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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended March 31, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to Commission File Number 0-18279 Tri-County Financial Corporation   Maryland
    

52-1652138(State of other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)3035 Leonardtown Road,
Waldorf, Maryland
    
    20601(Address of principal executive offices)
    
    (Zip Code)
 (301) 843-0854   Not applicable   Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act).
Yes o No þ As of April 26, 2005, the registrant had 1,163,336 shares of common stock outstanding.




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TRI-COUNTY FINANCIAL CORPORATION  FORM 10-Q
    
    INDEX
 PagePART I  FINANCIAL INFORMATIONItem 1 - Financial Statements (Unaudited)Consolidated Balance Sheets  March 31, 2005
and December 31, 2004
    
    3Consolidated Statements of Income and Comprehensive Income -
Three Months Ended March 31, 2005 and 2004
    
    4 - 5Consolidated Statements of Cash Flows  Three Months
Ended March 31, 2005 and 2004
    
    6 - 7Notes to Consolidated Financial Statements
    
    8 - 10Item 2- Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    11 - 16Item 3 - Quantitative and Qualitative Disclosures about Market Risk
    
    16Item 4  Controls and Procedures
    
    16PART II  OTHER INFORMATIONItem 1  Legal Proceedings
    
    17Item 2  Unregistered Sales of Equity Securities and Use of Proceeds
    
    17Item 3  Defaults Upon Senior Securities
    
    17Item 4  Submission of Matters to a Vote of Security Holders
    
    17Item 5  Other Information
    
    17Item 6  Exhibits
    
    17SIGNATURES
    
    18EX-31 SECTION 302, CERTIFICATION OF THE CEOEX-32 SECTION 906, CERTIFICATION OF THE CFO




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PART I  FINANCIAL INFORMATION 
 ITEM I. FINANCIAL STATEMENTS
 TRI-COUNTY FINANCIAL CORPORATION
 
 CONSOLIDATED BALANCE SHEETS MARCH 31, 2005 AND DECEMBER 31, 2004
 March 31, 2005
    
    
    December 31, 2004(Unaudited)ASSETSCash and due from banks
    
    $
    3,685,193
    
    
    $
    6,018,096Federal Funds sold
    
    
    297,526
    
    
    
    777,519Interest-bearing deposits with banks
    
    
    11,899,569
    
    
    
    10,920,164Securities available for sale  at fair value
    
    
    10,716,985
    
    
    
    12,948,971Securities held to maturity  at amortized cost
    
    
    171,539,879
    
    
    
    162,741,155Federal Home Loan Bank and Federal Reserve Bank stock  at cost
    
    
    7,461,500
    
    
    
    6,144,300Loans receivable  net of allowance for loan losses
of $3,120,585 and $3,057,558, respectively
    
    
    316,947,399
    
    
    
    289,325,051Premises and equipment, net
    
    
    6,535,118
    
    
    
    6,011,913Foreclosed real estate
    
    
    475,561
    
    
    
    475,561Accrued interest receivable
    
    
    2,086,200
    
    
    
    1,870,135Investment in bank-owned life insurance
    
    
    6,244,084
    
    
    
    6,182,955Other assets
    
    
    2,111,663
    
    
    
    2,351,303TOTAL ASSETS
    
    $
    540,000,677
    
    
    $
    505,767,123LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIES:Noninterest-bearing deposits
    
    $
    39,257,084
    
    
    $
    35,552,503Interest-bearing deposits
    
    
    241,306,544
    
    
    
    231,202,001Total deposits
    
    
    280,563,628
    
    
    
    266,754,504Short-term borrowings
    
    
    125,064,912
    
    
    
    115,304,210Long-term debt
    
    
    92,848,897
    
    
    
    82,931,113Guaranteed preferred beneficial interest in junior subordinated
debentures
    
    
    7,000,000
    
    
    
    7,000,000Accrued expenses and other liabilities
    
    
    2,501,187
    
    
    
    2,653,721Total liabilities
    
    
    507,978,624
    
    
    
    474,643,548STOCKHOLDERS EQUITY:Common stock  par value $.01; authorized - 15,000,000 shares;
issued 1,158,320 and 1,146,864 shares
    
    
    11,583
    
    
    
    11,469Additional paid in capital
    
    
    8,435,572
    
    
    
    8,252,152Retained earnings
    
    
    23,815,705
    
    
    
    22,833,112Accumulated other comprehensive(loss) income
    
    
    (113,526
    )
    
    
    186,140Unearned ESOP shares
    
    
    (127,281
    )
    
    
    (159,298
    )Total stockholders equity
    
    
    32,022,053
    
    
    
    31,123,575TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    540,000,677
    
    
    $
    505,767,123
 See notes to consolidated financial statements 3




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TRI-COUNTY FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
 THREE MONTHS ENDED MARCH 31, 2005 AND 2004
 2005
    
    
    2004INTEREST INCOME:Interest and fees on loans
    
    $
    4,811,653
    
    
    $
    3,546,545Taxable interest and dividends on investment securities
    
    
    1,739,523
    
    
    
    1,042,650Interest on deposits with banks
    
    
    13,692
    
    
    
    4,616Total interest income
    
    
    6,564,868
    
    
    
    4,593,811INTEREST EXPENSE:Interest on deposits
    
    
    1,011,619
    
    
    
    700,170Interest on short-term borrowings
    
    
    800,303
    
    
    
    78,622Interest on long-term debt
    
    
    997,158
    
    
    
    785,497Total interest expense
    
    
    2,809,080
    
    
    
    1,564,289NET INTEREST INCOME
    
    
    3,755,788
    

    
    
    3,029,522PROVISION FOR LOAN LOSSES
    
    
    63,027
    
    
    
