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 incorporation or organization)		(I.R.S. Employer 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
(Former name, former address and former fiscal year, 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 August 7, 2009, 4,043,171 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			36
Item 4T. Controls and procedures			36
PART II — OTHER INFORMATION
Item 1. Legal proceedings			36
Item 1A. Risk factors			36
Item 2. Unregistered sales of equity securities and use of proceeds			36
Item 3. Defaults upon senior securities			36
Item 4. Submission of matters to a vote of security holders			36
Item 5. Other information			37
Item 6. Exhibits			37
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

		June 30,				December 31,
(dollars in thousands, except per share data)		2009				2008
Assets
Interest bearing deposits with banks		$	13,165			$	3,254
Cash and due from banks			9,598				11,621
Federal funds sold			3,000				—
Total cash and cash equivalents			25,763				14,875
Securities available-for-sale			158,764				72,163
Securities held-to-maturity (fair value $1,985 - 2009 and $2,283 - 2008)			2,432				2,432
Restricted investment in bank stocks, at cost			4,262				2,692
Loans held for sale			4,753				7,373
Loans (net of deferred fees of $599 - 2009 and $566 - 2008)			612,113				573,078
Less-allowance for loan losses			(6,145	)			(4,690	)
Net loans			605,968				568,388
Premises and equipment, net			11,640				11,900
Other assets			26,443				22,943
Total assets		$	840,025			$	702,766
Liabilities
Deposits
Noninterest bearing		$	50,185			$	47,781
Interest bearing			635,327				550,348
Total deposits			685,512				598,129
Short-term borrowings			—				18,283
Long-term debt			69,585				19,186
Junior subordinated debt			10,310				10,310
Other liabilities			5,924				4,677
Total liabilities			771,331				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			15,751				—
Common stock, par value $2.50 per share; 10,000,000 shares authorized; 4,043,171 shares issued and outstanding - 2009 and 4,017,033 - 2008			10,108				10,043
Additional paid-in capital			36,884				35,877
Retained earnings			5,147				5,057
Accumulated other comprehensive income			804				1,204
Total shareholders’ equity			68,694				52,181
Total liabilities and shareholders’ equity		$	840,025			$	702,766

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements of Income

Unaudited

		Three months ended								Six months ended
		June 30,								June 30,
(dollars in thousands, except per share data)		2009				2008				2009				2008
Interest income
Loans, including fees		$	8,568			$	7,858			$	16,633			$	16,071
Investment securities
Taxable			841				607				1,677				1,254
Tax-exempt			533				320				899				634
Dividends			2				16				9				31
Federal funds sold			2				75				5				282
Other			17				1				29				2
Total interest income			9,963				8,877				19,252				18,274
Interest expense
Deposits			3,710				3,451				7,366				7,038
Federal funds purchased and other short-term borrowings			10				1				27				1
Long-term and junior subordinated debt			551				323				1,071				692
Total interest expense			4,271				3,775				8,464				7,731
Net interest income			5,692				5,102				10,788				10,543
Provision for loan losses			1,639				910				1,883				1,060
Net interest income after provision for loan losses			4,053				4,192				8,905				9,483
Noninterest income
Trust and investment services fees			303				362				614				676
Income from mutual fund, annuity and insurance sales			358				496				704				984
Service charges on deposit accounts			581				563				1,106				1,083
Income from bank owned life insurance			155				68				318				135
Other income			154				124				302				246
Gain on sales of mortgages			403				108				570				168
Gain on sales of securities			128				123				291				123
Total noninterest income			2,082				1,844				3,905				3,415
Noninterest expense
Personnel			3,157				2,675				6,503				5,533
Occupancy of premises, net			448				397				928				777
Furniture and equipment			401				368				836				718
Postage, stationery and supplies			139				126				249				235
Professional and legal			99				109				183				197
Marketing and advertising			115				210				240				282
FDIC insurance			646				96				876				152
Debit card processing			130				120				252				241
Charitable donations			31				45				207				600
Telephone			146				36				255				84
Other			807				659				1,398				819
Total noninterest expense			6,119				4,841				11,927				9,638
Income before income taxes (benefit)			16				1,195				883				3,260
Provision (benefit) for income taxes			(277	)			224				(373	)			766
Net income			293				971				1,256				2,494
Preferred stock dividends and discount accretion			244				—				467				—
Net income available to common shareholders		$	49			$	971			$	789			$	2,494
Net income per common share, basic		$	0.01			$	0.25			$	0.20			$	0.63
Net income per common share, diluted		$	0.01			$	0.24			$	0.20			$	0.63

