UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2011

0-24169

Commission File No.

PEOPLES BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland		52-2027776
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

P.O. Box 210, 100 Spring Avenue, Chestertown, Maryland		21620
(Address of Principal Executive Offices)		(Zip Code)

(410) 778-3500

Registrant’s Telephone Number, Including Area Code

Securities Registered pursuant to Section 12(g) of the Act: Common Stock, par value $10.00 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 16(d) of the Act. ¨

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 ¨

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 þ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company(check one): Large accelerated filer £ Accelerated filer £ Non-accelerated filer £ Smaller reporting company R

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

Yes £ No R

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $36,067,680.

The number of shares outstanding of the registrant’s common stock as of March 1, 2012 was 779,512.

Documents Incorporated by Reference

Portions of the definitive proxy statement to be filed with the SEC in connection with the registrant’s 2011 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

PEOPLES BANCORP, INC.

FORM 10-K

INDEX

PART I

Item 1.	Business	3
Item 1A.	Risk Factors	10
Item 1B.	Unresolved Staff Comments	17
Item 2.	Properties	18
Item 3.	Legal Proceedings	18
Item 4.	Mine Safety Disclosures	18

PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	18
Item 6.	Selected Financial Data	19
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	35
Item 8.	Financial Statements and Supplementary Data	36
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	70
Item 9A.	Controls and Procedures	70
Item 9B.	Other Information	72

PART III

Item 10.	Directors, Executive Officers and Corporation Governance	72
Item 11.	Executive Compensation	72
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	72
Item 13.	Certain Relationships and Related Transactions, and Director Independence	72
Item 14.	Principal Accountant Fees and Services	72

PART IV

Item 15.	Exhibits and Financial Statement Schedules	73

Signatures		73
Exhibit Index		75

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This Annual Report on Form 10-K of Peoples Bancorp, Inc. (the “Company” and, together with its consolidated subsidiaries, “we”, “our” or “us”) contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Such statements include projections, predictions, expectations or statements as to beliefs or future events or results or refer to other matters that are not historical facts. Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. The forward-looking statements contained in this annual report are based on various factors and were derived using numerous assumptions. In some cases, you can identify these forward-looking statements by words like “may”, “will”, “should”, “expect”, “plan”, “anticipate”, intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words. You should be aware that those statements reflect only our predictions. If known or unknown risks or uncertainties should materialize, or if underlying assumptions should prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. You should bear this in mind when reading this annual report and not place undue reliance on these forward-looking statements. Factors that might cause such differences include, but are not limited to:

the risk that the weak national and local economies and depressed real estate and credit markets caused by the recent global recession will continue to decrease the demand for loan, deposit and other financial services and/or increase loan delinquencies and defaults;

changes in market rates and prices may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our balance sheet;

our liquidity requirements could be adversely affected by changes in our assets and liabilities;

the effect of legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry;

competitive factors among financial services organizations, including product and pricing pressures and our ability to attract, develop and retain qualified banking professionals;

the effect of changes in accounting policies and practices, as may be adopted by the Financial Accounting Standards Board, the Securities and Exchange Commission (the “SEC”), the Public Company Accounting Oversight Board and other regulatory agencies; and

the effect of fiscal and governmental policies of the United States federal government.

You should also consider carefully the Risk Factors contained in Item 1A of Part I of this annual report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition. The risks discussed in this annual report are factors that, individually or in the aggregate, management believes could cause our actual results to differ materially from expected and historical results. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider such disclosures to be a complete discussion of all potential risks or uncertainties.

The forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

PART I

Item 1. Business.

General

The Company was incorporated under the laws of Maryland on December 10, 1996 and is a financial holding company registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company’s sole business is acting as the parent company to The Peoples Bank, a Maryland-chartered bank (the “Bank”), and Fleetwood, Athey, Macbeth & McCown, Inc., a Maryland insurance agency (the “Insurance Subsidiary”). The Bank has one subsidiary, PB Land Trust, which is a Maryland statutory trust that was organized to acquire, hold and dispose of real estate that the Bank acquires through foreclosure or by deed in lieu of foreclosure (the “Land Trust”).

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On January 2, 2007, the Company acquired the Insurance Subsidiary and began operating in the insurance products and services business segment. Prior to that date, we operated in only one business segment: community banking.

Location and Service Area

We offer a variety of services to consumer and commercial customers in our primary service area, which encompasses all of Kent County, northern Queen Anne’s County, and southern Cecil County, Maryland.

The principal components making up the economy for our service area are agriculture and light industry. Kent County is also growing as a tourist and retirement area. The tourist business is centered primarily in Chestertown and Rock Hall. There is a large retirement community, Heron Point, located in Chestertown. The seafood business, once prominent, is in decline. There are three health-care facilities located in Chestertown. Agriculture and agricultural-related businesses are the largest overall employers in the service area. There are several light industry companies in Kent County.

Banking Products and Services

Through the Bank’s five branches located throughout Kent County, Maryland and two branches in Queen Anne’s County, Maryland, we offer a full range of deposit services that are typically offered by most depository institutions in our service area, including checking accounts, NOW accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to our principal service area and have rates that are competitive with those offered by other institutions in the area. In addition, we offer certain retirement account services, such as Individual Retirements Accounts. All deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum amount allowed by law. We solicit these accounts from individuals, businesses, associations and organizations, and governmental authorities.

We also offer a full range of short- to medium-term commercial and personal loans. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements), and purchase of equipment and machinery. Consumer loans include secured and unsecured loans for financing automobiles, home improvements, education, and personal investments. We also originate mortgage loans and real estate construction and acquisition loans.

Other services include cash management services, safe deposit boxes, travelers checks, internet banking, direct deposit of payroll and social security checks, and automatic drafts for various accounts. The Bank is associated with a regional network of automated teller machines that may be used by our customers throughout Maryland and other regions. We also offer non-deposit investment products, such as insurance and securities products, through broker-dealer relationships.

Information about our revenues, net income and assets derived from our operations in the community banking segment for each of the years ended December 31, 2011 and 2010 may be found in our Consolidated Financial Statements and Notes thereto, which are included in Item 8 of Part II of this annual report.

Investment Activities

We maintain a portfolio of investment securities to provide liquidity and income. The current portfolio amounts to approximately 3.60% of our total assets and is invested primarily in U.S. government agency and mortgage-backed securities.

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A key objective of the investment portfolio is to provide a balance in our asset mix of loans and investments consistent with our liability structure, and to assist in management of interest rate risk. The investments augment our capital positions, providing the necessary liquidity to meet fluctuations in credit demand of the community and fluctuations in deposit levels. In addition, the portfolio provides collateral for pledging against public funds and repurchase agreements and a reasonable allowance for control of tax liabilities. Finally, the investment portfolio is designed as a source of income. In view of the above objectives, management treats the portfolio conservatively and generally only purchases securities that meet conservative investment criteria.

Insurance Activities

The Insurance Subsidiary is located in Chestertown, Kent County, Maryland and Cecilton, Cecil County, Maryland. The Insurance Subsidiary offers a full range of property and casualty insurance products and services to customers in our market area.

Seasonality

Management does not believe that our business activities are seasonal in nature. Demand for our products and services may vary depending on local and national economic conditions, but management believes that any variation will not have a material impact on our planning or policy-making strategies.

Employees

At March 1, 2011, we employed 70 persons, of which 62 were employed on a full-time basis.

COMPETITION

The banking business, in all of its phases, is highly competitive. Within our service area and the surrounding area, we compete with commercial banks (including local banks and branches or affiliates of other larger banks), savings and loan associations and credit unions for loans and deposits, with consumer finance companies for loans, with money market mutual funds and other investment vehicles for deposits, with insurance companies, agents and brokers for insurance products, and with other financial institutions for various types of financial products and services. There is also competition for commercial and retail banking business from banks and financial institutions located outside of our market area. Many of these financial institutions offer services, such as trust services, that we do not offer and have greater financial resources or have substantially higher lending limits than us.

The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized services.

To compete with other financial services providers, we rely principally upon local promotional activities, personal relationships established by officers, directors and employees with our customers and specialized services tailored to meet our customers’ needs. In those instances in which we are unable to accommodate a customer’s needs, we will arrange for those services to be provided by other financial services providers with which we have a relationship. We offer many personalized services and attract customers by being responsive and sensitive to the needs of the community. We rely not only on the goodwill and referrals of satisfied customers, as well as traditional media advertising to attract new customers, but also on individuals who develop new relationships to build our customer base. To enhance our image in the community, we support and participate in many local events. Our employees, officers and directors represent us on many boards and local civic and charitable organizations.

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The following table sets forth deposit data for Kent County, Maryland as of June 30, 2011, the most recent date for which comparative information is available:

Institution	Offices In Market Area		Deposits (in thousands)		Market Share
The Peoples Bank (f/k/a Peoples Bank of Kent County, Maryland)	5			180,738		35.87	%
PNC Bank National Assn	4			133,143		26.43	%
Chesapeake Bank & Trust Co	2			69,220		13.74	%
Branch Banking & Trust Co	2			48,094		9.55	%
CNB (f/k/a The Centreville National Bank of Maryland)	2			44,604		8.85	%
SunTrust Bank		1		28,011		5.56	%

Source: FDIC Deposit Market Share Report

SUPERVISION AND REGULATION

The following is a summary of the material regulations and policies applicable to us and is not intended to be a comprehensive discussion. Changes in applicable laws and regulations may have a material effect on our business, financial condition and results of operation.

General

The Company is a financial holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the BHC Act and, as such, is subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the FRB.

The Bank is a Maryland commercial bank subject to the banking laws of Maryland and to regulation by the Commissioner of Financial Regulation of Maryland (the “Maryland Commissioner”), who is required by statute to make

at least one examination in each calendar year (or at 18-month intervals if the Maryland Commissioner determines that an examination is unnecessary in a particular calendar year).

The Insurance Subsidiary is subject to examination by the FRB, and, as an affiliate of the Bank, may be subject to examination by the Bank’s regulators from time to time. In addition, the Insurance Subsidiary is subject to licensing and regulation by the insurance authorities of the states in which it does business. Retail sales of insurance products that have investment components by the Insurance Subsidiary to customers of the Bank are also subject to the requirements of the Interagency Statement on Retail Sales of Nondeposit Investment Products promulgated in 1994, as amended, by the federal banking regulators, including the FDIC and the FRB.

Regulation of Financial Holding Companies

In November 1999, the federal Gramm-Leach-Bliley Act (the “GLB Act”) was signed into law. Effective in pertinent part on March 11, 2000, the GLB Act revised the BHC Act and repealed the affiliation provisions of the Glass-Steagall Act of 1933, which, taken together, limited the securities, insurance and other non-banking activities of any company that controls an FDIC insured financial institution. Under the GLB Act, a bank holding company can elect, subject to certain qualifications, to become a “financial holding company.” The GLB Act provides that a financial holding company may engage in a full range of financial activities, including insurance and securities underwriting and agency activities, merchant banking, and insurance company portfolio investment activities, with new expedited notice procedures.

Under FRB policy, the Company is expected to act as a source of strength to its subsidiary bank, and the FRB may charge the Company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. In addition, under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), depository institutions insured by the FDIC can be held liable for any losses incurred by, or reasonably anticipated to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. Accordingly, in the event that any insured subsidiary of the Company causes a loss to the FDIC, other insured subsidiaries of the Company could be required to compensate the FDIC by reimbursing it for the estimated amount of such loss. Such cross guaranty liabilities generally are superior in priority to obligations of a financial institution to its stockholders and obligations to other affiliates.

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Regulation of the Bank

Federal and state banking regulators may prohibit the institutions over which they have supervisory authority from engaging in activities or investments that the agencies believe are unsafe or unsound banking practices. These banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities that violate law, regulation or a regulatory agreement or which are deemed to be unsafe or unsound practices. Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution-affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of or restrictions on directors, officers, employees and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or other court actions.

The Bank is subject to the provisions of Section 23A and Section 23B of the Federal Reserve Act. Section 23A limits the amount of loans or extensions of credit to, and investments in, the Company and its nonbank affiliates by the Bank. Section 23B requires that transactions between any of the Bank and the Company and its nonbank affiliates be on terms and under circumstances that are substantially the same as with non-affiliates.

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, and principal stockholders or any related interest of such persons, which generally require that such credit extensions be made on substantially the same terms as are available to third parties dealing with the Bank and not involve more than the normal risk of repayment. Other laws tie the maximum amount that may be loaned to any one customer and its related interests to capital levels.

As part of the Federal Deposit Insurance Company Improvement Act of 1991 (“FDICIA”), each federal banking regulator adopted non-capital safety and soundness standards for institutions under its authority. These standards include internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. An institution that fails to meet those standards may be required by the agency to develop a plan acceptable to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. We believe that the Bank meets substantially all standards that have been adopted. FDICIA also imposes new capital standards on insured depository institutions.

The Community Reinvestment Act (“CRA”) requires that, in connection with the examination of financial institutions within their jurisdictions, the federal banking regulators evaluate the record of the financial institution in meeting the credit needs of their communities including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered by all regulatory agencies in evaluating mergers, acquisitions and applications to open a branch or facility. As of the date of its most recent examination report, the Bank had a CRA rating of “Satisfactory.”

On October 14, 2008, the FDIC announced the creation of the Temporary Liquidity Guarantee Program (the “TLGP”) to decrease the cost of bank funding and, hopefully, normalize lending. This program is comprised of two components. The first component guarantees senior unsecured debt issued between October 14, 2008 and June 30, 2009. The guarantee will remain in effect until June 30, 2012 for such debts that mature beyond June 30, 2009. The second component, called the Transaction Accounts Guarantee Program (“TAG”), provided full coverage for non-interest bearing transaction deposit accounts, IOLTAs, and NOW accounts with interest rates of 0.25% or less, regardless of account balance, initially until December 31, 2009. The TAG program expired on December 31, 2010. We elected to participate in both programs and paid additional FDIC premiums in 2010 as a result. FDIC insurance reduced in 2011 due to the use of a new assessment base that uses assets and tier one capital in the assessment calculation.

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On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which made sweeping changes to the financial regulatory landscape and will impact all financial institutions, including the Company.

On November 9, 2010, the FDIC issued a final rule to implement Section 343 of the Dodd-Frank Act that provides temporary unlimited deposit insurance coverage for non-interest bearing transaction accounts at all FDIC-insured depository institutions. The coverage is automatic for all FDIC-insured institutions and does not include an opt out option. The separate coverage for noninterest-bearing transaction accounts became effective on December 31, 2010 and terminates on December 31, 2012.

These new laws, regulations and regulatory actions will cause our regulatory expenses to increase. Additionally, due in part to numerous bank failures throughout the country since 2008, the FDIC imposed an emergency insurance assessment to help restore the Deposit Insurance Fund and further required insured depository institutions to prepay their estimated quarterly risk-based deposit assessments through 2012 on December 30, 2009. Given the current state of the national economy, there can be no assurance that the FDIC will not impose future emergency assessments or further revise its rate structure.

The Dodd-Frank Act’s significant regulatory changes include the creation of a new financial consumer protection agency, known as the Bureau of Consumer Financial Protection (the “Consumer Protection Bureau”), that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer compliance. Moreover, the Dodd-Frank Act permits states to adopt stricter consumer protection laws and states’ attorneys general may enforce consumer protection rules issued by the Bureau. The Dodd-Frank Act also imposes more stringent capital requirements on bank holding companies by, among other things, imposing leverage ratios on bank holding companies and prohibiting new trust preferred securities issuances from counting as Tier 1 capital. These developments may limit our future capital strategies. The other provisions of the Dodd-Frank Act will increase our regulatory compliance burden and costs and may restrict the financial products and services we offer to our customers. In particular, the Dodd-Frank Act will require us to invest significant management attention and resources so that we can evaluate the impact of this law and make any necessary changes to our product offerings and operations.

Deposit Insurance

Deposits at the Bank are insured through the Deposit Insurance Fund, which is administered by the FDIC, and the Bank is required to pay quarterly deposit insurance premium assessments to the FDIC. The Deposit Insurance Fund was created pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), which was signed into law on February 8, 2006. This law (i) required the then-existing $100,000 deposit insurance coverage to be indexed for inflation (with adjustments every five years, commencing January 1, 2011), and (ii) increased the deposit insurance coverage for retirement accounts to $250,000 per participant, subject to adjustment for inflation. Effective October 3, 2008, however, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was enacted and, among other things, temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. EESA initially contemplated that the coverage limit would return to $100,000 after December 31, 2009, but the expiration date has since been extended to December 31, 2012. The coverage for retirement accounts did not change and remains at $250,000. On July 21, 2010, as part of the Dodd-Frank Act, the current standard maximum deposit insurance amount was permanently raised to $250,000.

The Reform Act also gave the FDIC greater latitude in setting the assessment rates for insured depository institutions which could be used to impose minimum assessments. On November 12, 2009, the FDIC adopted a final rule requiring insured depository institutions to prepay their estimated quarterly risk-based deposit assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009, along with each institution’s risk based deposit insurance assessment for the third quarter of 2009. This prepayment did not include the assessments for TLGP participation or the FICO assessment that will be billed quarterly. It was also announced that the assessment rate will increase by 3 basis points effective January 1, 2011. The prepayment will be accounted for as a prepaid expense to be amortized quarterly. The prepaid assessment will qualify for a zero risk weight under the risk-based capital requirements. The Bank’s three-year prepaid assessment was $1,022,585. The Bank expensed a total of $244,266 in FDIC premiums during 2011.

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Capital Requirements

Under Maryland law, the Bank must meet certain minimum capital stock and surplus requirements before it may establish a new branch office. With each new branch located outside the municipal area of the Bank’s principal banking office, these minimal levels are subject to upward adjustment based on the population size of the municipal area in which the branch will be located. Prior to establishment of the branch, the Bank must obtain Maryland Commissioner and FDIC approval. If establishment of the branch involves the purchase of a bank building or furnishings, the total investment in bank buildings and furnishings cannot exceed, with certain exceptions, 50% of the Bank’s unimpaired capital and surplus.

FDICIA established a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, federal banking regulators are required to rate supervised institutions on the basis of five capital categories: “well -capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized;” and to take certain mandatory actions, and are authorized to take other discretionary actions, with respect to institutions in the three undercapitalized categories. The severity of the actions will depend upon the category in which the institution is placed. A depository institution is “well capitalized” if it has a total risk based capital ratio of 10% or greater, a Tier 1 risk based capital ratio of 6% or greater, and a leverage ratio of 5% or greater and is not subject to any order, regulatory agreement, or written directive to meet and maintain a specific capital level for any capital measure. An “adequately capitalized” institution is defined as one that has a total risk based capital ratio of 8% or greater, a Tier 1 risk based capital ratio of 4% or greater and a leverage ratio of 4% or greater (or 3% or greater in the case of an institution with a composite CAMELS rating of 1). Tier 1 capital consists of common stockholders’ equity, qualifying perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, less certain intangibles.

