UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

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

Commission file number: 0-15536

CODORUS VALLEY BANCORP, INC.

(Exact name of registrant as specified in its charter)

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

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

717-747-1519

Not Applicable
if changed since the last report.)

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

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

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. On November 5, 2009, 4,061,445 shares of common stock, par value $2.50, were outstanding.

 

 

Codorus Valley Bancorp, Inc.
Form 10-Q Index

		Page #
PART I – FINANCIAL INFORMATION
Item 1. Financial statements (unaudited):
Consolidated balance sheets			3
Consolidated statements of income			4
Consolidated statements of cash flows			5
Consolidated statements of changes in shareholders’ equity			6
Notes to consolidated financial statements			7
Item 2. Management’s discussion and analysis of financial condition and results of operations			20
Item 3. Quantitative and qualitative disclosures about market risk			37
Item 4T. Controls and procedures			37
PART II – OTHER INFORMATION
Item 1. Legal proceedings			37
Item 1A. Risk factors			37
Item 2. Unregistered sales of equity securities and use of proceeds			37
Item 3. Defaults upon senior securities			37
Item 4. Submission of matters to a vote of security holders			37
Item 5. Other information			37
Item 6. Exhibits			38
SIGNATURES			39
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I — FINANCIAL INFORMATION

Item 1.		Financial Statements

Codorus Valley Bancorp, Inc.

Consolidated Balance Sheets

Unaudited

		September 30,				December 31,
(dollars in thousands, except per share data)		2009				2008
Assets
Interest bearing deposits with banks		$	1,319			$	3,254
Cash and due from banks			10,339				11,621
Total cash and cash equivalents			11,658				14,875
Securities available-for-sale			180,147				72,163
Securities held-to-maturity (fair value $2,372 — 2009 and $2,283 — 2008)			2,438				2,432
Restricted investment in bank stocks, at cost			4,262				2,692
Loans held for sale			2,342				7,373
Loans (net of deferred fees of $703 — 2009 and $566 — 2008)			637,128				573,078
Less-allowance for loan losses			(6,514	)			(4,690	)
Net loans			630,614				568,388
Premises and equipment, net			11,535				11,900
Other assets			26,831				22,943
Total assets		$	869,827			$	702,766
Liabilities
Deposits
Noninterest bearing		$	54,664			$	47,781
Interest bearing			658,311				550,348
Total deposits			712,975				598,129
Short-term borrowings			—				18,283
Long-term debt			69,280				19,186
Junior subordinated debt			10,310				10,310
Other liabilities			4,715				4,677
Total liabilities			797,280				650,585
Shareholders’ equity
Preferred stock, par value $2.50 per share; $1,000 liquidation preference, 1,000,000 shares authorized; 16,500 shares issued and outstanding — 2009 and 0 — 2008			15,790				—
Common stock, par value $2.50 per share; 10,000,000 shares authorized; 4,061,445 shares issued and outstanding — 2009 and 4,017,033 — 2008			10,154				10,043
Additional paid-in capital			36,904				35,877
Retained earnings			5,856				5,057
Accumulated other comprehensive income			3,843				1,204
Total shareholders’ equity			72,547				52,181
Total liabilities and shareholders’ equity		$	869,827			$	702,766

