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 June 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   ̈Non-accelerated
      Filer   ̈
                Smaller
      Reporting Company  x


(Do not
check if a smaller reporting company)





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


Yes  ̈         No
x





As of
July 24, 2009 the registrant had 2,968,367 shares of common stock
outstanding.








TRI-COUNTY
FINANCIAL CORPORATION





FORM
10-Q





INDEX





PagePART
      I - FINANCIAL INFORMATIONItem
      1 – Financial Statements (Unaudited)Consolidated
      Balance Sheets – June 30, 2009and
      December 31, 2008
                                    
                                    3Consolidated
      Statements of Income and Comprehensive Income -Three
      and Six Months Ended June 30, 2009 and 2008
                                    
                                    4-5Consolidated
      Statements of Cash Flows - Six MonthsEnded
      June 30, 2009 and 2008
                                    
                                    6-7Notes
      to Consolidated Financial Statements
                                    
                                    8-18Item
      2 – Management’s Discussion and Analysis of Financial Condition and Results of
      Operations
                                    
                                    19-28Item
      3 – Quantitative and Qualitative Disclosures about Market
    Risk
                                    
                                    28Item
      4 – Controls and Procedures
                                    
                                    29PART
      II - OTHER INFORMATIONItem
      1 –
                                    Legal
      Proceedings
                                    
                                    30Item
      1A –
                                    Risk
      Factors
                                    
                                    30Item
      2 –
                                    Unregistered
      Sales of Equity Securities and Use of Proceeds
                                    
                                    30Item
      3 –
                                    Defaults
      Upon Senior Securities
                                    
                                    30Item
      4 –
                                    Submission
      of Matters to a Vote of Security Holders
                                    
                                    30Item
      5 –
                                    Other
      Information
                                    
                                    31Item
      6 –
                                    Exhibits
                                    
                                    31SIGNATURES
                                    
                                    32


2


PART
I FINANCIAL STATEMENTS


ITEM
I. FINANCIAL STATEMENTS


TRI-COUNTY
FINANCIAL CORPORATION


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





June 30, 2009
                          
                          
                          December 31, 2008AssetsCash
      and due from banks
                          
                          $
                          22,193,413
                          
                          
                          $
                          5,071,614Federal
      funds sold
                          
                          
                          3,485,055
                          
                          
                          
                          989,754Interest-bearing
      deposits with banks
                          
                          
                          1,697,372
                          
                          
                          
                          8,413,164Securities
      available for sale, at fair value
                          
                          
                          23,889,888
                          
                          
                          
                          14,221,674Securities
      held to maturity, at amortized cost
                          
                          
                          104,553,145
                          
                          
                          
                          108,712,281Federal
      Home Loan Bank and Federal Reserve Bank stock - at cost
                          
                          
                          6,472,300
                          
                          
                          
                          6,453,000Loans
      held for sale
                          
                          
                          2,058,951
                          
                          
                          
                          -Loans
      receivable - net of allowance for loan losses of
$6,381,048and
      $5,145,673, respectively
                          
                          
                          583,671,431
                          
                          
                          
                          542,977,138Premises
      and equipment, net
                          
                          
                          12,433,413
                          
                          
                          
                          12,235,999Accrued
      interest receivable
                          
                          
                          2,887,865
                          
                          
                          
                          2,965,813Investment
      in bank owned life insurance
                          
                          
                          10,727,759
                          
                          
                          
                          10,526,286Other
      assets
                          
                          
                          4,313,181
                          
                          
                          
                          4,118,187Total
      Assets
                          
                          $
                          778,383,773
                          
                          
                          $
                          716,684,910Liabilities
      and Stockholders' EquityLiabilitiesDeposits:Non-interest-bearing
      deposits
                          
                          $
                          67,088,136
                          
                          
                          $
                          50,642,273Interest-bearing
      deposits
                          
                          
                          525,776,084
                          
                          
                          
                          474,525,293Total
      deposits
                          
                          
                          592,864,220
                          
                          
                          
                          525,167,566Short-term
      borrowings
                          
                          
                          641,990
                          
                          
                          
                          1,522,367Long-term
      debt
                          
                          
                          100,691,749
                          
                          
                          
                          104,963,428Guaranteed
      preferred beneficial interest in junior subordinated
      debentures
                          
                          
                          12,000,000
                          
                          
                          
                          12,000,000Accrued
      expenses and other liabilities
                          
                          
                          5,274,134
                          
                          
                          
                          5,917,130Total
      Liabilities
                          
                          
                          711,472,093
                          
                          
                          
                          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;
    issued2,959,680
      and 2,947,759 shares, respectively
                          
                          
                          29,597
                          
                          
                          
                          29,478Additional
      paid in capital
                          
                          
                          16,588,665
                          
                          
                          
                          16,517,649Retained
      earnings
                          
                          
                          34,042,384
                          
                          
                          
                          34,280,719Accumulated
      other comprehensive gain
                          
                          
                          222,236
                          
                          
                          
                          229,848Unearned
      ESOP shares
                          
                          
                          (288,202
                          )
                          
                          
                          (260,275
                          )Total
      Stockholders' Equity
                          
                          
                          66,911,680
                          
                          
                          
                          67,114,419Total
      Liabilities and Stockholders' Equity
                          
                          $
                          778,383,773
                          
                          
                          $
                          716,684,910


See
notes to consolidated financial statements


3


TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)


THREE
AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





Three Months Ended June 30,
                
                
                Six Months Ended June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008INTEREST
      INCOME:Interest
      and fees on loans
                
                $
                8,041,071
                
                
                $
                7,827,081
                
                
                $
                15,918,462
                
                
                $
                15,904,247Taxable
      interest and dividends on investment securities
                
                
                1,302,456
                
                
                
                1,368,011
                
                
                
                2,627,951
                
                
                
                2,762,535Interest
      on deposits with banks
                
                
                6,838
                
                
                
                24,179
                
                
                
                7,028
                
                
                
                60,272Total
      interest income
                
                
                9,350,365
                
                
                
                9,219,271
                
                
                
                18,553,441
                
                
                
                18,727,054INTEREST
      EXPENSE:Interest
      on deposits
                
                
                3,125,476
                
                
                
                3,195,461
                
                
                
                6,298,841
                
                
                
                6,525,701Interest
      on short-term borrowings
                
                
                5,934
                
                
                