FDICIA generally prohibits a depository institution from making any capital distribution, including the payment of cash dividends, or paying a management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. For a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee (subject to certain limitations) that the institution will comply with such capital restoration plan.

Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized and requirements to reduce total assets and stop accepting deposits from correspondent banks. Critically undercapitalized depository institutions are subject to the appointment of a receiver or conservator, generally within 90 days of the date such institution is determined to be critically undercapitalized.

As of December 31, 2011, the Company and the Bank were deemed to be “well capitalized.” For more information regarding the capital condition of the Company and the Bank, see Item 7 of Part II of this annual report under the caption “Capital.”

Limitations on Dividends

Holders of shares of the Company’s common stock are entitled to dividends if, when, and as declared by the Company’s Board of Directors out of funds legally available for that purpose, and the Board’s ability to declare dividends is subject to certain restrictions imposed under federal banking law and state banking and corporate law. These restrictions are discussed in more detail below in Item 1A of Part I of this report under the caption “Our ability to pay dividends is limited.”

USA PATRIOT Act

Congress adopted the USA PATRIOT Act (the “Patriot Act”) on October 26, 2001 in response to the terrorist attacks that occurred on September 11, 2001. Under the Patriot Act, certain financial institutions, including banks, are required to maintain and prepare additional records and reports that are designed to assist the government’s efforts to combat terrorism. The Patriot Act includes sweeping anti-money laundering and financial transparency laws and required additional regulations, including, among other things, standards for verifying client identification when opening an account and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

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Federal Securities Laws

The shares of the Company’s common stock are registered with the Securities and Exchange Commission (the “SEC”) under Section 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Company is subject to information reporting requirements, proxy solicitation requirements, insider trading restrictions and other requirements of the Exchange Act, including the requirements imposed under the federal Sarbanes-Oxley Act of 2002. Among other things, loans to and other transactions with insiders are subject to restrictions and heightened disclosure, the Company must disclose whether directors meet an “independent director” standard, and the Company is required to comply with certain corporate governance obligations.

Governmental Monetary and Credit Policies and Economic Controls

The earnings and growth of the banking industry and ultimately of the Bank are affected by the monetary and credit policies of governmental authorities, including the FRB. An important function of the FRB is to regulate the national supply of bank credit in order to control recessionary and inflationary pressures. Among the instruments of monetary policy used by the FRB to implement these objectives are open market operations in U.S. Government securities, changes in the federal funds rate, changes in the discount rate of member bank borrowings, and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the FRB authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future. In view of changing conditions in the national economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities, including the FRB, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or their effect on the business and earnings of the Company and its subsidiaries.

Item 1A. Risk Factors.

The significant risks and uncertainties related to us, our business and the Company’s securities of which we are aware are discussed below. You should carefully consider these risks and uncertainties before making investment decisions in respect of the Company’s securities. Any of these factors could materially and adversely affect our business, financial condition, operating results and prospects and could negatively impact the market price of the Company’s securities. If any of these risks materialize, you could lose all or part of your investment in the Company. Additional risks and uncertainties that we do not yet know of, or that we currently think are immaterial, may also impair our business operations. You should also consider the other information contained in this annual report, including our financial statements and the related notes, before making investment decisions.

Risks Relating to the Business of the Company and its Subsidiaries

The Company’s future depends on the successful growth of its subsidiaries.

The Company’s primary business activity for the foreseeable future will be to act as the holding company of the Bank and the Insurance Subsidiary. Therefore, the Company’s future profitability will depend on the success and growth of these subsidiaries. In the future, part of the Company’s growth may come from buying other banks and buying or establishing other companies. Such entities may not be profitable after they are purchased or established, and they may lose money, particularly at first. A new bank or company may bring with it unexpected liabilities, bad loans, or bad employee relations, or the new bank or company may lose customers.

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The majority of our business is concentrated in Maryland, a significant amount of which is concentrated in real estate-secured lending, so a decline in the local economy and real estate markets could adversely impact our financial condition and results of operations.

Because most of our loans are made to customers who reside on Maryland’s upper Eastern Shore, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose loan portfolios are geographically diverse. Further, we make many real estate secured loans, including construction and land development loans, all of which are in greater demand when interest rates are low and economic conditions are good.

The national and local economies have significantly weakened during the past two years in part due to the widely-reported problems in the sub-prime mortgage loan market and the resulting meltdown of the financial services industry as a whole. As a result, real estate values across the country, including in our market areas, have decreased and the general availability of credit, especially credit to be secured by real estate, has also decreased. These conditions have made it more difficult for real estate owners and owners of loans secured by real estate to sell their assets at the times and at the prices they desire. Not only has this impacted the demand for credit to finance the acquisition and development of real estate, but it has also impaired the ability of banks, including the Bank, to sell real estate acquired through foreclosure. In the case of real estate acquisition, construction and development projects that we have financed, these challenging economic conditions have caused some of our borrowers to default on their loans. Because of the deterioration in the market values of real estate collateral caused by the recession, banks, including the Bank, have been unable to recover the full amount due under their loans when forced to foreclose on and sell real estate collateral. As a result, the Bank has realized significant impairments and losses in it loan portfolio, which have materially and adversely impacted our financial condition and results of operations. These conditions and their consequences are likely to continue until the nation fully recovers from the recent economic recession. Management cannot predict the extent to which these conditions will cause future impairments or losses, nor can it provide any assurances as to when, or if, economic conditions will improve.

Our significant amount of real estate-secured commercial loans could subject us to increased regulatory scrutiny and directives, which could force us to preserve or raise capital and/or limit our future commercial lending activities.

The FRB and the FDIC, along with the other federal banking regulators, issued guidance in December 2006 entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” directed at institutions who have particularly high concentrations of commercial real estate loans within their lending portfolios. This guidance suggests that these institutions face a heightened risk of financial difficulties in the event of adverse changes in the economy and commercial real estate markets. Accordingly, the guidance suggests that institutions whose concentrations exceed certain percentages of capital should implement heightened risk management practices appropriate to their concentration risk. The guidance provides that banking regulators may require such institutions to reduce their concentrations and/or maintain higher capital ratios than institutions with lower concentrations in commercial real estate. Based on our concentration of commercial acquisition and development and construction lending as of December 31, 2011, we may be subject to heightened supervisory scrutiny during future examinations and/or be required to take steps to address our concentration and capital levels. Management cannot predict the extent to which this guidance will impact our operations or capital requirements.

The Bank may experience loan losses in excess of its allowance, which could materially and adversely impact our financial condition and results of operations.

The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectability is considered questionable. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require us to increase the allowance for loan losses as a part of its examination process, our earnings and capital could be significantly and adversely affected. Future adjustments may be necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to our non-performing or performing loans. Material additions to the allowance for loan losses would result in a decrease in our net income and capital, and could have a material adverse effect on our financial condition.

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Interest rates and other economic conditions will impact our results of operations.

Our results of operations may be materially and adversely affected by changes in prevailing economic conditions, including declines in real estate values, rapid changes in interest rates and the monetary and fiscal policies of the federal government. Our profitability is in part a function of the spread between the interest rates earned on assets and the interest rates paid on deposits and other interest-bearing liabilities (i.e., net interest income), including advances from the Federal Home Loan Bank (the “FHLB”) of Atlanta. Interest rate risk arises from mismatches (i.e., the interest sensitivity gap) between the dollar amount of repricing or maturing assets and liabilities. If more assets reprice or mature than liabilities during a falling interest rate environment, then our earnings could be negatively impacted. Conversely, if more liabilities reprice or mature than assets during a rising interest rate environment, then our earnings could be negatively impacted. Fluctuations in interest rates are not predictable or controllable. There can be no assurance that our attempts to structure our asset and liability management strategies to mitigate the impact on net interest income of changes in market interest rates will be successful in the event of such changes.

The market value of our investments could decline.

As of December 31, 2011, we had classified 99.95% of our investment securities as available-for-sale pursuant to Investments – Debt and Equity Securities No. 320 (“ASC 320”) relating to accounting for investments. ASC 320 requires that the available-for-sale portfolio be “marked to market” and that unrealized gains and losses be reflected as a separate item in stockholders’ equity (net of tax) as accumulated other comprehensive income. The remaining investment securities are classified as held-to-maturity in accordance with ASC 320, and are stated at amortized cost.

In the past, gains on sales of investment securities have not been a significant source of income for us. There can be no assurance that future market performance of our investment portfolio will enable us to realize income from sales of securities. Stockholders’ equity will continue to reflect the unrealized gains and losses (net of tax) of these investments. There can be no assurance that the market value of our investment portfolio will not decline, causing a corresponding decline in stockholders’ equity.

The Bank is a member of the FHLB of Atlanta. A member of the FHLB system is required to purchase stock issued by the relevant FHLB bank based on how much it borrows from the FHLB and the quality of the collateral pledged to secure that borrowing. Accordingly, we maintain investments in stock issued by the FHLB of Atlanta. The stock is carried at cost and is considered a long-term investment because of the restrictions on our ability to transfer the stock. The Company recognizes dividends on this stock on a cash basis. Accounting guidance indicates that an investor in FHLB stock should recognize impairment if it concludes that it is not probable that it will ultimately recover the par value of its shares. The decision of whether impairment exists is a matter of judgment that should reflect the investor’s view of an FHLB’s long-term performance, which includes factors such as its operating performance, the severity and duration of declines in the market value of its net assets related to its capital stock amount, its commitment to make payments required by law or regulation and the level of such payments in relation to its operating performance, the impact of legislation and regulatory changes on the FHLB, and accordingly, on the members of the FHLB and its liquidity and funding position. In the past, the FHLB of Atlanta has terminated and/or deferred the payment of dividends on its stock, and it may do so in the future. A future termination or deferral, together with other factors that may exist at the time, may require us to take an impairment charge on our FHLB stock.

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Management believes that several factors will affect the market values of our investment portfolio. These include, but are not limited to, changes in interest rates or expectations of changes, the degree of volatility in the securities markets, inflation rates or expectations of inflation and the slope of the interest rate yield curve (the yield curve refers to the differences between shorter-term and longer-term interest rates; a positively sloped yield curve means shorter-term rates are lower than longer-term rates). Also, the passage of time will affect the market values of our investment securities, in that the closer they are to maturing, the closer the market price should be to par value. These and other factors may impact specific categories of the portfolio differently, and management cannot predict the effect these factors may have on any specific category.

We operate in a competitive environment, and our inability to effectively compete in our markets could have an adverse impact on our financial condition and results of operations.

We operate in a competitive environment, competing for loans, deposits, and customers with commercial banks, savings associations and other financial entities. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market and mutual funds and other investment alternatives. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Competition for other products, such as insurance and securities products, comes from other banks, securities and brokerage companies, insurance companies, insurance agents and brokers, and other non-bank financial service providers in our market area. Many of these competitors are much larger in terms of total assets and capitalization, have greater access to capital markets, and/or offer a broader range of financial services than those that we offer. In addition, banks with a larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the needs of larger customers.

In addition, changes to the banking laws over the last several years have facilitated interstate branching, merger and expanded activities by banks and holding companies. For example, the GLB Act made it easier for financial institutions to branch across state lines and to engage in previously-prohibited activities that are now accepted elements of competition in the banking industry. These changes may bring us into competition with more and a wider array of institutions, which may reduce our ability to attract or retain customers. Management cannot predict the extent to which we will face such additional competition or the degree to which such competition will impact our financial conditions or results of operations.

The banking industry is heavily regulated; significant regulatory changes could adversely affect our operations.

Our operations will be impacted by current and future legislation and by the policies established from time to time by various federal and state regulatory authorities. The Company is subject to supervision by the FRB and the Bank is subject to supervision and periodic examination by the Maryland Commissioner and the FDIC. Banking regulations, designed primarily for the safety of depositors, may limit a financial institution’s growth and the return to its investors by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, investments, loans and interest rates, interest rates paid on deposits, expansion of branch offices, and the offering of securities or trust services. The Company and the Bank are also subject to capitalization guidelines established by federal law and could be subject to enforcement actions to the extent that either is found by regulatory examiners to be undercapitalized. It is not possible to predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects. Management also cannot predict the nature or the extent of the effect on our business and earnings of future fiscal or monetary policies, economic controls, or new federal or state legislation. Further, the cost of compliance with regulatory requirements may adversely affect our ability to operate profitably.

Our regulatory expenses will likely increase due to federal laws, rules and programs that have been enacted or adopted in response to the recent banking crisis and the current national recession.

In response to the banking crisis that began in 2008 and the resulting national recession, the federal government took drastic steps to help stabilize the credit market and the financial industry. These steps included the enactment of EESA, which, among other things, raised the basic limit on federal deposit insurance coverage to $250,000, and the FDIC’s adoption of the TLGP, which, under the TAG portion, provides full deposit insurance coverage through June 30, 2010 for non-interest bearing transaction deposit accounts, IOLTAs, and NOW accounts with interest rates of 0.50% or less, regardless of account balance. The TLGP was extended to December 31, 2012 and includes non-interest bearing transaction deposit accounts, IOLTAs, and NOW accounts with interest rates of 0.25% or less, regardless of account balance. The TLGP requires participating institutions, like us, to pay 10 basis points per annum for the additional insured deposits. These actions will cause our regulatory expenses to increase. Additionally, due in part to the failure of several depository institutions around the country since the banking crisis began, the FDIC imposed an emergency insurance assessment to help restore the Deposit Insurance Fund and further required insured depository institutions to prepay their estimated quarterly risk-based deposit assessments through 2012 on December 30, 2009. Given the current state of the national economy, there can be no assurance that the FDIC will not impose future emergency assessments or further revise its rate structure.

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In addition, and as noted above, the Dodd-Frank Act recently became law and implements significant changes in the financial regulatory landscape that will impact all financial institutions, including the Company and the Bank. The Dodd-Frank Act is likely to increase our regulatory compliance burden. It is too early, however, for us to assess the full impact that the Dodd-Frank Act may have on our business, financial condition or results of operations. Many of the Dodd-Frank Act’s provisions require subsequent regulatory rulemaking. The Dodd-Frank Act’s significant regulatory changes include the creation of the Consumer Protection Bureau a new financial consumer protection agency, known as the Bureau of Consumer Financial Protection, that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer compliance, which will increase our regulatory compliance burden and costs and may restrict the financial products and services we offer to our customers. Moreover, the Dodd-Frank Act permits states to adopt stricter consumer protection laws and states’ attorneys general may enforce consumer protection rules issued by the Bureau of Consumer Financial Protection. The Dodd-Frank Act also imposes more stringent capital requirements on bank holding companies by, among other things, imposing leverage ratios on bank holding companies and prohibiting new trust preferred issuances from counting as Tier 1 capital. These restrictions will limit our future capital strategies. The Dodd-Frank Act also increases regulation of derivatives and hedging transactions, which could limit our ability to enter into, or increase the costs associated with, interest rate and other hedging transactions. Although certain provisions of the Dodd-Frank Act, such as direct supervision by the Bureau of Consumer Financial Protection, will not apply to banking organizations with less than $10 billion of assets, such as First United Corporation and the Bank, the changes resulting from the legislation will impact our business. These changes will require us to invest significant management attention and resources to evaluate and make necessary changes.

Recent amendments to the FRB’s Regulation E may negatively impact our non-interest income.

On November 12, 2009, the FRB announced the final rules amending Regulation E (“Reg E”) that prohibit financial institutions from charging fees to consumers for paying overdrafts on automated teller machine and one-time debit card transactions, unless a consumer consents, or opts-in, to the overdraft service for those types of transactions. Compliance with this regulation is effective July 1, 2010 for new consumer accounts and August 15, 2010 for existing consumer accounts. These new rules negatively impacted certain non-interest income in 2011 by approximately 3.92% when compared to 2010, the effect of which is included in service charge income on the statement of operations.

Customer concern about deposit insurance may cause a decrease in deposits held at the Bank.

With recent increased concerns about bank failures, customers increasingly are concerned about the extent to which their deposits are insured by the FDIC. Customers may withdraw deposits from the Bank in an effort to ensure that the amount they have on deposit with us is fully insured. Decreases in deposits may adversely affect our funding costs and net income.

Our funding sources may prove insufficient to replace deposits and support our future growth.

We rely on customer deposits, advances from the FHLB, and lines of credit at other financial institutions to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, no assurance can be given that we would be able to replace such funds in the future if our financial condition or the financial condition of the FHLB or market conditions were to change. Our financial flexibility will be severely constrained and/or our cost of funds will increase if we are unable to maintain our access to funding or if financing necessary to accommodate future growth is not available at favorable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our profitability would be adversely affected.

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The loss of key personnel could disrupt our operations and result in reduced earnings.

Our growth and profitability will depend upon our ability to attract and retain skilled managerial, marketing and technical personnel. Competition for qualified personnel in the financial services industry is intense, and there can be no assurance that we will be successful in attracting and retaining such personnel. Our current executive officers provide valuable services based on their many years of experience and in-depth knowledge of the banking industry and our market area. Due to the intense competition for financial professionals, these key personnel would be difficult to replace and an unexpected loss of their services could result in a disruption to the continuity of operations and a possible reduction in earnings.

Our lending activities subject us to the risk of environmental liabilities.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

We may be subject to other claims and the costs of defensive actions.

Our customers may sue us for losses due to alleged breaches of fiduciary duties, errors and omissions of employees, officers and agents, incomplete documentation, our failure to comply with applicable laws and regulations, or many other reasons. Also, our employees may knowingly or unknowingly violate laws and regulations. Management may not be aware of any violations until after their occurrence. This lack of knowledge may not insulate us from liability. Claims and legal actions may result in legal expenses and liabilities that may reduce our profitability and hurt our financial condition.

We may be adversely affected by other recent legislation.

As discussed above, the GLB Act repealed restrictions on banks affiliating with securities firms and permits bank holding companies that become financial holding companies to engage in additional financial activities, including insurance and securities underwriting and agency activities, merchant banking, and insurance company portfolio investment activities that are currently not permitted for bank holding companies. Although the Company is a financial holding company, this law may increase the competition we face from larger banks and other companies. It is not possible to predict the full effect that this law will have on us.

