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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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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, 2005



Commission file
number: 000-23847



SHORE FINANCIAL CORPORATION

(Exact name of registrant in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|VIRGINIA                                                       |  | 54-1873994                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



25020 Shore
Parkway, Onley, Virginia 23418

(Address of principal executive offices) (Zip code)



Registrants telephone number, including area code:
(757) 787-1335



Securities registered pursuant to
Section 12(b) of the Act: None



Securities
registered pursuant to Section 12(g) of the Act:

Common Stock, $0.33 par value

(Title of Class)



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ̈No  x



Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act.    Yes ̈No  x



Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 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 if disclosure of delinquent filers in response to Item 405 of
Regulation S-K is not contained in this form and no disclosure will be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K.  x



Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.



|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large accelerated filer ̈ |  | Accelerated filer ̈ |  | Non-accelerated filer  x



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



On June 30, 2005, the aggregate market value of the 1,715,076 shares of Common Stock of the Registrant outstanding on such date, excluding shares held by affiliates of the Registrant, was approximately $30.9 million. This figure is
based on the closing price of $17.99 per share of the Registrants Common Stock on June 30, 2005.



Indicate the number of shares outstanding of each of the Registrant classes of common stock as of March 10, 2006.



|                              |  |                              
|----------------------------- |  | -----------------------------
|Class                         |  | Outstanding at March 10, 2006
|Common Stock, $0.33 par value |  | 2,076,367                    



DOCUMENTS
INCORPORATED BY REFERENCE



|(1) | Portions of the Registrants definitive proxy statement to be used in conjunction with the Registrants 2006 Annual Meeting of Shareholders are incorporated into Part III
of this Form 10-K.
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PART I



|Item 1. | BUSINESS
|------- | --------



General



Shore
Financial Corporation (the Company) is a Virginia corporation organized in September 1997 by Shore Bank (the Bank) for the purpose of becoming a unitary holding company of the Bank. The Companys assets primarily consist
of its investment in the Bank and approximately $4.3 million in cash and other investments. The business and management of the Company consists of the business and management of the Bank. The Bank is a Virginia chartered Federal Reserve member
commercial bank that began business in 1961. The Company and the Bank are headquartered in Onley, Virginia.



The Bank operates out of a 19,000 square foot headquarters and operations facility and delivers its banking services through seven full-service banking
centers located on the Eastern Shore of Virginia and Maryland, including the counties of Accomack and Northampton in Virginia and Salisbury/Wicomico County area in Maryland. The Bank has a 26.0% market share of the banking deposits in the Accomack
and Northampton Counties in Virginia and 3.2% of the market share in Wicomico County Maryland, based on June 30, 2005 deposit information. At December 31, 2005, the Company had consolidated assets of $247.4 million, Bank deposits of $189.0
million and stockholders equity of $23.6 million. Eighty-five dedicated employees staff the Companys facilities.



The Bank offers a full menu of banking products and services in the communities it serves. For business customers, the Bank offers checking, cash
management, credit card merchant services, Internet banking, and a variety of loan options including operating lines of credit, equipment loans, and real estate loans. The Bank is a leading real estate lender in its Virginia markets. For consumers,
the Bank offers a totally free checking account, along with telephone and Internet banking services, check cards, free use of the Banks nineteen ATMs, and a full compliment of retail banking products. Of the nineteen ATMs, thirteen of these
machines were added during 2005 and are located at several locations of a national grocery store chain and a convenience store chain in the Banks Virginia and Maryland markets. During 2004, the Bank opened a mortgage banking division that
offers a wide variety of residential loans, which are originated on a pre-sold basis. The Bank does not securitize these loans.



The Company also offers other services that complement the core financial services offered by the Bank. The Banks subsidiary, Shore Investments,
Inc. (Shore Investments), provides non-deposit investment products including stocks, bonds, mutual funds, and insurance products through the two locations and the Banks seven banking centers. During 2004, Shore Investments opened
an investment office managed by a Certified Financial Planner in its Maryland market. During 2005, Shore Investments opened a second investment office in Virginia managed by a new investment officer with over fifteen years of experience in the
investment brokerage field. Shore Investments has also invested in a Virginia title insurance agency that enables the Bank to offer title insurance policies to its real estate loan customers.



Market Area



The Banks headquarters, operations center, and five banking centers are located in Accomack and Northampton Counties,
which together form the Eastern Shore of Virginia. These two counties run approximately seventy miles from the Maryland state line south and have thousands of miles of coastline on the Chesapeake Bay and its tributaries on the west and the Atlantic
Ocean on the east. They represent the southern portion of the Delmarva (Delaware-Maryland-Virginia) Peninsula.



The Eastern Shore of Virginia is 20 miles by bridge and tunnel from Hampton Roads, Virginia (Norfolk, Virginia Beach, Chesapeake, Portsmouth, Hampton,
Suffolk), one of the largest population centers in the country. Tourism and agriculture, along with poultry and seafood processing are the predominant industries on the Eastern Shore.



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Northamption County, Virginia has experienced significant development in recent years, especially on the
southern end of the county. A planned-unit development named Bay Creek opened in spring 2001 that includes a 3,000-unit gated community and two golf courses designed by golf legends Arnold Palmer and Jack Nicklaus.



Accomack County, Virginia is the home of NASAs Wallops Island Space
Facility and the Regional Space Port Authority, as well as the tourist destinations of Chincoteague Island and the Assateague National Wildlife Refuge that draws over one million visitors annually. Residential development has accelerated in Accomack
County with pressure expected to continue in coming years.



The
Bank also has two banking centers in Salisbury, Maryland, the crossroads of the Delmarva Peninsula. Approximately 175,000 people live within a 30-mile radius of Salisbury, which is the regional hub for industry, commerce, health care, recreation and
the arts. Salisbury is home to Perdue Farms, Peninsula Regional Medical Center, and Salisbury University, as well as a vibrant microwave and wireless communications industry. Along with a strong and diversified industrial base, wholesalers,
retailers, and service firms serving ten counties in three states have made Wicomico County a regional supply center for the Eastern Shore of Delaware, Maryland, and Virginia.



Competition



In its market area, the Bank competes with regional commercial banks and independent community banks with multiple offices on the Eastern Shore. These and
certain other non-bank competitors may have greater financial resources, diversified markets, and branch networks than the Bank and may be able to offer similar services at varying costs with higher lending limits. With nationwide banking, the Bank
also faces the prospect of additional competitors entering its market area.



The Bank faces strong competition both in originating loans and in attracting deposits. Competition in originating loans comes primarily from commercial banks and mortgage lenders and to a lesser extent consumer
finance companies, credit unions, and savings institutions. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of service it provides to borrowers.



The Bank faces substantial competition in attracting deposits
from other banks, money market and mutual funds, credit unions, insurance companies and brokerage houses. The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the
requirements of investors as to rate of return, liquidity, risk, convenience and other factors. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, having convenient business hours, and by marketing
its position as the only locally-owned independent bank on the Eastern Shore of Virginia, and one of four in Salisbury/Wicomico, Maryland.



Credit Policies



The principal risk associated with each of the categories of loans in the Banks portfolio is the creditworthiness of its borrowers. Within each
category, such risk is increased or decreased, depending on prevailing economic conditions. The Bank employs extensive written policies and procedures to mitigate credit risk. The loan portfolio is managed under a specifically defined credit
process. This process includes formulation of portfolio management strategy, guidelines for underwriting standards and risk assessment, procedures for ongoing identification and management of credit deterioration, and regular portfolio reviews to
estimate loss exposure and to ascertain compliance with the Banks policies.



In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities that are disclosed but not reflected in its annual financial statements, including commitments to extend
credit. At December 31, 2005, commitments to extend credit totaled $52.9 million.



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One-to-Four Family Residential Real Estate and Land Lending. The Banks primary
lending program has been the origination of loans secured by one-to-four family residences and land, virtually all of which are located in its market area. At December 31, 2005, one-to-four family real estate and land loans aggregated $97.2
million or 49.7% of the Banks gross loans. The Bank evaluates both the borrowers ability to make principal and interest payments and the value of the property that will secure the loan. Federal law permits the Bank to make loans in
amounts of up to 100% of the appraised value of the underlying real estate. Generally, loans are made with a loan to value up to 90% for conventional mortgage loans on primary residences. The Bank generally originates mortgage loans that have an
adjustable rate feature in which the rate changes every one, three or five years. Most adjustable rate loans are tied to comparable maturity U.S. Treasury Bills. Where loans are not indexed, they generally have a balloon feature. However, the Bank
does offer fifteen year fixed rate home equity and purchase money mortgages on a more restrictive basis and offers conforming fixed rate mortgages through its mortgage banking division. There are unquantifiable risks resulting from potential
increased costs to the borrower as a result of repricing. Accordingly, it is possible that, during periods of rising interest rates, the risk of defaults on adjustable rate mortgages (ARMs) may increase due to the upward adjustment of
interest costs to borrowers.



Construction
Lending. The Bank makes local construction loans, primarily residential and small commercial loans. The construction loans are secured by the property for which the loan was obtained. At December 31, 2005, construction loans outstanding
were $9.0 million or 4.6% of gross loans. The average life of a construction loan is less than twelve months and they either reprice daily based on the prime rate or are fixed during the construction period.



Commercial Real Estate Lending. The Bank also originates
commercial real estate loans. Various types of commercial real estate secure these loans, including multifamily residential buildings, commercial buildings and offices, and raw land used for development. At December 31, 2005, commercial real
estate loans aggregated $61.9 million or 31.7% of the Banks gross loans. The interest rates on commercial real estate loans are usually fixed for 1 to 5 years, generally amortize over 5 to 15 years and may have a call provision. The
Banks commercial real estate loans are secured by properties in its market area.



In its underwriting of commercial real estate, the Bank may lend, under federal regulation, up to 100% of the security propertys appraised value, although the Banks loan to appraised value ratio on such
properties is 80% or less in most cases. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans may involve larger loan balances concentrated with single borrowers
or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject to adverse
conditions in the real estate market or in the economy generally. The Banks commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrowers creditworthiness and prior credit history
and reputation, and the personal guarantees or endorsements of borrowers.



Commercial Loans. At December 31, 2005, commercial loans aggregated $9.6 million or 4.9% of the Banks gross loans. Commercial business loans generally have a higher degree of risk than
residential mortgage loans, but have commensurably higher yields. To manage these risks, the Bank generally secures appropriate collateral and carefully monitors the financial condition of its large commercial exposures. Commercial business loans
typically are made on the basis of the borrowers ability to make repayment from the cash flow generated by its business and are often secured by business assets, such as accounts receivable, equipment and inventory. As a result, the
availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral for commercial business loans may depreciate over time and cannot be appraised with as
much precision as residential real estate. The Bank has a credit review and monitoring system to regularly review the cash flow and collateral of commercial borrowers.



Consumer Lending. The Bank offers various secured and unsecured consumer loans, including unsecured personal
loans and lines of credit, home equity lines of credit, automobile loans, deposit account loans and



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installment and demand loans. At December 31, 2005, the Bank had consumer loans of $17.9 million or 9.1% of gross loans. Such loans are generally made
to customers with whom the Bank has a preexisting relationship and are generally in amounts of under $100,000. The Bank originates virtually all of its consumer loans in its market area



Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that
are unsecured, such as lines of credit, or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan
balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the
borrowers continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state
bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.



Employees



At
December 31, 2005, the Company had 77 full-time and 8 part-time employees. The Company considers relations with its employees to be good.



Regulation and Supervision



Set forth below is a brief description of certain laws and regulations that relate to the regulation of the Company and the Bank. The descriptions of
these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, do not purport to be complete and are qualified in their entirety by reference to applicable laws and regulations.



The Company



General. The Company, as a bank holding company, is subject to regulation under the Bank Holding Company Act
of 1956 (the BHCA) and the regulation, supervision and examination requirements of the Board of Governors of the Federal Reserve System (the Federal Reserve). Bank holding companies are subject to extensive regulation by the
Federal Reserve as set forth in Regulation Y, 12 C.F.R. Part 225. Regulation Y establishes the registration, reporting, examination, applications, acquisitions, control and divestiture, change in bank control, appraisals, and change in director and
senior executive officers requirements applicable to bank holding companies. Regulation Y and the interpretations and rulings issued by the Federal Reserve thereunder identify various prohibited non-banking activities in which bank holding companies
and their subsidiaries may not engage as well as various exempt activities in which a bank holding company and its subsidiaries may engage either with or, in some cases, without prior Federal Reserve approval. Regulation Y further confirms the
authority of the Federal Reserve under the BHCA to impose criminal and civil penalties for violations of the BHCA and the regulations and orders issued thereunder and to issue cease and desist orders when necessary in connection therewith.



Activities Obligations and Restrictions. There
are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries that are designed to reduce potential loss exposure to the depositors of the depository institutions and to the Federal
Deposit Insurance Corporation (FDIC) insurance funds. For example, under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to
its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy.



Banking laws also provide that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be
distributed (after payment of secured claims) to pay the deposit



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liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or stockholder.
This provision would give depositors a preference over general and subordinated creditors and stockholders in the event a receiver is appointed to distribute the asset of any bank or savings bank subsidiaries.



The Corporation is subject to the periodic reporting requirements of the
Securities and Exchange Act of 1934, as amended (the Exchange Act), including the filing of annual, quarterly and other reports with the Securities and Exchange Commission (the SEC). As an Exchange Act reporting company, the
Corporation is directly affected by the Sarbanes-Oxley Act of 2002 and the rules and regulations enacted pursuant thereto (the SOX Act), the corporate responsibility and accounting reform legislation signed into law on July 30,
2002. Parts of the SOX Act that already are effective include provisions that (i) require that periodic reports containing financial statements that are filed with the SEC be accompanied by chief executive officer and chief financial officer
certifications as to their accuracy and compliance with law; (ii) prohibit public companies, with certain limited exceptions, from making personal loans to their directors or executive officers; (iii) force company chief executive officers
and chief financial officers to forfeit bonuses and profits if company financial statements are restated due to misconduct; (iv) require audit committees to pre-approve all audit and non-audit services provided by an issuers outside
auditors, except for deminimis non-audit services; (v) protect employees of public companies who assist in investigations relating to violations of the federal securities laws from job discrimination; (vi) require companies to disclose in
plain English on a rapid and current basis material changes in their financial condition or operations; (vii) require a public companys Section 16 insiders to make Form 4 filings with the SEC within two business days
following the day on which purchases or sales of the companys equity securities were made; and (viii) increase penalties for existing crimes and create new criminal offenses. Compliance with other provisions will be required after
implementing rules and regulations are adopted by the SEC and the newly created Public Company Accounting Oversight Board (PCAOB) authorized by the SOX Act. The Company has incurred significant expense to comply with the SOX Act and
management anticipates a significant ongoing expense will be necessary to meet the requirements of the SOX Act and, therefore, the regulations adopted by the SEC and the PCAOB may continue to significantly impact earnings in future periods.



The Bank



General. As a state chartered commercial bank, the Bank is subject to regulation, supervision and examination
requirements of the Virginia State Corporation Commissions (SCC) Bureau of Financial Institutions. The Bank is also subject to the regulation, supervision and examination requirements of the Federal Reserve and the FDIC. State and
federal laws also govern the activities in which the Bank may engage, the investments it may make and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Banks
operations. The Federal Reserve and the SCC conduct periodic examinations to test the Banks compliance with various regulatory requirements. The SCC completed its most recent examination in February 2004, while the Federal Reserve completed a
compliance examination of the Bank during November 2002 and a safety and soundness examination during April 2005. Federal and state laws preclude the Bank from disclosing the results of these examinations.



Insurance of Accounts. The FDIC insures the deposits of the
Bank up to the limits set forth under applicable law. A majority of the deposits of the Bank are subject to the deposit insurance assessments of the Savings Association Insurance Fund (SAIF). However, a portion of the Banks
deposits is subject to assessments imposed by the Bank Insurance Fund (BIF). The FDIC equalized the assessment rates for BIF-insured and SAIF-insured deposits effective January 1, 1998. Currently, the assessments imposed on all FDIC
deposits for deposit insurance have an effective rate ranging from zero ($2,000 minimum) to 0.27 percent of a banks average assessment base, depending on the institutions capital position and other supervisory factors.



In February 2006, Congress enacted the Federal Deposit Insurance Reform Act
of 2005 (the FDIR Act). As a result of the passage of the FDIR Act, over the course of the next year, among other things: (i) the BIF will



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be merged with the SAIF creating the Deposit Insurance Fund (the DIF); (ii) the $100,000 per account insurance level will be indexed to
reflect inflation; (iii) deposit insurance coverage for certain retirement accounts will be increased to $250,000; and (iv) a cap will be placed on the level of the DIF and dividends will be paid to banks once the level of the DIF exceeds
the specified threshold.



Check 21. On
October 28, 2003, President Bush signed into law the Check Clearing for the 21st Century Act, also known as Check 21. Check 21 gives substitute checks, such as a digital image of a check and copies made from that image, the same
legal standing as the original paper check. Some of the major provisions of Check 21 include:



| |  |  | allowing check truncation without making it mandatory;
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| |  |  | demanding that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their rights under the law;
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| |  |  | legalizing substitutions for and replacements of paper checks without agreement from consumers;
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| |  |  | retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;
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| |  |  | requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that
the account debit was accurate and valid; and
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| |  |  | requiring recrediting of funds to an individuals account on the next business day after a consumer proves that the financial institution has erred.
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This legislation will likely affect bank capital spending as many
financial institutions assess whether technological or operational changes are necessary to stay competitive and take advantage of the new opportunities presented by Check 21.



Regulatory Capital Requirements. The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Generally, the Company and the Bank are required to maintain a minimum ratio of total capital to risk-weighted assets of 8%. Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Companys financial statements. Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts
and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.



Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of
total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2005, that the Company meets all capital
adequacy requirements to which it is subject. In fact, at December 31, 2005, the Bank exceeded all of its regulatory capital requirements, with total capital to risk-weighted assets, tier 1 capital to risk-weighted assets and tier 1 capital to
average assets ratios of 12.54%, 11.28% and 7.97%, respectively.



Capital Distributions. The Bank is subject to legal limitations on capital distributions including the payment of dividends, if, after making such distribution, the institution would become undercapitalized (as
such term is used in the statute). For all state member banks of the Federal Reserve seeking to pay dividends, the prior approval of the applicable Federal Reserve Bank is required if the total of all dividends declared in any calendar year will
exceed the sum of the banks net profits for that year and its retained net profits for the preceding two calendar years. Federal law also generally prohibits a depository institution from making any capital distribution



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(including payment of a dividend or payment of a management fee to its holding company) if the depository institution would thereafter fail to maintain
capital above regulatory minimums. Federal Reserve member banks are also authorized to limit the payment of dividends by any state member bank if such payment may be deemed to constitute an unsafe or unsound practice. In addition, under Virginia
law, no dividend may be declared or paid that would impair a Virginia chartered banks paid-in capital. The SCC has general authority to prohibit payment of dividends by a Virginia chartered bank if it determines that the limitation is in the
public interest and is necessary to ensure the banks financial soundness.



Financial Modernization Legislation. The Gramm-Leach-Bliley Act of 1999 (GLBA) was signed into law on November 12, 1999. The main purpose of GLBA is to permit greater affiliations within
the financial services industry, primarily banking, securities and insurance. The provisions of GLBA that are believed to be of most significance to the Company are discussed below.



GLBA repeals sections 20 and 32 of the Glass-Steagall Act, which separated commercial banking from investment banking, and
substantially amends the BHCA, which limited the ability of bank holding companies to engage in the securities and insurance businesses. To achieve this purpose, GLBA provided for a new type of company, the financial holding company. A
financial holding company may engage in or acquire companies that engage in a broad range of financial services, including



| |  |  | Securities activities such as underwriting, dealing, brokerage, investment and merchant banking; and
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| |  |  | Insurance underwriting, sales and brokerage activities.
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A bank holding company may elect to become a financial holding company only if all of its depository institution subsidiaries are well-capitalized,
well-managed and have at least a satisfactory Community Reinvestment Act rating. While the Company meets the requirements to become a financial holding company, it has not elected to be treated as a financial holding company under GLBA at this time.



GLBA, and certain regulations issued by federal banking
agencies, also provide protections against the transfer and use by financial institutions of consumers nonpublic personal information. A financial institution must provide to its customers, at the beginning of the customer relationship and
annually thereafter, the institutions policies and procedures regarding the handling of customers nonpublic personal financial information. The privacy provisions generally prohibit a financial institution from providing a
customers personal financial information to unaffiliated third parties unless the institution discloses to the customer that the information may be so provided and the customer is given the opportunity to opt out of such disclosure.



Many of GLBAs provisions, including the customer privacy
protection provisions, required the Federal bank regulatory agencies and other regulatory bodies to adopt regulations to implement those respective provisions. Neither the provisions of GLBA nor the acts implementing regulations, as proposed
or adopted, have a material impact on the Companys or the Banks regulatory capital ratios (as discussed above) or ability to continue to operate in a safe and sound manner.



USA Patriot Act of 2001.In October 2001, the USA Patriot Act of 2001 (the Patriot
Act) was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcements and the intelligence
communities abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money
laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, 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.



Reporting Terrorist Activities.The Federal Bureau of Investigation (FBI) has sent, and will send, banking regulatory agencies lists of the names of persons suspected of
involvement in terrorist attacks. The Bank has been



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requested, and will be requested, to search its records for any relationships or transactions with persons on those lists. If the Bank finds any
relationships or transactions, it must file a suspicious activity report and contact the FBI.



The Office of Foreign Assets Control (OFAC), which is a division of the Department of Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with
enemies of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging
in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed a security officer to oversee
the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time
a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.



Reporting Terrorist Activities.Interest and other charges collected or contracted for by the Bank are subject to state usury
laws and federal laws concerning interest rates. The Banks loan operations will also be subject to federal laws applicable to credit transactions, such as:



| |  |  | the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
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| |  |  | the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial
institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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| |  |  | the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
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| |  |  | the Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;
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| |  |  | the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
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| |  |  | the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
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In addition, the deposit operations of the Bank will be subject to:



| |  |  | the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative
subpoenas of financial records; and
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| |  |  | the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that Act, which govern automatic deposits to and withdrawals from deposit
accounts and clients rights and liabilities arising from the use of automated teller machines and other electronic banking services.
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|Item 1A. | RISK FACTORS
|-------- | ------------



General economic conditions, either national or in the markets where the Company operates, may become unfavorable.



The Company is affected by general economic conditions in the United States and, in particular, the markets in which it
operates. An economic downturn within the Companys markets or the nation as a whole could negatively impact household and corporate incomes. This impact may lead to decreased demand for both loan and deposit products and increase the number of
customers who fail to pay interest or principal on their loans.



Due to the limited number of markets in which the Company operates, it is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Moreover, we cannot
give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.



If the Company does not adjust to rapid changes in the financial services industry, its financial performance may suffer.



The Companys ability to deliver strong financial performance and
returns on investment to shareholders will depend in part on its ability to expand the scope of available financial services offerings to meet the needs and demands of its customers. In addition to the challenge of competing against other banks in
attracting and retaining customers for traditional banking services, the Companys competitors also include securities dealers, brokers, mortgage bankers, investment advisors, specialty finance and insurance companies who seek to offer one-stop
financial services that may include services that banks have not been able or allowed to offer to their customers in the past. The increasingly competitive environment is primarily a result of changes in regulation, changes in technology and product
delivery systems and the accelerating pace of consolidation among financial service providers.



Legislative or regulatory changes or actions, or significant litigation, could adversely impact the Company or the businesses in which the Company is engaged.



The Company is subject to extensive state and federal regulation,
supervision and legislation that govern almost all aspects of its operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. The impact of any
changes to laws and regulations or other actions by regulatory agencies may negatively impact the Company or its ability to increase the value of its business. Additionally, actions by regulatory agencies or significant litigation against the
Company could cause it to devote significant time and resources to defending itself and may lead to penalties that materially affect the Company and its shareholders. Future changes in the laws or regulations or their interpretations or enforcement
could be materially adverse to the Company and its shareholders.



The
Company is exposed to operational risk.



Similar to
any corporation, the Company is exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors,
including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.



Negative public opinion can result from the Companys actual or alleged conduct in any number of activities, including lending practices, corporate
governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect the Companys ability to attract and keep customers and can
expose it to litigation and regulatory action.



Given the
volume of transactions at the Company, certain errors may be repeated or compounded before they are discovered and successfully rectified. The Companys necessary dependence upon automated systems to



10



---

record and process its transaction volume may further increase the risk that technical system flaws or employee tampering or manipulation of those systems
will result in losses that are difficult to detect. The Company may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical or
telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations
(or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Companys (or its vendors) business continuity and data security systems prove to be inadequate.



Changes in interest rates could affect the Companys income and
cash flows.



The Companys income and cash flows
depend to a great extent on the difference between the interest rates earned on interest-earning assets such as loans and investment securities, and the interest rates paid on interest-bearing liabilities such as deposits and borrowings. These rates
are highly sensitive to many factors that are beyond the Companys control, including general economic conditions and the policies of various governmental and regulatory agencies (in particular, the Federal Reserve). Changes in monetary policy,
including changes in interest rates, will influence the origination of loans, the prepayment speed of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits or
other sources of funding. The impact of these changes may be magnified if the Company does not effectively manage the relative sensitivity of its assets and liabilities to changes in market interest rates. Fluctuations in these areas may adversely
affect the Company and its shareholders.



Changes in accounting standards
could impact reported earnings.



The accounting
standard setters, including the Financial Accounting Standards Board, SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of the Companys consolidated financial
statements. These changes can be hard to predict and can materially impact how it records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively,
resulting in the restatement of prior period financial statements.



The
preparation of the Companys financial statements requires the use of estimates that may vary from actual results.



The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires
management to make significant estimates that affect the financial statements. Two of the Companys most critical estimates are the level of the allowance for credit losses and the valuation of certain assets, including available-for-sale
investment securities and real estate owned. Due to the inherent nature of these estimates, the Company cannot provide absolute assurance that it will not significantly increase the allowance for credit losses and/or sustain credit losses that are
significantly higher than the provided allowance, nor that it will not recognize a significant loss or impairment of its investment securities and real estate owned assets. For more information on the sensitivity of these estimates, refer to the
Critical Accounting Policies and Judgments section.



The Companys
stock price may fluctuate.



The Companys stock
price is publicly traded and, therefore, several factors exist that could cause the price to fluctuate substantially in the future. These factors include:



| |  |  | actual or anticipated variations in earnings;
| | - |  | ---------------------------------------------



| |  |  | changes in analysts recommendations or projections regarding bank stocks;
| | - |  | --------------------------------------------------------------------------



| |  |  | the Companys announcements of developments related to its businesses;
| | - |  | ----------------------------------------------------------------------



11



---

| |  |  | operating and stock performance of other companies deemed to be peers;
| | - |  | ----------------------------------------------------------------------



| |  |  | new technology used or services offered by traditional and non-traditional competitors;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | news reports of trends, concerns and other issues related to the financial services industry; and
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | the low transaction volume of the Companys stock.
| | - |  | --------------------------------------------------



The Companys stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to the Companys performance.
General market price declines or market volatility in the future could adversely affect the price of its common stock, and the current market price may not be indicative of future market prices.



Even though the Companys common stock is currently traded on the Nasdaq Stock
Markets National Market, it has less liquidity than the average stock quoted on a national securities exchange.



The trading volume in the Companys common stock on the Nasdaq National Market has been relatively low when compared with larger companies listed on
the Nasdaq National Market or the stock exchanges. Because of this, it may be more difficult for shareholders to sell a substantial number of shares for the same price at which shareholders could sell a smaller number of shares. Additionally,
volatility of the stock price may occur on relatively small trading volumes of the Companys stock.



The Company cannot predict the effect, if any, that future sales of its common stock in the market, or the availability of shares of common stock for sale
in the market, will have on the market price of the common stock. The Company can give no assurance that sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, would not cause the price
of its common stock to decline or impair The Companys future ability to raise capital through sales of its common stock.



|Item 1B. | UNRESOLVED STAFF COMMENTS
|-------- | -------------------------



There are no unresolved staff comments currently outstanding.



|Item 2. | PROPERTIES
|------- | ----------



The Companys headquarters is located at 25020 Shore Parkway, Onley, Virginia, a two story colonial brick building built in 2004 that houses the
Companys corporate offices and operations center. The Bank operates seven branch banking offices (5 in Virginia and 2 in Salisbury, Maryland), owning six of them free of any encumbrances and the other the Bank owns the building free of any
encumbrances, but leases the land under an agreement expiring in 2009, with two remaining five-year renewals. Shore Investments leases office space under an agreement expiring in 2010, with two optional five-year renewal periods.



|Item 3. | LEGAL PROCEEDINGS
|------- | -----------------



In the ordinary course of its operations, the Company is a party to various legal proceedings. Based upon information currently available, management
believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the business, financial condition, or results of operations of the Company.



|Item 4. | SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ----------------------------------------------------



No matter was submitted to a vote of security holders during the fourth quarter of 2005.



