Edgar Filing: TRI COUNTY FINANCIAL CORP /MD/

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2011

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to ______

Commission File Number 0-18279

Tri-County Financial Corporation

(Exact name of registrant as specified in its charter)

Maryland		52-1652138
(State of other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

3035 Leonardtown Road, Waldorf, Maryland		20601
(Address of principal executive offices)		(Zip Code)

(301) 645-5601

(Registrant's telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

¨Yes ¨No

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

Large Accelerated Filer ¨	Accelerated Filer ¨
Non-accelerated Filer ¨	Smaller Reporting Company x
(Do not check if a smaller reporting company)

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

Yes ¨ No x

As of May 4, 2011, the registrant had 3,022,848 shares of common stock outstanding.

TRI-COUNTY FINANCIAL CORPORATION

FORM 10-Q

INDEX

		Page
PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements (Unaudited)

Consolidated Balance Sheets – March 31, 2011 and December 31, 2010		3

Consolidated Statements of Income - Quarters Ended March 31, 2011 and 2010		4

Consolidated Statements of Cash Flows - Quarters Ended March 31, 2011 and 2010		5

Notes to Consolidated Financial Statements		7

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations		24

Item 3 – Quantitative and Qualitative Disclosures about Market Risk		34

Item 4 – Controls and Procedures		34

PART II - OTHER INFORMATION

Item 1 – Legal Proceedings		35

Item 1A – Risk Factors		35

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds		35

Item 3 – Defaults Upon Senior Securities		36

Item 4 – [Removed and Reserved]		36

Item 5 – Other Information		36

Item 6 – Exhibits		36

SIGNATURES		37

PART I FINANCIAL STATEMENTS

ITEM I. FINANCIAL STATEMENTS

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS MARCH 31, 2011 AND DECEMBER 31, 2010

	March 31,			December 31,
	2010			2010
	(Unaudited)
Assets
Cash and due from banks	$	14,526,264		$	8,695,590
Federal funds sold		2,145,000			615,000
Interest-bearing deposits with banks		841,315			512,846
Securities available for sale (AFS), at fair value		30,792,374			34,946,225
Securities held to maturity (HTM), at amortized cost		113,656,094			126,988,316
Federal Home Loan Bank and Federal Reserve Bank stock - at cost		6,354,000			6,315,600
Loans receivable - net of allowance for loan losses of $7,281,777 and $7,669,147		647,378,198			654,449,936
Premises and equipment, net		12,147,339			12,132,141
Foreclosed real estate		11,039,380			10,469,302
Accrued interest receivable		2,990,963			2,784,396
Investment in bank owned life insurance		17,607,387			17,447,692
Other assets		12,404,561			10,579,058
Total Assets	$	871,882,875		$	885,936,102

Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing deposits	$	64,000,231		$	75,642,197
Interest-bearing deposits		658,007,513			648,940,129
Total deposits		722,007,744			724,582,326
Short-term borrowings		453,090			816,422
Long-term debt		60,612,359			70,624,044
Guaranteed preferred beneficial interest in junior subordinated debentures		12,000,000			12,000,000
Accrued expenses and other liabilities		5,656,449			6,808,383
Total Liabilities		800,729,642			814,831,175

Stockholders' Equity
Fixed Rate Cumulative Perpetual Preferred Stock, Series A - par value $1,000; authorized 15,540; issued 15,540		15,540,000			15,540,000
Fixed Rate Cumulative Perpetual Preferred Stock, Series B - par value $1,000; authorized 777; issued 777		777,000			777,000
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 3,021,144 and 3,002,616 shares, respectively		30,211			30,026
Additional paid in capital		17,252,791			16,962,460
Retained earnings		37,780,539			37,892,557
Accumulated other comprehensive gain		313,738			411,188
Unearned ESOP shares		(541,046	)		(508,304	)
Total Stockholders’ Equity		71,153,233			71,104,927

Total Liabilities and Stockholders' Equity	$	871,882,875		$	885,936,102

See notes to consolidated financial statements

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

QUARTERS ENDED MARCH 31, 2011 AND 2010	Quarters Ended March 31,
	2011		2010
Interest and Dividend Income
Loans, including fees	$	8,860,571	$	8,758,786
Taxable interest and dividends on investment securities		969,837		1,202,574
Interest on deposits with banks		1,382		2,177
Total Interest and Dividend Income		9,831,790		9,963,537

Interest Expenses
Deposits		2,608,520		2,819,281
Short-term borrowings		14,433		10,854
Long-term debt		599,364		648,766
Total Interest Expenses		3,222,317		3,478,901