    70,202NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    
    
    3,692,761
    
    
    
    2,959,320
 4




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TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2005 AND 2004 2005
    
    
    2004NONINTEREST INCOME:Loan appraisal, credit, and miscellaneous charges
    
    
    62,907
    
    
    
    66,204Net gain on sale of loans held for sale
    
    
    
    
    
    
    21,404Net gain on the sale of foreclosed property
    
    
    36,000
    
    
    
    Income from bank-owned life insurance
    
    
    61,129
    
    
    
    73,848Loss on sale of investment securities
    
    
    (14,581
    )
    
    
    Service charges
    
    
    255,874
    
    
    
    234,772Total noninterest income
    
    
    401,329
    
    
    
    396,228NONINTEREST EXPENSE:Salary and employee benefits
    
    
    1,463,962
    
    
    
    1,298,380Occupancy
    
    
    231,873
    
    
    
    181,873Advertising
    
    
    87,412
    
    
    
    142,539Data processing
    
    
    160,824
    
    
    
    151,998Legal and professional fees
    
    
    119,445
    
    
    
    38,155Depreciation of furniture, fixtures and equipment
    
    
    87,100
    
    
    
    87,200Telephone communications
    
    
    29,194
    
    
    
    37,975Valuation allowance on foreclosed real estate
    
    
    
    
    
    
    113,827ATM expenses
    
    
    69,794
    
    
    
    80,098Office supplies
    
    
    30,364
    
    
    
    39,419Office equipment
    
    
    9,702
    
    
    
    26,391Other
    
    
    259,044
    
    
    
    197,868Total noninterest expenses
    
    
    2,548,714
    
    
    
    2,395,723INCOME BEFORE INCOME TAXES
    
    
    1,545,376
    
    
    
    959,825Income tax expense
    
    
    521,015
    
    
    
    70,627NET INCOME
    
    
    1,024,361
    
    
    
    889,198OTHER COMPREHENSIVE INCOME NET OF TAXNet unrealized holding (losses) gains arising during period
    
    
    (299,666
    )
    
    
    66,152COMPREHENSIVE INCOME
    
    $
    724,695
    
    
    $
    955,350INCOME PER COMMON SHAREBasic
    
    $
    0.89
    
    
    $
    0.79Diluted
    
    
    0.84
    
    
    
    0.75
 Share and per share data have been retroactively adjusted to effect a three for
two common stock split declared on October 22, 2004 as if it had occurred on
January 1, 2004. See notes to consolidated financial statements 5




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TRI-COUNTY FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 THREE MONTHS ENDED MARCH 31, 2005 AND 2004
 Three Months EndedMarch 31,2005
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    1,024,361
    
    
    $
    889,198Adjustments to reconcile net income to net
cash provided by operating activities:Valuation allowance on foreclosed real estate
    
    
    
    
    
    
    113,827Provision for loan losses
    
    
    63,027
    
    
    
    70,202Gain on sale of foreclosed property
    
    
    (36,000
    )
    
    
    Loss on sales of investment securities
    
    
    14,581
    
    
    
    Depreciation and amortization
    
    
    170,100
    
    
    
    143,049Net amortization of premium/discount on investment securities
    
    
    58,139
    
    
    
    119,478Increase in cash surrender of bank-owned life insurance
    
    
    (61,129
    )
    
    
    (17,883
    )Deferred income tax benefit
    
    
    51,110
    
    
    
    Increase in accrued interest receivable
    
    
    (216,065
    )
    
    
    (19,553
    )Decrease in deferred loan fees
    
    
    (121,043
    )
    
    
    (36,970
    )Decrease in accrued expenses and other liabilities
    
    
    (152,534
    )
    
    
    (408,674
    )Decrease in other assets
    
    
    342,902
    
    
    
    272,359Gain on sales of loans held for sale
    
    
    
    
    
    
    (21,404
    )Proceeds from sale of loans held for sale
    
    
    
    
    
    
    496,284Net cash provided by operating activities
    
    
    1,137,449
    
    
    
    1,599,913CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of investment securities available for sale
    
    
    (3,653
    )
    
    
    (7,503,838
    )Proceeds from sale, redemption or principal payments
of investment securities available for sale
    
    
    1,759,327
    
    
    
    8,857,505Purchase of investment securities held to maturity
    
    
    (25,049,248
    )
    
    
    (7,969,601
    )Proceeds from maturities or principal payments
of investment securities held to maturity
    
    
    16,200,076
    
    
    
    4,054,035Net purchase of FHLB and Federal Reserve Bank stock
    
    
    (1,317,200
    )
    
    
    (320,200
    )Loans originated or acquired
    
    
    (69,587,499
    )
    
    
    (44,183,877
    )Principal collected on loans
    
    
    42,023,167
    
    
    
    24,382,698Purchase of premises and equipment
    
    
    (693,305
    )
    
    
    (219,883
    )Proceeds from foreclosed real estate
    
    
    36,000
    
    
    
    25,000Net cash used in investing activities
    
    
    (36,632,335
    )
    
    
    (22,878,161
    )
 6




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TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2005 AND 2004 Three Months EndedMarch 31,2005
    
    
    2004CASH FLOWS FROM FINANCING ACTIVITIES:Net increase in deposits
    
    
    13,809,124
    
    
    
    12,537,258Proceeds from long-term borrowings
    
    
    10,000,000
    
    
    
    20,000,000Payments of long-term borrowings
    
    
    (82,214
    )
    
    
    (10,095,898
    )Net increase (decrease) in short-term borrowings
    
    
    9,760,702
    
    
    
    (3,570,983
    )Exercise of stock options
    
    
    155,168
    
    
    