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements of Income

Unaudited

		Three months ended								Nine months ended
		September 30,								September 30,
(dollars in thousands, except per share data)		2009				2008				2009				2008
Interest income
Loans, including fees		$	8,945			$	8,215			$	25,578			$	24,286
Investment securities
Taxable			837				569				2,514				1,823
Tax-exempt			585				315				1,484				949
Dividends			2				18				11				49
Federal funds sold			3				48				8				330
Other			10				—				39				2
Total interest income			10,382				9,165				29,634				27,439
Interest expense
Deposits			3,711				3,674				11,077				10,712
Federal funds purchased and other short-term borrowings			—				33				27				34
Long-term and junior subordinated debt			520				324				1,591				1,016
Total interest expense			4,231				4,031				12,695				11,762
Net interest income			6,151				5,134				16,939				15,677
Provision for loan losses			600				353				2,483				1,413
Net interest income after provision for loan losses			5,551				4,781				14,456				14,264
Noninterest income
Trust and investment services fees			347				307				961				983
Income from mutual fund, annuity and insurance sales			312				390				1,016				1,374
Service charges on deposit accounts			592				592				1,698				1,675
Income from bank owned life insurance			162				73				480				208
Other income			144				121				446				367
Gain on sales of mortgages			191				135				761				303
Gain on sales of securities			—				—				291				123
Total noninterest income			1,748				1,618				5,653				5,033
Noninterest expense
Personnel			3,199				2,744				9,702				8,277
Occupancy of premises, net			413				367				1,341				1,144
Furniture and equipment			427				349				1,263				1,067
Postage, stationery and supplies			104				117				353				352
Professional and legal			121				110				304				307
Marketing and advertising			235				249				475				531
FDIC insurance			278				86				1,154				238
Debit card processing			131				136				383				377
Charitable donations			7				20				214				621
Telephone			132				67				387				151
Foreclosed real estate			310				86				415				157
Other			791				592				2,084				1,339
Total noninterest expense			6,148				4,923				18,075				14,561
Income before income taxes (benefit)			1,151				1,476				2,034				4,736
Provision (benefit) for income taxes			75				346				(298	)			1,112
Net income			1,076				1,130				2,332				3,624
Preferred stock dividends and discount accretion			245				—				712				—
Net income available to common shareholders		$	831			$	1,130			$	1,620			$	3,624
Net income per common share, basic		$	0.21			$	0.28			$	0.40			$	0.92
Net income per common share, diluted		$	0.21			$	0.28			$	0.40			$	0.91

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements of Cash Flows

Unaudited

		Nine months ended
		September 30,
(dollars in thousands)		2009				2008
Cash flows from operating activities
Net income		$	2,332			$	3,624
Adjustments to reconcile net income to net cash provided by operations
Depreciation			1,047				880
Provision for loan losses			2,483				1,413
Provision for foreclosed real estate			189				—
Amortization of investment in real estate partnership			406				392
Increase in cash surrender value of life insurance investment			(480	)			(208	)
Originations of held for sale mortgages			(64,025	)			(29,376	)
Proceeds from sales of held for sale mortgages			66,232				23,926
Gain on sales of held for sale mortgages			(761	)			(303	)
Gain on sales of securities			(291	)			(123	)
Stock-based compensation expense			136				40
(Increase) decrease in accrued interest receivable			(942	)			224
Increase in other assets			(1,455	)			(1,081	)
Increase (decrease) in accrued interest payable			100				(46	)
Decrease in other liabilities			(59	)			(180	)
Other, net			353				(181	)
Net cash provided by (used in) operating activities			5,265				(999	)
Cash flows from investing activities
Securities available-for-sale
Purchases			(131,440	)			(16,016	)
Maturities and calls			18,332				15,665
Sales			8,947				6,639
Securities held-to-maturity, calls			—				1,036
Increase in restricted investment in bank stock			(1,570	)			(980	)
Net increase in loans made to customers			(63,979	)			(84,009	)
Purchases of premises and equipment			(682	)			(2,276	)
Investment in life insurance			(6	)			(7	)
Net cash used in investing activities			(170,398	)			(79,948	)
Cash flows from financing activities
Net increase (decrease) in demand and savings deposits			58,799				(25,000	)
Net increase in time deposits			56,047				65,923
Net (decrease) increase in short-term borrowings			(18,283	)			12,400
Proceeds from issuance of long-term debt			66,000				—
Repayment of long-term debt			(15,906	)			(869	)
Cash dividends paid to preferred shareholders			(495	)			—
Cash dividends paid to common shareholders			(926	)			(1,526	)
Net proceeds from issuance of preferred stock and common stock warrants			16,461				—
Issuance of common stock			219				915
Purchase of treasury stock			—				(127	)
Issuance of treasury stock			—				104
Cash paid in lieu of fractional shares			—				(5	)
Net cash provided by financing activities			161,916				51,815
Net decrease in cash and cash equivalents			(3,217	)			(29,132	)
Cash and cash equivalents at beginning of year			14,875				39,053
Cash and cash equivalents at end of period		$	11,658			$	9,921

