##### Table of Contents



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 June 30, 2006
 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 018279
 Tri-County Financial Corporation
  Maryland
(State of other jurisdiction of
incorporation or organization)
    
    52-1652138
(I.R.S. Employer
Identification No.)3035 Leonardtown Road, Waldorf, Maryland
(Address of principal executive offices)
    
    20601
(Zip Code)
 
 
 þ o
  o o þ
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##### Table of Contents



TRI-COUNTY FINANCIAL CORPORATION
 FORM 10-Q
 INDEX
 PagePART I FINANCIAL INFORMATIONItem 1 -
    
    Financial Statements (Unaudited)Consolidated Balance Sheets  June 30, 2006
and December 31, 2005
    
    
    3Consolidated Statements of Income and Comprehensive Income -
Three and Six Months Ended June 30, 2006 and 2005
    
    
    4Consolidated Statements of Cash Flows  Six Months
Ended June 30, 2006 and 2005
    
    
    6Notes to Consolidated Financial Statements
    
    
    8Item 2 -
    
    Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    12Item 3 -
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    20Item 4 -
    
    Controls and Procedures
    
    
    20PART II OTHER INFORMATIONItem 1 -
    
    Legal Proceedings
    
    
    21Item 1.A -
    
    Risk Factors
    
    
    21Item 2 -
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    21Item 3 -
    
    Defaults Upon Senior Securities
    
    
    21Item 4 -
    
    Submission of Matters to a Vote of Security Holders
    
    
    21Item 5 -
    
    Other Information
    
    
    22Item 6 -
    
    Exhibits
    
    
    22SIGNATURES
    
    
    23EX-3 AMENDED AND RESTATED BYLAWSEX-31 SECTION 302 CERTIFICATION OF CEO/CFOEX-32 SECTION 906 CERTIFICATION OF CEO/CFO




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##### Table of Contents



PART I FINANCIAL INFORMATION
 
 ITEM I. FINANCIAL STATEMENTS
 TRI-COUNTY FINANCIAL CORPORATION
 
 CONSOLIDATED
BALANCE SHEETS JUNE 30, 2006 AND DECEMBER 31, 2005 (UNAUDITED)
 June 30, 2006
    
    
    December 31, 2005ASSETSCash and due from banks
    
    $
    2,869,183
    
    
    $
    7,262,547Federal funds sold
    
    
    675,129
    
    
    
    640,818Interest-bearing deposits with banks
    
    
    12,454,378
    
    
    
    14,671,875Securities available for sale
    
    
    9,538,720
    
    
    
    7,178,894Securities held to maturity  at amortized cost
    
    
    106,205,210
    
    
    
    116,486,685Federal Home Loan Bank and Federal Reserve Bank stock  at cost
    
    
    7,158,800
    
    
    
    7,190,300Loans receivable  net of allowance for loan losses
of $3,549,270 and $3,383,334 respectively
    
    
    404,506,928
    
    
    
    369,592,253Premises and equipment, net
    
    
    6,546,664
    
    
    
    6,460,545Foreclosed real estate, net
    
    
    460,884
    
    
    
    475,561Accrued interest receivable
    
    
    2,549,593
    
    
    
    2,406,542Investment in bank owned life insurance
    
    
    8,593,983
    
    
    
    6,434,175Other assets
    
    
    3,020,764
    
    
    
    2,487,280TOTAL ASSETS
    
    $
    564,580,236
    
    
    $
    541,287,475LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIESNoninterest-bearing deposits
    
    $
    41,352,192
    
    
    $
    44,325,083Interest-bearing deposits
    
    
    346,735,839
    
    
    
    319,048,657Total deposits
    
    
    388,088,031
    
    
    
    363,373,740Short-term borrowings
    
    
    32,244,357
    
    
    
    20,074,975Long-term debt
    
    
    93,065,552
    
    
    
    107,823,759Guaranteed preferred beneficial interest in junior subordinated debentures
    
    
    12,000,000
    
    
    
    12,000,000Accrued expenses and other liabilities
    
    
    3,868,623
    
    
    
    3,436,845Total liabilities
    
    
    529,266,563
    
    
    
    506,709,319STOCKHOLDERS EQUITY:Common stock  par value $.01; authorized - 15,000,000 shares;
issued 1,761,499 and 1,760,991 shares, respectively
    
    
    17,615
    
    
    
    17,610Additional paid in capital
    
    
    9,182,554
    
    
    
    9,057,805Retained earnings
    
    
    26,369,872
    
    
    
    25,580,634Accumulated other comprehensive (loss) income
    
    
    (159,339
    )
    
    
    49,362Unearned ESOP shares
    
    
    (97,029
    )
    
    
    (127,255
    )Total stockholders equity
    
    
    35,313,673
    
    
    
    34,578,156TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    564,580,236
    
    
    $
    541,287,475
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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005INTEREST INCOME:Interest and fees on loans
    