    197,155Net change in unearned ESOP shares
    
    
    60,395
    
    
    
    74,011Repurchase of common stock
    
    
    (41,780
    )
    
    
    (152,558
    )Net cash provided by financing activities
    
    
    33,661,394
    
    
    
    18,988,985DECREASE IN CASH AND CASH EQUIVALENTS
    
    
    (1,833,491
    )
    
    
    (2,289,263
    )CASH AND CASH EQUIVALENTS  JANUARY 1
    
    
    17,715,779
    
    
    
    12,169,798CASH AND CASH EQUIVALENTS  MARCH 31
    
    $
    15,882,288
    
    
    $
    9,880,535SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:Cash paid during the three months for:Interest
    
    $
    2,763,742
    
    
    $
    1,669,753Income taxes
    
    $
    
    
    
    $
    
 See notes to consolidated financial statements 7




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  1.
    BASIS OF PRESENTATIONGeneral- The consolidated financial statements of Tri-County Financial Corporation (the
Company) and its wholly owned subsidiary, Community Bank of Tri-County (the Bank)
included herein are unaudited; however, they reflect all adjustments consisting only of
normal recurring accruals that, in the opinion of Management, are necessary to present
fairly the Companys financial condition, results of operations, and cash flows for the
periods presented. Certain information and note disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. The Company believes that the
disclosures are adequate to make the information presented not misleading. The balances as
of December 31, 2004 have been derived from audited financial statements. There have been no
significant changes to the Companys accounting policies as disclosed in the 2004 Annual
Report. The results of operations for the three months ended March 31, 2005 are not
necessarily indicative of the results of operations to be expected for the remainder of the
year or any other period. Certain previously reported amounts have been restated to conform
to the 2005 presentation.It is suggested that these consolidated financial statements be read in conjunction with the
consolidated financial statements and notes included in the Companys Annual Report for the
year ended December 31, 2004.2.
    NATURE OF BUSINESSThe Company, through its bank subsidiary, provides domestic financial services primarily in
southern Maryland. The primary financial services include real estate, commercial and
consumer lending, as well as traditional demand deposits and savings products.3.
    INCOME TAXESThe Company uses the liability method of accounting for income taxes as required by SFAS No.
109, Accounting for Income Taxes. Under the liability method, deferred-tax assets and
liabilities are determined based on differences between the financial statement carrying
amounts and the tax bases of existing assets and liabilities (i.e., temporary differences)
and are measured at the enacted rates that will be in effect when these differences reverse.4.
    EARNINGS PER SHAREEarnings per common share are computed by dividing net income by the weighted average number
of common shares outstanding during the period. Diluted net income per common share is
computed by dividing net income by the weighted average number of common shares outstanding
during the period, including any potential dilutive common shares outstanding, such as
options and warrants. As of March 31, 2005, there were no shares excluded from the diluted
net income per share computation because the average market price exceeded the exercise
price of all outstanding options. Basic and diluted earnings per share, have been computed
based on weighted-average common and common equivalent shares outstanding as follows: Three Months EndedMarch 31,2005
    
    
    2004Basic
    
    
    1,151,932
    
    
    
    1,134,567Diluted
    
    
    1,223,417
    
    
    
    1,191,996
 Share and per share data have been retroactively adjusted to effect a three for two common
stock split declared on October 22, 2004 as if it had occurred on January 1, 2004. 8




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5.
    STOCK-BASED COMPENSATIONStatement 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 these 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. The Company has elected to continue with the accounting methodology in Opinion
No. 25. 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.In December 2004, FASB issued SFAS No. 123R, Share-Based Payment, which is a revision of
SFAS No. 123, Accounting for Stock Issued for Employees. SFAS No. 123R requires that all
share-based payments to employees, including grants of employee stock options, be valued at
fair value on the grant date and be expensed over the applicable vesting period. SFAS No.
123R is effective for the Company on January 1, 2006. The Company will transition to SFAS
No. 123R using the modified prospective application. Under the modified prospective
application, compensation costs will be recognized in the financial statements for all new
share-based payments granted after January 1, 2006. Additionally, the Company will
recognize compensation costs for the portion of previously granted awards for which the
requisite service has not been rendered (nonvested awards) that are outstanding as of
January 1, 2006 over the remaining requisite service period of the awards. The compensation
expense to be recognized for the non-vested awards will be based on the fair value of the
awards. The Company does not expect the impact of utilizing the modified prospective
application to adopt SFAS No. 123R to be materially different from the pro-forma
information shown below.No options were awarded during the three-month period ended March 31, 2005, and all options
outstanding as of December 31, 2004 were vested; therefore, no awards of options or vesting
of previously awarded options have been recognized for pro-forma disclosure purposes during
the quarter ended March 31, 2005.If the Company had elected to recognize stock-based compensation cost based on fair value at
the grant dates for awards consistent with the method prescribed by SFAS No. 123, net income
and earnings per share would have been changed to the pro-forma amounts shown below for the
three-month periods ended March 31, 2005 and 2004. 2005
    
    
    2004Net Income as reported
    
    $
    1,024,361
    
    
    $
    889,198Less pro-forma stock-based compensation expense
determined under the fair value method, net of tax
effects.
    
