accepted accounting principles.


Winchester, Virginia
June 24, 2011


 
50 South Cameron Street
P.O. Box 2560
Winchester, VA 22604
(540) 662-3417                                   Offices located in: Winchester, Middleburg, Leesburg, Culpeper, and Richmond, Virginia
FAX (540) 662-4211                          Member: American Institute of Certified Public Accountants / Virginia Society of Certified Public Accountants

 
47
 
 
Community Financial Corporation
and Subsidiary

Consolidated Balance Sheets
 


 
 March 31,
 
2011
   
2010
 
             
        Assets
           
             
Cash (including interest bearing deposits of $4,118,603
    and $3,824,672)
  $ 7,897,955     $ 5,374,665  
Securities
               
    Held to maturity (fair value approximates $2,164,320
      and $1,698,155)
    2,198,000       1,698,000  
    Available for sale, at fair value
    38,647       73,397  
Restricted investment in Federal Home Loan Bank stock, at cost
    5,561,300       6,183,600  
Loans receivable, net of allowance for loan losses of
  $7,845,950 and $8,052,875
    478,292,834       502,125,963  
Real estate owned, net of valuation allowance of $1,378,585
  and $1,052,569
    10,383,549       3,182,419  
Property and equipment, net
    8,769,146       8,920,769  
Accrued interest receivable
    2,036,639       2,128,611  
Prepaid expenses and other assets
    14,901,933       17,492,388  
                 
Total assets
  $ 530,080,003     $ 547,179,812  
                 
        Liabilities and Stockholders’ Equity
               
                 
Liabilities
               
    Deposits
  $ 379,044,783     $ 398,420,330  
    Borrowings
    97,000,000       96,250,000  
    Securities sold under agreements to repurchase
    1,444,961       845,503  
    Advance payments by borrowers for taxes and insurance
    212,425       192,360  
    Other liabilities
    2,617,440       2,459,744  
                 
Total liabilities
    480,319,609       498,167,937  
                 
Commitments and Contingencies
    -       -  
                 
Stockholders’ Equity
               
    Preferred stock, $.01 par value, $1,000 liquidation value,
        authorized 3,000,000 shares, 12,643 outstanding
    12,643,000       12,643,000  
    Common stock, $.01 par value, 10,000,000 authorized
        shares, 4,361,658 and 4,361,658 shares outstanding
    43,617       43,617  
    Warrants
    603,153       603,153  
    Discount on preferred stock
    (327,701 )     (448,337 )
    Additional paid-in capital
    5,599,052       5,577,958  
    Retained earnings
    32,028,909       31,259,441  
    Accumulated other comprehensive (loss), net
    (829,636 )     (666,957 )
                 
Total stockholders’ equity
    49,760,394       49,011,875  
                 
Total liabilities and stockholders’ equity
  $ 530,080,003     $ 547,179,812  
See accompanying summary of accounting policies and notes to consolidated financial statements.

 
48
 
 
Community Financial Corporation
and Subsidiary

Consolidated Statements of Operations
 
 


 
 Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Interest and dividend income
                 
    Loans
  $ 27,330,101     $ 28,009,388     $ 28,128,744  
    Investment securities
    38,544       49,114       102,707  
    Other investments
    216,338       139,862       460,431  
                         
Total interest and dividend income
    27,584,983       28,198,364       28,691,882  
                         
Interest expense
                       
    Deposits
    4,911,753       7,149,169       10,497,223  
    Borrowed money
    700,004       932,177       1,962,933  
                         
Total interest expense
    5,611,757       8,081,346       12,460,156  
                         
Net interest income
    21,973,226       20,117,018       16,231,726  
                         
Provision for loan losses
    8,170,534       4,031,454       4,285,389  
                         
Net interest income after provision for
    loan losses
    13,802,692       16,085,564       11,946,337  
                         
Noninterest income
                       
    Service charges, fees and commissions
    3,711,799       3,299,784       3,036,692  
    Other
    377,408       550,421       386,158  
    Other-than-temporary impairment of
       equity securities
    -       -       (11,535,669 )
                         
Total noninterest income
    4,089,207       3,850,205       (8,112,819 )
                         
Noninterest expense
                       
    Compensation and employee benefits
    8,661,698       8,292,343       7,708,019  
    Occupancy
    1,518,331       1,719,320       1,537,291  
    Data processing
    1,513,035       1,486,174       1,495,990  
    Advertising
    522,072       490,110       477,852  
    Professional fees
    410,328       361,690       556,117  
    Deposit insurance
    699,681       1,108,652       327,523  
    Real estate owned and collections
    931,987       308,129       122,191  
    Other
    1,269,411       1,228,374       1,224,368  
                         
Total noninterest expense
    15,526,543       14,994,792       13,449,351  
                         



 
49
 
 
Community Financial Corporation
and Subsidiary

Consolidated Statements of Operations
(continued)
 
 


 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Income (loss) before income taxes
  $ 2,365,356     $ 4,940,977     $ (9,615,833 )
                         
Income tax expense (benefit)
    843,102       1,349,189       (3,792,549 )
                         
Net income (loss)
    1,522,254       3,591,788       (5,823,284 )
                         
Amortization of discount on preferred stock
    (120,636 )     (120,636 )     (34,180 )
                         
Cumulative dividends on preferred stock
    (632,150 )     (632,150 )     (176,334 )
                         
Net income (loss) available to common
                       
    stockholders
  $ 769,468     $ 2,839,002     $ (6,033,798 )
                         
Earnings (loss) per common share
                       
    Basic
  $ 0.18     $ 0.65     $ (1.39 )
    Diluted
  $ 0.18     $ 0.65     $ (1.39 )
See accompanying summary of accounting policies and notes to consolidated financial statements.


 
50
 
 
Community Financial Corporation
and Subsidiary
Consolidated Statements of Stockholders' Equity



 
                                        
Accumulated
       
                     
Discount on
   
Additional
         
Other Compre-
   
Total
 
   
Preferred
   
Common
         
Preferred
   
Paid-in
   
Retained
   
hensive Income
   
Stockholders’
 
   
Stock
   
Stock
   
Warrants
   
Stock
   
Capital
   
Earnings
   
(Loss), Net
   
Equity
 
                                                 
Balance, March 31, 2008
  $ -     $ 43,360     $ -     $ -     $ 5,391,704     $ 34,992,515     $ (1,722,876 )   $ 38,704,703  
Comprehensive loss:
                                                               
    Net loss
    -       -       -       -       -        (5,823,284      -        (5,823,284
    Change in unrealized loss
    on available for sale
    securities, net of tax
    -       -       -       -        -        -        1,353,616        1,353,616  
Pension liability adjustment,
   net of tax
    -       -       -       -       -       -       (4,971     (4,971
Total comprehensive loss
                                                             (4,474,639
Cash dividends on common
                                                               
   stock, $0.13 per share
    -       -       -       -        -        (565,814)        -       (565,814 )
Preferred stock issuance
    12,643,000       -       603,153       (603,153 )      -        -        -        12,643,000  
Reduction due to change
   in pension measurement date,
   net of tax
    -       -       -       -       -       (50,464 )     -       (50,464 )
Amortization of discount on
   preferred stock
    -       -       -       34,180       -       (34,180     -       -  
Dividend on preferred stock
    -       -       -       -        -        (98,334      -        (98,334
Stock-based compensation
   expense
    -       -       -       -        6,826        -        -        6,826  
Exercise of stock options
    -       257       -       -       171,028       -       -       171,285  
                                                                 
Balance, March 31, 2009
    12,643,000       43,617       603,153       (568,973 )     5,569,558       28,420,439       (374,231     46,336,563  
Comprehensive income:
                                                               
    Net income
    -       -       -       -        -        3,591,788        -        3,591,788  
Pension liability adjustment,
   net of tax
    -       -       -       -       -       -       (292,726     (292,726
Total comprehensive income
                                                            3,299,062  
Amortization of discount on
    preferred stock
    -       -       -       120,636        -        (120,636      -        -  
Stock-based compensation
    -       -       -       -       8,400       -       -       8,400  
Dividend on preferred stock
    -       -       -       -        -        (632,150      -        (632,150
                                                                 
Balance, March 31, 2010
    12,643,000       43,617       603,153       (448,337 )      5,577,958        31,259,441        (666,957      49,011,875  
Comprehensive income:
                                                               
    Net income
    -       -       -       -        -        1,522,254        -       1,522,254  
Pension liability adjustment,
   net of tax
    -       -       -       -        -        -        (162,679      (162,579
Total comprehensive income
                                                            1,359,575  
Amortization of discount on
    preferred stock
    -       -       -       120,636       -       (120,636     -       -  
Stock-based compensation
    -       -       -       -       21,094       -       -       21,094  
Dividend on preferred stock
    -       -       -       -        -        (632,150      -       (632,150
Balance, March 31, 2011
  $ 12,643,000     $ 43,617     $ 603,153     $ (327,701 )   5,599,052     32,028,909     (829,636 )   49,760,394  
See accompanying summary of accounting policies and notes to consolidated financial statements.

 
51
 
 
Community Financial Corporation
and Subsidiary

Consolidated Statements of Cash Flows
 


 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Operating activities
                 
    Net income (loss)
  $ 1,522,254     $ 3,591,788     $ (5,823,284 )
    Adjustments to reconcile net income (loss) to
        net cash provided by operating activities
                       
            Provision for loan losses
    8,170,534       4,031,454       4,285,389  
            Losses/impairment on foreclosed assets
    353,994       -       -  
            Depreciation
    627,361       603,873       585,777  
            Stock-based compensation expense
    21,094       8,400       6,826  
            Amortization of premium and accretion
                of discount on securities, net
    -       10       207  
            (Increase) decrease in net deferred loan
                origination costs
    (20,597 )     30,912       193,534  
            Securities impairment
    -       -       11,535,669  
            Deferred income tax expense (benefit)
    473,197       1,778,645       (5,851,976 )
            Decrease (increase) in other assets
    2,117,258       (4,826,785 )     420,522  
            Increase (decrease) in other liabilities
    177,761       (2,226,209 )     1,430,351  
                         
Net cash provided by operating activities
    13,442,856       2,992,088       6,783,015  
                         
Investing activities
                       
    Proceeds from maturities of held to
        maturity securities
    2,698,000       1,500,000       4,840,000  
    Proceeds from redemption of available
        for sale securities
    34,750       133,950       -  
    Purchase of held to maturity securities
    (3,198,000 )     (1,498,000 )     (3,600,000 )
    Net decrease (increase) in loans
    2,379,851       (33,469,313 )     (46,384,656 )
    Purchase of property and equipment
    (475,737 )     (1,172,963 )     (1,013,975 )
    Proceeds from sale of real estate owned
    5,677,509       2,449,136       1,321,568  
    Redemption (purchase) of FHLB stock
    622,300       (945,000 )     (27,800 )
                         