The Sarbanes-Oxley Act of 2002 requires management of publicly-traded companies to perform an annual assessment of their internal control over financial reporting and to report on whether the system is effective as of the end of the Company’s fiscal year. Disclosure of significant deficiencies or material weaknesses in internal controls could cause an unfavorable impact to stockholder value by affecting the market value of our stock.

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The Patriot Act reinforced the importance of implementing and following procedures required by the Bank Secrecy Act and money laundering issues. Non-compliance with this act or failure to file timely and accurate documentation could expose the Company to adverse publicity as well as fines and penalties assessed by regulatory agencies.

Periodically, the federal and state legislatures consider bills with respect to the regulation of financial institutions. Some of these proposals could significantly change the regulation of banks and the financial services industry. We cannot predict whether such proposals will be adopted or the impact on our business, earnings or operations of such future legislation.

We may not be able to keep pace with developments in technology, in which case we may become less competitive and lose customers.

We use various technologies in conducting our businesses, including telecommunication, data processing, computers, automation, internet-based banking, and debit cards. Technology changes rapidly. Our ability to compete successfully with other financial institutions may depend on whether we can exploit technological changes. We may not be able to exploit technological changes, and any investment we do make may not make us more profitable.

Safeguarding our business and customer information increases our cost of operations. To the extent that we, or our third party vendors, are unable to prevent the theft of or unauthorized access to this information, our operations may become disrupted, we may be subject to claims, and our net income may be adversely affected.

Our business depends heavily on the use of computer systems, the Internet and other means of electronic communication and recordkeeping. Accordingly, we must protect our computer systems and network from break-ins, security breaches, and other risks that could disrupt our operations or jeopardize the security of our business and customer information. Moreover, we use third party vendors to provide products and services necessary to conduct our day-to-day operations, which exposes us to risk that these vendors will not perform in accordance with the service arrangements, including by failing to protect the confidential information we entrust to them. Any security measures that we or our vendors implement, including encryption and authentication technology that we use to effect secure transmissions of confidential information, may not be effective to prevent the loss or theft of our information or to prevent risks associated with the Internet, such as cyber-fraud. Advances in computer capabilities, new discoveries in the field of cryptography, or other developments could permit unauthorized persons to gain access to our confidential information in spite of the use of security measures that we believe are adequate. Any compromise of our security measures or of the security measures employed by our vendors of our third party could disrupt our business and/or could subject us to claims from our customers, either of which could have a material adverse effect on our business, financial condition and results of operations.

Risks Related to the Company’s Common Stock

Our ability to pay dividends is limited.

The Company’s stockholders are entitled to dividends on their shares of common stock if, when, and as declared by the Company’s Board of Directors out of funds legally available for that purpose. The Company’s ability to pay dividends to stockholders is largely dependent upon the receipt of dividends from the Bank. Both federal and state laws impose restrictions on the ability of the Bank to pay dividends. Federal law prohibits the payment of a dividend by an insured depository institution if the depository institution is considered “undercapitalized” or if the payment of the dividend would make the institution “undercapitalized.” For a Maryland state-chartered bank, dividends may be paid out of undivided profits or, with the prior approval of the Maryland Commissioner, from surplus in excess of 100% of required capital stock. If, however, the surplus of a Maryland bank is less than 100% of its required capital stock, then cash dividends may not be paid in excess of 90% of net earnings. In addition to these specific restrictions, bank regulatory agencies have the ability to prohibit proposed dividends by a financial institution that would otherwise be permitted under applicable regulations if the regulatory body determines that such distribution would constitute an unsafe or unsound practice. Because of these limitations, there can be no guarantee that the Company’s Board will declare dividends in any fiscal quarter.

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Shares of the Company’s common stock are not insured.

Investments in shares of the Company’s common stock are not deposits and are not insured against loss by the government.

Shares of the Company’s common stock are not heavily traded.

There is no established trading market for the shares of common stock of the Company, and transactions are infrequent and privately negotiated by the buyer and seller in each case. See Item 5 of Part II of this annual report for further market information. Management cannot predict the extent to which an active public market for these securities will develop or be sustained in the future. Securities that are not heavily traded can be more volatile than stock trading in an active public market. Factors such as our financial results, the introduction of new products and services by us or our competitors, and various factors affecting the banking industry generally may have a significant impact on the market price of our common stock. In recent years, the stock market has experienced a high level of price and volume volatility, and market prices for the securities of many companies have experienced wide price fluctuations that have not necessarily been related to their operating performance. Accordingly, the Company’s stockholders may not be able to sell their shares at the volumes, prices, or times that they desire.

The Company’s Articles of Incorporation and Maryland law may discourage a corporate takeover.

The Company’s Articles of Incorporation, as amended, requires that any proposed merger, share exchange, consolidation, reverse stock split, sale, exchange, lease of all or substantially all of the assets of the Company or any similar transaction be approved by the affirmative vote of 75% of the outstanding shares of the Company’s common stock.

The Maryland Business Combination Act generally prohibits, subject to certain limited exceptions, corporations from being involved in any “business combination” (defined as a variety of transactions, including a merger, consolidation, share exchange, asset transfer or issuance or reclassification of equity securities) with any “interested shareholder” for a period of five years following the most recent date on which the interested shareholder became an interested shareholder. An interested shareholder is defined generally as a person who is the beneficial owner of 10% or more of the voting power of the outstanding voting stock of the corporation after the date on which the corporation had 100 or more beneficial owners of its stock or who is an affiliate or associate of the corporation and was the beneficial owner, directly or indirectly, of 10% percent or more of the voting power of the then outstanding stock of the corporation at any time within the two-year period immediately prior to the date in question and after the date on which the corporation had 100 or more beneficial owners of its stock. The Maryland Control Share Acquisition Act applies to acquisitions of “control shares,” which, subject to certain exceptions, are shares the acquisition of which entitle the holder, directly or indirectly, to exercise or direct the exercise of the voting power of shares of stock of the corporation in the election of directors within any of the following ranges of voting power: one-tenth or more, but less than one-third of all voting power; one-third or more, but less than a majority of all voting power or a majority or more of all voting power. Control shares have limited voting rights.

Although these provisions do not preclude a takeover, they may have the effect of discouraging, delaying or deferring a tender offer or takeover attempt that a stockholder might consider in his or her best interest, including those attempts that might result in a premium over the market price for the common stock. These provisions could potentially adversely affect the market price of the Company’s common stock.

Item 1B. Unresolved Staff Comments.

The Company is a “smaller reporting company” and, thus, this Item 1B is not applicable.

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Item 2. Properties.

Other than for our operating purposes, we do not invest in real estate. We operate branches at the following locations:

Location	Type of Office	Square Footage
100 Spring Avenue in Chestertown, Maryland 21620	Main Office		16,000
600 Washington Avenue, Chestertown, Maryland 21620	Branch		3,500
166 North Main Street, Galena, Maryland 21635	Branch		2,000
21337 Rock Hall Avenue, Rock Hall, Maryland 21661	Branch		2,000
31905 River Road, Millington, Maryland 21651	Branch		2,584
1005 Sudlersville Road, Church Hill, Maryland 21623	Branch		2,584
223 East Main Street, Sudlersville, Maryland 21668	Branch		2,584
100 Talbot Boulevard, Chestertown, Maryland 21620	Insurance Subsidiary		3,000
116 North Bohemia Avenue, Cecilton, Maryland 21913	Insurance Subsidiary		225

Except for the Insurance Subsidiary’s branch located in Cecilton, Maryland, we own all of the foregoing properties. We also own property located off of Route 544 in Chestertown, Maryland which is being held for possible future expansion purposes.

Item 3. Legal Proceedings

We are not a party to, nor is any of our properties the subject of, any material legal proceedings other than routine litigation arising in the ordinary course of business. In the opinion of management, no such proceeding will have a material adverse effect on our financial condition or results of operations.

Item 4. Mine Safety Disclosures

This item is not applicable.

PART II

Item 5. Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

As of March 1, 2012, the Company had 623 stockholders of record. Although certain brokers make a market in the shares of the Company’s common stock through the Over-the-Counter Bulletin Board (“OTCBB”) operated by The NASDAQ Stock Market, we believe there is no established trading market for the shares of common stock, that transactions are infrequent, and that most transactions are privately negotiated. Management cannot predict whether any market will develop in the near future. Market information for the Company’s common stock may be found at the OTCBB’s Internet website, www.otcbb.com, under the symbol “PEBC”. The information contained in or accessed through that website is not part of this annual report or incorporated herein by reference. The following table sets forth, to the best knowledge of the Company, the high and low sales prices for the shares of the Company’s common stock, along with the cash dividends paid, for each quarterly period of 2010 and 2011. There may have been sales during these periods of which the Company is not aware. These prices do not include retail mark-ups, markdowns or commissions, and may not necessarily represent actual transactions.

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	2010						2011
	Price Range				Dividends		Price Range				Dividends
		High		Low				High		Low
First Quarter	$	92.00	$	60.00	$	0.45		65.00	$	51.95	$	0.22
Second Quarter		65.00		40.00		0.45		65.00		60.00		0.11
Third Quarter		65.00		50.00		0.45		62.00		47.00		0.00
Fourth Quarter		65.00		65.00		0.45		50.00		45.00		0.00

The last sale known to the Company occurred on February 24, 2012 and the sales price reported through the OTCBB was $45.00 per share.

Cash dividends are at the discretion of the Board of Directors, based upon such factors as operating results, financial condition, capital adequacy, regulatory requirements, and stockholder return. The Company’s ability to pay dividends is limited by federal and Maryland law and is generally dependent on the ability of the Bank to declare and pay dividends to the Company, which is also limited by law. For more information regarding these limitations, see Item 1A of Part I of this annual report under the caption, “Our ability to pay dividends is limited.” There can be no assurance that dividends will be declared in any fiscal quarter. In 2010 and 2011, the Company paid cash dividends to stockholders totaling $1,403,122 and $257,239, respectively. On January 14, 2011, the Company’s Board of Directors reduced the quarterly cash dividend on the common stock for the fourth quarter of 2010 to $.22 per share from $.45 per share for the third quarter of 2010. The quarterly cash dividend declared on common stock for the first quarter of 2011 was declared at $.11 per share on April 14, 2011. As the result of our year-to-date loss and after consultation with the FRB, the Company’s Board voted to eliminate the quarterly cash dividend on the shares of common stock until the Company returns to positive earnings that will support the payment of dividends.

The transfer agent for the shares of common stock of the Company is:

The Peoples Bank

100 Spring Avenue

Chestertown, Maryland 21620

410-778-3500

The Company and its affiliates (as defined by Exchange Act Rule 10b-18) did not purchase any shares of the Company’s common stock during the three-month period ended December 31, 2011.

Item 6. Selected Financial Data.

The Company is a smaller reporting company and, as such, is not required to include the information required by this item.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion of consolidated financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes and other statistical information included in Item 8 of Part II of this annual report.

Overview

For the year ended December 31, 2011 and December 31, 2010, we recorded net losses of $1,987,281 and $373,535. Basic and diluted net loss per share was $2.55 for 2011, compared to basic and net loss per share of $.48 for 2010.

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Return on average assets decreased to (.80)% for 2011 from (.15)% for 2010. Return on average stockholders’ equity for 2011 was (7.41)%, compared to (1.31)% for 2010. Average assets increased to $249,612,448 in 2011, representing a .29% increase when compared to 2010. Average loans net of allowance for loan losses decreased 4.58% in 2011 to $198,723,080. During 2011, average deposits increased 3.59% to $196,708,790 when compared to 2010. Average stockholders’ equity for the year ended December 31, 2011 decreased 6.16% over 2010, totaling $26,836,434.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and follow general practices within the industries in which we operate. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.

The most significant accounting policies that we follow are presented in Note 1 to the Consolidated Financial Statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses to be the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

The allowance for loan losses (“ALL”) represents management’s best estimate of identified and inherent losses in the loan portfolio as of the balance sheet date. Adequacy of the ALL is evaluated no less than quarterly. Determining the amount of the ALL is difficult and calls for numerous subjective judgments as it relies on estimates of inherent loss on individual loans, the effects of portfolio trends due to evolving market conditions, and other internal and external factors.

The ALL consists of formula-based reserves for inherent losses in the balances of specific segments of the loan portfolio, specific reserve amounts for inherent losses on loans management has identified as impaired, and unallocated reserves not associated with a specific loan or portfolio segment.

The Bank evaluates loan portfolio risk for the purpose of establishing an adequate ALL. Management considers historical loss experience for all segments of the loan portfolio in order to determine an adequate level for the formula based portion of the ALL. Different segments of the loan portfolio are evaluated based on loss experience using a 36-month rolling historical loss ratio. Based on this evaluation, management applies a formula to current portfolio balances in the different portfolio segments, giving weight to portfolio segment size and loss experience for real estate construction and land development loans, other real estate secured loans, other loans to commercial borrowers and other personal loans to consumers.

Historical data may not present a complete prediction of loss potential in the current loan portfolio. Bearing this in mind, management also evaluates trends in delinquencies, lending volume, and changes in lending practices and policies. Management further considers external factors such as current local and national economic conditions and trends, reviews by independent loan review vendors, reviews by our outside auditors, and the results of examinations by bank regulatory authorities. The loan portfolio also represents the largest asset type on the consolidated balance sheets. Note 1 to Consolidated Financial Statements describes the methodology used to determine the allowance for loan losses, and a discussion of the factors driving changes in the amount of the allowance for loan losses is included below under the caption “FINANCIAL CONDITION—Market Risk Management.”

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RESULTS OF OPERATIONS

We reported a net loss of $1,987,281 for the year ended December 31, 2011, compared to a net loss of $373,535 for the year ended December 31, 2010. Basic and diluted net loss per share for the years ended December 31, 2011 and December 31, 2010 was $2.55 and $0.48, respectively. The higher loss in 2011 ($1,613,746 or 432.02%) when compared to 2010 was the direct result of a $1,640,000 increase in our provision for loan losses in 2011 to $6,550,000 from $4,910,000 in 2010. The increased provision was due primarily to increased losses in our loan portfolio during 2011.

Net Interest Income

The primary source of our income is net interest income, which is the difference between revenue on interest-earning assets, such as investment securities and loans, and interest incurred on interest-bearing sources of funds, such as deposits and borrowings. The level of net interest income is determined primarily by the average balance of interest-earning assets and funding sources and the various rate spreads between our interest-earning assets and our interest-bearing funding sources. The table “Average Balances, Interest, and Yields” that appears below shows our average volume of interest-earning assets and interest-bearing liabilities for 2011 and 2010, and related income/expense and yields. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, and increases or decreases in the average rates earned and paid on such assets and liabilities. The volume of interest-earning assets and interest-bearing liabilities is affected by the ability to manage the earning-asset portfolio (which includes loans), and the availability of particular sources of funds, such as noninterest bearing deposits. The table “Analysis of Changes in Net Interest Income” shows the amount of net interest income change from rate changes and from volume changes.

For the year ended December 31, 2011, net interest income decreased $499,209, or 5.52%, to $8,537,654 from $9,036,863 for the year ended December 31, 2010. The decrease in net interest income in 2011 was the result of a $1,095,266 decrease in interest income offset by a $596,057 decrease in interest expense. In 2011, deposits increased but our borrowed funds decreased with loan demand. Net interest income decreased because the yield earned on loans declined faster than yields on deposits and borrowed funds. The yield on interest-earning assets on a fully taxable equivalent basis was 5.77% in 2010 and 5.52% in 2011, with the combined effective rate on deposits and borrowed funds following the same fluctuation by decreasing from 2.08% in 2010 to 1.75% in 2011.

The key performance measure for net interest income is the “net margin on interest-earning assets”, or net interest income divided by average interest-earning assets. Our net interest margin for 2011 and 2010 on a fully taxable equivalent basis was 4.04% and 4.09%, respectively. Management attempts to maintain a net margin on interest-earning assets of 4.50% or higher. The net margin may decline, however, if competition increases, loan demand decreases, or the cost of funds rises faster or declines slower than the return on loans and securities. Although such expectations are based on management’s judgment, actual results will depend on a number of factors that cannot be predicted with certainty, and fulfillment of management’s expectations cannot be assured.

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Average Balances, Interest, and Yields

	For the Year Ended							For the Year Ended
	December 31, 2011							December 31, 2010
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets
Federal funds sold	$	4,385,386	$	6,404		0.15	%	$	1,338,039	$	2,433		0.18	%
Interest-bearing deposits		257,999		431		0.17	%		42,530		88		0.21	%
Investment securities:
U. S. government agency		9,573,552		110,785		1.16	%		13,033,449		315,862		2.42	%
FHLB of Atlanta &
CBB Financial Corp. Stock		1,923,037		16,636		0.87	%		2,320,287		8,305		0.36	%
		11,496,589		127,421					15,353,736		324,167			%
Loans
Business Loans		26,936,217		1,610,098		5.98	%		28,168,323		1,612,031		5.72	%
Mortgage loans		170,770,616		9,775,658		5.72	%		176,460,817		10,611,050		6.01	%
Personal loans		5,081,613		335,576		6.60	%		6,168,924		401,426		6.51	%
Total loans		202,788,446		11,721,332		5.78	%		210,798,064		12,624,507		5.99	%
Allowance for loan losses		4,065,366							3,148,200
Total loans, net of allowance		198,723,080		11,721,332		5.90	%		207,649,864		12,624,507		6.08	%
Total interest-earning assets		214,863,054		11,855,588		5.52	%		224,384,169		12,951,195		5.77	%
Non-interest-bearing cash		19,127,133							11,721,212
Premises and equipment		6,318,539							6,493,792
Other assets		9,303,722							6,296,970
Total assets	$	249,612,448						$	248,896,143

Liabilities and Stockholders’ Equity
Interest-bearing Deposits
Savings and NOW deposits	$	47,529,136	$	53,344		0.11	%	$	45,714,413	$	82,960		0.18	%
Money market and supernow		11,807,400		23,546		0.20	%		11,127,627		42,807		0.38	%
Other time deposits		98,522,114		2,401,344		2.44	%		97,006,196		2,795,184		2.88	%
Total interest-bearing deposits		157,858,650		2,478,234		1.57	%		153,848,236		2,920,951		1.90	%
Borrowed funds		24,248,093		702,772		2.90	%		27,902,456		855,923		3.07	%
Total interest-bearing liabilities		182,106,743		3,181,006		1.75	%		181,750,692		3,776,874		2.08	%
Noninterest-bearing deposits		38,850,140							36,043,099
		220,956,883							217,793,791
Other liabilities		1,819,131							2,505,653
Stockholders’ equity		26,836,434							28,596,699
Total liabilities and stockholders equity	$	249,612,448						$	248,896,143
Net interest spread						1.27	%						3.69	%
Net interest income			$	8,674,582						$	9,174,321
Net margin on interest-earning assets						4.04	%						4.09	%

Interest on tax-exempt loans and investments are reported on a fully taxable equivalent basis (a non GAAP financial measure).