                33,393
                
                
                
                29,800
                
                
                
                114,427Interest
      on long-term borrowings
                
                
                1,048,621
                
                
                
                1,172,032
                
                
                
                2,111,461
                
                
                
                2,412,247Total
      interest expense
                
                
                4,180,031
                
                
                
                4,400,886
                
                
                
                8,440,102
                
                
                
                9,052,375NET
      INTEREST INCOME
                
                
                5,170,334
                
                
                
                4,818,385
                
                
                
                10,113,339
                
                
                
                9,674,679PROVISION
      (CREDIT) FOR LOAN LOSSES
                
                
                929,488
                
                
                
                (5,479
                )
                
                
                1,462,373
                
                
                
                154,745NET
      INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
                
                
                4,240,846
                
                
                
                4,823,864
                
                
                
                8,650,966
                
                
                
                9,519,934


4





TRI-COUNTY
FINANCIAL CORPORATION


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


THREE
AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





Three Months Ended June 30,
                  
                  
                  Six Months Ended June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008NONINTEREST
      INCOME:Loan
      appraisal, credit, and miscellaneous charges
                  
                  $
                  245,214
                  
                  
                  $
                  124,288
                  
                  
                  $
                  360,892
                  
                  
                  $
                  234,551Gain
      on sale of loans held for sale
                  
                  
                  168,374
                  
                  
                  
                  -
                  
                  
                  
                  168,374
                  
                  
                  
                  -Gain
      on asset sale
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,041Income
      from bank owned life insurance
                  
                  
                  100,216
                  
                  
                  
                  189,271
                  
                  
                  
                  201,473
                  
                  
                  
                  286,489Loss
      on sale of investment securities
                  
                  
                  (12,863
                  )
                  
                  
                  -
                  
                  
                  
                  (12,863
                  )
                  
                  
                  -Recognition
      of other than temporary declinein
      value of investment securities
                  
                  
                  (118,744
                  )
                  
                  
                  -
                  
                  
                  
                  (118,744
                  )
                  
                  
                  -Service
      charges
                  
                  
                  399,574
                  
                  
                  
                  445,029
                  
                  
                  
                  769,096
                  
                  
                  
                  822,958Total
      noninterest income
                  
                  
                  781,771
                  
                  
                  
                  758,588
                  
                  
                  
                  1,368,228
                  
                  
                  
                  1,346,039NONINTEREST
      EXPENSE:Salary
      and employee benefits
                  
                  
                  2,101,058
                  
                  
                  
                  2,111,805
                  
                  
                  
                  4,251,834
                  
                  
                  
                  4,122,015Occupancy
                  
                  
                  466,221
                  
                  
                  
                  434,453
                  
                  
                  
                  870,748
                  
                  
                  
                  797,629Advertising
                  
                  
                  99,850
                  
                  
                  
                  100,929
                  
                  
                  
                  229,962
                  
                  
                  
                  271,372Data
      processing
                  
                  
                  210,445
                  
                  
                  
                  215,101
                  
                  
                  
                  436,620
                  
                  
                  
                  260,991Legal
      and professional fees
                  
                  
                  202,299
                  
                  
                  
                  224,309
                  
                  
                  
                  359,908
                  
                  
                  
                  338,476Depreciation
      of furniture, fixtures, and equipment
                  
                  
                  150,963
                  
                  
                  
                  138,878
                  
                  
                  
                  299,105
                  
                  
                  
                  271,280Telephone
      communications
                  
                  
                  34,898
                  
                  
                  
                  18,846
                  
                  
                  
                  68,173
                  
                  
                  
                  42,477Office
      supplies
                  
                  
                  37,673
                  
                  
                  
                  34,991
                  
                  
                  
                  87,385
                  
                  
                  
                  74,475FDIC
      Insurance
                  
                  
                  543,947
                  
                  
                  
                  70,769
                  
                  
                  
                  633,611
                  
                  
                  
                  124,254Other
                  
                  
                  431,319
                  
                  
                  
                  444,139
                  
                  
                  
                  855,489
                  
                  
                  
                  842,794Total
      noninterest expense
                  
                  
                  4,278,673
                  
                  
                  
                  3,794,220
                  
                  
                  
                  8,092,835
                  
                  
                  
                  7,145,763INCOME
      BEFORE INCOME TAXES
                  
                  
                  743,944
                  
                  
                  
                  1,788,232
                  
                  
                  
                  1,926,359
                  
                  
                  
                  3,720,210Income
      tax expense
                  
                  
                  221,730
                  
                  
                  
                  661,698
                  
                  
                  
                  634,305
                  
                  
                  
                  1,277,435NET
      INCOME
                  
                  
                  522,214
                  
                  
                  
                  1,126,534
                  
                  
                  
                  1,292,054
                  
                  
                  
                  2,442,775OTHER
      COMPREHENSIVE INCOME NET OF TAXNet
      unrealized holding losses arising during period
                  
                  
                  (220,599
                  )
                  
                  
                  (368,108
                  )
                  
                  
                  (7,612
                  )
                  
                  
                  (73,588
                  )COMPREHENSIVE
      INCOME
                  
                  $
                  301,615
                  
                  
                  $
                  758,426
                  
                  
                  $
                  1,284,442
                  
                  
                  $
                  2,369,187EARNINGS
      PER COMMON SHAREBasic
                  
                  $
                  0.10
                  
                  
                  $
                  0.38
                  
                  
                  $
                  0.29
                  
                  
                  $
                  0.83Diluted
                  
                  
                  0.10
                  
                  
                  
                  0.37
                  
                  
                  
                  0.29
                  
                  
                  
                  0.79DIVIDENDS
      PER COMMON SHARE
                  
                  
                  0.40
                  
                  
                  
                  0.40
                  
                  
                  
                  0.40
                  
                  
                  
                  0.40


See
notes to consolidated financial statements


5





TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)


SIX
MONTHS ENDED JUNE 30, 2009 AND 2008





Six Months Ended June 30,2009
                        
                        
                        2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                        
                        $
                        1,292,054
                        
                        
                        $
                        2,442,775Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                        
                        
                        1,462,373
                        
                        
                        
                        154,745Gain
      on sale of asset
                        
                        
                        -
                        
                        
                        
                        (2,041
                        )Loss
      on sales of investment securities
                        
                        
                        12,863
                        
                        
                        