    
    
    
    
    
    60,000Pro-forma net income
    
    $
    1,024,361
    
    
    $
    829,198Net income per shareBasic  as reported
    
    $
    0.89
    
    
    $
    0.79Basic  pro-forma
    
    $
    0.89
    
    
    $
    0.73Diluted  as reported
    
    $
    0.84
    
    
    $
    0.75Diluted  pro-forma
    
    $
    0.84
    
    
    $
    0.69
  Share and per share data have been retroactively adjusted to effect a three for two
common stock split declared on October 22, 2004 as if it had occurred on January 1, 2004. 9




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6.
    NEW ACCOUNTING STANDARDSIn December 2004, the Financial Accounting Standards Board (FASB) issued SAFS No. 153,
Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29, Accounting for
Non-monetary Transactions. This statement amends the principal that exchanges of
non-monetary assets should be measured based on the fair value of the assets exchanged and
more broadly provides for exceptions regarding exchanges of non-monetary assets that do not
have commercial substance. This Statement is effective for non-monetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. The adoption of this standard is
not expected to have a material impact on financial condition, results of operations, or
liquidity.In March 2004, FASB Emerging Issues Task Force (EITF) released Issue 03-01, Meaning of
Other Than Temporary Impairment and Its Application to Certain Investments. EITF 03-1
provides guidance for determining whether impairment for certain debt and equity investments
is other-than-temporary and the measurement of the impaired loss. Certain disclosure
requirements of EITF 03-1 were adopted in 2003 and the Company complied with the new
disclosure requirements in its consolidated financial statements. The recognition and
measurement requirements of EITF 03-01 were initially effective for periods beginning after
June 15, 2004. In September 2004, however, the FASB staff issued FASB Staff Position
(FSP) EITF 03-1-1, which delayed the effective date for certain measurement and
recognition guidance contained in Issue 03-1. The FSP requires the application of
pre-existing other-than-temporary guidance during the period of delay until a final
consensus is reached. Management does not anticipate the issuance of the final consensus
will have a material impact on financial condition, results of operations, or liquidity.In December 2003, the American Institute of Certified Public Accountants issued Statement of
Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a
Transfer. SOP 03-3 requires acquired loans, including debt from the seller for
those-individually-evaluated loans that have evidence of deterioration in credit quality
since origination, and it is probable all contractual cash flows on the loan will be unable
to be collected. SOP 03-3 also requires the excess of all undiscounted cash flows expected
to be collected at acquisition over the purchases initial investment to be recognized as
interest income on a level-yield basis over the life of the loan. Subsequent increases in
cash flows expected to be collected are recognized as impairment. Loans carried at fair
value, loans held for sale, and loans to borrowers in good standing under revolving credit
agreements are excluded from the scope of SOP 03-3. The guidance is effective for loans
acquired in fiscal years beginning after December 15, 2004 and is not expected to have a
material impact on the Companys financial condition, result of operations, or liquidity. 10




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ITEM 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION This document contains forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, including discussions of Tri-County Financial Corporations (the
Company) goals, strategies and expected outcomes; estimates of risks and future costs; and
reports of the Companys ability to achieve its financial and other goals. Forward-looking
statements are generally preceded by terms such as expects, believes, anticipates, intends
and similar expressions. These forward-looking statements are subject to significant known and
unknown risks and uncertainties because they are based upon future economic conditions,
particularly interest rates, competition within and without the banking industry, changes in laws
and regulations applicable to the Company and various other matters. Because of these
uncertainties, there can be no assurance that actual results, performance or achievements of the
Company will not differ materially from any future results, performance or achievements expressed
or implied by these forward-looking statements. The Company does not undertake  and specifically
disclaims any obligation  to publicly release the result of any revisions that may be made to any
forward-looking statement to reflect events or circumstances after the date of such statements or
to reflect the occurrence of anticipated or unanticipated events. GENERAL The Company is a bank holding company organized in 1989 under the laws of the State of Maryland.
It presently owns all the outstanding shares of capital stock of the Community Bank of Tri-County
(the Bank), a Maryland-chartered commercial bank. The Company engages in no significant activity
other than holding the stock of the Bank, the payment of its subordinated debt, and operating the
business of the Bank. Accordingly, the information set forth in this report, including financial
statements and related data, relates primarily to the Bank and its subsidiaries. The Bank serves the Southern Maryland area through its main office and seven branches located in
Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, and California, Maryland.
The Bank is engaged in the commercial and retail banking business as authorized by the banking
statutes of the State of Maryland and applicable Federal regulations. The Bank accepts demand and
time deposits and uses these funds along with borrowings from the Federal Home Loan Bank (FHLB),
to fund loan originations to individuals, associations, partnerships and corporations. The Bank
makes real estate loans including residential first and second mortgage loans, home equity lines of
credit and commercial mortgage loans. The Bank also makes commercial loans including secured and
unsecured loans. The Bank is a member of the Federal Reserve and FHLB Systems. The Savings
Association Insurance Fund (SAIF) of the Federal Deposit Insurance Corporation (FDIC) provides
deposit insurance coverage up to applicable limits. Since its conversion to a state chartered commercial bank in 1997, the Bank has sought to increase
its commercial, commercial real estate, construction, second mortgage, home equity, and consumer
lending business as well as the level of transactional deposits to levels consistent with similarly
sized commercial banks. As a result of this emphasis, the Banks percentage of assets invested in
residential first mortgage lending has declined since 1997. Conversely, targeted loan types have
increased. The Bank has also seen an increase in transactional deposit accounts while the
percentage of total liabilities represented by certificates of deposits has declined. Management
believes that these changes will enhance the Banks overall long-term financial performance. Management recognizes that the shift in composition of the Banks loan portfolio will tend to
increase its exposure to credit losses. The Bank continues to evaluate its allowance for loan
losses and the associated provision to compensate for the increased risk. Any evaluation of the
allowance for loan losses is inherently inexact and reflects managements expectations as to future
economic conditions in the Southern Maryland area as well as individual borrowers circumstances.
Management believes that its allowance for loan losses is adequate. For further information on the
Banks allowance for loan losses see the discussion in the sections captioned Financial Condition
and Critical Accounting Policies as well as the relevant discussions in the Form 10-K and annual
report for the year ended December 31, 2004. For several quarters until the fourth quarter
of 2004, the economy was recovering from a mild recession. In the last several quarters, the
Federal Reserve has signaled through rate increases its belief that the economys greatest danger
appears to be inflation rather than recession. Accordingly the Federal Funds rate has increased
from its recent low of 1.00% in June 2004 to 2.75% in March of 2005. While we believe that we are
positioned to perform well in a moderate rate increase environment, substantially higher interest
rates could effect our future financial performance particularly if key interest rates increased
funding costs faster than they increased yields on earning assets. Our ability to increase asset
yields in a rising interest rate environment is limited by periodic and lifetime caps on interest
rates embedded in many of our loans and investments. In addition, certain of our loans and
investments are for fixed rates. Moreover, substantially higher interest rates would tend to
increase borrowing costs for our customers and might lead to an increase in loan 11