Net cash provided by (used in)
  investing activities
    7,738,673       (33,002,190 )     (44,864,863 )



 
52
 
 
Community Financial Corporation
and Subsidiary

Consolidated Statements of Cash Flows
(continued)
 


 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Financing activities
                 
    Net (decrease) increase in certificates of
        deposit
  $ (33,772,052 )   $ 3,218,975     $ 10,491,810  
   Net increase in savings and checking deposits
    14,396,505       29,695,851       4,282,860  
    Proceeds from issuance of common stock
    -       -       171,285  
    Proceeds from issuance of preferred stock
    -       -       12,643,000  
    Increase (decrease) in securities sold under
        agreements to repurchase
    599,458       (630,091 )     (1,358,818 )
    Dividends paid
    (632,150 )     (632,150 )     (664,148 )
    Net change in borrowings
    750,000       1,250,000       (1,000,000 )
                         
Net cash (used in) provided by financing activities
    (18,658,239 )     32,902,585       24,565,989  
                         
Increase (decrease) in cash and cash
                       
   equivalents
    2,523,290       2,892,483       (13,515,859 )
                         
Cash and cash equivalents – beginning of year
    5,374,665       2,482,182       15,998,041  
                         
Cash and cash equivalents – end of year
  $ 7,897,955     $ 5,374,665     $ 2,482,182  
                         
Supplemental Disclosure of Cash Flow
    Information
                       
                         
Cash payments of interest expense
  $ 5,709,615     $ 9,827,121     $ 12,891,364  
                         
Cash payments of income taxes
  $ -     $ 2,852,283     $ 1,307,487  
                         
Supplemental Schedule of Non-Cash
    Investing and Financing Activities
                       
                         
Net change in unrealized gain (loss) on
  securities available for sale
  $ -     $ -     $ 2,180,606  
                         
Pension liability adjustment
  $ (262,386 )   $ (472,138 )   $ (8,019 )
                         
Transfers from loans to real estate acquired
    through foreclosure
  $ 14,457,276     $ 4,565,933     $ 2,129,151  
See accompanying summary of accounting policies and notes to consolidated financial statements.

 
53
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
Principles of Consolidation
 
The accompanying consolidated financial statements include the accounts of Community Financial Corporation (the "Corporation") and its wholly-owned subsidiary, Community Bank (the "Bank").  All material intercompany accounts and transactions have been eliminated in consolidation.
 
Nature of Business and Regulatory Environment
 
The Bank is a federally chartered savings association and the primary asset of the Corporation.  The Corporation provides a full range of banking services to individual and corporate customers primarily in the Shenandoah Valley and Hampton Roads regions of Virginia through its wholly-owned subsidiary.
 
The Office of Thrift Supervision ("OTS") is currently the primary regulator for federally chartered savings associations, as well as well as savings and loan holding companies but the Office of the Comptroller of the Currency is scheduled to to become the primary regulator during the fiscal year ended March 31, 2012.
 
The Bank's deposits are insured up to applicable limits by the Deposit Insurance Fund ("DIF"), which is administered by the Federal Deposit Insurance Corporation ("FDIC").  The FDIC has specific authority to prescribe and enforce such regulations and issue such orders as it deems necessary to prevent actions or practices by savings associations that pose a serious threat to the DIF.
 
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was effective January 1, 1993.  FDICIA contained provisions which allow regulators to impose prompt corrective action on undercapitalized institutions in accordance with a categorized capital-based system.
 
Estimates
 
In preparing consolidated financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the valuation of real estate owned, and the fair value of financial instruments.
 
Cash and Cash Equivalents
 
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits and federal funds sold.
 
Securities
 
Securities may be classified as either trading, held to maturity or available for sale.  Trading securities are held principally for resale and recorded at their fair values.  Unrealized gains and losses on trading securities are included immediately in operations.  Held to maturity securities are those which the Corporation has the positive
 

 
54
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
intent and ability to hold to maturity and are reported at amortized cost.  Available for sale securities consist of securities not classified as trading securities nor as held to maturity securities.  Unrealized holding gains and losses on available for sale securities are excluded from operations and reported in accumulated other comprehensive income.  Gains and losses on the sale of available for sale securities are recorded on the trade date and are determined using the specific identification method.  Premiums and discounts on securities are recognized in interest income using the interest method over the period to maturity.
 
Management evaluates securities for other-than-temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.  Impairment of securities occurs when the fair value of a security is less than its amortized cost.  For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) the Corporation intends to sell the security or (ii) it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis.  If, however, the Corporation does not intend to sell the security and it is not more-than-likely that the Corporation will be required to sell the security before recovery, management must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost of the security exceeds the present value of the cash flows expected to be collected from the security.  If there is no credit loss, there is no other-than-temporary impairment.  If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining  portion of impairment must be recognized in other comprehensive income.
 
Loans Receivable
 
Loans receivable consists primarily of long-term real estate loans secured by first deeds of trust on single family residences, other residential property, commercial property and land located primarily in the state of Virginia.  Interest income on mortgage loans is recorded when earned and is recognized based on the level yield method.  The Corporation provides an allowance for accrued interest deemed to be uncollectible, which is netted against accrued interest receivable in the consolidated balance sheets.
 
The Corporation defers loan origination and commitment fees, net of certain direct loan origination costs, and the net deferred fees are amortized into interest income over the lives of the related loans as yield adjustments.  Any unamortized net fees on loans fully repaid or sold are recognized as income in the year of repayment or sale.
 
The Corporation places all loans on nonaccrual status after being delinquent greater than 90 days or earlier if the Corporation becomes aware that the borrower has entered bankruptcy proceedings, or in situations in which the loans have developed inherent problems prior to being 90 days delinquent that indicate payments of principal or interest will not be made in full.  Whenever the accrual of interest is stopped, previously accrued but uncollected interest income is reversed.  Thereafter, interest is recognized only as cash is received until the loan is reinstated to accrual status.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
One-to-Four-Family Residential Real Estate Lending
 
Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. As
 

 
55
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
 
 
part of the application process, information is gathered concerning income, employment and credit history of the applicant. The valuation of residential collateral is provided by independent fee appraisers who have been approved by the Bank’s Board of Directors.
 
Commercial Real Estate Lending
 
Commercial real estate lending entails significant additional risk as compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or the economy, in general.
 
Construction and Land Development Lending
 
There are two characteristics of construction lending which impact its overall risk as compared to residential mortgage lending. First, there is more concentration risk due to the extension of a large loan balance through several lines of credit to a single developer or contractor. Second, there is more collateral risk due to the fact that loan funds are provided to the borrower based upon the estimated value of the collateral after completion. This could cause an inaccurate estimate of the amount needed to complete construction or an excessive loan-to-value ratio. To mitigate the risks associated with construction lending, the Bank generally limits loan amounts to 80% of the estimated appraised value of the finished home.
 
Commercial and Industrial Lending
 
Commercial business loans generally have more risk than residential mortgage loans, but have higher yields. To manage these risks, the Bank generally obtains appropriate collateral and personal guarantees from the borrower’s principal owners and monitors the financial condition of the borrower. Commercial business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much precision as residential real estate.
 
Consumer Lending
 
Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral on a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.
 
Troubled Debt Restructurings
 
In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as troubled
 

 
56
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
 
 
debt restructuring (TDR). Management strives to indentify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans.
 
Real Estate Owned
 
Real estate acquired through foreclosure is initially recorded at the lower of fair value, less selling costs, or the balance of the loan on the property at the date of foreclosure.  Costs relating to the development and improvement of property are capitalized, whereas those relating to holding the property are charged to expense.
 
Valuations are periodically performed by management, and an allowance for losses is established by a charge to operations if the carrying value of a property exceeds its estimated net realizable value.
 
Property and Equipment
 
Land is carried at cost.  Property and equipment is stated at cost less accumulated depreciation.  Provisions for depreciation are computed using the straight-line method over the estimated useful lives of the individual assets.  Expenditures for betterments and major renewals are capitalized and ordinary maintenance and repairs are charged to operations as incurred.  Estimated useful lives are three to ten years for furniture and equipment and five to fifty years for buildings and improvements.
 
Transfers of Financial Assets
 
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank – put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not  maintain effective control over the transferred assets through an agreement o repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
 
Income Taxes
 
Deferred income tax assets and liabilities are determined using the balance sheet method.  Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
 
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained.  The benefit of a tax position is recognized in the financial
 

 
57
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
 
 
statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions taken are not offset or aggregated with other positions.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.  The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefit in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.  Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the consolidated statements of operations.
 
Earnings Per Common Share
 
Basic earnings per common share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period.  Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.  Potential common shares that may be issued by the Corporation relate solely to outstanding stock options and are determined using the treasury stock method.
 
Stock-Based Compensation Plan
 
The Corporation recognizes the costs resulting from all share-based payments in the financial statements.  Share-based compensation is estimated at the date of grant using the Black-Scholes option valuation model for determining fair value.  The cost is recognized over the period the employee is required to provide services for the award.
 
Advertising Costs
 
The Corporation follows the policy of charging the costs of advertising to expense as incurred.
 
Comprehensive Income
 
Accounting principles generally 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 and pension liability adjustments, 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.
 
Fair Value Measurements
 
Fair value of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 5.  Fair value estimates involve uncertainties and matters of significant judgment.  Changes in assumptions or in market conditions could significantly affect estimates.
 

 
58
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
 
 
Reclassifications
 
Certain reclassifications have been made to prior period balances to conform to the current year presentation.
 
Recent Accounting Pronouncements
 
In June 2009, the Financial Accounting Standards Board (FASB) issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140,” was adopted into the Accounting Standards Codification (Codification) in December 2009 through the issuance of Accounting Standards Update (ASU) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets.  ASU 2009-16 was effective for transfers on or after January 1, 2010.  The adoption of the new guidance did not have a material impact on the Corporation’s consolidated financial statements.
 
In June 2009, the FASB issued new guidance relating to variable interest entities.  The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” was adopted into the Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 was effective as of January 1, 2010. The adoption of the new guidance did not have a material impact on the Corporation’s consolidated financial statements.
 
In October 2009, the FASB issued ASU 2009-15, “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of the new guidance did not have a material impact on the Corporation’s consolidated financial statements.
 
In January 2010, the FASB issued ASU 2010-04, “Accounting for Various Topics – Technical Corrections to SEC Paragraphs”. ASU 2010-04 makes technical corrections to existing Securities and Exchange Commission (SEC) guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements - subsequent events, use of residential method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The adoption of the new guidance did not have a material impact on the Corporation’s consolidated financial statements.
 