                        -Other
      than temporary decline in market value of investment
      securities
                        
                        
                        118,744
                        
                        
                        
                        -Depreciation
      and amortization
                        
                        
                        579,649
                        
                        
                        
                        516,762Net
      amortization of premium/discount on investment securities
                        
                        
                        (53,673
                        )
                        
                        
                        (33,123
                        )Increase
      in cash surrender of bank owned life insurance
                        
                        
                        (201,473
                        )
                        
                        
                        (197,351
                        )Deferred
      income tax benefit
                        
                        
                        (866,138
                        )
                        
                        
                        (408,351
                        )Decrease
      in accrued interest receivable
                        
                        
                        77,948
                        
                        
                        
                        131,501Increase
      in deferred loan fees
                        
                        
                        (10,755
                        )
                        
                        
                        (82,219
                        )Decrease
      in accounts payable, accrued expenses, other liabilities
                        
                        
                        (642,996
                        )
                        
                        
                        (457,573
                        )Decrease
      (increase) in other assets
                        
                        
                        675,065
                        
                        
                        
                        (135,470
                        )Loans
      originated for resale
                        
                        
                        (16,624,790
                        )
                        
                        
                        -Proceeds
      from sale of loans held for sale
                        
                        
                        14,671,153
                        
                        
                        
                        -Gain
      on sales of loans held for sale
                        
                        
                        (168,374
                        )
                        
                        
                        -Net
      cash provided by operating activities
                        
                        
                        321,650
                        
                        
                        
                        1,929,655CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of investment securities available for sale
                        
                        
                        (10,231,042
                        )
                        
                        
                        (4,931,155
                        )Proceeds
      from sale, redemption or principal paymentsof
      investment securities available for sale
                        
                        
                        500,624
                        
                        
                        
                        139,483Purchase
      of investment securities held to maturity
                        
                        
                        (8,377,442
                        )
                        
                        
                        (4,048,450
                        )Proceeds
      from maturities or principal paymentsof
      investment securities held to maturity
                        
                        
                        12,509,315
                        
                        
                        
                        4,447,413Net
      increase in FHLB and Federal Reserve stock
                        
                        
                        (19,300
                        )
                        
                        
                        (1,254,200
                        )Loans
      originated or acquired
                        
                        
                        (139,205,203
                        )
                        
                        
                        (116,109,162
                        )Principal
      collected on loans
                        
                        
                        97,122,352
                        
                        
                        
                        74,613,477Proceeds
      from disposal of premises and equipment
                        
                        
                        -
                        
                        
                        
                        2,041Purchase
      of premises and equipment
                        
                        
                        (777,063
                        )
                        
                        
                        (2,113,896
                        )Net
      cash used in investing activities
                        
                        
                        (48,477,759
                        )
                        
                        
                        (49,254,449
                        )


6





TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED) (continued)


SIX
MONTHS ENDED JUNE 30, 2009 AND 2008





Six Months Ended June 30,2009
                
                
                2008CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      increase in deposits
                
                $
                67,696,654
                
                
                $
                19,386,640Proceeds
      from long-term borrowings
                
                
                750,000
                
                
                
                24,000,000Payments
      of long-term borrowings
                
                
                (5,021,679
                )
                
                
                (5,020,829
                )Net
      (decrease) increase in short-term borrowings
                
                
                (880,377
                )
                
                
                7,381,849Exercise
      of stock options
                
                
                66,943
                
                
                
                725,905Excess
      tax benefits on stock-based compensation
                
                
                4,168
                
                
                
                4,250Net
      change in unearned ESOP shares
                
                
                (27,903
                )
                
                
                156,373Dividends
      Paid
                
                
                (1,530,389
                )
                
                
                (1,184,324
                )Redemption
      of common stock
                
                
                -
                
                
                
                (863,668
                )Net
      cash provided by financing activities
                
                
                61,057,417
                
                
                
                44,586,196INCREASE
      (DECREASE) IN CASH AND CASH EQUIVALENTS
                
                
                12,901,308
                
                
                
                (2,738,598
                )CASH
      AND CASH EQUIVALENTS - JANUARY 1
                
                
                14,474,532
                
                
                
                1,426,637CASH
      AND CASH EQUIVALENTS - JUNE 30
                
                
                27,375,840
                
                
                
                8,688,039SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during the six months for:Interest
                
                $
                9,124,850
                
                
                $
                9,068,586Income
      taxes
                
                $
                925,000
                
                
                $
                1,676,000





See
notes to consolidated financial statements


7


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)


SIX MONTHS ENDED JUNE 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 six months ended
June 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 Statement of Financial Accounting Standards No. 165
“Subsequent Events” (SFAS 165), the Company evaluated subsequent events after
the balance sheet date of June 30, 2009 through August 7, 2009, the date the
consolidated financial statements included in this Form 10Q 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 SFAS No. 157, “Fair Value
Measurements” (“SFAS 157”) which provides a framework for measuring and
disclosing fair value under generally accepted accounting
principles.  SFAS 157 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).





SFAS 157
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.  SFAS 157 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 value adjustments typically involve application of lower of
cost or market accounting or write-downs of individual assets.


8





Under
SFAS 157, 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 SFAS
114, “Accounting by Creditors for Impairment of a Loan,” (SFAS
114).  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 December 31, 2008, substantially all of the
impaired loans were evaluated based upon the fair value of the
collateral.  In accordance with SFAS 157, 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.





Foreclosed
Assets





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 and 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.


9





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





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





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
                  
                  $
                  23,889,888
                  
                  
                  $
                  -
                  
                  
                  $
                  23,889,888
                  
                  
                  $
                  -





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 June 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
                  
                  $
                  2,196,864
                  
                  
                  $
                  -
                  
                  
                  $
                  2,196,864
                  
                  
                  $
                  -





Loans
held for sale, which are carried at the lower of cost or market, did not have
any impairment charge at June 30, 2009.





4.
            INCOME
      TAXES





The
Company uses the liability method of accounting for income taxes as required by
SFAS No. 109, “Accounting for Income Taxes.”  Under the liability
method, deferred-tax assets and liabilities are determined based on differences
between the financial statement carrying amounts and the tax bases of existing
assets and liabilities (i.e., temporary differences) and are measured at the
enacted rates that will be in effect when these differences reverse. The Company
also adopted FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (“FIN 48”) on January 1, 2007.  Interest and penalties,
if any, are recorded in income tax expense.





