UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q


(Mark
One)


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


OF
THE SECURITIES EXCHANGE ACT OF 1934





For the
Quarterly Period Ended September 30, 2009





OR





 ̈           TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934





For the
transition period
from  ______  to  ______





Commission
File Number 0-18279





Tri-County Financial
Corporation


(Exact
name of registrant as specified in its charter)





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





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





(301)
645-5601


(Registrant's
telephone number, including area code)





Not
applicable


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





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


Yes  x    No ̈





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


 ̈Yes       ̈No





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





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





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


Yes  ̈         No
x




As of
November 12, 2009 the registrant had 2,976,467 shares of common stock
outstanding.








TRI-COUNTY
FINANCIAL CORPORATION





FORM
10-Q




INDEX





PagePART
      I - FINANCIAL INFORMATIONItem
      1 – Financial Statements (Unaudited)Consolidated
      Balance Sheets – September 30, 2009and December 31,
    2008
                                                                        3Consolidated
      Statements of Income and Comprehensive Income -Three and Nine Months
      Ended September 30, 2009 and 2008
                                                                        4-5Consolidated
      Statements of Cash Flows - Nine MonthsEnded September 30, 2009 and
      2008
                                                                        6-7Notes
      to Consolidated Financial Statements
                                                                        8-17Item
      2 – Management’s Discussion and Analysis of Financial Conditionand
      Results of Operations
                                                                        18-28Item
      3 – Quantitative and Qualitative Disclosures about Market
    Risk
                                                                        28Item
      4 – Controls and Procedures
                                                                        28PART
      II - OTHER INFORMATIONItem
      1 – Legal Proceedings
                                                                        29Item
      1A –  Risk Factors
                                                                        29Item
      2 – Unregistered Sales of Equity Securities and Use of
      Proceeds
                                                                        29Item
      3 – Defaults Upon Senior Securities
                                                                        29Item
      4T –    Submission of Matters to a Vote of Security
      Holders
                                                                        29Item
      5 – Other Information
                                                                        29Item
      6 – Exhibits
                                                                        29SIGNATURES
                                                                        30




2





PART
I FINANCIAL STATEMENTS


ITEM
I. FINANCIAL STATEMENTS


TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
BALANCE SHEETS (UNAUDITED) SEPTEMBER 30, 2009 AND DECEMBER 31, 2008





September 30,2009
                
                
                December 31, 2008AssetsCash
      and due from banks
                
                $
                20,116,141
                
                
                $
                5,071,614Federal
      Funds sold
                
                
                7,610,000
                
                
                
                989,754Interest-bearing
      deposits with banks
                
                
                946,009
                
                
                
                8,413,164Securities
      available for sale, at fair value
                
                
                47,507,201
                
                
                
                14,221,674Securities
      held to maturity, at amortized cost
                
                
                95,516,261
                
                
                
                108,712,281Federal
      Home Loan Bank and Federal Reserve Bank stock - at cost
                
                
                6,935,500
                
                
                
                6,453,000Loans
      held for sale
                
                
                772,877
                
                
                
                -Loans
      receivable - net of allowance for loan losses of $6,791,908 and
      $5,145,673, respectively
                
                
                586,487,319
                
                
                
                542,977,138Premises
      and equipment, net
                
                
                12,189,059
                
                
                
                12,235,999Foreclosed
      real estate
                
                
                922,934
                
                
                
                -Accrued
      interest receivable
                
                
                2,958,759
                
                
                
                2,965,813Investment
      in bank owned life insurance
                
                
                10,823,864
                
                
                
                10,526,286Other
      assets
                
                
                5,128,468
                
                
                
                4,118,187Total
      Assets
                
                $
                797,914,392
                
                
                $
                716,684,910Liabilities
      and Stockholders' EquityLiabilitiesDepositsNon-interest-bearing
      deposits
                
                $
                57,793,984
                
                
                $
                50,642,273Interest-bearing
      deposits
                
                
                569,201,810
                
                
                
                474,525,293Total
      deposits
                
                
                626,995,794
                
                
                
                525,167,566Short-term
      borrowings
                
                
                193,749
                
                
                
                1,522,367Long-term
      debt
                
                
                85,680,745
                
                
                
                104,963,428Guaranteed
      preferred beneficial interest in junior subordinated
      debentures
                
                
                12,000,000
                
                
                
                12,000,000Accrued
      expenses and other liabilities
                
                
                5,557,022
                
                
                
                5,917,130Total
      Liabilities
                
                
                730,427,310
                
                
                
                649,570,491Stockholders'
      EquityFixed
      Rate Cumulative Perpetual Preferred Stock, Series A - par value $1,000;
      authorized 15,540; issued 15,540
                
                
                15,540,000
                
                
                
                15,540,000Fixed
      Rate Cumulative Perpetual Preferred Stock, Series B - par value $1,000;
      authorized 777; issued 777
                
                
                777,000
                
                
                
                777,000Common
      stock - par value $.01; authorized - 15,000,000 shares; issued 2,967,680
      and 2,947,759 shares, respectively
                
                
                29,677
                
                
                
                29,478Additional
      paid in capital
                
                
                16,694,565
                
                
                
                16,517,649Retained
      earnings
                
                
                34,698,229
                
                
                
                34,280,719Accumulated
      other comprehensive gain
                
                
                52,094
                
                
                
                229,848Unearned
      ESOP shares
                
                
                (304,483
                )
                
                
                (260,275
                )Total
      Stockholders' Equity
                
                
                67,487,082
                
                
                
                67,114,419Total
      Liabilities and Stockholders' Equity
                
                $
                797,914,392
                
                
                $
                716,684,910





See
notes to consolidated financial statements


3




TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)


THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





Three Months Ended September 30,
                    
                    
                    Nine Months Ended September 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008INTEREST
      INCOME:Interest
      and fees on loans
                    
                    $
                    8,324,971
                    
                    
                    $
                    7,990,645
                    
                    
                    $
                    24,243,433
                    
                    
                    $
                    23,894,892Taxable
      interest and dividends on investment securities
                    
                    
                    1,286,507
                    
                    
                    
                    1,318,151
                    
                    
                    
                    3,914,458
                    
                    
                    
                    4,080,686Interest
      on deposits with banks
                    
                    
                    9,017
                    
                    
                    
                    13,291
                    
                    
                    
                    16,045
                    
                    
                    
                    73,563Total
      interest income
                    
                    
                    9,620,495
                    
                    
                    
                    9,322,087
                    
                    
                    
                    28,173,936
                    
                    
                    
                    28,049,141INTEREST
      EXPENSE:Interest
      on deposits
                    
                    
                    3,076,512
                    
                    
                    
                    3,233,917
                    
                    
                    
                    9,375,353
                    
                    
                    
                    9,759,618Interest
      on short-term borrowings
                    
                    
                    -
                    
                    
                    
                    19,917
                    
                    
                    
                    29,800
                    
                    
                    
                    134,344Interest
      on long-term borrowings
                    
                    
                    1,001,507
                    
                    
                    
                    1,239,381
                    
                    
                    
                    3,112,968
                    
                    
                    
                    3,651,628Total
      interest expenses
                    
                    
                    4,078,019
                    
                    
                    
                    4,493,215
                    
                    
                    
                    12,518,121
                    
                    
                    
                    13,545,590NET
      INTEREST INCOME
                    
                    
                    5,542,476
                    
                    
                    
                    4,828,872
                    
                    
                    
                    15,655,815
                    
                    
                    
                    14,503,551PROVISION
      FOR LOAN LOSSES
                    
                    
                    515,555
                    
                    
                    
                    462,622
                    
                    
                    
                    1,977,928
                    
                    
                    
                    617,367NET
      INTEREST INCOME AFTER PROVISION FOR LOAN
      LOSSES
                    
                    $
                    5,026,921
                    
                    
                    $
                    4,366,250
                    
                    
                    $
                    13,677,887
                    
                    
                    $
                    13,886,184




4





TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
(continued)


THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





Three Months Ended September&
      #160;30,
                        
                        
                        Nine Months Ended September&#
      160;30,2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008NONINTEREST
      INCOME:Recognition
      of other than temporary decline in value of investment
      securities
                        
                        $
                        (458,530
                        )
                        
                        $
                        -
                        
                        
                        $
                        (577,274
                        )
                        
                        $
                        -Less:
      portion recorded as comprehensive income
                        
                        
                        410,530
                        
                        
                        
                        -
                        
                        
                        
                        410,530
                        
                        
                        
                        -Impairment
      loss on investment securities, net
                        
                        
                        48,000
                        
                        
                        
                        -
                        
                        
                        
                        (166,744
                        )
                        
                        
                        -Loan
      appraisal, credit, and miscellaneous charges
                        
                        
                        104,219
                        
                        
                        
                        129,107
                        
                        
                        
                        465,111
                        
                        
                        
                        363,658Gain
      on sale of loans held for sale
                        
                        
                        72,862
                        
                        
                        
                        -
                        
                        
                        
                        241,236
                        
                        
                        
                        -Gain
      on asset sale
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,041Income
      from bank owned life insurance
                        
                        
                        96,105
                        
                        
                        
                        101,994
                        
                        
                        
                        297,578
                        
                        
                        
                        388,483Loss
      on sale of investment securities
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (12,863
                        )
                        
                        
                        -Service
      charges
                        
                        
                        443,161
                        
                        
                        
                        401,204
                        
                        
                        
                        1,212,257
                        
                        
                        
                        1,224,162Total
      noninterest income
                        
                        
                        668,347
                        
                        
                        
                        632,305
                        
                        
                        
                        2,036,575
                        
                        
                        
                        1,978,344NONINTEREST
      EXPENSE:Salary
      and employee benefits
                        
                        
                        2,284,641
                        
                        
                        
                        2,052,810
                        
                        
                        
                        6,536,475
                        
                        
                        
                        6,174,825Occupancy
                        
                        
                        399,648
                        
                        
                        
                        416,723
                        
                        
                        
                        1,270,396
                        
                        
                        
                        1,214,352Advertising
                        
                        
                        144,854
                        
                        
                        
                        160,281
                        
                        
                        
                        374,816
                        
                        
                        
                        431,653Data
      processing
                        
                        
                        245,974
                        
                        
                        
                        216,283
                        
                        
                        
                        682,594
                        
                        
                        
                        477,274Legal
      and professional fees
                        
                        
                        166,110
                        
                        
                        
                        98,978
                        
                        
                        
                        526,018
                        
                        
                        
                        437,454Depreciation
      of furniture, fixtures,
      and equipment
                        
                        
                        154,777
                        
                        
                        
                        141,859
                        
                        
                        
                        453,882
                        
                        
                        
                        413,139Telephone
      communications
                        
                        
                        33,698
                        
                        
                        
                        16,898
                        
                        
                        
                        101,871
                        
                        
                        
                        59,375Office
      supplies
                        
                        
                        37,076
                        
                        
                        
                        32,140
                        
                        
                        
                        124,461
                        
                        
                        
                        106,615FDIC
      Insurance
                        
                        
                        242,332
                        
                        
                        
                        71,692
                        
                        
                        
                        875,943
                        
                        
                        