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

Unaudited

																		Accumulated
										Additional								Other
		Preferred				Common				Paid-in				Retained				Comprehensive				Treasury
(dollars in thousands, except share data)		Stock				Stock				Capital				Earnings				Income				Stock				Total
For the nine months ended September 30, 2009
Balance, January 1, 2009		$	—			$	10,043			$	35,877			$	5,057			$	1,204			$	—			$	52,181
Comprehensive income:
Net income															2,332												2,332
Other comprehensive gain, net of tax:
Unrealized gains on securities, net																			2,639								2,639
Total comprehensive income																											4,971
Preferred stock and common stock warrants issued, net of issuance costs of $39			15,678								783																16,461
Preferred stock discount accretion			112												(112	)											—
Common stock cash dividends ($0.23 per share)															(926	)											(926	)
Preferred stock dividends															(495	)											(495	)
Stock-based compensation											136																136
Issuance of common stock:
23,164 shares under dividend reinvestment and stock purchase plan							58				120																178
7,581 shares under employee stock purchase plan							19				22																41
13,667 shares of stock-based compensation awards							34				(34	)															—
Balance, September 30, 2009		$	15,790			$	10,154			$	36,904			$	5,856			$	3,843			$	—			$	72,547
For the nine months ended September 30, 2008
Balance, January 1, 2008		$	—			$	9,347			$	32,516			$	6,267			$	285			$	—			$	48,415
Cumulative effect adjustment for adoption of EITF Issue No. 06-04															(703	)											(703	)
Comprehensive income:
Net income															3,624												3,624
Other comprehensive loss, net of tax:
Unrealized losses on securities, net																			(168	)							(168	)
Total comprehensive income																											3,456
Common stock cash dividends ($0.386 per share, adjusted)															(1,526	)											(1,526	)
Common stock 5% stock dividend — 187,363 shares at fair value							469				2,492				(2,966	)											(5	)
Purchase of 8,002 shares for treasury																							(127	)			(127	)
Stock-based compensation											40																40
Issuance of common stock:
62,710 shares under stock option plans							157				661																818
7,997 shares under the dividend reinvestment and stock purchase plan							20				77																97
Re-issuance of 8,002 shares under employee stock purchase plan											(23	)											127				104
Balance, September 30, 2008		$	—			$	9,993			$	35,763			$	4,696			$	117			$	—			$	50,569

See accompanying notes.

Notes to Consolidated Financial Statements (Unaudited)

Note 1—Basis of Presentation

The interim unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q, and FASB Accounting Standards Codification (ASC) 270-10-S99 (Prior authoritative literature: Article 10 of Regulation S-X). Accordingly, the interim financial statements do not include all of the financial information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the interim financial statements include all adjustments necessary to present fairly the financial condition and results of operations for the reported periods, and are of a normal and recurring nature.

These statements should be read in conjunction with the notes to the audited financial statements contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2008.

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

The results of operations for the nine-month period ended September 30, 2009 are not necessarily indicative of the results to be expected for the full year.

In accordance with FASB ASC 855-10-25 (Prior authoritative literature: FAS No. 165, “Subsequent Events”), the Corporation evaluated the events and transactions that occurred after the balance sheet date of September 30, 2009, but before the financial statements were issued for potential recognition or disclosure. In preparing these financial statements, the Corporation evaluated the events and transactions that occurred from September 30, 2009 through November 10, 2009, the date these financial statements were issued.

Note 2—Significant Accounting Policies

Stock Dividend and Per Share Computations

All per share computations include the effect of stock dividends declared. The weighted average number of shares of common stock outstanding used for basic and diluted calculations are provided below.

		Three months ended								Nine months ended
		September 30,								September 30,
(in thousands, except per share data)		2009				2008				2009				2008
Net income available to common shareholders		$	831			$	1,130			$	1,620			$	3,624
Weighted average shares outstanding (basic)			4,051				3,986				4,036				3,953
Effect of dilutive stock options			0				16				0				35
Weighted average shares outstanding (diluted)			4,051				4,002				4,036				3,988
Basic earnings per common share		$	0.21			$	0.28			$	0.40			$	0.92
Diluted earnings per common share		$	0.21			$	0.28			$	0.40			$	0.91
Anti-dilutive stock options and common stock warrants excluded from the computation of earnings per share			498				85				498				85

Comprehensive Income

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

		Three months ended								Nine months ended
		September 30,								September 30,
(dollars in thousands)		2009				2008				2009				2008
Unrealized holding gains (losses) arising during the period		$	4,604			$	326			$	4,289			$	(132	)
Reclassification adjustment for gains included in income			—				—				(291	)			(123	)
Net unrealized gains (losses)			4,604				326				3,998				(255	)
Tax effect			(1,565	)			(111	)			(1,359	)			87
Net of tax amount		$	3,039			$	215			$	2,639			$	(168	)

Cash Flow Information

For purposes of the statements of cash flows, the Corporation considers interest bearing deposits with banks, cash and due from banks, and federal funds sold to be cash and cash equivalents. Noncash items for the nine-month periods ended September 30, 2009 and 2008 consisted of the transfer of loans to foreclosed real estate for $2,992,000 and $1,674,000, respectively, and the transfer of loans held for sale to loans for investment for $3,585,000 and $0, respectively.