    $
    7,175,349
    
    
    $
    5,504,666
    
    
    $
    13,838,876
    
    
    $
    10,316,319Taxable interest and dividends
on investment securities
    
    
    1,589,901
    
    
    
    1,763,829
    
    
    
    3,181,203
    
    
    
    3,503,352Interest on deposits with banks
    
    
    62,660
    
    
    
    15,544
    
    
    
    107,790
    
    
    
    29,236Total interest income
    
    
    8,827,910
    
    
    
    7,284,039
    
    
    
    17,127,869
    
    
    
    13,848,907INTEREST EXPENSE:Interest on deposits
    
    
    2,766,038
    
    
    
    1,488,801
    
    
    
    5,228,780
    
    
    
    2,500,420Interest on short-term borrowings
    
    
    322,673
    
    
    
    838,994
    
    
    
    551,168
    
    
    
    1,639,297Interest on long-term debt
    
    
    1,385,212
    
    
    
    1,041,661
    
    
    
    2,739,791
    
    
    
    2,038,819Total interest expenses
    
    
    4,473,923
    
    
    
    3,369,456
    
    
    
    8,519,739
    
    
    
    6,178,536NET INTEREST INCOME
    
    
    4,353,987
    
    
    
    3,914,583
    
    
    
    8,608,130
    
    
    
    7,670,371PROVISION FOR LOAN LOSSES
    
    
    86,087
    
    
    
    126,097
    
    
    
    172,572
    
    
    
    189,124NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
    
    
    4,267,900
    
    
    
    3,788,486
    
    
    
    8,435,558
    
    
    
    7,481,247
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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005NONINTEREST INCOME:Loan appraisal, credit, and miscellaneous charges
    
    $
    135,172
    
    
    $
    61,973
    
    
    $
    233,789
    
    
    $
    124,880Net gain on the sale of foreclosed property
    
    
    
    
    
    
    3,756
    
    
    
    
    
    
    
    39,756Income from bank owned life insurance
    
    
    89,036
    
    
    
    62,201
    
    
    
    159,808
    
    
    
    123,330Loss on sale of investment securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,581
    )Service charges
    
    
    281,404
    
    
    
    305,876
    
    
    
    589,733
    
    
    
    561,750Total noninterest income
    
    
    505,612
    
    
    
    433,806
    
    
    
    983,330
    
    
    
    835,135NONINTEREST EXPENSE:Salary and employee benefits
    
    
    1,753,526
    
    
    
    1,358,491
    
    
    
    3,414,897
    
    
    
    2,822,453Occupancy
    
    
    324,981
    
    
    
    293,585
    
    
    
    604,288
    
    
    
    525,458Advertising
    
    
    100,983
    
    
    
    118,158
    
    
    
    246,191
    
    
    
    205,570Data processing
    
    
    210,339
    
    
    
    162,538
    
    
    
    430,573
    
    
    
    323,362Legal and professional fees
    
    
    309,153
    
    
    
    129,723
    
    
    
    548,167
    
    
    
    249,168Depreciation of furniture, fixtures, and equipment
    
    
    128,931
    
    
    
    109,250
    
    
    
    241,427
    
    
    
    196,350Telephone communications
    
    
    19,222
    
    
    
    24,208
    
    
    
    41,943
    
    
    
    53,402ATM expenses
    
    
    58,855
    
    
    
    80,087
    
    
    
    116,177
    
    
    
    149,881Office supplies
    
    
    33,239
    
    
    
    37,587
    
    
    
    68,950
    
    
    
    67,951Office equipment
    
    
    11,458
    
    
    
    19,974
    
    
    
    24,251
    
    
    
    29,676Other
    
    
    246,926
    
    
    
    256,314
    
    
    
    591,304
    
    
    
    515,358Total noninterest expenses
    
    
    3,197,613
    
    
    
    2,589,915
    
    
    
    6,328,168
    
    
    
    5,138,629INCOME BEFORE INCOME TAXES
    
    
    1,575,899
    
    
    
    1,632,377
    
    
    
    3,090,720
    
    
    
    3,177,753Income tax expense
    
    
    516,964
    
    
    
    553,288
    
    
    
    1,058,648
    
    
    
    1,074,303NET INCOME
    
    
    1,058,935
    
    
    
    1,079,089
    
    
    
    2,032,072
    
    
    
    2,103,450OTHER COMPREHENSIVE INCOME NET OF TAXNet unrealized holding (losses) gains arising during
period
    
    
    (46,914
    )
    
    
    216,596
    
    
    
    (208,701
    )
    
    
    (83,070
    )COMPREHENSIVE INCOME
    
    $
    1,012,021
    
    
    $
    1,295,685
    
    
    $
    1,823,371
    
    
    $
    2,020,380EARNINGS PER COMMON SHAREBasic
    
    $
    0.60
    
    
    $
    0.62
    
    
    $
    1.15
    
    
    $
    1.21Diluted
    
    
    0.56
    
    
    