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delinquency caused
by the borrowers inability to pay these higher costs in some cases. SELECTED FINANCIAL DATA Three Months EndedMarch 31,2005
    
    
    2004Condensed Income StatementInterest Income
    
    $
    6,564,868
    
    
    $
    4,593,811Interest Expense
    
    
    2,809,080
    
    
    
    1,564,289Net Interest Income
    
    
    3,755,788
    
    
    
    3,029,522Provision for Loan Loss
    
    
    63,027
    
    
    
    70,202Noninterest Income
    
    
    401,329
    
    
    
    396,228Noninterest Expense
    
    
    2,548,714
    
    
    
    2,395,723Income Before Income Taxes
    
    
    1,545,376
    
    
    
    959,825Income Taxes
    
    
    521,015
    
    
    
    70,627Net Income
    
    $
    1,024,361
    
    
    $
    889,198Per Common ShareBasic Earnings
    
    $
    0.89
    
    
    $
    0.79Diluted Earnings
    
    $
    0.84
    
    
    $
    0.75Book Value
    
    $
    27.65
    
    
    $
    25.12
 Share and per share data have been retroactively adjusted to effect a three for two common stock
split declared on October 22, 2004 as if it had occurred on January 1, 2004. RESULTS OF OPERATIONS Net income for the three-month period ended March 31, 2005 totaled $1,024,361 ($0.89 basic and
$0.84 diluted earnings per share) compared with a total of $889,198 ($0.79 basic and $0.75 diluted
earnings per share) for the same period in the prior year. This increase of $135,163 or 15.20% was
caused by an increase in net interest income combined with a slight decline in provision for loan
loss, a small increase in non-interest income, which offset higher non-interest expense and higher
tax expense. For the three-month period ended March 31, 2005, interest income increased by
$1,971,057 or 42.91% to $6,564,868. The increase was due to higher average balances of earning
assets which offset slightly lower yields. The Bank earned slightly lower yields as the percentage
of its assets invested in securities increased and the percentage of assets invested in loans
decreased.
Interest expense also increased to $2,809,080 in the three-month period ending March 31, 2005 as
compared to $1,564,289 in the same period in the prior year, an increase of $1,244,791 or 79.58%.
The increase was the result of higher average balances and slightly higher rates. The average rate
paid on liabilities increased as the Bank made greater use of non-retail deposit funding sources.
The changes in interest income and expense reflect the effects of the changing interest rate
environment, increased size of the balance sheet, and changes in balance sheet composition that
have taken place in the last year. Provision for loan losses decreased slightly from prior year levels to $63,027 for the three months
ended March 31, 2005 from $70,202 for the three month period ended March 31, 2004. The decrease in
provision expense was caused by the Banks continued success in controlling delinquency and
write-offs in its loan portfolio. Management will continue to periodically review its allowance for
loan losses and the related provision and adjust as deemed necessary. This review will include a
review of economic conditions nationally and locally, as well as a review of the performance of
significant major loans and the overall portfolio. Noninterest income increased to $401,329 for the three-month period ending March 31, 2005, an
increase of $5,101 or 1.29% over the prior year total of $396,228. In 2005, the Bank sold certain
foreclosed property which had previously been written off. The gain of $36,000 was recognized in
2005, while no similar gain was recognized in 2004. Loan appraisal, credit, and miscellaneous
charges decreased by $3,297 to $62,907. These charges are highly variable and collection of them is
often dependent on specific local market conditions. The Bank reported a net gain on selling
mortgage loans of $21,404 in 2004. No gains from selling loans were earned in 2005. The Bank
recorded a decline in income from bank-owned life insurance based on a decline in yield in 2005.
The Bank also recorded a loss of $14,581 in 12