Net Interest Income		6,609,473		6,484,636
Provision for loan losses		2,005,830		858,374
Net Interest Income After Provision For Loan Losses		4,603,643		5,626,262

Noninterest Income
Loan appraisal, credit, and miscellaneous charges		158,098		170,412
Income from bank owned life insurance		159,695		104,746
Service charges		426,959		404,044
Gain on sale of loans held for sale		25,575		82,023
Total Noninterest Income		770,327		761,225

Noninterest Expenses
Salary and employee benefits		2,751,474		2,362,534
Occupancy expense		417,391		427,644
Advertising		118,696		76,749
Data processing expense		282,753		246,140
Depreciation of furniture, fixtures, and equipment		99,529		127,598
Telephone communications		42,024		40,119
Office supplies		38,791		45,746
Professional fees		217,088		158,839
FDIC insurance		326,319		352,106
Valuation allowance on foreclosed real estate		315,883		-
Other		501,276		400,934
Total Noninterest Expenses		5,111,224		4,238,409

Income before income taxes		262,746		2,149,078
Income tax expense		21,248		784,654
Net Income	$	241,498	$	1,364,424
Preferred stock dividends		211,733		211,733
Net Income Available to Common Shareholders	$	29,765	$	1,152,691

Per Common Share
Basic earnings	$	0.01	$	0.39
Diluted earnings	$	0.01	$	0.38
Cash dividends declared	$	0.40	$	0.40

See notes to consolidated financial statements

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

QUARTERS ENDED MARCH 31, 2011 AND 2010

	Quarters Ended March 31,
	2011			2010

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	241,498		$	1,364,424

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

Provision for loan losses		2,005,830			858,374
Depreciation and amortization		214,957			251,863
Loans originated for resale		(1,476,600	)		(3,144,500	)
Proceeds from sale of loans originated for sale		1,491,984			3,146,147
Gain on sale of loans held for sale		(25,575	)		(82,023	)
Net amortization of premium/discount on investment securities		45,142			(88,162	)
Increase in foreclosed real estate valuation allowance		315,883			-
Increase in cash surrender of bank owned life insurance		(159,695	)		(104,746	)
Deferred income tax benefit		(37,136	)		(133,570	)
(Increase) decrease in accrued interest receivable		(206,567	)		13,280
Increase (decrease) in deferred loan fees		75,657			(32,576	)
Decrease in accounts payable, accrued expenses, other liabilities		(1,151,934	)		(908,876	)
Increase in other assets		(1,738,166	)		(537,836	)

Net cash (used in) provided by operating activities		(404,722	)		601,799

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities available for sale		(30,493	)		(33,177	)
Proceeds from redemption or principal payments of investment securities available for sale		4,055,862			4,312,203
Purchase of investment securities held to maturity		(99,951	)		(5,999,899	)
Proceeds from maturities or principal payments of investment securities held to maturity		13,367,862			5,583,073
Net increase of FHLB and Federal Reserve stock		(38,400	)		-
Loans originated or acquired		(47,637,459	)		(55,440,499	)
Principal collected on loans		51,751,940			57,218,716
Purchase of premises and equipment		(230,155	)		(148,270	)

Net cash provided by investing activities		21,139,206			5,492,147

TRI-COUNTY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

QUARTERS ENDED MARCH 31, 2011 AND 2010

(continued)

	Quarters Ended March 31,
	2011			2010

CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits	$	(2,574,582	)	$	21,612,021
Payments of long-term borrowings		(10,011,685	)		(5,011,226	)
Net decrease in short-term borrowings		(363,332	)		(12,829,434	)
Exercise of stock options		290,596			31,446
Dividends paid		(211,733	)		(211,733	)
Net change in unearned ESOP shares		(32,742	)		(12,549	)
Redemption of common stock		(141,863	)		-

Net cash (used in) provided by financing activities		(13,045,341	)		3,578,525

INCREASE IN CASH AND CASH EQUIVALENTS	$	7,689,143		$	9,672,471

CASH AND CASH EQUIVALENTS - JANUARY 1		9,823,436			11,247,967

CASH AND CASH EQUIVALENTS – MARCH 31	$	17,512,579		$	20,920,438

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the quarter for:
Interest	$	3,329,167		$	3,636,279
Income taxes	$	-		$	283,000
Issuance of common stock for payment of compensation	$	241,036		$	-
Transfer from loans to foreclosed real estate	$	1,156,723		$	5,969,882