    0.59
    
    
    
    1.08
    
    
    
    1.14
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TRI-COUNTY FINANCIAL CORPORATION
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2006 AND 2005
 Six Months EndedJune 30,2006
    
    
    2005CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    2,032,072
    
    
    $
    2,103,450Adjustments to reconcile net income to net
cash provided by operating activities:Provision for loan losses
    
    
    172,572
    
    
    
    189,124Loss on sales of investment securities
    
    
    
    
    
    
    14,581Depreciation and amortization
    
    
    455,017
    
    
    
    373,650Net amortization of premium/discount on investment securities
    
    
    13,095
    
    
    
    180,582Increase in cash surrender value of bank owned life insurance
    
    
    (159,808
    )
    
    
    (123,330
    )Deferred income tax provision (benefit)
    
    
    166,844
    
    
    
    (100,498
    )Increase in accrued interest receivable
    
    
    (143,051
    )
    
    
    (398,750
    )Decrease in deferred loan fees
    
    
    (92,284
    )
    
    
    (160,602
    )Increase in accounts payable, accrued expenses, other liabilities
    
    
    431,778
    
    
    
    373,807Increase in other assets
    
    
    (592,814
    )
    
    
    (111,572
    )Net cash provided by operating activities
    
    
    2,283,421
    
    
    
    2,340,442CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of investment securities available for sale
    
    
    (3,056,127
    )
    
    
    (7,316
    )Proceeds from sale, redemption or principal payments
of investment securities available for sale
    
    
    369,077
    
    
    
    3,171,871Purchase of investment securities held to maturity
    
    
    (4,300,000
    )
    
    
    (25,249,248
    )Proceeds from maturities or principal payments
of investment securities held to maturity
    
    
    14,579,389
    
    
    
    37,290,218Net sale of FHLB and Federal Reserve Bank stock
    
    
    31,500
    
    
    
    33,200Loans originated or acquired
    
    
    (93,286,715
    )
    
    
    (131,435,265
    )Principal collected on loans
    
    
    58,291,752
    
    
    
    81,490,185Purchase of bank owned life insurance
    
    
    (2,000,000
    )
    
    
    Purchase of premises and equipment
    
    
    (541,136
    )
    
    
    (1,203,473
    )Proceeds from sale of foreclosed real estate
    
    
    14,677
    
    
    
    39,756Net cash used in investing activities
    
    
    (29,897,583
    )
    
    
    (35,870,072
    )
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TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2006 AND 2005
 Six Months EndedJune 30,2006
    
    
    2005CASH FLOWS FROM FINANCING ACTIVITIES:Net increase in deposits
    
    $
    24,714,291
    
    
    $
    51,639,659Proceeds from long-term borrowings
    
    
    260,000
    
    
    
    20,000,000Payments of long-term borrowings
    
    
    (15,018,207
    )
    
    
    (5,090,513
    )Trust preferred debentures
    
    
    
    
    
    
    5,000,000Net increase (decrease) in short term borrowings
    
    
    12,169,382
    
    
    
    (35,419,900
    )Exercise of stock options
    
    
    81,505
    
    
    
    166,815Net change in unearned ESOP shares
    
    
    73,554
    
    
    
    60,395Dividends paid
    
    
    (972,966
    )
    
    
    (930,669
    )Redemption of common stock
    
    
    (269,947
    )
    
    
    (232,185
    )Net cash provided by financing activities
    
    
    21,037,612
    
    
    
    35,193,602(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    (6,576,550
    )
    
    
    1,663,972CASH AND CASH EQUIVALENTS JANUARY 1
    
    
    22,575,240
    
    
    
    17,715,779CASH AND CASH EQUIVALENTS JUNE 30
    
    $
    15,998,690
    
    
    $
    19,379,751SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid during the six months for:Interest
    
    $
    8,516,751
    
    
    $
    6,105,531Income taxes
    
    $
    1,251,000
    
    
    $
    1,002,500
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 1.
    
    BASIS OF PRESENTATIONGeneralThe 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, 2005 have been derived from audited financial statements. There have been no
significant changes to the Companys accounting policies as disclosed in the 2005 Annual
Report. The results of operations for the six months ended June 30, 2006 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 2006 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, 2005.2.
    
    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 earnings 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 June 30, 2006, there were no shares excluded from the diluted
earnings per share computation. Basic and diluted earnings per share, have been computed
based on weighted    average common and common equivalent shares outstanding as
follows:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Basic
    
    
    1,761,069
    
    
    
    1,734,383
    
    
    
    1,760,525
    
    
    
    1,731,356Diluted
    
    
    1,890,232
    
    
    
    1,847,276
    
    
    
    1,876,258
    
    
    
    1,845,375
 Share and per share data have been adjusted to reflect the three for two common stock
split effected on December 12, 2005 as if it had occurred on January 1, 2005.
 8




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5.
    