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##### Table of Contents



2005 on the sale of certain short-term securities compared to no loss in 2004. Finally, service charges increased to $255,874 in 2005 from
the prior year amount of $234,772, an increase of $21,102 or 8.99% due to higher amounts of
activity in certain demand deposit accounts. Noninterest expense for the three-month period increased by $152,991 or 6.39% to $2,548,714 from
$2,395,723 in the same period for the prior year. Salary and employee benefits increased by
12.75% to $1,463,962 from $1,298,380 for the same period in the prior year. The increase was
attributable to an increase in employees and to increases in average salary costs per employee.
Occupancy expense increased from $181,873 to $231,873, an increase of 27.49%, due to additional
locations. Advertising expenses decreased to $87,412 from $142,539, a decrease of $55,127 or
38.68%. The reduction in expenses was attributable to the internalization of the marketing
function as well as the realignment of expenses to coincide with objectives. Data processing
expense increased to $160,824 from a prior year total of $151,998, an increase of $8,826 or 5.81%.
This increase was due to increases in the Banks size and customer base. Legal and professional
fees increased to $119,445 from $38,155, an increase of $81,290 or 213.05%. This increase in
expense included increased expenses relating to preparing the Company to meet the additional
requirements of SarbanesOxley compliance including increases in outsourced accounting, legal, and
other professional services. Telephone communications declined to $29,194 from $37,975 in the prior
year, a decline of $8,781 or 23.12%. This decline reflected a change in service providers which
offset higher usage. The provision for valuation allowances on foreclosed real estate decreased to
$0 in 2005 from $113,827 for the three months ended March 31, 2004 as no further increases to the
valuation allowance were considered necessary. ATM related expenses decreased by $10,304 to $69,794
for the period ending March 31, 2005, a decrease of 12.86% due to price concessions by our ATM
service providers. Office supplies expense decreased to $30,364 from the prior year amount of
$39,419, a decrease of $9,055 or 22.97%. These expenses related to increased marketing efforts in
the prior year. Office equipment expenses decreased to $9,702 in 2005 from $26,391 in 2004, a
decrease of $16,689 or 63.24%. This decrease was caused by the retirement of certain equipment.
Other expenses increased to $259,044 from $197,868 an increase of $61,176 or 30.92%, reflecting
larger asset size and increased overall business activity. Income tax expense increased to $521,015 or 33.71% of pretax income in the current year, from
$70,627 or 7.36% of pretax income in the prior year. The prior years low income tax rate was
primarily attributable to the contribution of a foreclosed property to an environmental
organization which generated a large income tax deduction, effectively reducing the overall rate. FINANCIAL CONDITION Assets Total assets as of March 31, 2005 increased by $34,233,554 or 6.77% to $540,000,677 from the
December 31, 2004 level of $505,767,123. Cash and due from banks decreased by $2,332,903 or 38.76%
from December 31, 2004s total. Federal funds sold decreased to $297,526 from $777,519, a decline
of $479,993 or 61.73%. Interest-bearing deposits with banks increased by $979,405 or 8.97% during
the period to $11,899,569 at March 31, 2005. Changes in the amounts of these cash equivalents
reflect short-term cash changes to fund loans and investments. Investment securities, including
both the available for sale and held to maturity portfolios, increased from $175,690,126 to
$182,256,864, an increase of $6,566,738 or 3.74%. Increases were primarily the result of additional
purchases of investments, primarily floating rate longer-term securities which adjust to a margin
over LIBOR. The Banks loan portfolio increased by $27,622,348 or 9.55% during the three-month period ended
March 31, 2005 to $316,947,399 from $289,325,051 at December 31, 2004. The increase was primarily
the result of increases in the Banks portfolio of commercial real estate loans, residential
construction loans, and commercial lines of credit. The increase in commercial real estate lending
was a reflection of the strong local economy and continuing sales efforts by the Bank in this area.
Residential construction has increased as local builders continue to develop land. The increase in
commercial lines of credit reflect the Banks continued effort to build its commercial lending
business. At March 31, 2005 the Banks allowance for loan losses totals $3,120,585 or 0.95% of
loan balances as compared to $3,057,558 or 1.04% of loan balances at December 31, 2004.
Managements determination of the adequacy of the allowance is based on a periodic evaluation of
the portfolio with consideration given to the overall loss experience; current economic conditions;
volume, growth and composition of the loan portfolio; financial condition of the borrowers; and
other relevant factors that, in managements judgment, warrant recognition in providing an adequate
allowance. Management believes that the allowance is adequate. Additional loan information for
prior years is presented in the Companys Form 10-K for the year ended December 31, 2004. 13




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##### Table of Contents



The following table sets forth information concerning the Banks aggregate loans by type at the
dates indicated. March 31, 2005
    
    
    December 31, 2004Amount
    
    
    %
    
    
    Amount
    
    
    %Real Estate LoansCommercial
    
    $
    146,295,636
    
    
    
    45.62
    %
    
    $
    136,341,597
    
    
    
    46.51
    %Residential first mortgages
    
    
    62,396,013
    
    
    
    19.46
    %
    
    
    59,087,000
    
    
    
    20.16
    %Residential construction
    
    
    24,044,973
    
    
    
    7.50
    %
    
    
    17,597,911
    
    
    
    6.00
    %Second mortgage loans
    
    
    24,804,287
    
    
    
    7.73
    %
    
    
    23,925,108
    
    
    
    8.16
    %Commercial lines of credit
    
    
    44,264,377
    
    
    
    13.80
    %
    
    
    39,136,778
    
    
    
    13.35
    %Consumer loans
    
    
    3,509,695
    
    
    
    1.09
    %
    
    
    3,462,613
    
    
    
    1.18
    %Commercial equipment
    
    
    15,396,335
    
    
    
    4.80
    %
    
    
    13,595,978
    
    
    
    4.64
    %Total
    
    
    320,711,316
    
    
    
    100.00
    %
    
    
    293,146,983
    
    
    
    100.00
    %Less:Deferred loan fees
    
    
    643,332
    
    
    
    0.20
    %
    
    
    764,374
    
    
    
    0.26
    %Allowance for loan losses
    
    
    3,120,585
    
    
    
    0.97
    %
    
    
    3,057,558
    
    
    
    1.04
    %Total
    
    $
    316,947,399
    
    
    
    
    
    
    $
    289,325,051
 The following table summarizes changes in the allowance for loan losses for the periods
indicated. 3 Months Ended
    
    
    3 Months EndedMarch 31, 2005
    
    
    March 31, 2004Beginning Balance
    
    $
    3,057,558
    
    
    $
    2,572,799Charge-Offs
    
    
    
    
    
    
    Recoveries
    
    
    
    
    
    
    7,923Net Charge-Offs
    
    
    
    
    