Supplemental Benefit Plans

In January 2009, the Corporation incurred a non-recurring cost of $242,000 to restructure employee benefit plans. Restructuring the benefit plans resulted in federal income tax benefit so that the overall transaction had an insignificant impact on net income.

Income Taxes

The provision for income taxes for the current three-month period was $75,000 and for the nine-month period ended September 30, 2009 was a $298,000 credit, or tax benefit, which reflected a low level of pretax income and a significant increase in tax-exempt income. The year-to-date tax benefit included a non-recurring federal income tax benefit of $242,000 associated with restructuring employee benefit plans in the first quarter of 2009.

Reclassification

Certain amounts in the 2008 consolidated financial statements have been reclassified to conform to the 2009 presentation.

Recent Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140. This statement prescribes the information that a reporting entity must provide in its financial reports 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 in transferred financial assets. Specifically, among other aspects, SFAS 166 amends Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, or SFAS 140, by removing the concept of a qualifying special-purpose entity from SFAS 140 and removes the exception from applying FIN 46(R) to variable interest entities that are qualifying special-purpose entities. It also modifies the financial-components approach used in SFAS 140. SFAS 166 is effective for fiscal years beginning after November 15, 2009. We have not determined the effect that the adoption of SFAS 166 will have on our financial position or results of operations.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162. SFAS 168 replaces SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, to establish the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in preparation of financial statements in conformity with generally accepted accounting principles in the United States. The new standard became effective for interim and annual periods ending after September 15, 2009. The adoption of this statement did not have a material impact on the Corporation’s consolidated financial position or results of operations. Technical references to generally accepted accounting principals included in the Notes to Consolidated Financial Statements are provided under the new FASB ASC structure with the prior terminology included parenthetically.

In November 2008, the SEC released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (IASB). Under the proposed roadmap, the Company may be required to prepare financial statements in accordance with IFRS as early as 2014. The SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. The Corporation is currently assessing the impact that this potential change would have on its consolidated financial statements, and it will continue to monitor the development of the potential implementation of IFRS.

Note 3—Securities Available-for-Sale and Held-to-Maturity

In April 2009, the FASB issued FASB ASC 320-10-65 (Prior authoritative literature: FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments). FASB ASC 320-10-65 clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. For debt securities, management must assess whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment. Previously, this assessment required management to assert it has both the intent and the ability to hold a security for a period of time sufficient to allow for an anticipated recovery in fair value to avoid recognizing an other-than-temporary impairment. This change does not affect the need to forecast recovery of the value of the security through either cash flows or market price.

In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is unlikely that the investor will be required to sell the debt security prior to its anticipated recovery, FASB ASC 320-10-65 changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. The other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income. FASB ASC 320-10-65 is effective for the Corporation for interim and annual reporting periods ending after June 15, 2009 and thereafter. The adoption of FASB ASC 320-10-65 did not have a material impact on the Corporation’s financial condition or results of operation.

A summary of available-for-sale and held-to-maturity securities at September 30, 2009 and December 31, 2008 is provided below.

														Estimated
		Amortized				Gross Unrealized								Fair
(dollars in thousands)		Cost				Gains				Losses				Value
September 30, 2009
Available-for-sale
Debt securities
U.S. agency		$	13,528			$	153			$	—			$	13,681
State and municipal			73,355				3,087				(60	)			76,382
U.S. agency mortgage-backed			87,441				2,643				—				90,084
Total available-for-sale		$	174,324			$	5,883			$	(60	)		$	180,147
Held-to-maturity
Debt securities-corporate trust preferred		$	2,438				2				(68	)		$	2,372
Total held-to-maturity		$	2,438			$	2			$	(68	)		$	2,372
December 31, 2008
Available-for-sale
Debt securities
U.S. agency		$	5,001			$	134			$	—			$	5,135
State and municipal			32,392				926				(242	)			33,076
U.S. agency mortgage-backed		$	32,946			$	1,012			$	(6	)		$	33,952
Total available-for-sale		$	70,339			$	2,072			$	(248	)		$	72,163
Held-to-maturity
Debt securities-corporate trust preferred		$	2,432			$	22			$	(171	)		$	2,283
Total held-to-maturity		$	2,432			$	22			$	(171	)		$	2,283

The amortized cost and estimated fair value of debt securities at September 30, 2009 by contractual maturity are shown below. Actual maturities may differ from contractual maturities if call options on select debt issues are exercised in the future. Mortgage-backed securities are included in the maturity categories based on average expected life.