12



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PART II



|Item 5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ------------------------------------------------------------------------------------------------------------



Market Information



The Companys common stock is listed on the Nasdaq National Market
under the symbol SHBK. The following table sets forth the per share high and low closing prices along with dividends that were paid quarterly on the common stock as reported on the Nasdaq National Market for the periods indicated:



|               |  |      |       |     |   |                   |  |   |      
|-------------- |  | ---- | ----- | --- | - | ----------------- |  | - | -----
|               |  | High |       | Low |   | CashDividendsPaid
|2004           |  |      |       |     |   |                   |  |   |      
|First Quarter  |  | $    | 17.49 |     | $ | 15.61             |  | $ | 0.050
|Second Quarter |  |      | 17.00 |     |   | 16.05             |  |   | 0.050
|Third Quarter  |  |      | 16.25 |     |   | 15.15             |  |   | 0.060
|Fourth Quarter |  |      | 20.00 |     |   | 15.16             |  |   | 0.060
|               |  |      |      
|2005           |  |      |       |     |   |                   |  |   |      
|First Quarter  |  | $    | 20.79 |     | $ | 16.55             |  | $ | 0.060
|Second Quarter |  |      | 18.30 |     |   | 16.07             |  |   | 0.060
|Third Quarter  |  |      | 19.00 |     |   | 17.36             |  |   | 0.070
|Fourth Quarter |  |      | 18.70 |     |   | 16.22             |  |   | 0.070



At February 10,
2006, there were 2,074,807 shares of common stock outstanding held by 979 stockholders of record.



Dividend Policy



On
January 10, 2006, the Company declared a $0.07 per share quarterly cash dividend paid on February 1, 2006 to shareholders of record on January 23, 2006. The Company hopes to continue with a quarterly cash dividend on its common stock
in the future. Any future determination as to payment of cash dividends will be at the discretion of the Companys Board of Directors and will depend on the Companys earnings, financial condition, capital requirements and other factors
deemed relevant by the Board of Directors. During the year ended December 31, 2005, the Bank paid $500,000 in dividends to the Company, while the Bank did not pay any dividends to the Company during 2004. During February 2006, the Bank paid
$1,000,000 in dividends to the Company.



Equity Compensation Plan
Information



The following table summarizes information,
as of December 31, 2005, relating to the equity compensation plans of the Company pursuant to which grants of options to acquire shares of common stock may be granted from time to time.



|                                                       |  |                                                                                      |     |  |                                                                          |       |                                                                                      |        
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------ | --- |  | ------------------------------------------------------------------------ | ----- | ------------------------------------------------------------------------------------ | -------
|                                                       |  | Number of Shares to beIssued Upon Exerciseof Outstanding Options,Warrants and Rights |     |  | Weighted-AverageExercise Price ofOutstanding Options,Warrants and Rights |       | Number of Shares RemainingAvailable for Future IssuanceUnder Equity CompensationPlan
|Equity compensation plans approved by shareholders (1) |  | 113,381                                                                              | (2) |  | $                                                                        | 13.02 |                                                                                      | 207,800
|Equity compensation plans not approved by shareholders |  |                                                                                     |     |  |                                                                          |      |                                                                                      |       
|Total                                                  |  | 113,381                                                                              |     |  | $                                                                        | 13.02 |                                                                                      | 207,800

---

|(1) | These plans are the Companys 1992 Stock Option Plan and 2001 Stock Incentive Plan.
|--- | -----------------------------------------------------------------------------------



|(2) | Consists of options granted pursuant to the Companys stock incentive plans.
|--- | ----------------------------------------------------------------------------



13



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|Item 6. | SELECTED FINANCIAL DATA
|------- | -----------------------



|                                                                   |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|------------------------------------------------------------------ |  | ------------------------------------- | ------- | -- | ---- | - | ------- | ---- |  | - | ------- | -- |  | ---- | ------- | - |  | - | ------- | -
|                                                                   |  | Years Ended December 31,              |        
|                                                                   |  | 2005                                  |         |    | 2004 |   |         | 2003 |  |   | 2002    |    |  | 2001 |        
|                                                                   |  | (In thousands, except per share data) |        
|Income Statement Data:                                             |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Interest income                                                    |  | $                                     | 12,851  |    |      | $ | 10,697  |      |  | $ | 9,501   |    |  | $    | 9,406   |   |  | $ | 9,917   |  
|Interest expense                                                   |  |                                       | 4,414   |    |      |   | 3,275   |      |  |   | 3,275   |    |  |      | 3,716   |   |  |   | 4,929   |  
|Net interest income                                                |  |                                       | 8,437   |    |      |   | 7,422   |      |  |   | 6,226   |    |  |      | 5,690   |   |  |   | 4,988   |  
|Provision for loan losses                                          |  |                                       | 304     |    |      |   | 419     |      |  |   | 380     |    |  |      | 335     |   |  |   | 310     |  
|Noninterest income                                                 |  |                                       | 2,379   |    |      |   | 1,920   |      |  |   | 1,889   |    |  |      | 1,375   |   |  |   | 1,251   |  
|Noninterest expense                                                |  |                                       | 6,644   |    |      |   | 5,559   |      |  |   | 4,780   |    |  |      | 4,156   |   |  |   | 3,882   |  
|Income taxes                                                       |  |                                       | 1,193   |    |      |   | 1,011   |      |  |   | 893     |    |  |      | 802     |   |  |   | 616     |  
|                                                                   |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net income                                                         |  | $                                     | 2,675   |    |      | $ | 2,353   |      |  | $ | 2,062   |    |  | $    | 1,772   |   |  | $ | 1,431   |  
|                                                                   |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Per Share Data:                                                    |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Net incomebasic (3)                                               |  | $                                     | 1.29    |    |      | $ | 1.14    |      |  | $ | 1.01    |    |  | $    | 0.87    |   |  | $ | 0.68    |  
|Net incomedilutive (3)                                            |  |                                       | 1.27    |    |      |   | 1.12    |      |  |   | 1.00    |    |  |      | 0.86    |   |  |   | 0.68    |  
|Cash dividends (3)                                                 |  |                                       | 0.26    |    |      |   | 0.22    |      |  |   | 0.17    |    |  |      | 0.12    |   |  |   | 0.12    |  
|Book value at period end                                           |  |                                       | 11.39   |    |      |   | 10.64   |      |  |   | 9.80    |    |  |      | 10.73   |   |  |   | 9.58    |  
|Tangible book value at period end                                  |  |                                       | 11.17   |    |      |   | 10.39   |      |  |   | 9.51    |    |  |      | 10.35   |   |  |   | 9.56    |  
|Average shares outstanding (000s) (3)                             |  |                                       | 2,071   |    |      |   | 2,062   |      |  |   | 2,037   |    |  |      | 2,034   |   |  |   | 2,083   |  
|                                                                   |  |                                       |         |    |     
|Balance Sheet Data (period end):                                   |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Assets                                                             |  | $                                     | 247,419 |    |      | $ | 237,689 |      |  | $ | 196,550 |    |  | $    | 179,993 |   |  | $ | 142,851 |  
|Loans, net of unearned income and allowance                        |  |                                       | 192,697 |    |      |   | 175,995 |      |  |   | 140,207 |    |  |      | 116,810 |   |  |   | 104,096 |  
|Securities                                                         |  |                                       | 32,351  |    |      |   | 38,972  |      |  |   | 40,611  |    |  |      | 47,183  |   |  |   | 28,058  |  
|Deposits                                                           |  |                                       | 188,970 |    |      |   | 192,737 |      |  |   | 158,891 |    |  |      | 158,989 |   |  |   | 125,314 |  
|Stockholders equity                                               |  |                                       | 23,629  |    |      |   | 21,959  |      |  |   | 20,201  |    |  |      | 18,218  |   |  |   | 16,261  |  
|                                                                   |  |                                       |         |    |     
|Performance Ratios:                                                |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Return on average assets                                           |  |                                       | 1.10    | %  |      |   | 1.08    | %    |  |   | 1.11    | %  |  |      | 1.12    | % |  |   | 1.02    | %
|Return on average equity                                           |  |                                       | 11.74   | %  |      |   | 11.01   | %    |  |   | 10.64   | %  |  |      | 10.31   | % |  |   | 9.08    | %
|Net interest margin                                                |  |                                       | 3.75    | %  |      |   | 3.72    | %    |  |   | 3.63    | %  |  |      | 3.82    | % |  |   | 3.77    | %
|Efficiency (1)                                                     |  |                                       | 63.54   | %  |      |   | 59.47   | %    |  |   | 59.70   | %  |  |      | 59.01   | % |  |   | 62.45   | %
|                                                                   |  |                                       |         |    |     
|Asset Quality Ratios:                                              |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Allowance for loan losses to period end loans                      |  |                                       | 1.49    | %  |      |   | 1.35    | %    |  |   | 1.41    | %  |  |      | 1.35    | % |  |   | 1.26    | %
|Allowance for loan losses to nonaccrual loans                      |  |                                       | 267.95  | %  |      |   | 253.05  | %    |  |   | 362.68  | %  |  |      | 182.37  | % |  |   | 248.78  | %
|Nonperforming assets to period end loans and foreclosed properties |  |                                       | 0.56    | %  |      |   | 0.53    | %    |  |   | 0.39    | %  |  |      | 0.74    | % |  |   | 0.51    | %
|Net charge-offs (recoveries) to average loans                      |  |                                       | (0.08   | )% |      |   | 0.01    | %    |  |   | (0.01   | )% |  |      | 0.05    | % |  |   | 0.33    | %
|                                                                   |  |                                       |         |    |     
|Capital and Liquidity Ratios:                                      |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Leverage (2)                                                       |  |                                       | 9.55    | %  |      |   | 9.24    | %    |  |   | 10.28   | %  |  |      | 10.12   | % |  |   | 11.38   | %
|Risk-based:                                                        |  |                                       |         |    |      |   |         |      |  |   |         |    |  |      |         |   |  |   |         |  
|Tier 1 capital                                                     |  |                                       | 13.21   | %  |      |   | 12.74   | %    |  |   | 14.37   | %  |  |      | 15.02   | % |  |   | 15.67   | %
|Total capital                                                      |  |                                       | 14.53   | %  |      |   | 14.14   | %    |  |   | 15.74   | %  |  |      | 16.24   | % |  |   | 16.89   | %
|Average loans to average deposits                                  |  |                                       | 96.93   | %  |      |   | 87.60   | %    |  |   | 79.78   | %  |  |      | 80.56   | % |  |   | 78.33   | %

---

|(1) | Computed by dividing noninterest expense, net of nonrecurring expenses, by the sum of net interest income and noninterest income, net of security gains and losses.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Computed as a percentage of stockholders equity to period end assets.
|--- | ----------------------------------------------------------------------



|(3) | Earnings per share, dividends per share and average share data adjusted in periods prior to 2004 to reflect 20% stock dividend paid by the Company during December 2003.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14



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|Item 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



This Form 10-K, including information incorporated by reference into this Form 10-K, contains certain forward-looking
statements. For this purpose any statements contained in this Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as may, will,
expect, believe, anticipate, estimate or continue or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks
and uncertainties, and actual results may differ materially depending on a variety of factors.



Overview



The Company
experienced another period of record earnings during the year ended December 31, 2005, primarily resulting from solid loan growth, a steady net interest margin and growth in noninterest income. Net income for the year ended December 31,
2005 was $2.68 million, compared to $2.35 million for 2004, an increase of 13.7%. Diluted earnings per share increased 13.4% in 2005 to $1.27 per share, compared to $1.12 in 2004. Return on assets (ROA) was 1.10% for the year ended December 31,
2005, compared to 1.08% for the year ended December 31, 2004, while return on average equity (ROE) improved to 11.74% for 2005, compared to 11.01% for 2004. The Banks net interest margin increased to 3.75% during the year ended
December 31, 2005 compared to 3.72% during the year ended December 31, 2004. Yields on earning assets increased during the year as the Federal Reserve continued to maintain a monetary policy of tightening interest rates during 2005. The
Banks cost of interest-bearing liabilities experienced similar increases during 2005 as interest rates and deposit competition increased during the year. The Companys noninterest income increased to $2.4 million in 2005 from $1.9 million
during the prior year. The Companys efficiency ratio was 63.54% for the year compared to 59.47% for 2004, resulting from noninterest expenses increasing to $6.64 million from $5.56 million during 2004. This increase reflects additional costs
associated with opening a new facility that combined operations and corporate offices, information systems upgrades and additional professional fees, primarily resulting from costs associated with meeting the requirements of Sarbanes-Oxley.
Additionally, the Company continued to expand its ancillary service offerings by adding an investment officer with fifteen years of experience to its investment subsidiary, Shore Investments Inc.



Total assets grew to $247.4 million at December 31, 2005, compared to
$237.7 million at December 31, 2004, primarily resulting from a 9.5% increase in loans. Total gross loans ended the year at $195.5 million, compared to $178.4 million at December 31, 2004, while total deposits ended the year at $189.0
million, compared to $192.7 million at December 31, 2004. The Banks mortgage loan portfolio, including construction loans, experienced the largest percentage growth during the year with an increase of 15.3% since December 2004, while
commercial loans increased 5.0%. Increased competition inhibited deposit growth during the year, resulting in a decrease in year-end deposit balances. However, noninterest-bearing deposits continued to experience double-digit growth by increasing
17.8% since December 2004, while interest-bearing transaction accounts declined 5.4% and time deposits decreased 4.4% during the period. Total shareholders equity grew to $23.6 million at December 31, 2005, a 7.6% increase over the $22.0
million in equity at December 31, 2004.



During 2005, the
quality of the Banks loan portfolio continued to be strong. The Bank experienced net loan recoveries of $143,000 during 2005 at a rate of 0.08% of total loans, while the level of nonperforming assets to period end loans was 0.56% at
December 31, 2005. The Bank had no other real estate owned (OREO) or other foreclosed assets at December 31, 2005. The Bank maintained an allowance for loan losses to period end loans of 1.49% at the end of 2005.



15



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Results of Operation



General



Net interest income is the major component of the Companys earnings and is equal to the amount by which interest income exceeds interest expense.
Interest income is derived from interest-earning assets composed primarily of loans and securities. Interest expense results from interest-bearing liabilities, primarily consisting of deposits and short-term borrowings. Changes in the volume and mix
of these assets and liabilities, as well as changes in the yields earned and rates paid, determine changes in net interest income. Net interest margin is calculated by dividing net interest income by average earning assets and represents the
Companys net yield on its earning assets.



Interest Income



2005 Compared to 2004



During the year ended December 31, 2005, the Company earned $12.9
million in interest income, compared to the $10.7 million earned for the year ended December 31, 2004. Growth in the Companys loan portfolio and its asset-sensitive position during a period of rising interest rates resulted in the 20.1%
increase in interest income. Additionally, the Company continued to improve its assets mix by shifting assets from the investment portfolio to the higher-yielding loan portfolio.



Securities yielded 4.21% during the year ended December 31, 2005, compared to 4.07% for the year ended
December 31, 2004. Average securities declined by $1.1 million to $38.1 million during 2005 compared to $39.2 million during 2004. This decrease resulted from loan demand continuing to absorb available liquidity, benign deposit growth and a
weak investment market, partially due to a flattening yield curve.



Loans yielded 6.03% during the year ended December 31, 2005, compared to 5.71% during 2004. Average total loans increased $26.2 million, or 16.4%, to $186.4 million during 2005 from $160.2 million during 2004. The banks average
commercial loan portfolio experienced another year of significant growth with an increase of 20.2% since December 2004, while average mortgage loans (including construction loans) experienced solid growth with an increase of 17.1%. Average consumer
loans (including home equity lines) were $18.0 million for the year ended December 31, 2005, relatively flat when compared to the $17.9 million average outstanding during the year ended December 31, 2004. Although short-term interest rates
continued to rise during 2005, longer-term rates did not change significantly which allowed the real estate market to continue its expansion.



2004 Compared to 2003



During the year ended December 31, 2004, the Company earned $10.7 million in interest income, compared to the $9.5 million earned for the year ended
December 31, 2003. The Company overcame declining portfolio loan rates by growing loans 25.5% during the year, resulting in the 12.6% increase in interest income. Additionally, the Company increased its loan to deposit ratio from 79.8% in 2003
to 87.6% in 2004, thus improving the mix of interest earning assets.



Securities yielded 4.07% during the year ended December 31, 2004, compared to 4.03% for the year ended December 31, 2003. Average securities declined by $3.7 million to $39.2 million during 2004 compared to $42.9 million during
2003. This decrease resulted from the heavy loan demand experienced during the year absorbing most excess liquidity and the fewer investment opportunities that existed.



Loans yielded 5.71% during the year ended December 31, 2004, compared to 6.11% during 2003. Average total loans
increased $32.4 million, or 25.4%, to $160.2 million during 2004 from $127.8 million during 2003. The banks average commercial loan portfolio experienced the largest percentage growth during the year with an increase of 43.9% since December
2003, while average mortgage loans (including construction loans) also experienced double-digit growth with an increase of 18.2%. Average consumer loans (including home equity



16



---

lines) were $17.9 million for the year ended December 31, 2004, an increase of 10.0% over the $16.3 million average outstanding during the year ended
December 31, 2003. A vibrant loan market, driven by low interest rates and a strong real estate market, and seasoned loan producers significantly contributed to the loan growth success of 2004.



Interest Expense



2005 Compared to 2004



During 2005, an increase in the deposit market competition and a more opportunistic stock market inhibited the Banks ability to grow deposits. As a
result, the Bank increased its reliance on wholesale funding to provide the liquidity needed to fund loan growth. Consequently, the Companys interest expense increased $1.1 million to $4.4 million during the year ended December 31, 2005,
as compared to $3.3 million during 2004. Average interest-bearing liabilities increased 12.2% to $193.4 million during the year ended December 31, 2005, as compared to $172.3 million during 2004, while the cost of interest-bearing liabilities
increased 38 basis points from 1.90% during 2004 to 2.28% during 2005. Total average deposits, including noninterest-bearing demand deposits, increased 5.2% to $192.3 million during the year ended December 31, 2005 from $182.9 million during
2004. The Companys cost of funds (including demand deposits) was 2.00% during 2005, compared to 1.68% for the year ended December 31, 2004.



Average checking and savings account balances were $79.6 million during 2005 and the cost of these funds for the year was 78 basis points, representing a
15 basis point increase over the prior year. Average time deposit balances were $85.2 million and the cost of these funds increased by 24 basis points to 3.25% for the year. The Company continued to benefit from a growing number of commercial
customer relationships which resulted in an increase in average demand deposits of 18.7%. As a result of the Bank also relying more on wholesale funding during 2005, average Federal Home Loan Bank (FHLB) borrowings increased by $16.0
million to $28.6 million during the year. Since the majority of this funding floats based on an overnight rate, the cost of these funds increased 162 basis points to 3.59% during 2005.



2004 Compared to 2003



Even with double-digit growth in deposits, interest expense was flat at $3.3 million during the year ended December 31, 2004, as compared to 2003.
Average interest-bearing liabilities increased 16.6% to $172.3 million during the year ended December 31, 2004, as compared to $147.7 million during 2003, while the cost of interest-bearing liabilities decreased 32 basis points from 2.22%
during 2003 to 1.90% during 2004. Total average deposits, including noninterest-bearing demand deposits, increased 14.2% to $182.9 million during the year ended December 31, 2004 from $160.1 million during 2003. The Companys cost of funds
(including demand deposits) was 1.68% during 2004, compared to 1.97% for the year ended December 31, 2003.



Several factors contributed to interest expense remaining flat in spite of increased volumes, primarily related to the growth mix that occurred during the
year. Average checking and savings account balances increased $14.1 million during 2004 and the cost of these funds for the year was 63 basis points, representing only a 2 basis point increase over the prior year. Average time deposit balances
increased $3.8 million, but the cost of these deposits decreased 43 basis points to 3.01% for the year. The dependence on time deposit funding continued to decline with average time deposits representing 43.5% of average funding liabilities during
2004 compared to 48.9% during 2003. Also benefiting the Companys cost of funds is the continued growth in demand deposits. During 2004, average demand deposits grew $4.8 million or 26.2% over 2003 balances, representing a significant pool of
noninterest-bearing deposits to fund asset growth. The Bank also placed a heavier reliance on Federal Home Loan Bank (FHLB) borrowings during 2004 with the average balance increasing by $6.7 million. However, the increase in overnight
rates that occurred during 2004 caused the cost of these borrowings to increase by 19 basis points to 1.97% during the year.



17



---

Net Interest Income



2005 Compared to 2004



The Companys net interest margin improved during 2005 despite a trend of declining margins in the banking industry. The Companys net interest
margin increased from 3.72% during 2004 to 3.75% during 2005. The Company continues to benefit from its asset sensitive balance sheet position which was advantageous during the period of rising rates that occurred since June 2004. However, the
interest rate yield curve has flattened in recent, diluting the impact of the Companys asset sensitive balance sheet position. As a result of being asset sensitive and the Banks ability to grow loans, the Companys net interest
income increased 13.7% to $8.4 million during the year ended December 31, 2005 as compared to $7.4 million in 2004.



2004 Compared to 2003



The Company continued to improve its net interest margin during 2004. Helped by strong loan demand and rising rates during the second half of the year,
the Companys net interest margin increased from 3.63% during 2003 to 3.72% during 2004. As illustrated by the its interest sensitivity analysis, the Company remains asset sensitive, an advantageous position during a period of rising rates like
we experienced since June 2004. These factors, in conjunction with the continued improvement in the Banks funding mix, contributed to net interest income increasing 19.2% to $7.4 million during the year ended December 31, 2004 as compared
to $6.2 million in 2003.



18



---

The following tables illustrate average balances of total interest-earning assets and total
interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders equity and the related income, expense, and corresponding weighted average yields and costs. The average balances
used in these tables and other statistical data were calculated using daily average balances.



Average Balances, Income and Expenses, Yields and Rates



|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|------------------------------------------ |  | ------------------------ | ------- | - | -------------- | - | ------------ | ---- | ---- | -------------- |  | - | -------------- | - | ------------ | - | ------ | -------------- | ---- | - | -------------- | - | ------------ | - |  | - | ----- |  | ---- | -
|                                           |  | Years Ended December 31, |        
|                                           |  | 2005                     |         |   | 2004           |   |              | 2003 |     
|                                           |  | AverageBalance           |         |   | Income/Expense |   | Yield/  Rate |      |      | AverageBalance |  |   | Income/Expense |   | Yield/  Rate |   |        | AverageBalance |      |   | Income/Expense |   | Yield/  Rate |  
|                                           |  | (In Thousands)           |        
|Assets:                                    |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Securities (1)                             |  | $                        | 38,141  |   |                | $ | 1,607        |      | 4.21 | %              |  | $ | 39,192         |   |              | $ | 1,595  |                | 4.07 | % |                | $ | 42,906       |   |  | $ | 1,729 |  | 4.03 | %
|Loans (net of unearned income):            |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Real estate mortgage                       |  |                          | 97,888  |   |                |   | 5,503        |      | 5.62 | %              |  |   | 83,558         |   |              |   | 4,732  |                | 5.66 | % |                |   | 70,665       |   |  |   | 4,374 |  | 6.19 | %
|Commercial                                 |  |                          | 70,573  |   |                |   | 4,540        |      | 6.43 | %              |  |   | 58,693         |   |              |   | 3,480  |                | 5.93 | % |                |   | 40,791       |   |  |   | 2,553 |  | 6.26 | %
|Home equity lines                          |  |                          | 15,636  |   |                |   | 985          |      | 6.30 | %              |  |   | 15,473         |   |              |   | 718    |                | 4.64 | % |                |   | 13,720       |   |  |   | 632   |  | 4.61 | %
|Consumer                                   |  |                          | 2,319   |   |                |   | 205          |      | 8.84 | %              |  |   | 2,476          |   |              |   | 220    |                | 8.89 | % |                |   | 2,590        |   |  |   | 247   |  | 9.54 | %
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Total loans                                |  |                          | 186,416 |   |                |   | 11,233       |      | 6.03 | %              |  |   | 160,200        |   |              |   | 9,150  |                | 5.71 | % |                |   | 127,766      |   |  |   | 7,806 |  | 6.11 | %
|Interest-bearing deposits in other banks   |  |                          | 2,481   |   |                |   | 81           |      | 3.26 | %              |  |   | 2,152          |   |              |   | 25     |                | 1.16 | % |                |   | 2,438        |   |  |   | 20    |  | 0.82 | %
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Total earning assets                       |  |                          | 227,038 |   |                |   | 12,921       |      | 5.69 | %              |  |   | 201,544        |   |              |   | 10,770 |                | 5.34 | % |                |   | 173,110      |   |  |   | 9,555 |  | 5.52 | %
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Less: allowance for loan losses            |  |                          | (2,611  | ) |                |   |              |      |      |                |  |   | (2,196         | ) |              |   |        |                |      |   |                |   | (1,784       | ) |  |   |       |  |      |  
|Total nonearning assets                    |  |                          | 19,841  |   |                |   |              |      |      |                |  |   | 18,021         |   |              |   |        |                |      |   |                |   | 14,992       |   |  |   |       |  |      |  
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Total assets                               |  | $                        | 244,268 |   |                |   |              |      |      |                |  | $ | 217,369        |   |              |   |        |                |      |   |                | $ | 186,318      |   |  |   |       |  |      |  
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Liabilities                                |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Interest-bearing deposits:                 |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Checking and savings                       |  | $                        | 79,600  |   |                | $ | 620          |      | 0.78 | %              |  | $ | 74,536         |   |              | $ | 467    |                | 0.63 | % |                | $ | 60,461       |   |  | $ | 370   |  | 0.61 | %
|Time deposits                              |  |                          | 85,165  |   |                |   | 2,766        |      | 3.25 | %              |  |   | 85,123         |   |              |   | 2,559  |                | 3.01 | % |                |   | 81,284       |   |  |   | 2,799 |  | 3.44 | %
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Total interest-bearing deposits            |  |                          | 164,765 |   |                |   | 3,386        |      | 2.06 | %              |  |   | 159,659        |   |              |   | 3,026  |                | 1.90 | % |                |   | 141,745      |   |  |   | 3,169 |  | 2.24 | %
|FHLB advances                              |  |                          | 28,601  |   |                |   | 1,028        |      | 3.59 | %              |  |   | 12,627         |   |              |   | 249    |                | 1.97 | % |                |   | 5,961        |   |  |   | 106   |  | 1.78 | %
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Total interest-bearing liabilities         |  |                          | 193,366 |   |                |   | 4,414        |      | 2.28 | %              |  |   | 172,286        |   |              |   | 3,275  |                | 1.90 | % |                |   | 147,706      |   |  |   | 3,275 |  | 2.22 | %
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Non-interest bearing liabilities:          |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Demand deposits                            |  |                          | 27,556  |   |                |   |              |      |      |                |  |   | 23,215         |   |              |   |        |                |      |   |                |   | 18,397       |   |  |   |       |  |      |  
|Other liabilities                          |  |                          | 554     |   |                |   |              |      |      |                |  |   | 499            |   |              |   |        |                |      |   |                |   | 836          |   |  |   |       |  |      |  
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Total liabilities                          |  |                          | 221,476 |   |                |   |              |      |      |                |  |   | 196,000        |   |              |   |        |                |      |   |                |   | 166,939      |   |  |   |       |  |      |  
|Stockholders equity                       |  |                          | 22,792  |   |                |   |              |      |      |                |  |   | 21,369         |   |              |   |        |                |      |   |                |   | 19,379       |   |  |   |       |  |      |  
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Total liabilities and stockholders equity |  | $                        | 244,268 |   |                |   |              |      |      |                |  | $ | 217,369        |   |              |   |        |                |      |   |                | $ | 186,318      |   |  |   |       |  |      |  
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Net interest income (1)                    |  |                          |         |   |                | $ | 8,507        |      |      |                |  |   |                |   |              | $ | 7,495  |                |      |   |                |   |              |   |  | $ | 6,280 |  |      |  
|                                           |  |                          |         |   |                |   |              |      |      |                |  |   |                |   |              |   |        |                |      |   |                |   |              |   |  |   |       |  |      |  
|Interest rate spread (1)(2)(3)             |  |                          |         |   |                |   |              |      | 3.41 | %              |  |   |                |   |              |   |        |                | 3.44 | % |                |   |              |   |  |   |       |  | 3.30 | %
|Net interest margin (1)(2)(4)              |  |                          |         |   |                |   |              |      | 3.75 | %              |  |   |                |   |              |   |        |                | 3.72 | % |                |   |              |   |  |   |       |  | 3.63 | %

---

|(1) | Presented on a tax equivalent basis. The tax equivalent adjustment to net interest income was $70,000, $73,000 and $54,000 for the years ended December 31, 2005, 2004 and 2003,
respectively.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Interest rate spread is the average yield earned on earning assets less the average rate incurred on interest-bearing liabilities.
|--- | ----------------------------------------------------------------------------------------------------------------------------------



|(3) | Net interest margin is derived by dividing net interest income by average total earning assets.
|--- | -----------------------------------------------------------------------------------------------



19



---

The following table describes the impact on the interest income of the Company resulting from changes in
average balances and average rates for the periods indicated. The change in interest due to the mixture of volume and rate has been allocated solely to rate changes.