5.
            EARNINGS
      PER SHARE





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 June 30,
      2009 and 2008, there were 190,479 and 21,811 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:


10





6.
              STOCK-BASED
      COMPENSATION




Three Months Ended
            
            
            Six Months EndedJune 30,
            
            
            June 30,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      Income
            
            $
            522,214
            
            
            $
            1,126,534
            
            
            $
            1,292,054
            
            
            $
            2,442,775Less:
      Dividends payable on preferred stock
            
            
            (211,733
            )
            
            
            -
            
            
            
            (423,465
            )
            
            
            -Net
      income available to common shareholders
            
            $
            310,481
            
            
            $
            1,126,534
            
            
            $
            868,589
            
            
            $
            2,442,775Average
      number of common shares outstanding
            
            
            2,958,397
            
            
            
            2,944,890
            
            
            
            2,954,779
            
            
            
            2,938,794Effect
      of dilutive options
            
            
            27,370
            
            
            
            137,807
            
            
            
            34,283
            
            
            
            139,433Average
      number of shares used to calculate earningsper
      share outstanding
            
            
            2,985,767
            
            
            
            3,082,697
            
            
            
            2,989,062
            
            
            
            3,078,227




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 financial statements included in our
Annual Report to Stockholders for the year ended December 31,
2008.  Stock-based compensation related expenses of $4,780 were
recognized in the quarter ended June 30, 2009, compared to no stock-based
compensation expense for the quarter ended June 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 June 30, 2009, and changes during the
three-month period then ended is presented below:





Shares
                
                
                Weighted
                  Average
                  Exercise
                  Price
                
                
                Aggregate
                  Intrinsic
                  Value
                
                
                Weighted Average
                  Contractual Life
                  Remaining
                  In YearsOutstanding
      at December 31, 2008
                
                
                353,217
                
                
                $
                15.49Granted
      at fair value
                
                
                -
                
                
                
                -Exercised
                
                
                (12,186
                )
                
                
                7.88
                
                
                
                43,579Expired
                
                
                -
                
                
                
                -Forfeited
                
                
                (1
                )
                
                
                7.88Outstanding
      at June 30, 2009
                
                
                341,030
                
                
                $
                15.77
                
                
                $
                289,046
                
                
                
                1.9Exercisable
      at June 30, 2009
                
                
                341,030
                
                
                $
                15.77
                
                
                $
                289,046
                
                
                
                1.9


11





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 June
15, 2035, unless called by the Company not earlier than June 15,
2010.





On July
22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business
trust formed, funded and wholly owned by the Company, issued $7,000,000 of
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.





Costs
associated with the issuance of the trust-preferred securities were less than
$10,000 and were expensed as period costs.





8.
            PREFERRED
      STOCK





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





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.


12





9.
            SECURITIES





June 30, 2009Amortized
                  
                  
                  Gross
                    Unrealized
                  
                  
                  Gross
                    Unrealized
                  
                  
                  EstimatedCost
                  
                  
                  Gains
                  
                  
                  Losses
                  
                  
                  Fair
      ValueSecurities
      available for saleAsset-backed
      securities issued by GSEs
                  
                  $
                  20,015,431
                  
                  
                  $
                  354,948
                  
                  
                  $
                  102,033
                  
                  
                  $
                  20,268,346Corporate
      equity securities
                  
                  
                  37,310
                  
                  
                  
                  696
                  
                  
                  
                  248
                  
                  
                  
                  37,758Bond
      mutual funds
                  
                  
                  3,500,423
                  
                  
                  
                  83,360
                  
                  
                  
                  -
                  
                  
                  
                  3,583,783Total
      securities available for sale
                  
                  $
                  23,553,164
                  
                  
                  $
                  439,004
                  
                  
                  $
                  102,281
                  
                  
                  $
                  23,889,887Securities
      held-to-maturityAsset-backed
      securities issued by:GSEs
                  
                  $
                  82,383,843
                  
                  
                  $
                  1,609,994
                  
                  
                  $
                  268,357
                  
                  
                  $
                  83,725,480Other
                  
                  
                  22,157,748
                  
                  
                  
                  -
                  
                  
                  
                  5,537,692
                  
                  
                  
                  16,620,056Total
      debt securities held-to-maturity
                  
                  
                  104,541,591
                  
                  
                  
                  1,609,994
                  
                  
                  
                  5,806,049
                  
                  
                  
                  100,345,536U.S.
      Government obligations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Other
      investments
                  
                  
                  11,554
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  11,554Total
      securities held-to-maturity
                  
                  $
                  104,553,145
                  
                  
                  $
                  1,609,994
                  
                  
                  $
                  5,806,049
                  
                  
                  $
                  100,357,090





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





Other
investments consist of certain certificate of deposit strip instruments whose
fair value is based on market returns on similar risk and maturity instruments
because no active market exists for these instruments. In addition, at June 30,
2009, certain other securities with a carrying value of $2,474,571 were pledged
to secure certain deposits.  At June 30, 2009, securities with a
carrying value of $58,622,098 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 June 30, 2009, are as follows:





Continuous unrealized losses existing forLess Than 12
                
                
                More Than 12
                
                
                Total unrealizedFair Value
                
                
                Months
                
                
                Months
                
                
                LossesAsset-backed
      securities issued by GSE's:
                
                $
                5,299,989
                
                
                $
                -
                
                
                $
                102,033
                
                
                $
                102,033Corporate
      Equity Securities
                
                
                62
                
                
                
                248
                
                
                
                -
                
                
                
                248$
                5,300,051
                
                
                $
                248
                
                
                $
                102,033
                
                
                $
                102,281





The
available-for-sale investment portfolio has a fair value of $23,889,887, of
which $5,300,051 of the securities have some unrealized losses from their
amortized cost. Of these securities, $5,299,989, or 99%, are mortgage-backed
securities issued by GSEs and $62 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 (approximately 2%). We believe that the losses in the
equity securities are temporary. Persistent losses may require a reevaluation of
these losses. These factors coupled with the fact the Company has both the
intent and ability to hold these investments for a period of time sufficient to
allow for any anticipated recovery in fair value substantiates that the
unrealized losses in the available-for-sale portfolio are
temporary.