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements of Cash Flows

Unaudited

		Six months ended
		June 30,
(dollars in thousands)		2009				2008
Cash flows from operating activities
Net income		$	1,256			$	2,494
Adjustments to reconcile net income to net cash provided by operations
Depreciation			701				573
Provision for loan losses			1,883				1,060
Amortization of investment in real estate partnership			271				261
Increase in cash surrender value of life insurance investment			(318	)			(135	)
Originations of held for sale mortgages			(50,766	)			(15,670	)
Proceeds from sales of held for sale mortgages			50,371				12,416
Gain on sales of held for sale mortgages			(570	)			(168	)
Gain on sales of securities			(291	)			(123	)
Stock-based compensation expense			100				26
(Increase) decrease in accrued interest receivable			(555	)			270
Increase in other assets			(1,159	)			(1,290	)
Increase (decrease) in accrued interest payable			132				(92	)
Increase in other liabilities			1,118				622
Other, net			262				(121	)
Net cash provided by operating activities			2,435				123
Cash flows from investing activities
Securities available-for-sale
Purchases			(108,679	)			(9,608	)
Maturities and calls			12,565				8,788
Sales			8,947				6,639
Securities, held-to-maturity, calls			—				1,036
(Increase) decrease in restricted investment in bank stock			(1,570	)			2
Net increase in loans made to customers			(37,401	)			(51,199	)
Purchases of premises and equipment			(465	)			(1,213	)
Net cash used in investing activities			(126,603	)			(45,555	)
Cash flows from financing activities
Net increase (decrease) in demand and savings deposits			39,197				(10,394	)
Net increase in time deposits			48,186				49,677
Net (decrease) increase in short-term borrowings			(18,283	)			1,675
Proceeds from issuance of long-term debt			66,000				—
Repayment of long-term debt			(15,601	)			(576	)
Cash dividends paid to preferred shareholders			(289	)			—
Cash dividends paid to common shareholders			(804	)			(1,049	)
Net proceeds from issuance of preferred stock and common stock warrants			16,461				—
Issuance of common stock			189				689
Purchase of treasury stock			—				(66	)
Issuance of treasury stock			—				54
Cash paid in lieu of fractional shares			—				(5	)
Net cash provided by financing activities			135,056				40,005
Net increase (decrease) in cash and cash equivalents			10,888				(5,427	)
Cash and cash equivalents at beginning of year			14,875				39,053
Cash and cash equivalents at end of period		$	25,763			$	33,626

See accompanying notes.

Codorus Valley Bancorp, Inc.