Volume and Rate Analysis



|                                         |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|---------------------------------------- |  | ----------------------------------------------- | - |  | ----------------------------------------------- | - |  | ----------------------------------------------- | - |  | ------ | - |  | ---- | - |  | ------------------ | - |  | ------ | - |  | ------ | - |  | ------------------ | -
|                                         |  | Years Ended                                     |  
|                                         |  | December 31, 2005 compared to December 31, 2004 |   |  | December 31, 2004 compared to December 31, 2003 |   |  | December 31, 2003 compared to December 31, 2002 |  
|                                         |  | Change Due To:                                  |   |  | Change Due To:                                  |   |  | Change Due To:                                  |  
|                                         |  | Volume                                          |   |  | Rate                                            |   |  | Increase(Decrease)                              |   |  | Volume |   |  | Rate |   |  | Increase(Decrease) |   |  | Volume |   |  | Rate   |   |  | Increase(Decrease) |  
|Assets:                                  |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Securities                               |  | (43                                             | ) |  | 53                                              |   |  | 10                                              |   |  | (150   | ) |  | 16   |   |  | (134               | ) |  | 409    |   |  | (348   | ) |  | 61                 |  
|Loans (net of unearned income):          |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Real estate mortgage                     |  | 811                                             |   |  | (39                                             | ) |  | 772                                             |   |  | 798    |   |  | (440 | ) |  | 358                |   |  | 531    |   |  | (586   | ) |  | (55                | )
|Commercial                               |  | 704                                             |   |  | 356                                             |   |  | 1,060                                           |   |  | 1,121  |   |  | (194 | ) |  | 927                |   |  | 413    |   |  | (302   | ) |  | 111                |  
|Home equity lines                        |  | 8                                               |   |  | 260                                             |   |  | 268                                             |   |  | 81     |   |  | 5    |   |  | 86                 |   |  | 153    |   |  | (95    | ) |  | 58                 |  
|Consumer                                 |  | (14                                             | ) |  | (1                                              | ) |  | (15                                             | ) |  | (11    | ) |  | (16  | ) |  | (27                | ) |  | (67    | ) |  | 4      |   |  | (63                | )
|                                         |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Total loans                              |  | 1,509                                           |   |  | 576                                             |   |  | 2,085                                           |   |  | 1,989  |   |  | (645 | ) |  | 1,344              |   |  | 1,030  |   |  | (979   | ) |  | 51                 |  
|Interest-bearing deposits in other banks |  | 4                                               |   |  | 52                                              |   |  | 56                                              |   |  | (2     | ) |  | 7    |   |  | 5                  |   |  | (19    | ) |  | (9     | ) |  | (28                | )
|                                         |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Total earning assets                     |  | 1,470                                           |   |  | 681                                             |   |  | 2,151                                           |   |  | 1,837  |   |  | (622 | ) |  | 1,215              |   |  | 1,420  |   |  | (1,336 | ) |  | 84                 |  
|                                         |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Liabilities                              |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Interest-bearing deposits:               |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Checking and savings                     |  | 32                                              |   |  | 121                                             |   |  | 153                                             |   |  | 86     |   |  | 11   |   |  | 97                 |   |  | 145    |   |  | (291   | ) |  | (146               | )
|Time deposits                            |  | 1                                               |   |  | 206                                             |   |  | 207                                             |   |  | 132    |   |  | (372 | ) |  | (240               | ) |  | 138    |   |  | (484   | ) |  | (346               | )
|                                         |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Total interest-bearing deposits          |  | 33                                              |   |  | 327                                             |   |  | 360                                             |   |  | 218    |   |  | (361 | ) |  | (143               | ) |  | 283    |   |  | (775   | ) |  | (492               | )
|FHLB advances                            |  | 315                                             |   |  | 464                                             |   |  | 779                                             |   |  | 119    |   |  | 24   |   |  | 143                |   |  | 172    |   |  | (121   | ) |  | 51                 |  
|                                         |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Total interest-bearing liabilities       |  | 348                                             |   |  | 791                                             |   |  | 1,139                                           |   |  | 337    |   |  | (337 | ) |  |                   |   |  | 455    |   |  | (896   | ) |  | (441               | )
|                                         |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  
|Change in net interest income            |  | 1,122                                           |   |  | (110                                            | ) |  | 1,012                                           |   |  | 1,500  |   |  | (285 | ) |  | 1,215              |   |  | 965    |   |  | (440   | ) |  | 525                |  
|                                         |  |                                                 |   |  |                                                 |   |  |                                                 |   |  |        |   |  |      |   |  |                    |   |  |        |   |  |        |   |  |                    |  



Interest Sensitivity



Management evaluates interest rate sensitivity
periodically through the use of an asset/liability management reporting model. Using this model, management determines the overall magnitude of interest sensitivity risk and then formulates policies governing asset generation and pricing, funding
sources and pricing, and off-balance-sheet commitments in order to reduce sensitivity risk. These decisions are based on managements outlook regarding future interest rate movements, the state of the local and national economy, and other
financial and business risk factors.



An important element of
the Companys asset/liability management process is monitoring its interest sensitivity gap. The interest sensitivity gap is the difference between interest sensitive assets and interest sensitive liabilities at a specific time interval. A gap
is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities, and is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets during a given period. Generally, during a period of rising interest rates, a negative gap within shorter maturities would adversely affect net interest income, while a positive gap within shorter maturities would result in an
increase in net interest income. Conversely, during a period of falling interest rates, a negative gap within shorter maturities



20



---

would result in an increase in net interest income while a positive gap within shorter maturities would have the opposite effect. This gap can be managed by
repricing assets or liabilities, by selling investments available for sale, by replacing an asset or liability at maturity, or by adjusting the interest rate during the life of an asset or liability. Matching the amounts of assets and liabilities
maturing in the same time interval helps to hedge the risk and minimize the impact on net interest income in periods of rising or falling interest rates.



The following table presents the Companys interest sensitivity position at December 31, 2005. This one-day position, which continually is
changing, is not necessarily indicative of the Companys position at any other time.



Interest Sensitivity Analysis



|                                                                            |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|--------------------------------------------------------------------------- |  | ----------------- | ------ | -- | ---------- | - | ------- | ----------- |  | - | ----------- | - |  | ----- | ------- | - |  | - | ------- | -
|                                                                            |  | December 31, 2005 |       
|                                                                            |  | Within90 Days     |        |    | 91-365Days |   |         | 1 to 5Years |  |   | Over 5Years |   |  | Total |        
|                                                                            |  | (In Thousands)    |       
|Interest-Earning Assets:                                                    |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Loans (1)                                                                   |  | $                 | 51,496 |    |            | $ | 45,019  |             |  | $ | 91,868      |   |  | $     | 7,248   |   |  | $ | 195,631 |  
|Securities                                                                  |  |                   | 3,967  |    |            |   | 4,792   |             |  |   | 21,094      |   |  |       | 2,498   |   |  |   | 32,351  |  
|Money market and other short term securities                                |  |                   | 1,775  |    |            |   |        |             |  |   |            |   |  |       |        |   |  |   | 1,775   |  
|Other earning assets                                                        |  |                   |       |    |            |   |        |             |  |   |            |   |  |       | 3,415   |   |  |   | 3,415   |  
|                                                                            |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Total earning assets                                                        |  | $                 | 57,238 |    |            | $ | 49,811  |             |  | $ | 112,962     |   |  | $     | 13,161  |   |  | $ | 233,172 |  
|                                                                            |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Cumulative earning assets                                                   |  | $                 | 57,238 |    |            | $ | 107,049 |             |  | $ | 220,011     |   |  | $     | 233,172 |   |  | $ | 233,172 |  
|                                                                            |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|                                                                            |  |                   |        |    |           
|Interest-Bearing Liabilities:                                               |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Money market savings                                                        |  | $                 | 25,822 |    |            | $ |        |             |  | $ |            |   |  | $     |        |   |  | $ | 25,822  |  
|Interest checking (2)                                                       |  |                   |       |    |            |   |        |             |  |   | 27,758      |   |  |       |        |   |  |   | 27,758  |  
|Savings (2)                                                                 |  |                   | 608    |    |            |   | 776     |             |  |   | 20,055      |   |  |       |        |   |  |   | 21,439  |  
|Certificates of deposit                                                     |  |                   | 12,455 |    |            |   | 29,494  |             |  |   | 41,952      |   |  |       | 1,185   |   |  |   | 85,086  |  
|FHLB advances                                                               |  |                   | 25,500 |    |            |   | 2,000   |             |  |   | 6,000       |   |  |       | 550     |   |  |   | 34,050  |  
|                                                                            |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Total interest-bearing liabilities                                          |  | $                 | 64,385 |    |            | $ | 32,270  |             |  | $ | 95,765      |   |  | $     | 1,735   |   |  | $ | 194,155 |  
|                                                                            |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Cumulative interest-bearing liabilities                                     |  | $                 | 64,385 |    |            | $ | 96,655  |             |  | $ | 192,420     |   |  | $     | 194,155 |   |  | $ | 194,155 |  
|                                                                            |  |                   |        |    |            |   |         |             |  |   |             |   |  |       |         |   |  |   |         |  
|Period gap                                                                  |  | $                 | (7,147 | )  |            | $ | 17,541  |             |  | $ | 17,197      |   |  | $     | 11,426  |   |  | $ | 39,017  |  
|Cumulative gap                                                              |  | $                 | (7,147 | )  |            | $ | 10,394  |             |  | $ | 27,591      |   |  | $     | 39,017  |   |  | $ | 39,017  |  
|Ratio of cumulative interest-earning assets to interest-bearing liabilities |  |                   | 88.90  | %  |            |   | 110.75  | %           |  |   | 114.34      | % |  |       | 120.10  | % |  |   | 120.10  | %
|Ratio of cumulative gap to total earning assets                             |  |                   | (3.07  | )% |            |   | 4.46    | %           |  |   | 11.83       | % |  |       | 16.73   | % |  |   | 16.73   | %

---

|(1) | Includes nonaccrual loans of $1.1 million, which are spread throughout the categories.
|--- | --------------------------------------------------------------------------------------



|(2) | Management has determined that interest checking and savings accounts, excluding $911,000 in savings accounts with more frequent rate adjustment terms, are not sensitive to changes
in related market rates and, therefore, they are placed in the 1 to 5 years and over 5 years categories, respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | All securities without specific maturities are included in the 1 to 5 years category since they are not considered as sensitive to interest rate changes.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------



Noninterest Income



2005 Compared to 2004



During the year ended December 31, 2005, noninterest income increased to $2.38 million from $1.92 million in 2004,
representing a 23.9% increase. Noninterest income benefited from growth in the Companys



21



---

ancillary service sectors which include mortgage banking and investment brokerage services. The Banks mortgage banking division produced $173,400 in
fees during 2005, while the investment brokerage subsidiary generated $172,100 in commissions during the year. During 2005, the Companys investment subsidiary hired a new investment officer with over fifteen years of experience. The addition
of this seasoned broker along with the other brokerage representatives and service offerings provided by the Company should result in additional growth in this sector. Other factors positively impacting noninterest income during 2005 include gains
on sales of securities of $166,400 and a one-time gain on the sale of real estate of $149,500.



Deposit account and loan fees increased 5.0% and 40.3%, respective during 2005. Deposit account fees consist of charges related insufficient funds, check printing, cashiers checks, service charges, ATM, check cards
and others, while loan fees primarily consist of late charges and prepayment penalties on loans. These fees are core earnings that are not interest sensitive and have provided a stable source of income for the Bank.



2004 Compared to 2003



During the year ended December 31, 2004, noninterest income increased to $1.92 million from $1.89 million in 2003.
Excluding gains on sales of securities of $148,100 and $269,400 for the years ended December 31, 2004 and 2003, respectively, noninterest income increased 9.5% to $1.77 million during 2004, as compared to $1.62 million for the 2003 year-end
period. A 14.7% increase in deposit account fees generated from strong consumer and commercial deposit growth represented the primary factor driving noninterest income growth during the year. These accounts generate fees including insufficient
funds, check printing, cashiers checks, service charges, ATM, check cards and others, several of which experienced double-digit growth during 2004. These fees are core earnings that are not interest sensitive and have provided a stable source of
income for the Bank. Additionally, the Company took steps to expand its ancillary service offerings and improve its noninterest income by expanding its investment subsidiary, Shore Investments Inc., through the addition of a Certified Financial
Planner in the Companys Maryland market and by starting a mortgage banking division within the Bank dedicated to originating and selling conforming fixed rate loan products. The Company began to benefit from fees generated by these services
during the last quarter of 2004 and anticipates additional growth in future periods.



Noninterest Expense



2005 Compared to 2004



Noninterest expense for the year ended December 31,
2005 increased 20.0% to $6.64 million, as compared to $5.56 million during the 2004 period. The 2005 amounts reflect additional costs associated with operating the Companys new corporate headquarters for an entire year, upgrades to information
systems, increases in employee compensation and benefit expense resulting from growth in core banking and ancillary services and additional professional fees, primarily resulting from costs associated with meeting the requirements of Sarbanes-Oxley.
As a result, occupancy and equipment expenses increased 13.0% to $1.59 million during 2005, compared to $1.40 million for 2004, while data processing costs increased 12.0% to $762,200 during the year, compared to $680,800 for the prior year.
Compensation and benefits increased by 27.8% to $3.14 million during the year ended December 31, 2005, as compared to $2.46 million for the year ended December 31, 2004, while professional fees increased 46.3% to $316,700 in 2005, as
compared to $216,500 in 2004. Advertising, promotion and other noninterest expenses increased 4.4% in total to $835,000 during the year ended December 31, 2005, as compared to $800,000 for the 2004 period, primarily due to increased costs
associated with growth in the Banks internet banking products.



2004
Compared to 2003



Noninterest expense for the year ended
December 31, 2004 increased 16.4% to $5.56 million, as compared to $4.78 million during the 2003 period. The 2004 amounts reflect additional costs associated with opening a new facility that combined operations and corporate offices and with
upgrading the companys computer systems



22



---

which included new hardware, software, and additional security protection. Related occupancy and equipment expenses increased 16.8% to $1.40 million during
2004, compared to $1.20 million for 2003, while data processing increased 45.6% to $680,800 during the year, compared to $467,700 for the prior year. Increases in employee compensation and benefits expense and professional and regulatory fees
accounted for the remaining expense growth. Compensation and benefits increased by 11.1% to $2.46 million during the year ended December 31, 2004, as compared to $2.21 million for the year ended December 31, 2003, while other noninterest
expense, which includes professional fees, increased 6.6% to $828,800 in 2004, as compared to $777,800 in 2003. Advertising and promotion expenses increased 71.7% to $162,300 during the year ended December 31, 2004, as compared to $94,500 for
the 2003 period, primarily due to various internal and external promotions run during the year to generate loan and deposit growth. The Companys efficiency ratio remained strong during 2004 at 59.47%, down slightly from prior years ratio
of 59.70%.



Financial Condition



Loan Portfolio



The Banks loan portfolio is comprised of real estate mortgage loans, construction loans, commercial loans, home equity
loans, and consumer loans. The primary market areas in which the Bank originates loans are the counties of Accomack and Northampton, Virginia and Salisbury/Wicomico County, Maryland.



Total loans (excluding allowances and deferred loan costs and fees) increased to $195.6 million at December 31,
2005, a 9.8% increase over the $178.2 million outstanding at December 31, 2004. Gross loan production of approximately $76.0 million resulted in growth across most categories of the Banks loan portfolio during 2005. Residential real
estate (including construction loans) increased 15.3% during 2005, while commercial loans grew 5.0% and consumer and home equity loans were flat during the year.



The following table summarizes the composition of the Banks loan portfolio at the dates indicated.



Loan Portfolio



|                               |  |                |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------ |  | -------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                               |  | December 31,   |        
|                               |  | 2005           |         |   | 2004 |   |         | 2003 |  |   | 2002    |   |  | 2001 |        
|                               |  | (In Thousands) |        
|Residential mortgage           |  | $              | 97,245  |   |      | $ | 86,537  |      |  | $ | 72,339  |   |  | $    | 66,637  |   |  | $ | 47,205  |  
|Commercial mortgage            |  |                | 61,917  |   |      |   | 59,414  |      |  |   | 39,621  |   |  |      | 28,841  |   |  |   | 26,366  |  
|Commercialother               |  |                | 9,590   |   |      |   | 8,673   |      |  |   | 8,568   |   |  |      | 4,921   |   |  |   | 10,079  |  
|Real estate construction (1)   |  |                | 9,026   |   |      |   | 5,658   |      |  |   | 4,005   |   |  |      | 2,184   |   |  |   | 1,051   |  
|Home equity lines of credit    |  |                | 15,293  |   |      |   | 15,581  |      |  |   | 14,951  |   |  |      | 12,905  |   |  |   | 8,912   |  
|Consumer                       |  |                | 2,559   |   |      |   | 2,378   |      |  |   | 2,508   |   |  |      | 2,720   |   |  |   | 11,670  |  
|                               |  |                |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total loans                    |  |                | 195,630 |   |      |   | 178,241 |      |  |   | 141,992 |   |  |      | 118,208 |   |  |   | 105,283 |  
|Less:                          |  |                |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Deferred loan (fees) cost, net |  |                | (82     | ) |      |   | 158     |      |  |   | 217     |   |  |      | 205     |   |  |   | 139     |  
|Allowance for loan losses      |  |                | (2,851  | ) |      |   | (2,404  | )    |  |   | (2,002  | ) |  |      | (1,603  | ) |  |   | (1,326  | )
|                               |  |                |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loans                      |  | $              | 192,697 |   |      | $ | 175,995 |      |  | $ | 140,207 |   |  | $    | 116,810 |   |  | $ | 104,096 |  
|                               |  |                |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  

---

|(1) | Amounts are disclosed net of loans in process of approximately $5.9 million, $4.2 million, $3.1 million, $2.3 million and $1.6 million for 2005, 2004, 2003, 2002 and 2001,
respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



23



---

The following table sets forth the composition of the Banks loan portfolio by percentage at the
dates indicated.



Loan Portfolio by Percentage



|                            |  |              |   |  |        |   |  |        |   |  |        |   |  |        |  
|--------------------------- |  | ------------ | - |  | ------ | - |  | ------ | - |  | ------ | - |  | ------ | -
|                            |  | December 31, |  
|                            |  | 2005         |   |  | 2004   |   |  | 2003   |   |  | 2002   |   |  | 2001   |  
|Residential mortgage        |  | 49.71        | % |  | 48.55  | % |  | 50.95  | % |  | 56.37  | % |  | 44.84  | %
|Commercial mortgage         |  | 31.65        | % |  | 33.33  | % |  | 27.90  | % |  | 24.40  | % |  | 25.04  | %
|Commercialother            |  | 4.90         | % |  | 4.87   | % |  | 6.03   | % |  | 4.16   | % |  | 9.57   | %
|Real estate construction    |  | 4.61         | % |  | 3.18   | % |  | 2.82   | % |  | 1.85   | % |  | 1.00   | %
|Home equity lines of credit |  | 7.82         | % |  | 8.74   | % |  | 10.53  | % |  | 10.92  | % |  | 8.47   | %
|Consumer                    |  | 1.31         | % |  | 1.33   | % |  | 1.77   | % |  | 2.30   | % |  | 11.08  | %
|                            |  |              |   |  |        |   |  |        |   |  |        |   |  |        |  
|Total loans                 |  | 100.00       | % |  | 100.00 | % |  | 100.00 | % |  | 100.00 | % |  | 100.00 | %
|                            |  |              |   |  |        |   |  |        |   |  |        |   |  |        |  



The following table
presents the maturities of selected loans outstanding at December 31, 2005.



Maturity Schedule of Loans



|                                         |  |                   |        |                                     |           |                     |              |        |         |                |   |         |  |   |        |  |   |        
|---------------------------------------- |  | ----------------- | ------ | ----------------------------------- | --------- | ------------------- | ------------ | ------ | ------- | -------------- | - | ------- |  | - | ------ |  | - | -------
|                                         |  | December 31, 2005
|                                         |  | Due inone year    |        | Due after oneyear throughfive years |           | Due afterfive years |              | Totals |         | After one year
|                                         |  |                   |        |                                     | FixedRate |                     | VariableRate
|                                         |  | (In Thousands)   
|Residential and commercial mortgages (1) |  | $                 | 20,518 |                                     | $         | 39,012              |              | $      | 99,632  |                | $ | 159,162 |  | $ | 25,423 |  | $ | 113,221
|Commercialother                         |  |                   | 5,842  |                                     |           | 3,051               |              |        | 697     |                |   | 9,590   |  |   | 2,136  |  |   | 1,612  
|Real estate construction                 |  |                   | 9,026  |                                     |           |                    |              |        |        |                |   | 9,026   |  |   |       |  |   |       
|Home equity lines of credit              |  |                   | 15,293 |                                     |           |                    |              |        |        |                |   | 15,293  |  |   |       |  |   |       
|Consumer                                 |  |                   | 1,624  |                                     |           | 841                 |              |        | 94      |                |   | 2,559   |  |   | 935    |  |   |       
|                                         |  |                   |        |                                     |           |                     |              |        |         |                |   |         |  |   |        |  |   |        
|Total                                    |  | $                 | 52,303 |                                     | $         | 42,904              |              | $      | 100,423 |                | $ | 195,630 |  | $ | 28,494 |  | $ | 114,833
|                                         |  |                   |        |                                     |           |                     |              |        |         |                |   |         |  |   |        |  |   |        

---

|(1) | Includes mortgages with terms that include 3-year, 5-year and 7-year balloon payment features in the 1 to 5 years and after 5 years fixed rate category.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------



Securities



When securities are purchased, they are classified as securities held to maturity if management has the positive intent and
the Company has the ability to hold them until maturity. These investment securities are carried at cost adjusted for amortization of premium and accretion of discounts. Unrealized losses in the portfolio are not recognized unless management of the
Company believes that other than a temporary decline has occurred. Securities held for indefinite periods of time and not intended to be held to maturity are classified as available for sale at the time of purchase. Securities available for sale are
recorded at fair value. The net unrealized holding gain or loss on securities available for sale, net of deferred income taxes, is included in other comprehensive income as a separate component of stockholders equity. A decline in the fair
value of any securities available for sale below cost, that is deemed other than temporary, is charged to earnings and results in a new cost basis for the security. Cost of securities sold is determined on the basis of specific identification. The
Company holds no securities classified as trading.



Investment Securities. The carrying value of investment securities (effected for all applicable fair value adjustments) amounted to $32.4 million at December 31, 2005, compared to $39.0 million and $40.6 million at



24



---

December 31, 2004 and 2003, respectively. Decreases in securities primarily resulted from increased loan demand during 2005 and 2004, flat deposit
levels during 2005, and few adequate return opportunities in the investment market. The comparison of amortized cost to fair value is shown in Note 3 of the notes to the financial statements. Note 3 also provides an analysis of gross unrealized
gains and losses of investment securities. Investment securities consist of the following:



Investment Securities Portfolio



|                                                |  |                          |        |      |   |        |  |   |       
|----------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | - | ------
|                                                |  | Years Ended December 31,
|                                                |  | 2005                     |        | 2004 |   | 2003  
|Amortized Cost:                                 |  |                          |        |      |   |        |  |   |       
|U.S. Treasury and other U.S.government agencies |  | $                        | 17,546 |      | $ | 22,208 |  | $ | 22,308
|Tax-exempt municipal bonds                      |  |                          | 3,996  |      |   | 3,849  |  |   | 3,944 
|Mortgage-backed securities                      |  |                          | 1,528  |      |   | 1,941  |  |   | 2,583 
|Corporate bonds                                 |  |                          | 2,008  |      |   | 3,021  |  |   | 4,035 
|Adjustable rate loan funds                      |  |                          | 817    |      |   | 1,590  |  |   | 1,990 
|FHLMC stock                                     |  |                          | 232    |      |   | 232    |  |   | 232   
|Preferred stock                                 |  |                          | 1,898  |      |   | 1,707  |  |   | 1,707 
|Trust preferred stock                           |  |                          |       |      |   | 75     |  |   | 150   
|Other equity securities                         |  |                          | 1,757  |      |   | 1,666  |  |   | 1,406 
|                                                |  |                          |        |      |   |        |  |   |       
|Total available for sale securities             |  |                          | 29,782 |      |   | 36,289 |  |   | 38,355
|Other investment securities                     |  |                          | 2,461  |      |   | 1,733  |  |   | 1,031 
|                                                |  |                          |        |      |   |        |  |   |       
|Total securities                                |  | $                        | 32,243 |      | $ | 38,022 |  | $ | 39,386
|                                                |  |                          |        |      |   |        |  |   |       



Securities
Available for Sale.Securities available for sale are used as part of the Companys interest rate risk management strategy and may be sold in response to changes in interest rates, changes in prepayment risk, liquidity needs, the
need to increase regulatory capital and other factors. The fair value of securities available for sale totaled $29.9 million at December 31, 2005, compared to $37.2 million and $39.6 million at December 31, 2004 and 2003, respectively. The
comparison of fair market value to amortized cost is shown in Note 3 of the notes to the financial statements. Note 3 also provides an analysis of gross unrealized gains and losses of securities available for sale. The following summarizes available
for sale securities for the respective periods.



Securities
Available for Sale



|                                                 |  |                          |        |      |   |        |  |   |       
|------------------------------------------------ |  | ------------------------ | ------ | ---- | - | ------ |  | - | ------
|                                                 |  | Years Ended December 31,
|                                                 |  | 2005                     |        | 2004 |   | 2003  
|Fair Value:                                      |  |                          |        |      |   |        |  |   |       
|U.S. Treasury and other U.S. government agencies |  | $                        | 17,287 |      | $ | 22,322 |  | $ | 22,688
|Tax-exempt municipal bonds                       |  |                          | 3,988  |      |   | 3,892  |  |   | 4,030 
|Mortgage-backed securities                       |  |                          | 1,492  |      |   | 1,938  |  |   | 2,577 
|Corporate bonds                                  |  |                          | 2,060  |      |   | 3,177  |  |   | 4,312 
|Adjustable rate loan funds                       |  |                          | 797    |      |   | 1,569  |  |   | 1,936 
|FHLMC stock                                      |  |                          | 275    |      |   | 310    |  |   | 245   
|Preferred stock                                  |  |                          | 1,897  |      |   | 1,735  |  |   | 1,795 
|Trust preferred stock                            |  |                          |       |      |   | 171    |  |   | 338   
|Other equity securities                          |  |                          | 2,094  |      |   | 2,124  |  |   | 1,659 
|                                                 |  |                          |        |      |   |        |  |   |       
|Total available for sale securities              |  |                          | 29,890 |      |   | 37,238 |  |   | 39,580
|Other investment securities                      |  |                          | 2,461  |      |   | 1,733  |  |   | 1,031 
|                                                 |  |                          |        |      |   |        |  |   |       
|Total securities                                 |  | $                        | 32,351 |      | $ | 38,971 |  | $ | 40,611
|                                                 |  |                          |        |      |   |        |  |   |       



25



---

The following table sets forth the maturity distribution and weighted average yields of the securities
portfolio at December 31, 2005. The weighted average yields are calculated on the basis of carrying value of the investment portfolio and on the interest income of investments adjusted for amortization of premium and accretion of discount.