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Analysis of Changes in Net Interest Income

	Year ended December 31,									Year ended December 31,
	2011 compared with 2010									2010 compared with 2009
	variance due to									variance due to
	Total			Rate			Volume			Total			Rate			Volume
Earning assets
Federal funds sold	$	3,971		$	(566	)	$	4,537		$	(7,267	)	$	728		$	(7,995	)
Interest-bearing deposits		343			(20	)		363			(8	)		102			(110	)
Investment securities:
U. S. government agency		(205,077	)		(135,987	)		(69,090	)		(238,125	)		(221,018	)		(17,107	)
FHLB & CBB Financial Corp. stock		8,331			9,970			(1,639	)		627			818			(191	)
Loans:
Demand and time		(1,933	)		70,134			(72,067	)		(405,428	)		(121,467	)		(283,961	)
Mortgage		(835,392	)		(499,827	)		(335,565	)		(234,660	)		(613,911	)		379,251
Installment		(65,850	)		5,872			(71,722	)		(191,282	)		(116,672	)		(74,610	)
Total interest revenue		(1,095,607	)		(550,424	)		(545,183	)		(1,076,143	)		(1,071,420	)		(4,723	)

Interest-bearing liabilities
Savings and NOW deposits		(29,616	)		(32,791	)		3,175			(3,541	)		(9,057	)		5,516
Money market and supernow		(19,261	)		(21,734	)		2,473			(20,032	)		(22,296	)		2,264
Other time deposits		(393,840	)		(436,901	)		43,061			(130,669	)		(393,822	)		263,153
Other borrowed funds		(153,151	)		(45,404	)		(107,747	)		(676,368	)		(137,713	)		(538,655	)
Total interest expense		(595,868	)		(536,830	)		(59,038	)		(830,610	)		(562,888	)		(267,722	)

Net interest income	$	(499,207	)	$	(13,594	)	$	(486,145	)	$	(245,533	)	$	(508,532	)	$	262,999

Notes:

(1)

Interest on tax-exempt loans and investments are reported on fully taxable equivalent basis (a non GAAP financial measure).

(2)

The variance that is due both to rate and volume is divided proportionally between the rate and volume variance.

Noninterest Revenue

Noninterest revenue for the 12 months ended December 31, 2011 was $2,421,168, compared to $2,305,062 for same period in 2010. This increase resulted from a $50,155 increase in the Insurance Subsidiary’s insurance commissions and a $41,125 increase in service charges on deposit accounts when compared to 2010. Additionally, there was a net loss of $77,827 on the sale of foreclosed real estate, compared to a net loss of $53,515 in 2010, and an increase in other income of $49,138.

The following table presents the principal components of noninterest revenue for the years ended December 31, 2011 and 2010:

Noninterest Revenue

	2011			2010
Service charges on deposit accounts	$	897,996		$	856,871
Insurance commissions		1,233,112			1,182,957
Loss on sale of foreclosed real estate		(77,827	)		(53,515	)
Other noninterest revenue		367,887			318,749
Total noninterest revenue	$	2,421,168		$	2,305,062

Noninterest revenue as a percentage of total revenue		17.12	%		15.25	%

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Noninterest Expense

Noninterest expense for the 12-month period ended December 31, 2011 increased by $410,103, or 5.72%, to $7,583,753, from $7,173,650 in 2010. This increase was attributable to the increases in the Bank’s foreclosed real estate expense of $392,936, or 290.65%, directors fees of $26,590, or 18.17%, and professional fees of $58,301, or $44.53%, offset by decreases of $16,903, or 24.79%, to public relations and contribution expenses and $56,061, or 16.87%, in regulatory assessments.

The following table presents the principal components of noninterest expense for the years ended December 31, 2011 and 2010:

Noninterest Expense

	2011			2010

Compensation and related expenses	$	3,977,538		$	3,952,737
Occupancy expense		500,849			515,091
Furniture and equipment expense		330,404			345,097
Data processing and correspondent bank costs		664,598			681,718
Director fees		172,938			146,348
Postage		103,254			110,799
Office supplies		87,896			96,054
Professional fees		189,234			130,933
Printing and stationery		7,629			14,905
Public relations and contributions		51,285			68,188
Telephone		41,931			43,747
Regulatory assessments		276,247			332,308
Loan products		15,310			13,825
Foreclosed real estate expense		528,128			135,192
Advertising		53,457			59,532
Insurance		34,016			37,687
Other		549,039			489,489

Total noninterest expense	$	7,583,753		$	7,173,650

Noninterest expense as a percentage of total expense		47.43	%		46.30	%

Income Taxes

We file consolidated federal and state income tax returns. Our effective income tax rate was 37.4% in 2011 and 49.60% in 2010.

Results for the Fourth Quarter of 2010

During the fourth quarters of 2011 and 2010, we recorded a net loss of $1,219,156 and $994,960, respectively. Correspondingly, we recorded a net loss per share of $1.56 for the forth quarter of 2011 and $1.28 for the fourth quarter of 2010. The higher loss in 2011 resulted from a $225,931 decrease in net interest income, offset by a decrease of $250,000 in the provision for loan loss, a $50,487 increase in compensation and related expenses and a $53,279 increase in forclosed real estate expense when compared to 2010.

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The Company recorded net interest income of $2,140,883 for the fourth quarter of 2011, which represents a $225,931 decrease over the $2,366,814 recorded for the three months ended December 31, 2010. The decrease was due primarily to loan revenues and borrowed funds interest expense reducing in direct correlation to the reduction in loan and borrowed funds account balances. Deposit balances increased during this period and interest expense decreased as the direct result of lower interest rates for the period and the repricing of matured time deposits at lower rates. Comparing the fourth quarter of 2011 to the fourth quarter of 2010, interest revenue decreased $403,676, with $380,428 of this decrease resulting from a decrease in loan interest expense. Interest expense decreased $177,745, with $140,664 of this decrease resulting from a decrease in borrowed funds interest expense. The provision for loan losses for the fourth quarter of 2011 decreased by $250,000 to $2,675,000 when compared to the fourth quarter of 2010.

Noninterest income for the fourth quarter of 2011 increased $31,883 to $552,567 when compared to the same period of 2010. This increase was due primarily to a $64,230 increase in service charges and an $8,658 increase in insurance commissions, offset by a $16,720 loss on the sale of forclosed real estate and a $24,285 decrease in other income for the fourth quarter of 2011 when compared to the fourth quarter of 2010.

Total noninterest expense increased $111,357 to $1,743,952 for the quarter ended December 31, 2011, from $1,632,595 for the corresponding quarter of 2010. This increase primarily resulted from a $53,279 increase in foreclosed real estate expense and a $50,487 increase compensation and related expenses. We have reduced those expenses that are under management’s control and constantly attempts to increase overall income.

FINANCIAL CONDITION

Assets

Total assets increased 3.00% to $253,158,228 at December 31, 2011 when compared to assets at December 31, 2010. Average total assets for 2011 were $249,612,448, an increase of .29% from 2010. The loan portfolio represented 92.49% of average earning assets in 2011, compared to 92.54% in 2010, and was the primary source of income for the Company.

Funding for loans is provided primarily by core deposits, securities repurchase agreements, and FHLB borrowings. Total deposits increased 7.15% to $203,195,268 at December 31, 2011 when compared to 2010.

Composition of Loan Portfolio

Because loans are expected to produce higher yields than investment securities and other interest-earning assets (assuming that loan losses are not excessive), the absolute volume of loans and the volume as a percentage of total earning assets is an important determinant of net interest margin. Average loans, net of the allowance for loan losses, were $198,723,080 and $207,649,864 for 2011 and 2010, respectively, which constituted 92.49% and 92.54% of average interest-earning assets for the respective years. At December 31, 2011, our loan to deposit ratio was 92.95%, compared to 109.31% at December 31, 2010, while the ratio of average loans to average deposits was 101.02% and 109.35% for 2011 and 2010, respectively. The securities sold under agreements to repurchase function like deposits with the securities providing collateral in place of the FDIC insurance. The Bank also borrows from correspondent banks and the FHLB to fund loans. Our ratio of average loans to average deposits plus average borrowed funds was 89.94% for the year ended December 31, 2011, compared to 95.34% for the year ended December 31, 2010. We extend loans primarily to customers located in and near Kent County, Queen Anne’s County and Cecil County in Maryland. There are no industry concentrations in our loan portfolio. A substantial portion of our loans are, however, secured by real estate and, accordingly, the real estate market in the region will influence the performance of our loan portfolio.

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The following table sets forth the composition of our loan portfolio at December 31, 2011 and 2010:

Composition of Loan Portfolio

	2011						2010
				Percent						Percent
	Amount			of total			Amount			of total
Commercial	$	23,714,668			12.28	%	$	29,052,413			13.65	%
Real estate – residential		72,620,650			37.61	%		75,206,074			35.33	%
Real estate - commercial		83,938,292			43.47	%		89,617,135			42.10	%
Construction		7,919,498			4.10	%		13,403,765			6.30	%
Consumer		4,901,916			2.54	%		5,588,830			2.62	%
Total loans		193,095,024			100.00	%		212,868,217			100.00	%
Deferred costs, net of deferred fees		76,723						84,448
Allowance for loan losses		(4,295,541	)					(5,656,788	)
Net loans	$	188,876,206					$	207,295,877

The following table sets forth the maturity distribution, classified according to sensitivity to changes in interest rates, for selected components of our loan portfolio at December 31, 2011:

Loan Maturity Schedule and Sensitivity to Changes in Interest Rates

	December 31, 2011
	One year or less		Over one through five		Over five years		Total

Commercial	$	22,284,183	$	1,333,124	$	97,361	$	23,714,668
Real estate – residential		44,012,071		28,441,897		166,682		72,620,650
Real estate - commercial		48,845,537		35,092,755		-		83,938,292
Construction		6,724,622		1,086,115		108,761		7,919,498
Consumer		3,905,384		971,623		24,909		4,901,916
Total	$	125,771,797	$	66,925,514	$	397,713	$	193,095,024

Fixed interest rate	$	115,252,260	$	66,913,123	$	397,713	$	182,563,096
Variable interest rate		10,519,537		12,391		-		10,531,928
Total	$	125,771,797	$	66,925,514	$	397,713	$	193,095,024

At December 31, 2011, $10,531,928, or 5.45%, of the total loans were either variable-rate loans or loans written on demand.

Off-Balance Sheet Arrangements

In the normal course of business, to meet the financing needs of our customers, we are a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Our exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of the instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. We generally require collateral or other security to support the financial instruments with credit risk. The amount of collateral or other security is determined based on management’s credit evaluation of the counterparty. We evaluate each customer’s creditworthiness on a case-by-case basis.

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Letters of credit are conditional commitments that we issue to guarantee the performance of a customer to a third party. Letters of credit and other commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the letters of credit and commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. See Note 4 to the Consolidated Financial Statements, which is included in Item 8 of Part II of this annual report, for further information about these commitments.

Loan Quality

The allowance for loan losses represents a reserve for inherent losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated monthly based on a review of all significant loans, with a particular emphasis on non-accruing, past due, and other loans that management believes require attention. The determination of the reserve level rests upon management’s judgment about factors affecting loan quality and assumptions about the economy. Management considers the year-end allowance appropriate and adequate to cover inherent losses in the loan portfolio; however, management’s judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the loan loss allowance will not be required.

For significant problem loans, management’s review consists of evaluation of the financial strengths of the borrowers and guarantors, the related collateral, and the effects of economic conditions. The overall evaluation of the adequacy of the total allowance for loan losses is based on an analysis of historical loan loss ratios, loan charge-offs, delinquency trends, and previous collection experience, along with an assessment of the effects of external economic conditions.

Risk Elements of Loan Portfolio

	For the Years Ended December 31,
	2011		2010

Non-Accrual Loans	$	9,465,430	$	5,325,495
Accruing Loans Past Due 90 Days or More		107,206		6,368,643

During the previous year management reevaluated how loans were placed in a nonaccrual status. As the result loans are now placed in nonaccrual at the time they reach 90 days past due unless management’s review of the loan determines the collateral is sufficient to discharge the debt in full or the loan is in the process of collection.

The following table, “Allocation of Allowance for Loan Losses”, shows the specific allowance applied by loan type and also the general allowance included in the allowance for loan losses at December 31, 2011 and 2010:

	2011		2010

Commercial	$	342,962	$	676,113
Residential real estate		1,467,947		806,728
Commercial real estate		1,608,829		1,124,851
Construction and land development		777,031		2,780,148
Other real estate		9,755		2,122
Consumer		65,539		126,751
Overdraft		1,047		3,028
Unallocated		22,431		137,047
Total	$	4,295,541	$	5,656,788

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The provision for loan losses is a charge to earnings in the current period to replenish the allowance for loan losses and maintain it at a level management has determined to be adequate. The provision for loan losses was $6,550,000 in 2011, which represents an increase of $1,640,000 over the $4,910,000 that was recorded in 2010. We added to our reserves in anticipation of inherent losses in connection with the higher than normal balances of nonaccrual loans. The following table shows information about the allowance for loan losses for each of the last two years:

Allowance for loan Losses

	Year ended			Year ended
	December 31,			December 31,
	2011			2010
Balance at beginning of year	$	5,656,788		$	2,845,364
Loans charged off:
Commercial		669,862			166,779
Mortgages		7,310,607			1,846,683
Consumer		19,850			104,791
Total loan losses		8,000,319			2,118,253
Recoveries on loans previously charged off
Commercial		6,498			2,660
Mortgages		53,565			374
Consumer		29,009			16,643
Total loan recoveries		89,072			19,677
Net loan losses		7,911,247			2,098,576
Provision for loan losses charged to expense		6,550,000			4,910,000
Balance at end of year	$	4,295,541		$	5,656,788

Allowance for loan losses to loans outstanding		2.22	%		2.66	%

Net charge-offs to average loans		3.90	%		1.00	%

As a result of management’s ongoing review of the loan portfolio, a loan is considered impaired when, based on current information and events, management believes that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impairment is measured on a loan by loan basis. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. The accrual of interest is discontinued when principal or interest is ninety days past due or when the loan is determined to be impaired, unless collateral is sufficient to discharge the debt in full and the loan is in process of collection. When a loan is placed in nonaccrual status, all interest that had been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.

We had nonperforming loans of $9,572,636 and $11,694,138 at December 31, 2011 and 2010, respectively. Management considers the nonaccrual loans and loans over 90 days past due to be nonperforming loans. We had $4,122,400 and $1,201,600 in foreclosed other real estate at December 31, 2011 and 2010, respectively. After our borrowers default, we acquire real estate securing our loans either by taking title by deed in lieu of foreclosure or through foreclosure. The real estate is placed in foreclosed other real estate after we take title. During 2011, the Bank added a large parcel valued at approximately $2,500,000 to foreclosed other real estate. Foreclosed other real estate is considered part of non-performing assets.

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Investment Securities

Our security portfolio is categorized as available-for-sale and held to maturity. Investment securities classified as available-for-sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions or for liquidity purposes as part of our overall asset/liability management strategy. Available-for-sale securities are carried at market value, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income included in stockholders’ equity, net of applicable income taxes. We do not currently follow a strategy of making security purchases with a view of near-term resales and, therefore, do not own any securities classified as trading securities. Management intends to hold investment securities classified as held-to-maturity until they mature. Held-to maturity securities are recorded at amortized cost. For additional information about the investment portfolio, see Note 3 to the Consolidated Financial Statements, which are included in Item 8 of Part II of this annual report.

The following table sets forth the maturities of the investment portfolio as of December 31, 2011.

	Available for Sale				Held to maturity
	Amortized		Fair		Amortized		Fair
December 31, 2011	cost		Value		cost		Value
Maturing
Within one year.	$	4,011,267	$	4,017,270	$	-	$	-
Over one to five years		5,043,086		5,059,720		-		-
Mortgage-backed securities		-		-		4,303		4,370
	$	9,054,353	$	9,076,990	$	4,303	$	4,370

Pledged securities	$	2,671,734	$	2,682,359	$	-	$	-

Liquidity Management

Liquidity describes our ability to meet financial obligations that arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of customers and to fund current and planned expenditures. Liquidity is derived through increased customer deposits, maturities in the investment portfolio, loan repayments and income from earning assets. To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term funds markets. The funds invested in federal funds sold also provide liquidity, as do lines of credit, overnight federal funds, and reverse repurchase agreements available from correspondent banks. The aggregate amount available from correspondent banks under all lines of credit at December 31, 2011 was $11,650,000. The Bank has a partially funded line of credit from the FHLB of Atlanta under which it may borrow up to $29,482,946 through any combination of notes or line of credit advances. As of December 31, 2011, the Bank had borrowed $20,000,000 as line of credit advances. The Bank was required to purchase shares of capital stock in the FHLB as a condition to obtaining the line of credit. This line is secured by the Bank’s residential mortgage loan portfolio. Additionally, the Bank has a secured line of credit with the Federal Reserve Discount Window under which it may borrow approximately $18,000,000.

Average liquid assets (cash and amounts due from banks, interest bearing deposits in other banks, federal funds sold, and investment securities available for sale) were 16.29% of average deposits for 2011, compared to 10.38% for 2010.

We have various financial obligations, including contractual obligations and commitments, that may require future cash payments. Management does not believe that any of the foregoing arrangements have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

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Market Risk Management

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates or equity pricing. Our principal market risk is interest rate risk that arises from our lending, investing and deposit taking activities. Our profitability is primarily dependent on the Bank’s net interest income. Interest rate risk can significantly affect net interest income to the degree that interest-bearing liabilities mature or reprice at different intervals than interest-earning assets. The degree to which these different assets mature or reprice is known as interest rate sensitivity.

The primary objective of asset/liability management is to ensure the steady growth of net interest income. To lessen the impact of these margin swings, the balance sheet should be structured so that repricing opportunities exist for both assets and liabilities in roughly equivalent amounts at approximately the same time intervals. Interest rate sensitivity may be controlled on either side of the balance sheet. On the asset side, management can exercise some control on maturities. Also, loans may be structured with rate floors and ceilings on variable rate notes and by providing for repricing opportunities on fixed rate notes. Our available for sale investment portfolio, including federal funds sold, provides the most flexible and fastest control over rate sensitivity since it can generally be restructured more quickly than the loan portfolio. On the liability side, deposit products can be restructured so as to offer incentives to attain the maturity distribution desired. Competitive factors sometimes make control over deposits more difficult and less effective.