See notes to consolidated financial statements

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

QUARTERS ENDED MARCH 31, 2011 AND 2010

BASIS OF PRESENTATION

General - The consolidated financial statements of Tri-County Financial Corporation (the “Company”) and its wholly owned subsidiary, Community Bank of Tri-County (the “Bank”), and the Bank’s wholly owned subsidiary Community Mortgage Corporation of Tri-County, included herein are unaudited. However, they reflect all adjustments consisting only of normal recurring accruals that, in the opinion of management, are necessary to present fairly the Company’s financial condition, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company believes that the disclosures are adequate to make the information presented not misleading. The balances as of December 31, 2010 have been derived from audited financial statements. There have been no significant changes to the Company’s accounting policies as disclosed in the 2010 Annual Report. The results of operations for the quarter ended March 31, 2011 are not necessarily indicative of the results of operations to be expected for the remainder of the year or any other period. Certain previously reported amounts have been restated to conform to the 2011 presentation.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report for the year ended December 31, 2010.

NATURE OF BUSINESS

The Company provides a variety of financial services to individuals and businesses through its offices in Southern Maryland. Its primary deposit products are demand, savings and time deposits, and its primary lending products are commercial and consumer mortgage loans, commercial loans, construction and land development loans, home equity and second mortgages and commercial equipment loans.

FAIR VALUE MEASUREMENTS

The Company adopted the Financial Accounting Standards Board’s (“FASB”) Accounting Standard’s Codification (“ASC”) Topic 820, “Fair Value Measurements” and FASB ASC Topic 825, “The Fair Value Option for Financial Assets and Financial Liabilities” which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. FASB ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).

FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. FASB ASC Topic 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Under FASB ASC Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:

Level 1 inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the 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 and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

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.

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly or quarterly valuation process.

There were no transfers between levels of the fair value hierarchy and the Company had no Level 3 fair value assets or liabilities for the quarters ended March 31, 2011 and 2010, respectively.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities (‘GSEs”), municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans Receivable

The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Management estimates the fair value of impaired loans using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At March 31, 2011, substantially all of the impaired loans were evaluated based upon the fair value of the collateral. In accordance with FASB ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.

Loans Held for Sale

Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, in the aggregate. Fair value is derived from secondary market quotations for similar instruments. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold, using the specific identification method.

Foreclosed Real Estate

Foreclosed real estate is adjusted for fair value upon transfer of the loans to foreclosed real estate. Subsequently, foreclosed real estate is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis:

The table below presents the recorded amount of assets and liabilities, as of March 31, 2011 measured at fair value on a recurring basis.

			Fair Value Measurements
			At March 31, 2011
			Using:
	Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description of Asset
Securities available for sale:
Asset-backed securities issued by GSEs
CMOs	$	23,742,541	$	-	$	23,742,541	$	-
MBS		3,176,081		-		3,176,081		-
Corporate equity securities		37,512		-		37,512		-
Bond mutual funds		3,836,240		-		3,836,240		-
Total securities available for sale	$	30,792,374	$	-	$	30,792,374	$	-

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:

The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis as of March 31, 2011 are included in the table below:

			Fair Value Measurements
			At March 31, 2011
			Using:
	Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description of Asset
Loans with impairment:
Commercial real estate	$	6,018,319	$	-	$	6,018,319	$	-
Commercial loans		4,198,992		-		4,198,992		-
Total loans with impairment	$	10,217,311	$	-	$	10,217,311	$	-

Foreclosed Real Estate	$	11,039,380	$	-	$	11,039,380	$	-

INCOME TAXES

The Company files a consolidated federal income tax return with its subsidiaries. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. It is the Company’s policy to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense.

EARNINGS PER COMMON SHARE

Basic earnings per common share are computed by dividing net income less dividends on preferred shares, by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed by dividing net income less dividends on preferred shares, by the weighted average number of common shares outstanding during the period, including any potential dilutive common shares outstanding, such as options and warrants. As of March 31, 2011 and 2010, there were 102,524 and 253,359 shares, respectively, excluded from the diluted net income per share computation because the exercise price of the stock options were greater than the market price, and thus were anti-dilutive. Basic and diluted earnings per share have been computed based on weighted-average common and common equivalent shares outstanding as follows:

	Quarters Ended
	March 31,
	2011			2010
Net Income	$	241,498		$	1,364,424
Less: dividends payable on preferred stock		(211,733	)		(211,733	)
Net income available to common shareholders	$	29,764		$	1,152,691

Average number of common shares outstanding		3,009,516			2,978,388
Effect of dilutive options		44,361			21,125
Average number of shares used to calculate diluted earnings per share		3,053,877			2,999,513

COMPREHENSIVE INCOME

Comprehensive income is net income adjusted for net unrealized holding gains or losses and other than temporary impairment for the period.