    
    (7,923
    )Additions Charged to Operations
    
    
    63,027
    
    
    
    70,202Balance at the end of the Period
    
    $
    3,120,585
    
    
    $
    2,650,924
 The following table provides information with respect to our non-performing assets at the
dates indicated. Balances as of
    
    
    Balances as ofMarch 31, 2005
    
    
    December 31, 2004Restructured Loans
    
    $
    
    
    
    $
    Accruing loans which are contractually
past due 90 days or more:
    
    $
    
    
    
    $
    Loans accounted for on a non-accrual
basis
    
    $
    679,980
    
    
    $
    674,961Total non-performing loans
    
    $
    679,980
    
    
    $
    674,961Non-performing loans to total loans
    
    
    0.21
    %
    
    
    0.22
    %Allowance for loan losses to non-performing loans
    
    
    458.92
    %
    
    
    453.00
    %
 14




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##### Table of Contents



Premises and equipment increased due to the renovation of parts of the home office building
and the construction of the Prince Frederick Branch. These improvements were partially offset by
depreciation. Accrued interest receivable increased by $216,155 due to increases in asset size.
Investment in bank-owned life insurance increased due to income accruals. Other assets decreased to
$2,111,663 from $2,351,303 at December 31, 2004. Liabilities Deposit balances increased by $13,809,124 or 5.18% for the three months ended March 31, 2005.
This increase was primarily in interest bearing deposits. Management believes that ongoing stock
market volatility combined with questions about certain mutual fund operations has made bank
deposits more attractive to the general public. The Bank has also increased marketing efforts for
all deposit products in the last year. Short-term borrowings increased to $125,064,912, an increase
of $9,760,702 or 8.47% while long term-debt also increased to $92,848,897, an increase of
$9,917,784, or 11.96%. These funds were used to fund loans and purchase investments. Accrued
expenses decreased slightly to $2,501,187. The decline was caused by the timing of certain tax
payments. Stockholders Equity Stockholders equity increased $898,478 or 2.89% to $32,022,053 at March 31, 2005 compared to
$31,123,575 at December 31, 2004. This reflects the net income of $1,024,361 for the three months
period. Other changes in equity occurred as a result of using $41,780 to purchase 1,198 shares,
the exercise of stock options of $155,168, and activity related to the ESOP shares of $60,395. Book
value on a per share basis was $27.65 at March 31, 2004, as compared to $27.14 at December 31, 2004. LIQUIDITY AND CAPITAL RESOURCES The Company currently has no business other than that of the Bank and does not currently have any
material funding commitments, other than the payment of dividends, the payment of dividends and
principal on debentures, and the repurchase of common shares. The Companys principal sources of
liquidity are cash on hand and dividends received from the Bank. The Bank is subject to various
regulatory restrictions on the payment of dividends. The Banks principal sources of funds for investments and operations are net income, deposits from
its primary market area, principal and interest payments on loans, interest received on investment
securities and proceeds from maturing investment securities. Its principal funding commitments are
for the origination or purchase of loans and the payment of maturing deposits. Deposits are
considered a primary source of funds supporting the Banks lending and investment activities. The
Bank also uses various wholesale funding instruments including FHLB advances and reverse repurchase
agreements. The Bank may borrow up to 40% of consolidated Bank assets on a line of credit available
from the FHLB. As of March 31, 2005, the maximum available under this line would be $216 million,
while outstanding advances totaled $141 million. In order to draw on this line the Bank must have
sufficient collateral. Qualifying collateral includes residential 1-4 family first mortgage loans,
certain second mortgage loans, certain commercial real estate loans, and various investment
securities. At March 31, 2005, the Bank had pledged collateral sufficient to draw $164 million
under the line. The Banks most liquid assets are cash and cash equivalents, which are cash on hand, amounts due
from financial institutions, federal funds sold, and money market mutual funds. The levels of such
assets are dependent on the Banks operating financing and investment activities at any given time.
The variations in levels of cash and cash equivalents are influenced by deposit flows and
anticipated future deposit flows. Cash, cash equivalents, and interest-bearing deposits with banks as of March 31, 2005 totaled
$15,882,288, a decrease of $1,833,491 or 10.35% from the December 31, 2004 total of $17,715,779.
This decrease was due to the Banks increase in loans and investment securities. The Banks principal sources of cash flows are its financing activities including deposits and
borrowings. During the first quarter in 2005, all financing activities provided $33,661,394 in
cash compared to $18,988,985 for the first quarter of 2004. The increase in cash flows from
financing activities during the most recent period was principally due to an increase in borrowing
activity in 2005. Short-term borrowing provided a net increase in cash of $9,760,702 in 2005,
compared to a use of cash of $3,570,983 in 2004. During the first quarter of 2005, net deposit
growth was $13,809,124 compared to $12,537,258 in 2004. The Bank also receives cash from its
operating activities, which provided $1,137,449 in the first quarter of 2005 compared to $1,599,913
during the first quarter of 2004. The decrease in operating cash flows 15