Consolidated Statements 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 (Loss)				Stock				Total
For the six months ended June 30, 2009
Balance, January 1, 2009		$	—			$	10,043			$	35,877			$	5,057			$	1,204			$	—			$	52,181
Comprehensive income:
Net income															1,256												1,256
Other comprehensive loss, net of tax:
Unrealized losses on securities, net																			(400	)							(400	)
Total comprehensive income																											856
Preferred stock and common stock warrants issued, net of issuance costs of $39			15,678								783																16,461
Preferred stock discount accretion			73												(73	)											—
Common stock cash dividends ($0.20 per share)															(804	)											(804	)
Preferred stock dividends															(289	)											(289	)
Stock-based compensation											100																100
Issuance of common stock:
18,557 shares under dividend reinvestment and stock purchase plan							46				102																148
7,581 shares under employee stock purchase plan							19				22																41
Balance, June 30, 2009		$	15,751			$	10,108			$	36,884			$	5,147			$	804			$	—			$	68,694
For the six months ended June 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															2,494												2,494
Other comprehensive loss, net of tax:
Unrealized losses on securities, net																			(383	)							(383	)
Total comprehensive income																											2,111
Common stock cash dividends ($0.266 per share, adjusted)															(1,049	)											(1,049	)
Common stock 5% stock dividend - 187,363 shares at fair value							469				2,492				(2,966	)											(5	)
Purchase of 3,783 shares for treasury																							(66	)			(66	)
Stock-based compensation											26																26
Issuance of common stock:
50,577 shares under stock option plan							126				563																689
Re-issuance of 3,783 shares under employee stock purchase plan											(12	)											66				54
Balance, June 30, 2008		$	—			$	9,942			$	35,585			$	4,043			$	(98	)		$	—			$	49,472

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 for interim financial information, the instructions to Form 10-Q, and Article 10 of Regulation S-X. Accordingly, they 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 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 six-month period ended June 30, 2009 are not necessarily indicative of the results to be expected for the full year.

In accordance with Financial Accounting Standards No. 165, “Subsequent Events,” the Corporation evaluated the events and transactions that occurred after the balance sheet date of June 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 June 30, 2009 through August 11, 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								Six months ended
		June 30,								June 30,
(in thousands, except per share data)		2009				2008				2009				2008
Net income available to common shareholders		$	49			$	971			$	789			$	2,494
Weighted average shares outstanding (basic)			4,032				3,947				4,028				3,937
Effect of dilutive stock options			0				43				0				47
Weighted average shares outstanding (diluted)			4,032				3,990				4,028				3,984
Basic earnings per common share		$	0.01			$	0.25			$	0.20			$	0.63
Diluted earnings per common share		$	0.01			$	0.24			$	0.20			$	0.63
Anti-dilutive stock options and common stock warrants excluded from the computation of earnings per share			435				4				423				4

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								Six months ended
		June 30,								June 30,
(dollars in thousands)		2009				2008				2009				2008
Unrealized holding losses arising during the period		$	(3	)		$	(1,788	)		$	(315	)		$	(458	)
Reclassification adjustment for gains included in income			(128	)			(123	)			(291	)			(123	)
Net unrealized losses			(131	)			(1,911	)			(606	)			(581	)
Tax effect			44				650				206				198
Net of tax amount		$	(87	)		$	(1,261	)		$	(400	)		$	(383	)

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 six-month periods ended June 30, 2009 and 2008 consisted of the transfer of loans to foreclosed real estate for $1,556,000 and $1,674,000, respectively, and the transfer of loans held for sale to loans 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 tax for the current three and six month periods ended June 30, 2009 was a 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. SFAS 168 is effective for interim and annual periods ending after September 15, 2009. We do not expect the adoption of this standard to have an impact on our financial position or results of operations.

In November 2008, the SEC released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (IASB). Under the proposed roadmap, the 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 FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP FAS 115-2 and FAS 124-2). FSP FAS 115-2 and FAS 124-2 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, FSP FAS 115-2 and FAS 124-2 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. The FSP is effective for the Corporation for interim and annual reporting periods ending after June 30, 2009 and thereafter. The adoption of this FSP for the quarter ending June 30, 2009 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 June 30, 2009 and December 31, 2008 is provided below.