	Quarters Ended March 31,
	2011			2010
Net Income	$	241,498		$	1,364,424
Other comprehensive income net of tax:
Net unrealized holding (losses) gains arising during period		(97,450	)		98,455
Comprehensive income	$	144,048		$	1,462,879

STOCK-BASED COMPENSATION

The Company has stock option and incentive arrangements to attract and retain key personnel. In May 2005, the 2005 Equity Compensation Plan (the “Plan”) was approved by the shareholders, and authorizes the issuance of restricted stock, stock appreciation rights, stock units and stock options to the Board of Directors and key employees. Compensation expense for service based awards is recognized over the vesting period. Performance based awards are recognized based on a vesting, if applicable, and the probability of achieving the goals.

There was $50,888 in stock-based compensation expense for the quarter ended March 31, 2011 compared to no expense recognized for the quarter ended March 31, 2010. The fair value of the Company’s employee stock options granted is estimated on the date of grant using the Black-Scholes option pricing model. The Company estimates expected market price volatility and expected term of the options based on historical data and other factors.

The exercise price for options granted is set at the discretion of the committee administering the Plan, but is not less than the market value of the shares as of the date of grant. An option’s maximum term is 10 years and the options vest at the discretion of the committee.

The Company has accrued the full amounts due under these plans, but currently it is not possible to identify the portion that will be paid out in the form of stock–based compensation because such payments are subject to the future election of the recipient as to whether to receive payment in the form of stock or cash. A summary of the Company’s stock option plans as of March 31, 2011 and changes during the quarter then ended is presented below:

				Weighted				Weighted-Average
				Average		Aggregate		Contractual Life
				Exercise		Intrinsic		Remaining In
	Shares			Price		Value		Years

Outstanding at January 1, 2011		299,237		$	16.86	$	524,392
Granted at fair value		-			-
Exercised		(17,353	)		8.45		163,796
Expired		-			-
Forfeited		(1 ,576	)		15.02
Outstanding at March 31, 2011		280,308		$	17.39	$	530,312	2.3
Exercisable at March 31, 2011		280,308		$	17.39	$	530,312	2.3

Aggregate intrinsic value of outstanding stock options and exercisable stock options was $530,312 at March 31, 2011. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the period, which was $16.10 at March 31, 2011, and the exercise price multiplied by the number of options outstanding.

The Company has outstanding restricted stock and stock units granted in accordance with the Plan. The following table summarizes the unvested restricted stock awards and units outstanding at March 31, 2011:

	Restricted Stock					Restricted Stock Units
	Number of Shares			Weighted Average Grant Date Fair Value		Number of Shares		Weighted Average Grant Date Fair Value

Nonvested at January 1, 2011		2,720		$	11.90		3,739	$	16.10
Granted		6,500			16.10		3,106		16.89
Vested		(2,661	)		16.10		-		-

Nonvested at March 31, 2011		6,559		$	14.36		6,845	$	16.46

GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES

On June 15, 2005, Tri-County Capital Trust II (“Capital Trust II”), a Delaware business trust formed, funded and wholly owned by the Company, issued $5,000,000 of variable-rate capital in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 1.70%. The Trust used the proceeds from this issuance, along with the $155,000 for Capital Trust II’s common securities, to purchase $5,155,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust II’s obligations with respect to the capital securities. These capital securities qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust II and the junior subordinated debentures are scheduled to mature on June 15, 2035, unless called by the Company.

On July 22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business trust formed, funded and wholly owned by the Company, issued $7,000,000 of variable-rate capital securities in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 2.60%. The Trust used the proceeds from this issuance, along with the Company’s $217,000 capital contribution for Capital Trust I’s common securities, to purchase $7,217,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust I’s obligations with respect to the capital securities. These debentures qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust I and the junior subordinated debentures are scheduled to mature on July 22, 2034, unless called by the Company.

PREFERRED STOCK

On December 19, 2008, the United States Department of the Treasury (“Treasury”), acting under the authority granted to it by the Troubled Asset Relief Program’s Capital Purchase Program purchased $15,540,000 of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) issued by the Company. The preferred stock has a perpetual life, has liquidation priority over the Company’s common shareholders, and is cumulative. The dividend rate is 5% for the first five years, rising to 9% thereafter. The Series A Preferred Stock may not be redeemed unless the Company has paid all dividends accumulated. As condition to the issuance of the Series A Preferred Stock the Company agreed to accept restrictions on the repurchase of its common stock, the payment of dividends and certain compensation practices.