    STOCK-BASED COMPENSATIONThe Company has stock option and incentive plans to attract and retain key personnel in
order to promote the success of the business. These plans are described in note 12 to the
financial statements included in our Annual Report to Stockholders for the year ended
December 31, 2005. Prior to 2006, the Company applied the intrinsic value method as outlined
in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
(APB No. 25) and related interpretations in accounting for stock options granted. Under
the intrinsic value method, no compensation expense was recognized if the exercise price of
the Companys employee stock options equaled the market price of the underlying stock on the
date of the grant. Accordingly, no compensation cost was recognized in the accompanying
consolidated statements of earnings prior to 2006 on stock options granted to employees or
directors, since all options granted under the Companys incentive programs had an exercise
price equal to the market value of the underlying common stock on the date of grant.Effective January 1, 2006, the Company adopted SFAS No. 123(R), Share    Based
Payment (SFAS No. 123(R)). This statement replaced SFAS No. 123, Accounting for
Stock    based Compensation and superseded APB No. 25. SFAS No. 123(R) requires that
all stockbased compensation be recognized as an expense in the financial statements and
that such cost be measured at the fair value of the award. This statement was adopted using
the modified prospective method of application, which requires the Company to recognize
compensation expense on a prospective basis. Therefore, prior period financial statements
have not been restated. Under this method, in addition to reflecting compensation expense
for new share-based awards, expense is also recognized to reflect the remaining service
period of outstanding awards that had been included in pro forma disclosures in prior
periods. As of December 31, 2005, all outstanding options were fully vested, so no expense
will be recognized for options outstanding as of that date; however, the Company has accrued
for outstanding options relating to the current year. SFAS No. 123(R) also requires that
excess tax benefits related to stock option exercises be reflected as financing cash flows
instead of operating cash flows.The Company and the Bank currently maintain incentive plans which provide for payments to be
made in either cash or stock options. The Company has accrued the full amounts due under
these plans, but currently it is not possible to identify the portion that will be paid out
in the form of stock options.The following table illustrates the effect on the net earnings per common share if the fair
value method had been applied to all outstanding awards for the three and six months ended
June 30, 2005:
 Three Months Ended
    
    Six Months EndedJune 30, 2005
    
    June 30, 2005Net income as reported
    
    $
    1,079,089
    
    
    $
    2,103,450Less pro forma stock-based compensation:Expense determined under fair value method,
net
tax effects
    
    
    (193,614
    )
    
    
    (193,614
    )$
    885,475
    
    
    $
    1,909,836Earnings per common shareBasic as reported
    
    $
    0.62
    
    
    $
    1.21Basic pro forma
    
    $
    0.51
    
    
    $
    1.10Diluted as reported
    
    $
    0.59
    
    
    $
    1.14Diluted pro forma
    
    $
    0.48
    
    
    $
    1.03
 9




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A summary of the Companys stock option plans as of June 30, 2006 and changes during the
six    month period then ended is presented below:
 Weighted
    
    
    
    
    
    
    Weighted  AverageAverage
    
    
    Aggregate
    
    
    Contractual LifeExercise
    
    
    Intrinsic
    
    
    Remaining InShares
    
    
    Price
    
    
    Value (1)
    
    
    YearsOutstanding at December 31,
2005
    
    
    296,502
    
    
    $
    20.38GrantedExercised
    
    
    (6,279
    )
    
    
    12.98ExpiredForfeited
    
    
    (5,156
    )
    
    
    19.27Outstanding at June 30, 2006
    
    
    285,068
    
    
    $
    20.57
    
    
    $
    4,328,091
    
    
    
    5.8Exercisable at June 30, 2006
    
    
    285,068
    
    
    $
    20.57
    
    
    $
    4,328,091
    
    
    
    5.8
 Share and per share data have been adjusted to reflect the three for two common stock split
effected on December 12, 2005 as if it had occurred on January 1, 2005.6.
    
    GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURESOn June 15, 2005, Tri County Capital Trust II (Capital Trust II), a Delaware business
trust formed, funded and wholly owned by the Company, issued $5,000,000 of
variable  rate capital securities with an interest rate of 5.07% in a private pooled
transaction. The variable rate is based on the 90day LIBOR rate plus 1.70% and adjusts
quarterly. The Trust used the proceeds from this issuance to purchase $5.2 million of the
Companys junior subordinated debentures. The interest rate on the debentures is identical to
the interest rate on the trust preferred securities. The Company has, through various
contractual arrangements, fully and unconditionally guaranteed all of Capital Trust IIs
obligations with respect to the capital securities. These capital securities qualify as Tier I
capital and are presented in the Consolidated Balance Sheets as Guaranteed Preferred
Beneficial Interests in Junior Subordinated Debentures. Both the capital securities of Capital
Trust II and the junior subordinated debentures are scheduled to mature on June 15, 2035,
unless called by the Company not earlier than June 15, 2010.On July 22, 2004, Tri County Capital Trust I (Capital Trust I), a Delaware business
trust formed, funded and wholly owned by the Company, issued $7,000,000 of
variable    rate capital securities with an interest rate of 4.22% in a private pooled
transaction. The variable rate is based on the 90day LIBOR rate plus 2.60% and adjusts
quarterly. The Trust used the proceeds from this issuance to purchase $7.2 million of the
Companys junior subordinated debentures. The interest rate on the debentures is identical to
the interest rate on the trust preferred securities. The Company has, through various
contractual arrangements, fully and unconditionally guaranteed all of Capital Trust
Is obligations with respect to the capital securities. These capital securities qualify as
Tier I capital and are presented in the Consolidated Balance Sheets as Guaranteed Preferred
Beneficial Interests in Junior Subordinated Debentures. Both the capital securities of Capital
Trust I and the junior subordinated debentures are scheduled to mature on July 22, 2034, unless
called by the Company not earlier than July 22, 2009.Costs associated with the issuance of the trust-preferred securities were less than
$10,000 and were expensed as period costs.7.
    
    NEW ACCOUNTING STANDARDSIn February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments which amends SFAS No. 133 Accounting for Derivative Instruments and Hedging
Activities and SFAS No. 140,
 10




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##### Table of Contents



Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities. SFAS 155 simplifies the accounting for certain
derivative embedded in other financial instruments by allowing them to be accounted for as a
whole if the holder elects to account for the whole instrument on a fair value basis. SFAS
155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155
is effective for all financial instruments acquired, issued or subject to a re-measurement
event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is
permitted, provided the Company has not yet issued financial statements, including for
interim periods, for that fiscal year. Management does not expect the adoption of SFAS 155
to have a material impact on the consolidated financial statements.In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial
Assets which amends SFAS No. 140 and SFAS 156 requires that all separately recognized
servicing assets and servicing liabilities be initially measured at fair value, if
practicable. The statement permits, but does not require, the subsequent measurement of
servicing assets and servicing liabilities at fair value. SFAS 156 is effective for fiscal
years beginning after September 15, 2006. Management does not expect the adoption of SFAS 155
to have a material impact on the consolidated financial statements.In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation
(FIN) No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB
Statement No. 109. This Interpretation prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax position taken, or
expects to be taken in a tax return, and provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and transition. This
Interpretation is effective for fiscal years beginning after December 15, 2006. Management does
not expect the adoption of SFAS 155 to have a material impact on the consolidated financial
statements.In June 2006, the FASB ratified Emerging Issues Task Force (EITF) No. 06-2, Accounting
for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting
for Compensated Absences (SAFS 43) (EITF 062). EITF 06-2 provides guidelines under which
sabbatical leave or other similar benefits provided to an employee are considered to
accumulate, as defined in SFAS 43. If such benefits are deemed to accumulate, then the
compensation cost associated with a sabbatical or other similar benefit arrangement should be
accrued over the requisite service period. The provisions of the EITF are effective for fiscal
years beginning after December 15, 2006 and allow for either retrospective application or a
cumulative effect adjustment approach upon adoption. Management does not expect the adoption of
SFAS 155 to have a material impact on the consolidated financial statements.
 11




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##### Table of Contents



ITEM 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
        12




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##### Table of Contents









Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Condensed Income StatementInterest Income
    
    $
    8,827,910
    
    
    $
    7,284,039
    
    
    $
    17,127,869
    
    
    $
    13,848,907Interest Expense
    
    
    4,473,923
    
    
    
    3,369,456
    
    
    
    8,519,739
    
    
    
    6,178,536Net Interest Income
    
    
    4,353,987
    
    
    
    3,914,583
    
    
    
    8,608,130
    
    
    
    7,670,371Provision for Loan Loss
    
    
    86,087
    
    
    
    126,097
    
    
    
    172,572
    
    
    
    189,124Noninterest Income
    
    
    505,612
    
    
    
    433,806
    
    
    
    983,330
    
    
    
    835,135Noninterest Expense
    
    
    3,197,613
    
    
    
    2,589,915
    
    
    
    6,328,168
    
    
    
    5,138,629Income Before Income Taxes
    
    
    1,575,899
    
    
    
    1,632,377
    
    
    
    3,090,720
    
    
    
    3,177,753Income Taxes
    
    
    516,964
    
    
    
    553,288
    
    
    
    1,058,648
    
    
    
    1,074,303Net Income
    
    
    1,058,935
    
    
    
    1,079,089
    
    
    
    2,032,072
    
    
    