                        195,946Other
                        
                        
                        557,942
                        
                        
                        
                        416,486
                        
                        
                        
                        1,413,431
                        
                        
                        
                        1,259,280Total
      noninterest expenses
                        
                        
                        4,267,052
                        
                        
                        
                        3,624,150
                        
                        
                        
                        12,359,887
                        
                        
                        
                        10,769,913INCOME
      BEFORE INCOME TAXES
                        
                        
                        1,428,216
                        
                        
                        
                        1,374,405
                        
                        
                        
                        3,354,575
                        
                        
                        
                        5,094,615Income
      tax expense
                        
                        
                        560,640
                        
                        
                        
                        490,236
                        
                        
                        
                        1,194,945
                        
                        
                        
                        1,767,761NET
      INCOME
                        
                        
                        867,576
                        
                        
                        
                        884,169
                        
                        
                        
                        2,159,630
                        
                        
                        
                        3,326,854OTHER
      COMPREHENSIVE INCOME NET OF TAXNet
      unrealized holding gains arising during period
                        
                        
                        100,808
                        
                        
                        
                        109,500
                        
                        
                        
                        93,196
                        
                        
                        
                        35,912Other-than-temporary
      impairment on securities held-to-maturity
                        
                        
                        (270,950
                        )
                        
                        
                        -
                        
                        
                        
                        (270,950
                        )
                        
                        
                        -COMPREHENSIVE
      INCOME
                        
                        $
                        697,434
                        
                        
                        $
                        993,669
                        
                        
                        $
                        1,981,876
                        
                        
                        $
                        3,362,766EARNINGS
      PER COMMON SHAREBasic
                        
                        $
                        0.22
                        
                        
                        $
                        0.30
                        
                        
                        $
                        0.52
                        
                        
                        $
                        1.13Diluted
                        
                        
                        0.22
                        
                        
                        
                        0.29
                        
                        
                        
                        0.51
                        
                        
                        
                        1.09Dividends
      paid per common share
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        0.40
                        
                        
                        
                        0.40





See
notes to consolidated financial statements


5





TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)


NINE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





Nine Months Ended September 30,2009
                
                
                2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                
                $
                2,159,630
                
                
                $
                3,326,944Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                
                
                1,977,928
                
                
                
                617,367Gain
      on sale of asset
                
                
                -
                
                
                
                (2,041
                )Loss
      on sales of investment securities
                
                
                12,863
                
                
                
                -Other
      than temporary decline in market value of investment
      securities
                
                
                166,744
                
                
                
                -Depreciation
      and amortization
                
                
                875,337
                
                
                
                789,628Net
      amortization of premium/discount on investment securities
                
                
                (134,621
                )
                
                
                (41,014
                )Increase
      in cash surrender of bank owned life insurance
                
                
                (297,578
                )
                
                
                (299,345
                )Deferred
      income tax benefit
                
                
                (1,266,083
                )
                
                
                (627,033
                )Decrease
      in accrued interest receivable
                
                
                7,054
                
                
                
                56,203Decrease
      (increase) in deferred loan fees
                
                
                349
                
                
                
                (78,784
                )(Increase)
      decrease in accounts payable, accrued expenses, other
      liabilities
                
                
                (360,108
                )
                
                
                677,897Decrease
      in other assets
                
                
                347,374
                
                
                
                77,865Loans
      originated for resale
                
                
                (19,238,916
                )
                
                
                -Proceeds
      from sale of loans held for sale
                
                
                18,412,708
                
                
                
                -Gain
      on sales of loans held for sale
                
                
                (241,236
                )
                
                
                -Net
      cash provided by operating activities
                
                
                2,421,445
                
                
                
                4,497,687CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of investment securities available for sale
                
                
                (35,245,124
                )
                
                
                (4,973,823
                )Proceeds
      from sale, redemption or principal payments of investment securities
      available for sale
                
                
                2,117,244
                
                
                
                253,765Purchase
      of investment securities held to maturity
                
                
                (8,377,442
                )
                
                
                (5,644,733
                )Proceeds
      from maturities or principal payments of investment securities held to
      maturity
                
                
                21,101,505
                
                
                
                7,323,180Net
      increase in FHLB and Federal Reserve stock
                
                
                (482,500
                )
                
                
                (893,800
                )Loans
      originated or acquired
                
                
                (190,835,961
                )
                
                
                (174,963,324
                )Principal
      collected on loans
                
                
                144,719,136
                
                
                
                114,083,214Proceeds
      from disposal of premises and equipment
                
                
                -
                
                
                
                2,041Purchase
      of premises and equipment
                
                
                (828,397
                )
                
                
                (3,516,067
                )Net
      cash used in investing activities
                
                
                (67,831,539
                )
                
                
                (68,329,547
                )




6





TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)


NINE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





Nine Months Ended September 30,2009
                
                
                2008CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      increase in deposits
                
                $
                101,828,228
                
                
                $
                57,768,858Proceeds
      from long-term borrowings
                
                
                750,000
                
                
                
                24,000,000Payments
      of long-term borrowings
                
                
                (20,032,683
                )
                
                
                (5,031,401
                )Net
      decrease in short-term borrowings
                
                
                (1,328,618
                )
                
                
                (739,082
                )Exercise
      of stock options
                
                
                162,143
                
                
                
                868,684Excess
      tax benefits on stock-based compensation
                
                
                14,947
                
                
                
                51,880Net
      change in unearned ESOP shares
                
                
                (44,183
                )
                
                
                156,373Dividends
      Paid
                
                
                (1,742,122
                )
                
                
                (1,184,324
                )Redemption
      of common stock
                
                
                -
                
                
                
                (889,650
                )Net
      cash provided by financing activities
                
                
                79,607,712
                
                
                
                75,001,338INCREASE  IN
      CASH AND CASH EQUIVALENTS
                
                
                14,197,618
                
                
                
                11,169,478CASH
      AND CASH EQUIVALENTS - JANUARY 1
                
                
                14,474,532
                
                
                
                11,426,637CASH
      AND CASH EQUIVALENTS - SEPTEMBER 30
                
                $
                28,672,150
                
                
                $
                22,596,115SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during the six months for:Interest
                
                $
                13,566,054
                
                
                $
                13,069,941Income
      taxes
                
                $
                1,776,676
                
                
                $
                2,223,625SUPPLEMENTAL
      SCHEDULE OF NON-CASH OPERATING ACTIVITIES:Issuance
      of common stock for payment of compensation
                
                $
                99,980
                
                
                $
                140,088Transfer
      of loans to OREO
                
                $
                922,934
                
                
                $
                -





See
notes to consolidated financial statements


7


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)


SIX MONTHS ENDED SEPTEMBER
30, 2009 AND 2008





1.
            BASIS
      OF PRESENTATION





General- The consolidated
financial statements of Tri-County Financial Corporation (the “Company”) and its
wholly owned subsidiary, Community Bank of Tri-County (the “Bank”) 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, 2008 have been derived
from audited financial statements.  There have been no significant
changes to the Company’s accounting policies as disclosed in the 2008 Annual
Report.  The results of operations for the three and nine months ended
September 30, 2009 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 2009 presentation.





These
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes included in the Company’s Annual
Report for the year ended December 31, 2008. Further, in connection with
preparation of the condensed consolidated financial statements and in accordance
with the recently issued guidance by the Financial Accounting Standards Board
(“FASB”) in the Accounting Standards Codification (“ASC”) regarding subsequent
events, the Company evaluated subsequent events after the balance sheet date of
September 30, 2009 through November 7, 2009, the date the consolidated financial
statements included in this Form 10-Q were issued.





2.
            NATURE
      OF BUSINESS





The
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.
            FAIR
      VALUE MEASUREMENTS





Effective
January 1, 2008, the Company adopted guidance issued by FASB regarding fair
value measurements which provides a framework for measuring and disclosing fair
value under generally accepted accounting principles. This guidance requires
disclosures about the fair value of assets and liabilities recognized in the
balance sheet in periods subsequent to initial recognition, whether the
measurements are made on a recurring basis (for example, available for sale
investment securities) or on a nonrecurring basis (for example, impaired
loans).





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





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


8





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





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





Level 2
inputs - Inputs other than quoted prices included in Level 1 that are observable
for the asset or liability, either directly or indirectly.  These
might include quoted prices for similar assets and liabilities in active
markets, and inputs other than quoted prices that are observable for the asset
or liability, such as interest rates and yield curves that are observable at
commonly quoted intervals.





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





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





Investment
Securities Available for Sale





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





Loans





The
Company does not record loans at fair value on a recurring basis, however, from
time to time, a loan is considered impaired and an allowance for loan loss is
established.  Loans for which it is probable that payment of interest
and principal will not be made in accordance with the contractual terms of the
loan are considered impaired.  Once a loan is identified as
individually impaired, management measures impairment in accordance with the ASC
Receivables Topic.  The fair value of impaired loans is estimated
using one of several methods, including the collateral value, market value of
similar debt, enterprise value, liquidation value and discounted cash
flows.  Those impaired loans not requiring a specific allowance
represent loans for which the fair value of expected repayments or collateral
exceed the recorded investment in such loans.  At September 30, 2009,
substantially all of the impaired loans were evaluated based upon the fair value
of the collateral.  In accordance with guidance regarding fair value
measurements, impaired loans where an allowance is established based on the fair
value of collateral require classification in the fair value
hierarchy.  When the fair value of the collateral is based on an
observable market price or a current appraised value, the Company records the
loan as nonrecurring Level 2.  When an appraised value is not
available or management determines the fair value of the collateral is further
impaired below the appraised value and there is no observable market price, the
Company records the loan as nonrecurring Level 3.


9







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





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





The table
below presents the recorded amount of assets and liabilities, as of September
30, 2009 measured at fair value on a recurring basis.





Fair Value MeasurementsAt September 30, 2009Using:Fair Value
                    
                    
                    Quoted Prices
                      in Active
                      Markets for
                      Identical Assets
                      (Level 1)
                    
                    
                    Significant
                      Other
                      Observable
                      Inputs
                      (Level 2)
                    
                    
                    Significant
                      Unobservable
                      Inputs
                      (Level 3)Description
      of AssetAvailable-for-Sale
      Securities
                    
                    $
                    47,507,201
                    
                    
                    $
                    -
                    
                    
                    $
                    47,507,201
                    
                    
                    $
                    -Loans
      Held for Sale
                    
                    $
                    772,877
                    
                    
                    $
                    -
                    
                    
                    $
                    772,877
                    
                    
                    $
                    -





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





The
Company may be required from time to time, to measure certain assets at fair
value on a nonrecurring basis in accordance with U.S. generally accepted
accounting principles.  These include assets that are measured at the
lower of cost or market that were recognized at fair value below cost at the end
of the period.  Assets measured at fair value on a nonrecurring basis
as of September 30, 2009 are included in the table below:





Fair Value
                    
                    
                    Quoted Prices
                      in Active
                      Markets for
                      Identical Assets
                      (Level 1)
                    
                    
                    Significant
                      Other
                      Observable
                      Inputs
                      (Level 2)
                    
                    
                    Significant
                      Unobservable
                      Inputs
                      (Level 3)Description
      of AssetImpaired
      loans
                    
                    $
                    4,408,815
                    
                    
                    $
                    -
                    
                    
                    $
                    4,408,815
                    
                    
                    $
                    -Held-to-Maturity
      Security
                    
                    $
                    744,610
                    
                    
                    $
                    -
                    
                    
                    $
                    744,610
                    
                    
                    $
                    -





4.
            INCOME
      TAXES





The
Company uses the liability method of accounting for income taxes as required by
guidance issued regarding 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. The Company also adopted FASB guidance regarding accounting for
uncertainty in income taxes on January 1, 2007.  Interest and
penalties, if any, are recorded in income tax expense.