At the same time the Company issued its Series A Preferred Stock, it issued to the Treasury a warrant to purchase Fixed Rate Cumulative Perpetual Preferred Stock, Series B Preferred Stock (“Series B Preferred Stock”) in the amount of 5% of the Series A Preferred Stock or 777 shares with a par value of $777,000. The warrant had an exercise price of $.01 per share. The Series B Preferred Stock has the same rights, preferences and privileges as the Series A Preferred Stock except, the Series B Preferred Stock has a dividend rate of 9%. This warrant was immediately exercised.

Under the terms of the Treasury purchase of preferred stock, the Company cannot repurchase common stock without Treasury’s consent until December 19, 2018 or until the preferred stock issued to the Treasury is redeemed. On November 12, 2010, after approval from the Treasury, the Company approved a repurchase program under which the Company may repurchase shares of common stock equaling up to 1% of the Company’s stockholders’ equity. The Company intends to repurchase shares from time to time, depending on market conditions.

The Company believes that it is in compliance with all terms of the Preferred Stock Purchase Agreement.

10.

SECURITIES

	March 31, 2011
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Securities available for sale (AFS)
Asset-backed securities issued by GSEs	$	26,293,860	$	624,762	$	-	$	26,918,622
Corporate equity securities		37,310		202		-		37,512
Bond mutual funds		3,727,702		108,538		-		3,836,240
Total securities available for sale	$	30,058,872	$	733,502	$	-	$	30,792,374

Securities held to maturity (HTM)
Asset-backed securities issued by:
GSEs	$	101,558,790	$	1,444,706	$	598,036	$	102,405,460
Other		11,245,727		109,800		1,325,414		10,030,113
Total debt securities held to maturity		112,804,517		1,554,506		1,923,450		112,435,573

U.S. Government obligations		851,577		-		-		851,577
Agency Bonds		-		-		-		-
Other investments		-		-		-		-
Total securities held to maturity	$	113,656,094	$	1,554,506	$	1,923,450	$	113,287,148

		December 31, 2010
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Securities available for sale (AFS)
Asset-backed securities issued by GSEs	$	30,327,808	$	761,138	$	-	$	31,088,946
Corporate equity securities		37,310		80		-		37,390
Bond mutual funds		3,697,208		122,681		-		3,819,889
Total securities available for sale	$	34,062,326	$	883,899	$	-	$	34,946,225

Securities held to maturity (HTM)
Asset-backed securities issued by:
GSEs	$	113,772,011	$	1,761,809	$	782,270	$	114,751,550
Other		12,463,500		132,928		1,709,386		10,887,042
Total debt securities held to maturity		126,235,511		1,894,737		2,491,656		125,638,592

U.S. Government obligations		752,805		-		-		752,805
Other investments		-		-		-		-
Total securities held to maturity	$	126,988,316	$	1,894,737	$	2,491,656	$	126,391,397

At March 31, 2011, certain other securities with a carrying value of $10.5 million were pledged to secure certain deposits. At March 31, 2011, securities with a carrying value of $21.2 million were pledged as collateral for advances from the Federal Home Loan Bank of Atlanta.

At March 31, 2010, the AFS and HTM asset-backed securities investment portfolio was $139,723,139, or 97%, of the Company’s total AFS and HTM portfolios. Ninety-four percent of the asset-backed securities portfolio was rated AAA by Standard & Poor’s. AFS asset-backed securities issued by GSEs have an average life of 3.74 years and average duration of 3.53 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs have an average life of 3.58 years and average duration of 3.32 years and are guaranteed by their issuer as to credit risk.

At March 31, 2011, the AFS investment portfolio has a fair value of $30,792,374 with no unrealized losses from their amortized cost.

Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at March 31, 2011, are as follows:

	Less Than 12				More Than 12
	Months				Months				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Asset-backed securities issued by GSEs	$	45,728,435	$	452,358	$	8,132,117	$	145,678	$	53,860,552	$	598,036

Asset-backed securities issued by others		-		-		7,851,453		1,325,414		7,851,453		1,325,414
	$	45,728,435	$	452,358	$	15,983,570	$	1,471,092	$	61,712,005	$	1,923,450

The HTM investment portfolio has an estimated fair value of $113,287,148, of which $61,712,005, or 54% of the securities, had some unrealized losses from their amortized cost. Of these securities, $53,860,552, or 87%, were mortgage-backed securities issued by GSEs and the remaining $7,851,453, or 13%, were asset-backed securities issued by others.

HTM securities issued by GSEs are guaranteed by the issuer. Total unrealized losses on the asset-backed securities issued by GSEs were $598,036, or 0.59%, of the amortized cost of $101,558,790. HTM asset-backed securities issued by GSEs with unrealized losses have an average life of 4.07 years and an average duration of 3.71 years. We believe that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.