    2,103,450Per Common ShareBasic Earnings
    
    $
    0.60
    
    
    $
    0.62
    
    
    $
    1.15
    
    
    $
    1.21Diluted Earnings
    
    $
    0.56
    
    
    $
    0.59
    
    
    $
    1.08
    
    
    $
    1.14Book Value
    
    $
    20.05
    
    
    $
    18.57
    
    
    $
    20.05
    
    
    $
    18.57










13




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##### Table of Contents



Six Months Ended June 30,2006
    
    
    2005
    
    
    $ Change
    
    
    % ChangeNONINTEREST INCOMELoan appraisal, credit, and miscellaneous charges
    
    $
    233,789
    
    
    $
    124,880
    
    
    $
    108,909
    
    
    
    87.21
    %Net gain on the sale of foreclosed property
    
    
    
    
    
    
    39,756
    
    
    
    (39,756
    )
    
    
    (100.00
    %)Income from bank owned life insurance
    
    
    159,808
    
    
    
    123,330
    
    
    
    36,478
    
    
    
    29.58
    %Loss on sale of investment securities
    
    
    
    
    
    
    (14,581
    )
    
    
    14,581
    
    
    
    (100.00
    %)Service charges
    
    
    589,733
    
    
    
    561,750
    
    
    
    27,983
    
    
    
    4.98
    %Total noninterest income
    
    $
    983,330
    
    
    $
    835,135
    
    
    $
    148,195
    
    
    
    17.75
    %
  Six Months Ended June 30,2006
    
    
    2005
    
    
    $ Change
    
    
    % ChangeNONINTEREST EXPENSESalary and employee benefits
    
    $
    3,414,897
    
    
    $
    2,822,453
    
    
    $
    592,444
    
    
    
    20.99
    %Occupancy
    
    
    604,288
    
    
    
    525,458
    
    
    
    78,830
    
    
    
    15.00
    %Advertising
    
    
    246,191
    
    
    
    205,570
    
    
    
    40,621
    
    
    
    19.76
    %Data processing
    
    
    430,573
    
    
    
    323,362
    
    
    
    107,211
    
    
    
    33.16
    %Legal and professional fees
    
    
    548,167
    
    
    
    249,168
    
    
    
    298,999
    
    
    
    120.00
    %Depreciation of furniture, fixtures, and equipment
    
    
    241,427
    
    
    
    196,350
    
    
    
    45,077
    
    
    
    22.96
    %Telephone communications
    
    
    41,943
    
    
    
    53,402
    
    
    
    (11,459
    )
    
    
    (21.46
    %)ATM expenses
    
    
    116,177
    
    
    
    149,881
    
    
    
    (33,704
    )
    
    
    (22.49
    %)Office supplies
    
    
    68,950
    
    
    
    67,951
    
    
    
    999
    
    
    
    1.47
    %Office equipment
    
    
    24,251
    
    
    
    29,676
    
    
    
    (5,425
    )
    
    
    (18.28
    %)Other
    
    
    591,304
    
    
    
    515,358
    
    
    
    75,946
    
    
    
    14.74
    %Total noninterest expenses
    
    $
    6,328,168
    
    
    $
    5,138,629
    
    
    $
    1,189,539
    
    
    
    23.15
    %
  14




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##### Table of Contents



Three Months Ended June 30,2006
    
    2005
    
    $ Change
    
    % ChangeLoan appraisal, credit, and miscellaneous
charges
    
    $
    135,172
    
    
    $
    61,973
    
    
    $
    73,199
    
    
    
    118.11
    %Net gain on the sale of foreclosed property
    
    
    
    
    
    
    3,756
    
    
    
    (3,756
    )
    
    
    (100.00
    %)Income from bank owned life insurance
    
    
    89,036
    
    
    
    62,201
    
    
    
    26,835
    
    
    
    43.14
    %Service charges
    
    
    281,404
    
    
    
    305,876
    
    
    
    (24,472
    )
    
    
    (8.00
    %)Total noninterest income
    
    
    505,612
    
    
    
    433,806
    
    
    
    71,806
    
    
    
    16.55
    %
  Three Months Ended June 30,2006
    
    2005
    
    $ Change
    
    % ChangeSalary and employee benefits
    
    
    1,753,526
    
    
    
    1,358,491
    
    
    
    395,035
    
    
    
    29.08
    %Occupancy
    
    
    324,981
    
    
    
    293,585
    
    
    
    31,396
    
    
    
    10.69
    %Advertising
    
    
    100,983
    
    
    
    118,158
    
    
    
    (17,175
    )
    
    
    (14.54
    %)Data processing
    
    
    210,339
    
    
    
    162,538
    
    
    
    47,801
    
    
    
    29.41
    %Legal and professional fees
    
    
    309,153
    
    
    
    129,723
    
    
    
    179,430
    
    
    
    138.32
    %Depreciation of furniture,
fixtures, and equipment
    
    
    128,931
    
    
    
    109,250
    
    
    
    19,681
    
    
    
    18.01
    %Telephone communications
    
    
    19,222
    
    
    
    24,208
    
    
    