10





5.
            EARNINGS
      PER SHARE





Basic
      earnings per common share are computed by dividing net income less
      dividends on preferred shares, by the weighted average number of common
      shares outstanding during the period. Diluted net income available to
      common shareholders is divided 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 September
      30, 2009 and 2008, there were 216,804 and 102,524 shares,
      respectively, excluded from the diluted net income per share
      computation because inclusion of these options would be
      anti-dilutive.  Basic and diluted earnings per share, have been
      computed based on weighted-average common and common equivalent shares
      outstanding as follows:





Three Months Ended
                  
                  
                  Nine Months EndedSeptember 30,
                  
                  
                  September 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Net
      Income
                  
                  $
                  867,576
                  
                  
                  $
                  884,169
                  
                  
                  $
                  2,159,630
                  
                  
                  $
                  3,326,854Less:
      Dividends payable on preferred stock
                  
                  
                  (211,733
                  )
                  
                  
                  -
                  
                  
                  
                  (635,198
                  )
                  
                  
                  -Net
      income available to common shareholders
                  
                  $
                  655,843
                  
                  
                  $
                  884,169
                  
                  
                  $
                  1,524,432
                  
                  
                  $
                  3,326,854Average
      number of common shares outstanding
                  
                  
                  2,965,332
                  
                  
                  
                  2,948,727
                  
                  
                  
                  2,958,336
                  
                  
                  
                  2,942,129Effect
      of dilutive options
                  
                  
                  27,802
                  
                  
                  
                  112,496
                  
                  
                  
                  31,708
                  
                  
                  
                  123,905Average
      number of shares used to calculate earnings per share
      outstanding
                  
                  
                  2,993,134
                  
                  
                  
                  3,061,223
                  
                  
                  
                  2,990,044
                  
                  
                  
                  3,066,034





6.
              STOCK-BASED
      COMPENSATION





The
Company has stock-based incentive compensation plans to attract and retain key
personnel in order to promote the success of the business.  These
plans are described in Note 13 to the consolidated financial statements included
in our Annual Report to Stockholders for the year ended December 31,
2008.  Stock-based compensation related expenses of $31,702 were
recognized in the nine months ended September 30, 2009, compared to no
stock-based compensation expense for the nine months ended September 30, 2008.
The Company and the Bank currently maintain incentive plans which provide for
payments to be made in cash, stock, 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–based
compensation because such payments are subject to the future election of the
recipient. A summary of the Company’s stock option plans as of September 30,
2009, and changes during the nine-month period then ended is presented
below:





Weighted
                            
                            
                            
                            
                            Weighted-AverageAverage
                            
                            
                            Aggregate
                            
                            Contractual LifeExercise
                            
                            
                            Intrinsic
                            
                            Remaining InShares
                            
                            
                            Price
                            
                            
                            Value
                            
                            YearsOutstanding
      at December 31, 2008
                            
                            
                            353,217
                            
                            
                            $
                            15.49Granted
      at fair value
                            
                            
                            -
                            
                            
                            
                            -Exercised
                            
                            
                            (12,186
                            )
                            
                            
                            7.88
                            
                            
                            $
                            43,579Expired
                            
                            
                            -
                            
                            
                            
                            -Forfeited
                            
                            
                            (1
                            )
                            
                            
                            7.88Outstanding
      at September 30, 2009
                            
                            
                            341,030
                            
                            
                            $
                            15.77
                            
                            
                            $
                            288,169
                            
                            1.7Exercisable
      at September 30, 2009
                            
                            
                            341,030
                            
                            
                            $
                            15.77
                            
                            
                            $
                            288,169
                            
                            1.7





The
following table summarizes restricted stock award activity for the Company under
the 2006 Equity Plan for the nine months ended September 30,
2009:


11





Number
                  
                  
                  Weighted Average
                    Grantof Shares
                  
                  
                  Date Fair valueNonvested
      at January 1, 2009
                  
                  
                  -
                  
                  
                  $
                  -Granted
                  
                  
                  8,000
                  
                  
                  
                  11.90Vested
                  
                  
                  (2,640
                  )
                  
                  
                  11.90Cancelled
                  
                  
                  -
                  
                  
                  
                  -Nonvested
      at September 30, 2009
                  
                  
                  5,360
                  
                  
                  $
                  11.90





7.
            GUARANTEED PREFERRED BENEFICIAL
      INTEREST IN JUNIOR SUBORDINATED
  DEBENTURES





On June
15, 2005, Tri-County Capital Trust II (“Capital Trust II”), a Delaware business
trust formed, funded and wholly owned by the Company, issued $5,000,000 of
capital securities with an interest rate based on the 90-day LIBOR rate plus
1.70%.  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 and the trust preferred securities is variable
and adjusts quarterly.  The Company has, through various contractual
arrangements, fully and unconditionally guaranteed all of Capital Trust II’s
obligations with respect to the capital securities.  These capital
securities qualify as Tier I capital and are presented in the Consolidated
Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior
Subordinated Debentures.”  Both the capital securities of Capital
Trust II and the junior subordinated debentures are scheduled to mature on
September 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
capital securities with an interest rate based on the 90-day LIBOR rate plus
2.60%.  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 and the trust preferred securities is variable
and adjusts quarterly.  The Company has, through various contractual
arrangements, fully and unconditionally guaranteed all of Capital Trust I’s
obligations with respect to the capital securities.  These 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.





8.
            PREFERRED
      STOCK





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


12





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





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





9.
            SECURITIES





September 30, 2009Amortized
                
                
                Gross
                  Unrealized
                
                
                Gross
                  Unrealized
                
                
                EstimatedCost
                
                
                Gains
                
                
                Losses
                
                
                Fair ValueSecurities
      available for saleAsset-backed
      securities issued by GSEs
                
                $
                43,446,294
                
                
                $
                520,033
                
                
                $
                169,222
                
                
                $
                43,797,105Corporate
      equity securities
                
                
                37,310
                
                
                
                1,824
                
                
                
                130
                
                
                
                39,004Bond
      mutual funds
                
                
                3,534,135
                
                
                
                136,957
                
                
                
                -
                
                
                
                3,671,092Total
      securities available for sale
                
                $
                47,017,739
                
                
                $
                658,814
                
                
                $
                169,352
                
                
                $
                47,507,201Securities
      held-to-maturityAsset-backed
      securities issued by:GSEs
                
                $
                75,494,712
                
                
                $
                1,771,070
                
                
                $
                139,940
                
                
                $
                77,125,842Other
                
                
                20,011,521
                
                
                
                8,912
                
                
                
                4,152,522
                
                
                
                15,867,911Total
      debt securities held-to-maturity
                
                
                95,506,233
                
                
                
                1,779,982
                
                
                
                4,292,462
                
                
                
                92,993,753U.S.
      Government obligations
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Other
      investments
                
                
                10,028
                
                
                
                -
                
                
                
                -
                
                
                
                10,028Total
      securities held-to-maturity
                
                $
                95,516,261
                
                
                $
                1,779,982
                
                
                $
                4,292,462
                
                
                $
                93,003,781





December 31, 2008Amortized
                  
                  
                  Gross
                    Unrealized
                  
                  
                  Gross
                    Unrealized
                  
                  
                  EstimatedCost
                  
                  
                  Gains
                  
                  
                  Losses
                  
                  
                  Fair ValueSecurities
      available for saleAsset-backed
      securities issued by GSEs
                  
                  $
                  10,214,278
                  
                  
                  $
                  298,224
                  
                  
                  $
                  7,544
                  
                  
                  $
                  10,504,958Corporate
      equity securities
                  
                  
                  156,054
                  
                  
                  
                  912
                  
                  
                  
                  237
                  
                  
                  
                  156,729Bond
      mutual funds
                  
                  
                  3,503,086
                  
                  
                  
                  56,901
                  
                  
                  
                  -
                  
                  
                  
                  3,559,987Total
      securities available for sale
                  
                  $
                  13,873,418
                  
                  
                  $
                  356,037
                  
                  
                  $
                  7,781
                  
                  
                  $
                  14,221,674Securities
      held-to-maturityAsset-backed
      securities issued by:GSEs
                  
                  $
                  82,544,538
                  
                  
                  $
                  337,224
                  
                  
                  $
                  931,832
                  
                  
                  $
                  81,949,930Other
                  
                  
                  25,150,396
                  
                  
                  
                  -
                  
                  
                  
                  5,137,129
                  
                  
                  
                  20,013,266Total
      debt securities held-to-maturity
                  
                  
                  107,694,934
                  
                  
                  
                  337,224
                  
                  
                  
                  6,068,961
                  
                  
                  
                  101,963,196U.S.
      Government obligations
                  
                  
                  999,908
                  
                  
                  
                  92
                  
                  
                  
                  -
                  
                  
                  
                  1,000,000Other
      investments
                  
                  
                  17,439
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  17,439Total
      securities held-to-maturity
                  
                  $
                  108,712,281
                  
                  
                  $
                  337,316
                  
                  
                  $
                  6,068,961
                  
                  
                  $
                  102,980,635





At
September 30, 2009, certain other securities with a carrying value of $2,429,352
were pledged to secure certain deposits. At September 30, 2009, securities with
a carrying value of $49,210,658 were pledged as collateral for advances from the
Federal Home Loan Bank of Atlanta.


13




Gross
unrealized losses and estimated fair value by length of time that the individual
available-for-sale securities have been in a continuous unrealized loss position
at September 30, 2009, are as follows:





Continuous unrealized losses existing forLess Than 12
                
                
                More Than 12
                
                
                TotalunrealizedFair Value
                
                
                Months
                
                
                Months
                
                
                LossesAsset-backed
      securities issued by GSE's:
                
                $
                26,597,102
                
                
                $
                169,222
                
                
                $
                -
                
                
                $
                169,222Corporate
      Equity Securities
                
                
                180
                
                
                
                130
                
                
                
                -
                
                
                
                130$
                26,597,282
                
                
                $
                169,352
                
                
                $
                -
                
                
                $
                169,352





The
available-for-sale investment portfolio has a fair value of $47,507,201, of
which $26,597,282 of the securities have some unrealized losses from their
amortized cost. Of these securities, $26,597,102, or 99%, are mortgage-backed
securities issued by GSEs and $180 or less than 1% are short duration mutual
fund shares.  The unrealized losses that exist in the asset-backed
securities and mutual fund shares are the result of market changes in interest
rates on similar instruments.