		Available-for-sale								Held-to-maturity
		Amortized				Fair				Amortized				Fair
(dollars in thousands)		Cost				Value				Cost				Value
Due in one year or less		$	4,295			$	4,348			$	516			$	518
Due after one year through five years			112,948				116,453				—				—
Due after five years through ten years			51,753				53,760				—				—
Due after ten years			5,328				5,586				1,922				1,854
Total debt securities		$	174,324			$	180,147			$	2,438			$	2,372

Gross gains realized from the sale of available-for-sale securities were $291,000 and $123,000 for the nine months ended September 30, 2009 and 2008, respectively. Realized gains and losses from the sale of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security and are shown net as a separate line item in the income statement. Securities, issued by agencies of the federal government, with a carrying value of $66,987,000 and $24,843,000 on September 30, 2009 and December 31, 2008, respectively, were pledged to secure public and trust deposits.

The table below shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2009 and December 31, 2008.

		Less than 12 months								12 months or more								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(dollars in thousands)		Value				Losses				Value				Losses				Value				Losses
September 30, 2009
Available-for-sale securities
State and municipal		$	4,147			$	59			$	503			$	1			$	4,650			$	60
Total temporarily impaired debt securities, available- for-sale		$	4,147			$	59			$	503			$	1			$	4,650			$	60
Held-to-maturity
Debt securities-corporate trust preferred		$	—			$	—			$	1,853			$	68			$	1,853			$	68
December 31, 2008
Available-for-sale securities
State and municipal		$	6,046			$	242			$	—			$	—			$	6,046			$	242
U.S. agency mortgage-backed			599				6				—				—				599				6
Total temporarily impaired debt securities, available- for-sale		$	6,645			$	248			$	—			$	—			$	6,645			$	248
Held-to-maturity
Debt securities-corporate trust preferred		$	1,920			$	171			$	—			$	—			$	1,920			$	171

At September 30, 2009, the unrealized losses within the less than 12 months category of $59,000 in the available-for-sale portfolio were attributable to eight different municipality securities. The unrealized loss within the 12 months or more category of $1,000 in the available-for-sale portfolio was attributable to one municipal security and $68,000 in the held-to-maturity portfolio was attributable to three corporate trust preferred securities.

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

Management believes that unrealized losses at September 30, 2009 were primarily the result of changes in market interest rates and that it has the ability to hold these investments for a time necessary to recover the amortized cost. To date, the Corporation has collected all interest and principal on its investment securities as scheduled. Management believes that collection of the contractual principal and interest is probable and therefore, all impairment is considered to be temporary.

Note 4—Restricted Investment in Bank Stocks

Restricted stock, which represents required investments in the common stock of correspondent banks, is carried at cost and as of September 30, 2009 and December 31, 2008 consists of the common stock of FHLB of Pittsburgh (FHLB) and Atlantic Central Bankers Bank (ACBB). In December 2008, the FHLB notified member banks that it was suspending dividend payments and the repurchase of capital stock.

Management evaluates the restricted stock for impairment in accordance with FASB ASC 942-325-35 (Prior authoritative literature: Statement of Position (SOP) 01-6, Accounting by Certain Entities (Including Entities With Trade Receivables) That Lend to or Finance the Activities of Others). Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as: (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB.

Management believes no impairment charge was necessary related to the restricted stock as of September 30, 2009.