Maturities of Investments



|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|--------------------------------------------------- |  | ------------------ | ------ | --------------- | ---------------- | -------------------- |  | ---- | ------------- |  | --------------- | - | -------------------- | - | - |  | ---- | -
|                                                    |  | Available-for-Sale |        |                 | Held-to Maturity |                     
|                                                    |  | AmortizedCost      |        | FairMarketValue |                  | WeightedAverageYield |  |      | AmortizedCost |  | FairMarketValue |   | WeightedAverageYield |  
|U.S. Government Agencies and other U.S. securities: |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Within one year                                     |  | $                  | 4,620  |                 | $                | 4,589                |  | 3.60 | %             |  | $               |  |                      | $ |  |  | 0.00 | %
|After one year to five years                        |  |                    | 11,958 |                 |                  | 11,716               |  | 3.88 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|After five years                                    |  |                    | 968    |                 |                  | 982                  |  | 5.02 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Total                                               |  |                    | 17,546 |                 |                  | 17,287               |  | 3.87 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Municipal Securities:                               |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Within one year                                     |  |                    | 1,000  |                 |                  | 1,001                |  | 5.68 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|After one year to five years                        |  |                    |       |                 |                  |                     |  | 0.00 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|After five years                                    |  |                    | 2,996  |                 |                  | 2,987                |  | 5.33 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|                                                    |  |                    | 3,996  |                 |                  | 3,988                |  | 5.42 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Mortgage Backed Securities:                         |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Within one year                                     |  |                    |       |                 |                  |                     |  | 0.00 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|After one year to five years                        |  |                    | 404    |                 |                  | 389                  |  | 3.83 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|After five years                                    |  |                    | 1,124  |                 |                  | 1,103                |  | 4.78 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|                                                    |  |                    | 1,528  |                 |                  | 1,492                |  | 4.53 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Corporate Bonds:                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Within one year                                     |  |                    |       |                 |                  |                     |  | 0.00 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|After one year to five years                        |  |                    | 2,008  |                 |                  | 2,060                |  | 6.50 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|After five years                                    |  |                    |       |                 |                  |                     |  | 0.00 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|                                                    |  |                    | 2,008  |                 |                  | 2,060                |  | 6.50 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Other Securities:                                   |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|No stated maturity                                  |  |                    | 7,165  |                 |                  | 7,524                |  | 5.42 | %             |  |                 |  |                      |   |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  
|Total securities                                    |  | $                  | 32,243 |                 | $                | 32,351               |  | 4.60 | %             |  | $               |  |                      | $ |  |  | 0.00 | %
|                                                    |  |                    |        |                 |                  |                      |  |      |               |  |                 |   |                      |   |   |  |      |  



26



---

Deposits



The Bank depends on deposits to fund its lending activities, generate fee income opportunities, and create a captive market for loan products. The table
below presents a history of average deposits and the rates paid on interest-bearing deposit accounts for the periods indicated.



Average Deposits and Average Rates Paid



|                                |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|------------------------------- |  | ------------------------ | ------- | ----------- | ---- | - | -------------- | ---- | ----------- |  | ---- | -------------- |  | ----------- | ------- |  | ---- | -
|                                |  | Years Ended December 31, |        
|                                |  | 2005                     |         |             | 2004 |   |                | 2003 |            
|                                |  | AverageBalance           |         | AverageRate |      |   | AverageBalance |      | AverageRate |  |      | AverageBalance |  | AverageRate |        
|Interest-bearing deposits:      |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|Checking and savings            |  | $                        | 79,600  |             | 0.78 | % |                | $    | 74,536      |  | 0.63 | %              |  | $           | 60,461  |  | 0.61 | %
|Certificates of deposit:        |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|Less than $100,000              |  |                          | 66,146  |             | 3.16 | % |                |      | 67,812      |  | 2.97 | %              |  |             | 66,404  |  | 3.39 | %
|$100,000 and over               |  |                          | 19,019  |             | 3.54 | % |                |      | 17,311      |  | 3.27 | %              |  |             | 14,880  |  | 3.68 | %
|                                |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|Total interest-bearing deposits |  |                          | 164,765 |             | 2.06 | % |                |      | 159,659     |  | 1.90 | %              |  |             | 141,745 |  | 2.24 | %
|                                |  |                          |         |             |      |  
|Noninterest-bearing deposits    |  |                          | 27,556  |             | 0.00 | % |                |      | 23,215      |  | 0.00 | %              |  |             | 18,397  |  | 0.00 | %
|                                |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  
|Total average deposits          |  | $                        | 192,321 |             | 1.76 | % |                | $    | 182,874     |  | 1.65 | %              |  | $           | 160,142 |  | 1.98 | %
|                                |  |                          |         |             |      |   |                |      |             |  |      |                |  |             |         |  |      |  



Deposits averaged
$192.3 million during the year ended December 31, 2005, an increase of 5.2% and 20.1% over the $182.9 million and $160.1 million during 2004 and 2003, respectively. Interest-bearing demand deposits accounted for the largest portion of the
increase, followed by noninterest-bearing demand deposits.



The
following table is a summary of the maturity distribution of certificates of deposit in amounts of $100,000 or more as of December 31, 2005.



Maturities of CDs of $100,000 or More



|                              |  |                   |        |         |        |  
|----------------------------- |  | ----------------- | ------ | ------- | ------ | -
|                              |  | December 31, 2005 |       
|                              |  | Amount            |        | Percent |       
|Three months or less          |  | $                 | 2,730  |         | 14.20  | %
|Over three months to one year |  |                   | 6,155  |         | 32.01  | %
|Over one year to five years   |  |                   | 10,343 |         | 53.79  | %
|Over five years               |  |                   |       |         | 0.00   | %
|                              |  |                   |        |         |        |  
|Total                         |  | $                 | 19,228 |         | 100.00 | %
|                              |  |                   |        |         |        |  



Capital Resources



Capital represents funds, earned or obtained, over
which banks can exercise greater control in comparison with deposits and borrowed funds. The adequacy of the Companys capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the
Companys resources and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will support anticipated asset growth and absorb potential losses.



Banking regulations established to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of
December 31, 2005, that the Company meets all capital adequacy requirements to which it is subject.



27



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The following table details the components of Tier 1 and Tier 2 capital and related ratios for the
periods indicated.



Analysis of Capital



|                                                  |  |                |         |   |      |   |         |  
|------------------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                                  |  | December 31,   |        
|                                                  |  | 2005           |         |   | 2004 |  
|                                                  |  | (In Thousands) |        
|Tier 1 Capital:                                   |  |                |         |   |      |   |         |  
|Common stock                                      |  | $              | 685     |   |      | $ | 681     |  
|Additional paid-in capital                        |  |                | 8,267   |   |      |   | 8,199   |  
|Retained earnings                                 |  |                | 14,632  |   |      |   | 12,494  |  
|Accumulated other comprehensive income            |  |                | 45      |   |      |   | 585     |  
|                                                  |  |                |         |   |      |   |         |  
|Total capital (GAAP)                              |  |                | 23,629  |   |      |   | 21,959  |  
|Less: Intangibles Intangibles                     |  |                | (464    | ) |      |   | (526    | )
|Net unrealized gain on debt and equity securities |  |                | (45     | ) |      |   | (585    | )
|                                                  |  |                |         |   |      |   |         |  
|Total Tier 1 capital                              |  |                | 23,120  |   |      |   | 20,848  |  
|                                                  |  |               
|Tier 2 Capital:                                   |  |                |         |   |      |   |         |  
|Allowable allowances for loan losses              |  |                | 2,152   |   |      |   | 2,007   |  
|Net unrealized gains on equity securities         |  |                | 161     |   |      |   | 289     |  
|                                                  |  |                |         |   |      |   |         |  
|Total Tier 2 capital                              |  | $              | 25,433  |   |      | $ | 23,144  |  
|                                                  |  |                |         |   |      |   |         |  
|Risk-weighted assets                              |  | $              | 174,986 |   |      | $ | 163,642 |  
|                                                  |  |               
|Capital Ratios:                                   |  |                |         |   |      |   |         |  
|Tier 1 risk-based capital ratio                   |  |                | 13.21   | % |      |   | 12.74   | %
|Total risk-based capital ratio                    |  |                | 14.53   | % |      |   | 14.14   | %
|Tier 1 capital to average adjusted total assets   |  |                | 9.44    | % |      |   | 9.62    | %

---

|(1) | The required minimum capital ratios for capital adequacy purposes, as defined collectively by the federal banking agencies, for Tier 1 risk-based capital, total risk-based capital,
and Tier 1 capital to average adjusted assets was 4.0%, 8.0% and 4.0%, respectively. To be considered well capitalized under federal prompt corrective action regulations, these same required ratios are 6.0%, 10.0% and 5.0%, respectively.
See Note 11 of the notes to the financial statements for a detail of the capital ratios.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Asset Quality



Allowance for loan losses.The allowance for loan losses represents an amount management believes is adequate to provide for probable loan losses inherent in the loan portfolio. Management evaluates the allowance
for loan losses on a regular basis using a methodology that considers various risk factors in accordance with SFAS No. 5, Accounting for Contingencies. This methodology includes analyzing historical loan losses, current trends in
delinquencies and charge-offs, concentrations, economic conditions, changes in the size and composition of the loan portfolio and industry data. However, risks of future losses cannot be quantified precisely or attributed to particular loans or
classes of loans. Because those risks are influenced by general economic trends as well as conditions affecting individual borrowers, managements judgment of the allowance is necessarily approximate and imprecise. The allowance is also subject
to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies.



28



---

Set forth below is a table detailing the allowance for loan losses for the periods indicated.



Allowance for Loan Losses



|                                                                           |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|-------------------------------------------------------------------------- |  | ------------------------ | ------ | -- | ---- | - | ------ | ---- |  | - | ------ | -- |  | ---- | ------ | - |  | - | ------ | -
|                                                                           |  | Years Ended December 31, |       
|                                                                           |  | 2005                     |        |    | 2004 |   |        | 2003 |  |   | 2002   |    |  | 2001 |       
|                                                                           |  | (In Thousands)           |       
|Balance, beginning of period                                               |  | $                        | 2,404  |    |      | $ | 2,002  |      |  | $ | 1,603  |    |  | $    | 1,326  |   |  | $ | 1,336  |  
|Loans charged off:                                                         |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|Commercial                                                                 |  |                          | (29    | )  |      |   | (11    | )    |  |   |       |    |  |      |       |   |  |   |       |  
|Real estate mortgage                                                       |  |                          |       |    |      |   |       |      |  |   | (4     | )  |  |      |       |   |  |   | (282   | )
|Consumer                                                                   |  |                          | (18    | )  |      |   | (27    | )    |  |   | (24    | )  |  |      | (83    | ) |  |   | (53    | )
|                                                                           |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|Total loans charged-off                                                    |  |                          | (47    | )  |      |   | (38    | )    |  |   | (28    | )  |  |      | (83    | ) |  |   | (335   | )
|                                                                           |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|Recoveries:                                                                |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|Commercial                                                                 |  |                          | 172    |    |      |   | 11     |      |  |   |       |    |  |      |       |   |  |   |       |  
|Real estate mortgage                                                       |  |                          |       |    |      |   |       |      |  |   |       |    |  |      |       |   |  |   |       |  
|Consumer                                                                   |  |                          | 18     |    |      |   | 10     |      |  |   | 47     |    |  |      | 25     |   |  |   | 15     |  
|                                                                           |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|Total recoveries                                                           |  |                          | 190    |    |      |   | 21     |      |  |   | 47     |    |  |      | 25     |   |  |   | 15     |  
|                                                                           |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|Net recoveries (charge-offs)                                               |  |                          | 143    |    |      |   | (17    | )    |  |   | 19     |    |  |      | (58    | ) |  |   | (320   | )
|Provision for loan losses                                                  |  |                          | 304    |    |      |   | 419    |      |  |   | 380    |    |  |      | 335    |   |  |   | 310    |  
|                                                                           |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|Balance, end of period                                                     |  | $                        | 2,851  |    |      | $ | 2,404  |      |  | $ | 2,002  |    |  | $    | 1,603  |   |  | $ | 1,326  |  
|                                                                           |  |                          |        |    |      |   |        |      |  |   |        |    |  |      |        |   |  |   |        |  
|Allowance for loan losses to loans outstanding at end of period            |  |                          | 1.49   | %  |      |   | 1.35   | %    |  |   | 1.41   | %  |  |      | 1.35   | % |  |   | 1.26   | %
|                                                                           |  |                          |        |    |     
|Allowance for loan losses to nonaccrual loans outstanding at end of period |  |                          | 267.95 | %  |      |   | 253.05 | %    |  |   | 362.68 | %  |  |      | 182.37 | % |  |   | 248.78 | %
|                                                                           |  |                          |        |    |     
|Net charge-offs (recoveries) to average loans outstanding during period    |  |                          | (0.08  | )% |      |   | 0.01   | %    |  |   | (0.01  | )% |  |      | 0.05   | % |  |   | 0.33   | %



As in recent years,
the Banks charge-offs during 2005 continued to be minimal. With the exception of 2001, charge-offs have primarily occurred in the consumer loan category over the past five years. During 2001, the Bank experienced a $172,000 charge-off relating
to the insufficient collateral on two loans foreclosed on during the year. During 2004, the Bank obtained possession of additional property owned by this borrower. During 2005, the Bank sold the property, recovered all deficient amounts and
recognized a gain of $149,000.



The Banks loan portfolio
continues to evolve from primarily residential real estate mortgages to one with a significant emphasis in commercial and consumer loans. Increased competition in the real estate mortgage arena and the desire to diversify contributed to this shift
in lending and customer relationships. However, with this change comes increased risk associated with potential loan losses. The allowance for loan losses as a percentage of period end loans has been between 1.26% and 1.49% over the past five years,
while the ratio of the allowance for loan losses as a percentage of nonaccrual loans outstanding has ranged from 182.37% to 362.68%. Based on these and other factors, management believes that allowances for losses existing at December 31, 2005
are sufficient to cover any anticipated or unanticipated losses on loans outstanding in accordance with SFAS No. 5, Accounting for Contingencies.



29



---

An allocation of the allowance for loan losses in dollars and as a percent of the total allowance is
provided in the following tables. Because all of these factors are subject to change, the allocation is not necessarily predictive of future loan losses in the indicated categories.



Allocation of Allowance for Loan Losses



|             |  |                         |       |                            |             |   |                         |          |                            |  |       |                         |  |                            |     |  |       |  
|------------ |  | ----------------------- | ----- | -------------------------- | ----------- | - | ----------------------- | -------- | -------------------------- |  | ----- | ----------------------- |  | -------------------------- | --- |  | ----- | -
|             |  | Commercial              |       |                            | Real Estate |   |                         | Consumer |                           
|             |  | Allowancefor LoanLosses |       | Percentageof LoanAllowance |             |   | Allowancefor LoanLosses |          | Percentageof LoanAllowance |  |       | Allowancefor LoanLosses |  | Percentageof LoanAllowance |    
|             |  | (In Thousands)          |      
|December 31, |  |                         |       |                            |             |   |                         |          |                            |  |       |                         |  |                            |     |  |       |  
|2005         |  | $                       | 1,949 |                            | 68.37       | % |                         | $        | 242                        |  | 8.49  | %                       |  | $                          | 660 |  | 23.14 | %
|2004         |  |                         | 1,556 |                            | 64.73       | % |                         |          | 242                        |  | 10.07 | %                       |  |                            | 606 |  | 25.20 | %
|2003         |  |                         | 1,175 |                            | 58.69       | % |                         |          | 278                        |  | 13.89 | %                       |  |                            | 549 |  | 27.42 | %
|2002         |  |                         | 684   |                            | 42.67       | % |                         |          | 249                        |  | 15.53 | %                       |  |                            | 670 |  | 41.80 | %
|2001         |  |                         | 497   |                            | 37.48       | % |                         |          | 268                        |  | 20.21 | %                       |  |                            | 561 |  | 42.31 | %



The following table
details information concerning nonaccrual and past due loans, as well as foreclosed assets.



Nonperforming Assets



|                                                                     |  |                |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|-------------------------------------------------------------------- |  | -------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                     |  | December 31,   |       
|                                                                     |  | 2005           |        |   | 2004 |   |        | 2003 |  |   | 2002   |   |  | 2001 |       
|                                                                     |  | (In Thousands) |       
|Nonaccrual loans:                                                    |  |                |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial                                                           |  | $              | 194    |   |      | $ | 374    |      |  | $ | 126    |   |  | $    |       |   |  | $ |       |  
|Real estate mortgage                                                 |  |                | 811    |   |      |   | 272    |      |  |   | 321    |   |  |      | 677    |   |  |   | 453    |  
|Home equity lines of credit                                          |  |                |       |   |      |   | 120    |      |  |   | 28     |   |  |      |       |   |  |   | 22     |  
|Consumer                                                             |  |                | 59     |   |      |   | 184    |      |  |   | 77     |   |  |      | 202    |   |  |   | 58     |  
|                                                                     |  |                |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total nonaccrual loans                                               |  |                | 1,064  |   |      |   | 950    |      |  |   | 552    |   |  |      | 879    |   |  |   | 533    |  
|Other real estate owned                                              |  |                |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|                                                                     |  |                |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total nonperforming assets                                           |  | $              | 1,064  |   |      | $ | 950    |      |  | $ | 552    |   |  | $    | 879    |   |  | $ | 533    |  
|                                                                     |  |                |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Loans past due 90 or more days accruing interest                     |  |                |       |   |      |   |       |      |  |   |       |   |  |      |       |   |  |   |       |  
|Allowance for loan losses to nonaccrual loans                        |  |                | 267.95 | % |      |   | 253.05 | %    |  |   | 362.68 | % |  |      | 182.37 | % |  |   | 248.78 | %
|Nonperforming assets to period end loans and other real estate owned |  |                | 0.56   | % |      |   | 0.53   | %    |  |   | 0.39   | % |  |      | 0.74   | % |  |   | 0.51   | %



Total nonperforming
assets consist of nonaccrual loans and foreclosed properties that are not producing income for the Bank. The Banks policy is that whenever a loan reaches 90 days delinquent interest accruals are suspended until six months after the loan
becomes current again. In recent years, the Bank has experienced strong asset quality in its loan portfolio. Low interest rates and an exuberant real estate market have created a vibrant lending environment and provided borrowers the opportunity to
finance larger purchases at lower costs. Accordingly, trends in total nonperforming assets and the related ratios have been relatively positive for the periods presented.



At December 31, 2005, the Bank identified $314,000 of loans as impaired as defined by generally accepted accounting
principles. Impaired loans have a valuation allowance allocation of $47,000 at December 31, 2005. At December 31, 2004, no loans were identified by the Bank as impaired and, accordingly, no specific allowances were provided with respect to
impaired loans. Included in nonaccrual loans at December 31, 2003 and 2002 is one impaired loan to the same borrower with a balance of $126,000 and $368,000, respectively. The balance was



30



---

partially paid and brought current during 2003. However, the borrower was unable to meet the remaining obligation and, consequently, filed for bankruptcy
protection. The Bank entered into an agreement with the bankruptcy trustee to sell the collateral during the first quarter of 2004. Proceeds from these sales were sufficient to satisfy all principal and interest amounts due. At December 31,
2001, there were no loans identified by the Bank as impaired under the established accounting guidelines.



In conjunction with the methodology described above to calculate the allowance for loan losses, the Bank closely monitors individual loans that are deemed
to be potential problem loans. Loans are viewed as potential problem loans when possible credit problems of borrowers or industry trends cause management to have doubts as to the ability of such borrowers to comply with current repayment terms.
Those loans are subject to regular management attention, and their status is reviewed on a regular basis. In instances where management determines that a specific allowance should be set, the Bank takes such action as deemed appropriate.



As of December 31, 2005, all loans 60 days or more delinquent,
including nonperforming loans, totaled $1.28 million. Additionally, other performing loans totaling $1.92 million existed that were current, but had other potential weaknesses that management considers to warrant additional monitoring. All loans in
these categories are subject to constant management attention, and their status is reviewed on a regular basis. These loans are generally secured by residential and commercial real estate and equipment with appraised values that exceed the remaining
principal balances on such loans.



Liquidity; Asset Management



Liquidity represents the Companys ability to
meet present and future obligations through the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold,
investments maturing within one year, and investments that are categorized as available-for-sale. The Companys ability to obtain deposits and purchase funds at favorable rates impacts its liability liquidity. As a result of the Companys
management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors requirements and meet its
customers credit needs.



The table below summarizes the
Companys balance sheet liquidity position for the periods presented. Additionally, alternative sources of liquidity are available to the Company including its capacity to borrow additional funds when the need arises. The Bank has an available
line of credit with the FHLB for up to 25% of Bank assets, or approximately $61.2 million at December 31, 2005. However, the Bank may request an increase in this borrowing capacity from the FHLB. At December 31, 2005 the Bank had
sufficient collateral pledged to borrow a total of approximately $73.3 million from the FHLB. The borrowing capacity is subject to certain collateral requirements as stipulated in the FHLB borrowing agreement. Additionally, the Bank maintains other
available borrowing arrangements of approximately $8.4 million. Based on these factors, the Company maintains sufficient liquidity to meet anticipated needs.



Summary of Liquid Assets



|                                                         |  |                        |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                         |  | December 31,           |        
|                                                         |  | 2005                   |         |   | 2004 |   |         | 2003 | 
|                                                         |  | (Dollars in thousands) |        
|Cash and due from banks                                  |  | $                      | 9,176   |   |      | $ | 9,415   |      |  | $ | 5,794   |  
|Held-to-maturity securities due within one year          |  |                        |        |   |      |   |        |      |  |   |        |  
|Available-for-sale and other securities                  |  |                        | 32,351  |   |      |   | 38,971  |      |  |   | 39,580  |  
|                                                         |  |                        |         |   |      |   |         |      |  |   |         |  
|Total liquid assets                                      |  | $                      | 41,527  |   |      | $ | 48,386  |      |  | $ | 45,374  |  
|                                                         |  |                        |         |   |      |   |         |      |  |   |         |  
|Deposits and other liabilities                           |  | $                      | 223,790 |   |      | $ | 215,730 |      |  | $ | 176,349 |  
|                                                         |  |                        |         |   |      |   |         |      |  |   |         |  
|Ratio of liquid assets to deposits and other liabilities |  |                        | 18.56   | % |      |   | 22.43   | %    |  |   | 25.73   | %
|                                                         |  |                        |         |   |      |   |         |      |  |   |         |  



31



---

Total cash and cash equivalents were $9.2 million at December 31, 2005, compared to $9.4 million and
$5.8 million at December 31, 2004 and 2003, respectively. Net cash flows from operating activities were $3.0 million for the year ended December 31, 2005, compared to $3.5 million and $2.5 million for the years ended December 31, 2004
and 2003, respectively. This fluctuation primarily resulted from net income growth and other changes in normal operating activities during the periods.



Net cash flows used for investing activities were $11.1 million during the year ended December 31, 2005, compared to $38.3 million and $18.6 million
during the years ended December 31, 2004 and 2003, respectively. Fueled by low rates and a vibrant real estate market, loan growth was strong during the last three years with net originations of $17.1 million, $36.2 million and $23.8 million
during the years ended December 31, 2005, 2004 and 2003, respectively. This resulted in other investment activities being greatly limited during these periods.



Net cash flows from financing activities were $7.8 million for the year ended December 31, 2005, compared to $38.5
million and $14.4 million during 2004 and 2003, respectively. Deposits declined during 2005 compared to deposits increasing by $33.8 million in 2004 and being flat during 2003. The Banks deposit markets were very competitive during 2005,
preventing it from growing these balances without paying rates that exceeded those available through comparable wholesale funding sources. Accordingly, net proceeds from FHLB borrowings were $12.1 million in 2005, as compared to $5.1 million and
$14.7 million during 2004 and 2003, respectively. Increased borrowings during 2005 were required to fund liquidity shortfalls created by the strong loan demand and declining deposit balances.



The Bank occasionally finds it necessary to borrow funds on a short-term
basis due to fluctuations in loan and deposit levels. The Bank has several arrangements whereby it may borrow funds overnight and on terms. As discussed above, the Bank currently has borrowing capacity of approximately $61.2 million, provided it
meets all borrowing guidelines with the FHLB. At December 31, 2005, the Bank had $34.1 million in outstanding FHLB advances, compared to $22.0 million at December 31, 2004.



The following table details information concerning the Banks short-term borrowings for the periods presented.



Summary of Borrowed Funds



|                                                                                 |  |                        |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------------------------- |  | ---------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                 |  | December 31,           |       
|                                                                                 |  | 2005                   |        |   | 2004 |   |        | 2003 | 
|                                                                                 |  | (Dollars in thousands) |       
|Actual period end balances                                                       |  | $                      | 25,500 |   |      | $ | 21,350 |      |  | $ | 16,200 |  
|Monthly average balance of short-term borrowings outstanding during the period   |  | $                      | 21,033 |   |      | $ | 6,915  |      |  | $ | 5,250  |  
|Weighted-average interest rate on monthly average short-term borrowings          |  |                        | 3.34   | % |      |   | 1.72   | %    |  |   | 1.27   | %
|Maximum month-end balance of short-term borrowings outstanding during the period |  | $                      | 28,500 |   |      | $ | 21,350 |      |  | $ | 16,200 |  



32



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Contractual Obligations, Contingent Liabilities and Commitments



The following table summarizes the Companys significant contractual
obligations, contingent liabilities and certain other commitments outstanding at December 31, 2005:



Contractual Obligations, Contingent Liabilities and Commitments



|                                                                                                                |  |                        |        |                 |   |           |  |           |       |                  |   |       |  |   |    
|--------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------ | --------------- | - | --------- |  | --------- | ----- | ---------------- | - | ----- |  | - | ---
|                                                                                                                |  | Payments Due By Period
|Contractual Obligations                                                                                         |  | Total                  |        | Less Than1 Year |   | 1-3 Years |  | 3-5 Years |       | More Than5 Years
|                                                                                                                |  | (Dollars in Thousands)
|Operating lease obligations                                                                                     |  | $                      | 180    |                 | $ | 36        |  | $         | 72    |                  | $ | 72    |  | $ |   
|Other long-term liabilities reflected on the Companys balance sheet under GAAP Federal Home Loan Bank Advances |  |                        | 34,050 |                 |   | 27,500    |  |           | 4,000 |                  |   | 2,000 |  |   | 550
|Other commitments                                                                                               |  |                        |        |                 |   |           |  |           |       |                  |   |       |  |   |    
|Standby letters of credit                                                                                       |  |                        | 1,281  |                 |   | 1,281     |  |           |      |                  |   |      |  |   |   
|Commitments to extend credit                                                                                    |  |                        | 51,661 |                 |   | 51,661    |  |           |      |                  |   |      |  |   |   
|                                                                                                                |  |                        |        |                 |   |           |  |           |       |                  |   |       |  |   |    
|Total contractual obligations                                                                                   |  | $                      | 87,172 |                 | $ | 80,478    |  | $         | 4,072 |                  | $ | 2,072 |  | $ | 550
|                                                                                                                |  |                        |        |                 |   |           |  |           |       |                  |   |       |  |   |    



Return on Equity and Assets



The following table summarizes ratios considered to
be significant indicators of the Companys profitability and financial condition during the periods indicated.



Return on Equity and Assets



|                                      |  |                         |   |  |       |   |  |       |  
|------------------------------------- |  | ----------------------- | - |  | ----- | - |  | ----- | -
|                                      |  | Year Ended December 31, |  
|                                      |  | 2005                    |   |  | 2004  |   |  | 2003  |  
|Return on average assets              |  | 1.10                    | % |  | 1.08  | % |  | 1.11  | %
|Return on average equity              |  | 11.74                   | % |  | 11.01 | % |  | 10.64 | %
|Average equity to average asset ratio |  | 9.33                    | % |  | 9.83  | % |  | 10.40 | %
|Dividend payout ratio                 |  | 20.16                   | % |  | 19.30 | % |  | 16.83 | %



Critical Accounting Policies and
Judgments



The accounting principles followed by the
Company and the methods of applying these principles conform with generally accepted accounting principles and to general practices within the banking industry. Our most critical accounting policies require managements judgment to ascertain
the valuation of assets, liabilities, commitments and contingencies. These policies require the use of subjective and complex estimates, assumptions and judgments, which are based on information available as of the date of the financial statements
and are important to our reported financial condition and results of operations. Accordingly, as this information changes, our financial statements could reflect different estimates, assumptions and judgments and as such have a greater possibility
of producing results that could be materially different than originally reported.



The allowance for loan losses is established and maintained at levels management deems adequate to cover losses inherent in the loan portfolio, based upon our evaluation of the risks in the portfolio and changes in
the nature and volume of loan activity. Management determines loan loss estimates by analyzing historical loan losses, current trends in delinquencies and charge-offs, concentrations, economic conditions, changes in the size and composition of the
loan portfolio and industry data. Additionally, we consider the impact of economic events, the outcome of which is uncertain. While we use the best information available in establishing the



33



---

allowance, actual economic conditions differing significantly from our assumptions in determining the loan loss valuation allowance may result in future
adjustments, or regulators may require adjustments based upon information available to them at the time of their examinations. Although we believe that our allowance for loan losses is adequate and properly recorded in our financial statements,
differing economic conditions or alternate methods of estimation could result in materially different amounts of loan losses.