The
asset-backed securities have an average duration of less than 1 year and are
guaranteed by their issuer as to credit risk. Total unrealized losses on these
investments are small (less than 1%). We believe that the losses in the equity
securities are temporary. Persistent losses may require a reevaluation of these
losses. Because our intention is not to sell the investments and it is not more
likely than not that we will be required to sell the investments before recovery
of their amortized cost basis, which may be maturity, as such, management does
not consider these investments to be other-than-temporarily impaired at
September 30, 2009.





Gross
unrealized losses and estimated fair value by length of time that the individual
held-to-maturity securities have been in a continuous unrealized loss position
at September 30, 2009 are as follows:





Continuous unrealized losses existing forLess Than 12
                
                
                More Than 12
                
                
                TotalunrealizedFair Value
                
                
                Months
                
                
                Months
                
                
                LossesAsset-backed
      securities issued by GSE's:
                
                $
                18,643,898
                
                
                $
                87,411
                
                
                $
                52,529
                
                
                $
                139,940Asset-backed
      securities issued by other
                
                
                15,056,973
                
                
                
                -
                
                
                
                4,563,052
                
                
                
                4,563,052$
                33,700,871
                
                
                $
                87,411
                
                
                $
                4,615,580
                
                
                $
                4,702,992





The
held-to-maturity investment portfolio has an estimated fair value of
$93,003,781, of which $33,700,871 or 36% of the securities have some unrealized
losses from their amortized cost. Of these securities, $18,643,898 or 55%, are
mortgage-backed securities issued by GSEs and the remaining $15,056,973 are
asset-backed securities issued by others. As with the available for sale
securities, we believe that the losses are the result of general perceptions of
safety and credit worthiness of the entire sector and a general disruption of
orderly markets in the asset class. The securities issued by GSE’s are
guaranteed by the issuer. They have an average duration of less than 1
year.  The average unrealized loss on GSE issued held to maturity
securities is 1.4%. We believe that the securities will either recover in market
value or be paid off as agreed. The Company intends to, and has the ability to
hold these securities to maturity.





The
asset-backed securities issued by others are mortgage-backed securities. All of
the securities have credit support tranches which absorb losses prior to the
tranches which the Company owns. The Company reviews credit support positions on
its securities regularly. These securities have an average life under three
years.  More than 95% of the market value of the securities is rated
AAA by Standard & Poor’s, with the remainder rated at least BBB. Total
unrealized losses on the asset-backed securities issued by others are $4,563,052
or 30% of the amortized cost.  We believe that the securities will
either recover in market value or be paid off as agreed. The Company intends to,
and has the ability to hold these securities to maturity.


14





As of
June 30, 2009, the Company recorded a charge of $118,744 related to
other-than-temporary impairment on Silverton Bank common stock. This charge
was recorded in earnings as investment securities losses and eliminating the
cost basis. During the quarter ended September 30, 2009, the Company
recorded a charge of $48,000 related to other-than-temporary impairment on a
single CMO issue. The issue has a par value of $1,202,000 with a carrying value
after the impairment charge of $1,154,000.





There
were sales of investments available for sale securities of $73,200 during the
nine-month period ended September 30, 2009 compared to no sales for the same
period in the prior year. These sales produced a net loss of $(12,863) for the
nine month period ended September 30, 2009. Asset-backed securities are
comprised of mortgage-backed securities as well as mortgage-derivative
securities such as collateralized mortgage obligations and real estate mortgage
investment conduits.





10.
            NEW
      ACCOUNTING STANDARDS





During
December 2007, the Financial Accounting Standards Board (“FASB”) issued new
accounting guidance for business combinations in the Accounting Standards
Codification (“ASC”).  This guidance is for business combinations
which the acquisition date is on or after December 15, 2008. These business
combinations use “acquisition accounting” which recognizes and measures the
goodwill acquired in the business combination and defines a bargain purchase,
and requires the acquirer to recognize that excess as a gain attributable to the
acquirer.  The Company adopted this new guidance effective March 31,
2009, and adoption did not have a material impact on the Company’s consolidated
financial statements.




During
December 2007, the FASB issued accounting guidance for consolidations which
establishes accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statement, but separate from the parent’s equity.  This
guidance is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008. Management adopted this guidance
effective March 31, 2009, and adoption did not have a material impact on the
Company’s consolidated financial condition or results of
operations.




In March
2008, the FASB issued new guidance regarding disclosures for
derivatives.  This guidance requires qualitative disclosures about
objectives and strategies for using derivative, quantitative disclosures about
fair value amounts of and gains and losses on derivative instruments, and
disclosures about credit-risk-related contingent features in derivative
agreements. This guidance is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008. Adoption of
this new guidance, effective January 1, 2009, did not have a material impact on
the consolidated financial statements.




In June
2008, the FASB issued guidance regarding earnings per share which requires
companies to treat unvested share-based payment awards that have non-forfeitable
rights to dividend or dividend equivalents as a separate class of securities in
calculating earnings per share. This guidance is effective for financial
statements issued for fiscal years and interim periods beginning after December
15, 2008, and requires a company to retrospectively adjust its earnings per
share data. The Company adopted this guidance effective March 31, 2009, and
adoption did not have a material effect on consolidated results of operations or
earnings per share.




In April
2009, the FASB issued guidance regarding the application of fair value
accounting to address concerns regarding (1) determining whether a market is not
active and a transaction is not orderly, (2) recognition and presentation of
other-than-temporary impairments and (3) interim disclosures of fair values of
financial instruments.  The Company adopted this guidance effective
September 30, 2009, and adoption did not have a material effect on consolidated
results of operations.


15





During
May 2009, the FASB issued guidance regarding subsequent events.  The
objective of this guidance is to establish general standards of accounting for
and disclosure of events that occur after the balance sheet date, but before
financial statements are issued or are available to be issued.  The
Company adopted this guidance effective September 30, 2009, and adoption did not
have a material impact on the Company’s consolidated financial condition or
results of operations.





During
June 2009, the FASB issued guidance on the transfers and servicing of financial
assets.  This guidance eliminates the concept of a “qualifying
special-purpose entity” from the original accounting guidance and removes the
exception from applying FASB guidance on  consolidation of variable
interest entities, to qualifying special-purpose entities.  This
guidance is effective at the beginning of a reporting entity’s first fiscal year
that begins after November 15, 2009.  The Company does not anticipate
that its adoption would have a material impact on the Company’s consolidated
financial condition or results of operations.





During
June 2009, the FASB guidance on the consolidation of variable interest
entities.  This statement amends amends the original guidance to
require an enterprise to perform an analysis to determine whether the
enterprise’s variable interest or interests give it a controlling financial
interest in a variable interest entity (VIE).  This analysis
identifies the primary beneficiary of a VIE as the enterprise that has both (a)
the power to direct the activities of a VIE that most significantly impact the
entity’s economic performance, and (b) the obligation to absorb losses of the
entity that could potentially be significant to the
VIE.  Additionally, this new guidance requires an enterprise to assess
whether it has an implicit financial responsibility to ensure that a VIE
operates as designed when determining it has the power to direct the activities
of the VIE that most significantly impact the entity’s economic
performance.   It is effective at the beginning of a company’s
first fiscal year that begins after November 15, 2009.  The Company
does not anticipate that its adoption would have a material impact on the
Company’s consolidated financial condition or results of
operations.





11.
            FAIR
      VALUE OF FINANCIAL INSTRUMENTS





The
estimated fair value amounts have been determined by the Company using available
market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Therefore, any aggregate unrealized gains or losses should not be interpreted as
a forecast of future earnings or cash flows. Furthermore, the fair values
disclosed should not be interpreted as the aggregate current value of the
Company.





September 30, 2009
                
                
                December 31, 2008Carrying
                
                
                Estimated
                
                
                Carrying
                
                
                EstimatedAmount
                
                
                Fair Value
                
                
                Amount
                
                
                Fair ValueAssets:Cash
      and cash equivalents
                
                $
                28,672,150
                
                
                $
                28,672,150
                
                
                $
                14,474,532
                
                
                $
                14,474,532Investment
      securities and stock in FHLB and FRB
                
                
                150,369,492
                
                
                
                147,445,483
                
                
                
                129,038,699
                
                
                
                123,655,310Loans
      receivable, net
                
                
                587,260,196
                
                
                
                597,762,000
                
                
                
                542,977,138
                
                
                
                585,899,804Liabilities:Non-interest
      bearing demand, Savings, NOW, and money market accounts
                
                
                249,758,528
                
                
                
                249,758,528
                
                
                
                205,126,970
                
                
                
                205,483,312Time
      certificates
                
                
                377,237,266
                
                
                
                381,667,000
                
                
                
                320,040,596
                
                
                
                324,199,698Short
      and Long-term debt and other borrowed funds
                
                
                85,874,494
                
                
                
                83,219,000
                
                
                
                106,485,795
                
                
                
                107,628,766Guaranteed
      preferred beneficial interest in junior subordinated
      securities
                
                
                12,000,000
                
                
                
                3,083,307
                
                
                
                12,000,000
                
                
                
                11,520,000




16





At
September 30, 2009, the Company had outstanding loan commitments and standby
letters of credit of $99 million and $20 million, respectively. Based on the
short-term lives of these instruments, the Company does not believe that the
fair value of these instruments differs significantly from their carrying
values.





Valuation Methodology Cash and Cash
Equivalents- For cash and cash equivalents, the carrying amount is a
reasonable estimate of fair value.





Investment Securities- Fair
values are based on quoted market prices or dealer quotes. If a quoted market
price is not available, fair value is estimated using quoted market prices for
similar securities.





Loans Receivable- For
conforming residential first-mortgage loans, the market price for loans with
similar coupons and maturities was used. For nonconforming loans with maturities
similar to conforming loans, the coupon was adjusted for credit risk. Loans
which did not have quoted market prices were priced using the discounted cash
flow method. The discount rate used was the rate currently offered on similar
products. Loans priced using the discounted cash flow method included
residential construction loans, commercial real estate loans, and consumer
loans. The estimated fair value of loans held for sale is based on the terms of
the related sale commitments.





Deposits- The fair value of
checking accounts, saving accounts, and money market accounts was the amount
payable on demand at the reporting date.





Time Certificates- The fair
value was determined using the discounted cash flow method. The discount rate
was equal to the rate currently offered on similar products.





Long-Term Debt and Other Borrowed
Funds- These were valued using the discounted cash flow method. The
discount rate was equal to the rate currently offered on similar
borrowings.





Guaranteed Preferred Beneficial
Interest in Junior Subordinated Securities -These were valued using
discounted cash flows. The discount rate was equal to the rate currently offered
on similar borrowings. The 2009 valuations reflect a lack of liquidity in this
market.





Off-Balance Sheet Instruments- The Company charges fees for commitments to extend credit. Interest
rates on loans for which these commitments are extended are normally committed
for periods of less than one month. Fees charged on standby letters of credit
and other financial guarantees are deemed to be immaterial and these guarantees
are expected to be settled at face amount or expire unused. It is impractical to
assign any fair value to these commitments.





The fair
value estimates presented herein are based on pertinent information available to
management as of September 30, 2009 and December 31, 2008. Although management
is not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since that date and, therefore, current estimates
of fair value may differ significantly from the amount presented
herein.