HTM asset-backed securities issued by others are mortgage-backed securities. All of the securities have credit support tranches that absorb losses prior to the tranches which the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $1,325,414, or 11.79%, of the amortized cost of $11,245,727. HTM asset-backed securities issued by others with unrealized losses have an average life of 3.34 years and an average duration of 2.50 years. We believe that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity. We believe that the losses are the result of general perceptions of safety and creditworthiness of the entire sector and a general disruption of orderly markets in the asset class.

Management has the ability and intent to hold the securities with unrealized losses classified as held to maturity until they mature, at which time the Company will receive full value for the securities. Because our intention is not to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, management considers the unrealized losses in the held-to-maturity portfolio to be temporary, except for a single CMO issue, for which an other-than-temporary charge of $148,000 was recorded in 2009. At March 31, 2011, the single CMO issue had a par value of $1,058,000, a market fair value of $728,000 and a carrying value of $653,000.

There were no sales of AFS or HTM securities during the quarters ended March 31, 2011 and March 31, 2010. Asset-backed securities are comprised of mortgage-backed securities as well as mortgage-derivative securities such as collateralized mortgage obligations and real estate mortgage investment conduits.

The table below presents the Standard & Poor’s credit rating of AFS and HTM asset-backed securities issued by GSEs and others at March 31, 2011 carrying value:

Credit Rating	Amount
AAA	$	131,572,646
AA+		356,432
AA-		777,355
A-		-
BBB+		103,245
BBB-		1,882,416
BB+		1,257,437
B+		652,599
CCC+		3,121,009
Total	$	139,723,139

11.

FORECLOSED REAL ESTATE

Foreclosed assets are presented net of an allowance for losses. An analysis of the allowance for losses on foreclosed assets is as follows.

	Quarter Ended			Year Ended
	March 31,			December 31,
	2011			2010
Balance at beginning of period	$	10,469,302		$	922,934
Additions of underlying property		1,348,107			11,768,778
Disposals of underlying property		(462,146	)		(1,934,476	)
Valuation allowance		(315,883	)		(287,934	)
Balance at end of period	$	11,039,380		$	10,469,302

Expenses applicable to foreclosed real estate include the following.

	Quarters Ended March 31,
	2011		2010
Valuation allowance	$	315,883	$	-
Operating expenses		143,868		1,786
	$	459,751	$	1,786

12.

LOANS

Loans consist of the following:

	March 31, 2011		December 31, 2010

Commercial real estate	$	343,071,081	$	336,299,836
Residential first mortgages		144,139,698		136,048,577
Construction and land development		36,204,608		42,504,200
Home equity and second mortgage		23,863,632		24,379,664
Commercial loans		89,365,928		104,566,261
Consumer loans		1,185,542		1,273,080
Commercial equipment		17,841,327		17,983,648
		655,671,816		663,055,266
Less:
Deferred loan fees		1,011,841		936,183
Allowance for loan loss		7,281,777		7,669,147
		8,293,618		8,605,330

	$	647,378,198	$	654,449,936

At March 31, 2011, the Bank’s allowance for loan losses totaled $7,281,777, or 1.11%, of loan balances as compared to $7,669,147, or 1.16%, of loan balances at December 31, 2010. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience, current economic conditions, volume, growth and composition of the loan portfolio, financial condition of the borrowers and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance.

The following table details activity in the allowance for loan losses and loan receivable balances for the quarter ended March 31, 2011 and the year ended December 31, 2010. An allocation of the allowance to one category of loans does not prevent the Company’s ability to utilize the allowance to absorb losses in a different category. The loan receivables are disaggregated on the basis of the Company’s impairment methodology.

							Construction
At March 31, 2011	Commercial			Residential			and Land			Home Equity			Commercial			Consumer			Commercial
	Real Estate			First Mortgage			Development			and Second Mtg.			Loans			Loans			Equipment			Total
Allowance for loan losses:
Balance at January 1,	$	3,313,983		$	204,073		$	1,266,625		$	97,519		$	2,552,039		$	32,209		$	202,699		$	7,669,147
Charge-offs		(515,049	)		(49,005	)		(213,020	)		-			(1,568,150	)		(1,000	)		(48,005	)		(2,394,229	)
Recoveries		-			-			-			-			-			1,029			-			1,029
Provisions		576,468			190,867			(83,322	)		(2,064	)		1,328,925			(3,785	)		(1,259	)		2,005,830
Balance at March 31,	$	3,375,402		$	345,935		$	970,283		$	95,455		$	2,312,814		$	28,453		$	153,435		$	7,281,777