														Estimated
		Amortized				Gross Unrealized								Fair
(dollars in thousands)		Cost				Gains				Losses				Value
June 30, 2009
Available-for-sale
Debt securities
U.S. agency		$	13,530			$	136			$	(21	)		$	13,645
State and municipal			68,612				914				(882	)			68,644
U.S. agency mortgage-backed			75,404				1,106				(35	)			76,475
Total available-for-sale		$	157,546			$	2,156			$	(938	)		$	158,764
Held-to-maturity
Debt securities-corporate trust preferred			2,432				—				(447	)			1,985
Total held-to-maturity		$	2,432			$	—			$	(447	)		$	1,985
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 June 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		$	4,152			$	4,234			$	—			$	—
Due after one year through five years			107,006				108,414				—				—
Due after five years through ten years			40,516				40,448				—				—
Due after ten years			5,872				5,668				2,432				1,985
Total debt securities		$	157,546			$	158,764			$	2,432			$	1,985

Gross gains realized from the sale of available-for-sale securities were $291,000 and $123,000 for the six months ended June 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 $41,732,000 and $24,843,000 on June 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 June 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
June 30, 2009
Available-for-sale securities
U.S. agency		$	6,000			$	21			$	—			$	—			$	6,000			$	21
State and municipal			26,018				711				2,933				171				28,951				882
U.S. agency mortgage-backed			15,518				35				—				—				15,518				35
Total temporarily impaired debt securities, available- for-sale		$	47,536			$	767			$	2,933			$	171			$	50,469			$	938
Held-to-maturity
Debt securities-corporate trust preferred		$	1,174			$	271			$	811			$	176			$	1,985			$	447
December 31, 2008
Available-for-sale securities
U.S. agency		$	—			$	—			$	—			$	—			$	—			$	—
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

The unrealized losses within the less than 12 months category of $767,000 in the available-for-sale portfolio were attributable to sixty-three different securities, primarily municipalities, and $271,000 in the held-to-maturity portfolio were attributable to three different single issue corporate trust preferred securities. The unrealized losses within the 12 months or more category of $171,000 in the available-for-sale portfolio were attributable to five different municipal securities and $176,000 in the held-to-maturity portfolio was attributable to one single issue corporate trust preferred security.

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 June 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 June 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 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 is necessary related to the restricted stock as of June 30, 2009.

Note 5—Deposits

The composition of deposits on June 30, 2009 and December 31, 2008, was as follows:

		June 30,				December 31,
(Dollars in thousands)		2009				2008
Noninterest bearing demand		$	50,185			$	47,781
NOW			52,186				50,027
Money market			165,169				133,924
Savings			23,426				20,037
Time CDs less than $100,000			233,483				206,293
Time CDs $100,000 or more			161,063				140,067
Total deposits		$	685,512			$	598,129

Note 6—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 June 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.

		June 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				0
Due June 2010, 4.32%			6,000				6,000
Due January 2011, 2.06%			14,000				0
Due January 2011, 4.30%, amortizing			3,821				3,964
Due August 2011, 2.42%			12,000				0
Due January 2012, 2.34%			10,000				0
Due June 2012, 4.25%, amortizing			1,133				1,313
Due May 2013, 3.46%, amortizing			2,166				2,422
			69,120				18,699
Capital lease obligation			465				487
Total long-term debt		$	69,585			$	19,186

Note 7—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 June 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 8—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 June 30, 2009
Capital ratios:
Tier 1 risk based		$	77,546				11.79	%		$	26,309				4.00	%			n/a				n/a
Total risk based			83,691				12.72				52,619				8.00				n/a				n/a
Leverage			77,546				9.36				33,131				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 June 30, 2009
Capital ratios:
Tier 1 risk based		$	72,472				11.11	%		$	26,101				4.00	%		$	39,152				6.00	%
Total risk based			78,617				12.05				52,202				8.00				65,253				10.00
Leverage			72,472				8.81				32,923				4.00				41,154				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 8—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 allows 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. 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 7, “Regulatory Matters” for details of the Corporation’s regulatory capital.

The preferred stock ranks senior to the Corporation’s common shares and pays a compounding 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 (expires 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 9—Contingent Liabilities

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

Note 10—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 the 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 $3,968,000 of standby letters of credit outstanding on June 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 current amount of the liability as of June 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 11—Fair Value Measurements and Fair Values of Financial Instruments

In September 2006, the FASB issued 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. Statement 157 applies to other accounting pronouncements that require or permit fair value measurements. As permitted by the accounting guidance, the Corporation began applying Statement 157 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 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 (FSP FAS 157-4). FASB Statement 157, Fair Value Measurements, 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. FSP FAS 157-4 provides additional guidance on determining when the volume and level of activity for the asset or liability has significantly decreased. The FSP also includes guidance on identifying circumstances when a transaction may not be considered orderly.