17


ITEM
2


MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





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,
changes in accounting principles, and various other
matters.  Additional factors that may affect our results are discussed
in Part I of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2008 (the “Form 10-K”) and Part II of this Quarterly Report on Form
10-Q under “Item 1A. Risk Factors.”  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 owns all the outstanding shares of capital stock of
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
preferred stock obligations, and directing 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 Southern Maryland through its main office and nine branches located in
Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, Prince
Frederick, Lusby, 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 deposits and uses these funds along with funds generated from operations
and borrowings from the Federal Home Loan Bank (the “FHLB”) to fund loan
originations to individuals, associations, partnerships and corporations and to
invest in securities. 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, and consumer loans.  The Bank is a member of the
Federal Reserve and FHLB Systems. The Federal Deposit Insurance Corporation
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,
and home equity lending business as well as the level of transactional
deposits.  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 away from
residential first mortgage lending 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 interest rates, economic conditions in
the Southern Maryland area as well as individual borrowers’
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, 2008.


18





The
Company’s results are influenced by local and national economic conditions.
These conditions include the level of short-term interest rates such as the
federal funds rate, the differences between short- and long-term interest rates,
the prospects for economic growth or decline, and the rates of anticipated and
current inflation. Local conditions, including employment growth or declines,
may have direct or indirect effects on our borrowers’ ability to meet their
obligations.





Interest
rates can directly influence the Bank’s funding costs and loan and investment
yields, as well serve to increase or decrease general economic activity. The
federal funds target rate increased for much of 2006 and 2007, hitting a
multi-year peak on September 29, 2007 of 5.25%. Shortly afterwards, it became
clear that the U.S. economy suffered from an over-extension of credit in many
sectors. This realization led to a sudden, dramatic decline in the availability
of credit to many borrowers which deflated a housing price bubble and threatened
to create a credit crisis.  The Federal Reserve reacted by cutting the
Federal Funds rate by 50 basis points in September 2007.  Despite
further Federal Reserve rate cuts, the crisis in housing, which was once
confined to subprime mortgage loans continued to spread.  The U.S.
Treasury responded by injecting capital directly into banks by using the Capital
Purchase Program (“CPP”) of the Troubled Asset Repurchase Program
(“TARP”).  The Federal Reserve, Treasury, FDIC and other governmental
bodies chose to guarantee various forms of debt issuance to stave off a total
collapse of credit markets.  In addition, the U.S. government provided
cash and debt guarantees to many private companies.  Besides these
policy moves, the Federal Reserve reduced the Federal Funds rate to a range of
0% to 0.25% in December 2008. The Federal Funds rate has stayed at this level
throughout 2009.





SELECTED FINANCIAL DATAThree Months Ended
                      
                      
                      Nine Months EndedSeptember 30,
                      
                      
                      September 30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Condensed
      Income StatementInterest
      Income
                      
                      $
                      9,620,495
                      
                      
                      $
                      9,322,087
                      
                      
                      $
                      28,173,936
                      
                      
                      $
                      28,049,141Interest
      Expense
                      
                      
                      4,078,019
                      
                      
                      
                      4,493,215
                      
                      
                      
                      12,518,121
                      
                      
                      
                      13,545,590Net
      Interest Income
                      
                      
                      5,542,476
                      
                      
                      
                      4,828,872
                      
                      
                      
                      15,655,815
                      
                      
                      
                      14,503,551Provision
      for Loan Loss
                      
                      
                      515,555
                      
                      
                      
                      462,622
                      
                      
                      
                      1,977,928
                      
                      
                      
                      617,367Noninterest
      Income
                      
                      
                      668,347
                      
                      
                      
                      632,305
                      
                      
                      
                      2,036,575
                      
                      
                      
                      1,978,344Noninterest
      Expense
                      
                      
                      4,267,052
                      
                      
                      
                      3,624,150
                      
                      
                      
                      12,359,887
                      
                      
                      
                      10,769,913Income
      Before Income Taxes
                      
                      
                      1,428,216
                      
                      
                      
                      1,374,405
                      
                      
                      
                      3,354,575
                      
                      
                      
                      5,094,615Income
      Taxes
                      
                      
                      560,640
                      
                      
                      
                      490,236
                      
                      
                      
                      1,194,945
                      
                      
                      
                      1,767,761Net
      Income
                      
                      
                      867,576
                      
                      
                      
                      884,169
                      
                      
                      
                      2,159,630
                      
                      
                      
                      3,326,944Per
      Common ShareBasic
      Earnings
                      
                      $
                      0.22
                      
                      
                      $
                      0.30
                      
                      
                      $
                      0.52
                      
                      
                      $
                      1.13Diluted
      Earnings
                      
                      $
                      0.22
                      
                      
                      $
                      0.29
                      
                      
                      $
                      0.51
                      
                      
                      $
                      1.09Book
      Value
                      
                      $
                      17.24
                      
                      
                      $
                      17.26
                      
                      
                      $
                      17.24
                      
                      
                      $
                      17.26





RESULTS
OF OPERATIONS – NINE MONTHS ENDED SEPTEMBER 30, 2009





Net
income for the nine-month period ended September 30, 2009 totaled $2,159,630
($0.52 basic and $0.51 diluted earnings per common share) compared to $3,326,944
($1.13 basic and $1.09 diluted earnings per common share) for the same period in
the prior year. This decrease of $1,167,314, or 35.09%, was caused by increases
in noninterest expense and the provision for loan losses, partially offset by an
increase in net interest income and a decline in income tax expense. The decline
in earnings per common share was also affected by the accrual of preferred stock
dividends in 2009.


19





Nine Months EndedSeptember 30,2009
                  
                  
                  2008
                  
                  
                  $ Change
                  
                  
                  %ChangeInterest
      income
                  
                  $
                  28,173,936
                  
                  
                  $
                  28,049,141
                  
                  
                  $
                  124,795
                  
                  
                  
                  0.44
                  %Interest
      expense
                  
                  
                  12,518,121
                  
                  
                  
                  13,545,590
                  
                  
                  
                  (1,027,469
                  )
                  
                  
                  (7.59
                  )%Net
      interest income
                  
                  
                  15,655,815
                  
                  
                  
                  14,503,551
                  
                  
                  
                  1,152,264
                  
                  
                  
                  7.94
                  %Provision
      for loan losses
                  
                  
                  1,977,928
                  
                  
                  
                  617,367
                  
                  
                  
                  1,360,561
                  
                  
                  
                  220.38
                  %





For the
nine-month period ended September 30, 2009, interest income increased due to
higher average asset balances in the current period offset by lower rates earned
on interest earning assets. The lower rates on assets were primarily the result
of lower rates earned on loans tied to the prime rate, which declined throughout
the fourth quarter of 2008 as the federal funds target rate declined. Interest
expense decreased in the nine-month period ended September 30, 2009 as a result
of lower interest rates on certain deposit types, partially offset by a higher
average balance of interest-bearing liabilities. The lower deposit rates were
primarily in shorter-term interest bearing deposits such as short-term
certificates of deposit and money market deposit accounts.  The rates
on these accounts tend to decrease when the federal funds target rate
decreases.





The
provision for loan losses increased due to increases in the Company’s
charge-offs, delinquencies and non-accrual loans, loan growth, and a change in
the factors related to a change in projected losses due to the economic
environment.  The Bank’s net charge-offs increased by $275,792 from
$55,901 for the nine months ended September 30, 2008 to $331,693 for the nine
months ended September 30, 2009. The Bank experienced an increase in non-accrual
loans from $4,936,000 at December 31, 2008 to $21,752,754 at September 30, 2009.
Management will continue to periodically review its allowance for loan losses
and the related provision and make adjustments as deemed
necessary.  Our reviews 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.





Nine Months Ended September 30,NONINTEREST INCOME:
                  
                  2009
                  
                  
                  2008
                  
                  
                  $ Change
                  
                  
                  % ChangeRecognition
      of other than temporary decline inin
      value of investment securities
                  
                  $
                  (577,274
                  )
                  
                  $
                  -
                  
                  
                  $
                  (577,274
                  )
                  
                  
                  -Less:
      Portion recorded as comprehensive income
                  
                  
                  410,530
                  
                  
                  
                  -
                  
                  
                  
                  410,530
                  
                  
                  
                  -Impairment
      loss on investment securities, net
                  
                  
                  (166,744
                  )
                  
                  
                  -
                  
                  
                  
                  (166,744
                  )
                  
                  
                  -Loan
      appraisal, credit, and miscellaneous charges
                  
                  
                  465,111
                  
                  
                  
                  363,658
                  
                  
                  
                  101,453
                  
                  
                  
                  27.90
                  %Gain
      on sale of loans held for sale
                  
                  
                  241,236
                  
                  
                  
                  -
                  
                  
                  
                  241,236
                  
                  
                  
                  -Gain
      on asset sale
                  
                  
                  -
                  
                  
                  
                  2,041
                  
                  
                  
                  (2,041
                  )
                  
                  
                  -Income
      from bank owned life insurance
                  
                  
                  297,578
                  
                  
                  
                  388,483
                  
                  
                  
                  (90,905
                  )
                  
                  
                  (23.40
                  )%Loss
      on sale of investment securities
                  
                  
                  (12,863
                  )
                  
                  
                  -
                  
                  
                  
                  (12,863
                  )
                  
                  
                  -Service
      charges
                  
                  
                  1,212,257
                  
                  
                  
                  1,224,162
                  
                  
                  
                  (11,905
                  )
                  
                  
                  (0.97
                  )%Total
      noninterest income
                  
                  $
                  2,036,575
                  
                  
                  $
                  1,978,344
                  
                  
                  $
                  58,231
                  
                  
                  
                  2.94
                  %





Loan
appraisal, credit, and miscellaneous charges increased as loan volume increased.
The increase in gain on sale of loans held for sale reflects the sale of
$18,466,039 of longer-term, fixed rate mortgage loans in the first nine months
of 2009, while none were sold in 2008. Income from bank owned life insurance in
2008 was increased by a one time gain from a policy refund. The recognition of
other than temporary decline in the value of investment securities related to
the Bank’s ownership of stock in Silverton Bank, N.A. On May 1, 2009,
Silverton Bank, N.A.’s parent, Silverton Financial Services, Inc., was closed by
the Office of the Comptroller of the Currency and the Federal Deposit Insurance
Corporation was named receiver. The value of the Bank’s investment in
Silverton Bank was written off. In addition, the underlying collateral of a
single private label collateralized mortgage security, which the Bank holds in
its held-to-maturity portfolio, has suffered sufficient losses that may put the
collection of contractually due interest and principal in doubt. The Bank has
recorded an other than temporary impairment charge of $48,000 on this CMO issue.
As of September 30, 2009, the Bank has a total remaining cost basis of
$1,154,000 in this CMO issue.