In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods
 

 
59
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
Recent Accounting Pronouncements (continued)
 
beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years.  The adoption of the new guidance did not have a material impact on the Corporation’s consolidated financial statements.
 
In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.”  ASU 2010-09 addresses both the interaction of the requirements of Topic 855 with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provisions related to subsequent events.  An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated.  ASU 2010-09 was effective immediately. The adoption of the new guidance did not have a material impact on the Corporation’s consolidated financial statements.
 
In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.”  The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements.  The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending on or after December 15, 2010.  Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures will be required for periods beginning on or after December 15, 2010.  The Corporation has included the required disclosures in its consolidated financial statements.
 
On September 15, 2010, the SEC issued Release No. 33-9142, “Internal Control Over Financial Reporting In Exchange Act Periodic Reports of Non-Accelerated Filers.”  This release issued a final rule adopting amendments to its rules and forms to conform them to Section 404(c) of the Sarbanes-Oxley Act of 2002 (SOX), as added by Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  SOX Section 404(c) provides that Section 404(b) shall not apply with respect to any audit report prepared for an issuer that is neither an accelerated filer nor a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934. Release No. 33-9142 was effective September 21, 2010.
 
On September 17, 2010, the SEC issued Release No. 33-9144, “Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management’s Discussion and Analysis.”  This interpretive release is intended to improve discussion of liquidity and capital resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations in order to facilitate understanding by investors of the liquidity and funding risks facing the registrant. This release was issued in conjunction with a proposed rule, “Short-Term Borrowings Disclosures,” that would require public companies to disclose additional information to investors about their short-term borrowing arrangements. Release No. 33-9144 was effective on September 28, 2010.
 
In December 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.”  The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period.  If comparative financial statements are
 

 
60
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
Recent Accounting Pronouncements (continued)
 
presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period.  ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  Early adoption is permitted.  The adoption of the new guidance is not expected to have a material impact on the Corporation’s consolidated financial statements.
 
In December 2010, the FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.”  The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists.  For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted.  The adoption of the new guidance is not expected to have a material impact on the Corporation’s consolidated financial statements.
 
The SEC has issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting,” which requires companies to submit financial statements in XBRL (extensible business reporting language) format with their SEC filings on a phased-in schedule.  Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.
 
In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114.  This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series.  This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification.  The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series.  The effective date for SAB 114 is March 28, 2011.   The adoption of the new guidance did not have a material impact on the Corporation’s consolidated financial statements.
 
In April 2011, the FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.”  The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor.  They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty.  The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011.  Early adoption is permitted.  Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required.  As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired.  For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning
 

 
61
 
 
Community Financial Corporation
and Subsidiary

Summary of Accounting Policies
 


 
Recent Accounting Pronouncements (continued)
 
on or after June 15, 2011. The Corporation is currently assessing the impact that ASU 2011-02 will have on its consolidated financial statements.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
62
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements


 
1.Securities
 
A summary of the amortized cost and estimated market values of securities is as follows:
 
March 31, 2011
                       
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated
Market
Value
 
                         
Held to Maturity
                       
                         
    United States government and
        agency obligations
  $ 2,000,000       -     $ 33,680     $ 1,966,320  
                                 
    Other
    198,000       -       -       198,000  
      2,198,000       -       33,680       2,164,320  
Available for Sale
                               
                                 
    Equity securities
    38,647       -       -       38,647  
                                 
    $ 2,236,647       -     $ 33,680     $ 2,202,967  
   

March 31, 2010
                       
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated
Market
Value
 
                         
Held to Maturity
                       
                         
    United States government and
        agency obligations
  $ 1,500,000     $ 2,655     $ 2,500     $ 1,500,155  
                                 
    Other
    198,000       -       -       198,000  
      1,698,000       2,655       2,500       1,698,155  
Available for Sale
                               
                                 
    Equity securities
    73,397       -       -       73,397  
                                 
    $ 1,771,357     $ 2,655     $ 2,500     $ 1,771,552  


 
63
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements



1.Securities (continued)
 
The amortized cost and estimated market value of securities at March 31, 2011, by contractual maturity, are as follows:
 
             
   
Amortized
Cost
   
Estimated
Market
Value
 
             
Held to Maturity
           
             
    Due in one year or less
  $ 198,000     $ 198,000  
    Due in one through five years
    2,000,000       1,966,320  
      2,198,000       2,164,320  
                 
Available for Sale
               
                 
    Equity securities
    38,647       38,647  
                 
    $ 2,236,647     $ 2,202,967  
                 

Securities having a market value of $1,468,510 and $1,500,155 at March 31, 2011 and 2010, respectively, were pledged by the Corporation for purposes required by law.
 
 
 

 

 
64
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements



1.Securities (continued)
 
Information pertaining to securities with gross unrealized losses at March 31, 2011 and 2010, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
 
March 31, 2011
Less Than Twelve Months
Over Twelve Months
 
Gross
Unrealized
Losses
Estimated
Market
Value
Gross
Unrealized
Losses
Estimated
Market
Value
         
         
Held to Maturity
       
         
    United States government and
      agency obligations
$33,680
$1,966,320
$            -
$            -

March 31, 2010
Less Than Twelve Months
Over Twelve Months
 
Gross
Unrealized
Losses
Estimated
Market
Value
Gross
Unrealized
Losses
Estimated
Market
Value
         
         
Held to Maturity
       
         
    United States government and
      agency obligations
$2,500
$997,500
$            -
$            -


 
65
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements


 
1.Securities (continued)
 
United States government and agency obligations.  The unrealized loss on the three investments in direct obligations of U.S. government agencies was caused by interest rate increases.  The contractual terms of these investments do not permit the issuer to settle at a price less than the amortized cost bases of the investment.  Because the Corporation does not intend to sell the investment and it is not more likely than not that the Corporation will be required to sell the investment before recovery of the amortized cost basis, which may be maturity, the Corporation does not consider this investment to be other-than-temporarily impaired at March 31, 2011.
 
During the year ended March 31, 2009 due to the conservatorship of Fannie Mae and Freddie Mac in September 2008 and the related restrictions on its outstanding preferred stock (including the elimination of dividends), the Corporation recorded an other-than-temporary impairment (OTTI) charge with respect to the Fannie Mae and Freddie Mac preferred stock it owned of $11.5 million. The OTTI charge was based on the closing quoted stock market values on March 31, 2009. The Corporation used guidance in ASC 320, Investments – Debt and Equity Securities, to determine the OTTI. The Company sold its remaining 57,000 shares of Fannie Mae and Freddie Mac preferred stock during fiscal year 2011.
 
The Corporation's investment in FHLB stock totaled $5,561,300 at March 31, 2011.   FHLB stock is generally viewed as a long-term investment and as a restricted security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions.  Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.  Despite the FHLB's temporary suspension of repurchases of excess capital stock in 2009, we do not consider this investment to be other-than-temporarily impaired at March 31, 2011 and no impairment has been recognized.  FHLB stock is shown in restricted investments on the balance sheet and is not part of the AFS securities portfolio.
 
2.Loans Receivable, Net
 
Loans receivable by segment are summarized as follows:
 
March 31,
 
2011
   
2010
 
             
Residential
  $ 195,128,796     $ 192,928,599  
Commercial - real estate
    181,822,323       171,805,427  
Construction
    20,649,944       47,647,798  
Commercial – non real estate
    49,085,530       53,402,539  
Consumer – non real estate
    38,721,182       43,435,217  
      485,407,775       509,219,580  
Less:
               
    Deferred loan (costs), net
    (731,009 )     (959,258 )
    Allowance for loan losses
    7,845,950       8,052,875  
      7,114,941       7,093,617  
    $ 478,292,834     $ 502,125,963  

Loans serviced for others amounted to $211,616 and $236,639 at March 31, 2011 and 2010, respectively.  The loans are not included in the accompanying consolidated balance sheets.
 

 
66
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
2.Loans Receivable, Net (continued)
 
A summary of the allowance for loan losses is as follows:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Balance at beginning of year
  $ 8,052,875     $ 5,955,847     $ 3,214,771  
Provision for loan loss
    8,170,534       4,031,454       4,285,389  
Loans charged-off
    (8,721,350 )     (2,105,988 )     (1,682,067 )
Recoveries of loans previously charged-off
    343,891       171,562       137,754  
Balance at end of year
  $ 7,845,950     $ 8,052,875     $ 5,955,847  

The allowance for loan losses allocated by segment is as follows:
 
Year Ended March 31, 2011
 
   
Commercial –
Non Real
Estate
   
Commercial –
Real Estate
   
Construction
   
Consumer –
Non Real
Estate
   
Residential
   
Total
 
Allowance for Loan Losses:
 
Individually evaluated for impairment
  $ 68,695     $ 257,770     $ ---     $ 16,541     $ 1,707,734     $ 2,050,740  
Collectively evaluated for impairment
    30,713       1,965,320       549,393       336,407       2,913,377       5,795,210  
Ending Balance:
  $ 99,408     $ 2,223,090     $ 549,393     $ 352,948     $ 4,621,111     $ 7,845,950  
                                                 
Loans:
 
Individually evaluated for impairment
  $ 3,575,958     $ 3,873,407     $ ---     $ 16,540     $ 6,772,734     $ 14,238,639  
Collectively evaluated for impairment
    45,509,572       177,948,916       20,649,944       38,704,642       188,356,062       471,169,136  
Ending Balance:
  $ 49,085,530     $ 181,822,323     $ 20,649,944     $ 38,721,182     $ 195,128,796     $ 485,407,775  

Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.  These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. At March 31, 2011 and 2010, the Corporation had $20,363,241 and $3,458,156 of mortgage loans and $679,023 and $255,093 of consumer loans that were modified in troubled debt restructurings with $20,287,241 of mortgage loans and $534,383 of consumer loans performing in accordance with payment terms.
 
No additional funds are committed to be advanced in connection with impaired loans.  There were no loans past due 90 days and still accruing interest.
 
Nonaccrual loans excluded from impaired loan disclosure amounted to $2,679,922, $7,487,929 and $3,050,662 at March 31, 2011, 2010 and 2009, respectively.  If interest on these loans had been accrued, such income would have approximated $324,689, $668,028 and $222,629 for the years ended March 31, 2011, 2010 and 2009, respectively.
 