Ending balance: individually
evaluated for impairment	$	514,829		$	-		$	-		$	-		$	1,375,209		$	-		$	-		$	1,890,038

Ending balance: collectively
evaluated for impairment	$	2,860,573		$	345,935		$	970,283		$	95,455		$	937,605		$	28,453		$	153,435		$	5,391,739
Loan receivables:
Ending balance	$	343,071,081		$	144,139,698		$	36,204,608		$	23,863,632		$	89,365,928		$	1,185,542		$	17,841,327		$	655,671,816

Ending balance: individually
evaluated for impairment	$	23,683,685		$	4,773,045		$	5,952,586		$	359,050		$	18,242,080		$	154,821		$	345,673		$	53,510,940

Ending balance: collectively
evaluated for impairment	$	319,387,396		$	139,366,653		$	30,252,022		$	23,504,582		$	71,123,848		$	1,030,721		$	17,495,654		$	602,160,876

							Construction
At December 31, 2010	Commercial			Residential			and Land			Home Equity			Commercial			Consumer			Commercial
	Real Estate			First Mortgage			Development			and Second Mtg.			Loans			Loans			Equipment			Total
Allowance for loan losses:
Balance at January 1,	$	2,661,371		$	127,848		$	1,696,396		$	130,692		$	2,109,513		$	63,989		$	681,505		$	7,471,314
Charge-offs		(525,992	)		(62,999	)		(2,248,967	)		(70,999	)		(568,992	)		(10,000	)		(255,996	)		(3,743,945	)
Recoveries		-			-			1,041			-			-			7,290			-			8,331
Provisions		1,178,604			139,224			1,818,155			37,826			1,011,518			(29,070	)		(222,810	)		3,933,447
Balance at December 31,	$	3,313,983		$	204,073		$	1,266,625		$	97,519		$	2,552,039		$	32,209		$	202,699		$	7,669,147

Ending balance: individually
evaluated for impairment	$	500,000		$	-		$	-		$	-		$	1,449,179		$	-		$	48,456		$	1,997,635

Ending balance: collectively
evaluated for impairment	$	2,813,983		$	204,073		$	1,266,625		$	97,519		$	1,102,860		$	32,209		$	154,243		$	5,671,512
Loan receivables:
Ending balance	$	336,299,836		$	136,048,577		$	42,504,200		$	24,379,664		$	104,566,261		$	1,273,080		$	17,983,648		$	663,055,266

Ending balance: individually
evaluated for impairment	$	20,800,730		$	3,664,442		$	12,221,463		$	319,112		$	19,991,537		$	701		$	319,770		$	57,317,755

Ending balance: collectively
evaluated for impairment	$	315,499,106		$	132,384,135		$	30,282,737		$	24,060,552		$	84,574,724		$	1,272,379		$	17,663,878		$	605,737,511

Non-accrual and Past Due Loans

Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Consumer loans are typically charged-off no later than 90 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Non-accrual loans are evaluated for impairment on a loan by loan basis in accordance with the Company’s impairment methodology.

All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Non-accrual loans as of March 31, 2011 and December 31, 2010 were as follows:

	March 31, 2011				December 31, 2010
			Number				Number
	Dollars		of Loans		Dollars		of Loans

Commercial real estate	$	7,463,777		12	$	8,244,683		12
Residential first mortgages		1,356,473		6		1,746,786		6
Construction and land development		-		-		983,867		1
Home equity and second mortgage		198,454		4		232,644		5
Commercial loans		1,891,063		6		2,261,642		6
Consumer loans		-		-		701		1
Commercial equipment		176,593		3		48,456		1
	$	11,086,360		31	$	13,518,779		32

Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $3,791,958 and $8,715,318 at March 31, 2011 and December 31, 2010, respectively. Interest due not recognized on these balances at March 31, 2011 and December 31, 2010 was $271,515 and $598,603, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $7,294,402 and $4,803,461 at March 31, 2011 and December 31, 2010, respectively. Interest due not recognized on these balances at March 31, 2011 and December 31, 2010 was $664,330 and $276,567, respectively.