    (4,986
    )
    
    
    (20.60
    %)ATM expenses
    
    
    58,855
    
    
    
    80,087
    
    
    
    (21,232
    )
    
    
    (26.51
    %)Office supplies
    
    
    33,239
    
    
    
    37,587
    
    
    
    (4,348
    )
    
    
    (11.57
    %)Office equipment
    
    
    11,458
    
    
    
    19,974
    
    
    
    (8,516
    )
    
    
    (42.64
    %)Other
    
    
    246,926
    
    
    
    256,314
    
    
    
    (9,388
    )
    
    
    (3.66
    %)Total noninterest expenses
    
    
    3,197,613
    
    
    
    2,589,915
    
    
    
    607,698
    
    
    
    23.46
    %
  15




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##### Table of Contents



Assets
    
    June 30, 2006
    
    
    December 31, 2005
    
    
    $ Change
    
    
    % ChangeCash and due from banks
    
    $
    2,869,183
    
    
    $
    7,262,547
    
    
    $
    (4,393,364
    )
    
    
    (60.49
    %)Federal funds sold
    
    
    675,129
    
    
    
    640,818
    
    
    
    34,311
    
    
    
    5.35
    %Interest    bearing deposits with banks
    
    
    12,454,378
    
    
    
    14,671,875
    
    
    
    (2,217,497
    )
    
    
    (15.11
    %)Securities available for sale
    
    
    9,538,720
    
    
    
    7,178,894
    
    
    
    2,359,826
    
    
    
    32.87
    %Securities held to maturity at amortized cost
    
    
    106,205,210
    
    
    
    116,486,685
    
    
    
    (10,281,475
    )
    
    
    (8.83
    %)Federal Home Loan Bank and Federal Reserve
Bank stock at cost
    
    
    7,158,800
    
    
    
    7,190,300
    
    
    
    (31,500
    )
    
    
    (0.44
    %)Loans receivable net of allowance for loan losses
of $3,549,270 and $3,383,334 respectively
    
    
    404,506,928
    
    
    
    369,592,253
    
    
    
    34,914,675
    
    
    
    9.45
    %Premises and equipment, net
    
    
    6,546,664
    
    
    
    6,460,545
    
    
    
    86,119
    
    
    
    1.33
    %Foreclosed real estate
    
    
    460,884
    
    
    
    475,561
    
    
    
    (14,677
    )
    
    
    (3.09
    %)Accrued interest receivable
    
    
    2,549,593
    
    
    
    2,406,542
    
    
    
    143,051
    
    
    
    5.94
    %Investment in bank owned life insurance
    
    
    8,593,983
    
    
    
    6,434,175
    
    
    
    2,159,808
    
    
    
    33.57
    %Other assets
    
    
    3,020,764
    
    
    
    2,487,280
    
    
    
    533,484
    
    
    
    21.45
    %Total Assets
    
    $
    564,580,236
    
    
    $
    541,287,475
    
    
    $
    23,292,761
    
    
    
    4.30
    %
   June 30, 2006
    
    
    December 31, 2005Amount
    
    
    %
    
    
    Amount
    
    
    %Real estate loansCommercial
    
    $
    175,021,917
    
    
    
    42.84
    %
    
    $
    166,850,838
    
    
    
    44.66
    %Residential first mortgages
    
    
    76,902,713
    
    
    
    18.82
    %
    
    
    73,627,717
    
    
    
    19.71
    %Residential construction
    
    
    34,678,763
    
    
    
    8.49
    %
    
    
    32,608,002
    
    
    
    8.73
    %Second mortgage loans
    
    
    26,636,264
    
    
    
    6.52
    %
    
    
    25,884,406
    
    
    
    6.93
    %Commercial lines of credit
    
    
    74,216,583
    
    
    
    18.17
    %
    
    
    54,737,693
    
    
    
    14.65
    %Consumer loans
    
    
    3,217,163
    
    
    
    0.79
    %
    
    
    3,128,425
    
    
    
    0.84
    %Commercial equipment
    
    
    17,894,225
    
    
    
    4.38
    %
    
    
    16,742,220
    
    
    
    4.48
    %Total Loans
    
    
    408,567,628
    
    
    
    100.00
    %
    
    
    373,579,301
    
    
    
    100.00
    %Less:Deferred loan fees
    
    
    511,430
    
    
    
    0.13
    %
    
    
    603,714
    
    
    
    0.16
    %Allowance for loan loss
    
    
    3,549,270
    
    
    
    0.87
    %
    
    
    3,383,334
    
    
    
    0.91
    %$
    404,506,928
    
    
    
    
    
    
    $
    369,592,253
 16




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##### Table of Contents



6 Months Ended
    
    
    6 Months EndedJune 30, 2006
    
    
    June 30, 2005Beginning Balance
    
    $
    3,383,334
    
    
    $
    3,057,558Charge Offs
    
    
    6,636
    
    
    