The estimation of fair value is significant to several of our assets, including available-for-sale (AFS) investment securities and real estate owned
(REO). AFS securities are recorded at fair value, while REO is generally recorded at the lower of cost or fair value (less estimated selling costs). Fair values can be volatile and may be influenced by a number of factors, including market interest
rates, prepayment speeds, discount rates and market conditions, among others. Since these factors can change significantly and rapidly, fair values are difficult to predict and are subject to material changes, which could impact our financial
condition.



Impact of Accounting Pronouncements



In December 2004, the FASB issued Statement No. 123(R),
Share-Based Compensation, which requires the recognition of costs resulting from transactions involving the acquisition of goods and services by issuing its shares, share options, or other equity instruments. This standard requires a
fair value-based measurement method in accounting for share-based payment transactions with both employees and non-employees. This standard replaces Statement No. 123, Accounting for Stock-Based Compensation, and supersedes
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, the use of the intrinsic value method as provided under APB Opinion No. 25 will be eliminated. SFAS
No. 123(R) is effective for all awards of share-based payments granted, modified, or cancelled after June 15, 2005, except for public entities filing as small business issuers. Public entities that file as small business issuers will be
required to apply Statement 123(R) in the first interim or reporting period that begins after December 15, 2005. In addition, compensation costs for the unvested portion of awards, issued prior to and outstanding as of June 15, 2005, would
continue to be recognized at the grant-date fair value as the remaining requisite service is rendered. The potential effect of Statement No. 123(R) on the financial statements is currently being considered.



In May 2005, the FASB issued FASB Statement 154, Accounting Changes and Error
Corrections (SFAS 154), which requires retrospective application of all comparative financial statements for voluntary accounting principle changes. This statement, however, does not apply to changes in principle due to
new accounting pronouncements when the new pronouncement includes specific transition provisions. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of
this standard is currently not expected to have a material impact on the Companys consolidated results of operations and financial position in the foreseeable future.



On November 3, 2005, the FASB issued FASB Staff Position on SFAS 115 and 124, The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments (FSP FAS 115-1 and 124-1). This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement
of an impairment loss. It is effective for reporting periods beginning after December 15, 2005. Accordingly, the Company is reviewing its processes and will adopt the required accounting and disclosures.



On December 19, 2005, the FASB issued a FASB Staff Position
(FSP) on American Institute of Certified Public Accountants Statement of Position 94-6, Terms of Loan Products that May Give Rise to a Concentration of Credit Risk (FSP SOP 94-6-1). This FSP provides guidance on what
circumstances, if any, do the terms of loan products, specifically nontraditional loan products, give rise to a concentration of credit risk. Nontraditional loan products are those that expose the originator, holder, investor, guarantor, or servicer
to higher risk than traditional products. Examples include interest-only loans, loans with the contractual ability to negatively amortize, and loans with below market or teaser interest rates. FSP SOP 94-6-1 is effective for interim and annual
periods ending after December 19, 2005. The adoption of this standard did not have a material impact on the Companys consolidated results of operations and financial position.



34



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Effects of Inflation



The Company believes that its net interest income and results of operations have not been significantly affected by
inflation during the years ended December 31, 2005, 2004 and 2003.



|Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------



The Company uses a third party provider to perform computer modeling methodologies that assist in determining the overall magnitude of interest
sensitivity risk. Based on these methodologies, management formulates policies governing asset generation and pricing, funding sources and pricing, and off-balance-sheet commitments in order to reduce sensitivity risk. These decisions are based on
managements outlook regarding future interest rate movements, the state of the local and national economy, and other financial and business risk factors.



The modeling methodologies used measure interest rate sensitivity by analyzing the potential impact on net interest income under various interest rate
scenarios. One such scenario would assume a hypothetical 200 basis point instantaneous and parallel shift in the yield curve in interest rates. Accordingly, management modeled the impact of a 200 basis point decline in interest rates and a 200 basis
point increase in interest rates at December 31, 2005. The model indicates that a 200 basis point instantaneous and parallel decrease in the yield curve in interest rates would cause net interest income to decrease by $199,000, while a 200
basis point instantaneous and parallel increase in the yield curve in interest rates would cause net interest income to increase by $44,000.



The computer model uses standard algebraic formula for calculating present value. The calculation discounts the future cash flows of the Companys
portfolio of interest rate sensitive instruments to present value utilizing techniques designed to approximate current market rates for securities, current offering rates for loans, and the cost of alternative funding for the given maturity of
deposits and then assumes an instantaneous and parallel shift in these rates. The difference between these numbers represents the resulting hypothetical change in the fair value of interest rate sensitive instruments.



As with any modeling techniques, certain limitations and shortcomings are
inherent in the Companys methodology. Significant assumptions must be made in the calculation including: (1) no growth in volume or balance sheet mix; (2) constant market interest rates reflecting the average rate from the last month
of the given quarter; and (3) pricing spreads to market rates derived from an historical analysis, or from assumptions by instrument type. Additionally, the computations do not contemplate certain actions management could undertake in response
to changes in interest rates.



35



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|Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
|------- | ------------------------------------------



SHORE FINANCIAL CORPORATION



Consolidated Statements of Financial Condition



|                                                                                                                                         |  |              |             |      |   |            
|---------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----------- | ---- | - | -----------
|                                                                                                                                         |  | December 31,
|                                                                                                                                         |  | 2005         |             | 2004
|ASSETS                                                                                                                                   |  |              |             |      |   |            
|Cash (including interestearning deposits of approximately $1,775,300 and $3,149,300, respectively)                                      |  | $            | 9,176,000   |      | $ | 9,415,000  
|Investment securities:                                                                                                                   |  |              |             |      |   |            
|Available-for-sale (amortized cost of $29,781,900 and $36,437,500, respectively)                                                         |  |              | 29,889,900  |      |   | 37,238,200 
|Other investments, at cost                                                                                                               |  |              | 2,460,900   |      |   | 1,732,900  
|Loans receivable, net                                                                                                                    |  |              | 192,696,500 |      |   | 175,995,200
|Premises and equipment, net                                                                                                              |  |              | 7,464,600   |      |   | 8,024,900  
|Other assets                                                                                                                             |  |              | 5,731,000   |      |   | 5,282,300  
|                                                                                                                                         |  |              |             |      |   |            
|                                                                                                                                         |  | $            | 247,418,900 |      | $ | 237,688,500
|                                                                                                                                         |  |              |             |      |   |            
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                     |  |              |             |      |   |            
|Deposits:                                                                                                                                |  |              |             |      |   |            
|Interest-bearing                                                                                                                         |  | $            | 160,105,000 |      | $ | 168,242,100
|Noninterest-bearing                                                                                                                      |  |              | 28,864,700  |      |   | 24,495,000 
|                                                                                                                                         |  |              |             |      |   |            
|Total deposits                                                                                                                           |  |              | 188,969,700 |      |   | 192,737,100
|Advances from Federal Home Loan Bank                                                                                                     |  |              | 34,050,000  |      |   | 21,966,700 
|Other liabilities                                                                                                                        |  |              | 770,600     |      |   | 1,025,700  
|                                                                                                                                         |  |              |             |      |   |            
|Total liabilities                                                                                                                        |  |              | 223,790,300 |      |   | 215,729,500
|                                                                                                                                         |  |              |             |      |   |            
|Stockholders equity                                                                                                                     |  |              |             |      |   |            
|Preferred stock, par value $1 per share, 500,000 shares authorized; none issued and outstanding                                          |  |              |            |      |   |           
|Common stock, par value $.33 per share, 5,000,000 shares authorized; 2,074,207 and 2,063,284 shares issued and outstanding,
respectively |  |              | 684,500     |      |   | 680,900    
|Additional capital                                                                                                                       |  |              | 8,267,400   |      |   | 8,199,000  
|Retained earnings                                                                                                                        |  |              | 14,631,400  |      |   | 12,494,400 
|Accumulated other comprehensive income                                                                                                   |  |              | 45,300      |      |   | 584,700    
|                                                                                                                                         |  |              |             |      |   |            
|Total stockholders equity                                                                                                               |  |              | 23,628,600  |      |   | 21,959,000 
|                                                                                                                                         |  |              |             |      |   |            
|                                                                                                                                         |  | $            | 247,418,900 |      | $ | 237,688,500
|                                                                                                                                         |  |              |             |      |   |            



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



36



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SHORE FINANCIAL CORPORATION



Consolidated Statements of Income



|                                                    |  |                          |            |      |   |            |  |   |          
|--------------------------------------------------- |  | ------------------------ | ---------- | ---- | - | ---------- |  | - | ---------
|                                                    |  | Years Ended December 31,
|                                                    |  | 2005                     |            | 2004 |   | 2003      
|Interest and dividend income                        |  |                          |            |      |   |            |  |   |          
|Loans                                               |  | $                        | 11,232,700 |      | $ | 9,150,300  |  | $ | 7,806,000
|Investments                                         |  |                          |            |      |   |            |  |   |          
|Taxable interest                                    |  |                          | 1,307,600  |      |   | 1,247,600  |  |   | 1,402,400
|Tax-exempt interest                                 |  |                          | 135,600    |      |   | 140,800    |  |   | 104,100  
|Dividends                                           |  |                          | 174,600    |      |   | 158,800    |  |   | 189,000  
|                                                    |  |                          |            |      |   |            |  |   |          
|Total interest and dividend income                  |  |                          | 12,850,500 |      |   | 10,697,500 |  |   | 9,501,500
|                                                    |  |                          |            |      |   |            |  |   |          
|Interest expense                                    |  |                          |            |      |   |            |  |   |          
|Deposits                                            |  |                          | 3,385,900  |      |   | 3,025,900  |  |   | 3,168,800
|FHLB/other advances                                 |  |                          | 1,028,100  |      |   | 249,300    |  |   | 106,200  
|                                                    |  |                          |            |      |   |            |  |   |          
|Total interest expense                              |  |                          | 4,414,000  |      |   | 3,275,200  |  |   | 3,275,000
|                                                    |  |                          |            |      |   |            |  |   |          
|Net interest income                                 |  |                          | 8,436,500  |      |   | 7,422,300  |  |   | 6,226,500
|                                                    |  |                          |           
|Provision for loan losses                           |  |                          | 303,700    |      |   | 418,800    |  |   | 380,400  
|                                                    |  |                          |            |      |   |            |  |   |          
|Net interest income after provision for loan losses |  |                          | 8,132,800  |      |   | 7,003,500  |  |   | 5,846,100
|                                                    |  |                          |            |      |   |            |  |   |          
|Noninterest income                                  |  |                          |            |      |   |            |  |   |          
|Deposit account fees                                |  |                          | 1,343,100  |      |   | 1,279,500  |  |   | 1,115,100
|Loan fees                                           |  |                          | 118,000    |      |   | 84,100     |  |   | 104,000  
|Mortgage banking fees                               |  |                          | 173,400    |      |   | 9,300      |  |   |         
|Commissions on investment brokerage sales           |  |                          | 172,100    |      |   | 119,400    |  |   | 140,100  
|Gains on sales of securities                        |  |                          | 166,400    |      |   | 148,100    |  |   | 269,400  
|Gains on sale of real estate                        |  |                          | 149,500    |      |   |           |  |   |         
|Other                                               |  |                          | 256,900    |      |   | 278,700    |  |   | 260,600  
|                                                    |  |                          |            |      |   |            |  |   |          
|Total noninterest income                            |  |                          | 2,379,400  |      |   | 1,919,100  |  |   | 1,889,200
|                                                    |  |                          |            |      |   |            |  |   |          
|Noninterest expense                                 |  |                          |            |      |   |            |  |   |          
|Compensation and employee benefits                  |  |                          | 3,144,100  |      |   | 2,459,300  |  |   | 2,213,800
|Occupancy and equipment                             |  |                          | 1,586,100  |      |   | 1,403,200  |  |   | 1,201,800
|Data processing                                     |  |                          | 762,200    |      |   | 680,800    |  |   | 467,700  
|Professional fees                                   |  |                          | 316,700    |      |   | 216,500    |  |   | 195,400  
|Advertising and promotion                           |  |                          | 148,200    |      |   | 162,300    |  |   | 94,500   
|Other                                               |  |                          | 686,800    |      |   | 637,000    |  |   | 607,000  
|                                                    |  |                          |            |      |   |            |  |   |          
|Total noninterest expense                           |  |                          | 6,644,100  |      |   | 5,559,100  |  |   | 4,780,200
|                                                    |  |                          |            |      |   |            |  |   |          
|Income before income taxes                          |  |                          | 3,868,100  |      |   | 3,363,500  |  |   | 2,955,100
|                                                    |  |                          |           
|Income taxes                                        |  |                          | 1,192,800  |      |   | 1,010,700  |  |   | 893,000  
|                                                    |  |                          |            |      |   |            |  |   |          
|Net income                                          |  | $                        | 2,675,300  |      | $ | 2,352,800  |  | $ | 2,062,100
|                                                    |  |                          |            |      |   |            |  |   |          
|Earnings Per Common Share:                          |  |                          |            |      |   |            |  |   |          
|Basic                                               |  | $                        | 1.29       |      | $ | 1.14       |  | $ | 1.01     
|                                                    |  |                          |            |      |   |            |  |   |          
|Diluted                                             |  | $                        | 1.27       |      | $ | 1.12       |  | $ | 1.00     
|                                                    |  |                          |            |      |   |            |  |   |          



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



37



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SHORE FINANCIAL CORPORATION



Consolidated Statements of Stockholders Equity



|                                                                                              |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  
|--------------------------------------------------------------------------------------------- |  | --------------- |  | ----------- | ------- | ----------------- | - | ---------------- |  | - | ------------------------------------------ | - |  | ----- | -------- | - |  | - | ---------- | -
|                                                                                              |  | Number ofShares |  | CommonStock |         | AdditionalCapital |   | RetainedEarnings |  |   | AccumulatedOtherComprehensiveIncome (Loss) |   |  | Total |         
|Balance, December 31, 2002                                                                    |  | 1,695,817       |  | $           | 559,600 |                   | $ | 2,654,500        |  | $ | 14,394,200                                 |   |  | $     | 609,200  |   |  | $ | 18,217,500 |  
|Common stock cash dividend declared                                                           |  |                |  |             |        |                   |   |                 |  |   | (340,400                                   | ) |  |       |         |   |  |   | (340,400   | )
|Twenty Percent Common stock dividend declared                                                 |  | 341,657         |  |             | 112,800 |                   |   | 5,407,800        |  |   | (5,520,600                                 | ) |  |       |         |   |  |   |           |  
|Exercise of stock options, net of 9,750 existing shares exchanged in lieu of exercise payment |  | 24,250          |  |             | 8,000   |                   |   | 102,300          |  |   |                                           |   |  |       |         |   |  |   | 110,300    |  
|Comprehensive income                                                                          |  |                |  |             |        |                   |   |                 |  |   | 2,062,100                                  |   |  |       | 151,700  |   |  |   | 2,213,800  |  
|                                                                                              |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  
|Balance, December 31, 2003                                                                    |  | 2,061,724       |  |             | 680,400 |                   |   | 8,164,600        |  |   | 10,595,300                                 |   |  |       | 760,900  |   |  |   | 20,201,200 |  
|Common stock cash dividend declared                                                           |  |                |  |             |        |                   |   |                 |  |   | (453,700                                   | ) |  |       |         |   |  |   | (453,700   | )
|Exercise of stock options                                                                     |  | 1,560           |  |             | 500     |                   |   | 13,500           |  |   |                                           |   |  |       |         |   |  |   | 14,000     |  
|Tax benefit associated with the exercise of stock options                                     |  |                |  |             |        |                   |   | 20,900           |  |   |                                           |   |  |       |         |   |  |   | 20,900     |  
|Comprehensive income                                                                          |  |                |  |             |        |                   |   |                 |  |   | 2,352,800                                  |   |  |       | (176,200 | ) |  |   | 2,176,600  |  
|                                                                                              |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  
|Balance, December 31, 2004                                                                    |  | 2,063,284       |  |             | 680,900 |                   |   | 8,199,000        |  |   | 12,494,400                                 |   |  |       | 584,700  |   |  |   | 21,959,000 |  
|Common stock cash dividend declared                                                           |  |                |  |             |        |                   |   |                 |  |   | (538,300                                   | ) |  |       |         |   |  |   | (538,300   | )
|Exercise of stock options, net of 1,492 existing shares exchanged in lieu of exercise payment |  | 10,923          |  |             | 3,600   |                   |   | 59,100           |  |   |                                           |   |  |       |         |   |  |   | 62,700     |  
|Tax benefit associated with the exercise of stock options                                     |  |                |  |             |        |                   |   | 9,300            |  |   |                                           |   |  |       |         |   |  |   | 9,300      |  
|Comprehensive income (loss)                                                                   |  |                |  |             |        |                   |   |                 |  |   | 2,675,300                                  |   |  |       | (539,400 | ) |  |   | 2,135,900  |  
|                                                                                              |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  
|Balance, December 31, 2005                                                                    |  | 2,074,207       |  | $           | 684,500 |                   | $ | 8,267,400        |  | $ | 14,631,400                                 |   |  | $     | 45,300   |   |  | $ | 23,628,600 |  
|                                                                                              |  |                 |  |             |         |                   |   |                  |  |   |                                            |   |  |       |          |   |  |   |            |  



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



38



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SHORE FINANCIAL CORPORATION



Consolidated Statements of Cash Flows



|                                                                               |  |                          |             |   |      |   |             |      |  |   |             |  
|------------------------------------------------------------------------------ |  | ------------------------ | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                               |  | Years Ended December 31, |            
|                                                                               |  | 2005                     |             |   | 2004 |   |             | 2003 | 
|Cash flows from operating activities                                           |  |                          |             |   |      |   |             |      |  |   |             |  
|Net income                                                                     |  | $                        | 2,675,300   |   |      | $ | 2,352,800   |      |  | $ | 2,062,100   |  
|Adjustments to reconcile to net cash provided by operating activities:         |  |                          |             |   |      |   |             |      |  |   |             |  
|Provision for loan losses                                                      |  |                          | 303,700     |   |      |   | 418,800     |      |  |   | 380,400     |  
|Depreciation and amortization                                                  |  |                          | 731,500     |   |      |   | 576,400     |      |  |   | 411,300     |  
|Amortization of premium and accretion of discount on securities, net           |  |                          | 65,500      |   |      |   | 70,800      |      |  |   | 94,500      |  
|Gain on sale of investment securities                                          |  |                          | (166,400    | ) |      |   | (148,100    | )    |  |   | (269,400    | )
|Gain on sale of real estate                                                    |  |                          | (149,500    | ) |      |   |            |      |  |   |            |  
|Loss on disposal of fixed assets                                               |  |                          | 6,500       |   |      |   | 700         |      |  |   | 600         |  
|Gain on noncash donation                                                       |  |                          |            |   |      |   | (4,000      | )    |  |   |            |  
|Increase in cash surrender value of life insurance                             |  |                          | (134,600    | ) |      |   | (135,500    | )    |  |   | (145,000    | )
|Tax benefit of stock options                                                   |  |                          | 9,300       |   |      |   | 20,900      |      |  |   |            |  
|Changes in:                                                                    |  |                          |             |   |      |   |             |      |  |   |             |  
|Deferred loan fees                                                             |  |                          | (34,100     | ) |      |   | 32,800      |      |  |   | (12,400     | )
|Other assets                                                                   |  |                          | (75,000     | ) |      |   | (157,500    | )    |  |   | 15,300      |  
|Other liabilities                                                              |  |                          | (255,100    | ) |      |   | 450,600     |      |  |   | (61,400     | )
|                                                                               |  |                          |             |   |      |   |             |      |  |   |             |  
|Net cash flows from operating activities                                       |  |                          | 2,977,100   |   |      |   | 3,478,700   |      |  |   | 2,476,000   |  
|                                                                               |  |                          |             |   |      |   |             |      |  |   |             |  
|Cash flows from investing activities                                           |  |                          |             |   |      |   |             |      |  |   |             |  
|Purchase of available-for-sale securities                                      |  |                          | (3,108,400  | ) |      |   | (4,437,900  | )    |  |   | (4,502,800  | )
|Proceeds from maturities, sales and calls of available-for-sale securities     |  |                          | 9,716,600   |   |      |   | 6,481,500   |      |  |   | 6,873,600   |  
|Proceeds from maturities, prepayments and calls of held-to-maturity securities |  |                          |            |   |      |   |            |      |  |   | 5,000,000   |  
|Purchase of other investments                                                  |  |                          | (3,709,300  | ) |      |   | (638,300    | )    |  |   | (342,600    | )
|Proceeds from maturities, sales and calls of other investments                 |  |                          | 2,981,300   |   |      |   | 39,900      |      |  |   |            |  
|Proceeds from sale of real estate                                              |  |                          | 323,100     |   |      |   |            |      |  |   |             |  
|Loan originations, net of repayments                                           |  |                          | (17,144,500 | ) |      |   | (36,240,200 | )    |  |   | (23,764,800 | )
|Purchase of premises and equipment                                             |  |                          | (115,200    | ) |      |   | (3,552,600  | )    |  |   | (1,885,100  | )
|                                                                               |  |                          |             |   |      |   |             |      |  |   |             |  
|Net cash flows from investing activities                                       |  |                          | (11,056,400 | ) |      |   | (38,347,600 | )    |  |   | (18,621,700 | )
|                                                                               |  |                          |             |   |      |   |             |      |  |   |             |  



39



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SHORE FINANCIAL CORPORATION



Consolidated Statements of Cash Flows



|                                                                    |  |                          |              |   |      |   |             |      |  |   |             |  
|------------------------------------------------------------------- |  | ------------------------ | ------------ | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                    |  | Years Ended December 31, |             
|                                                                    |  | 2005                     |              |   | 2004 |   |             | 2003 | 
|Cash flows from financing activities                                |  |                          |              |   |      |   |             |      |  |   |             |  
|Net increase in demand deposits                                     |  | $                        | (2,177,400   | ) |      | $ | 21,478,200  |      |  | $ | 13,000,500  |  
|Net increase (decrease) in time deposits                            |  |                          | (1,590,000   | ) |      |   | 12,368,200  |      |  |   | (13,099,100 | )
|Proceeds from FHLB advances                                         |  |                          | 133,600,000  |   |      |   | 64,852,000  |      |  |   | 51,700,000  |  
|Repayments of FHLB advances                                         |  |                          | (121,516,700 | ) |      |   | (59,768,600 | )    |  |   | (36,966,700 | )
|Proceeds from exercise of stock options                             |  |                          | 62,700       |   |      |   | 14,000      |      |  |   | 110,300     |  
|Payment of dividends on common stock                                |  |                          | (538,300     | ) |      |   | (453,700    | )    |  |   | (340,400    | )
|                                                                    |  |                          |              |   |      |   |             |      |  |   |             |  
|Net cash flows from financing activities                            |  |                          | 7,840,300    |   |      |   | 38,490,100  |      |  |   | 14,404,600  |  
|                                                                    |  |                          |              |   |      |   |             |      |  |   |             |  
|Change in cash and cash equivalents                                 |  |                          | (239,000     | ) |      |   | 3,621,200   |      |  |   | (1,741,100  | )
|Cash and cash equivalents, beginning of year                        |  |                          | 9,415,000    |   |      |   | 5,793,800   |      |  |   | 7,534,900   |  
|                                                                    |  |                          |              |   |      |   |             |      |  |   |             |  
|Cash and cash equivalents, end of year                              |  | $                        | 9,176,000    |   |      | $ | 9,415,000   |      |  | $ | 5,793,800   |  
|                                                                    |  |                          |              |   |      |   |             |      |  |   |             |  
|                                                                    |  |                          |             
|Supplemental disclosure of cash flow information                    |  |                          |              |   |      |   |             |      |  |   |             |  
|Cash paid during the period for interest                            |  | $                        | 4,288,700    |   |      | $ | 3,167,200   |      |  | $ | 3,284,000   |  
|Cash paid during the period for income taxes                        |  | $                        | 1,158,500    |   |      | $ | 1,010,700   |      |  | $ | 1,040,000   |  
|Conversion of Trust Preferred Stock investment to common stock      |  | $                        | 72,000       |   |      | $ | 75,000      |      |  |   |            |  
|                                                                    |  |                          |             
|Supplemental schedule of noncash investing and financing activities |  |                          |              |   |      |   |             |      |  |   |             |  
|Declaration of 20% common stock dividend                            |  | $                        |             |   |      | $ |            |      |  | $ | 5,520,600   |  







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



40



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1ORGANIZATION AND BUSINESS



Shore Financial Corporation (the Company) is a Virginia corporation organized in September 1997 by Shore Bank (the Bank) for the
purpose of becoming a unitary holding company of the Bank. The Company became a unitary holding company of the Bank on March 16, 1998. The business and management of the Company consists of the business and management of the Bank. The Bank
became a Virginia chartered, Federal Reserve member, commercial bank on March 31, 1998. Previously, the Bank was a federally chartered savings bank. The Company and the Bank are headquartered on the Eastern Shore in Onley, Virginia.



The Companys assets primarily consist of approximately $4.3 million
in cash and investments and its investment in the Bank. Currently, the Company does not participate in any other activities outside of controlling the Bank. The Bank provides a full range of banking services to individual and corporate customers
through its seven banking offices located on the Eastern Shore of Virginia and Maryland, including the counties of Accomack and Northampton, Virginia, and the Salisbury/Wicomico County area in Maryland. The Companys common stock became
publicly traded in August 1997, upon completing its subscription rights and initial public offerings, which included the sale of 431,250 shares of common stock.



Shore Investments, Inc. (Shore Investments), a subsidiary of the Bank, engages in financial activities supporting the Banks
operations. These activities include, but are not limited to, the selling of investment and insurance products. The Banks subsidiary is invested in a title insurance agency and an investment company while the Company is invested in a trust
company, all of which provide services to banking customers.



NOTE
2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation and Consolidation



The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, the Bank and Shore Investments. All significant intercompany balances and transactions have been eliminated in consolidation.



Estimates



The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of real
estate owned.



Advertising



The Company expenses advertising costs as they are incurred.



Investment Securities



Investments in debt securities classified as held-to-maturity are stated at
cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Management has a positive intent and ability to hold these securities to maturity and, accordingly, adjustments are not made for temporary declines in
their market value below amortized cost. Investments in debt and equity securities classified as trading, if any, are stated at fair value. Unrealized holding gains and losses for trading securities are included in the statement of income. The
Company had no such securities during the periods reported in the financial statements. All other



41



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



investment securities with readily determinable fair values are classified as available-for-sale. Unrealized holding gains and losses on available-for-sale
securities are excluded from earnings and reported, net of tax effect, in other comprehensive income until realized.



Investments in Federal Home Loan Bank of Atlanta, Federal Reserve Bank, Community Bankers Bank and Maryland Financial Bank stock are stated at cost,
as these securities are restricted and do not have readily determinable fair values.



Gains and losses on the sale of securities are determined using the specific identification method. Other-than-temporary declines in the fair value of individual held-to-maturity and available-for-sale securities
below their cost, if any, are included in earnings as realized losses.



Loans Receivable



Loans receivable
consist of real estate loans secured by first deeds of trust on single-family residences, other residential property, commercial property and land located primarily in an area known as the Eastern Shore of Virginia and Maryland, as well as secured
and unsecured consumer and commercial loans.



Loans that
management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred
fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. 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 Bank places loans on nonaccrual status after being
delinquent greater than 90 days, or earlier, if the loans have developed inherent problems prior to being 90 days delinquent that indicate payments of principal or interest will not be made in full. Whenever the accrual of interest is stopped, a
specific allowance is established through a charge to income for previously accrued but uncollected interest income. Thereafter, interest is recognized only as cash is received until six months after the loan is brought current.



The allowance for loan losses represents an amount management believes is
adequate to provide for probable loan losses inherent in the loan portfolio. Management evaluates the allowance for loan losses on a regular basis using a methodology that considers various risk factors in accordance with SFAS No. 5,
Accounting for Contingencies. This methodology includes analyzing historical loan losses, current trends in delinquencies and charge-offs, concentrations, economic conditions, changes in the size and composition of the loan portfolio and
industry data. However, risks of future losses cannot be quantified precisely or attributed to particular loans or classes of loans. Because those risks are influenced by general economic trends as well as conditions affecting individual borrowers,
managements judgment of the allowance is necessarily approximate and imprecise. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to
calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies. In the opinion of management, the present allowance is adequate to absorb reasonably foreseeable loan losses. Additions to the
allowance are reflected in current operations. Charge-offs to the allowance are made when the loan is considered uncollectible or is transferred to real estate acquired in settlement of loans.