 
67
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
2.Loans Receivable, Net (continued)
 
Impaired loans by class are as follows:
 
Year Ended March 31, 2011
 
   
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no related allowance:
 
Commercial – Non Real Estate
 
Commercial & Industrial
  $ 3,909,295     $ 3,909,295     $ ---     $ 1,814,361     $ 185,434  
Commercial Real Estate
 
Commercial Real Estate
    12,330,888       12,330,888       ---       7,014,822       733,552  
Land
    590,914       590,914       ---       695,445       10,198  
Multifamily
    943,791       943,791       ---       306,226       60,898  
Construction
 
Residential
    321,114       321,114       ---       323,182       16,056  
Commercial
    ---       ---       ---       ---       ---  
Consumer – Non Real Estate
 
Automobile
    211,494       211,494       ---       190,448       14,623  
Other
    27,615       27,615       ---       39,692       1,573  
Residential
 
Single Family
    10,443,463       10,443,463       ---       6,085,676       526,808  
Equity Lines and Loans
    158,493       158,493       ---       247,320       5,769  
   
With allowance recorded:
 
Commercial – Non Real Estate
 
Commercial & Industrial
  $ 106,576     $ 106,576     $ 68,695     $ 1,855,492     $ 7,128  
Commercial Real Estate
 
Commercial Real Estate
    493,867       493,867       207,867       1,271,307       ---  
Land
    ---       ---       ---       1,713,795       ---  
Multifamily
    94,903       94,903       49,903       47,452       4,271  
Construction
 
Residential
    ---       ---       ---       658,538       ---  
Commercial
    ---       ---       ---       ---       ---  
Consumer – Non Real Estate
 
Automobile
    13,561       13,561       13,561       3,390       504  
Other
    2,980       2,980       2,980       1,490       ---  
Residential
 
Single Family
    5,392,344       5,392,344       1,563,034       3,504,700       168,012  
Equity Lines and Loans
    144,700       144,700       144,700       219,714       2,080  



 
68
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
2.Loans Receivable, Net (continued)
 
Impaired loans by class are as follows (continue):
 
Year Ended March 31, 2011
 
   
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
Total:
 
Commercial – Non Real Estate
 
Commercial & Industrial
  $ 4,015,871     $ 4,015,871     $ 68,695     $ 3,669,853     $ 192,562  
Commercial Real Estate
 
Commercial Real Estate
    12,824,755       12,824,755       207,867       8,286,129       733,552  
Land
    590,914       590,914       ---       2,409,240       10,198  
Multifamily
    1,038,694       1,038,694       49,903       353,678       65,169  
Construction
 
Residential
    321,114       321,114       ---       981,720       16,056  
Commercial
    ---       ---       ---       ---       ---  
Consumer – Non Real Estate
 
Automobile
    225,055       225,055       13,561       193,838       15,127  
Other
    30,595       30,595       2,980       41,182       1,573  
Residential
 
Single Family
    15,835,807       15,835,807       1,563,034       9,590,376       694,820  
Equity Lines and Loans
    303,193       303,193       144,700       467,034       7,849  
   

Impaired loans with a valuation allowance totaled $11,209,986 and $9,792,151 at March 31, 2010 and 2009, respectively.  The valuation allowance related to these impaired loans was $3,878,534 and $1,873,646 at March 31, 2010 and 2009, respectively.  Impaired loans without a valuation allowance totaled $3,713,249 and $28,771 as of March 31, 2010 and 2009, respectively.
 
The average investment in impaired loans for the years ended March 31, 2010 and 2009 totaled $13,392,119 and $2,784,423, respectively.  No interest income was recognized on these loans.
 


 
69
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
2.Loans Receivable, Net (continued)
 
Nonaccrual and past due loans by class are as follows:
 
Year Ended March 31, 2011
 
   
   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days or
More
Past Due
   
Total
Past Due
   
Nonaccrual
Loans
 
Commercial – Non Real Estate
                             
Commercial & Industrial
  $ 743,540     $ 609,235     $ 606,202     $ 1,958,977     $ 606,202  
Commercial Real Estate
                                       
Commercial Real estate
    239,678       1,754,785       1,236,047       3,230,510       1,236,047  
Land
    335,602       ---       337,747       673,349       337,747  
Multifamily
    ---       ---       ---       ---       ---  
Construction
                                       
Residential
    ---       ---       ---       ---       ---  
Commercial
    ---       ---       ---       ---       ---  
Consumer – Non Real Estate
                                       
Automobile
    441,153       122,476       74,699       638,328       74,699  
Other
    16,167       285,055       3,821       305,043       3,821  
Residential
                                       
Single Family
    755,029       717,528       3,660,755       5,133,312       3,660,755  
Equity Lines and Loans
    404,394       150,033       256,328       810,755       256,328  
Totals
  $ 2,935,563     $ 3,639,112     $ 6,175,599     $ 12,750,274     $ 6,175,599  





 
70
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
2.Loans Receivable, Net (continued)
 
The Corporation uses the following rating system for evaluating the risks associated with loans:
 
Pass
A Pass loan’s primary source of repayment is satisfactory, with secondary sources very likely to be realized if necessary.
Special Mention
A Special Mention loan has potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or the Corporation’s credit position at some future date.  Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard
A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.
Doubtful
A loan classified Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loss
A loan classified Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted.  This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

Credit Quality by class is as follows:
 
Year Ended March 31, 2011
 
   
Internal Risk Rating Grades
 
Pass
   
Special
Mention
   
Substandard
   
Doubtful
   
Loss
 
Commercial – Non Real Estate
                             
Commercial & Industrial
  $ 38,043,245     $ 4,858,861     $ 6,112,424     $ 71,000     $ ---  
Commercial Real Estate
                                       
Commercial Real estate
    101,373,538       17,705,767       7,806,399       ---       ---  
Land
    31,858,946       4,424,158       1,946,165       ---       ---  
Multifamily
    15,676,683       ---       1,030,667       ---       ---  
Construction
                                       
Residential
    13,329,026       855,077       332,000       ---       ---  
Commercial
    6,133,841       ---       ---       ---       ---  
Consumer – Non Real Estate
                                       
Automobile
    30,824,809       226,026       235,550       ---       ---  
Other
    7,012,773       29,057       392,967       ---       ---  
Residential
                                       
Single Family
    121,410,759       12,964,909       13,822,691       ---       ---  
Equity Lines and Loans
    43,823,032       2,382,852       724,553       ---       ---  
Totals
  $ 409,486,652     $ 43,446,707     $ 32,403,416     $ 71,000     $ ---  
 



 
71
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 3.Other Real Estate Owned (OREO)
 
At March 31, 2011 and 2010, OREO was $10,263,489 and $3,030,569, respectively.  OREO is primarily comprised of residential single family properties, residential lots and commercial real estate.  Changes in the balance for OREO are as follows:
 
March 31,
 
2011
   
2010
 
             
Balance at the beginning of year, gross
  $ 4,022,853     $ 1,865,041  
Transfers from loans
    14,457,276       4,565,933  
Capitalized costs
    304,179       563,288  
Sales proceeds
    (5,677,509 )     (2,449,186 )
Gain (loss) on disposition
    (1,497,033 )     (522,223 )
Balance at the end of year, gross
    11,609,766       4,022,853  
Less valuation allowance
    (1,346,278 )     (992,284 )
Balance at the end of year, net
  $ 10,263,488     $ 3,030,569  

Changes in the allowance for OREO are as follows:
 
Balance at the beginning of the year
    992,284       575,002  
Provision for losses
    1,402,359       792,241  
Charge-offs, net
    (1,048,365 )     (374,959 )
Balance at the end of year
  $ 1,346,278     $ 992,284  

Expenses applicable to OREO, other than the valuation allowance, were $931,987 and $308,129 for the years ended March 31, 2011 and 2010, respectively.
 
4.Property and Equipment
 
Property and equipment are summarized as follows:
 
March 31,
 
2011
   
2010
 
             
Buildings
  $ 8,870,546     $ 8,848,863  
Land and improvements
    2,793,404       2,662,512  
Furniture and equipment
    6,191,553       5,881,673  
Construction in progress
    16,783       3,500  
      17,872,286       17,396,548  
Less accumulated depreciation and amortization
    9,103,140       8,475,779  
Property and equipment, net
  $ 8,769,146     $ 8,920,769  

Depreciation expense for the years ended March 31, 2011, 2010 and 2009 amounted to $627,361, $603,873 and $585,777, respectively.
 

 
72
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
5.Deposits
 
Deposits are summarized as follows:
 
March 31,
 
2011
   
2010
 
             
Demand deposits
           
    Noninterest bearing
  $ 27,560,553     $ 28,465,460  
    Savings accounts
    33,997,042       31,586,397  
    NOW accounts
    47,885,332       40,378,534  
    Money market deposit accounts
    43,849,794       38,465,825  
                 
Total demand deposits
    153,292,721       138,896,216  
                 
Time deposits
    225,752,062       259,524,114  
                 
    $ 379,044,783     $ 398,420,330  

The aggregate amount of time deposit accounts with a minimum denomination of $100,000 was $83,906,174 and $98,256,051 at March 31, 2011 and 2010, respectively.
 
Time deposits mature as follows:
 
Year Ending March 31,
       
         
2012
  $ 174,948,231    
2013
    22,773,307    
2014
    12,139,891    
2015
    6,438,473    
2016
    9,452,160    
           
           
    $ 225,752,062    

At March 31, 2011 and 2010, overdraft demand deposits reclassified to loans totaled $83,831 and $75,906, respectively.
 
Brokered time deposits totaled $15,323,370 and $22,468,768 at March 31, 2011 and 2010, respectively, and are included in time deposits above.
 

 
73
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
5.Deposits (continued)
 
Interest expense on deposits is summarized as follows:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Time deposits
  $ 4,138,751     $ 6,246,167     $ 9,569,305  
Money market deposit and NOW accounts
    597,465       633,449       602,623  
Savings
    175,537       269,553       325,295  
                         
    $ 4,911,753     $ 7,149,169     $ 10,497,223  

6.Fair Value Measurements
 
The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer the liability in an orderly transaction between market participants at the measurement date.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Corporation's various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
 
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date  under current market conditions.  If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate.  In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.  The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
 
Fair Value Hierarchy
In accordance with this guidance, the Corporation groups assets and liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value.
 
 
Level 1
Valuation is based on quoted prices in active markets for identical assets and liabilities.
       
 
Level 2
Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

 
74
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
6.Fair Value Measurements (continued)
 
 
Level 3
Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Corporation to measure certain financial assets  recorded at fair value on a recurring basis in the financial statements:
 
Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).
 