An analysis of past due loans as of March 31, 2011 and December 31, 2010 were as follows:

							Greater				Total		Loans > 90
			31-60		61-90		than 90		Total		Loan		Days and
	Current		Days		Days		Days		Past Due		Receivables		Accruing
March 31, 2011

Commercial real estate	$	334,429,870	$	961,710	$	215,724	$	7,463,777	$	8,641,211	$	343,071,081	$	-
Residential first mortgages		142,435,899		347,326		-		1,356,473		1,703,799		144,139,698		-
Construction and land dev.		36,204,608		-		-		-		-		36,204,608		-
Home equity and second mtg.		23,459,475		108,836		96,867		198,454		404,157		23,863,632		-
Commercial loans		83,859,005		3,325,679		290,181		1,891,063		5,506,923		89,365,928		-
Consumer loans		1,182,012		3,530		-		-		3,530		1,185,542		-
Commercial equipment		17,494,225		133,621		36,888		176,593		347,102		17,841,327		-
Total	$	639,065,094	$	4,880,702	$	639,660	$	11,086,360	$	16,606,722	$	655,671,816	$	-

December 31, 2010

Commercial real estate	$	327,358,352	$	696,801	$	-	$	8,244,683	$	8,941,484	$	336,299,836	$	-
Residential first mortgages		134,142,088		159,703		-		1,746,786		1,906,489		136,048,577		-
Construction and land dev.		41,520,333		-		-		983,867		983,867		42,504,200		-
Home equity and second mtg.		23,947,389		199,631		-		232,644		432,275		24,379,664		-
Commercial loans		102,221,510		83,109		-		2,261,642		2,344,751		104,566,261		-
Consumer loans		1,268,738		3,141		500		701		4,342		1,273,080		-
Commercial equipment		17,935,192		-		-		48,456		48,456		17,983,648		-
Total	$	648,393,602	$	1,142,385	$	500	$	13,518,779	$	14,661,664	$	663,055,266	$	-

Credit Quality Indicators

A risk grading matrix is used to assign grades to commercial real estate, construction and land development, commercial loans and commercial equipment loans. Loans are graded at inception, annually thereafter when financial statements are received, and at other times when there is an indication that a credit may have weakened or improved. Only commercial loan relationships with an aggregate exposure to the Bank of $350,000 or greater are subject to being risk rated. Relationships that are comprised of only a few loans which are fully amortizing, secured by real estate and have not had a history of delinquency are exempt from the annual review. Loans are graded on a scale of 1 to 10.

Ratings 1 thru 6 - Pass

Ratings 1 thru 6 have asset risks ranging from excellent low risk to adequate. The specific rating assigned considers customer history of earnings, cash flows, liquidity, leverage, capitalization, consistency of debt service coverage, the nature and extent of customer relationship and other relevant specific business factors such as the stability of the industry or market area, changes to management, litigation or unexpected events that could have an impact on risks.

Rating 7 - OAEM (Other Assets Especially Mentioned) – Special Mention

These credits, while protected by the financial strength of the borrowers, guarantors or collateral, have reduced quality due to economic conditions, less than adequate earnings performance or other factors which require the Lending Officer to direct more than normal attention to the credit. Financing alternatives may be limited and/or command higher risk interest rates. OAEM classified loans are the first adversely classified assets on our Watch List. These relationships will be reviewed at least quarterly.

Rating 8 - Substandard

Substandard assets are assets that are inadequately protected by the sound worth or paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. The loans may have a delinquent history or combination of weak collateral, weak guarantor strength or operating losses. These assets listed may include assets with histories of repossessions or some that are non-performing bankruptcies. These relationships will be reviewed at least quarterly.

Rating 9 - Doubtful

Doubtful assets have many of the same characteristics of Substandard with the exception that the Bank has determined that loss is not only possible but is probable and the risk is close to certain that loss will occur. When a loan is assigned to this category the Bank will identify the probable loss and it will receive a specific reserve in the loan loss allowance analysis. These relationships will be reviewed at least quarterly.

Rating 10 - Loss

Once an asset is identified as a definite loss to the Bank, it will receive the classification of “loss”. There may be some future potential recovery; however it is more practical to write off the loan at the time of classification. Losses will be taken in the period in which they are determined to be uncollectable.

Residential first mortgages, home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an OAEM or higher risk rating due to a delinquent payment history.

Management regularly reviews credit quality indicators in assessing the overall quality of the Bank’s loan portfolio including the composition of the loan portfolio, net charge-offs, nonperforming loans, performance of troubled debt restructured loans and general economic conditions in the Southern Maryland market. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans.

Credit quality indicators as of March 31, 2011 and December 31, 2010 were as follows:

Credit Risk Profile by Internally Assigned Grade

	Commercial Real Estate				Construction and Land Dev.
	3/31/2011		12/31/2010		3/31/2011		12/31/2010

Unrated	$	1,021,249	$	1,074,330	$	133,501	$	-
Pass		321,572,184		317,579,637		30,118,521		30,274,737
Special mention		4,740,410		3,628,052		1,593,550		1,585,035
Substandard		15,737,238