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 June 30, 2009 are as follows:





Continuous unrealized losses existing forLess Than12
                
                
                More Than 12
                
                
                Total
                  unrealizedFair Value
                
                
                Months
                
                
                Months
                
                
                LossesAsset-backed
      securities issued by GSE's:
                
                $
                23,425,985
                
                
                $
                -
                
                
                $
                268,357
                
                
                $
                268,357Asset-backed
      securities issued by other
                
                
                16,620,241
                
                
                
                -
                
                
                
                5,537,692
                
                
                
                5,537,692$
                40,046,226
                
                
                $
                -
                
                
                $
                5,806,049
                
                
                $
                5,806,049





The
held-to-maturity investment portfolio has an estimated fair value of
$100,357,090, of which $40,046,226, or 40% of the securities have some
unrealized losses from their amortized cost. Of these securities, $23,425,985 or
58%, are mortgage-backed securities issued by GSEs and the remaining $16,620,241
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%. 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 64% 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 $5,537,692 or 25% 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.





There
were sales of investments available for sale securities of $73,200 during the
six-month period ended June 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 six month
period ended June 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





SFAS No. 141, “Business
Combinations (Revised 2007).”SFAS 141R replaces SFAS 141,
“Business Combinations,” and applies to all transactions and other events in
which one entity obtains control over one or more other businesses.
SFAS 141R requires an acquirer, upon initially obtaining control of another
entity, to recognize the assets, liabilities and any non-controlling interest in
the acquiree at fair value as of the acquisition date. Contingent consideration
is required to be recognized and measured at fair value on the date of
acquisition rather than at a later date when the amount of that consideration
may be determinable beyond a reasonable doubt. This fair value approach replaces
the cost-allocation process required under SFAS 141 whereby the cost of an
acquisition was allocated to the individual assets acquired and liabilities
assumed based on their estimated fair value. SFAS 141R requires acquirers
to expense acquisition-related costs as incurred rather than allocating such
costs to the assets acquired and liabilities assumed, as was previously the case
under SFAS 141. Under SFAS 141R, the requirements of SFAS 146,
“Accounting for Costs Associated with Exit or Disposal Activities,” would have
to be met in order to accrue for a restructuring plan in purchase accounting.
Pre-acquisition contingencies are to be recognized at fair value, unless it is a
non-contractual contingency that is not likely to materialize, in which case,
nothing should be recognized in purchase accounting and, instead, that
contingency would be subject to the probable and estimable recognition criteria
of SFAS 5, “Accounting for Contingencies.” SFAS 141R is applicable to
the Company’s accounting for business combinations closing on or after
January 1, 2009.





SFAS No. 160, “Noncontrolling
Interest in Consolidated Financial Statements, an amendment of ARB Statement
No. 51.” SFAS 160 amends Accounting Research Bulletin (ARB)
No. 51, “Consolidated Financial Statements,” to establish accounting and
reporting standards for the non-controlling interest in a subsidiary and for the
deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling
interest in a subsidiary, which is sometimes referred to as minority interest,
is an ownership interest in the consolidated entity that should be reported as a
component of equity in the consolidated financial statements. Among other
requirements, SFAS 160 requires consolidated net income to be reported at
amounts that include the amounts attributable to both the parent and the
non-controlling interest. It also requires disclosure, on the face of the
consolidated income statement, of the amounts of consolidated net income
attributable to the parent and to the non-controlling interest. SFAS 160
became effective for the Company on January 1, 2009 and did not have a
significant impact on the Company’s financial statements.





SFAS No. 165, “Subsequent
Events.”SFAS 165 establishes general standards of accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or available to be issued. SFAS 165 defines
(i) the period after the balance sheet date during which a reporting
entity’s management should evaluate events or transactions that may occur for
potential recognition or disclosure in the financial statements (ii) the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and
(iii) the disclosures an entity should make about events or transactions
that occurred after the balance sheet date. SFAS 165 became effective for
the Company’s financial statements for periods ending after June 15, 2009.
SFAS 165 did not have a significant impact on the Company’s financial
statements.




15




SFAS No. 166, “Accounting for
Transfers of Financial Assets, an Amendment of FASB Statement No. 140.”SFAS 166 amends SFAS 140, “Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities,” to
enhance reporting about transfers of financial assets, including
securitizations, and where companies have continuing exposure to the risks
related to transferred financial assets. SFAS 166 eliminates the concept of
a “qualifying special-purpose entity” and changes the requirements for
derecognizing financial assets. SFAS 166 also requires additional
disclosures about all continuing involvements with transferred financial assets
including information about gains and losses resulting from transfers during the
period. SFAS 166 will be effective January 1, 2010 and is not expected to
have a significant impact on the Company’s financial statements.





SFAS No. 167, “Amendments to
FASB Interpretation No. 46(R).”SFAS 167 amends FIN 46
(Revised December 2003), “Consolidation of Variable Interest
Entities,” to change how a company determines when an entity that is
insufficiently capitalized or is not controlled through voting (or similar
rights) should be consolidated. The determination of whether a company is
required to consolidate an entity is based on, among other things, an entity’s
purpose and design and a company’s ability to direct the activities of the
entity that most significantly impact the entity’s economic performance.
SFAS 167 requires additional disclosures about the reporting entity’s
involvement with variable-interest entities and any significant changes in risk
exposure due to that involvement as well as its affect on the entity’s financial
statements. SFAS 167 will be effective January 1, 2010 and is not
expected to have a significant impact on the Company’s financial
statements.





SFAS No. 168, “The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles, a Replacement of FASB Statement No. 162.”SFAS 168 replaces SFAS 162, “The Hierarchy of Generally
Accepted Accounting Principles” and establishes the FASB Accounting Standards
Codification (the “Codification”) as the source of authoritative accounting
principles recognized by the FASB to be applied by non-governmental entities in
the preparation of financial statements in conformity with generally accepted
accounting principles. Rules and interpretive releases of the SEC under
authority of federal securities laws are also sources of authoritative guidance
for SEC registrants. All guidance contained in the Codification carries an equal
level of authority. All non-grandfathered, non-SEC accounting literature not
included in the Codification is superseded and deemed non-authoritative.
SFAS 168 will be effective for the Company’s financial statements for
periods ending after September 15, 2009. SFAS 168 is not expected have
a significant impact on the Company’s financial statements.