20





Nine Months Ended September 30,NONINTEREST EXPENSE:
                
                2009
                
                
                2008
                
                
                $ Change
                
                
                % ChangeSalary
      and employee benefits
                
                $
                6,536,475
                
                
                $
                6,174,825
                
                
                $
                361,650
                
                
                
                5.86
                %Occupancy
                
                
                1,270,396
                
                
                
                1,214,352
                
                
                
                56,044
                
                
                
                4.62
                %Advertising
                
                
                374,816
                
                
                
                431,653
                
                
                
                (56,837
                )
                
                
                (13.17
                )%Data
      processing
                
                
                682,594
                
                
                
                477,274
                
                
                
                205,320
                
                
                
                43.02
                %Legal
      and professional fees
                
                
                526,018
                
                
                
                437,454
                
                
                
                88,564
                
                
                
                20.25
                %Depreciation
      of furniture, fixtures, and equipment
                
                
                453,882
                
                
                
                413,139
                
                
                
                40,743
                
                
                
                9.86
                %Telephone
      communications
                
                
                101,871
                
                
                
                59,375
                
                
                
                42,496
                
                
                
                71.57
                %Office
      supplies
                
                
                124,461
                
                
                
                106,615
                
                
                
                17,846
                
                
                
                16.74
                %FDIC
      Insurance
                
                
                875,943
                
                
                
                195,946
                
                
                
                679,997
                
                
                
                347.03
                %Other
                
                
                1,413,431
                
                
                
                1,259,280
                
                
                
                154,151
                
                
                
                12.24
                %Total
      noninterest expenses
                
                $
                12,359,887
                
                
                $
                10,769,913
                
                
                $
                1,589,974
                
                
                
                14.76
                %





Salary
and employee benefits and occupancy expense increased as the Bank opened an
additional branch in late 2008. The Bank also experienced increases in land
rentals on certain properties.  Advertising expense decreased as the
Bank had fewer advertising campaigns in the second and third quarters of 2009
than in the same periods in the prior year. The increase in data processing
expense reflects a credit received from a vendor in the first quarter of 2008 to
settle previous pricing issues. In addition, data processing expenses relates to
increases in the number of customer accounts. Other increases in this area were
incurred in the process of converting to different vendors for part of our
information processing operations. Legal and professional fees increased due to
the increase in regulatory issues including the Company’s participation in the
CPP program. Increased depreciation of furniture, fixtures, and equipment
reflect increases in the size of the Bank’s operations. Telephone communications
expenses increased due to the increases in the size of the Company’s operations.
In addition, the Bank has utilized additional telecommunication services to aid
in providing data backup services. FDIC insurance expense increased due to the
expense of a one time special assessment recognized in the amount of $343,600 in
the current period and an increase in assessment rate compared to the same
period in the prior year. In addition, in 2008 the Bank was able to offset much
of its regular FDIC insurance expense by the use of credits available to it.
These credits were used up by the end of 2008.





Income
tax expense decreased to $1,194,945, or 35.62%, of pretax income, in the first
three quarters of 2009, from $1,767,761, or 34.70%, of pretax income, in the
prior year. The higher effective tax rate in the current year was caused by an
increase in the amount of non-deductible expenses in 2009.





RESULTS
OF OPERATIONS – THREE MONTHS ENDED SEPTEMBER30, 2009





Net
income for the three-month period ended September 30, 2009 totaled $867,576
($0.22 basic and diluted earnings per common share), compared to $884,169 ($0.30
basic and $0.29 diluted earnings per common share) for the same period in the
prior year.  This decrease of $16,593, or 1.88%, was caused by an
increase in noninterest expense and provision for loan loss partially offset by
higher net interest income.





Three Months EndedSeptember 30,2009
                    
                    
                    2008
                    
                    
                    $ Change
                    
                    
                    % ChangeInterest
      income
                    
                    $
                    9,620,495
                    
                    
                    $
                    9,322,087
                    
                    
                    $
                    298,408
                    
                    
                    
                    3.20
                    %Interest
      expense
                    
                    
                    4,078,019
                    
                    
                    
                    4,493,215
                    
                    
                    
                    (415,196
                    )
                    
                    
                    (9.24
                    )%Net
      interest income
                    
                    
                    5,542,476
                    
                    
                    
                    4,828,872
                    
                    
                    
                    713,604
                    
                    
                    
                    14.78
                    %Provision
      for loan losses
                    
                    
                    515,555
                    
                    
                    
                    462,622
                    
                    
                    
                    52,933
                    
                    
                    
                    11.44
                    %


21


Interest
income increased due to higher average balances in loans and investments, which
were partially offset by lower interest rate yields on loans and
investments.  Interest expense decreased due to lower interest rates
paid on deposits and borrowings offset by higher average balances of deposits
and borrowings for the period. The decreased yields and rates paid were due to
lower market interest rates. As noted above, increases in the provision for loan
losses were due to loan growth and economic conditions that effected the loss
factors used to compute the allowance as well as changes in the circumstances of
particular loans, increases in the level of delinquencies, charge-offs and
nonperforming loans.





The
following table shows the components of noninterest income and the dollar and
percentage changes for the periods presented.





Three Months EndedSeptember 30,2009
                          
                          
                          2008
                          
                          
                          $ Change
                          
                          
                          % ChangeNONINTEREST
      INCOME:Recognition
      of other than temporary decline invalue
      of investment securities
                          
                          $
                          (458,530
                          )
                          
                          $
                          -
                          
                          
                          $
                          (458,530
                          )
                          
                          
                          -Less:
      Portion recorded as comprehensive income
                          
                          
                          410,530
                          
                          
                          
                          -
                          
                          
                          
                          410,530
                          
                          
                          
                          -Impairment
      loss on investment securities, net
                          
                          
                          (48,000
                          )
                          
                          
                          
                          
                          
                          
                          (48,000
                          )
                          
                          
                          -Loan
      appraisal, credit, andmiscellaneous
      charges
                          
                          
                          104,219
                          
                          
                          
                          129,107
                          
                          
                          
                          (24,888
                          )
                          
                          
                          (19.28
                          )%Gain
      on sale of loans held for sale
                          
                          
                          72,862
                          
                          
                          
                          -
                          
                          
                          
                          72,862
                          
                          
                          
                          -Income
      from bank ownedlife
      insurance
                          
                          
                          96,105
                          
                          
                          
                          101,994
                          
                          
                          
                          (5,889
                          )
                          
                          
                          (5.77
                          )%Service
      charges
                          
                          
                          443,161
                          
                          
                          
                          401,204
                          
                          
                          
                          41,957
                          
                          
                          
                          10.46
                          %Total
      noninterest income
                          
                          $
                          668,347
                          
                          
                          $
                          632,305
                          
                          
                          $
                          36,042
                          
                          
                          
                          5.70
                          %





Loan
appraisal, credit, and miscellaneous charges decreased due to a decline in loan
originations. Gain on sale of loans held for sale increased due to the sales of
$3,900,200 in fixed-rate longer-term one-to-four-family loans in 2009. Income
from bank owned life insurance reflects a higher average balance of bank owned
life in the current year offset by the affect of a one-time gain in 2008. As
noted above, the recognition of other than temporary decline in value of
investment securities related to a reduction in the value of a private label
mortgage backed security. Service charges increased as the Bank increased the
per item charges on certain transactions. The effect of higher fees on each
transaction was partially offset by a drop in check volume, which reduced the
amounts of overdraft fee income earned.





The
following table shows the components of noninterest expense and the dollar
percentage changes for the periods presented.





Three Months EndedSeptember 30,2009
                  
                  
                  2008
                  
                  
                  $ Change
                  
                  
                  % ChangeNONINTEREST
      EXPENSE:Salary
      and employee benefits
                  
                  $
                  2,284,641
                  
                  
                  $
                  2,052,810
                  
                  
                  $
                  231,831
                  
                  
                  
                  11.29
                  %Occupancy
                  
                  
                  399,648
                  
                  
                  
                  416,723
                  
                  
                  
                  (17,075
                  )
                  
                  
                  (4.10
                  )%Advertising
                  
                  
                  144,854
                  
                  
                  
                  160,281
                  
                  
                  
                  (15,427
                  )
                  
                  
                  (9.62
                  )%Data
      processing
                  
                  
                  245,974
                  
                  
                  
                  216,283
                  
                  
                  
                  29,691
                  
                  
                  
                  13.73
                  %Legal
      and professional fees
                  
                  
                  166,110
                  
                  
                  
                  98,978
                  
                  
                  
                  67,132
                  
                  
                  
                  67.83
                  %Depreciation
      of furniture, fixtures, and equipment
                  
                  
                  154,777
                  
                  
                  
                  141,859
                  
                  
                  
                  12,918
                  
                  
                  
                  9.11
                  %Telephone
      communications
                  
                  
                  33,698
                  
                  
                  
                  16,898
                  
                  
                  
                  16,800
                  
                  
                  
                  99.42
                  %Office
      supplies
                  
                  
                  37,076
                  
                  
                  
                  32,140
                  
                  
                  
                  4,936
                  
                  
                  
                  15.36
                  %FDIC
      Insurance
                  
                  
                  242,332
                  
                  
                  
                  71,692
                  
                  
                  
                  170,640
                  
                  
                  
                  238.02
                  %Other
                  
                  
                  557,942
                  
                  
                  
                  416,486
                  
                  
                  
                  141,456
                  
                  
                  
                  33.96
                  %Total
      noninterest expenses
                  
                  $
                  4,267,052
                  
                  
                  $
                  3,624,150
                  
                  
                  $
                  642,902
                  
                  
                  
                  17.74
                  %


22





Salary
and employee benefits expense has increased as the Bank has added additional
employees due to the Bank’s growth in 2009. Occupancy expense decreased due to
lower maintenance costs compared to prior year. Data processing costs increased
due to overall growth in the Bank and due to certain charges related to
improvements in services. Legal and professional fees increased due to the need
for additional legal advice in dealing with delinquent loans. Telephone
communications expense increased as the Bank used additional services to
facilitate data transmission in 2009. As noted above, the FDIC insurance expense
reflects increased ongoing insurance rates as well as the usage of credits to
decrease expense in 2008. Other expenses increased due to increases in the
Bank’s size and ATM related expenses.  Income tax expenses decreased
due to the decrease in pretax income.