    3,201RecoveriesNet Charge Offs
    
    
    6,636
    
    
    
    3,201Additions Charged to Operations
    
    
    172,572
    
    
    
    189,124Balance at the end of the Period
    
    $
    3,549,270
    
    
    $
    3,243,481
  Balances as of
    
    
    Balances as ofJune 30, 2006
    
    
    December 31, 2005Restructured Loans
    
    $
    
    
    
    $
    Accruing loans which are contractually
past due 90 days or more:
    
    $
    
    
    
    $
    Loans accounted for on a nonaccrual
basis
    
    $
    518,673
    
    
    $
    590,498Total nonperforming loans
    
    $
    518,673
    
    
    $
    590,498Nonperforming loans to total loans
    
    
    0.13
    %
    
    
    0.16
    %Allowance for loan losses to non
performing loans
    
    
    684.30
    %
    
    
    572.96
    %
  June 30, 2006
    
    
    December 31, 2005
    
    
    $ Change
    
    
    % ChangeNoninterest    bearing deposits
    
    $
    41,352,192
    
    
    $
    44,325,083
    
    
    
    (2,972,891
    )
    
    
    (6.71
    %)Interest    bearing deposits
    
    
    346,735,839
    
    
    
    319,048,657
    
    
    
    27,687,182
    
    
    
    8.68
    %Total deposits
    
    
    388,088,031
    
    
    
    363,373,740
    
    
    
    24,714,291
    
    
    
    6.80
    %Short    term borrowings
    
    
    32,244,357
    
    
    
    20,074,975
    
    
    
    12,169,382
    
    
    
    60.62
    %Long    term debt
    
    
    93,065,552
    
    
    
    107,823,759
    
    
    
    (14,758,207
    )
    
    
    (13.69
    %)Guaranteed preferred beneficial
interest in junior subordinated
debentures
    
    
    12,000,000
    
    
    
    12,000,000
    
    
    
    
    
    
    
    0.00
    %Accrued expenses and other liabilities
    
    
    3,868,623
    
    
    
    3,436,845
    
    
    
    431,778
    
    
    
    12.56
    %Total Liabilities
    
    $
    529,266,563
    
    
    $
    506,709,319
    
    
    
    22,557,244
    
    
    
    4.45
    %
 17




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##### Table of Contents



June 30, 2006
    
    
    December 31, 2005
    
    
    $ Change
    
    
    % ChangeCommon stock
    
    $
    17,615
    
    
    $
    17,610
    
    
    
    5
    
    
    
    0.03
    %Additional paid in capital
    
    
    9,182,554
    
    
    
    9,057,805
    
    
    
    124,749
    
    
    
    1.38
    %Retained earnings
    
    
    26,369,872
    
    
    
    25,580,634
    
    
    
    789,238
    
    
    
    3.09
    %Accumulated other
comprehensive income
(loss)
    
    
    (159,339
    )
    
    
    49,362
    
    
    
    (208,701
    )
    
    
    (422.80
    %)Unearned ESOP shares
    
    
    (97,029
    )
    
    
    (127,255
    )
    
    
    30,226
    
    
    
    (23.75
    %)$
    35,313,673
    
    
    $
    34,578,156
    
    
    
    735,517
    
    
    
    2.13
    %
       18




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##### Table of Contents



19




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
  20




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##### Table of Contents



PART II OTHER INFORMATION
 
  
  
  (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 June 30, 2006.
 (c)Total Numberof Shares
    
    (d)Purchased
    
    Maximum(a)
    
    
    
    
    
    as Part of
    
    Number of SharesTotal
    
    (b)
    
    Publicly
    
    that May Yet BeNumber of
    
    Average
    
    Announced Plans
    
    Purchased UnderShares
    
    Price Paid
    
    or
    
    the Plans orPeriod
    
    Purchased (I)
    
    per Share
    
    Programs
    
    ProgramsApril 2006
    
    
    2,514
    
    
    
    34.46
    
    
    
    2,514
    
    
    
    55,241May 2006
    
    
    1,103
    
    
    
    35.00
    
    
    
    1,103
    
    
    
    54,138June 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54,138Total
    
    
    3,617
    
    
    $
    34.62
    
    
    
    3,617
  
  
  21




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##### Table of Contents



Exhibit 3 Amended and Restated BylawsExhibit 31 Rule 13a14(a) CertificationsExhibit 32 Section 1350 Certifications
 22




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##### Table of Contents



SIGNATURES
  TRI-COUNTY FINANCIAL CORPORATION:Date:  August 11, 2006
    By:

/s/
Michael L. MiddletonMichael L. Middleton, President, ChiefExecutive Officer and Chairman of the
BoardDate:  August 11, 2006
    By:

/s/
William J. PasenelliWilliam J. Pasenelli, Executive VicePresident and Chief Financial Officer
(Principal Financial and Accounting Officer) 23