FSP EITF 03-6-1, “Determining
Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities.” FSP EITF 03-6-1 provides that
unvested share-based payment awards that contain nonforfeitable rights to
dividends or dividend equivalents (whether paid or unpaid) are participating
securities and shall be included in the computation of earnings per share
pursuant to the two-class method. FSP EITF 03-6-1 became effective on
January 1, 2009. Adoption of FSP EITF 03-6-1 did not have a significant
effect on the Company’s financial statements.





FSP SFAS 157-4, “Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly.” FSP SFAS 157-4 affirms that the objective of fair
value when the market for an asset is not active is the price that would be
received to sell the asset in an orderly transaction, and clarifies and includes
additional factors for determining whether there has been a significant decrease
in market activity for an asset when the market for that asset is not active.
FSP SFAS 157-4 requires an entity to base its conclusion about whether
a transaction was not orderly on the weight of the evidence.
FSP SFAS 157-4 also amended SFAS 157, “Fair Value Measurements,”
to expand certain disclosure requirements. The Company adopted the provisions of
FSP SFAS 157-4 during the second quarter of 2009. Adoption of
FSP SFAS 157-4 did not significantly impact the Company’s financial
statements.




16




FSP SFAS 115-2 and
SFAS 124-2, “Recognition and Presentation of Other-Than-Temporary
Impairments.” FSP SFAS 115-2 and SFAS 124-2 (i) changes
existing guidance for determining whether an impairment is other than temporary
to debt securities and (ii) replaces the existing requirement that the
entity’s management assert it has both the intent and ability to hold an
impaired security until recovery with a requirement that management assert:
(a) it does not have the intent to sell the security; and (b) it is
more likely than not it will not have to sell the security before recovery of
its cost basis. Under FSP SFAS 115-2 and SFAS 124-2, declines in
the fair value of held-to-maturity and available-for-sale securities below their
cost that are deemed to be other than temporary are reflected in earnings as
realized losses to the extent the impairment is related to credit losses. The
amount of the impairment related to other factors is recognized in other
comprehensive income. The Company adopted the provisions of
FSP SFAS 115-2 and SFAS 124-2 during the second quarter of 2009.
Adoption of FSP SFAS 115-2 and SFAS 124-2 did not significantly impact
the Company’s financial statements.





FSP SFAS 107-1 and APB 28-1,
“Interim Disclosures about Fair Value of Financial Instruments.”
FSP SFAS 107-1 and APB 28-1 amends SFAS 107, “Disclosures about Fair
Value of Financial Instruments,” to require an entity to provide disclosures
about the fair value of financial instruments in interim financial information
and amends Accounting Principles Board (APB) Opinion No. 28,
“Interim Financial Reporting,” to require those disclosures in summarized
financial information at interim reporting periods. The new interim disclosures
required by FSP SFAS 107-1 and APB 28-1 are included in
Note   - Fair Value Measurements.





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.





June 30, 2009
                
                
                December 31, 2008Estimated
                
                
                
                .
                
                
                EstimatedCarrying
                
                
                Fair
                
                
                Carrying
                
                
                FairAmount
                
                
                Value
                
                
                Amount
                
                
                ValueAssets:Cash
      and cash equivalents
                
                $
                27,375,840
                
                
                $
                27,375,840
                
                
                $
                14,474,532
                
                
                $
                14,474,532Investment
      securities and stock in FHLB and FRB
                
                
                134,578,610
                
                
                
                130,719,277
                
                
                
                129,038,699
                
                
                
                123,655,310Loans
      receivable, net
                
                
                585,730,382
                
                
                
                592,241,613
                
                
                
                542,977,138
                
                
                
                585,899,804Liabilities:Savings,
      NOW, and money market accounts
                
                
                237,100,127
                
                
                
                237,100,127
                
                
                
                205,126,970
                
                
                
                205,483,312Time
      certificates
                
                
                355,215,059
                
                
                
                358,747,103
                
                
                
                320,040,596
                
                
                
                324,199,698Long-term
      debt and other borrowed funds
                
                
                101,333,739
                
                
                
                104,376,051
                
                
                
                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





At
December 31, 2008, the Company had outstanding loan commitments and standby
letters of credit of $84 million and $18 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.




17




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.





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 June 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.




18




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 the Southern Maryland area 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.




19




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 moved up for much of 2006 and 2007, hitting a
multi-year peak on June 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 .25% in December 2008.





SELECTED FINANCIAL DATAThree Months Ended
                          
                          
                          Six Months EndedJune 30,
                          
                          
                          June 30,2009
                          
                          
                          2008
                          
                          
                          2009
                          
                          
                          2008Condensed
      Income StatementInterest
      Income
                          
                          $
                          9,350,365
                          
                          
                          $
                          9,219,271
                          
                          
                          $
                          18,553,441
                          
                          
                          $
                          18,727,054Interest
      Expense
                          
                          
                          4,180,031
                          
                          
                          
                          4,400,886
                          
                          
                          
                          8,440,102
                          
                          
                          
                          9,052,375Net
      Interest Income
                          
                          
                          5,170,334
                          
                          
                          
                          4,818,385
                          
                          
                          
                          10,113,339
                          
                          
                          
                          9,674,679Provision
      (Credit) for Loan Losses
                          
                          
                          929,488
                          
                          
                          
                          (5,479
                          )
                          
                          
                          1,462,373
                          
                          
                          
                          154,745Noninterest
      Income
                          
                          
                          781,771
                          
                          
                          
                          758,588
                          
                          
                          
                          1,368,228
                          
                          
                          
                          1,346,039Noninterest
      Expense
                          
                          
                          4,278,673
                          
                          
                          
                          3,794,220
                          
                          
                          
                          8,092,835
                          
                          
                          
                          7,145,763Income
      Before Income Taxes
                          
                          
                          743,944
                          
                          
                          
                          1,788,232
                          
                          
                          
                          1,926,359
                          
                          
                          
                          3,720,210Income
      Taxes
                          
                          
                          221,730
                          
                          
                          
                          661,698
                          
                          
                          
                          634,305
                          
                          
                          
                          1,277,435Net
      Income
                          
                          
                          522,214
                          
                          
                          
                          1,126,534
                          
                          
                          
                          1,292,054
                          
                          
                          
                          2,442,775Per
      Common Share:Basic
      Earnings
                          
                          $
                          0.10
                          
                          
                          $
                          0.38
                          
                          
                          $
                          0.29
                          
                          
                          $
                          0.83Diluted
      Earnings
                          
                          $
                          0.10
                          
                          
                          $
                          0.37
                          
                          
                          $
                          0.29
                          
                          
                          $
                          0.79Book
      Value
                          
                          $
                          17.09
                          
                          
                          $
                          16.90
                          
                          
                          $
                          17.09
                          
                          
                          $
                          16.90





RESULTS
OF OPERATIONS – SIX MONTHS ENDED JUNE 30, 2009




Net
income for the six-month period ended June 30, 2009 totaled $1,292,054 ($0.29
basic and diluted earnings per common share) compared to $2,442,775 ($0.83 basic
and $0.79 diluted earnings per common share) for the same period in the prior
year.  This decrease of $1,150,721, or 47.11%, 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.