FINANCIAL
CONDITION





September 30, 2009
                      
                      
                      December 31, 2008
                      
                      
                      $ Change
                      
                      
                      % ChangeAssetsCash
      and due from banks
                      
                      $
                      20,116,141
                      
                      
                      $
                      5,071,614
                      
                      
                      $
                      15,044,527
                      
                      
                      
                      296.64
                      %Federal
      Funds sold
                      
                      
                      7,610,000
                      
                      
                      
                      989,754
                      
                      
                      
                      6,620,246
                      
                      
                      
                      668.88
                      %Interest-bearing
      deposits with banks
                      
                      
                      946,009
                      
                      
                      
                      8,413,164
                      
                      
                      
                      (7,467,155
                      )
                      
                      
                      (88.76
                      )%Securities
      available for sale, at fair value
                      
                      
                      47,507,201
                      
                      
                      
                      14,221,674
                      
                      
                      
                      33,285,527
                      
                      
                      
                      234.05
                      %Securities
      held to maturity, at amortized cost
                      
                      
                      95,516,261
                      
                      
                      
                      108,712,281
                      
                      
                      
                      (13,196,020
                      )
                      
                      
                      (12.14
                      )%Federal
      Home Loan Bank and Federal Reserve Bank stock - at
      cost
                      
                      
                      6,935,500
                      
                      
                      
                      6,453,000
                      
                      
                      
                      482,500
                      
                      
                      
                      7.48
                      %Loans
      held for sale
                      
                      
                      772,877
                      
                      
                      
                      -
                      
                      
                      
                      772,877Loans
      receivable - net of allowance for loan losses of $6,791,908
      and $5,145,673, respectively
                      
                      
                      586,487,319
                      
                      
                      
                      542,977,138
                      
                      
                      
                      43,510,181
                      
                      
                      
                      8.01
                      %Premises
      and equipment, net
                      
                      
                      12,189,059
                      
                      
                      
                      12,235,999
                      
                      
                      
                      (46,940
                      )
                      
                      
                      (0.38
                      )%Foreclosed
      real estate
                      
                      
                      922,934
                      
                      
                      
                      -
                      
                      
                      
                      922,934Accrued
      interest receivable
                      
                      
                      2,958,759
                      
                      
                      
                      2,965,813
                      
                      
                      
                      (7,054
                      )
                      
                      
                      (0.24
                      )%Investment
      in bank owned life insurance
                      
                      
                      10,823,864
                      
                      
                      
                      10,526,286
                      
                      
                      
                      297,578
                      
                      
                      
                      2.83
                      %Other
      assets
                      
                      
                      5,128,468
                      
                      
                      
                      4,118,187
                      
                      
                      
                      1,010,281
                      
                      
                      
                      24.53
                      %Total
      Assets
                      
                      $
                      797,914,392
                      
                      
                      $
                      716,684,910
                      
                      
                      $
                      81,229,482
                      
                      
                      
                      11.33
                      %





The
Company increased some of its most liquid assets which are cash and due from
banks and federal funds sold. Interest-bearing deposits with banks declined. The
differences in allocations between the different categories reflect operational
needs. Investment securities available for sale increased for the same reason.
The securities held to maturity portfolio declined due to principal paydowns
offset by additional purchases of securities, primarily asset-backed securities
issued by government-sponsored entities. The increase in loans held for sale was
due to the Company’s decision to sell some of its current fixed-rate mortgages.
The balance in loans held for sale will be reduced by future sales to investors
with servicing rights retained by the Bank. These servicing rights attributed to
the increase in other assets as well as the increases in the Bank’s deferred tax
benefit. The loan portfolio increased as a result of increases in commercial
real estate loans, residential first mortgage loans and residential construction
loans.  These increases were partially offset by decreases in
commercial lines of credit, consumer, second mortgage, and commercial equipment
loans. The Bank foreclosed on some real estate in the current period increasing
the foreclosed real estate balance.





Details
of the Bank’s loan portfolio are presented below:


23





September 30, 2009
                  
                  
                  December 31, 2008Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %Real
      Estate LoansCommercial
                  
                  $
                  273,587,035
                  
                  
                  
                  46.09
                  %
                  
                  $
                  236,409,990
                  
                  
                  
                  43.11
                  %Residential
      first mortgages
                  
                  
                  113,454,307
                  
                  
                  
                  19.11
                  %
                  
                  
                  104,607,136
                  
                  
                  
                  19.07
                  %Residential
      construction
                  
                  
                  61,830,595
                  
                  
                  
                  10.42
                  %
                  
                  
                  57,564,710
                  
                  
                  
                  10.50
                  %Second
      mortgage loans
                  
                  
                  25,116,769
                  
                  
                  
                  4.23
                  %
                  
                  
                  25,412,415
                  
                  
                  
                  4.63
                  %Commercial
      lines of credit
                  
                  
                  98,422,905
                  
                  
                  
                  16.58
                  %
                  
                  
                  101,935,520
                  
                  
                  
                  18.59
                  %Consumer
      loans
                  
                  
                  1,569,321
                  
                  
                  
                  0.26
                  %
                  
                  
                  2,045,838
                  
                  
                  
                  0.37
                  %Commercial
      equipment
                  
                  
                  19,609,534
                  
                  
                  
                  3.30
                  %
                  
                  
                  20,458,092
                  
                  
                  
                  3.73
                  %593,590,466
                  
                  
                  
                  100.00
                  %
                  
                  
                  548,433,701
                  
                  
                  
                  100.00
                  %Less:Deferred
      loan fees
                  
                  
                  311,239
                  
                  
                  
                  0.05
                  %
                  
                  
                  310,890
                  
                  
                  
                  0.06
                  %Allowance
      for loan loss
                  
                  
                  6,791,908
                  
                  
                  
                  1.14
                  %
                  
                  
                  5,145,673
                  
                  
                  
                  0.94
                  %7,103,147
                  
                  
                  
                  
                  
                  
                  
                  5,456,563$
                  586,487,319
                  
                  
                  
                  
                  
                  
                  $
                  542,977,138





At
September 30, 2009, the Bank’s allowance for loan losses totaled $6,791,908, or
1.14% of loan balances, as compared to $5,145,673, or 0.94% of loan balances, at
December 31, 2008. 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, 2008.





The
following table summarizes changes in the allowance for loan losses for the
periods indicated.





Nine Months
                    Ended
                  
                  
                  Nine Months
                    EndedSeptember 30, 2009
                  
                  
                  September 30, 2008Beginning
      Balance
                  
                  $
                  5,145,673
                  
                  
                  $
                  4,482,483Charge
      Offs
                  
                  
                  331,793
                  
                  
                  
                  57,368Recoveries
                  
                  
                  100
                  
                  
                  
                  1,467Net
      Charge Offs
                  
                  
                  331,693
                  
                  
                  
                  55,901Additions
      Charged to Operations
                  
                  
                  1,977,928
                  
                  
                  
                  617,367Balance
      at the end of the Period
                  
                  $
                  6,791,908
                  
                  
                  $
                  5,043,949





The
following table provides information with respect to our non-performing loans at
the dates indicated.





Balances as of
                          
                          
                          Balances as ofSeptember 30, 2009
                          
                          
                          December 31, 2008Restructured
      Loans
                          
                          $
                          1,917,156
                          
                          
                          $
                          -Accruing
      loans which are contractually past due 90 days or
      more:
                          
                          $
                          -
                          
                          
                          $
                          -Loans
      accounted for on a nonaccrual basis
                          
                          $
                          21,752,754
                          
                          
                          $
                          4,936,000Total
      non- performing loans
                          
                          $
                          23,669,910
                          
                          
                          $
                          4,936,000Non-performing
      loans to total loans
                          
                          
                          3.99
                          %
                          
                          
                          0.90
                          %Allowance
      for loan losses to non performing
      loans
                          
                          
                          28.69
                          %
                          
                          
                          104.25
                          %


24


As of
September 30, 2009 and December 31, 2008, $5,761,492 and $1,520,100 in loans
were considered impaired under SFAS 114, respectively. The following table
details the amount and type of non-accrual loans at December 31, 2008 and
September 30, 2009. The largest concentration of non-accrual loans is in the
residential construction portfolio which has been particularly affected by
recent economic factors which have slowed absorption of finished lots and homes.
Other loan types have also been affected by the economic conditions in our local
and national markets. Management continues to monitor these loans and is working
to resolve these loans in a manner which will, in our
opinion,  preserve the most value for the Company.





Non-accrual loans by loan type:September 30, 2009
                
                
                December 31, 2008Dollars
                
                
                Number of
                  Loans
                
                
                Dollars
                
                
                Number of LoansReal
      Estate LoansCommercial
                
                $
                7,548,166
                
                
                
                8
                
                
                $
                1,850,972
                
                
                
                3Residential
      first mortgages
                
                
                338,806
                
                
                
                1
                
                
                
                339,521
                
                
                
                1Residential
      construction
                
                
                9,692,614
                
                
                
                5
                
                
                
                1,500,607
                
                
                
                3Second
      mortgage loans
                
                
                21,654
                
                
                
                1
                
                
                
                97,806
                
                
                
                1Commercial
      lines of credit
                
                
                3,184,702
                
                
                
                10
                
                
                
                902,713
                
                
                
                5Consumer
      loans
                
                
                2,878
                
                
                
                3
                
                
                
                50,460
                
                
                
                14Commercial
      equipment
                
                
                963,934
                
                
                
                3
                
                
                
                193,921
                
                
                
                2$
                21,752,754
                
                
                
                31
                
                
                $
                4,936,000
                
                
                
                29





Liabilities
                
                September 30, 2009
                
                
                December 31, 2008
                
                
                $ Change
                
                
                % ChangeDepositsNon-interest-bearing
      deposits
                
                $
                57,793,984
                
                
                $
                50,642,273
                
                
                $
                7,151,711
                
                
                
                14.12
                %Interest-bearing
      deposits
                
                
                569,201,810
                
                
                
                474,525,293
                
                
                
                94,676,517
                
                
                
                19.95
                %Total
      deposits
                
                
                626,995,794
                
                
                
                525,167,566
                
                
                
                101,828,228
                
                
                
                19.39
                %Short-term
      borrowings
                
                
                193,749
                
                
                
                1,522,367
                
                
                
                (1,328,618
                )
                
                
                (87.27
                )%Long-term
      debt
                
                
                85,680,745
                
                
                
                104,963,428
                
                
                
                (19,282,683
                )
                
                
                (18.37
                )%Trust
      preferred securities
                
                
                12,000,000
                
                
                
                12,000,000
                
                
                
                -Accrued
      expenses and other liabilities
                
                
                5,557,022
                
                
                
                5,917,130
                
                
                
                (360,108
                )
                
                
                (6.09
                )%Total
      Liabilities
                
                $
                730,427,310
                
                
                $
                649,570,491
                
                
                $
                80,856,819
                
                
                
                12.45
                %





Deposit
balances increased primarily in certificates of deposits, interest bearing
checking, and noninterest checking accounts due to the Bank’s continuing efforts
to increase its market share through branch improvements and marketing efforts.
The Bank paid off $20,000,000 in maturing long term advances which decreased in
its long-term debt. The increases in deposits were used to fund loan growth,
increase the balances of cash and cash equivalents and to reduce long and
short-term debt.





Stockholders’ Equity
                
                September 30, 2009
                
                
                December 31, 2008
                
                
                $ Change
                
                
                % ChangePerpetual
      Preferred Stock  Series A
                
                $
                15,540,000
                
                
                $
                15,540,000
                
                
                $
                -
                
                
                
                0.00
                %Perpetual
      Preferred Stock, Series B
                
                
                777,000
                
                
                
                777,000
                
                
                
                -
                
                
                
                0.00
                %Common
      stock - par value
                
                
                29,677
                
                
                
                29,478
                
                
                
                199
                
                
                
                0.68
                %Additional
      paid in capital
                
                
                16,694,565
                
                
                
                16,517,649
                
                
                
                176,916
                
                
                
                1.07
                %Retained
      earnings
                
                
                34,698,229
                
                
                
                34,280,719
                
                
                
                417,510
                
                
                
                1.22
                %Accumulated
      other comprehensive gain
                
                
                52,094
                
                
                
                229,848
                
                
                
                (177,754
                )
                
                
                77.34
                %Unearned
      ESOP shares
                
                
                (304,483
                )
                
                
                (260,275
                )
                
                
                (44,208
                )
                
                
                16.99
                %Total
      Stockholders’ Equity
                
                $
                67,758,032
                
                
                $
                67,114,419
                
                
                $
                372,663
                
                
                
                0.56
                %


25





Common
stock and additional paid in capital increased due to the exercise of options.
Retained earnings increased because of earnings, offset by the payment of
dividends on preferred and common stock. Book value per common share decreased
from $17.26 per common share to $17.24 reflecting the total change in common
equity.