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and 2010:
 
         
Fair Value Measurements Using
 
         
Quoted Prices
             
         
in Active
   
Significant
       
         
Markets for
   
Other
   
Significant
 
         
Identical
   
Observable
   
Unobservable
 
         
Assets
   
Inputs
   
Inputs
 
Description
 
Balance
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
                         
March 31, 2011:
                       
Equity securities
  $ 38,647     $ -     $ 38,647     $ -  
                                 
March 31, 2010:
                               
Equity securities
  $ 73,397     $ -     $ 73,397     $ -  

Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
 
The following describes the valuation techniques used by the Corporation to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
 
Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan,  the fair value of the collateral or discounted cash flow analyses.  Fair value is
 


 
75
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
6. Fair Value Measurements (continued)
 
Impaired Loans (continued): typically measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate  or  business  assets  including  equipment,  inventory,  and  accounts  receivable.  The  vast  majority  of  the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Corporation using observable market data (Level 2).  However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3).  Loans valued using discounted cash flow analyses are considered Level 3.  Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Operations.
 
Real Estate Owned: Foreclosed assets and repossessions are adjusted to fair value upon transfer of the loans to foreclosed assets and repossessions.  Subsequently, foreclosed assets and repossessions are carried at the lower of carrying value or fair value.  Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Corporation records the foreclosed asset as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the foreclosed asset or repossession as nonrecurring Level 3.
 
The following table summarizes the Corporation’s assets that were measured at fair value on a nonrecurring basis during the period.
 
         
Carrying Value
 
         
Quoted Prices
             
         
in Active
   
Significant
       
         
Markets for
   
Other
   
Significant
 
         
Identical
   
Observable
   
Unobservable
 
         
Assets
   
Inputs
   
Inputs
 
Description
 
Balance
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
March 31, 2011
                       
  Assets
                       
    Impaired loans net of
                       
      valuation allowance
  $ 4,198,192     $ -     $ 4,160,713     $ 37,479  
    Real estate owned
  $ 10,383,549     $ -     $ 8,988,875     $ 1,394,674  
                                 
March 31, 2010
                               
  Assets
                               
    Impaired loans net of
                               
      valuation allowance
  $ 7,331,452     $ -     $ -     $ 7,331,452  
    Real estate owned
  $ 3,182,419     $ -     $ 855,000     $ 2,327,419  

 
76
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
6.Fair Value Measurements (continued)
 
The estimated fair values of the Corporation's financial instruments are as follows:
 
March 31,
 
2011
   
2010
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
(In Thousands)
 
Amount
   
Value
   
Amount
   
Value
 
                         
Financial assets
                       
    Cash and cash equivalents
  $ 7,898     $ 7,898     $ 5,375     $ 5,375  
    Securities
    2,237       2,203       1,771       1,772  
    Federal Home Loan Bank stock, restricted
    5,561       5,561       6,184       6,184  
    Loans, net
    478,293       490,657       502,126       514,522  
    Accrued interest receivable
    2,037       2,037       2,129       2,129  
   
Financial liabilities
                               
    Deposits
  $ 379,045     $ 382,055     $ 398,420     $ 403,330  
    Borrowings
    97,000       96,998       96,250       96,550  
    Securities sold under agreements to repurchase
    1,445       1,445       846       846  
    Accrued interest payable
    50       50       148       148  

Accounting guidance excludes certain financial instruments and all non-financial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation.
 
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.
 
Cash and cash equivalents
 
For those short-term investments, the carrying amount is a reasonable estimate of fair value.
 
Securities
 
Fair values for securities, excluding Federal Home Loan Bank stock, are based on quoted market prices or dealer quotes.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.  The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.
 


 
77
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
6.Fair Value of Financial Instruments (continued)
 
Loans receivable
 
For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  Fair values for certain mortgage loans (e.g., one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics.  Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
 
Deposit liabilities
 
The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts).  The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
 
Borrowings
 
For advances that mature within one year of the balance sheet date, carrying value is considered a reasonable estimate of fair value.  The fair values of all other advances are estimated using discounted cash flow analysis based on the Corporation's current incremental borrowing rate for similar types of advances.
 
Securities sold under agreements to repurchase
 
Securities sold under agreements to repurchase are treated as short-term borrowings and the carrying value approximates fair value.
 
Accrued interest
 
The carrying amounts of accrued interest approximate fair value.
 


 
78
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements



6.Fair Value of Financial Instruments (continued)
 
Off-balance sheet instruments
 
The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.  The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.  At March 31, 2011 and 2010, the fair value of loan commitments and standby letters of credit were deemed immaterial.
 
7.Borrowings
 
Advances from the Federal Home Loan Bank and other borrowings are summarized as follows:
 
 Due in year ending March 31,
   
     
2012
  $ 97,000,000  

The weighted average interest rate on borrowings was 0.23% and 0.90% at March 31, 2011 and 2010, respectively.  The fixed-rate FHLB advances are collateralized by the investment in FHLB stock and the Corporation’s portfolio of first mortgage loans, multi-family, commercial real estate, second mortgage and home equity lines of credit under a Blanket Floating Lien Agreement.  Value of this collateral as of March 31, 2011 was $140,006,173.
 
Information related to borrowing activity of the borrowings is as follows:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Maximum amount outstanding during the year
  $ 108,000,000     $ 117,625,000     $ 113,000,000  
                         
Average amount outstanding during the year
  $ 96,402,388     $ 100,477,527     $ 96,204,110  
                         
Average interest rate during the year
    0.71 %     0.92 %     2.02 %

During the year ended March 31, 2009, the Corporation became non-compliant on a line of credit of $5 million due to being less than “well capitalized” related to the OTTI charge on its Fannie Mae and Freddie Mac preferred stock. The Corporation has entered into a Waiver and Loan Modification agreement with the lender to waive the previous non-compliance violations and has agreed to quarterly principal payments of $125,000.  The term of the borrowing was extended to October 30, 2010.  The balance on this line of credit was $0 at March 31, 2011.  The Company also regained “well capitalized” status subsequent to the OTTI charge and was in compliance with all loan covenants at March 31, 2011.
 

 
79
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements


8.Securities Sold Under Agreements to Repurchase
 
Securities sold under agreements to repurchase are secured borrowings that generally mature within one to four days from the transaction date.  These amounts are recorded at the amount of cash received in connection with the transaction.  The Corporation may be required to provide additional collateral based on the fair value of the underlying securities.
 
The following is a summary of certain information regarding the Corporation’s repurchase agreements:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Balance at end of year
  $ 1,444,961     $ 845,503     $ 1,475,594  
                         
Weighted average interest rate during the year
    0.91 %     1.01 %     1.00 %
                         
Average amount outstanding during the year
  $ 1,339,032     $ 1,080,290     $ 2,089,259  
                         
Maximum amount outstanding at any month end
                       
during the year
  $ 2,653,374     $ 1,694,704     $ 3,010,248  

9.Income Taxes
 
The Corporation files income tax returns in the U.S. federal jurisdiction and the state of Virginia.  With few exceptions, the Corporation is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2007.
 
Deferred tax assets (liabilities), included in the consolidated balance sheets are as follows:
 
March 31,
 
2011
   
2010
   
               
Deferred tax assets
             
    Allowance for losses
  $ 2,981,461     $ 3,060,093    
    Deferred compensation
    759,533       724,071    
    Securities impairment
    4,248       1,121,824    
    Pension
    415,713       342,281    
    Real estate owned
    1,886,110       512,662    
   Nonaccrual interest
    124,586       303,303    
    Credit carryforward
    458,881       -    
                   
      6,630,532       6,064,234    
Deferred tax liabilities
                 
    Depreciable assets
    (173,320 )     (179,926 )  
Net deferred tax asset
  $ 6,457,212     $ 5,884,308    


 
80
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
9.Income Taxes (continued)
 
In accordance with ASC 740, Income Taxes, the Corporation was unable to recognize the deferred tax benefit related to the OTTI charge on Fannie Mae and Freddie Mac preferred stock during the quarter ended September 30, 2008.  Tax laws in effect at September 30, 2008 characterized the loss as a capital loss.  The Company did not have sufficient capital gain income to offset the loss and therefore set up a valuation allowance related to the capital loss.  Subsequent to the September 30, 2008 quarter, the U.S. Congress passed the Emergency Economic Stabilization Act which re-characterized the OTTI loss on the Company’s Fannie Mae and Freddie Mac preferred stock to ordinary from capital for tax purposes. The tax benefit related to this loss of $11.5 million based on the Company’s approximate income tax rate of 38% was $4.4 million.  Therefore the Company recognized the deferred tax asset during the quarter ended December 31, 2008, the period of enactment, as required by ASC 740.  The Company also determined that it had sufficient taxable income available in carryback years and probable future taxable income to fully recognize the deferred tax asset.  The deferred tax asset related to the OTTI loss was $4,248 and $1.1 million at March 31, 2011 and 2010, respectively.  During the year ended March 31, 2011, the Corporation sold and therefore realized losses for tax purposes on a portion of the preferred stock.
 
The provision (benefit) for income taxes charged to operations for the years ended March 31, 2011, 2010 and 2009, consists of the following:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
    Current
  $ 369,905     $ (429,456 )   $ 2,059,427  
    Deferred
    473,197       1,778,645       (5,851,976 )
                         
    $ 843,102     $ 1,349,189     $ (3,792,549 )

Differences between the statutory and effective tax rates are summarized as follows:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Tax at statutory rate
    34.0 %     34.0 %     34.0 %
Increases (decreases) in taxes resulting from:
                       
    State income taxes, net of federal benefit
    4.1       3.7       4.2  
    Non-taxable interest and dividend received deduction
    -       -       0.5  
   Bank-owned life insurance
    (1.8 )     (1.8 )     0.9  
   Rehabilitation tax credit
    -       (9.8 )     -  
    Other
    (0.7 )     1.2       (0.2 )
                         
      35.6 %     27.3 %     39.4 %


 
81
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
10.Comprehensive Income (Loss)
 
The components of comprehensive income (loss) are summarized as follows:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Net income (loss)
  $ 1,522,254     $ 3,591,788     $ (5,823,284 )
Other comprehensive income (loss), net of tax:
                       
  Unrealized holding (loss) arising during the period
    -       -       (2,180,606 )
  Pension liability adjustment
    (262,386 )     (472,138 )     (8,019 )
Income tax (expense) benefit related to items of other
 comprehensive income
    99,707       179,412       (823,942 )
Total other comprehensive income (loss), net of tax
    (162,679 )     (292,726 )     1,348,645  
                         
Total comprehensive income (loss)
  $ 1,359,575     $ 3,299,062     $ (4,474,639 )

The components of accumulated other comprehensive income (loss), included in stockholders' equity, are as follows:

March 31,
 
2011
   
2010
   
               
Pension liability adjustment
  $ (1,338,123 )   $ (1,075,737 )  
Tax effect
    508,487       408,780    
     Net-of-tax amount
  $ (829,636 )   $ (666,957 )  

11.Stockholders’ Equity and Regulatory Capital Requirements
 
Savings institutions must maintain specific capital standards that are no less stringent than the capital standards applicable to national banks.  The OTS regulations currently have three capital standards including (i) a tangible capital requirement, (ii) a core capital requirement, and (iii) a risk-based capital requirement.  The tangible capital standard requires savings institutions to maintain tangible capital of not less than 1.5% of adjusted total assets.  The core capital standard requires a savings institution to maintain core capital of not less than 4.0% of adjusted total assets.  The risk-based capital standard requires risk-based capital of not less than 8.0% of risk-weighted assets.
 