20




Six Months EndedJune 30,2009
                                            
                                            
                                            2008
                                            
                                            
                                            $ Change
                                            
                                            
                                            %ChangeInterest
      income
                                            
                                            $
                                            18,553,441
                                            
                                            
                                            $
                                            18,727,054
                                            
                                            
                                            
                                            (173,613
                                            )
                                            
                                            
                                            (0.93
                                            )%Interest
      expense
                                            
                                            
                                            8,440,102
                                            
                                            
                                            
                                            9,052,375
                                            
                                            
                                            
                                            (612,273
                                            )
                                            
                                            
                                            (6.76
                                            )%Net
      interest income
                                            
                                            
                                            10,113,339
                                            
                                            
                                            
                                            9,674,679
                                            
                                            
                                            
                                            438,660
                                            
                                            
                                            
                                            4.53
                                            %Provision
      for loan losses
                                            
                                            
                                            1,462,373
                                            
                                            
                                            
                                            154,745
                                            
                                            
                                            
                                            1,307,628
                                            
                                            
                                            
                                            845.02
                                            %





For the
six-month period ended June 30, 2009, interest income decreased by $173,613, or
0.93%, to $18,553,441. The decrease was due to lower rates earned on interest
earning assets partially offset by higher average asset balances in the current
period.  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 to $8,440,102 in the six-month period ended June 30, 2009 as
compared to $9,052,375 in the same period in the prior year, a decrease of
$612,273, or 6.76%.  The decrease was the 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 effect of
the changes in interest income and expense was to increase the amount of net
interest income by $438,660 or 4.53%.





The
provision for loan losses increased to $1,462,373 for the six months ended June
30, 2009 from $154,475 for the six-month period ended June 30,
2008.  The increase in the loan provision was due to increases in the
Company’s delinquencies and non-accrual loans, loan growth, allowance factors
for the calculation of the provision and a change in projected losses due to the
economic environment.  The Bank’s net charge-offs of loans increased
by $192,065 from $34,933 for the six months ended June 30, 2008 to $226,998 for
the six months ended June 30, 2009.  The Bank experienced an increase
in non-accrual loans from $4,936,000 at December 31, 2008 to $13,478,732 at June
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.





Six Months Ended June 30,2009
                            
                            
                            2008
                            
                            
                            $Change
                            
                            
                            %ChangeNONINTEREST
      INCOME:Loan
      appraisal, credit, and miscellaneous charges
                            
                            $
                            360,892
                            
                            
                            $
                            234,551
                            
                            
                            $
                            126,341
                            
                            
                            
                            53.87
                            %Gain
      on sale of loans held for sale
                            
                            
                            168,374
                            
                            
                            
                            -
                            
                            
                            
                            168,374
                            
                            
                            
                            -Gain
      on asset sale
                            
                            
                            -
                            
                            
                            
                            2,041
                            
                            
                            
                            (2,041
                            )
                            
                            
                            -Income
      from bank owned life insurance
                            
                            
                            201,473
                            
                            
                            
                            286,489
                            
                            
                            
                            (85,016
                            )
                            
                            
                            (29.68
                            )%Loss
      on sale of investment securities
                            
                            
                            (12,863
                            )
                            
                            
                            -
                            
                            
                            
                            (12,863
                            )
                            
                            
                            -Recognition
      of other than temporarydecline
      in value of investment securities
                            
                            
                            (118,744
                            )
                            
                            
                            -
                            
                            
                            
                            (118,744
                            )
                            
                            
                            -Service
      charges
                            
                            
                            769,096
                            
                            
                            
                            822,958
                            
                            
                            
                            (53,862
                            )
                            
                            
                            (6.54
                            )%Total
      noninterest income
                            
                            $
                            1,368,228
                            
                            
                            $
                            1,346,039
                            
                            
                            $
                            22,189
                            
                            
                            
                            1.65
                            %





Loan
appraisal, credit, and miscellaneous charges increased as loan volume
increased.  The Bank sold $14,565,839 of longer-term, fixed rate
mortgage loans in the first six 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.




21




Six Months Ended June 30,2009
                                
                                
                                2008
                                
                                
                                $ Change
                                
                                
                                %ChangeNONINTEREST
      EXPENSE:Salary
      and employee benefits
                                
                                $
                                4,251,834
                                
                                
                                $
                                4,122,015
                                
                                
                                $
                                129,819
                                
                                
                                
                                3.15
                                %Occupancy
                                
                                
                                870,748
                                
                                
                                
                                797,629
                                
                                
                                
                                73,119
                                
                                
                                
                                9.17
                                %Advertising
                                
                                
                                229,962
                                
                                
                                
                                271,372
                                
                                
                                
                                (41,410
                                )
                                
                                
                                (15.26
                                )%Data
      processing
                                
                                
                                436,620
                                
                                
                                
                                260,991
                                
                                
                                
                                175,629
                                
                                
                                
                                67.29
                                %Legal
      and professional fees
                                
                                
                                359,908
                                
                                
                                
                                338,476
                                
                                
                                
                                21,432
                                
                                
                                
                                6.33
                                %Depreciation
      of furniture, fixtures,and
      equipment
                                
                                
                                299,105
                                
                                
                                
                                271,280
                                
                                
                                
                                27,825
                                
                                
                                
                                10.26
                                %Telephone
      communications
                                
                                
                                68,173
                                
                                
                                
                                42,477
                                
                                
                                
                                25,696
                                
                                
                                
                                60.49
                                %Office
      supplies
                                
                                
                                87,385
                                
                                
                                