A loan is considered impaired when it is probable that the Bank will be
unable to collect all principal and interest amounts according to the contractual terms of the loan agreement. A performing loan may be considered



42



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



impaired. The allowance for loan losses related to loans identified as impaired is primarily based on the excess of the loans current outstanding
principal balance over the estimated fair value of the related collateral. For a loan that is not collateral-dependent, the allowance is recorded at the amount by which the outstanding principal balance exceeds the current best estimate of the
future cash flows on the loan discounted at the loans original effective interest rate. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual
consumer and residential loans for impairment disclosures.



For
impaired loans that are on nonaccrual status, cash payments received are generally applied to reduce the outstanding principal balance. However, all or a portion of a cash payment received on a nonaccrual loan may be recognized as interest income to
the extent allowed by the loan contract, assuming management expects to fully collect the remaining principal balance on the loan.



Credit Related Financial Instruments



In the ordinary course of business, the Bank has entered into commitments to extend credit, including commitments under home equity lines of credit,
overdraft protection arrangements, commercial lines of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.



Transfers of Financial Assets



Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to
be surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of conditions that restrain it from taking advantage of that right) to pledge or exchange the transferred assets, and
(3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.



Real Estate Owned



Real estate acquired through foreclosure is initially recorded at the lower of fair value or the loan balance at date of foreclosure. Subsequently,
property that is held for resale is carried at the lower of cost or fair value minus estimated selling costs. Costs relating to the development and improvement of property are capitalized, whereas those relating to holding the property are charged
to expense.



Management periodically performs valuations, and
an allowance for losses is established by a charge to operations if the carrying value of a property exceeds its fair value minus estimated selling costs.



Premises and Equipment



Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using accelerated and straight-line methods over the
estimated useful lives of the respective assets. Estimated useful lives are as follows:



|                                |  |               
|------------------------------- |  | --------------
|Buildings                       |  | 25 to 40 years
|Furniture and equipment         |  | 5 to 15 years 
|Computer equipment and software |  | 3 to 5 years  
|Automobiles                     |  | 3 to 5 years  



43



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Income Taxes



Deferred income taxes payable represent the cumulative tax effect from temporary differences in the recognition of taxable
or deductible amounts for income tax and financial reporting purposes.



Prior to July 1, 1996, in computing federal income taxes, savings banks that met certain definitional tests and other conditions prescribed by the Internal Revenue Code were allowed, within limitations, to deduct from taxable income an
allowance for bad debts based on actual loss experience, a percentage of taxable income before such deduction or an amount based on a percentage of eligible loans. The applicable percentage of taxable income used for the bad debt deduction was 8%.
Effective July 1, 1996, the percentage of taxable income method and the percentage of eligible loans method for determining the bad debt deduction are no longer available. At December 31, 2005, the cumulative bad debt reserve, upon which
no taxes have been paid on tax returns, was approximately $1.2 million. Of this amount, $783,000 represents that portion of the cumulative bad debt reserve for which financial statement income taxes have not been provided, in accordance with FASB
Statement No. 109, Accounting for Income Taxes.



Earnings Per Common Share



Basic
Earnings Per Share (EPS) excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised, converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Potential common shares that may be issued by the Company
relate solely to outstanding stock options, and are determined using the treasury stock method.



Comprehensive Income



Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets
and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.



Segment Reporting



Public business enterprises are required to report information about
operating segments in annual financial statements, and selected information about operating segments in financial reports issued to shareholders. Operating segments are components of an enterprise about which separate financial information is
available, and evaluated regularly by management in deciding how to allocate resources and in assessing performance. Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments.



Derivative Instruments and Hedging Transactions



SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. The
Company did not hold derivatives during the periods reported on in the consolidated financial statements.



44



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



On March 13, 2002, the Financial Accounting Standards Board (FASB) determined that
loan commitments related to the acquisition or origination of mortgage loans that will be held for sale must be accounted for as derivative instruments, effective for fiscal quarter beginning after April 20, 2002. Accordingly, the Company
adopted such accounting on July 1, 2002. The Company did not hold any mortgage loans for sale during the periods reported on in the consolidated financial statements.



Cash and Cash Equivalents



Cash equivalents include currency, balances due from banks, interest-earning deposits with maturities of ninety days or less
and federal funds sold.



The Company is required to maintain
reserves with the Federal Reserve Bank. The aggregate daily average reserves required for the final reporting period was $25,000 for each of the years ended December 31, 2005 and 2004, which was satisfied by the Company.



Goodwill and Other Intangibles



The Company adopted Statement of Financial Standards No. 142,
Goodwill and Other Intangible Assets (SFAS 142), effective January 1, 2002. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to an annual assessment for impairment by
applying a fair value based test. Additionally, under SFAS 142, acquired intangible assets are separately recognized if the benefit of the asset can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful life. Branch
acquisition transactions were outside the initial scope of SFAS 142 and, accordingly, intangible assets related to such transactions continued to amortize upon the adoption of SFAS 142. However, in October 2002, the FASB issued Statement
No. 147, Acquisitions of Certain Financial Institutionsan amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9. This statement amends previous interpretative guidance on the application of the
purchase method of accounting to acquisitions of financial institutions, and requires the application of FASB Statement No. 141, Business Combinations, and FASB No. 142 to branch acquisitions if such transactions meet the definition
of a business combination.



Management has evaluated the
deposit acquisition that occurred in 2002. The acquisition of the Susquehanna Bank deposits in the Salisbury, Maryland market do not qualify as a business combination and the intangible asset related to this deposit acquisition will continue to be
amortized over the estimated useful life of the deposits acquired.



Stock Compensation Plans



Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured
at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value
based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or
other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Companys stock option plans have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is
recognized for them.



45



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



The Company has elected to continue with the accounting methodology in Opinion No. 25 and, as a result, has provided pro forma disclosures of the net
income and earnings per share and other disclosures, as if the fair value based method of accounting had been applied.



Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based CompensationTransition and Disclosurean
amendment of SFAS 123, Accounting for Stock-Based Compensation, was issued by the Financial Accounting Standards Board (FASB) in December, 2002. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value-based
method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. Accordingly, the Company has incorporated such disclosures, but is still assessing the recognition provisions of the Standard.



|                                                                                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |  
|----------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                                                                                    |  | Years Ended December 31,                      |          
|                                                                                                                                    |  | 2005                                          |           |   | 2004 |   |           | 2003 | 
|                                                                                                                                    |  | (Dollars in thousands, except per share data) |          
|Net income, as reported                                                                                                             |  | $                                             | 2,675,300 |   |      | $ | 2,352,800 |      |  | $ | 2,062,100 |  
|Deduct:                                                                                                                             |  |                                               |           |   |      |   |           |      |  |   |           |  
|Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                                               | (116,600  | ) |      |   | (60,200   | )    |  |   | (57,800   | )
|                                                                                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |  
|Pro forma net income                                                                                                                |  | $                                             | 2,558,700 |   |      | $ | 2,292,600 |      |  | $ | 2,004,300 |  
|                                                                                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |  
|Earnings per share:                                                                                                                 |  |                                               |           |   |      |   |           |      |  |   |           |  
|Basicas reported                                                                                                                   |  | $                                             | 1.29      |   |      | $ | 1.14      |      |  | $ | 1.01      |  
|                                                                                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |  
|Basicpro forma                                                                                                                     |  | $                                             | 1.24      |   |      | $ | 1.11      |      |  | $ | 0.98      |  
|                                                                                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |  
|Dilutedas reported                                                                                                                 |  | $                                             | 1.27      |   |      | $ | 1.12      |      |  | $ | 1.00      |  
|                                                                                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |  
|Dilutedpro forma                                                                                                                   |  | $                                             | 1.22      |   |      | $ | 1.09      |      |  | $ | 0.97      |  
|                                                                                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |  



The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:



|                        |  |                          |   |  |       |   |  |       |  
|----------------------- |  | ------------------------ | - |  | ----- | - |  | ----- | -
|                        |  | Years Ended December 31, |  
|                        |  | 2005                     |   |  | 2004  |   |  | 2003  |  
|Dividend yield          |  | 1.44                     | % |  | 1.50  | % |  | 1.50  | %
|Expected life           |  | 5.6                      |   |  | 5.9   |   |  | 5.9   |  
|Expected volatility     |  | 25.00                    | % |  | 25.00 | % |  | 22.56 | %
|Risk-free interest rate |  | 4.30                     | % |  | 3.50  | % |  | 3.22  | %



Accounting for
Long-Lived Assets



Effective January 1, 2002, the
Company adopted FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The statement
specifies criteria for classifying assets as held for sale. The adoption of this statement did not have a material impact on the Companys financial condition and results of operations.



46



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Guarantees



FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees
(FIN 45), requires that a liability be recognized, at inception, for the fair value of certain guarantees and for the ongoing obligation, if any, to perform over the term of the guarantee. The recognition provisions of FIN 45 are
effective for certain guarantees modified or issued after December 31, 2002. The adoption of FIN 45 did not have a material impact on the Companys results of operation or financial condition.



Lease Commitments



The Company enters into lease commitments for the use of certain real estate
facilities as considered necessary to conduct its operations. These commitments are often for terms of five years with additional renewal options available and generally require monthly lease payments. These leases qualify as operating leases under
applicable accounting guidance and, therefore, the monthly lease payments are expensed as incurred.



Reclassifications



Certain reclassifications of the prior years information have been made to conform to the December 31, 2005 presentation.



Accounting Changes



In December 2004, the FASB issued Statement No. 123(R),
Share-Based Compensation, which requires the recognition of costs resulting from transactions involving the acquisition of goods and services by issuing its shares, share options, or other equity instruments. This standard requires a
fair value-based measurement method in accounting for share-based payment transactions with both employees and non-employees. This standard replaces Statement No. 123, Accounting for Stock-Based Compensation, and supersedes
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, the use of the intrinsic value method as provided under APB Opinion No. 25 will be eliminated. SFAS
No. 123(R) is effective for all awards of share-based payments granted, modified, or cancelled after June 15, 2005, except for public entities filing as small business issuers. Public entities that file as small business issuers will be
required to apply Statement 123(R) in the first interim or reporting period that begins after December 15, 2005. In addition, compensation costs for the unvested portion of awards, issued prior to and outstanding as of June 15, 2005, would
continue to be recognized at the grant-date fair value as the remaining requisite service is rendered. The potential effect of Statement No. 123(R) on the financial statements is currently being considered.



In May 2005, the FASB issued FASB Statement 154, Accounting Changes and
Error Corrections(SFAS 154), which requires retrospective application of all comparative financial statements for voluntary accounting principle changes. This statement, however, does not apply to changes in
principle due to new accounting pronouncements when the new pronouncement includes specific transition provisions. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
The adoption of this standard is currently not expected to have a material impact on the Companys consolidated results of operations and financial position in the foreseeable future.



On November 3, 2005, the FASB issued FASB Staff Position on SFAS 115 and
124, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (FSP FAS 115-1 and 124-1). This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is
other



47



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Concluded)



than temporary, and the measurement of an impairment loss. It is effective for reporting periods beginning after December 15, 2005. Accordingly, the
Company is reviewing its processes and will adopt the required accounting and disclosures.



On December 19, 2005, the FASB issued a FASB Staff Position (FSP) on American Institute of Certified Public Accountants Statement of Position 94-6, Terms of Loan Products that May Give Rise to a
Concentration of Credit Risk (FSP SOP 94-6-1). This FSP provides guidance on what circumstances, if any, do the terms of loan products, specifically nontraditional loan products, give rise to a concentration of credit risk.
Nontraditional loan products are those that expose the originator, holder, investor, guarantor, or servicer to higher risk than traditional products. Examples include interest-only loans, loans with the contractual ability to negatively amortize,
and loans with below market or teaser interest rates. FSP SOP 94-6-1 is effective for interim and annual periods ending after December 19, 2005. The adoption of this standard did not have a material impact on the Companys consolidated
results of operations and financial position.



48



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 3INVESTMENT SECURITIES



A summary of the amortized cost and estimated fair values of investment securities is as follows:



|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|------------------------------------------------------ |  | ------------- | ---------- | -------------------- | - | --------------------- |  | - | ------------------- | - |  | - | ----------
|                                                       |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|December 31, 2005                                      |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                       |  |               |            |                     
|Held-to-maturity                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|United States government and agency obligations        |  | $             |           |                      | $ |                      |  | $ |                    |   |  | $ |          
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Available-for-sale                                     |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Debt securities:                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|United States government and agency obligations        |  |               | 17,545,800 |                      |   | 13,400                |  |   | (272,600            | ) |  |   | 17,286,600
|Tax-exempt municipal bonds                             |  |               | 3,996,300  |                      |   | 5,800                 |  |   | (14,000             | ) |  |   | 3,988,100 
|Corporate bonds                                        |  |               | 2,007,700  |                      |   | 52,300                |  |   |                    |   |  |   | 2,060,000 
|Mortgage-backed securities                             |  |               | 1,527,500  |                      |   |                      |  |   | (36,000             | ) |  |   | 1,491,500 
|Adjustable Rate Mortgage Fund                          |  |               | 816,800    |                      |   |                      |  |   | (19,500             | ) |  |   | 797,300   
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Total debt securities                                  |  |               | 25,894,100 |                      |   | 71,500                |  |   | (342,100            | ) |  |   | 25,623,500
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Marketable equity securities:                          |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Federal Home Loan Mortgage Corporation common stock    |  |               | 232,400    |                      |   | 42,100                |  |   |                    |   |  |   | 274,500   
|Citigroup preferred stock                              |  |               | 1,032,900  |                      |   | 10,500                |  |   | (9,400              | ) |  |   | 1,034,000 
|Consolidated Edison preferred stock                    |  |               | 271,500    |                      |   |                      |  |   | (1,600              | ) |  |   | 269,900   
|Federal Home Loan Mortgage Corporation preferred stock |  |               | 340,400    |                      |   |                      |  |   | (3,300              | ) |  |   | 337,100   
|HBSC preferred stock                                   |  |               | 126,500    |                      |   | 1,300                 |  |   |                    |   |  |   | 127,800   
|Goldman Sachs preferred stock                          |  |               | 125,800    |                      |   | 1,700                 |  |   |                    |   |  |   | 127,500   
|Other equity securities                                |  |               | 1,758,300  |                      |   | 356,700               |  |   | (19,400             | ) |  |   | 2,095,600 
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Total marketable equity securities                     |  |               | 3,887,800  |                      |   | 412,300               |  |   | (33,700             | ) |  |   | 4,266,400 
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                       |  |               | 29,781,900 |                      |   | 483,800               |  |   | (375,800            | ) |  |   | 29,889,900
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Other investment securities:                           |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Federal Home Loan Bank Stock                           |  |               | 2,093,700  |                      |   |                      |  |   |                    |   |  |   | 2,093,700 
|Federal Reserve Bank Stock                             |  |               | 124,800    |                      |   |                      |  |   |                    |   |  |   | 124,800   
|Community Bankers Bank                                |  |               | 63,300     |                      |   |                      |  |   |                    |   |  |   | 63,300    
|Bankers Title of Hampton Roads                        |  |               | 13,300     |                      |   |                      |  |   |                    |   |  |   | 13,300    
|VBA Investment Services                                |  |               | 145,800    |                      |   |                      |  |   |                    |   |  |   | 145,800   
|Maryland Financial Bank                                |  |               | 20,000     |                      |   |                      |  |   |                    |   |  |   | 20,000    
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                       |  |               | 2,460,900  |                      |   |                      |  |   |                    |   |  |   | 2,460,900 
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                       |  | $             | 32,242,800 |                      | $ | 483,800               |  | $ | (375,800            | ) |  | $ | 32,350,800
|                                                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           



49



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 3INVESTMENT SECURITIES (Continued)



|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|--------------------------------------------------- |  | ------------- | ---------- | -------------------- | - | --------------------- |  | - | ------------------- | - |  | - | ----------
|                                                    |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|December 31, 2004                                   |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                    |  |               |            |                     
|Held-to-maturity                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|United States government and agency obligations     |  | $             |           |                      | $ |                      |  | $ |                    |   |  | $ |          
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Available-for-sale                                  |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Debt securities:                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|United States government and agency obligations     |  |               | 22,208,400 |                      |   | 150,200               |  |   | (37,000             | ) |  |   | 22,321,600
|Tax-exempt municipal bonds                          |  |               | 3,848,900  |                      |   | 42,900                |  |   |                    |   |  |   | 3,891,800 
|Corporate bonds                                     |  |               | 3,021,000  |                      |   | 156,200               |  |   |                    |   |  |   | 3,177,200 
|Mortgage-backed securities                          |  |               | 1,940,800  |                      |   | 3,500                 |  |   | (6,800              | ) |  |   | 1,937,500 
|Adjustable Rate Mortgage Fund                       |  |               | 1,589,900  |                      |   |                      |  |   | (21,100             | ) |  |   | 1,568,800 
|Adjustable Rate Commercial Loan Fund                |  |               |           |                      |   |                      |  |   |                    |   |  |   |          
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Total debt securities                               |  |               | 32,609,000 |                      |   | 352,800               |  |   | (64,900             | ) |  |   | 32,896,900
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Marketable equity securities:                       |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Federal Home Loan Mortgage Corporation common stock |  |               | 232,400    |                      |   | 77,100                |  |   |                    |   |  |   | 309,500   
|Citigroup preferred stock                           |  |               | 1,032,900  |                      |   | 30,400                |  |   |                    |   |  |   | 1,063,300 
|MBNA preferred stock                                |  |               | 131,400    |                      |   | 500                   |  |   |                    |   |  |   | 131,900   
|Consolidated Edison preferred stock                 |  |               | 543,000    |                      |   |                      |  |   | (3,000              | ) |  |   | 540,000   
|Commonwealth Bankshares trust preferred stock       |  |               | 75,000     |                      |   | 96,200                |  |   |                    |   |  |   | 171,200   
|Other equity securities                             |  |               | 1,665,500  |                      |   | 459,900               |  |   |                    |   |  |   | 2,125,400 
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Total marketable equity securities                  |  |               | 3,680,200  |                      |   | 664,100               |  |   | (3,000              | ) |  |   | 4,341,300 
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                    |  |               | 36,289,200 |                      |   | 1,016,900             |  |   | (67,900             | ) |  |   | 37,238,200
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Other investment securities:                        |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|Federal Home Loan Bank Stock                        |  |               | 1,376,500  |                      |   |                      |  |   |                    |   |  |   | 1,376,500 
|Federal Reserve Bank Stock                          |  |               | 124,800    |                      |   |                      |  |   |                    |   |  |   | 124,800   
|Community Bankers Bank                             |  |               | 63,300     |                      |   |                      |  |   |                    |   |  |   | 63,300    
|Bankers Title of Hampton Roads                     |  |               | 13,300     |                      |   |                      |  |   |                    |   |  |   | 13,300    
|VBA Investment Services                             |  |               | 135,000    |                      |   |                      |  |   |                    |   |  |   | 135,000   
|Maryland Financial Bank                             |  |               | 20,000     |                      |   |                      |  |   |                    |   |  |   | 20,000    
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                    |  |               | 1,732,900  |                      |   |                      |  |   |                    |   |  |   | 1,732,900 
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           
|                                                    |  | $             | 38,022,100 |                      | $ | 1,016,900             |  | $ | (67,900             | ) |  | $ | 38,971,100
|                                                    |  |               |            |                      |   |                       |  |   |                     |   |  |   |           



50



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 3INVESTMENT SECURITIES (Continued)



The amortized cost and estimated fair value of debt securities at December 31, 2005 by
contractual maturity, are shown below:



|                                       |  |               |            |            |   |           
|-------------------------------------- |  | ------------- | ---------- | ---------- | - | ----------
|                                       |  | AmortizedCost |            | Fair Value
|Available-for-sale                     |  |               |            |            |   |           
|Due in one year or less                |  | $             | 5,620,300  |            | $ | 5,590,200 
|Due after one year through five years  |  |               | 14,369,100 |            |   | 14,374,700
|Due after five years through ten years |  |               | 3,964,700  |            |   | 3,758,800 
|Due after ten years                    |  |               | 1,123,200  |            |   | 1,102,500 
|Adjustable Rate Mortgage Fund          |  |               | 816,800    |            |   | 797,300   
|                                       |  |               |            |            |   |           
|                                       |  | $             | 25,894,100 |            | $ | 25,623,500
|                                       |  |               |            |            |   |           



At December 31,
2005 and 2004, investment securities with a carrying value of approximately $1.6 million were pledged as collateral for public deposits.



For the years ended December 31, 2005, 2004 and 2003, proceeds from the sales of securities available for sale amounted to $1.5 million, $1.0 million
and $1.7 million, respectively. Gross realized gains amounted to $189,000, $182,000 and $288,000, respectively, while gross realized losses were $23,000, $34,000 and $19,000, respectively. The tax provision applicable to these net realized gains and
losses amounted to $56,000, $50,000 and $91,000, respectively.



The following table summarizes the Companys investments gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position,
at December 31, 2005.



|                                                |  |                     |            |                  |                   |          |            |       |                  |           |  |            |          |                  |  |   |            |  |   |          |  
|----------------------------------------------- |  | ------------------- | ---------- | ---------------- | ----------------- | -------- | ---------- | ----- | ---------------- | --------- |  | ---------- | -------- | ---------------- |  | - | ---------- |  | - | -------- | -
|                                                |  | Less Than 12 Months |            |                  | 12 Months or More |          |            | Total |                 
|Description of Securities                       |  | Fair Value          |            | UnrealizedLosses |                   |          | Fair Value |       | UnrealizedLosses |           |  | Fair Value |          | UnrealizedLosses | 
|United States government and agency obligations |  | $                   | 8,677,700  |                  | $                 | (144,500 | )          |       | $                | 5,944,100 |  | $          | (128,100 | )                |  | $ | 14,621,800 |  | $ | (272,600 | )
|Tax-exempt municipal bonds                      |  |                     | 1,721,200  |                  |                   | (14,000  | )          |       |                  |          |  |            |         |                  |  |   | 1,721,200  |  |   | (14,000  | )
|Corporate bonds                                 |  |                     |           |                  |                   |         |            |       |                  |          |  |            |         |                  |  |   |           |  |   |         |  
|Mortgage-backed securities                      |  |                     | 1,102,500  |                  |                   | (20,600  | )          |       |                  | 389,000   |  |            | (15,400  | )                |  |   | 1,491,500  |  |   | (36,000  | )
|Adjustable Rate Mortgage Fund                   |  |                     |           |                  |                   |         |            |       |                  | 797,300   |  |            | (19,500  | )                |  |   | 797,300    |  |   | (19,500  | )
|                                                |  |                     |            |                  |                   |          |            |       |                  |           |  |            |          |                  |  |   |            |  |   |          |  
|Subtotal, debt securities                       |  |                     | 11,501,400 |                  |                   | (179,100 | )          |       |                  | 7,130,400 |  |            | (163,000 | )                |  |   | 18,631,800 |  |   | (342,100 | )
|                                                |  |                     |            |                  |                   |          |            |       |                  |           |  |            |          |                  |  |   |            |  |   |          |  
|Federal Home Loan Mortgage                      |  |                     |            |                  |                   |          |            |       |                  |           |  |            |          |                  |  |   |            |  |   |          |  
|Corporation common stock                        |  |                     |           |                  |                   |         |            |       |                  |          |  |            |         |                  |  |   |           |  |   |         |  
|Preferred stock                                 |  |                     | 1,122,000  |                  |                   | (14,300  | )          |       |                  |          |  |            |         |                  |  |   | 1,122,000  |  |   | (14,300  | )
|Other equity securities                         |  |                     | 175,700    |                  |                   | (19,400  | )          |       |                  |          |  |            |         |                  |  |   | 175,700    |  |   | (19,400  | )
|                                                |  |                     |            |                  |                   |          |            |       |                  |           |  |            |          |                  |  |   |            |  |   |          |  
|Subtotal, equity securities                     |  |                     | 1,297,700  |                  |                   | (33,700  | )          |       |                  |          |  |            |         |                  |  |   | 1,297,700  |  |   | (33,700  | )
|                                                |  |                     |            |                  |                   |          |            |       |                  |           |  |            |          |                  |  |   |            |  |   |          |  
|Total temporarily impaired securities           |  | $                   | 12,799,100 |                  | $                 | (212,800 | )          |       | $                | 7,130,400 |  | $          | (163,000 | )                |  | $ | 19,929,500 |  | $ | (375,800 | )
|                                                |  |                     |            |                  |                   |          |            |       |                  |           |  |            |          |                  |  |   |            |  |   |          |  



51



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 3INVESTMENT SECURITIES (Concluded)



There are a total of thirty-four securities that have unrealized losses as of December 31, 2005:
sixteen United States government and agency securities, three United States agency MBS securities, one adjustable rate mortgage fund security, five municipal securities, three preferred stock securities, five equity securities, one FHLMC common
stock security. The debt securities are obligations of entities that are excellent credit risks. The impairment as noted is the result of interest rate market conditions and does not reflect on the ability of the issuers to repay the debt
obligations. The preferred stock category represents ownership in three reputable companies whose credit ratings remain strong as measured by Moodys and S&P. The losses in the equity securities, including the FHLMC common stock, represent
normal swings in the equity markets. The impairment is the result of interest rate market conditions and there is a high probability of full recovery of investment. The Company maintains the ability and intent to hold all securities for the
foreseeable future.



Other investment securities are accounted
for using the cost method and are not included in the evaluation of impairment. However, these investments were reviewed by management and no identified events or changes in circumstances were identified that may have a significant adverse effect on
their fair value.



NOTE 4LOANS RECEIVABLE



Loans receivable are summarized below:



|                                         |  |              |             |      |   |             |  
|---------------------------------------- |  | ------------ | ----------- | ---- | - | ----------- | -
|                                         |  | December 31, |            
|                                         |  | 2005         |             | 2004 |  
|Real estate loans:                       |  |              |             |      |   |             |  
|Coventional mortgage:                    |  |              |             |      |   |             |  
|Secured by one-to-four family residences |  | $            | 71,721,300  |      | $ | 64,488,500  |  
|Commercial mortgages                     |  |              | 61,916,600  |      |   | 59,414,400  |  
|Land                                     |  |              | 25,524,400  |      |   | 22,048,300  |  
|Short-term construction                  |  |              | 14,966,200  |      |   | 9,882,100   |  
|Home equity lines of credit              |  |              | 15,293,100  |      |   | 15,580,800  |  
|Consumer loans                           |  |              | 2,559,000   |      |   | 2,378,200   |  
|Commercial loans:                        |  |              |             |      |   |             |  
|Secured                                  |  |              | 6,154,000   |      |   | 5,999,500   |  
|Unsecured                                |  |              | 3,435,500   |      |   | 2,674,300   |  
|                                         |  |              |             |      |   |             |  
|Total loans                              |  |              | 201,570,100 |      |   | 182,466,100 |  
|Less:                                    |  |              |             |      |   |             |  
|Loans in process                         |  |              | 5,940,600   |      |   | 4,224,400   |  
|Deferred loan fees (costs), net          |  |              | 82,300      |      |   | (158,000    | )
|Allowance for loan losses                |  |              | 2,850,700   |      |   | 2,404,500   |  
|                                         |  |              |             |      |   |             |  
|                                         |  | $            | 192,696,500 |      | $ | 175,995,200 |  
|                                         |  |              |             |      |   |             |  



52



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 4LOANS RECEIVABLE (Concluded)



The allowance for loan losses is summarized below:



|                               |  |                          |           |      |   |           |      |  |   |          
|------------------------------ |  | ------------------------ | --------- | ---- | - | --------- | ---- |  | - | ---------
|                               |  | Years Ended December 31,
|                               |  | 2005                     |           | 2004 |   |           | 2003
|Balance at beginning of period |  | $                        | 2,404,500 |      | $ | 2,002,500 |      |  | $ | 1,603,200
|Provision charged to expense   |  |                          | 303,700   |      |   | 418,800   |      |  |   | 380,400  
|(Charge-offs) recoveries, net  |  |                          | 142,500   |      |   | (16,800   | )    |  |   | 18,900   
|                               |  |                          |           |      |   |           |      |  |   |          
|Balance at end of the period   |  | $                        | 2,850,700 |      | $ | 2,404,500 |      |  | $ | 2,002,500
|                               |  |                          |           |      |   |           |      |  |   |          



There was $314,000 of
impaired loans identified at December 31, 2005. Impaired loans have a valuation allowance allocation of $47,000 at December 31, 2005. No loans were identified as impaired at December 31, 2004. For the years ended December 31,
2005, 2004 and 2003, the average recorded investment in impaired loans was $100,000, $30,000 and $187,000, respectively, and interest income recognized on impaired loans, all on the cash basis, was $15,000, $11,000 and $18,000, respectively. No
additional funds are committed to be advanced in connection with impaired loans. At December 31, 2005, nonaccrual loans were $1.1 million and no loans existed that are past due 90 days or more and still accruing interest.