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during 2005 was primarily due to a decrease in proceeds from sale of loans held for sale. The Banks principal use of cash has been in investing activities including its investments in
loans for portfolio, investment securities and other assets. During the quarter ended March 31,
2005, the Bank invested a total of $36,632,446 compared to $22,878,161 in 2004. The principal
reason for the increase in cash used in investing activities was an increase in the purchase of
investments. REGULATORY MATTERS The Bank is subject to Federal Reserve Board capital requirements as well as statutory capital
requirements imposed under Maryland law. At March 31, 2005, the Banks tangible, leverage and
risk-based capital ratios were 7.21%, 9.52% and 10.27%, respectively. These levels are in excess
of the required 4.0%, 4.0% and 8.0% ratios required by the Federal Reserve Board as well as the
5.0%, 5.0%, and 10% ratios required to be considered well capitalized. CRITICAL ACCOUNTING POLICIES The Companys financial statements are prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP). The financial information contained within the
financial statements is, to a significant extent, financial information that is based on measures
of financial effects of transactions and events that have already occurred. A variety of factors
could affect the ultimate value that is obtained when earning of income, recognizing an expense,
recovering an asset or relieving a liability. We use historical loss factors as one in determining
the inherent loss that may be present in our loan portfolio. Actual losses could differ
significantly from the historical factors that we use. In addition GAAP itself may change from one
previously acceptable method to another method. Although the economics of our transactions would
be the same, the timing of events that would impact our transactions could change. The Company considers the allowance for loan losses to be a critical accounting policy. The
allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio.
The allowance is based on two basic principles of accounting: (1) SFAS 5, Accounting for
Contingencies, which requires that losses be accrued when they are probable of occurring and
estimable and (2) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that
losses be accrued based on the differences between the value of collateral, present value of future
cash flows or values that are observable in the secondary market and the loan balance. Management has significant discretion in making the judgments inherent in the determination of the
provision and allowance for loan losses, including in connection with the valuation of collateral,
a borrowers prospects of repayment, and in establishing allowance factors on the non-specific
allowance. The establishment of allowance factors is a continuing exercise, based on managements
continuing assessment of the global factors such as delinquencies, loss history, trends in the
volume and term of loans, national and local economic trends, concentration of credit, loan
classification, and other factors. Changes in allowance factors will have a direct impact on the
amount of the provision and a corresponding effect on net income. Errors in managements
perception and assessment of the global factors and their impact on the portfolio could result in
the allowance not being adequate to cover losses in the portfolio, and may result in additional
provisions or charge offs. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Not applicable. The Company qualifies as a small business issuer. 
 ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, management of the Company carried out an
evaluation, under the supervision and with the participation of the Companys principal executive
officer and principal financial officer, of the effectiveness of the Companys disclosure
controls and procedures. Based on this evaluation, the Companys principal executive officer and
principal financial officer concluded that the Companys disclosure controls and procedures are
effective in ensuring that information required to be disclosed by the Company in reports that it
files or submits under the Securities Exchange Act of 1934, as amended, (1) is recorded,
processed, summarized and reported, within the time periods specified in the Securities and
Exchange Commissions rules and forms and (2) is accumulated and communicated to the Companys
management, including its principal and executive and financial officers as appropriate to allow
timely decisions regarding required disclosure. It should be noted that the design of the
Companys disclosure controls and procedures is based in part upon certain reasonable assumptions
about the likelihood of future events, and there can be no reasonable assurance that any design
of disclosure controls and procedures will succeed in 16




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achieving its stated goals under all
potential future conditions, regardless of how remote, but the Companys principal executive and
financial officers have concluded that the Companys disclosure controls and procedures are, in
fact, effective at a reasonable assurance level. In addition, there have been no changes in the Companys internal control over financial
reporting (to the extent that elements of internal control over financial reporting are subsumed
within disclosure controls and procedures) identified in connection with the evaluation described
in the above paragraph that occurred during the Companys last fiscal quarter, that has
materially affected, or is reasonably likely to materially affect, the Companys internal control
over financial reporting. 
 PART II  OTHER INFORMATION 
 Item 1  Legal Proceedings  The Company is not involved in any pending legal proceedings. The Bank
is not involved in any pending legal proceedings other than routine legal proceedings occurring in
the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by
management to be immaterial to the financial condition and results of operations of the company. 
 Item 2  Unregistered sales of equity securities and use of proceeds  (a)
    Not applicable(b)
    Not applicable(c)
    The following table sets forth information regarding the Companys repurchases
of its Common Stock during the quarter ended March 31, 2005. (c)
    
    
    (d)Total Number
    
    
    Maximumof Shares
    
    
    Number ofPurchased
    
    
    Shares(a)
    
    
    
    
    
    
    as Part of
    
    
    that May Yet BeTotal
    
    
    (b)
    
    
    Publicly
    
    
    PurchasedNumber of
    
    
    Average
    
    
    Announced Plans
    
    
    UnderShares
    
    
    Price Paid
    
    
    or
    
    
    the Plans orPeriod
    
    Purchased
    
    
    per Share
    
    
    Programs
    
    
    ProgramsJanuary 2005
    
    
    1,106
    
    
    $
    34.63
    
    
    
    1,106
    
    
    
    55,894February 2005
    
    
    92
    
    
    
    38.00
    
    
    
    92
    
    
    
    55,802March 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    55,802Total
    
    
    1,198
    
    
    $
    34.89
    
    
    
    1,198
    
    
    
    55,802
 On October 25, 2004, Tri-County Financial Corporation announced a repurchase program under which it
would repurchase 57,000 shares of its common stock. The program will continue until it is
completed or terminated by the Board of Directors. 
 Item 3  Default Upon Senior Securities  None 
 Item 4  Submission of Matters to a Vote of Security Holders None 
 Item 5  Other Information  None 17




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##### Table of Contents



Item 6  Exhibits Exhibit 31 Rule 13a-14(a) Certifications Exhibit 32 Section 1350 Certifications 18




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SIGNATURES Pursuant to the requirements 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. TRI-COUNTY FINANCIAL CORPORATION:Date:
    
    May 12, 2005
    
    
    
    By:
    
    /s/ Michael L. MiddletonMichael L. Middleton, Presidentand Chairman of the BoardDate:
    
    May 12, 2005
    
    
    
    By:
    

    /s/ William J. PasenelliWilliam J. Pasenelli, ExecutiveVice President and ChiefFinancial Officer