Note 5—Loans

The composition of the loan portfolio was as follows:

		September 30,				December 31,
(dollars in thousands)		2009				2008
Commercial, industrial and agricultural		$	400,311			$	348,111
Real estate – construction and development			110,985				100,088
Total commercial related loans			511,296				448,199
Real estate – residential mortgages			71,757				64,928
Installment			54,075				59,951
Total consumer related loans			125,832				124,879
Total loans		$	637,128			$	573,078

Note 6—Deposits

The composition of deposits was as follows:

		September 30,				December 31,
(dollars in thousands)		2009				2008
Noninterest bearing demand		$	54,664			$	47,781
NOW			51,466				50,027
Money market			181,489				133,924
Savings			22,949				20,037
Time CDs less than $100,000			236,730				206,293
Time CDs $100,000 or more			165,677				140,067
Total deposits		$	712,975			$	598,129

Note 7—Long-term Debt

PeoplesBank’s obligations to the Federal Home Loan Bank of Pittsburgh (FHLBP) are primarily fixed rate instruments. A summary of long-term debt at September 30, 2009 and December 31, 2008, is provided below. The increase in long-term debt since year-end 2008 provided the financing for a leverage strategy, which is discussed in other sections of this report.

		September 30,				December 31,
(dollars in thousands)		2009				2008
Obligations of PeoplesBank to FHLBP
Due December 2009, 3.47%, convertible quarterly after December 2006		$	5,000			$	5,000
Due February 2010, 1.55%			15,000				—
Due June 2010, 4.32%			6,000				6,000
Due January 2011, 2.06%			14,000				—
Due January 2011, 4.30%, amortizing			3,749				3,964
Due August 2011, 2.42%			12,000				—
Due January 2012, 2.34%			10,000				—
Due June 2012, 4.25%, amortizing			1,041				1,313
Due May 2013, 3.46%, amortizing			2,036				2,422
			68,826				18,699
Capital lease obligation			454				487
Total long-term debt		$	69,280			$	19,186

Note 8—Regulatory Matters

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

Quantitative measures established by regulators to ensure capital adequacy require Codorus Valley and PeoplesBank to maintain minimum ratios, as set forth below, to total and Tier 1 capital as a percentage of risk-weighted assets, and of Tier 1 capital to quarter-to-date average assets (leverage ratio). Management believes that Codorus Valley and PeoplesBank were well capitalized on September 30, 2009, based on FDIC capital guidelines. The increase in the capital ratios since year-end 2008 primarily reflects the sale of $16.5 million of cumulative perpetual preferred stock, which qualifies as Tier 1 capital, to the U.S. Department of the Treasury under its Capital Purchase Program, described more fully in Note 9—Shareholders’ Equity.

										Minimum for								Well Capitalized
		Actual								Capital Adequacy								Minimum*
(dollars in thousands)		Amount				Ratio				Amount				Ratio				Amount				Ratio
Codorus Valley Bancorp, Inc. (consolidated)
at September 30, 2009
Capital ratios:
Tier 1 risk based		$	78,369				11.86	%		$	26,441				4.00	%			n/a				n/a
Total risk based			84,883				12.84				52,881				8.00				n/a				n/a
Leverage			78,369				9.14				34,312				4.00				n/a				n/a
at December 31, 2008
Capital ratios:
Tier 1 risk based		$	60,613				10.03	%		$	24,179				4.00	%			n/a				n/a
Total risk based			65,303				10.80				48,357				8.00				n/a				n/a
Leverage			60,613				9.12				26,576				4.00				n/a				n/a
PeoplesBank, A Codorus Valley Company
at September 30, 2009
Capital ratios:
Tier 1 risk based		$	73,106				11.15	%		$	26,223				4.00	%		$	39,334				6.00	%
Total risk based			79,620				12.15				52,446				8.00				65,557				10.00
Leverage			73,106				8.58				34,097				4.00				42,621				5.00
at December 31, 2008
Capital ratios:
Tier 1 risk based		$	56,857				9.49	%		$	23,964				4.00	%		$	35,947				6.00	%
Total risk based			61,547				10.27				47,929				8.00				59,911				10.00
Leverage			56,857				8.63				26,359				4.00				32,949				5.00

Note 9—Shareholders’ Equity

Preferred Stock Issued to the United States Department of the Treasury

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

On January 9, 2009, the Corporation entered into a Securities Purchase Agreement with the Treasury pursuant to which the Corporation sold to the Treasury, for an aggregate purchase price of $16.5 million, 16,500 shares of non-voting cumulative perpetual preferred stock, $1,000 liquidation value, $2.50 par value, and warrants to purchase up to 263,859 shares of common stock, par value $2.50 per share, with an exercise price of $9.38 per share. As a condition under the CPP, without the consent of the Treasury, the Corporation’s share repurchases are limited to purchases in connection with the administration of any employee benefit plan, including purchases to offset share dilution in connection with any such plans. This restriction is effective until January 9, 2012 or until the Treasury no longer owns any of the Corporation’s preferred shares issued under the CPP. The Corporation’s preferred stock is included as a component of Tier 1 capital in accordance with regulatory capital requirements. See Note 8, “Regulatory Matters” for details of the Corporation’s regulatory capital.