 
82
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
11.Stockholders’ Equity and Regulatory Capital Requirements (continued)
 
The following table represents the Bank's regulatory capital levels, relative to the OTS requirements applicable at that date:
 
   
Well Capitalized
   
Well Capitalized
                     
   
Amount
   
Percent
   
Actual
   
Actual
   
Excess
   
 March 31, 2011
 
Required
   
Required
   
Amount
   
Percent
   
Amount
   
(In Thousands)
                               
                                 
Tangible Capital
  $ 26,610          5.00%     $ 49,592          9.32%     $ 22,982    
Core Capital
    31,932       6.00       49,592       9.32       17,660    
Risk-based Capital
    44,933       10.00         55,209       12.29         10,276    
 
   
Well Capitalized
   
Well Capitalized
                           
   
Amount
   
Percent
   
Actual
   
Actual
   
Excess
 March 31, 2010
 
Required
   
Required
   
Amount
   
Percent
   
Amount
                                           
Tangible Capital
  $ 27,506          5.00%     $ 48,965          8.90%     $ 21,459    
Core Capital
    33,007       6.00       48,965       8.90       15,958    
Risk-based Capital
    47,241       10.00         53,129       11.25         5,888    

The Bank may not declare or pay a cash dividend, or repurchase any of its capital stock if the effect thereof would cause the net worth of the Bank to be reduced below certain requirements imposed by federal regulations.
 
Capital distributions by OTS-regulated savings banks are limited by regulation ("Capital Distribution Regulation").  Capital distributions are defined to include, in part, dividends, stock repurchases and cash-out mergers.  The Capital Distribution Regulation permits a "Tier 1" savings bank to make capital distributions during a calendar year equal to net income for the current year plus the previous two years net income, less capital distributions paid over that same time period.  Any distributions in excess of that amount require prior OTS notice, with the opportunity for OTS to object to the distribution.  A Tier 1 savings bank is defined as a savings bank that has, on a pro forma basis after the proposed distribution, capital equal to or greater than the OTS fully phased-in capital requirement and has not been deemed by the OTS to be "in need of more than normal supervision".  The Bank is currently classified as a Tier 1 institution for these purposes.  The Capital Distribution Regulation requires that savings banks provide the applicable OTS District Director with a 30-day advance written notice of all proposed capital distributions whether or not advance approval is required by the regulation.
 


 
83
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
11.Stockholders’ Equity and Regulatory Capital Requirements (continued)
 
On December 19, 2008, the Corporation received an investment from the U.S. Treasury Department ("the Treasury") of $12,643,000 in the form of 5% cumulative preferred stock.  The Corporation also issued a warrant to purchase 351,194 shares of common stock at $5.40 per share to the Treasury.  This investment was part of the Treasury's Capital Purchase Plan.  The preferred stock will pay cumulative dividends at a rate of 5% per year for the first five years and 9% per year thereafter.  The preferred stock is generally nonvoting.  The warrant is immediately exercisable.
 
12.Earnings Per Common Share
 
During the year ended March 31, 2003, the Board of Directors authorized a stock repurchase program under which 368,706 shares of the Corporation’s stock may be repurchased. No shares were repurchased during the fiscal years ended March 31, 2011, 2010 or 2009.
 
Earnings per common share is calculated as follows:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Basic earnings (loss) per common share
                 
                   
Income (loss) available to common shareholders
  $ 769,468     $ 2,839,002     $ (6,033,798 )
                         
Weighted average shares outstanding
    4,361,658       4,361,658       4,355,909  
                         
Basic earnings (loss) per common share
  $ 0.18     $ 0.65     $ (1.39 )
                         
Diluted earnings (loss) per common share
                       
                         
Income (loss) available to common shareholders
  $ 769,468     $ 2,839,002     $ (6,033,798 )
                         
Weighted average shares outstanding
    4,361,658       4,361,658       4,355,909  
                         
    Dilutive effect of stock options
    321       468       -  
                         
Total weighted average shares outstanding
    4,361,979       4,362,126     $ 4,355,909  
                         
Diluted earnings (loss) per common share
  $ 0.18     $ 0.65     $ (1.39 )

During the years ended March 31, 2011, 2010 and 2009, stock options and warrants representing 282,750 shares, 307,200 shares and 499,447 shares, respectively, on average were not included in the calculation of earnings per share because their effect would have been antidilutive.
 


 
84
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
13.Employee Benefit Plans
 
Pension Plan
 
The Corporation has a noncontributory defined benefit pension plan covering substantially all of its employees.  The benefits are based on years of service and final average compensation.  The Corporation's funding policy is to contribute amounts to the pension trust at least equal to the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA), but not in excess of the maximum tax deductible amount.  Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.    The following is a summary of information with respect to the plan:

March 31,
 
2011
   
2010
   
2009
 
                   
Change in benefit obligation:
                 
  Benefit obligation at beginning of year
  $ 4,570,285     $ 3,683,909     $ 3,422,890  
  Service cost
    338,646       306,260       412,726  
  Interest cost
    274,515       238,195       262,757  
  Actuarial (gain) loss
    (13,499 )     423,500       (81,231 )
  Benefits paid
    (88,027 )     (81,579 )     (333,233 )
  Prior service cost
    435,000       -       -  
                         
  Benefit obligation at end of year
    5,516,920       4,570,285       3,683,909  
                         
Change in plan assets:
                       
  Fair value of plan assets at beginning of year
    3,667,809       3,571,818       3,697,356  
  Actual return on plan assets
    386,420       177,750       207,695  
  Employer contribution
    450,000       -       -  
  Benefits paid
    (88,027 )     (81,759 )     (333,233 )
                         
  Fair value of plan assets at end of year
    4,416,202       3,667,809       3,571,818  
                         
Funded status
  $ (1,100,538 )   $ (902,296 )   $ (112,091 )

Amounts recognized in the balance sheet:
                 
  Other liabilities
  $ 1,100,538     $ 902,296     $ 112,091  

Amounts recognized in accumulated other
  comprehensive (loss):
                 
     Net (loss)
  $ (1,338,123 )   $ (1,075,737 )   $ (603,599 )


 
85
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
13.Employee Benefit Plans (continued)
 
The accumulated benefit obligation for the defined benefit pension plan was $4,156,158, $3,169,588 and $2,554,868 as of March 31, 2011, 2010 and 2009, respectively.
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Components of net periodic pension cost:
                 
                   
  Service cost
  $ 338,646     $ 306,260     $ 412,726  
  Interest cost
    274,515       238,195       262,757  
  Expected return on plan assets
    (283,918 )     (246,153 )     (320,873 )
  Recognized net actuarial loss
  Amortization of prior service cost
    20,363 36,250       19,765 -       23,926 -  
  Net periodic benefit cost
    385,856       318,067       378,536  
                         
Other changes in plan assets and benefit obligations
                       
  recognized in other comprehensive income:
                       
    Net loss (gain)
    (136,364 )     472,138       8,019  
   Prior service cost
    398,750       ---       ---  
    Deferred income tax (benefit)
    (99,707 )     (179,412 )     (3,048 )
    Total recognized in other comprehensive loss
    162,679       292,726       4,971  
                         
     Total recognized in net periodic benefit cost and
                       
         other comprehensive loss
  $ 548,535     $ 610,793     $ 383,507  
   
Year Ended March 31,
                    2009  
   
Adjustment to retained earnings due to change
 
in measurement date:
 
    Service cost
                  $ 87,669  
    Interest cost
                    53,011  
    Expected return on plan assets
                    (64,175 )
    Recognized net actuarial loss
                    4,888  
    Detailed income tax (benefit)
                    (30,929 )
    Net periodic benefit cost
                  $ 50,464  
                         


 
86
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
13.Employee Benefit Plans (continued)
 
The following assumed rates were used in determining the benefit obligations:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
   
Weighted average discount rate
    5.75 %     6.00 %     6.50 %
 
Increase in future compensation levels
    4.00 %     4.00 %     4.00 %

The following assumed rates were used in determining the net periodic pension costs:
 
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Weighted average discount rate
    6.00 %     6.50 %     6.25 %
                         
Expected long-term rate of return on plan assets
    7.00 %     7.00 %     7.00 %
                         
Increase in future compensation levels
    4.00 %     4.00 %     4.00 %

Long-Term Rate of Return
 
The plan sponsor, in consultation with management, selects the expected long-term rate of return on assets assumption in consultation with their investment advisors.  The rate is intended to reflect the average rate of earnings expected to be earned on the funds invested to provide plan benefits.  Historical performance is reviewed with respect to real rates of return (net of inflation) for the major asset classes held or anticipated to be held by the trust, and for the trust itself.  Undue weight is not given to recent experience that may not continue over the measurement period, with higher significance placed on current forecasts of future long-term economic conditions.
 

 
87
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements


 
   
Fair Value Measurements at March 31, 2011
 
         
Quoted Prices in
             
         
Active Markets
   
Significant
   
Significant
 
         
for Identical
   
Observable
   
Unobservable
 
Asset Category
 
Total
   
Assets (Level 1)
   
Inputs (Level 2)
   
Inputs (Level 3)
 
                         
Cash and due from broker
  $ 4,192     $ 4,192     $ -     $ -  
Equities
    1,138,605       1,138,605       -       -  
Fixed income
    3,273,405       3,272,405       -       -  
                                 
Total
  $ 4,416,202     $ 4,416,202     $ -     $ -  

   
Fair Value Measurements at March 31, 2010
 
         
Quoted Prices in
             
         
Active Markets
   
Significant
   
Significant
 
         
for Identical
   
Observable
   
Unobservable
 
Asset Category
 
Total
   
Assets (Level 1)
   
Inputs (Level 2)
   
Inputs (Level 3)
 
                         
Cash and due from broker
  $ 91,459     $ 91,459     $ -     $ -  
Equities
    242,718       242,718       -       -  
Fixed income
    2,817,639       2,817,639       -       -  
Other
    516,033       516,033       -       -  
                                 
Total
  $ 3,667,809     $ 3,667.809     $ -     $ -  

The investment policy of the Plan is to employ a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk.  The intent of this strategy is to minimize plan expenses by exceeding the interest growth in long-term plan liabilities.  Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition.  This consideration involves the use of long-term measures that address both return and risk.  The investment portfolio contains a diversified blend of equity and fixed income investments.  Investment risks and returns are measured and monitored on an ongoing basis through regular investment portfolio reviews.
 