The rate-sensitive position, or gap, is the difference in the volume of rate-sensitive assets and liabilities at a given time interval. The general objective of gap management is to actively manage rate-sensitive assets and liabilities to reduce the impact of interest rate fluctuations on the net interest margin. Management generally attempts to maintain a balance between rate-sensitive assets and liabilities as the exposure period is lengthened to minimize our overall interest rate risk.

Several aspects of the asset mix of the balance sheet are continually evaluated: yield; credit quality; appropriate funding sources; and liquidity. Management of the liability mix of the balance sheet focuses on expanding the various funding sources.

The interest rate sensitivity position at December 31, 2011 is presented in the table “Interest Sensitivity Analysis”. The difference between rate-sensitive assets and rate-sensitive liabilities, or the interest rate sensitivity gap, is shown at the bottom of the table. We were asset-sensitive for the three month, twelve month and over five year time horizons and liability sensitive in the after one year and within five year time horizon. For asset-sensitive institutions, if interest rates should decrease, the net interest margins should decline. Because all interest rates and yields do not adjust at the same velocity, the gap is only a general indicator of rate sensitivity.

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Interest Sensitivity Analysis

	December 31, 2011
	Within			After three			After one
	Three			but within			but within			After
	Months			12 months			five years			five years			Total
Assets
Earning assets
Interest-bearing deposits	$	210,299		$	250,000		$	-		$	-		$	460,299
Federal funds sold		9,018,000			-			-			-			9,018,000
Investment securities
Available for sale		2,004,120			2,013,150			5,059,720			-			9,076,990
Held to maturity		-			-			4,303			-			4,303
Restricted stock		-			-			-			1,601,400			1,601,400
Loans		75,837,962			49,933,835			66,925,514			397,713			193,095,024
Total earning assets	$	87,070,381		$	52,196,985		$	71,989,537		$	1,999,113		$	213,256,016
Liabilities
Interest-bearing liabilities
Money market and Supernow	$	13,095,200		$	-		$	-		$	-		$	13,095,200
Savings and NOW deposits		50,736,832			-			-			-			50,736,832
Certificates $100,000 and over		1,247,587			3,328,336			29,809,165			519,963			34,905,051
Certificates under $100,000		3,149,111			5,197,518			53,704,029			200,236			62,250,894
Securities sold under repurchase agreements & federal funds purchased		1,914,007			-			1,002,893			-			2,916,900
Notes payable		14,000,000			3,000,000			3,000,000			-			20,000,000
Total interest-bearing liabilities	$	84,142,737		$	11,525,854		$	87,516,087		$	720,199		$	183,904,877

Period gap	$	2,927,644		$	40,671,131		$	(15,526,550	)	$	1,278,914		$	29,351,139
Cumulative gap		2,927,644			43,598,775			28,072,225			29,351,139			29,351,139
Ratio of cumulative gap to total earning assets		1.37	%		20.44	%		13.16	%		13.76	%		13.76	%

From time to time, we may also employ other methods to assess our interest rate sensitivity, such as simulation models to quantify the effect a hypothetical immediate upward or downward change in rates would have on net interest income and the fair value of capital.

Deposits and Other Interest-Bearing Liabilities

Average interest-bearing liabilities increased $356,051, or .20%, to $182,106,743 in 2011, from $181,750,692 in 2010. Average interest-bearing deposits increased $4,010,414, or 2.61%, to $157,858,650 in 2011 from $153,848,236 in 2010. Correspondingly, average demand deposits increased $2,807,041, or 7.79%, to $38,850,140 in 2011 from $36,043,099 in 2010.

Total deposits at December 31, 2011 were $203,195,268, an increase of 7.15% when compared to deposits of $189,640,730 at December 31, 2010.

- 31 -

The following table sets forth deposits by category at December 31, 2011 and 2010:

	2011					2010
			Percent of					Percent of
	Amount		Deposits			Amount		Deposits
Demand deposit accounts	$	42,207,291		20.77	%	$	35,219,753		18.57	%
Savings and NOW accounts		50,736,832		24.97	%		45,538,267		24.02	%
Money market accounts		13,095,200		6.44	%		10,778,134		5.68	%
Time deposits less than $100,000		62,250,893		30.64	%		63,187,359		33.32	%
Time deposits of $100,000 or more		34,905,052		17.18	%		34,917,217		18.41	%
Total deposits	$	203,195,268		100.00	%	$	189,640,730		100.00	%

Core deposits, which exclude certificates of deposit of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits increased $13,566,703 during 2011, primarily due to competitor’s branch closing in our service area. In the past, deposits, particularly core deposits, have been our primary source of funding and have enabled us to meet our short-term liquidity needs. In recent years, we have borrowed from correspondent banks and the FHLB of Atlanta to meet liquidity needs. The maturity distribution of our time deposits over $100,000 at December 31, 2011 is shown in the following table.

Maturities of Certificates of Deposit and Other Time Deposits of $100,000 or More

	December 31, 2011
	Within three months		After three through six months		After six through 12 months		After 12 months		Total
Certificates of Deposit - $100,000 or more	$	1,247,587	$	2,375,634	$	952,702	$	30,329,129	$	34,905,052

Large certificate of deposit customers tend to be extremely sensitive to interest rates, making these deposits less reliable sources of funding for liquidity planning purposes than core deposits. Some financial institutions partially fund their balance sheets using large certificates of deposit obtained through brokers. These brokered deposits are generally expensive and are unreliable as long-term funding sources. Accordingly, we do not typically purchase brokered deposits.

The average balance of borrowings decreased $3,654,363, or 13.10%, in 2011 when compared to 2010. The average balance of borrowings decreased $17,182,103, or 38.11%, in 2010. The decrease in 2011 when compared to 2010 was due primarily to the fact that loan demand has reduced and we were able to reduce our lines of credit, particularly at the FHLB of Atlanta, during 2011.

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Short-term Borrowings

The following table sets forth our position with respect to short-term borrowings for each of the last two years ended December 31:

	2011					2010
	Amount		Rate			Amount		Rate

At year end:
Repurchase Agreements	$	2,916,900		0.21	%	$	2,754,321		0.38	%

Average for the year:
Retail Repurchase Agreements	$	2,478,167		1.53	%	$	2,324,268		1.76	%
Federal Funds purchased		0		0.00	%		107		0.63	%

Maximum Month End Balance:
Retail Repurchase Agreements	$	6,993,283				$	7,956,138
Federal Funds purchased		0					27,000

The Bank may borrow up to approximately $29,000,000 from the FHLB of Atlanta through any combination of notes or line of credit advances. Both the notes payable and the line of credit are secured by a floating lien on all of the Bank’s real estate mortgage loans. The Bank was required to purchase shares of capital stock in the FHLB of Atlanta as a condition to obtaining the line of credit.

We provide collateral of 105% of the repurchase agreement balances by pledging U.S. Government Agency securities.

The Bank has lines of credit of $6,650,000 in unsecured overnight federal funds and $5,000,000 in secured overnight federal funds with correspondent banks at December 31, 2011. The bank has a secured line of credit with the Federal Reserve Discount Window of approximately $18,000,000.

Capital

Under the capital adequacy guidelines of the FRB and the FDIC, the Company and the Bank are required to maintain minimum capital ratios. These requirements are described above in Item 1 or Part I under “SUPERVISION AND REGULATION—Capital Requirements.” At December 31, 2011 and 2010, the Company and the Bank were considered “well-capitalized.” The table below compares the capital ratios of the Bank with the regulatory minimums. The Company’s only assets in 2011 other than its equity interest in the Bank were its equity interest in the Insurance Subsidiary and a small amount of cash. The value of the equity interest in the Insurance Subsidiary at December 31, 2011 did not cause the Company’s capital ratios as of December 31, 2011 to materially differ from the Bank’s ratios.

Analysis of Capital

				Actual Ratios			Actual Ratios
	Required			2011			2010
	Minimums			Bank			Bank
Total risk-based capital ratio		8.0	%		13.7	%		14.3	%
Tier I risk-based capital ratio		4.0	%		12.4	%		13.0	%
Tier I leverage ratio		4.0	%		9.5	%		10.5	%

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RECENT ACCOUNTING PRONOUNCEMENTS

Management has the responsibility for the selection and use of appropriate accounting policies. The significant accounting policies used by the Company and the Bank are described in the notes to the consolidated financial statements.

On July 1, 2009, the Financial Accounting Standards Board (“FASB”) adopted Accounting Standards Codification (“ASC”) as the officially recognized source of authoritative U.S. generally accepted accounting principles (“GAAP”) applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (“AICPA”), the Emerging Issues Task Force (“EITF”) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies.

The following accounting guidance has been approved by the Financial Accounting Standards Board and would apply to the Company if the Company or Bank entered into an applicable activity. Some of these new pronouncements become effective in 2011.

ASU No. 2010-20, “Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a roll-forward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period became effective for the Company’s financial statements beginning on January 1, 2011. ASU 2011-01, “Receivables (Topic 310) - Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of the then proposed ASU 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” which is further discussed below.

ASU No. 2010-28, “Intangibles - Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. ASU 2010-28 became effective for the Company on January 1, 2011.

ASU No. 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-02, that both of the following exist: (i) the restructuring constitutes a concession; and (ii) the debtor is experiencing financial difficulties. ASU 2011-02 will be effective for the Company on July 1, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011.

- 34 -

ASU No. 2011-03, “Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements.” ASU 2011-03 is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 removes from the assessment of effective control (i) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance guidance related to that criterion. ASU 2011-03 will be effective for the Company on January 1, 2012.

ASU 2011-04, “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures,” to converge the fair value measurement guidance in GAAP and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU 2011-04 is effective for annual periods beginning after December 15, 2011.

ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.” ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 is effective for annual periods beginning after December 15, 2011.

ASU No. 2010-20, “Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a rollforward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period became effective for the Company’s financial statements beginning on January 1, 2011. ASU 2011-01, “Receivables (Topic 310) - Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of the then proposed ASU 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” which is further discussed below.

The accounting policies adopted by management are consistent with authoritative U.S. generally accepted accounting principles and are consistent with those followed by peer bank holding companies and banks.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk.

The information required by this item may be found in Item 7 of this Part II under the caption “FINANCIAL CONDITION—Market Risk Management”, which is incorporated herein by reference.

- 35 -

Item 8. Financial Statements and Supplementary Data.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm	37
Consolidated Balance Sheets	38
Consolidated Statements of Income	39
Consolidated Statements of Changes in Stockholders’ Equity	40
Consolidated Statements of Cash Flows	41
Notes to Consolidated Financial Statements	43

- 36 -

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Peoples Bancorp, Inc.

Chestertown, Maryland

We have audited the accompanying consolidated balance sheets of Peoples Bancorp, Inc. and Subsidiaries as of December 31, 2011 and 2010 and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the two year period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Peoples Bancorp, Inc. and Subsidiaries as of December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the years in the two year period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

	/s/ Rowles & Company, LLP

Baltimore, Maryland
March 24, 2012

- 37 -

PEOPLES BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS	DECEMBER 31,

	2011			2010

Cash and due from banks	$	27,613,717		$	10,378,485
Federal funds sold		9,018,000			1,016,000
Cash and cash equivalents		36,631,717			11,394,485
Securities available for sale		9,076,990			8,035,780
Securities held to maturity (fair value of $4,370 and $3,554,315)		4,303			3,510,533
Federal Home Loan Bank and CBB Financial Corp. stock, at cost		1,601,400			2,151,600
Loans, less allowance for loan losses of $4,295,541 and $5,656,788		188,876,206			207,295,877
Premises and equipment		6,186,844			6,389,781
Goodwill and intangible assets		547,932			603,988
Accrued interest receivable		1,087,971			1,360,708
Deferred income taxes		1,678,922			2,367,847
Foreclosed real estate		4,122,400			1,201,600
Other assets		3,343,543			1,480,216
	$	253,158,228		$	245,792,415

LIABILITIES AND STOCKHOLDERS' EQUITY

		2011			2010

Deposits
Noninterest bearing checking	$	42,207,291		$	35,219,753
Savings and NOW		50,736,832			45,538,267
Money market		13,095,200			10,778,134
Other time		97,155,945			98,104,576
		203,195,268			189,640,730

Securities sold under repurchase agreements		2,916,900			2,754,321
Federal Home Loan Bank advances		20,000,000			24,000,000
Accrued interest payable		345,359			414,758
Other liabilities		1,886,780			1,590,442
		228,344,307			218,400,251
Stockholders' equity
Common stock, par value $10 per share; authorized 1,000,000 shares; issued and outstanding 779,512 shares		7,795,120			7,795,120
Additional paid-in capital		2,920,866			2,920,866
Retained earnings		14,844,222			17,088,742
Accumulated other comprehensive income Unrealized gain on securities available for sale		13,707			11,474
Unfunded liability for defined benefit plan		(759,994	)		(424,038	)
		24,813,921			27,392,164
	$	253,158,228		$	245,792,415

The accompanying notes are an integral part of these consolidated financial statements.

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PEOPLES BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

	YEARS ENDED DECEMBER 31,

	2011			2010

Interest and dividend revenue
Loans, including fees	$	11,591,338		$	12,505,705
U.S. government agency securities		104,758			297,851
Federal funds sold		6,404			2,433
Other		16,160			7,937
Total interest and dividend revenue		11,718,660			12,813,926

Interest expense
Deposits		2,478,234			2,920,951
Borrowed funds		702,772			856,112
Total interest expense		3,181,006			3,777,063

Net interest income		8,537,654			9,036,863

Provision for loan losses		6,550,000			4,910,000
Net interest income after provision for loan losses		1,987,654			4,126,863
Noninterest revenue
Service charges on deposit accounts		897,996			856,871
Insurance commissions		1,233,112			1,182,957
Loss on sale of foreclosed real estate		(42,827	)		(53,515	)
Other noninterest revenue		367,887			318,749
Total noninterest revenue		2,456,168			2,305,062
Noninterest expense
Salaries		2,979,382			3,004,709
Employee benefits		998,156			948,028
Occupancy		500,849			515,091
Furniture and equipment		330,404			345,097
Data processing and correspondent fees		664,598			681,718
Forclosed real estate expense		563,128			135,192
Other operating		1,582,236			1,543,815
Total noninterest expense		7,618,753			7,173,650

Loss before income tax benefits		(3,174,931	)		(741,725	)

Income tax (benefit)		(1,187,650	)		(368,190	)

Net loss	$	(1,987,281	)	$	(373,535	)

Loss per common share - basic and diluted	$	(2.55	)	$	(0.48	)

The accompanying notes are an integral part of these consolidated financial statements.

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PEOPLES BANCORP, INC. AND SUBSIDIARIES

Statements of Comprehensive Income

	Years Ended December 31,
	2011			2010

Net income (loss)	$	(1,987,281	)	$	(373,535	)

Other comprehensive income
Unrealized gain/loss on securities available for sale		3,687			11,990
Change in underfunded status of defined beinefit plan		(554,795	)		447,446
		(551,108	)		459,436
Income Tax relating to items above		217,385			(180,363	)
Other comprehensive income		(333,723	)		279,073

Total comprehensive income	$	(2,321,004	)	$	(94,462	)

The accompanying notes are an integral part of these consolidated financial statements.

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PEOPLES BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 2011 and 2010

										Accumulated
					Additional					other			Total
	Common stock				paid-in		Retained			comprehensive			stockholders
	Shares		Par value		capital		earnings			income			equity

Balance, December 31, 2009		779,512	$	7,795,120	$	2,920,866	$	18,865,399		$	(691,637	)	$	28,889,748

Net loss		-		-		-		(373,535	)		-			(373,535	)
Change in underfunded status of defined benefit plan net of income taxes of $176,261		-		-		-		-			271,185			271,185
Unrealized gain on investment securities available for sale net of income taxes of $4,102		-		-		-		-			7,888			7,888
Cash dividend, $1.80 per share		-		-		-		(1,403,122	)		-			(1,403,122	)

Balance, December 31, 20010		779,512		7,795,120		2,920,866		17,088,742			(412,564	)		27,392,164

Net loss		-		-		-		(1,987,281	)		-			(1,987,281	)
Change in underfunded status of defined benefit plan net of income taxes of $218,839		-		-		-		-			(335,956	)		(335,956	)
Unrealized gain on investment securities available for sale net of income taxes of $1,454		-		-		-		-			2,233			2,233
Cash dividend, $.33 per share		-		-		-		(257,239	)		-			(257,239	)

Balance, December 31, 2011		779,512	$	7,795,120	$	2,920,866	$	14,844,222		$	(746,287	)	$	24,813,921

The accompanying notes are an integral part of these consolidated financial statements.

- 41 -

PEOPLES BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	YEARS ENDED DECEMBER 31,

	2011			2010

Cash flows from operating activities
Interest received	$	12,045,938		$	12,949,311
Fees and commissions received		2,463,995			2,358,577
Interest paid		(3,340,180	)		(3,801,715	)
Cash paid to suppliers and employees		(8,904,491	)		(6,210,301	)
Income taxes paid		2,093,677			(978,679	)
		4,358,939			4,317,193
Cash flows from investing activities
Proceeds from maturities and calls of investment securities
Held to maturity		3,500,946			6,551,030
Available for sale		6,000,000			1,000,000
Purchase of investment securities
Available for sale		(7,079,054	)		(6,022,073	)
Redemption of Federal Home Loan Bank stock		550,200			249,600
Purchase of CBB Financial Corp. stock		-			-
Loans made, net of principal collected		7,109,360			(8,722,941	)
Purchase of premises, equipment, and software		(142,495	)		(235,041	)
Proceeds from sale of foreclosed real estate		1,479,459			428,485
		11,418,416			(6,750,940	)
Cash flows from financing activities
Net increase (decrease) in
Time deposits		(948,631	)		3,535,326
Other deposits		14,503,168			(7,145,504	)
Securities sold under repurchase agreements and federal funds purchased		162,579			(163,018	)
Federal Home Loan Bank advances, net of repayments		(4,000,000	)		(4,000,000	)
Dividends paid		(257,239	)		(1,403,122	)
		9,459,877			(9,176,318	)

Net increase (decrease) in cash and cash equivalents		25,237,232			(11,610,065	)

Cash and cash equivalents at beginning of year		11,394,485			23,004,550

Cash and cash equivalents at end of year	$	36,631,717		$	11,394,485

- 42 -

PEOPLES BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

	YEARS ENDED DECEMBER 31,

	2011			2010

Reconciliation of net loss to net cash provided by operating activities
Net loss	$	(1,987,281	)	$	(373,535	)

Adjustments to reconcile net loss to net cash provided by operating activities
Amortization of premiums and accretion of discounts		46,816			27,796
Provision for loan losses		6,550,000			4,910,000
Depreciation and software amortization		340,722			354,426
Amortization of intangible assets		56,056			67,672
Write-down of foreclosed real estate		309,500			50,000
Gain on sale of foreclosed real estate		42,827			53,515
Deferred income taxes		906,027			(1,185,153	)
Decrease (increase) in Accrued interest receivable		272,737			89,447
Prepaid income taxes		-			(161,716	)
Other assets		(1,858,617	)		508,829
Increase (decrease) in
Deferred origination fees and costs, net		7,725			18,142
Accrued interest payable		(159,174	)		(24,652	)
Other liabilities		(168,399	)		(17,578	)
	$	4,358,939		$	4,317,193
Non cash transactions
Transfer of foreclosed real estate	$	4,752,586		$	398,600

The accompanying notes are an integral part of these consolidated financial statements.