FSP FAS 157-4 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 Statement 157.

This FSP clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The FSP 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.

This FSP is effective for interim and annual reporting periods for the Corporation for the quarter ended June 30, 2009 and after. The adoption of this FSP for the quarter ending June 30, 2009 did not have a material impact on the Corporation’s financial condition or results of operations.

Statement 157 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 Statement 157 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
June 30, 2009
Measured at fair value on a recurring basis:
Securities available-for-sale		$	158,764				—			$	158,764				—
Measured at fair value on a nonrecurring basis:
Impaired loans		$	3,655				—				—			$	3,655
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

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP FAS 107-1 and APB 28-1). FSP FAS 107-1 and APB 28-1 amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods.

This FSP is effective for the Corporation for interim periods June 30, 2009 and after. The adoption of the FSP for the quarter ending June 30, 2009 did not have a material impact on the Corporation’s financial condition or results of operations.

The following information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. The methods and assumptions that follow were used to estimate the fair values of the Corporation’s financial instruments at June 30, 2009 and December 31, 2008.

Cash and cash equivalents (carried at cost)

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

Securities

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

Restricted investment in bank stocks (carried at cost)

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

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

The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan. At June 30, 2009, the fair value of loans held for sale exceeded the cost basis, therefore, no write-down to fair value, valuation allowance or charge to earnings was recorded.

Loans (carried at cost)

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

Impaired loans (generally carried at fair value)

Impaired loans are those that are accounted for under FASB Statement No. 114, “Accounting by Creditors for Impairment of a Loan,” in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. A portion of the allowance for loan losses is allocated to impaired loans if the value of the collateral supporting such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to require increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes that the uncollectability of a loan is confirmed. These loans are included as Level 3 fair values, based on the lowest level of input that is significant to the fair value measurements. The fair value consists of loan balances of $5,601,000, net of a valuation allowance of $1,946,000. Additional provision for loan losses on these impaired loans was $1,826,000 for the six-months ended June 30, 2009, of this amount $1,596,000 pertained to the second quarter.

Interest receivable and payable (carried at cost)

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

Deposit liabilities (carried at cost)

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

Short-term borrowings (carried at cost)

The carrying amounts of short-term borrowings approximate their fair values.

Long-term debt (carried at cost)

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

Junior subordinated debt (carried at cost)

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

Off-balance sheet financial instruments (disclosed at cost)

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

The estimated fair values of the Corporation’s financial instruments were as follows at June 30, 2009 and December 31, 2008.

		June 30, 2009								December 31, 2008
						Estimated								Estimated
		Carrying				Fair				Carrying				Fair
(dollars in thousands)		Amount				Value				Amount				Value
Financial assets
Cash and cash equivalents		$	25,763			$	25,763			$	14,875			$	14,875
Securities, available-for-sale			158,764				158,764				72,163				72,163
Securities, held-to-maturity			2,432				1,985				2,432				2,283
Restricted investment in bank stocks			4,262				4,262				2,692				2,692
Loans held for sale			4,753				4,807				7,373				7,409
Loans			605,968				607,344				568,388				565,982
Interest receivable			3,055				3,055				2,500				2,500
Financial liabilities
Noninterest bearing demand, NOW, money market and savings deposits		$	290,966			$	290,966			$	251,769			$	251,769
Time deposits			394,546				399,154				346,360				351,201
Short-term borrowings			—				—				18,283				18,283
Long-term debt			69,585				70,387				19,186				19,757
Junior subordinated debt			10,310				2,949				10,310				4,566
Interest payable			938				938				806				806
Off-balance sheet instruments			—				—				—				—