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

Common Stock Warrants

The 263,859 shares of common stock warrants issued to the Treasury have a term of 10 years (expiring January 9, 2019) and are exercisable at any time, in whole or in part, at an exercise price of $9.38 per share (subject to certain anti-dilution adjustments). The Treasury may not exercise the warrants for, or transfer the warrants with respect to, more than half of the initial shares of common stock underlying the warrants prior to the earlier of (i) the date on which the Corporation receives aggregate gross proceeds of not less than $16.5 million from one or more qualified equity offerings and (ii) December 31, 2009. The number of shares to be delivered upon settlement of the warrants will be reduced by 50% if the Corporation receives aggregate gross proceeds of at least 100 percent of the aggregate liquidation preference of the preferred stock from one or more qualified equity offerings prior to December 31, 2009.

The $16.5 million of proceeds was allocated to the preferred stock and the warrants based on their relative fair values at issuance ($15.7 million was allocated to the preferred stock and $783,000 to the warrants). The difference between the initial value allocated to the preferred stock of approximately $15.7 million and the liquidation value of $16.5 million, i.e., the preferred stock discount, will be charged to retained earnings over the first five years of the contract as an adjustment to the dividend yield using the effective yield method.

Note 10—Contingent Liabilities

Management was not aware of any material contingent liabilities on September 30, 2009.

Note 11—Guarantees

Codorus Valley does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are written conditional commitments issued by PeoplesBank to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued, have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $4,792,000 of standby letters of credit outstanding on September 30, 2009, compared to $4,010,000 on December 31, 2008. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payment required under the corresponding letters of credit. The amount of the liability as of September 30, 2009 and December 31, 2008, for guarantees under standby letters of credit issued, was not material. Many of the commitments are expected to expire without being drawn and therefore, generally do not present significant liquidity risk to the Corporation or PeoplesBank.

Note 12—Fair Value Measurements and Fair Values of Financial Instruments

In September 2006, the FASB issued FASB ASC 820-10 (Prior authoritative literature: FASB Statement No. 157, “Fair Value Measurements”), which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB ASC 820-10 applies to other accounting pronouncements that require or permit fair value measurements. As permitted by the accounting guidance, the Corporation began applying FASB ASC 820-10 to all non-financial assets and liabilities measured on a non-recurring basis effective for its fiscal year beginning January 1, 2009.

In April 2009, the FASB issued FASB ASC 820-10-65 (Prior authoritative literature: FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly). FASB ASC 820-10, defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. FASB ASC 820-10-65 provides additional guidance on determining when the volume and level of activity for the asset or liability has significantly decreased. FASB ASC 820-10-65 also includes guidance on identifying circumstances when a transaction may not be considered orderly.

FASB ASC 820-10-65 provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with FASB ASC 820-10.

FASB ASC 820-10-65 clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. FASB ASC 820-10-65 provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

FASB ASC 820-10-65 is effective for interim and annual reporting periods for the Corporation for the quarter ended June 30, 2009 and thereafter. The adoption of FASB ASC 820-10-65 did not have a material impact on the Corporation’s financial condition or results of operations.

FASB ASC 820-10 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820-10 are as follows:

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

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

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

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

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

						(Level 1)				(Level 2)				(Level 3)
						Quoted Prices in				Significant Other				Significant Other
						Active Markets for				Observable				Unobservable
(dollars in thousands)						Identical Assets				Inputs				Inputs
September 30, 2009
Measured at fair value on a recurring basis:
Securities available-for-sale		$	180,147				—			$	180,147				—
Measured at fair value on a nonrecurring basis:
Impaired loans		$	3,467				—				—			$	3,467
Other real estate owned		$	668				—				—			$	668
December 31, 2008
Measured at fair value on a recurring basis:
Securities available-for-sale		$	72,163				—			$	72,163				—
Measured at fair value on a nonrecurring basis:
Impaired loans		$	3,151				—				—			$	3,151