- 43 -

PEOPLES BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Summary of Significant Accounting Policies

The accounting and reporting policies reflected in the accompanying financial statements of Peoples Bancorp, Inc. and its subsidiaries, The Peoples Bank, a Maryland commercial bank (the “Bank”), and Fleetwood, Athey, MacBeth & McCown, Inc., an insurance agency (the “Insurance Subsidiary”), conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the banking industry. As used in these notes, unless the context requires otherwise, the term “the Company” refers collectively to Peoples Bancorp, Inc., the Bank and the Insurance Subsidiary.

Principles of consolidation

The consolidated financial statements include the accounts of the Peoples Bancorp, Inc., the Bank, and the Insurance Subsidiary. The Bank has one subsidiary, PB Land Trust, which is a Maryland statutory trust that was formed to acquire, hold and dispose of real estate that the Bank acquires by deed in lieu of foreclosure or through foreclosure (the “Land Trust”). The accounts of the Land Trust are included in the Bank’s accounts. Intercompany balances and transactions have been eliminated.

Nature of business

Peoples Bancorp, Inc. and its subsidiaries operate primarily in Kent and Queen Anne’s Counties, Maryland. The Bank, which operates out of a main office and six branches, offers deposit services and loans to individuals, small businesses, associations, and government entities. Other services include direct deposit of payroll and social security checks, automatic drafts from accounts, automated teller machine services, cash management services, safe deposit boxes, money orders, travelers cheques, and on-line banking with bill payment service.

The Insurance Subsidiary operates from one location in Kent County and one in Cecil County. They provide a full range of insurance products to businesses and consumers. Product lines include property, casualty, life, marine, long-term care and health insurance.

Use of estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions may affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Cash and cash equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.

Investment securities

As securities are purchased, management determines if the securities should be classified as held to maturity or available for sale. Securities which management has the intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost which is cost adjusted for amortization of premiums and accretion of discounts to maturity, or over the expected life in the case of mortgage-backed securities. Amortization and accretion are recorded using the interest method. Securities which may be sold before maturity are classified as available for sale and carried at fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income.

Gains and losses on the sale of securities are determined using the specific identification method.

Federal Home Loan Bank stock and CBB Financial Corp.

Federal Home Loan Bank stock and CBB Financial Corp. stock are carried at cost, which approximates fair value. Both stocks are restricted as to their ability to resale and trade in a limited market. As a member of the Federal Home Loan Bank, the Bank is required to purchase stock based on its total assets. Additional stock is purchased and redeemed based on the outstanding Federal Home Loan Bank advances to the Bank.

- 44 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Summary of Significant Accounting Policies (Continued)

Loans and allowance for loan losses

Loans are stated at their outstanding unpaid principal balance adjusted for deferred origination costs, deferred origination fees, and the allowance for loan losses.

Interest on loans is accrued based on the principal amounts outstanding. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. The accrual of interest is discontinued when it is not reasonable to expect collection of interest under the original terms. As a result of management’s ongoing review of the loan portfolio, loans are classified as nonaccrual when it is not reasonable to expect collection of interest under the original terms. These loans are classified as nonaccrual even though the presence of collateral or the borrower’s financial strength may be sufficient to provide for ultimate repayment. Interest on nonaccrual loans is recognized only when received. A loan is generally placed in nonaccrual status when it is specifically determined to be impaired or it becomes 90 days or more past due. When a loan is placed in nonaccrual status, all interest that had been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes a loan is uncollectible. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general, and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, an allowance is established when the collateral value, if the loan is collateral dependent, or the discounted cash flows of the impaired loan is lower that the carrying value of that loan. The general component covers nonclassified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, management believes that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impairment is measured on a loan by loan basis. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. The accrual of interest is discontinued when principal or interest is ninety days past due or when the loan is determined to be impaired, unless collateral is sufficient to discharge the debt in full and the loan is in process of collection. When a loan is placed in nonaccruing status, any interest previously accrued but unpaid is reversed from interest revenue. Interest payments received on nanaccrual loans are generally recorded as a reduction of principal, but may be recorded as cash basis income depending on management’s judgment on the a loan by loan basis. A loan will be returned to accrual status when all of the principal and interest amounts contractually due are brought current and management believes that future principal and interest amounts contractually due are reasonably assured, which belief is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.

As a general rule, a loan, or a portion thereof, is deemed uncollectable and is charged-off as and when required by bank regulatory guidelines, which provide that the loan, or portion thereof, should be charged-off when the Company becomes aware of the loss. The Company becomes aware of a loss upon the occurrence of one or more triggering events, including, among other things, the receipt of new information about the borrower’s intent and/or ability to repay the loan, the severity of delinquency, the borrower’s bankruptcy, the detection of fraud, or the borrower’s death.

- 45 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Summary of Significant Accounting Policies (Continued)

Premises and equipment

Premises and equipment are recorded at cost less accumulated depreciation. Depreciation is computed using the straight-line method over estimated useful lives of three to ten years for furniture and equipment, ten to forty years for premises, and three years for software.

Foreclosed real estate

Real estate acquired through foreclosure is recorded at the lower of cost or fair value on the date acquired. In general, cost equals the Company’s investment in the property at the time of foreclosure. Losses incurred at the time of acquisition of the property are charged to the allowance for loan losses. Subsequent reductions in the estimated value of the property are included in other operating expense.

Goodwill and intangible assets

In 2007, the Company acquired the Insurance Subsidiary and recorded goodwill of $273,000 and other intangible assets of approximately $550,000.

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability. Goodwill is not ratably amortized into the income statement over an estimated life, but rather is tested at least annually for impairment. Intangible assets that have finite lives are amortized over their estimated useful lives and are also subject to impairment testing. The Company’s intangible assets have finite lives and are amortized on a straight-line basis over periods not exceeding 10 years.

Income taxes

The provision for income taxes includes taxes payable for the current year and deferred income taxes. Deferred income taxes are provided for the temporary differences between financial and taxable income.

The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

Per share data

Basic earnings(loss) per share is calculated by dividing net income(loss) available to common stockholders by the weighted-average number of common shares outstanding and does not include the effect of any potentially dilutive common stock equivalents. Diluted earnings(loss) per share is calculated by dividing net income(loss) by the weighted-average number of shares outstanding, adjusted for the dilutive effect of stock-based awards. There is no dilutive effect on the loss per share during loss periods. The weighted average number of shares outstanding were 779,512 for 2011 and 2010. There were no dilutive common stock equivalents outstanding in 2011 or 2010.

Subsequent Events

The Company has evaluated events and transactions occurring subsequent to the balance sheet issuance date of December 31, 2011 through March 23, 2012 for items that should potentially be recognized or disclosed in these financial statements. No significant subsequent events were identified that would affect the presentation of the financial statements.

- 46 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Cash and Due From Banks

The Bank normally carries balances with other banks that exceed the federally insured limit. The average balances carried in excess of the limit, including unsecured federal funds sold to the same banks, were $3,368,540 for 2011 and $1,338,038 for 2010.

Banks are required to carry noninterest-bearing cash reserves at specified percentages of deposit balances. The Bank's normal amount of cash on hand and on deposit with other banks is sufficient to satisfy the reserve requirements.

Investment Securities

Investment securities are summarized as follows:

	Amortized		Unrealized		Unrealized		Fair
December 31, 2011	cost		gains		losses		value
Available for sale
U. S. government agency	$	9,054,353	$	22,637	$	-	$	9,076,990

Held to maturity
Mortgage-backed securities	$	4,303	$	67	$	-	$	4,370

December 31, 2010
Available for sale
U. S. government agency	$	8,016,831	$	18,949	$	-	$	8,035,780

Held to maturity
U. S. government agency	$	3,505,278	$	43,757	$	-	$	3,549,035
Mortgage-backed securities		5,255		25		-		5,280
	$	3,510,533	$	43,782	$	-	$	3,554,315

Contractual maturities and the amount of pledged securities are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities are paid monthly.

- 47 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Investment Securities (Continued)

	Available for sale				Held to maturity
	Amortized		Fair		Amortized		Fair
December 31, 2011	cost		value		cost		value
Maturing
Within one year	$	4,011,267	$	4,017,270	$	-	$	-
Over one to five years		5,043,086		5,059,720		-		-
Mortgage-backed securities		-		-		4,303		4,370
	$	9,054,353	$	9,076,990	$	4,303	$	4,370

Pledged securities	$	2,671,734	$	2,682,359	$	-	$	-

December 31, 2010
Maturing
Within one year	$	6,002,966	$	6,018,760	$	3,505,278	$	3,549,035
Over one to five years		2,013,865		2,017,020		-		-
Mortgage-backed securities		-		-		5,255		5,280
	$	8,016,831	$	8,035,780	$	3,510,533	$	3,554,315

Pledged securities	$	633,593	$	637,127	$	2,530,378	$	2,562,778

Investments are pledged to secure the deposits of federal and local governments and as collateral for repurchase agreements.

As of December 31, 2011, there were no securities in an unrealized loss position.

There were no sales of securities in 2011 or 2010.

Loans and Allowance for Loan Losses

Major classifications of loans as of December 31, are as follows:

	2011			2010

Real estate
Residential	$	72,620,650		$	75,206,074
Commercial		64,164,400			65,357,188
Other		19,773,892			24,259,947
Construction		7,919,498			13,403,765
Commercial		23,714,668			29,052,413
Consumer		4,901,916			5,588,830
		193,095,024			212,868,217
Deferred costs, net of deferred fees		76,723			84,448
Allowance for loan losses		(4,295,541	)		(5,656,788	)
	$	188,876,206		$	207,295,877

- 48 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and Allowance for Loan Losses (Continued)

Loan Origination/Risk Management.

The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, loan delinquencies and non-performing and potential problem loans.

Real Estate Loans

Real estate loans are segregated into the following categories: Residential; Commercial; Construction and Land Development; and Other Loans.

Residential real estate loans are underwritten based on management’s determination of the borrower’s ability and willingness to repay, and a loan-to-value ratio of offered collateral of not more than 80% of the appraised value of the collateral.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are assessed primarily based on cash flow and secondarily on the underlying real estate collateral. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral and cash flow. With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success.

Construction, including land development, loans are underwritten based on financial analyses of the developers and property owners, and estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial Loans:

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and to prudently expand its business. The Company’s management examines current and projected cash flows to determine the ability of the borrower to repay its obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis.

Consumer Loans:

The Company originates consumer loans. To monitor and manage consumer loan risk, underwriting policies and procedures are developed and modified as needed. The Company believes that its monitoring activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk.

- 49 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and Allowance for Loan Losses (Continued)

The Company obtains an independent loan review from a third party vendor that reviews and evaluates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures. Most of the Company’s lending activity occurs in Kent County, Northern Queen Anne’s County, and Southern Cecil County in Maryland.

The rate repricing and maturity distribution of the loan portfolio at December 31, is as follows:

	2011
Within ninety days	$	75,837,962
Over ninety days to one year		49,933,835
Over one year to five years		66,925,514
Over five years		397,713
	$	193,095,024

Variable rate loans included in above	$	47,509,265

The following table illustrates total impaired loans segmented by those with and without a related allowance as of December 31, 2011 and 2010.

Total Impaired Loans Segmented by With and Without a Related Allowance Recorded

December 31, 2011

	Number				Unpaid				Interest		Average
	of		Recorded		Contractual		Related		Income		Recorded
Description of Loans	loans		Investment		Balance		Allowance		Recognized		Investment

With Related Allowance recorded
Residential real estate		18	$	3,032,410	$	3,407,124	$	632,496	$	104,883	$	2,649,640
Commercial real estate		3		3,177,730		3,614,975		444,903		102,048		3,497,395
Other real estate		-		-		-		-		-		-
Construction and land development		3		452,549		670,371		154,782		9,604		581,392
Commercial loans		1		149,751		150,420		31,671		3,930		149,751
Consumer loans		-		-		-		-		-		-
Total impaired loans		25	$	6,812,440	$	7,842,890	$	1,263,852	$	220,465	$	6,878,178

With No Related Allowance recorded
Residential real estate		39	$	5,916,089	$	6,644,581	$	-	$	308,487	$	6,484,492
Commercial real estate		6		1,541,699		2,367,015		-		69,761		1,931,087
Other real estate		4		1,028,000		1,031,466		-		74,254		1,014,270
Construction and land development		6		788,183		1,023,929		-		29,667		949,221
Commercial loans		-		-		-		-		-		-
Consumer loans		-		-		-		-		-		-
Total impaired loans		55	$	9,273,971	$	11,066,991	$	-	$	482,169	$	10,379,070

TOTAL
Residential real estate		57	$	8,948,499	$	10,051,705	$	632,496	$	413,370	$	9,134,132
Commercial real estate		9		4,719,429		5,981,990		444,903		171,809		5,428,482
Other real estate		4		1,028,000		1,031,466		-		74,254		1,014,270
Construction and land development		9		1,240,732		1,694,300		154,782		39,271		1,530,613
Commercial loans		1		149,751		150,420		31,671		3,930		149,751
Consumer loans		-		-		-		-		-		-
Total impaired loans		80	$	16,086,411	$	18,909,881	$	1,263,852	$	702,634	$	17,257,248

- 50 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and Allowance for Loan Losses (Continued)

Total Impaired Loans Segmented by With and Without a Related Allowance Recorded

December 31, 2010

	Number				Unpaid				Interest		Average
	of		Recorded		Contractual		Related		Income		Recorded
Description of Loans	loans		Investment		Balance		Allowance		Recognized		Investment

With Related Allowance recorded
Residential real estate		7	$	1,092,458	$	1,092,458	$	217,644	$	16,091	$	1,109,176
Commercial real estate		6		1,670,505		1,670,505		535,044		72,645		1,589,338
Other real estate		-		-		-		-		-		-
Construction and land development		3		5,169,481		5,169,481		2,494,682		239,506		4,726,734
Commercial loans		3		160,283		160,283		46,126		1,511		138,065
Consumer loans		-		-		-		-		-		-
Total impaired loans		19	$	8,092,727	$	8,092,727	$	3,293,496	$	329,753	$	7,563,313

With No Related Allowance recorded
Residential real estate		10	$	1,080,353	$	1,080,353	$	-	$	33,360	$	1,105,548
Commercial real estate		6		1,441,244		1,441,244		-		24,395		2,032,234
Other real estate		-		-		-		-		-		-
Construction and land development		3		625,967		625,967		-		3,552		617,399
Commercial loans		3		385,221		385,221		-		-		385,221
Consumer loans		-		-		-		-		-		-
Total impaired loans		22	$	3,532,785	$	3,532,785	$	-	$	61,307	$	4,140,402

TOTAL
Residential real estate		17	$	2,172,811	$	2,172,811	$	217,644	$	49,451	$	2,214,724
Commercial real estate		12		3,111,749		3,111,749		535,044		97,040		3,621,572
Other real estate		-		-		-		-		-		-
Construction and land development		6		5,795,448		5,795,448		2,494,682		243,058		5,344,133
Commercial loans		6		545,504		545,504		46,126		1,511		523,286
Consumer loans		-		-		-		-		-		-
Total impaired loans		41	$	11,625,512	$	11,625,512	$	3,293,496	$	391,060	$	11,703,715

- 51 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and Allowance for Loan Losses (Continued)

The following table represents the allowance for loan losses and loan balances that are individually evaluated for impairment and loan balances collectively evaluated for inherent impairment.

Allowance for Loan Losses and Loan Balances that are Individually and Collectively Evaluated for Inherent Impairment

December 31, 2011

													Construction
							Residential			Commercial			and land			Other
	Unallocated			Commercial			Real Estate			Real Estate			Development			Real Estate		Consumer			Overdraft			Total
Allowance for loan losses
Beginning balance	$	137,047		$	676,113		$	806,728		$	1,124,851		$	2,780,148		$	2,122	$	126,751		$	3,028		$	5,656,788
Charge-offs		-			(669,862	)		(1,780,502	)		(2,786,202	)		(2,743,903	)		-		(17,330	)		(2,520	)		(8,000,319	)
Recoveries		-			6,498			31,414			6,051			16,100			-		27,825			1,184			89,072
Provision		(114,616	)		330,213			2,410,307			3,264,129			724,686			7,633		(71,707	)		(645	)		6,550,000
Ending balance	$	22,431		$	342,962		$	1,467,947		$	1,608,829		$	777,031		$	9,755	$	65,539		$	1,047		$	4,295,541

Ending balance allocated to:
Loans individually evaluated for impairment	$	-		$	31,671		$	632,496		$	444,903		$	154,782		$	-	$	-		$	-		$	1,263,852
Loans collectively evaluated for impairment		22,431			311,291			835,451			1,163,926			622,249			9,755		65,539			1,047			3,031,689
	$	22,431		$	342,962		$	1,467,947		$	1,608,829		$	777,031		$	9,755	$	65,539		$	1,047		$	4,295,541

Allowance for Loan Losses and Loan Balances that are Individually and Collectively Evaluated for Inherent Impairment

December 31, 2010

													Construction
							Residential			Commercial			and land			Other
	Unallocated			Commercial			Real Estate			Real Estate			Development			Real Estate			Consumer			Overdraft			Total
Allowance for loan losses
Beginning balance	$	140,751		$	728,049		$	920,132		$	643,430		$	164,539		$	2,782		$	245,137		$	544		$	2,845,364
Charge-offs		-			(166,779	)		(888,040	)		(951,603	)		(7,040	)		-			(101,162	)		(3,629	)		(2,118,253	)
Recoveries		-			2,660			374			-			-			-			15,113			1,530			19,677
Provision		(3,704	)		112,183			774,262			1,433,024			2,622,649			(660	)		(32,337	)		4,583			4,910,000
Ending balance	$	137,047		$	676,113		$	806,728		$	1,124,851		$	2,780,148		$	2,122		$	126,751		$	3,028		$	5,656,788

Ending balance allocated to:
Loans individually evaluated for impairment	$	-		$	46,126		$	217,644		$	535,044		$	2,494,682		$	-		$	-		$	-		$	3,293,496
Loans collectively evaluated for impairment		137,047			629,987			589,084			589,807			285,466			2,122			126,751			3,028			2,363,292
	$	137,047		$	676,113		$	806,728		$	1,124,851		$	2,780,148		$	2,122		$	126,751		$	3,028		$	5,656,788

- 52 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and Allowance for Loan Losses (Continued)

As part of the on-going monitoring of the quality of the Bank’s loan portfolio, management tracks certain credit quality indicators. The Bank risk rates all loans. Loans are risk rated based on the scale below:

Grade 1 through 4 – These grades include “pass grade” loans to borrowers of acceptable credit quality and risk.