LIQUIDITY
AND CAPITAL RESOURCES





The
Company currently conducts no business other than holding the stock of the Bank
and paying interest on its subordinated debentures and preferred
stock.  Its primary uses of funds are for the payment of dividends on
common and preferred stock and the payment of interest and principal on
debentures.  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,
proceeds from the sale of loans, advances and other borrowings, interest
received on investment securities and proceeds from the sale and maturity of
investment securities. Its principal funding commitments are for the origination
or purchase of loans, the purchase of investment securities 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 September 30, 2009, the maximum
available under this line was $318,350,799, while outstanding advances totaled
$85,680,745. In order to draw on this line, the Bank must have sufficient
collateral.  Qualifying collateral includes residential
one-to-four-family first mortgage loans, certain second mortgage loans, certain
commercial real estate loans, and various investment securities.  At
September 30, 2009, the Bank had pledged collateral sufficient to draw an
additional $61,020,997 under the line for a total current possible outstanding
of $146,701,742. The Bank also has collateral available, which is currently
unpledged, which would provide additional borrowing capacity of $74,583,213
under this arrangement. In addition, the Bank has established, with separate
collateral, other lines of credit totaling $30,994,555.





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 September 30,
2009 totaled $28,672,150, an increase of $14,197,618, or 98.09%, from the
December 31, 2008 total of $14,474,532.  This increase was due to an
increase in deposits offset by funds used to pay down short-term borrowings and
long-term debt.  The Bank’s principal sources of cash flows are its
financing activities including deposits and borrowings.  During the
first nine months of 2009, all financing activities provided $79,607,712 in cash
compared to the $75,001,338 for the same period in 2008. The increase in cash
provided of $4,606,374 or 6.14% was due to the net increase in deposits of
$101,828,228 for the nine months ended September 30, 2009 compared to
$57,768,858 for the same period in the prior year. The increase in cash provided
by the net increase in deposits was partially offset by a decline in the
proceeds from long-term borrowings from $24,000,000 in the first nine months of
2008 to $750,000 in the same period in 2009. Payments of long-term borrowings
also increased, using cash of $20,032,638 in the first nine months of 2009
compared to using cash of $5,031,401 in the same period of 2008. Operating
activities provided cash of $2,421,445 in the first nine months of 2009 compared
to $4,497,687 provided in the same period of 2008. The change was caused
primarily by the $19,238,916 of origination of loans held for sale and decline
in net income offset by $18,412,708 increase in proceeds from sale of loans held
for sale.


26


The
Bank’s principal use of cash has been in investments in loans, investment
securities and other assets.  During the nine months ended September
30, 2009, the Bank invested a total of $67,831,539 compared to $68,329,547 for
the same period in 2008.  In 2009, large increases in loan
originations were offset by higher principal repayments of loans. Similarly, the
higher level of purchases of securities in 2009 were offset by increased levels
of securities repayments.





REGULATORY
MATTERS





The Bank
is subject to Federal Reserve Board capital requirements as well as statutory
capital requirements imposed under Maryland law.  At September 30,
2009, the Bank’s tangible, leverage and risk-based capital ratios were 9.93%,
12.60% and 13.71%, 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%, 6.0%, and 10% ratios required to be considered well
capitalized.  At September 30, 2009, the Company’s tangible, leverage
and risk-based capital ratios were 10.14%, 12.83% and 13.94%,
respectively.  These levels are also in excess of the 4.0%, 4.0% and
8.0% ratios required by the Federal Reserve Board as well as the 5.0%, 6.0%, and
10% ratios required to be considered well capitalized.





CRITICAL
ACCOUNTING POLICIES





The
Company’s consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and the
general practices of the United States banking industry.  Application
of these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions and judgments are based on
information available as of the date of the financial statements; accordingly,
as information changes, the financial statements could reflect different
estimates, assumptions, and judgments. Certain policies inherently have a
greater reliance on the use of estimates, assumptions and judgments and as such
have a greater possibility of producing results that could be materially
different than originally reported. The Company considers its determination of
the allowance for loan losses and the valuation allowance on its foreclosed real
estate to be critical accounting policies.  Estimates, assumptions,
and judgments are necessary when assets and liabilities are required to be
recorded at fair value, when a decline in the value of an asset not carried on
the financial statements at fair value warrants an impairment write-down or
valuation reserve to be established, or when an asset or liability needs to be
recorded contingent upon a future event. Carrying assets and liabilities at fair
value inherently results in more financial statement volatility. The fair values
and the information used to record valuation adjustments for certain assets and
liabilities are based either on quoted market prices or are provided by other
third-party sources, when available.  When these sources are not
available, management makes estimates based upon what it considers to be the
best available information.





The
allowance for loan losses is an estimate of the losses that may be sustained in
the loan portfolio. The allowance is based on two principles of accounting: (a)
Accounting Standards Codification (“ASC”) Contingencies Topic, which requires
that losses be accrued when they are probable of occurring and are estimable and
(b) ASC Receivables Topic, which requires that losses be accrued when it is
probable that the Company will not collect all principal and interest payments
according to the contractual terms of the loan. The loss, if any, is determined
by the difference between the loan balance and the value of collateral, the
present value of expected future cash flows and values observable in the
secondary markets.





The loan
loss allowance balance is an estimate based upon management’s evaluation of the
loan portfolio.  The allowance is comprised of a specific and a
general component.  The specific component consists of management’s
evaluation of certain classified and non-accrual loans and their underlying
collateral.  Loans are examined to determine the specific allowance
based upon the borrower’s payment history, economic conditions specific to the
loan or borrower, or other factors that would impact the borrower’s ability to
repay the loan on its contractual basis.  Management assesses the
ability of the borrower to repay the loan based upon all information
available.  Depending on the assessment of the borrower’s ability to
pay the loan as well as the type, condition, and amount of collateral,
management will establish an allowance amount specific to the
loan.


27


In
establishing the general component of the allowance, management analyzes
non-classified and non-impaired loans in the portfolio including changes in the
amount and type of loans.  Management also examines the Bank’s loss
experience within each loan category.  The state of the local and
national economy is also considered.  Based upon these factors, the
Bank’s loan portfolio is categorized and a loss factor is applied to each
category.  These loss factors may be higher or lower than the Bank’s
actual recent average losses in any particular loan category, particularly in
loan categories where the Bank is rapidly increasing the size of its
portfolio.  Based upon these factors and recent net charge-offs, the
Bank will adjust the loan loss allowance through the provision for loan
losses.





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 loss factors on the general component of the
allowance.  Changes in loss 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. For additional information regarding the
allowance for loan losses, refer to Notes 1 and 4 to the Consolidated Financial
Statements as presented in the Company’s Form 10-K for the year ended December
31, 2008.





In
addition to the loan loss allowance, the Company also maintains a valuation
allowance on its foreclosed real estate.  As with the allowance for
loan losses, the valuation allowance on foreclosed real estate is based on ASC
Contingencies Topic, as well as the accounting guidance on impairment of long
lived assets. These statements require that the Company establish a valuation
allowance when it has determined that the carrying amount of a foreclosed asset
exceeds its fair value.  Fair value of a foreclosed asset is measured
by the cash flows expected to be realized from its subsequent
disposition.  These cash flows should be reduced for the costs of
selling or otherwise disposing of the asset.





In
estimating the cash flows from the sale of foreclosed real estate, management
must make significant assumptions regarding the timing and amount of cash
flows.  In cases where the real estate acquired is undeveloped land,
management must gather the best available evidence regarding the market value of
the property, including appraisals, cost estimates of development, and broker
opinions.  Due to the highly subjective nature of this evidence, as
well as the limited market, long time periods involved, and substantial risks,
cash flow estimates are highly subjective and subject to
change.  Errors regarding any aspect of the costs or proceeds of
developing, selling, or otherwise disposing of foreclosed real estate could
result in the allowance being inadequate to reduce carrying costs to fair value
and may require an additional provision for valuation allowances.





ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET
RISK





Not
applicable as the Company is a smaller reporting company.





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 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 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.


28





There
were no changes in the Company’s internal control over financial reporting
during the nine months ended September 30, 2009 that have materially affected,
or are reasonable 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 1A
- Risk Factors.  In addition to the other information set forth
in this report, you should carefully consider the factors discussed in Part I,
“Item 1A. Risk Factors” in the Form 10-K, which could materially affect our
business, financial condition or future results.  The risks described
in the Form 10-K are not the only risks that we face.  Additional
risks and uncertainties not currently known to us or that we currently deem to
be immaterial also may materially adversely affect our business, financial
condition and/or operating results.





Item 2 -
Unregistered Sales of Equity Securities and Use of Proceeds





(a)
            Not
      applicable





(b)
            Not
      applicable





(c)
            The
      Company did not repurchase any shares of common stock in the quarter ended
      September 30, 2009.  On September 25, 2008, Tri-County Financial
      Corporation announced a repurchase program under which it would repurchase
      up to 5% of its outstanding common stock or approximately 147,435
      shares.  However, as part of the Company’s participation in the
      Capital Repurchase Program of the U.S. Department of Treasury’s Troubled
      Asset Repurchase Program, prior to the earlier of
      (a) December 19, 2018 or (b) the date on which the
      Series A preferred stock and the Series B preferred stock has
      been redeemed in full or the Treasury has transferred all of the
      Series A preferred stock and the Series B preferred stock to
      non-affiliates, the Company, without the consent of the Treasury, cannot
      repurchase any shares of its common stock or other capital stock or equity
      securities or trust preferred securities. These repurchase restrictions do
      not apply in certain limited circumstances, including the repurchase of
      common stock in connection with the administration of any employee benefit
      plan in the ordinary course of business and consistent with past practice.
      In addition, during the period beginning on December 19, 2018 and
      ending on the date on which the Series A preferred stock and the
      Series B preferred stock have been redeemed in full or the Treasury
      has transferred all of the Series A preferred stock and the
      Series B preferred stock to non-affiliates, the Company cannot
      repurchase any shares of its common stock or other capital stock or equity
      securities or trust preferred securities without the consent of the
      Treasury.





Item 3 -
Default Upon Senior Securities — None





Item 4 -
Submission of Matters to a Vote of Security Holders —None





Item 5 -
Other Information — None





Item 6 -
Exhibits





Exhibit 31 Rule 13a-14(a)
Certifications





Exhibit 32 Section 1350
Certifications


29





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 CORPORATIONDate: November 12, 2009
                        By:
                        /s/
      Michael L. MiddletonMichael
      L. Middleton, President, ChiefExecutive Officer
      and Chairman of the Board





Date:
      November 12, 2009
                By:
                /s/
      William J. PasenelliWilliam
      J. Pasenelli, Executive VicePresident
      and Chief Financial
Officer


30