NOTE 5PREMISES AND EQUIPMENT



Premises and equipment are summarized as follows:



|                              |  |              |            |   |      |   |            |  
|----------------------------- |  | ------------ | ---------- | - | ---- | - | ---------- | -
|                              |  | December 31, |           
|                              |  | 2005         |            |   | 2004 |  
|Land                          |  | $            | 739,500    |   |      | $ | 714,500    |  
|Buildings                     |  |              | 6,845,900  |   |      |   | 7,034,000  |  
|Furniture and fixtures        |  |              | 2,272,400  |   |      |   | 2,178,400  |  
|Computer equipment & software |  |              | 897,000    |   |      |   | 698,200    |  
|Automobiles                   |  |              | 89,100     |   |      |   | 89,100     |  
|Construction in process       |  |              | 6,100      |   |      |   | 37,500     |  
|                              |  |              |            |   |      |   |            |  
|                              |  |              | 10,850,000 |   |      |   | 10,751,700 |  
|Lessaccumulated depreciation |  |              | (3,385,400 | ) |      |   | (2,726,800 | )
|                              |  |              |            |   |      |   |            |  
|                              |  | $            | 7,464,600  |   |      | $ | 8,024,900  |  
|                              |  |              |            |   |      |   |            |  



Depreciation expense
for the years ended December 31, 2005, 2004 and 2003 amounted to $666,400, $511,300 and $369,800, respectively.



53



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 6DEPOSITS



Deposits accounts are summarized below:



|                              |  |              |             |      |   |            
|----------------------------- |  | ------------ | ----------- | ---- | - | -----------
|                              |  | December 31,
|                              |  | 2005         |             | 2004
|Demand deposits:              |  |              |             |      |   |            
|Noninterest-bearing           |  | $            | 28,864,700  |      | $ | 24,495,000 
|                              |  |              |             |      |   |            
|Interest-bearing:             |  |              |             |      |   |            
|Savings accounts              |  |              | 21,960,200  |      |   | 22,641,600 
|Checking accounts             |  |              | 27,343,500  |      |   | 28,264,700 
|Money market deposit accounts |  |              | 25,714,900  |      |   | 28,355,500 
|                              |  |              |             |      |   |            
|Total interest-bearing        |  |              | 75,018,600  |      |   | 79,261,800 
|                              |  |              |             |      |   |            
|Total demand deposits         |  |              | 103,883,300 |      |   | 103,756,800
|Time deposits                 |  |              | 85,086,400  |      |   | 88,980,300 
|                              |  |              |             |      |   |            
|                              |  | $            | 188,969,700 |      | $ | 192,737,100
|                              |  |              |             |      |   |            



The aggregate amount
of certificates of deposit with a minimum denomination of $100,000 was approximately $19.2 million and $19.5 million at December 31, 2005 and 2004, respectively.



Time deposits outstanding at December 31, 2005 mature as follows:



|                    |  |   |           
|------------------- |  | - | ----------
|Within one year     |  | $ | 41,769,000
|One to two years    |  |   | 8,692,000 
|Two to three years  |  |   | 20,054,000
|Three to four years |  |   | 4,392,000 
|Four to five years  |  |   | 8,960,000 
|Thereafter          |  |   | 1,219,400 
|                    |  |   |           
|                    |  | $ | 85,086,400
|                    |  |   |           



54



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 7FAIR VALUE OF FINANCIAL INSTRUMENTS



The estimated fair values of the Banks financial instruments as of December 31, 2005 and 2004 are as follows:



|                                        |  |                |         |            |   |        
|--------------------------------------- |  | -------------- | ------- | ---------- | - | -------
|                                        |  | CarryingAmount |         | Fair Value
|                                        |  | (in thousands)
|December 31, 2005                       |  |                |         |            |   |        
|                                        |  |               
|Financial assets                        |  |                |         |            |   |        
|Cash and cash equivalents               |  | $              | 9,176   |            | $ | 9,176  
|Securities                              |  | $              | 32,351  |            | $ | 32,351 
|Loans, net of allowance for loan losses |  | $              | 192,697 |            | $ | 194,924
|Accrued interest receivable             |  | $              | 1,008   |            | $ | 1,008  
|Financial liabilities                   |  |                |         |            |   |        
|Deposits                                |  | $              | 188,970 |            | $ | 188,842
|Advances from Federal Home Loan Bank    |  | $              | 34,050  |            | $ | 34,460 
|Accrued interest payable                |  | $              | 181     |            | $ | 181    
|Unrecognized financial instruments      |  |                |         |            |   |        
|Commitments to extend credit            |  |                | N/A     |            |   | N/A    
|                                        |  |               
|December 31, 2004                       |  |                |         |            |   |        
|                                        |  |               
|Financial assets                        |  |                |         |            |   |        
|Cash and cash equivalents               |  | $              | 9,415   |            | $ | 9,415  
|Securities                              |  | $              | 38,971  |            | $ | 38,971 
|Loans, net of allowance for loan losses |  | $              | 175,995 |            | $ | 178,835
|Accrued interest receivable             |  | $              | 921     |            | $ | 921    
|Financial liabilities                   |  |                |         |            |   |        
|Deposits                                |  | $              | 192,737 |            | $ | 192,753
|Advances from Federal Home Loan Bank    |  | $              | 21,967  |            | $ | 21,981 
|Accrued interest payable                |  | $              | 164     |            | $ | 164    
|Unrecognized financial instruments      |  |                |         |            |   |        
|Commitments to extend credit            |  |                | N/A     |            |   | N/A    



The following methods
and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.



Cash and cash equivalents



For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.



Securities



Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market
prices for similar securities. For restricted securities without readily determinable values, the carrying amount is considered a reasonable estimate of fair value.



Loan receivables



The fair value of loans is estimated by discounting future cash flows, using market rates at which similar loans would be made to borrowers with similar
remaining maturities. This calculation ignores loan fees and



55



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 7FAIR VALUE OF FINANCIAL INSTRUMENTS (Concluded)



certain factors affecting the interest rates charged on various loans, such as the borrowers creditworthiness and compensating balances, and dissimilar
types of real estate held as collateral.



Deposit
liabilities



The fair value of demand deposits, savings
accounts, and certain money market deposits is the amount payable on demand at the balance sheet date. The fair value of fixed-maturity certificates of deposit is estimated by discounting remaining maturities amounts using market rates for similar
replacement funding sources.



Accrued interest receivable
and payable



The carrying amounts of accrued interest
receivable and payable approximate their fair values.



Advances from Federal Home Loan Bank



The
carrying value of advances from the Federal Home Loan Bank due within ninety days from the balance sheet date approximates fair value. For those borrowings that mature beyond ninety days, the fair value of the borrowing is estimated by discounting
future cash flows, using the current rates at which similar borrowings would be obtained from the Federal Home Loan Bank with similar remaining maturities.



Commitments to extend credit



The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of
the agreements and the present creditworthiness of the borrowers. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Because of the competitive nature of the
marketplace, loan fees vary greatly with no fees charged in many cases. Therefore, management has concluded no value should be assigned.



NOTE 8ADVANCES FROM FEDERAL HOME LOAN BANK



Borrowings (advances) from the Federal Home Loan Bank (FHLB) are scheduled to mature as follows:



|                    |  |              |            |      |   |           
|------------------- |  | ------------ | ---------- | ---- | - | ----------
|                    |  | December 31,
|                    |  | 2005         |            | 2004
|Within one year     |  | $            | 27,500,000 |      | $ | 21,350,000
|One to two years    |  |              | 2,000,000  |      |   |          
|More than two years |  |              | 4,550,000  |      |   | 616,700   
|                    |  |              |            |      |   |           
|                    |  | $            | 34,050,000 |      | $ | 21,966,700
|                    |  |              |            |      |   |           



Information regarding
FHLB advances is summarized below:



|                                                    |  |                          |            |      |   |           
|--------------------------------------------------- |  | ------------------------ | ---------- | ---- | - | ----------
|                                                    |  | Years Ended December 31,
|                                                    |  | 2005                     |            | 2004
|Monthly average balance of borrowings outstanding   |  | $                        | 28,601,000 |      | $ | 12,626,600
|Maximum month-end balance of borrowings outstanding |  | $                        | 37,066,700 |      | $ | 21,966,700



56



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 8ADVANCES FROM FEDERAL HOME LOAN BANK (Concluded)



The weighted average interest rate on advances was 3.59%, 1.97% and 1.78% for the years ended
December 31, 2005, 2004 and 2003, respectively. These advances are collateralized by the Banks investment in FHLB stock, qualifying real estate loans with a principal balance of approximately $84.4 million, and government agency and
mortgage-backed securities with a fair market value of approximately $11.3 million held under a specific collateral agreement. The Bank has an available line of credit with the FHLB for up to 25% of Bank assets, or approximately $61.2 million at
December 31, 2005. However, the Bank may request an increase in this borrowing capacity from the FHLB. At December 31, 2005 the Bank had sufficient collateral pledged to borrow a total of approximately $73.0 million from the FHLB. The
borrowing capacity is subject to certain collateral requirements as stipulated in the FHLB borrowing agreement.



NOTE 9OTHER NONINTEREST INCOME AND EXPENSE



Other noninterest income and expense consists of the following:



|                                            |  |                          |         |      |   |         |  |   |        
|------------------------------------------- |  | ------------------------ | ------- | ---- | - | ------- |  | - | -------
|                                            |  | Years Ended December 31,
|                                            |  | 2005                     |         | 2004 |   | 2003   
|Other noninterest income                    |  |                          |         |      |   |         |  |   |        
|Credit life commissions                     |  | $                        | 2,100   |      | $ | 9,700   |  | $ | 5,100  
|Income from real estate held for investment |  |                          | 31,600  |      |   | 41,400  |  |   | 26,200 
|Safe deposit box rental                     |  |                          | 21,200  |      |   | 21,600  |  |   | 19,900 
|Increase in BOLI cash surrender value       |  |                          | 134,700 |      |   | 135,500 |  |   | 145,000
|Gain on disposal of fixed assets            |  |                          |        |      |   | 1,400   |  |   |       
|Miscellaneous fees and commissions          |  |                          | 67,300  |      |   | 69,100  |  |   | 64,400 
|                                            |  |                          |         |      |   |         |  |   |        
|                                            |  | $                        | 256,900 |      | $ | 278,700 |  | $ | 260,600
|                                            |  |                          |         |      |   |         |  |   |        
|Other noninterest expense                   |  |                          |         |      |   |         |  |   |        
|Education and seminars                      |  | $                        | 39,200  |      | $ | 30,100  |  | $ | 31,900 
|Personnel costs                             |  |                          | 77,700  |      |   | 55,800  |  |   | 58,900 
|Travel                                      |  |                          | 34,300  |      |   | 23,400  |  |   | 20,000 
|Courier cost                                |  |                          | 26,700  |      |   | 27,900  |  |   | 27,600 
|Supervisory fees                            |  |                          | 30,400  |      |   | 40,800  |  |   | 38,400 
|Loan costs                                  |  |                          | 48,300  |      |   | 51,500  |  |   | 56,400 
|ATM/VISA check card fees                    |  |                          | 95,700  |      |   | 79,400  |  |   | 82,500 
|Internet banking fees                       |  |                          | 154,700 |      |   | 105,600 |  |   | 70,000 
|Insurance                                   |  |                          | 36,200  |      |   | 36,500  |  |   | 33,300 
|Bank service charges                        |  |                          | 70,900  |      |   | 69,100  |  |   | 60,900 
|Deposit account write-offs                  |  |                          | 26,300  |      |   | 79,000  |  |   | 66,600 
|REO property expense                        |  |                          |        |      |   | 2,400   |  |   | 700    
|Loss on disposal of fixed assets            |  |                          | 6,500   |      |   |        |  |   | 600    
|Miscellaneous                               |  |                          | 39,900  |      |   | 35,500  |  |   | 59,200 
|                                            |  |                          |         |      |   |         |  |   |        
|                                            |  | $                        | 686,800 |      | $ | 637,000 |  | $ | 607,000
|                                            |  |                          |         |      |   |         |  |   |        



57



---

SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 10INCOME TAXES



The provision for income taxes (benefit) is summarized below:



|         |  |                          |           |   |      |   |           |  |   |         |  
|-------- |  | ------------------------ | --------- | - | ---- | - | --------- |  | - | ------- | -
|         |  | Years Ended December 31, |          
|         |  | 2005                     |           |   | 2004 |   | 2003      | 
|Current  |  |                          |           |   |      |   |           |  |   |         |  
|Federal  |  | $                        | 1,378,300 |   |      | $ | 960,900   |  | $ | 971,100 |  
|State    |  |                          | 2,000     |   |      |   | 11,700    |  |   | 12,000  |  
|         |  |                          |           |   |      |   |           |  |   |         |  
|         |  |                          | 1,380,300 |   |      |   | 972,600   |  |   | 983,100 |  
|         |  |                          |           |   |      |   |           |  |   |         |  
|Deferred |  |                          |           |   |      |   |           |  |   |         |  
|Federal  |  |                          | (187,500  | ) |      |   | 38,100    |  |   | (90,100 | )
|State    |  |                          |          |   |      |   |          |  |   |        |  
|         |  |                          |           |   |      |   |           |  |   |         |  
|         |  |                          | (187,500  | ) |      |   | 38,100    |  |   | (90,100 | )
|         |  |                          |           |   |      |   |           |  |   |         |  
|Total    |  |                          |           |   |      |   |           |  |   |         |  
|Federal  |  |                          | 1,190,800 |   |      |   | 999,000   |  |   | 881,000 |  
|State    |  |                          | 2,000     |   |      |   | 11,700    |  |   | 12,000  |  
|         |  |                          |           |   |      |   |           |  |   |         |  
|         |  | $                        | 1,192,800 |   |      | $ | 1,010,700 |  | $ | 893,000 |  
|         |  |                          |           |   |      |   |           |  |   |         |  



|                                                 |  |              |         |      |   |         |  
|------------------------------------------------ |  | ------------ | ------- | ---- | - | ------- | -
|                                                 |  | December 31, |        
|                                                 |  | 2005         |         | 2004 |  
|Deferred tax asset                               |  |              |         |      |   |         |  
|Bad debts and other provisions                   |  | $            | 960,000 |      | $ | 818,000 |  
|Other                                            |  |              | 2,900   |      |   |        |  
|                                                 |  |              |         |      |   |         |  
|Total deferred tax asset                         |  |              | 962,900 |      |   | 818,000 |  
|                                                 |  |              |         |      |   |         |  
|Deferred tax liability                           |  |              |         |      |   |         |  
|FHLB stock                                       |  |              | 70,000  |      |   | 70,000  |  
|Depreciation                                     |  |              | 431,000 |      |   | 460,000 |  
|Unrealized gain on securities available for sale |  |              | 36,000  |      |   | 322,000 |  
|Other                                            |  |              |        |      |   | 13,600  |  
|                                                 |  |              |         |      |   |         |  
|Total deferred tax liability                     |  |              | 537,000 |      |   | 865,600 |  
|                                                 |  |              |         |      |   |         |  
|Net deferred tax liability                       |  | $            | 425,900 |      | $ | (47,600 | )
|                                                 |  |              |         |      |   |         |  



The differences
between expected federal and state income tax expense at statutory rates to actual income tax expense are summarized as follows:



|                                             |  |                          |           |   |      |   |           |      |  |   |           |  
|-------------------------------------------- |  | ------------------------ | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                             |  | Years Ended December 31, |          
|                                             |  | 2005                     |           |   | 2004 |   |           | 2003 | 
|Federal income tax expenseat statutory rate |  | $                        | 1,315,000 |   |      | $ | 1,144,000 |      |  | $ | 1,005,000 |  
|Tax effect of:                               |  |                          |           |   |      |   |           |      |  |   |           |  
|Tax exempt interest income                   |  |                          | (50,000   | ) |      |   | (57,000   | )    |  |   | (43,000   | )
|BOLI cash surrender value increase           |  |                          | (46,000   | ) |      |   | (46,000   | )    |  |   | (49,000   | )
|Dividends received deduction                 |  |                          | (42,000   | ) |      |   | (38,000   | )    |  |   | (27,000   | )
|Other, net                                   |  |                          | 15,800    |   |      |   | 7,700     |      |  |   | 7,000     |  
|                                             |  |                          |           |   |      |   |           |      |  |   |           |  
|                                             |  | $                        | 1,192,800 |   |      | $ | 1,010,700 |      |  | $ | 893,000   |  
|                                             |  |                          |           |   |      |   |           |      |  |   |           |  



58



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11STOCKHOLDERS EQUITY



The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Companys financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Company and its banking subsidiary must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.



Quantitative measures established by regulation to ensure capital adequacy
require the Company and its banking subsidiary to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average
assets (as defined). Management believes, as of December 31, 2005, that the Company and the Bank meet all capital adequacy requirements to which they are subject.



As of December 31, 2005, the most recent notification from the Federal Deposit Insurance Corporation categorized the
Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table.
There are no conditions or events since that notification that management believes have changed the Banks category. The Company and the Banks actual capital amounts and ratios are presented in the table.



|                                          |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|----------------------------------------- |  | ---------------------- | ------ | ----- | ---------------------------- | - | ------ | ------------------------------------------------------------- | ------ |  | ---- | ------ |  | ----- | ------ |  | ----- | -
|                                          |  | Actual                 |        |       | For CapitalAdequacy Purposes |   |        | To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                                          |  | Amount                 |        | Ratio |                              |   | Amount |                                                               | Ratio  |  |      | Amount |  | Ratio |       
|                                          |  | (Dollars in Thousands) |       
|As of December 31, 2005:                  |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|Total Capital (to Risk-Weighted Assets):  |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|Consolidated                              |  | $                      | 25,433 |       | 14.53                        | % |        | $                                                             | 13,999 |  | 8.00 | %      |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |                        | 21,500 |       | 12.54                        | % |        |                                                               | 13,720 |  | 8.00 | %      |  |       | 17,150 |  | 10.00 | %
|                                          |  |                        |        |       |                              |  
|Tier 1 Capital (to Risk-Weighted Assets): |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|Consolidated                              |  | $                      | 23,120 |       | 13.21                        | % |        | $                                                             | 6,999  |  | 4.00 | %      |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |                        | 19,345 |       | 11.28                        | % |        |                                                               | 6,860  |  | 4.00 | %      |  |       | 10,290 |  | 6.00  | %
|                                          |  |                        |        |       |                              |  
|Tier 1 Capital (to Average Assets):       |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|Consolidated                              |  | $                      | 23,120 |       | 9.44                         | % |        | $                                                             | 9,799  |  | 4.00 | %      |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |                        | 19,345 |       | 7.97                         | % |        |                                                               | 9,708  |  | 4.00 | %      |  |       | 12,135 |  | 5.00  | %
|                                          |  |                        |        |       |                              |  
|As of December 31, 2004:                  |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|Total Capital (to Risk-Weighted Assets):  |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|Consolidated                              |  | $                      | 23,144 |       | 14.14                        | % |        | $                                                             | 13,091 |  | 8.00 | %      |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |                        | 19,257 |       | 12.02                        | % |        |                                                               | 12,815 |  | 8.00 | %      |  |       | 16,018 |  | 10.00 | %
|                                          |  |                        |        |       |                              |  
|Tier 1 Capital (to Risk-Weighted Assets): |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|Consolidated                              |  | $                      | 20,848 |       | 12.74                        | % |        | $                                                             | 6,546  |  | 4.00 | %      |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |                        | 17,220 |       | 10.75                        | % |        |                                                               | 6,407  |  | 4.00 | %      |  |       | 9,611  |  | 6.00  | %
|                                          |  |                        |        |       |                              |  
|Tier 1 Capital (to Average Assets):       |  |                        |        |       |                              |   |        |                                                               |        |  |      |        |  |       |        |  |       |  
|Consolidated                              |  | $                      | 20,848 |       | 9.62                         | % |        | $                                                             | 8,672  |  | 4.00 | %      |  | $     | N/A    |  | N/A   |  
|Shore Bank                                |  |                        | 17,220 |       | 8.04                         | % |        |                                                               | 8,571  |  | 4.00 | %      |  |       | 10,713 |  | 5.00  | %



59



---

SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 11STOCKHOLDERS EQUITY (Concluded)



Federal and state banking regulations place certain restrictions on dividends paid and loans or
advances made by the Bank to the Company. The total amount of dividends that may be paid at any date is generally limited to the retained earnings (as defined) for the Bank for the current and past two years, and loans or advances are limited to 10
percent of the Banks capital stock and surplus on a secured basis. In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Banks capital to be reduced below applicable minimum
capital requirements.



At December 31, 2005, the
Banks retained earnings available for the payment of dividends was $4.3 million. Accordingly, $15.3 million of the Companys equity in the net assets of the Bank was restricted at December 31, 2005. Funds available for loans or
advances by the Bank to the Company amounted to $400,000.



During the year ended December 31, 2005, the Company paid quarterly cash dividends of $0.06 per share for the first and second quarters and $0.07 per share for the third and fourth quarters. During the year ended December 31,
2004, the Company paid quarterly cash dividends of $0.05 per share for the first and second quarters and $0.06 per share for the third and fourth quarters. During the year ended December 31, 2003, the Company paid quarterly cash dividends of
$0.04 per share for the first three quarters and $0.048 per share in the fourth quarter. During December 2003, the Company declared a 20% stock dividend paid on December 31, 2003 to shareholders of record on December 20, 2003. All 2003
dividends per share have been adjusted to reflect the December 2003 20% stock dividend. On January 10, 2006, the Company declared a $0.07 per share quarterly cash dividend paid on February 1, 2006 to shareholders of record on
January 23, 2006.



During October 2001, the Companys
Board of Directors approved a Dividend Reinvestment Plan (DRIP Plan) whereby shareholders may elect to have cash dividends paid by the Company reinvested in its common stock, subject to certain limitations. Shareholders may also make
optional cash payments to purchase additional shares of the Companys common stock. The DRIP Plan document details the plan and was sent to each shareholder during November 2001.



NOTE 12EMPLOYEE BENEFIT PLANS



401k Profit Sharing Plan



The Companys 401k Profit Sharing Plan Trust (the Plan) provides for retirement, death and disability benefits. An employee becomes
eligible for participation in the Plan on the first day of the month following their ninety day anniversary date with the Company. However, an employee must be employed on the last day of the year to be eligible for profit sharing under the Plan.



Employees may elect to defer 2%-15% of their compensation,
with the Company making matching contributions equal to 100% of the first 3% of compensation deferred, and 50% of the next 3%. Matching contributions made by the Company under the Plan totaled approximately $87,600, $66,300 and $66,600 for the years
ended December 31, 2005, 2004 and 2003, respectively. The Company may also elect to make discretionary contributions to the Plan. Accordingly, $106,000, $96,000 and $78,000 of such contributions were made during the years ended
December 31, 2005, 2004 and 2003, respectively.



Stock Option Plans



The Company currently has one stock option plan for
employees in effectthe 2001 Stock Incentive Plan (the 2001 Plan). The 1992 Stock Option Plan expired. But certain options deemed earned are still exercisable.



60



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 12EMPLOYEE BENEFIT PLANS (Continued)



The Companys 2001 Plan is designed to attract and retain qualified personnel in key positions, provide employees with a proprietary interest in the
Company as an incentive to contribute to the success of the Company and the Bank and reward employees for outstanding performance and the attainment of targeted goals. The 2001 Plan provides for the grant of incentive stock options intended to
comply with the requirements of Section 422 of the Internal Revenue Code of 1986 (incentive stock options), as well as nonqualified stock options.



The 2001 Plan, approved by the Companys shareholders on April 17, 2001, provides up to 324,000 shares of common
stock (as adjusted for the December 2003 20% stock dividend) for granting restricted stock awards and stock options in the form of incentive stock options and nonstatutory stock options to employees of the Company. The 2001 Plan also provides for
the granting of restricted stock awards. The 2001 Plan expires on April 16, 2011.



The 2001 Plan is administered by the Compensation Committee formed by the Companys Board of Directors, each member of which is a nonemployee director as defined in Rule 16b-3 under the Securities
Exchange Act of 1934. The 2001 Plan is in effect for a period of ten years from the date of adoption by the Board of Directors.



Under the 2001 Plan, the committee determines which employees will be granted options, whether such options will be incentive or nonqualified options, the
number of shares subject to each option, whether such options may be exercised by delivering other shares of common stock and when such options become exercisable. In general, the per share exercise price of an incentive stock option shall be at
least equal to the fair market value of a share of common stock on the date the option is granted. The per share exercise price of a nonqualified stock option shall be not less than 50% of the fair market value of a share of common stock on the date
the option is granted.



Stock options shall become vested and
exercisable in the manner specified by the committee. In general, each stock option or portion thereof shall be exercisable at any time on or after it vests and is exercisable for periods of up to 10 years after its date of grant. Stock options are
nontransferable except by will or the laws of descent and distribution.



The committee also determines which employees will be awarded restricted stock and the number of shares to be awarded. The value of the restricted stock is to be at least equal to the fair market value of the common stock on the date the
stock is granted. No shares of restricted stock have been awarded.



During the years ended December 31, 2005, 2004 and 2003, the Company granted 25,462, 15,172 and 15,367 incentive stock options under the 2001 Plan at an average exercise price of $18.70, $16.20 and $10.68, respectively, and granted
8,800, 8,350 and 7,260 nonqualified stock options under the 2001 plan at an average exercise price of $19.68, $16.20 and $10.68, respectively.



61



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 12EMPLOYEE BENEFIT PLANS (Concluded)



The following table represents options outstanding under the Stock Option Plan:



|                                               |  |                          |  |                               |       |         |        |                               |   |         |  |                               |  |   |      
|---------------------------------------------- |  | ------------------------ |  | ----------------------------- | ----- | ------- | ------ | ----------------------------- | - | ------- |  | ----------------------------- |  | - | -----
|                                               |  | Years Ended December 31,
|                                               |  | 2005                     |  | 2004                          |       | 2003   
|                                               |  | Options                  |  | Weighted-AverageExercisePrice |       | Options |        | Weighted-AverageExercisePrice |   | Options |  | Weighted-AverageExercisePrice
|Outstandingbeginning of year                  |  | 92,899                   |  | $                             | 10.12 |         | 72,007 |                               | $ | 7.84    |  | 88,260                        |  | $ | 7.27 
|Granted                                        |  | 34,262                   |  |                               | 18.95 |         | 23,522 |                               |   | 16.20   |  | 22,627                        |  |   | 10.68
|Exercised                                      |  | 12,415                   |  |                               | 7.46  |         | 1,560  |                               |   | 8.99    |  | 37,200                        |  |   | 7.36 
|Forfeited                                      |  | 1,365                    |  |                               | 15.13 |         | 1,070  |                               |   | 13.33   |  | 1,680                         |  |   | 11.33
|                                               |  |                          |  |                               |       |         |        |                               |   |         |  |                               |  |   |      
|Outstandingend of year                        |  | 113,381                  |  | $                             | 13.02 |         | 92,899 |                               | $ | 10.12   |  | 72,007                        |  | $ | 7.84 
|                                               |  |                          |  |                               |       |         |        |                               |   |         |  |                               |  |   |      
|Exercisableend of year                        |  | 112,581                  |  | $                             | 13.01 |         | 92,899 |                               | $ | 10.12   |  | 72,007                        |  | $ | 7.84 
|                                               |  |                          |  |                               |       |         |        |                               |   |         |  |                               |  |   |      
|Weighted average fair value of options granted |  |                          |  | $                             | 3.91  |         |        |                               | $ | 3.91    |  |                               |  | $ | 1.78 
|                                               |  |                          |  |                               |       |         |        |                               |   |         |  |                               |  |   |      



During 2003, 9,750
shares of outstanding common stock were exchanged in lieu of payment towards the exercise price of 22,039 of the total shares exercised during the year. During 2004, no outstanding shares were exchanged towards the exercise of stock options, while
1,492 outstanding shares were exchanged towards the exercise of stock options during 2005.