 
88
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
13.Employee Benefit Plans (continued)
 
Asset Allocation
 
The pension plan’s weighted-average asset allocations at March 31, 2011 and 2010, by asset category are as follows:
 
March 31,
 
2011
   
2010
 
             
Fixed income securities
    74 %     80 %
Equity securities
    26 %     7 %
Cash
    -       3 %
Other
    -       10 %
      100 %     100 %

The Corporation made a contribution of $233,000 to its pension plan for the year ended March 31, 2011 during the June 30, 2011 quarter.
 
Estimated future benefit payments, which reflect expected future service, as appropriate, are as follows:
 
 
Year Ending March 31,
     
       
2012
  $ 113,351  
2013
    137,766  
2014
    197,501  
2015
    237,028  
2016
    252,442  
2017-2021
    1,570,197  



 
89
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
13.Employee Benefit Plans (continued)
 
Employee Stock Ownership Plan
 
The Employee Stock Ownership and 401(k) Profit Sharing Plan (the "Plan") is a combination of a profit sharing plan with 401(k) and a stock bonus plan.  The Plan provides for retirement, death, and disability benefits for all eligible employees.
 
An employee becomes eligible for participation after completion of six months of service.  After meeting the eligibility requirements, an employee becomes a member of the Plan on the earliest January 1, April 1, July 1, or October 1 occurring on or after his or her qualification.
 
The contributions to the Plan are discretionary and are determined by the Board of Directors.  The contributions are limited annually to the maximum amount permitted as a tax deduction under the applicable Internal Revenue Code provisions
 
Profit-sharing expenses were approximately $235,000, $195,000 and $172,000 for the years ended March 31, 2011, 2010 and 2009, respectively.
 
Deferred Compensation Plans
 
During the year ended March 31, 2004, the Corporation adopted deferred compensation plans for the Board of Directors, President and four Executive Officers.  Benefits are to be paid in monthly installments commencing at retirement and ending upon the death of the director or officer.  The agreement provides that if board membership or employment is terminated for reasons other than death or disability prior to retirement age, the amount of benefits would be reduced.  The deferred compensation expense for the years ended March 31, 2011, 2010, and 2009, based on the present value of the retirement benefits was $168,000, $215,000 and $438,000, respectively.  The deferred compensation liability was $1,999,000 and $1,905,000 at March 31, 2011 and 2010, respectively.  Payments in the amount of $84,081 were made to retired management personnel and $12,156 to retired directors for the fiscal year ended March 31, 2011. The plans are unfunded; however, life insurance has been acquired on the life of the employees in amounts sufficient to discharge the obligation.
 


 
90
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
14.Stock Option Plan
 
The Corporation has a noncompensatory stock option plan (the "Plan") designed to provide long-term incentives to employees.  All options are exercisable at end of year.
 
The following table summarizes options outstanding:
 
Year Ended March 31,
 
2011
       
         
Weighted -
       
         
Average
   
Aggregate
 
         
Exercise
   
Intrinsic
 
   
Shares
   
Price
   
Value
 
Outstanding at
                 
   beginning of year
    314,700       $8.66          
                       
Granted
      20,000       3.13        
Forfeited
      (78,800)       5.96        
Exercised
              -            -        
Outstanding at
                     
   end of year
    255,900       9.06       $200   
                         
Exercisable at end
                       
   of year
    255,900       9.06       $200  
                         
Weighted-average fair
                       
   value of options granted
            $1.05           
                         



 
91
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
14.Stock Option Plan (continued)
 
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by option holders had all option holders exercised their options on March 31, 2011.  This amount changes based on changes in the market value of the Corporation's stock.
 
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
 
Year Ended March 31
 
2011
 
    Dividend yield
    2.07 %
    Expected life
 
10 years
    Expected volatility
    30.83 %
    Risk-free interest rate
    3.36 %

The expected volatility is based on historical volatility.  The risk-free interest rates for periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of the grant.  The expected life is based on historical experience.  The dividend yield assumption is based on the Corporation's history and expectation of dividend payouts.
 
The following table summarizes information about stock options outstanding and exercisable at March 31, 2011:
 
 
   
Options Outstanding and Exercisable
 
           
Weighted
       
           
Average
   
Weighted
 
           
Remaining
   
Average
 
           
Contractual
   
Exercise
 
Range of Exercise Price
   
Number
   
Life (in Years)
   
Price
 
$ 3.13 - $ 8.75       67,500       5.64       5.88  
$ 9.40 - $ 9.40       94,400       2.71       9.40  
$ 10.90-$11.22       94,000       4.13       11.17    

15.Commitments and Contingencies
 
The Corporation is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit.  Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
 
The Corporation’s exposure to credit loss is represented by the contractual amount of these commitments.  The Corporation follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
 

 
92
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
15.Commitments and Contingencies (continued)
 
At March 31, 2011 and 2010, the following financial instruments were outstanding whose contract amounts represent credit risk:
 
Contract Amount
 
March 31,
 
2011
   
2010
 
(In Thousands)
           
             
Commitments to grant loans
  $ 3,403     $ 5,192  
Unfunded commitments under lines of credit
    25,894       30,249  
Standby letters of credit
    2,988       1,783  

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  The commitments for equity lines of credit may expire without being drawn upon.  Therefore, the total commitment amounts do not necessarily represent future cash requirements.  The amount of collateral obtained, if it is deemed necessary by the Corporation, is based on management’s credit evaluation of the customer.
 
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers.  These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Corporation is committed.
 
Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party.  Those letters of credit are primarily issued to support public and private borrowing arrangements.  Essentially all letters of credit issued have expiration dates within one year.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  The Corporation generally holds collateral supporting those commitments if deemed necessary.
 

 
93
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements

 

 
15.Commitments and Contingencies (continued)
 
Leases
 
The Corporation is obligated under several noncancellable operating leases.  Future minimum annual rental commitments under the leases are as follows:
 
Year Ending March 31,
 
Amount
 
       
2012
  $ 183,723  
2013
    130,159  
2014
    67,143  
2015
    43,500  
2016
    43,500  
Thereafter
    152,250  
         
    $ 620,275  

Total lease expense was approximately $194,513, $201,022 and $194,000 for the years ended March 31, 2011, 2010 and 2009, respectively.
 
In the normal course of business, the Corporation has entered into employment or severance agreements with certain officers of the Bank.
 
The Corporation maintains its cash accounts in several correspondent banks.  As of March 31, 2011, deposits in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) were approximately $4,011,000.
 
16.Related Party Transactions
 
The Corporation has had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, principal shareholders, executive officers, their immediate families and affiliated companies in which they are principal shareholders (commonly referred to as related parties), on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others.  At March 31, 2011 and 2010, these loans totaled $798,568 and $828,285, respectively.  During the year ended March 31, 2011, total principal additions were $1,768 and total principal payments were $31,485.
 
Deposits from related parties held by the Corporation at March 31, 2011 and 2010 amounted to $693,076 and $742,450, respectively.
 

 
94
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements
(continued)



 

 
17.Condensed Financial Information of the Corporation (Parent Company Only)
 
Condensed Balance Sheets
 
   
March 31,
 
2011
   
2010
 
             
        Assets
           
             
Investment in subsidiary
  $ 48,761,945     $ 48,298,344  
Cash
    14,430       37,100  
Prepaid expenses and other assets
    985,805       931,983  
                 
Total assets
  $ 49,762,180     $ 49,267,427  
                 
                 
        Liabilities and Stockholders’ Equity
               
                 
Liabilities
               
   Borrowings
  $ -     $ 250,000  
   Other liabilities
    1,786       5,552  
                 
Total liabilities
    1,786       255,552  
                 
Stockholders’ Equity
               
    Preferred stock
    12,643,000       12,643,000  
    Common stock
    43,617       43,617  
    Warrants
    603,153       603,153  
    Discount on preferred stock
    (327,701 )     (448,337 )
    Additional paid-in capital
    5,599,052       5,577,958  
    Retained earnings
    32,028,909       31,259,441  
    Accumulated other comprehensive (loss), net
    (829,636 )     (666,957 )
                 
Total stockholders’ equity
    49,760,394       49,011,875  
                 
Total liabilities and stockholders’ equity
  $ 49,762,180     $ 49,267,427  

 
95
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements
(continued)



 

 
17.Condensed Financial Information of the Corporation (Parent Company Only) (continued)
 
Condensed Statements of Operations
 
   
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Income
                 
    Dividend from subsidiary
  $ 990,000     $ 1,500,000     $ -  
    Interest income
    21,069       17,087       54,241  
                         
Total income
    1,011,069       1,517,087       54,241  
                         
Expenses
                       
Interest expense
    861       25,944       59,889  
Noninterest expenses
    171,763       156,733       199,151  
                         
Total expenses
    172,624       182,677       259,040  
                         
Income (loss) before equity in undistributed net
                       
    income of subsidiary
    838,445       1,334,410       (204,799 )
                         
Equity in earnings (loss) of subsidiary, net of distributions
    626,279       2,194,520       (5,693,635 )
                         
Income (loss) before income taxes
    1,464,724       3,528,930       (5,898,434 )
Income tax (benefit)
    (57,530 )     (62,858 )     (75,150 )
                         
Net income (loss)
  $ 1,522,254     $ 3,591,788     $ (5,823,284 )


 
96
 
 
Community Financial Corporation
and Subsidiary

Notes to Consolidated Financial Statements
(continued)


 

 
17.Condensed Financial Information of the Corporation (Parent Company Only) (continued)
 
Condensed Statements of Cash Flows
 
   
Year Ended March 31,
 
2011
   
2010
   
2009
 
                   
Operating activities
                 
    Net income (loss)
  $ 1,522,254     $ 3,591,788     $ (5,823,284 )
    Adjustments
                       
        Equity in (earnings) loss of subsidiary, net of distributions
    (626,279 )     (2,194,520 )     5,693,635  
      (Increase) in prepaid and other assets
    (53,822 )     (67,608 )     (74,316 )
      Stock-based compensation expense
    21,094       8,400       6,826  
      Increase (decrease) in other liabilities
    (3,767 )     3,917       1,635  
                         
Net cash provided by (used in) operating activities
    859,480       1,341,977       (195,504 )
                         
Investing activities
                       
    Capital to subsidiary
    -       -       (13,643,000 )
                         
Net cash (used in) investing activities
    -       -       (13,643,000 )
                         
Financing activities
                       
    Cash dividends paid on common stock
    -       -       (565,814 )
    Cash dividends paid on preferred stock
    (632,150 )     (632,150 )     (98,334 )
    Proceeds from issuance of common stock
    -       -       171,285  
    Proceeds from issuance of preferred stock
    -       -       12,643,000  
    Proceeds from borrowed money
    -       -       4,000,000  
    Repayment of borrowed money
    (250,000 )     (750,000 )     (3,000,000 )
                         
Net cash provided by (used in) financing activities
    (882,150 )     (1,382,150 )     13,150,137  
                         
 (Decrease) in cash
    (22,670 )     (40,173 )     (688,367 )
                         
Cash, beginning of year
    37,100       77,273       765,640  
                         
Cash, end of year
  $ 14,430     $ 37,100     $ 77,273  


 
97
 
 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
There has been no current report on Form 8-K filed within 48 months prior to the date of the most recent financial statements reporting a change in accountants and/or reporting disagreements on any matter of accounting principle on financial statements disclosure.
 