Grade 5 – This grade includes loans that are on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near future

Grade 6 – This grade is for “Other Assets Especially Mentioned” or “Special Mention” in accordance with regulatory guidelines. This grade is intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation. This grade may include loans not fully secured where a specific valuation allowance may be necessary.

Grade 7 through 9 – This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which accrual of interest may have stopped. This grade includes loans where loans are past due or not fully secured where a specific valuation allowance may be necessary.

The following table illustrates classified loans by class. Classified loans included loans in Risk Grades 5, 6 and 7 through 9.

					Special
December 31, 2011	Pass		Pass Watch		Mention		Substandard		Total

Commercial	$	22,175,382	$	675,334	$	-	$	893,326	$	23,744,042
Residential real estate		62,132,321		4,435,904		65,025		6,013,960		72,647,210
Commercial real estate		56,702,832		3,310,503		-		4,151,670		64,165,005
Construction and land development		6,880,548		-		-		1,040,411		7,920,959
Other real estate		17,778,047		-		1,951,473		43,655		19,773,175
Consumer		4,875,006		36,453		-		9,897		4,921,356
	$	170,544,136	$	8,458,194	$	2,016,498	$	12,152,919	$	193,171,747

					Special
December 31, 2010	Pass		Pass Watch		Mention		Substandard		Total

Commercial	$	26,179,149	$	159,817	$	39,722	$	2,673,725	$	29,052,413
Residential real estate		68,782,787		1,975,178		-		4,448,109		75,206,074
Commercial real estate		55,433,530		3,255,868		1,833,303		4,834,487		65,357,188
Construction and land development		3,090,584		301,009		-		10,012,172		13,403,765
Other real estate		24,216,301		-		-		43,646		24,259,947
Consumer		5,566,718		11,695		-		10,417		5,588,830
	$	183,269,069	$	5,703,567	$	1,873,025	$	22,022,556	$	212,868,217

- 53 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and Allowance for Loan Losses (Continued)

The following table analyzes the age of past due loans, including both accruing and nonaccruing loans, segregated by class of loans as of the years ended December 31, 2011 and 2010.

					Greater than
	30-59 Days		60-89 Days		90 Days and		Total				Total		Loans 90 Days
December 31, 2011	Past Due		Past Due		Nonaccruing		Past Due		Current		Loans		and Accruing

Residential real estate	$	2,435,288	$	942,334	$	3,730,214	$	7,107,836	$	65,512,814	$	72,620,650	$	107,206
Commercial real estate		1,839,733		212,058		5,128,702		7,180,493		56,983,906		64,164,399		-
Other real estate		122,533		-		-		122,533		19,651,359		19,773,892		-
Construction and land development		20,093		-		662,139		682,232		7,237,267		7,919,499		-
Commercial loans		208,884		28,003		13,377		250,264		23,464,404		23,714,668		-
Consumer loans		59,857		49,321		38,204		147,382		4,754,534		4,901,916		-
Total	$	4,686,388	$	1,231,716	$	9,572,636	$	15,490,740	$	177,604,284	$	193,095,024	$	107,206

					Greater than
	30-59 Days		60-89 Days		90 Days and		Total				Total		Loans 90 Days
December 31, 2010	Past Due		Past Due		Nonaccruing		Past Due		Current		Loans		and Accruing

Residential real estate	$	1,452,435	$	1,258,246	$	4,506,064	$	7,216,745	$	67,989,329	$	75,206,074	$	2,008,168
Commercial real estate		980,023		467,285		3,216,515		4,663,823		60,693,365		65,357,188		2,120,564
Other real estate		-		-		1,130,824		1,130,824		23,129,123		24,259,947		1,130,824
Construction and land development		-		-		2,180,150		2,180,150		11,223,615		13,403,765		1,022,686
Commercial loans		54,262		28,545		594,022		676,829		28,375,584		29,052,413		19,838
Consumer loans		122,969		25,878		66,563		215,410		5,373,420		5,588,830		66,563
Total	$	2,609,689	$	1,779,954	$	11,694,138	$	16,083,781	$	196,784,436	$	212,868,217	$	6,368,643

Loans on which the accrual of interest has been discontinued or reduced, and the interest that would have been accrued at December 31, are as follows:

	2011		2010

Residential real estate	$	3,623,008	$	2,497,896
Commercial real estate		5,128,702		1,095,951
Other real estate		-		-
Construction and land development		662,139		1,157,464
Commercial loans		13,377		574,184
Consumer loans		38,204		-
Total	$	9,465,430	$	5,325,495

Interest not accrued on nonaccrual loans	$	621,287	$	644,566

A loan will be returned to accrual status when all of the principal and interest amounts contractually due are brought current and management believes that future principal and interest amounts contractually due are reasonably assured, which belief is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.

The modification of terms on a loan (restructuring) is considered a “troubled debt restructuring” if it is done to accommodate a borrower who is experiencing financial difficulties. The lender may forgive principal, lower the interest rate or payment amount, or may modify the payment due dates or maturity date of the loan for a troubled borrower. The Company’s troubled debt restructurings at December 31, 2011 are set forth in the following table:

- 54 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and Allowance for Loan Losses (Continued)

TROUBLED DEBT RESTRUCTURINGS

					Paying as agreed				Past due
	Number of		Contract		under		Number of		30 days or more
December 31, 2011	Contracts		balance		modified terms		Contracts		Or non-accruing
Troubled Debt restructurings
Residential real estate		41	$	5,987,534	$	4,090,470	$	17	$	1,897,065
Commercial real estate		28		6,857,017		2,230,550		17		4,626,466
Other real estate		4		1,028,000		1,028,000		-		-
Construction and land development		1		189,184		-		1		189,184
Commercial loans		2		199,742		199,742		-		-
Consumer loans		-		-		-		-		-
		76	$	14,261,477	$	7,548,762	$	35	$	6,712,715

					Paying as agreed				Past due
	Number of		Contract		under		Number of		30 days or more
December 31, 2010	Contracts		balance		modified terms		Contracts		Or non-accruing
Troubled Debt restructurings
Residential real estate		37	$	6,970,359	$	3,603,477	$	14	$	3,366,882
Commercial real estate		29		8,499,471		7,863,026		4		636,445
Other real estate		-		-		-		-		-
Construction and land development		4		1,134,751		67,500		3		1,067,251
Commercial loans		-		-		-		-		-
Consumer loans		-		-		-		-		-
		70	$	16,604,581	$	11,534,003	$	21	$	5,070,578

Outstanding loan commitments, unused lines of credit, and letters of credit as of December 31, are as follows:

	2011		2010

Check loan lines of credit	$	493,545	$	468,621
Mortgage lines of credit and loan commitments		6,910,187		6,727,480
Other lines of credit and commitments		10,942,715		10,964,947
Undisbursed construction loan commitments		1,381,015		2,240,747
	$	19,727,462	$	20,401,795

Standby letters of credit	$	2,685,138	$	3,761,110

Loan commitments and lines of credit are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market rates, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time.

Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. The Bank’s exposure to credit loss in the event of nonperformance by the borrower is represented by the contract amount of the commitment. Management is not aware of any fact that could cause the Bank to incur an accounting loss as a result of funding these commitments.

- 55 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans and Allowance for Loan Losses (Continued)

The Company lends to customers located primarily in and near Kent County, Queen Anne’s County, and Cecil County, Maryland. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.

Premises and Equipment

A summary of premises and equipment and related depreciation expense as of December 31, is as follows:

	2011		2010

Land	$	2,432,279	$	2,432,279
Premises		5,151,031		5,054,037
Furniture and equipment		3,087,624		3,067,445
		10,670,934		10,553,761
Accumulated depreciation		4,484,091		4,163,980
Net premises and equipment	$	6,186,843	$	6,389,781

Depreciation expense	$	327,794	$	344,882

Computer software included in other assets and the related amortization are as follows:

	2011		2010

Cost	$	134,967	$	110,296
Accumulated amortization		96,473		83,545
Net computer software	$	38,494	$	26,751

Amortization expense	$	12,928	$	9,545

Other Time Deposits

Maturities of other time deposits as of December 31, are as follows:

	2011		2010

Within one year	$	11,721,019	$	23,900,138
Over one to two years		23,296,101		7,896,616
Over two to three years		23,270,159		23,404,265
Over three to four years		18,091,632		22,925,801
Over four to five years		20,056,835		19,388,381
Over five years		720,199		589,375
	$	97,155,945	$	98,104,576

Included in other time deposits are certificates of deposit in amounts of $100,000 or more of $34,905,052 and $34,917,217 as of December 31, 2011 and 2010, respectively.

- 56 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Securities Sold Under Repurchase Agreements

Securities sold under repurchase agreements represent borrowings from customers. The government agency securities that are the collateral for these agreements are owned by the Bank and maintained in the custody of an unaffiliated bank. Additional information is as follows:

	2011			2010

Maximum month-end amount outstanding	$	6,993,283		$	7,956,138
Average amount outstanding		2,478,167			2,324,268
Average rate paid during the year		1.53	%		1.76	%
Investment securities underlying agreements at year-end
Book value		2,349,657			2,354,950
Fair value		2,357,306			2,339,598

Intangibles and Goodwill

The Company recorded a $550,000 intangible asset and $272,932 in goodwill in connection with the Insurance Subsidiary acquisition in 2007. The intangible asset is fully amortizable straight-line over 10 years for financial statement purposes and 15 years for income tax purposes. Goodwill is not amortized, but is annually evaluated for impairment.

In addition, the Insurance Subsidiary acquired a local insurance agency in 2009 and recording a $25,344 intangible asset that is fully amortizable over two years. No goodwill was recorded in connection with this transaction.

Information relating to goodwill and intangible assets at December 31, 2011 is as follows:

	Balance
Goodwill	$	272,932
Intangible assets		575,344
Accumulated amortization		(300,344	)
Goodwill and intangible assets, net	$	547,932

Amortization expense recognized in 2011	$	56,056

Estimated amortization expense:
2012	$	55,000
2013		55,000
2014		55,000
2015		55,000
2016		55,000

- 57 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Notes Payable and Lines of Credit

The Bank may borrow up to approximately $29,000,000 from the Federal Home Loan Bank (the “FHLB”) through any combination of notes or line of credit advances. Both the notes payable and the line of credit are secured by a floating lien on all of the Bank’s real estate mortgage loans. As of December 31, 2011, the Bank had $9,482,946 of mortgage loans available to pledge as collateral to the FHLB. The Bank was required to purchase shares of capital stock in the FHLB as a condition to obtaining the line of credit.

The Bank’s borrowings from the FHLB as of December 31, 2011 and 2010 are summarized as follows:

Maturity	Interest			2011		2010
date	rate			Balance		Balance

March 17, 2011		2.12	%	$	-	$	1,000,000
March 28, 2011		2.00	%		-		1,000,000
July 22, 2011		1.48	%		-		1,000,000
October 11, 2011		1.32	%		-		1,000,000
March 27, 2012		2.43	%		1,000,000		1,000,000
April 2, 2012		1.26	%		1,000,000		1,000,000
June 9, 2012		2.19	%		1,000,000		1,000,000
October 9, 2012		1.94	%		1,000,000		1,000,000
October 22, 2012		1.53	%		1,000,000		1,000,000
April 2, 2013		1.93	%		1,000,000		1,000,000
April 22, 2013		1.85	%		1,000,000		1,000,000
June 24, 2013		1.60	%		1,000,000		1,000,000
October 27, 2014		2.55	%		2,000,000		2,000,000
January 26, 2017		4.36	%		5,000,000		5,000,000
August 2, 2017		4.34	%		5,000,000		5,000,000
				$	20,000,000	$	24,000,000

The outstanding advances require interest payments monthly or quarterly with principal due at maturity.

In addition to the line from the FHLB, the Bank has lines of credit of $6,650,000 in unsecured overnight federal funds and $5,000,000 in secured overnight federal funds at December 31, 2011. The Bank has a secured line of credit with the Federal Reserve Discount Window of approximately $18,000,000. As of December 31, 2011, the Bank had not borrowed under these federal funds lines of credit or the Federal Reserve Discount Window.

10.

Income Taxes

The components of income tax expense (benefit) are as follows:

	2011			2010
Current
Federal	$	(1,727,945	)	$	671,320
State		(355,098	)		145,643
		(2,083,043	)		816,963
Deferred		895,393			(1,185,153	)
	$	(1,187,650	)	$	(368,190	)

- 58 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10. Income Taxes (Continued)

The components of the deferred income tax expense (benefit) are as follows:

Provision for loan losses and bad debts	$	1,032,355		$	(983,487	)
Prepaid pension costs		(30,718	)		(24,954	)
Depreciation and amortization		(37,017	)		(4,417	)
Discount accretion		(3,443	)		(21,835	)
Nonaccrual interest		9,182			(142,741	)
Deferred compensation		28,461			(7,072	)
Write-down of foreclosed real estate		(103,427	)		(647	)
	$	895,393		$	(1,185,153	)

The components of the net deferred income tax asset are as follows:

Deferred income tax assets
Allowance for loan losses and bad debt reserve	$	893,163	$	1,937,899
Deferred compensation		165,446		193,907
Pension liability		392,166		142,891
Nonaccrual interest		245,067		254,249
Foreclosed real estate valuation allowance		147,064		43,744
		1,842,906		2,572,690
Deferred income tax liabilities
Depreciation and amortization		155,055		193,925
Discount accretion		-		3,443
Unrealized gain on investment securities available for sale		8,929		7,475
		163,984		204,843
Net deferred income tax asset	$	1,678,922	$	2,367,847

A reconciliation of the provisions for income taxes from statutory federal rates to effective rates follows:

	2011			2010

Tax at statutory federal income tax rate		34.0	%		34.0	%
Tax effect of
Tax-exempt income		2.0			9.0
State income taxes, net of federal benefit		2.0			4.1
Other, net		(0.6	)		2.5
		37.4	%		49.6	%

- 59 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. Profit Sharing Plan

The Company has a profit sharing plan qualifying under section 401(k) of the Internal Revenue Code that covers all of the Company’s employees with one year of service who have attained age 21. The Company matches 15% of employee contributions to the Plan, up to a maximum of 2% of pay. The Company may make discretionary contributions to the Plan in amounts approved by its Board of Directors. Plan expenses, included in employee benefits expense for 2011 and 2010, were $9,114 and $9,422, respectively.

12. Pension

The Bank has a defined benefit pension plan covering substantially all of the employees of the Bank. Benefits are based on years of service and the employee’s highest average rate of earnings for five consecutive years during the final ten full years before retirement. The Bank’s funding policy is to contribute annually the maximum amount that can be deducted for income tax purposes, determined using the projected unit credit cost method.

The following table sets forth the financial status of the plan at December 31:

	2011			2010
Change in plan assets
Fair value of plan assets at beginning of year	$	2,627,528		$	2,618,274
Actual return on plan assets		88,045			86,123
Employer contribution		145,000			136,351
Benefits paid		(52,991	)		(213,220	)
Fair value of plan assets at end of year		2,807,582			2,627,528

Change in benefit obligation
Projected benefit obligation at beginning of year		2,989,189			3,364,118
Service cost		170,418			100,334
Interest cost		185,168			205,566
Benefits paid		(52,991	)		(213,220	)
Actuarial loss (gain)		509,846			(467,609	)
Projected benefit obligation at end of year		3,801,630			2,989,189

Funded status		(994,048	)		(361,661	)
Unamortized prior service cost		(5	)		(1,382	)
Unrecognized net loss		1,255,157			702,180
Prepaid pension expense included in other assets	$	261,104		$	339,137

Accumulated benefit obligation	$	2,814,987		$	2,036,621

- 60 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. Pension (Continued)

Net pension expense includes the following components:

	2011			2010

Service cost	$	170,418		$	100,334
Interest cost		185,168			205,566
Expected return on assets		(153,729	)		(150,155	)
Amortization of prior service cost		(1,377	)		(1,377	)
Amortization of loss		22,395			45,246
Net pension expense	$	222,875		$	199,614

Assumptions used in the accounting for net pension expense were:

Discount rates	5.00	%	6.25	%
Rate of increase in compensation level	2.75	%	5.00	%
Long-term rate of return on assets	5.75	%	5.75	%

The Bank intends to contribute approximately $175,000 to the Plan in 2012.

Projected benefits expected to be paid from the Plan are as follows:

Year	Amount

2012	$	43,000
2013	$	43,000
2014	$	109,000
2015	$	108,000
2016	$	115,000
2017-2021	$	901,000

The long-term rate of return on assets assumption considers the current earnings on assets of the Plan as well as the effects of asset diversification. The Plan’s investment strategy is to earn a reasonable return while safeguarding the benefits promised to employees. All assets of the Plan are invested in deposit accounts at the Bank.

- 61 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. Other Operating Expenses

Other operating expenses consist of the following:

	2011		2010

Directors' fees	$	172,938	$	146,348
Professional fees		189,234		130,933
Advertising		53,457		59,532
Postage		103,254		110,799
Public relations and contributions		51,285		68,188
Office supplies and printing		95,525		110,959
Telephone		41,931		43,747
Regulatory assessments		276,247		332,308
Loan product costs		15,310		13,825
Insurance		34,016		37,687
Other		549,039		489,489
	$	1,582,236	$	1,543,815

14. Related Party Transactions

In the normal course of banking business, loans are made to senior officers and directors of the Company as well as to companies and individuals affiliated with those officers and directors. The terms of these transactions are substantially the same as the terms provided for similar transactions to borrowers who are not related to the Company. In the opinion of management, these loans are consistent with sound banking practices, are within regulatory lending limitations, and do not involve more than normal credit risk.