Other information pertaining to options outstanding at December 31, 2005 is as follows:



|                         |  |                     |  |                                                  |  |                              |       |                   |        |                              |   |      
|------------------------ |  | ------------------- |  | ------------------------------------------------ |  | ---------------------------- | ----- | ----------------- | ------ | ---------------------------- | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                             
|Range of Exercise Prices |  | NumberOutstanding   |  | Weighted AverageRemainingContractual Life(Years) |  | WeightedAverageExercisePrice |       | NumberExercisable |        | WeightedAverageExercisePrice
|$  6.02  $10.68         |  | 57,847              |  | 5.47                                             |  | $                            | 8.37  |                   | 57,847 |                              | $ | 8.37 
|$16.20  $19.68          |  | 55,534              |  | 7.48                                             |  | $                            | 17.86 |                   | 54,734 |                              | $ | 17.84



NOTE 13RELATED PARTY
TRANSACTIONS



In the normal course of business, the Bank
makes loans to and receives deposits from directors, officers and other related parties. Loans to employees are made on substantially the same terms as those prevailing at the time for comparable transactions with other borrowers, except that the
interest rate is reduced by a stated amount for primary residence loans, as long as such person remains employed by the Bank. At December 31, 2005, total deposit balances outstanding of related parties were $2.5 million. A summary of related
party loan activity for the periods indicated is as follows:



|                           |  |   |            |  
|-------------------------- |  | - | ---------- | -
|Balance, December 31, 2004 |  | $ | 3,368,000  |  
|Originations/Disbursements |  |   | 802,000    |  
|Repayments                 |  |   | (1,225,000 | )
|                           |  |   |            |  
|Balance, December 31, 2005 |  | $ | 2,945,000  |  
|                           |  |   |            |  



62



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 13RELATED PARTY TRANSACTIONS (Concluded)



The Bank has a lease agreement with the Banks former Chairman of the Board of Directors to
lease a lot at Four Corners Plaza, Onley, Virginia, for $2,000 per month expiring in 2009 with two five-year renewals. Each renewal will be at the option of the Bank and the leases will be based on the previous lease rate, after being adjusted for
changes in the consumer price index. Shore Investments Inc. has a lease agreement with a partnership whereby the Companys Chairman of the Board is the majority partner. The lease is for property located in Accomac, Virginia at $1,000 per month
expiring in 2010 with two five-year renewal options available if the Bank chooses to exercise them.



Through January 2003, the Bank had a lease agreement with a Maryland general partnership, of which a related party is a general partner, providing for the
use of commercial office space to facilitate the Banks downtown Salisbury, Maryland branch location. The lease term began in September 1997 and was renewed during August 2002. The agreement originally provided for three five-year renewal
periods at the Banks option and monthly lease amounts during the lease term were $2,250. However, pursuant to the Banks purchase option within the lease agreement, it purchased the building from the general partnership during early 2003
for $680,000. Accordingly, lease payments related to this lease ceased during early 2003.



All related party transactions were consummated in terms equivalent to those that prevail in arms length transactions.



NOTE 14COMMITMENTS AND CONTINGENCIES AND OTHER RELATED PARTY TRANSACTIONS



Minimum future lease payments for these operating leases are as follows:



|                          |  |   |        
|------------------------- |  | - | -------
|Years Ending December 31, |  |   |        
|2006                      |  | $ | 36,100 
|2007                      |  | $ | 36,100 
|2008                      |  | $ | 36,100 
|2009                      |  | $ | 36,100 
|2010                      |  | $ | 36,100 
|                          |  |   |        
|                          |  | $ | 180,500
|                          |  |   |        



Rental expense under
operating leases was $30,600, $47,600 and $56,100 for the years ended December 31, 2005, 2004 and 2003, respectively.



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



Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each
customers credit worthiness on a



63



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 14COMMITMENTS AND CONTINGENCIES AND OTHER RELATED PARTY TRANSACTIONS
(Concluded)



case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on managements credit
evaluation of the counter party. Collateral held varies but may include single-family residences, other residential property, commercial property and land. At December 31, 2005 and 2004, the Bank had outstanding commitments to originate loans,
including outstanding construction loan commitments, with variable interest rates of approximately $15.5 million and $9.0 million, respectively. In addition, unused lines of credit, primarily at variable rates, amounted to approximately $31.3
million and $37.0 million at December 31, 2005 and 2004, respectively. Standby letters of credit at December 31, 2005 and 2004 were $1.3 million and $812,000, respectively. The distribution of commitments to extend credit approximates the
distribution of loans outstanding.



In the normal course of
business, the Bank has entered into employment agreements with some of its key executives. The Company may terminate the employment agreements with proper notice as specified in the agreements. Termination without cause (as defined in the agreement)
entitles the executive to base salary and benefits for a specified period of time from the date of termination, depending on the agreement.



The Bank has an agreement with a service company whereby the latter furnishes data processing services to the Bank. The contract was last renewed during
2005 for an additional 60 months that is similar to the previous agreement and to those entered into by other entities in the financial institution industry. The costs represent normal operating costs to the Bank.



Shore Investments Inc. had an agreement with a registered broker-dealer to
sell investment products. However, this agreement was terminated during 2003 and a new agreement was entered into with another registered broker-dealer. The terms of the new agreement are similar to those under the prior agreement. The agreement has
no expiration date, but can be terminated by either party with ninety days notice.



Various legal claims also arise from time to time in the normal course of business that, in the opinion of management, will have no material effect on the Companys consolidated financial statements.



NOTE 15EARNINGS PER SHARE RECONCILIATION



The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations.



|                                                  |  |                          |           |      |   |           |  |   |          
|------------------------------------------------- |  | ------------------------ | --------- | ---- | - | --------- |  | - | ---------
|                                                  |  | Years Ended December 31,
|                                                  |  | 2005                     |           | 2004 |   | 2003     
|Net income (numerator, basic and diluted)         |  | $                        | 2,675,300 |      | $ | 2,352,800 |  | $ | 2,062,100
|Weighted average shares outstanding (denominator) |  |                          | 2,070,900 |      |   | 2,062,400 |  |   | 2,036,300
|                                                  |  |                          |           |      |   |           |  |   |          
|Earnings per common sharebasic                   |  | $                        | 1.29      |      | $ | 1.14      |  | $ | 1.01     
|                                                  |  |                          |           |      |   |           |  |   |          
|Effect of dilutive securities:                    |  |                          |           |      |   |           |  |   |          
|                                                  |  |                          |          
|Weighted average shares outstanding               |  |                          | 2,070,900 |      |   | 2,062,400 |  |   | 2,036,300
|Effect of stock options                           |  |                          | 30,200    |      |   | 33,800    |  |   | 31,900   
|                                                  |  |                          |           |      |   |           |  |   |          
|Diluted average shares outstanding (denominator)  |  |                          | 2,101,100 |      |   | 2,096,200 |  |   | 2,068,200
|                                                  |  |                          |           |      |   |           |  |   |          
|Earnings per common shareassuming dilution       |  | $                        | 1.27      |      | $ | 1.12      |  | $ | 1.00     
|                                                  |  |                          |           |      |   |           |  |   |          



64



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 16PARENT COMPANY



Since its inception, the Companys business activities have been limited to investment activities related to the Bank
and its excess cash. Dividends and management fees from the Bank and investment income represent the only sources of funds for the Company. Certain restrictions exist that limit the amount of dividends the Bank may declare without obtaining
regulatory approval. At December 31, 2005, the Bank had approximately $4.3 million available to declare in dividends under existing regulatory guidelines.



The Companys primary costs consist of its employees compensation expense, board of directors expenses, public reporting requirements
and annual fees associated with being a public company. During the years ended December 31, 2005, 2004 and 2003, the Bank paid the Company management fees of $431,000, $410,000 and $430,000, respectively, for its proportion of operating costs.



The Companys condensed balance sheets as of
December 31, 2005 and 2004, and the related condensed statements of income and cash flows for years ended December 31, 2005, 2004 and 2003 are provided below:



Condensed Balance Sheets



|                                           |  |              |            |      |   |           
|------------------------------------------ |  | ------------ | ---------- | ---- | - | ----------
|                                           |  | December 31,
|                                           |  | 2005         |            | 2004
|Assets                                     |  |              |            |      |   |           
|Cash and due from banks                    |  | $            | 320,000    |      | $ | 372,000   
|Securities available-for-sale              |  |              | 3,943,000  |      |   | 3,960,000 
|Investment in Shore Bank                   |  |              | 19,647,000 |      |   | 17,991,000
|Other assets                               |  |              | 140,000    |      |   | 131,000   
|                                           |  |              |            |      |   |           
|Total assets                               |  | $            | 24,050,000 |      | $ | 22,454,000
|                                           |  |              |            |      |   |           
|Liabilities and Stockholders Equity       |  |              |            |      |   |           
|Liabilities                                |  | $            | 421,000    |      | $ | 495,000   
|Stockholders equity                       |  |              | 23,629,000 |      |   | 21,959,000
|                                           |  |              |            |      |   |           
|Total liabilities and stockholders equity |  | $            | 24,050,000 |      | $ | 22,454,000
|                                           |  |              |            |      |   |           



65



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 16PARENT COMPANY (Continued)



Condensed Statements of Income



|                                                                                |  |                          |           |      |   |           |  |   |          
|------------------------------------------------------------------------------- |  | ------------------------ | --------- | ---- | - | --------- |  | - | ---------
|                                                                                |  | Years Ended December 31,
|                                                                                |  | 2005                     |           | 2004 |   | 2003     
|Income                                                                          |  |                          |           |      |   |           |  |   |          
|Dividends from Shore Bank                                                       |  | $                        | 500,000   |      | $ |          |  | $ |         
|Management Fees                                                                 |  |                          | 431,000   |      |   | 410,000   |  |   | 430,000  
|Investment income                                                               |  |                          | 171,000   |      |   | 162,000   |  |   | 151,000  
|Gain on sales of securities                                                     |  |                          | 185,000   |      |   | 149,000   |  |   | 262,000  
|                                                                                |  |                          |           |      |   |           |  |   |          
|Total income                                                                    |  |                          | 1,287,000 |      |   | 721,000   |  |   | 843,000  
|                                                                                |  |                          |           |      |   |           |  |   |          
|Expenses                                                                        |  |                          |           |      |   |           |  |   |          
|Compensation and benefits                                                       |  |                          | 412,000   |      |   | 418,000   |  |   | 400,000  
|Directors fees                                                                 |  |                          | 93,000    |      |   | 77,000    |  |   | 59,000   
|Accounting and professional fees                                                |  |                          | 97,000    |      |   | 75,000    |  |   | 102,000  
|Other                                                                           |  |                          | 73,000    |      |   | 72,000    |  |   | 73,000   
|                                                                                |  |                          |           |      |   |           |  |   |          
|Total expenses                                                                  |  |                          | 675,000   |      |   | 642,000   |  |   | 634,000  
|                                                                                |  |                          |           |      |   |           |  |   |          
|Income before income taxes and equity in undistributed net income of subsidiary |  |                          | 612,000   |      |   | 79,000    |  |   | 209,000  
|Income tax expense                                                              |  |                          |          |      |   |          |  |   | 26,000   
|                                                                                |  |                          |           |      |   |           |  |   |          
|Income before equity in undistributed net income of subsidiary                  |  |                          | 612,000   |      |   | 79,000    |  |   | 183,000  
|Equity in undistributed net income of subsidiary (1)                            |  |                          | 2,063,000 |      |   | 2,274,000 |  |   | 1,879,000
|                                                                                |  |                          |           |      |   |           |  |   |          
|Net income                                                                      |  | $                        | 2,675,000 |      | $ | 2,353,000 |  | $ | 2,062,000
|                                                                                |  |                          |           |      |   |           |  |   |          



66



---

SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 16PARENT COMPANY (Concluded)



Projected Condensed Statements of Cash Flows



|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  
|--------------------------------------------------- |  | ------------------------ | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                    |  | Years Ended December 31, |           
|                                                    |  | 2005                     |            |   | 2004 |   |            | 2003 | 
|Operating Activities                                |  |                          |            |   |      |   |            |      |  |   |            |  
|Net income                                          |  | $                        | 2,675,000  |   |      | $ | 2,353,000  |      |  | $ | 2,062,000  |  
|Equity in undistributed net income of subsidiary    |  |                          | (2,063,000 | ) |      |   | (2,274,000 | )    |  |   | (1,879,000 | )
|Other non-cash transactions                         |  |                          |           |   |      |   | 10,000     |      |  |   |           |  
|Gain on sale of securities                          |  |                          | (185,000   | ) |      |   | (149,000   | )    |  |   | (262,000   | )
|Tax benefit from stock options                      |  |                          | 9,000      |   |      |   | 21,000     |      |  |   |           |  
|Change in other assets                              |  |                          | (9,000     | ) |      |   | 7,000      |      |  |   | (101,000   | )
|Change in other liabilities                         |  |                          | 9,000      |   |      |   | (13,000    | )    |  |   | 138,000    |  
|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  
|Cash flows from operating activities                |  |                          | 436,000    |   |      |   | (45,000    | )    |  |   | (42,000    | )
|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  
|Investing Activities                                |  |                          |            |   |      |   |            |      |  |   |            |  
|Proceeds from sale of available-for-sale securities |  |                          | 855,000    |   |      |   | 885,000    |      |  |   | 1,024,000  |  
|Purchase of available-for-sale securities           |  |                          | (877,000   | ) |      |   | (598,000   | )    |  |   | (923,000   | )
|Sale of premises and equipment                      |  |                          |           |   |      |   | 266,000    |      |  |   |           |  
|Other investing activities                          |  |                          |           |   |      |   |           |      |  |   | 53,000     |  
|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  
|Cash flows from investing activities                |  |                          | (22,000    | ) |      |   | 553,000    |      |  |   | 154,000    |  
|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  
|Financing Activities                                |  |                          |            |   |      |   |            |      |  |   |            |  
|Proceeds from exercise of common stock options      |  |                          | 72,000     |   |      |   | 14,000     |      |  |   | 110,000    |  
|Payment of dividends on common stock                |  |                          | (538,000   | ) |      |   | (454,000   | )    |  |   | (340,000   | )
|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  
|Cash flows from financing activities                |  |                          | (466,000   | ) |      |   | (440,000   | )    |  |   | (230,000   | )
|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  
|Change in cash and cash equivalents                 |  |                          | (52,000    | ) |      |   | 68,000     |      |  |   | (118,000   | )
|                                                    |  |                          |           
|Cash and cash equivalents, beginning of period      |  |                          | 372,000    |   |      |   | 304,000    |      |  |   | 422,000    |  
|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  
|Cash and cash equivalents, end of period            |  | $                        | 320,000    |   |      | $ | 372,000    |      |  | $ | 304,000    |  
|                                                    |  |                          |            |   |      |   |            |      |  |   |            |  



67



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 17QUARTERLY CONDENSED STATEMENTS OF INCOMEUNAUDITED



Quarterly Condensed Statements of IncomeUnaudited



|                                                    |  |                     |           |         |   |              |  |             |           |  |   |          
|--------------------------------------------------- |  | ------------------- | --------- | ------- | - | ------------ |  | ----------- | --------- |  | - | ---------
|                                                    |  | 2005 Quarters Ended
|                                                    |  | March 31            |           | June 30 |   | September 30 |  | December 31
|Total interest and dividend income                  |  | $                   | 3,022,900 |         | $ | 3,115,200    |  | $           | 3,311,400 |  | $ | 3,401,000
|Net interest income after provision for loan losses |  |                     | 1,994,900 |         |   | 1,964,700    |  |             | 2,058,900 |  |   | 2,114,300
|Noninterest income                                  |  |                     | 522,200   |         |   | 563,900      |  |             | 672,600   |  |   | 620,700  
|Noninterest expense                                 |  |                     | 1,600,500 |         |   | 1,639,100    |  |             | 1,716,900 |  |   | 1,687,600
|Income before income taxes                          |  |                     | 916,600   |         |   | 889,500      |  |             | 1,014,600 |  |   | 1,047,400
|Net income                                          |  |                     | 631,100   |         |   | 613,700      |  |             | 700,100   |  |   | 730,400  
|Earnings per common sharediluted                   |  |                     | 0.30      |         |   | 0.29         |  |             | 0.33      |  |   | 0.35     
|Dividends per common share                          |  |                     | 0.06      |         |   | 0.06         |  |             | 0.07      |  |   | 0.07     
|                                                    | 
|                                                    |  | 2004 Quarters Ended
|                                                    |  | March 31            |           | June 30 |   | September 30 |  | December 31
|Total interest and dividend income                  |  | $                   | 2,487,600 |         | $ | 2,543,100    |  | $           | 2,767,100 |  | $ | 2,899,700
|Net interest income after provision for loan losses |  |                     | 1,632,600 |         |   | 1,642,700    |  |             | 1,819,300 |  |   | 1,908,900
|Noninterest income                                  |  |                     | 519,100   |         |   | 459,200      |  |             | 436,400   |  |   | 505,100  
|Noninterest expense                                 |  |                     | 1,278,000 |         |   | 1,292,900    |  |             | 1,393,000 |  |   | 1,595,900
|Income before income taxes                          |  |                     | 873,700   |         |   | 809,000      |  |             | 862,700   |  |   | 818,100  
|Net income                                          |  |                     | 600,800   |         |   | 556,100      |  |             | 593,200   |  |   | 602,700  
|Earnings per common sharediluted                   |  |                     | 0.29      |         |   | 0.26         |  |             | 0.28      |  |   | 0.29     
|Dividends per common share                          |  |                     | 0.05      |         |   | 0.05         |  |             | 0.06      |  |   | 0.06     



NOTE 18SEGMENT INFORMATION



Management determines the Companys operating
segments and evaluates their performance by the markets in which the Bank operates. Currently, the Bank operates in two different geographical markets: Virginia and Maryland. Generally, each market possesses a different customer base and
occasionally requires that management approach product pricing and promotion in different manners. However, products offered in each market are similar. Additionally, the Maryland market represents a newer market to the Bank than does the Virginia
market.



The accounting policies of the segments are the same
as those described in the summary of significant accounting policies. The Company evaluates performance based on net interest income from operations and asset growth within the segments.



68



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SHORE FINANCIAL CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 18SEGMENT INFORMATION (Concluded)



Since the Company derives a significant portion of its revenues from interest income and interest
expense is the most significant expense, the segments are reported below using net interest income for the periods indicated. The Other column primarily represents the Companys investment activities resulting from excess cash
available within the individual segments. The Elimination column represents intersegment activities and reconciles the segments to the Companys consolidated financial statements.



|                             |  |                |         |          |   |        |  |                                        |        |  |       |         |   |  |   |        
|---------------------------- |  | -------------- | ------- | -------- | - | ------ |  | -------------------------------------- | ------ |  | ----- | ------- | - |  | - | -------
|                             |  | Virginia       |         | Maryland |   | Other  |  | Elimination ofIntersegmentTransactions |        |  | Total
|                             |  | (In thousands)
|Net Interest Income:         |  |                |         |          |   |        |  |                                        |        |  |       |         |   |  |   |        
|Year ended December 31, 2005 |  | $              | 5,982   |          | $ | 1,690  |  | $                                      | 572    |  | $     | 193     |   |  | $ | 8,437  
|Year ended December 31, 2004 |  | $              | 5,254   |          | $ | 1,323  |  | $                                      | 1,297  |  | $     | (452    | ) |  | $ | 7,422  
|Year ended December 31, 2003 |  | $              | 4,589   |          | $ | 852    |  | $                                      | 1,591  |  | $     | (805    | ) |  | $ | 6,227  
|                             |  |                |         |          |  
|Assets:                      |  |                |         |          |   |        |  |                                        |        |  |       |         |   |  |   |        
|December 31, 2005            |  | $              | 186,922 |          | $ | 46,145 |  | $                                      | 45,042 |  | $     | (30,690 | ) |  | $ | 247,419
|December 31, 2004            |  | $              | 178,140 |          | $ | 47,566 |  | $                                      | 53,756 |  | $     | (41,773 | ) |  | $ | 237,689



NOTE 19BRANCH DEPOSIT
ACQUISITION



On December 13, 2002, the Bank acquired
certain assets and assumed certain liabilities of the Salisbury, Maryland branch of Susquehanna Bank, a wholly-owned subsidiary of Susquehanna Bankshares Inc. The approximate fair value of the net assets acquired and deposit liabilities assumed
amounted to $50,000 and $17.5 million, respectively. The Bank realized proceeds of approximately $16.8 million from the transaction, net of a deposit premium intangible of $620,000. The Bank is amortizing this intangible over ten years. During the
years ended December 31, 2005, 2004 and 2003, the Bank realized amortization expense of $62,000, $62,000 and $62,000 respectively, on this asset and the accumulated amortization for the periods then ended was $186,000, $124,000 and $62,000,
respectively.



NOTE 20COMPREHENSIVE INCOME



Total comprehensive income consists of the following for the years
indicated:



|                                  |  |                          |           |   |      |   |           |      |  |   |          
|--------------------------------- |  | ------------------------ | --------- | - | ---- | - | --------- | ---- |  | - | ---------
|                                  |  | Years Ended December 31,
|                                  |  | 2005                     |           |   | 2004 |   |           | 2003
|Net income                        |  | $                        | 2,675,300 |   |      | $ | 2,352,800 |      |  | $ | 2,062,100
|Other comprehensive income (loss) |  |                          | (539,400  | ) |      |   | (176,200  | )    |  |   | 151,700  
|                                  |  |                          |           |   |      |   |           |      |  |   |          
|Total comprehensive income        |  | $                        | 2,135,900 |   |      | $ | 2,176,600 |      |  | $ | 2,213,800
|                                  |  |                          |           |   |      |   |           |      |  |   |          



The components of
other comprehensive income are as follows for the years indicated:



|                                                              |  |                          |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------- |  | ------------------------ | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                              |  | Years Ended December 31, |         
|                                                              |  | 2005                     |          |   | 2004 |   |          | 2003 | 
|Unrealized gains (losses) on available-for-sale securities:   |  |                          |          |   |      |   |          |      |  |   |          |  
|Unrealized holding gains (losses) arising during the period   |  | $                        | (674,600 | ) |      | $ | (127,900 | )    |  | $ | 550,400  |  
|Less: reclassification adjustment for gain included in income |  |                          | (166,400 | ) |      |   | (148,100 | )    |  |   | (269,400 | )
|                                                              |  |                          |          |   |      |   |          |      |  |   |          |  
|Total other comprehensive gain (loss) before tax effect       |  |                          | (841,000 | ) |      |   | (276,000 | )    |  |   | 281,000  |  
|                                                              |  |                          |         
|Tax benefit (expense)                                         |  |                          | 301,600  |   |      |   | 99,800   |      |  |   | (129,300 | )
|                                                              |  |                          |          |   |      |   |          |      |  |   |          |  
|Net unrealized gain (loss)                                    |  | $                        | (539,400 | ) |      | $ | (176,200 | )    |  | $ | 151,700  |  
|                                                              |  |                          |          |   |      |   |          |      |  |   |          |  



69



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Board of Directors and Stockholders

Shore Financial Corporation and Subsidiaries



We have audited the accompanying consolidated balance sheets of Shore Financial Corporation and Subsidiaries as of December 31, 2005
and 2004, and the related consolidated statements of income, shareholders equity and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the
Banks management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.



In our
opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Shore Financial Corporation and Subsidiaries as of December 31, 2005 and 2004, and the results of their operations
and their cash flows for each of the years in the three-year period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.



LOGO

Norfolk, Virginia

January 27,
2006



70



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|Item 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------



None.



|Item 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------



Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have
evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the year. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls
and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.



Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial
officer, as appropriate, to allow timely decisions regarding required disclosure.



71



---

PART III



|Item 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|-------- | --------------------------------------------------



The following provides information on the only executive officer of the Company who is not a director of the Company and is not included in the Proxy
Statement:



|                 |  |     |  |                                                                                                                                  
|---------------- |  | --- |  | ---------------------------------------------------------------------------------------------------------------------------------
|Name             |  | Age |  | Position                                                                                                                         
|Steven M. Belote |  | 40  |  | Vice President, Chief Financial Officer andSecretary of the Company; Senior Vice Presidentand Chief Financial Officer of the Bank



|Item 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------



|Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------



|Item 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|-------- | ----------------------------------------------



|Item 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES
|-------- | --------------------------------------



Other than as specified above, and pursuant to General Instructions E(3), the information called for by Part III, Items 10. through 14., are
incorporated herein by reference from the Companys definitive proxy statement for the Companys Annual Meeting of Shareholders to be held on April 18, 2006, which will be filed with the Securities and Exchange Commission within 120
days of December 31, 2005.



72



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PART IV



|Item 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES
|-------- | ---------------------------------------



The following documents are filed as part of this report:



(a)(1) Financial Statements



The following consolidated financial statements and reports of independent auditors of the Company are in Part II, Item 8 on pages 36 thru
70:



Consolidated Balance SheetsDecember 31, 2005 and
2004



Consolidated Statements of IncomeYears ended
December 31, 2005, 2004 and 2003



Consolidated Statements of
Changes in Stockholders EquityYears ended December 31, 2005, 2004 and 2003



Consolidated Statements of Cash FlowsYears ended December 31, 2005, 2004 and 2003



Notes to Consolidated Financial Statements



Report of Independent Registered Public Accounting Firm



(a)(2) Financial Statement Schedules



All schedules are omitted since they are not required, are not applicable, or the required information is
shown in the consolidated financial statements or notes thereto.



(a)(3) The following exhibits are filed as part of this Form 10-K and this list includes the Exhibit Index.



|     |  |                                                                                                                          
|---- |  | -------------------------------------------------------------------------------------------------------------------------
|No.  |  | Description                                                                                                              
|3.1  |  | Articles of Incorporation of Registrant.*                                                                                
|     | 
|3.2  |  | Bylaws of Registrant.*                                                                                                   
|     | 
|10.1 |  | Companys 1992 Incentive Stock Option Plan.*                                                                             
|     | 
|10.2 |  | Amended and Restated Employment Agreement between the Company and Scott C. Harvard.***                                   
|     | 
|10.3 |  | Management Continuity Agreement between the Company and Scott C. Harvard.***                                             
|     | 
|10.4 |  | Companys 2001 Stock Incentive Plan.****                                                                                 
|     | 
|10.5 |  | Form of Employment Agreement between the Company and each of J. Anderson Duer, Jr. and Steven M. Belote (filed herewith).
|     | 
|11.0 |  | Earnings Per Share Computation.**                                                                                        
|     | 
|13.0 |  | 2005 Annual Report to Shareholders (filed herewith).                                                                     
|     | 
|21.0 |  | Subsidiaries of the RegistrantReference is made to Item 1. Business or the required information.                      
|     | 
|31.1 |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).     
|     | 
|31.2 |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).     
|     | 
|32.1 |  | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).     
|     | 
|32.2 |  | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).     

---

|* | Incorporated herein by reference from the Companys Registration Statement on Form S-4 (Registration No. 333-35389) filed by the Company with the Commission on
September 15, 1997.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



73



---

|** | Information required herein is incorporated by reference from Note 15 on page 58 of the financial statements attached hereto to this Form 10-K.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------



|*** | Incorporated herein by reference from the Companys Annual Report on Form 10-KSB for the year ended December 31, 2001.
|--- | ----------------------------------------------------------------------------------------------------------------------



|**** | Incorporated herein by reference from the Companys Registration Statement on Form S-8 (Registration No. 333-82838) filed by the Company with the Commission on
February 15, 2002.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



74



---

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.



SHORE FINANCIAL CORPORATIONBy:

/s/    SCOTT C.
HARVARDScott C. HarvardPresident and Chief Executive OfficerDated: March 20, 2006




Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.



|                                                |  |                                                             |  |               
|----------------------------------------------- |  | ----------------------------------------------------------- |  | --------------
|Signature                                       |  | Capacity                                                    |  | Date          
|                                                |  |                                                            
|/s/    HENRY P. CUSTIS,
JR.Henry P. Custis,
Jr. |  | Chairman of the Board and Director                          |  | March 20, 2006
|                                                |  |                                                            
|/s/    SCOTT C.
HARVARDScott C.
Harvard         |  | President (Principal Executive Officer) and Director        |  | March 20, 2006
|                                                |  |                                                            
|/s/    STEVEN M.
BELOTESteven M.
Belote         |  | Vice President (Principal Financial and Accounting Officer) |  | March 20, 2006
|                                                |  |                                                            
|/s/    TERRELL E.
BOOTHETerrell E.
Boothe       |  | Director                                                    |  | March 20, 2006
|                                                |  |                                                            
|/s/    D. PAGE ELMORED. Page Elmore             |  | Director                                                    |  | March 20, 2006
|                                                |  |                                                            
|/s/    RICHARD F. HALL,
IIIRichard F. Hall, III |  | Director                                                    |  | March 20, 2006
|                                                |  |                                                            
|/s/    LLOYD J. KELLAM,
IIILloyd J. Kellam, III |  | Director                                                    |  | March 20, 2006
|                                                |  |                                                            
|/s/    L. DIXON
LEATHERBURYL. Dixon
Leatherbury |  | Director                                                    |  | March 20, 2006



75