ITEM 9A.  CONTROLS AND PROCEDURES
 
An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) as of March 31, 2011, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management. The Corporation's Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. In addition, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended March 31, 2011, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all errors and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls may be circumvented by the individual acts of some persons, by collusion of two or more people, or by override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
 
Management's Report on Internal Control over Financial Reporting
 
The management of Community Financial Corporation is responsible for establishing and maintaining adequate internal control over financial reporting.  This internal control system has been designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of the Company’s published financial statements.

All internal control systems, no matter how well designed, have inherent limitations.  Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

The management of Community Financial Corporation has assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2011.  To make the assessment, we used the criteria for effective internal control over financial reporting described in Internal Control –
 
 
 
98
 
 
 
 
 
Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on our assessment, we believe that, as of March 31, 2011, the Company’s internal control over financial reporting was effective based on those criteria.
 
This annual report does not include the attestation report of the Corporation’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Corporation’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Corporation to provide only management’s report in this annual report.
 
ITEM 9B.  OTHER INFORMATION
 
None.
 
PART III
 
ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE
 
Directors and Executive Officers.  Information concerning directors of the Registrant is incorporated herein by reference from our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders, copy of which will be filed not later than 120 days after the close of the fiscal year.
 
Information concerning executive officers is set forth in Item 1 of this report under the caption “Executive Officers.”
 
Compliance with Section 16(a).  Information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference from our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
Audit Committee Matters and Audit Committee Financial Expert.  Information concerning the audit committee of the Company’s Board of Directors, including information regarding audit committee financial experts serving on the audit committee, is incorporated herein by reference from the definitive Proxy Statement for the 2011 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
Code of Ethics.  The Company has adopted a written Code of Ethics based upon the standards set forth under Item 406 of Regulation S-K of the Securities Exchange Act.  The Code of Ethics applies to all of the Company’s directors, officers and employees.  A copy of the Company’s Code of Ethics was filed with the SEC as Exhibit 14 to its Annual Report on Form 10-KSB for the year ended March 31, 2004 and as posted in the Investor Relations section of our web site at www.cbnk.com.  You may obtain a copy of the Code of Ethics free of charge from the Company by writing to the Secretary of Community Financial Corporation at 38 North Central Avenue, Staunton, Virginia 24401, or by calling (540) 886-0796.
 
Nomination Procedures.  There have been no material changes to the procedures by which shareholders may recommend nominees to the Company’s Board of Directors.
 
 
 
99
 
 
 
 
 
ITEM 11.  EXECUTIVE COMPENSATION
 
Information concerning executive compensation is incorporated herein by reference from our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
The following table summarizes our equity compensation plans as of March 31, 2011.
 
Equity Compensation Plans
Plan Category
 
Number of securities
to be issued upon
exercise of out-
standing options,
warrants and rights
   
Weighted-average
exercise price of
outstanding options,
warrants and rights
   
Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column)
 
                   
Equity compensation
plans approved by
security holders
    255,900     $ 9.06       17,100  
                         
Equity compensation
plans not approved
by security holders
    0       0       0  
                         
Total
    255,900     $ 9.06       17,100  

The number of shares available for issuance are adjusted for changes in capitalization due to reorganization, recapitalization, stock splits, stock dividends combination or exchange of shares, merger, consolidation or any change in the corporate structure.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
 
INDEPENDENCE
 
Information concerning certain relationships and transactions and director dependence is incorporated herein by reference from our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
 
Information concerning fees and services by our principal accountants is incorporated herein by reference from our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
 
 
 
100
 
 
 
 
 
PART IV
 
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
 
See Exhibit Index.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
101
 
 

SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
COMMUNITY FINANCIAL CORPORATION
 
Date:     June 24, 2011
By:
/s/ Norman C. Smiley, III
   
Norman C. Smiley, III
(Duly Authorized Representative)

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 
By:
/s/Norman C. Smiley, III
By:
/s/ James R. Cooke, Jr.
 
Norman C. Smiley, III
Director, President and Chief
Executive Officer
     (Principal Executive Officer)
 
James R. Cooke, Jr.
Chairman of the Board
and Director
       
Date:
June 24, 2011
Date:
June 24, 2011
       
 
By:
 
/s/ P. Douglas Richard
 
By:
 
/s/ Charles F. Andersen
 
P. Douglas Richard
Vice Chairman of the Board
and Director
 
Charles F. Andersen
Director
       
Date:
June 24, 2011
Date:
June 24, 2011
       
 
By:
 
/s/ Dale C. Smith
 
By:
 
/s/ Morgan N. Trimyer, Jr.
 
Dale C. Smith
Director
 
 
Morgan N. Trimyer, Jr.
Director
 
Date:
June 24, 2011
Date:
June 24, 2011
       
 
By:
 
/s/ R. Jerry Giles
 
By:
 
/s/ Charles W. Fairchilds
 
R. Jerry Giles
Chief Financial Officer
   (Principal Financial and     Accounting Officer)
 
Charles W. Fairchilds
Director
       
Date:
June 24, 2011
Date:
June 24, 2011
       

 
102
 
 


INDEX TO EXHIBITS
 
Regulation
S-K Exhibit
Number
 
Document
3.1
 
Amended and Restated Articles of Incorporation, filed on July 5, 1996 as an exhibit to the Registrant’s Definitive Proxy Statement on Schedule 14A (SEC File No. 000-18265), are incorporated herein by reference.
 
3.2
 
Certificate of Amendment and Articles of Amendment for the Series A Preferred Stock, filed on December 22, 2008, as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
3.3
 
Bylaws, as amended and restated and currently in effect, filed on December 20, 2007 as Exhibit 3.2 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
4.1
 
Registrant’s Specimen Common Stock Certificate, filed on June 29, 1999 as Exhibit 4 to the Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 1999, is incorporated herein by reference.
 
4.2
 
Registrant’s Form of Certificate for the Series A Preferred Stock, filed on December 22, 2008, as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
4.3
 
Registrant’s Form of Warrant for Purchase of Shares of Common Stock, filed on December 22, 2008, as Exhibit 4.2 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
10.1
 
Registrant’s 1996 Incentive Plan, filed on July 5, 1996 as an exhibit to the Registrant’s Definitive Proxy Statement on Schedule 14A (SEC File No. 000-18265), is incorporated herein by reference.
 
10.2
 
Form of Change in Control Agreement by and between Community Bank and each of R. Jerry Giles and Benny N. Werner, filed on May 5, 2006 as Exhibit 99.5 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
10.3
 
Retirement Agreements by and between Community Bank and Non-Employee Directors filed on June 29, 2004 as an exhibit to the Registrant’s Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 2004, and incorporated here by reference.
 
10.4
 
Form of First Amendment to the Retirement Agreements by and between Community Bank and Non-Employee Directors, filed on June 29, 2005 as an exhibit to the Registrant’s Annual Report on Form 10-K (SEC File No. 000-18265) for the fiscal year ended March 31, 2005, is incorporated here by reference.
 
 
 
103
 
 
 
 

 
10.5
 
Salary Continuance Agreements by and between Community Bank and Officers Giles, Smiley and Werner filed on June 29, 2004 as an exhibit to the Registrant’s Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 2004, and incorporated here by reference.
 
10.6
 
Form of Director Deferred Fee Agreement, as amended, filed on June 29, 2005 as an exhibit to the Registrant’s Annual Report on Form 10-K (SEC File No. 000-18265) for the fiscal year ended March 31, 2005, is incorporated here by reference.
 
10.7
 
Registrant’s 2003 Stock Option and Incentive Plan, filed on June 26, 2003 as an exhibit to the Registrant’s Definitive Proxy Statement on Schedule 14A (SEC File No. 000-18265), is incorporated herein by reference.
 
10.8
 
Form of Incentive Stock Option Agreement and Non-Qualified Stock Option Agreement for Registrant’s 2003 Stock Option and Incentive Plan, filed on August 12, 2005 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-18265) for the quarter ended June 30, 2005, are incorporated herein by reference.
 
10.9
 
Employment Agreement by and between Community Bank and Norman C. Smiley, III, filed on June 16, 2008 as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
10.10
 
Change in Control Agreement by and between Community Financial Corporation and Norman C. Smiley, III, filed on June 16, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
10.11
 
Form of Change in Control Agreement by and between Community Financial Corporation and Lyle Moffett, filed on July 1, 2008 as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
10.12
 
Form of Change in Control Agreement by and between Community Financial Corporation and John Howerton is filed with this Form 10-Q.
 
10.13
 
Letter Agreement, including Schedule A, and Securities Purchase Agreement, dated December 19, 2008, between Community Financial Corporation and United States Department of the Treasury, with respect to the issuance and sale of the Series A Preferred Stock and the Warrant, filed on December 22, 2008, as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
10.14
 
Form of Compensation Modification Agreement and Waiver, executed by each of P. Douglas Richard, Norman C. Smiley, III and Chris P. Kyriakides, filed on December 22, 2008, as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
 
11
 
Statement re computation of per share earnings (see Note 12 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K).


 
104
 
 
 

 

14
 
Code of Ethics, filed on June 29, 2004 as an exhibit to the Registrant’s Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 2004, and incorporated here by reference.
 
21
 
Subsidiaries of the Registrant, filed on June 29, 2005 as an exhibit to the Registrant’s Annual Report on Form 10-K (SEC File No. 000-18265) for the fiscal year ended March 31, 2005, is incorporated here by reference.
 
23
 
Consent of Independent Auditors
 
31.1
 
Rule 13(a)-14(a) Certification (Chief Executive Officer)
 
31.2
 
Rule 13(a)-14(a) Certification (Chief Financial Officer)
 
32
 
Section 1350 Certifications
 
99.1
 
Certification of Principal Executive Officer Pursuant to 31 CFR §30.15
 
99.2
 
Certification of Principal Financial Officer Pursuant to 31 CFR §30.15

 
105