A summary of these loans is as follows:

	2011			2010

Beginning loan balances	$	5,088,728		$	5,251,105
Advances		5,089,891			4,115,395
Repayments		(6,283,285	)		(4,275,123	)
Change in related parties		-			(2,649	)
Ending loan balances	$	3,895,334		$	5,088,728

In addition to the outstanding balances listed above, the officers and directors and their related interests have $4,351,524 in unused loans committed but not funded as of December 31, 2011.

A director is a partner in a law firm that provides services to the Company. Payments of $11,000 were made to that firm during 2011 and 2010.

Deposits from senior officers and directors and their related interests were $2,381,768 as of December 31, 2011 and $2,752,485 as of December 31, 2010.

- 62 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. Capital Standards

The Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation have adopted risk-based capital standards for banking organizations. These standards require ratios of capital to assets for minimum capital adequacy and to be classified as well capitalized under prompt corrective action provisions. The table below sets forth the capital ratios of the Bank as of December 31, 2011 and 2010. Because Peoples Bancorp, Inc.’s only asset other than its equity interest in the Bank and the Insurance Subsidiary is a small amount of cash, its capital ratios do not differ materially from those of the Bank.

						Minimum					To be well
	Actual					capital adequacy					capitalized
(in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio

December 31, 2011
Total capital (to risk-weighted assets)	$	26,073		13.7	%	$	15,256		8.0	%	$	19,070		10.0	%
Tier 1 capital (to risk-weighted assets)	$	23,665		12.4	%	$	7,628		4.0	%	$	11,442		6.0	%
Tier 1 capital (to average fourth quarter assets)	$	23,665		9.5	%	$	9,946		4.0	%	$	12,433		5.0	%

December 31, 2010
Total capital (to risk-weighted assets)	$	28,651		14.3	%	$	16,050		8.0	%	$	20,062		10.0	%
Tier 1 capital (to risk-weighted assets)	$	26,104		13.0	%	$	8,025		4.0	%	$	12,037		6.0	%
Tier 1 capital (to average fourth quarter assets)	$	26,104		10.5	%	$	9,934		4.0	%	$	12,418		5.0	%

Tier 1 capital consists of common stock, additional paid on capital, and undivided profits. Total capital includes a limited amount of the allowance for loan losses. In calculating risk-weighted assets, specified risk percentages are applied to each category of asset and off-balance sheet items.

Failure to meet the capital requirements could affect the Bank's ability to pay dividends and accept deposits and may significantly affect the operations of the Bank.

In the most recent regulatory report, the Bank was categorized as well capitalized under the prompt corrective action regulations. Management knows of no events or conditions that should change this classification.

16. Foreclosed Real Estate

The increase in foreclosed real estate in 2011 was mainly attributable to the Bank’s acquisition by foreclosure of one customer’s large parcel of building lots valued at approximately $2,500,000.

Activity in foreclosed real estate is as follows:

	2011			2010

Beginning of year balance	$	1,201,600		$	1,335,000
Additions		4,752,586			398,600
Write downs		(309,500	)		(50,000	)
Proceeds from sales		(1,479,459	)		(428,485	)
Gain (loss) on sales		(42,827	)		(53,515	)
End of year balance	$	4,122,400		$	1,201,600

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17. Fair Value Measures

The fair value of an asset or a liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. FASB ASC valuation techniques include the assumptions that market participants would use in pricing an asset or a liability. FASB ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1 inputs — Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 inputs — Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates. volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

Level 3 inputs — Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the issuer’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although management believes the Company’s valuation methodologies are appropriate and consistent with those used by other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and, therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstance that caused the transfer, which generally coincides with the Company’s monthly and quarterly valuation process.

Fair value measured on a recurring basis

The Company measures securities available for sale at fair value on a recurring basis. The following table summarizes securities available for sale measured at fair value on a recurring basis as of December 31, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.

December 31, 2011
Available for Sale	Total		Level 1 Inputs		Level 2 Inputs		Level 3 Inputs
U. S. Government Agency Securities	$	9,076,990	$	9,076,990	$	-	$	-

December 31, 2010
Available for Sale	Total		Level 1 Inputs		Level 2 Inputs		Level 3 Inputs
U. S. Government Agency Securities	$	8,035,780	$	8,035,780	$	-	$	-

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17.

Fair Value Measures (Continued)

Fair values on a nonrecurring basis

The Company’s foreclosed real estate and impaired loans are measured at fair value on a nonrecurring basis, which means that the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of reduced property value). Foreclosed real estate measured at fair value on a non-recurring basis during the twelve months ended December 31, 2011 is reported at the fair value of the underlying collateral, assuming that the sale prices of the properties will be their current appraised values. Appraised values are estimated using Level 2 inputs based on observable market data and current property tax assessments. Impaired loans were measured at fair value during the same period and are reported at the fair value of the loan’s collateral. Fair value is generally determined using Level 3 inputs based upon independent appraisals of the properties, or discounted cash flows based upon the expected proceeds.

	Level		Level		Level
	1 Inputs		2 Inputs		3 Inputs		Total
December 31, 2011
Foreclosed real estate	$	-	$	4,122,400	$	-	$	4,122,400
Impaired Loans		-		-		14,822,559		16,086,411
	$	-	$	4,122,400	$	14,822,559	$	20,208,811

December 31, 2010
Foreclosed real estate	$	-	$	1,201,600	$	-	$	1,201,600
Impaired Loans		-		-		8,332,016		11,625,512
	$	-	$	1,201,600	$	8,332,016	$	12,827,112

FASB ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis.

The Company does not measure the fair value of any of its other financial assets or liabilities on a recurring basis. The fair value of financial instruments equals the carrying value of the instruments except as noted.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17. Fair Value Measures (Continued)

	December 31,
	2011				2010
	Carrying		Fair		Carrying		Fair
	amount		value		amount		value

Financial assets
Cash and due from banks	$	27,613,717	$	27,613,717	$	10,378,485	$	10,378,485
Federal funds sold		9,018,000		9,018,000		1,016,000		1,016,000
Investment securities (total)		9,081,293		9,081,360		11,546,313		11,590,095
Federal Home Loan Bank and CBB Financial Corp. stock		1,601,400		1,601,400		2,151,600		2,151,600
Loans, net		188,876,206		208,116,545		207,295,877		208,116,545
Accrued interest receivable		1,087,971		1,087,971		1,306,708		1,360,708

Financial liabilities
Noninterest-bearing deposits	$	42,207,291	$	4,207,291	$	35,219,753	$	35,219,753
Interest-bearing deposits		160,987,977		164,463,824		154,420,977		157,626,964
Short-term borrowings		2,916,900		2,916,900		2,754,321		2,754,321
Federal Home Loan Bank advances		20,000,000		21,878,280		24,000,000		25,230,768
Accrued interest payable		345,358		345,358		414,758		414,758

The fair value of fixed-rate loans is estimated to be the present value of scheduled payments discounted using interest rates currently in effect. The fair value of variable-rate loans, including loans with a demand feature, is estimated to equal the carrying amount of the loan. The valuation of loans is adjusted for possible loan losses.

The fair value of interest-bearing checking, savings, and money market deposit accounts is equal to the carrying amount. The fair value of fixed-maturity time deposits and borrowings is estimated based on interest rates currently offered for deposits and borrowings of similar remaining maturities.

It is not practicable to estimate the fair value of outstanding loan commitments, unused lines of credit, and letters of credit.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18. Parent Company Financial Information

The balance sheets, statements of income, and statements of cash flows for Peoples Bancorp, Inc. (Parent Only) follow:

	December 31,
Balance Sheets	2011			2010
Assets
Cash	$	314,903		$	306,690
Investment in bank subsidiary		22,918,726			25,690,671
Investment in insurance agency subsidiary		1,565,132			1,399,805
Due from bank subsidiary		1,571			-
Income tax refund receivable		16,288			4,839
Total assets	$	24,816,620		$	27,402,005

Liabilities and Stockholders' Equity

Other liabilities	$	2,699		$	9,841
Stockholders' equity
Common stock		7,795,120			7,795,120
Additional paid-in capital		2,920,866			2,920,866
Retained earnings		14,844,222			17,088,741
Accumulated other comprehensive income (loss)		(746,287	)		(412,563	)
Total stockholders' equity		24,813,921			27,392,164
Total liabilities and stockholders' equity	$	24,816,620		$	27,402,005

	Years Ended December 31,
Statements of Income	2011			2010

Interest revenue	$	2,324		$	3,626
Dividends from bank subsidiary		317,239			1,413,122
Equity in undistributed income of insurance agency subsidiary		165,327			165,047
Equity in undistributed income of bank subsidiary		(2,438,222	)		(1,945,573	)
		(1,953,332	)		(363,778	)
Expenses
Professional fees		35,163			8,000
Other		15,075			4,915
		50,238			12,915

Loss before income tax benefit		(2,003,570	)		(376,693	)
Income tax (benefit)		(16,289	)		(3,158	)
Net loss	$	(1,987,281	)	$	(373,535	)

- 67 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18. Parent Company Financial Information (Continued)

	Years Ended December 31,
Statements of Cash Flows	2011			2010

Cash flows from operating activities
Interest and dividends received	$	319,563		$	1,416,748
Income taxes refunded		4,838			3,158
Cash paid for operating expenses		(58,949	)		(17,333	)
		265,452			1,402,573

Cash flows from financing activities
Dividends paid		(257,239	)		(1,403,122	)

Net increase (decrease) in cash		8,213			(549	)
Cash at beginning of year		306,690			307,239
Cash at end of year	$	314,903		$	306,690

Reconciliation of net income to net cash provided by operating activities
Net loss	$	(1,987,281	)	$	(373,535	)
Adjustments to reconcile net loss to net cash provided by operating activities
Undistributed net income of subsidiaries		2,272,895			1,780,526
Increase (decrease) in other liabilities		(7,142	)		(6,974	)
(Increase) decrease in income tax refund receivable		(11,450	)		2,556
(Increase) decrease in accounts receivable		(1,570	)		-
	$	265,452		$	1,402,573

- 68 -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

19. Quarterly Results of Operations (Unaudited)

	Three Months Ended
(in thousands)	December 31,			September 30,			June 30,			March 31,
except per share information
2011
Interest revenue	$	2,875		$	2,932		$	2,977		$	2,935
Interest expense		734			776			817			854
Net interest income		2,141			2,156			2,160			2,081
Provision for loan losses		2,675			1,450			925			1,500
Net income (loss)		(1,219	)		(430	)		(40	)		(298	)
Comprehensive income (loss)		(1,553	)		(438	)		(30	)		(300	)

Earnings (loss) per share	$	(1.57	)	$	(0.55	)	$	(0.05	)	$	(0.38	)

2010
Interest revenue	$	3,279		$	3,048		$	3,157		$	3,330
Interest expense		912			936			944			985
Net interest income		2,367			2,112			2,213			2,345
Provision for loan losses		2,925			485			1,025			475
Net income (loss)		(995	)		288			(68	)		401
Comprehensive income (loss)		(727	)		292			(59	)		400

Earnings (loss) per share	$	(1.28	)	$	0.38		$	(0.09	)	$	0.51

- 69 -

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed under the Exchange Act with the Securities and Exchange Commission, such as this annual report, is recorded, processed, summarized and reported within the time periods specified in those rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s principal executive officer, who also serves as the Company’s principal accounting officer (the “CEO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of December 31, 2011 was carried out under the supervision and with the participation of the Company’s management, including the CEO. Based on that evaluation, the Company’s management, including the CEO, has concluded that the Company’s disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the fourth quarter of 2011, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has performed an evaluation and testing of the Company’s internal control over financial reporting as of December 31, 2011. Management’s report on the Company’s internal control over financial reporting is included on the following page.

- 70 -

Management’s Report on Internal Control Over Financial Reporting

Management of Peoples Bancorp, Inc. (the “Company”) is responsible for the preparation, integrity and fair presentation of the consolidated financial statements included in this annual report. The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and, as such, include some amounts that are based on the best estimates and judgments of management.

This annual report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting because management’s report was not subject to attestation pursuant to rules of the SEC that permit the Company to provide only this management’s report.

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. This internal control system is designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of the Company’s financial reporting and the preparation and presentation of financial statements for external reporting purposes in conformity with accounting principles generally accepted in the United States of America, as well as to safeguard assets from unauthorized use or disposition. The system of internal control over financial reporting is evaluated for effectiveness by management and tested for reliability through a program of internal audit with actions taken to correct potential deficiencies as they are identified. Because of inherent limitations in any internal control system, no matter how well designed, misstatement due to error or fraud may occur and not be detected, including the possibility of the circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, internal control effectiveness may vary over time.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011 based upon criteria set forth in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

Based on this assessment and on the foregoing criteria, management has concluded that, as of December 31, 2011, the Company’s internal control over financial reporting is effective. The Company is a “smaller reporting company” as defined by Exchange Act Rule 12b-2 and, accordingly, its independent registered public accounting firm is not required to attest to the foregoing management report.

March 28, 2012

/s/ Thomas G. Stevenson
Thomas G. Stevenson,
President, Chief Executive Officer & Chief Financial Officer
(Principal Executive Officer & Principal Accounting Officer)

- 71 -

Item 9B. Other Information.

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance.

The Company has adopted a Code of Ethics that applies to all of its directors, officers, and employees, including its principal executive officer, principal financial officer, principal accounting officer, or controller, or persons performing similar functions. A written copy of the Company’s Code of Ethics will be provided to stockholders, free of charge, upon request to: Stephanie Usilton, Peoples Bancorp, Inc., 100 Spring Avenue, Chestertown, Maryland 21620 or (410) 778-3500.

All other information required by this item is incorporated herein by reference to the following sections of the Company’s definitive proxy statement to be filed in connection with the 2012 Annual Meeting of Stockholders:

Election of Directors (Proposal 1);

Qualifications of Director Nominees;

Executive Officers;

Section 16(a) Beneficial Ownership Reporting Compliance; and

Corporate Governance Matters (under “Board Committees”).

Item 11. Executive Compensation.

The information required by this item is incorporated herein by reference to the sections of the Company’s definitive proxy statement to be filed in connection with the 2012 Annual Meeting of Stockholders entitled “Director Compensation” and “Executive Compensation”.

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The Company has not adopted any compensation plan or arrangement pursuant to which our executive officers may receive shares of the Company’s common stock. All other information required by this item is incorporated herein by reference to the section of the Company’s definitive proxy statement to be filed in connection with the 2012 Annual Meeting of Stockholders entitled “Beneficial Ownership of Common Stock”.

The information required by this item is incorporated herein by reference to the sections of the Company’s definitive proxy statement to be filed in connection with the 2012 Annual Meeting of Stockholders entitled “Certain Relationships and Related Transactions” and “Corporate Governance Matters” (under the heading, “Director Independence”).

Item 14. Principal Accountant Fees and Services.

The information required by this item is incorporated herein by reference to the section of the Company’s definitive proxy statement to be filed in connection with the 2012 Annual Meeting of Stockholders entitled “Audit Fees and Services”.

- 72 -

PART IV

Item 15. Exhibits and Financial Statement Schedules.

(a)(1), (2) and (c). Financial statements and schedules:

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets at December 31, 2011 and 2010

Consolidated Statements of Income for the years Ended December 31, 2011 and 2010

Consolidated Statements of Changes in Stockholders’ Equity for the years Ended December 31, 2011 and 2010

Consolidated Statements of Cash Flows for the years Ended December 31, 2011 and 2010

Notes to Consolidated Financial Statements for the years ended December 31, 2011 and 2010

(a)(3) and (b). Exhibits required to be filed by Item 601 of Regulation S-K:

The exhibits filed or furnished with this annual report are shown on the Exhibit List that follows the signatures to this annual report, which list is incorporated herein by reference.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	PEOPLES BANCORP, INC.

Date: March 28, 2012	By:	/s/ Thomas G. Stevenson
		Thomas G. Stevenson
		President, CEO and CFO

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Date:	March 28, 2012	By:	/s/ E. Jean Anthony
			E. Jean Anthony, Director

Date:	March 28, 2012	By:	/s/Robert W. Clark, Jr.
			Robert W. Clark, Jr., Director

Date:	March 28, 2012	By:	/s/Lamont e. Cooke
			LaMonte E. Cooke, Director

Date:	March 28, 2012	By:	/s/ Gary B. Fellows
			Gary B. Fellows, Director

Date:	March 28, 2012	By:	/s/ Herman E. Hill, Jr.
			Herman E. Hill, Jr., Director

Date:	March 28, 2012	By:	/s/ Patricia Joan Ozman Horsey
			Patricia Joan Ozman Horsey, Director

Date:	March 28, 2012	By:
			P. Patrick McClary, Director

- 73 -

Date:	March 28, 2012	By:	/s/ Alexander P. Rasin, III
			Alexander P. Rasin, III, Director

Date:	March 28, 2012	By:	/s/ Stefan R. Skipp
			Stefan R. Skipp, Director

Date:	March 28, 2012	By:	/s/ Thomas G. Stevenson
			Thomas G. Stevenson, President, CEO,
			CFO and Director

Date:	March 28, 2012	By:	/s/ Elizabeth A. Strong
			Elizabeth A. Strong, Director

Date:	March 28, 2012	By:	/s/ William G. Wheatley
			William G. Wheatley, Director

- 74 -

EXHIBIT INDEX

Exhibit No.		Description

3.1		Articles of Incorporation of the Company, as corrected and amended (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on January 24, 2005)
3.2		Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.2 of the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2004)
21		Subsidiaries of the Company (filed herewith)
31.1		Certifications of the PEO/PAO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.1		Certification of the PEO/PAO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)

101.INS		XBRL Instance Document (furnished herewith)

101.SCH		XBRL Taxonomy Extension Schema (furnished herewith)

101.CAL		XBRL Taxonomy Extension Calculation Linkbase (furnished herewith)

101.DEF		XBRL Taxonomy Extension Definition Linkbase (furnished herewith)

101.LAB		XBRL Taxonomy Extension Label Linkbase (furnished herewith)

101.PRE		XBRL Taxonomy Extension Presentation Linkbase (furnished herewith)

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PEOPLES BANCORP INC/MD 10-K