                                74,475
                                
                                
                                
                                12,910
                                
                                
                                
                                17.33
                                %FDIC
      Insurance
                                
                                
                                633,611
                                
                                
                                
                                124,254
                                
                                
                                
                                509,357
                                
                                
                                
                                409.93
                                %Other
                                
                                
                                855,489
                                
                                
                                
                                842,794
                                
                                
                                
                                12,695
                                
                                
                                
                                1.51
                                %Total
      noninterest expenses
                                
                                $
                                8,092,835
                                
                                
                                $
                                7,145,763
                                
                                
                                $
                                947,072
                                
                                
                                
                                13.25
                                %





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 quarter of 2009 than in the
same period 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. Legal and professional fees
increased due to the increase in regulatory issues including the Company’s
participation in the CPP program. 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 $634,305, or 32.93%, of pretax income, in the first two
quarters of 2009, from $1,277,435, or 34.34%, of pretax income, in the prior
year. The lower effective tax rate in the current year was caused by an increase
in the relative effect of the Company’s tax exempt income in 2009.





RESULTS
OF OPERATIONS – THREE MONTHS ENDED JUNE 30, 2009





Net
income for the three-month period ended June 30, 2009 totaled $552,214 ($0.10
basic and $0.10 diluted earnings per common share), compared to $1,126,534
($0.38 basic and $0.37 diluted earnings per common share) for the same period in
the prior year.  This decrease of $604,320, or 53.64%, was caused by
an increase in noninterest expense and provision for loan loss partially offset
by higher net interest income and noninterest income and a decrease in income
tax expense.





Three Months EndedJune 30,2009
                                              
                                              
                                              2008
                                              
                                              
                                              $ Change
                                              
                                              
                                              %ChangeInterest
      income
                                              
                                              $
                                              9,350,365
                                              
                                              
                                              $
                                              9,219,271
                                              
                                              
                                              
                                              131,094
                                              
                                              
                                              
                                              1.42
                                              %Interest
      expense
                                              
                                              
                                              4,180,031
                                              
                                              
                                              
                                              4,400,886
                                              
                                              
                                              
                                              (220,855
                                              )
                                              
                                              
                                              (5.02
                                              )%Net
      interest income
                                              
                                              
                                              5,170,334
                                              
                                              
                                              
                                              4,818,385
                                              
                                              
                                              
                                              351,949
                                              
                                              
                                              
                                              7.30
                                              %Provision
      (reversal) for loan losses
                                              
                                              
                                              929,488
                                              
                                              
                                              
                                              (5,479
                                              )
                                              
                                              
                                              (934,967
                                              )
                                              
                                              
                                              (17,064.56
                                              )%




22




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. As noted above, increases in the provision for
loan losses were due to loan growth and economic conditions as well as changes
in the circumstances of particular loans, increases in the level of
delinquencies, and increases in 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 EndedJune 30,2009
                  
                  
                  2008
                  
                  
                  $ Change
                  
                  
                  % ChangeNONINTEREST
      INCOME:Loan
      appraisal, credit, and miscellaneous charges
                  
                  $
                  245,214
                  
                  
                  $
                  124,288
                  
                  
                  $
                  120,926
                  
                  
                  
                  97.29
                  %Gain
      on sale of loans held for sale
                  
                  
                  168,374
                  
                  
                  
                  -
                  
                  
                  
                  168,374
                  
                  
                  
                  -Income
      from bank owned life insurance
                  
                  
                  100,216
                  
                  
                  
                  189,271
                  
                  
                  
                  (89,055
                  )
                  
                  
                  (47.05
                  )%Loss
      on sale of investment securities
                  
                  
                  (12,863
                  )
                  
                  
                  -
                  
                  
                  
                  (12,863
                  )
                  
                  
                  -Recognition
      of other than temporary decline in valueof
      investment securities
                  
                  
                  (118,744
                  )
                  
                  
                  -
                  
                  
                  
                  (118,744
                  )
                  
                  
                  -Service
      charges
                  
                  
                  399,574
                  
                  
                  
                  45,029
                  
                  
                  
                  (45,455
                  )
                  
                  
                  (10.21
                  )%Total
      noninterest income
                  
                  $
                  781,771
                  
                  
                  $
                  758,588
                  
                  
                  $
                  23,183
                  
                  
                  
                  3.06
                  %





Loan
appraisal, credit, and miscellaneous charges increased due to increased loan
closings and additional fees charged. Gain on sale of loans held for sale
increased due to the sales of $14,565,839 in fixed-rate longer-term
one-to-four-family loans made in 2009. Income from bank owned life insurance was
affected in 2008 by a one-time gain which was not repeated in 2009. Loss on the
sale of securities reflected the sale of $73,200 of securities in 2009. As noted
above, the recognition of other than temporary decline in value of investment
securities related to the investment in Silverton Bank, N.A.  Service
charges decreased as the Bank experienced a drop in check volume, which reduced
the amounts of overdraft fee income earned. The drop in check volume was
partially offset by increases in certain monthly service charges.





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





Three Months EndedJune 30,2009
                  
                  
                  2008
                  
                  
                  $ Change
                  
                  
                  % ChangeNONINTEREST
      EXPENSE:Salary
      and employee benefits
                  
                  $
                  2,101,058
                  
                  
                  $
                  2,111,805
                  
                  
                  $
                  (10,747
                  )
                  
                  
                  (0.51
                  )%Occupancy
                  
                  
                  466,221
                  
                  
                  
                  434,453
                  
                  
                  
                  31,768
                  
                  
                  
                  7.31
                  %Advertising
                  
                  
                  99,850
                  
                  
                  
                  100,929
                  
                  
                  
                  (1,079
                  )
                  
                  
                  (1.07
                  )%Data
      processing
                  
                  
                  210,445
                  
                  
                  
                  215,101
                  
                  
                  
                  (4,656
                  )
                  
                  
                  (2.16
                  )%Legal
      and professional fees
                  
                  
                  202,299
                  
                  
                  
                  224,309
                  
                  
                  
                  (22,010
                  )
                  
                  
                  (9.81
                  )%Depreciation
      of furniture, fixtures, and equipment
                  
                  
                  150,963
                  
                  
                  
                  138,878
                  
                  
                  
                  12,085
                  
                  
                  
                  8.70
                  %Telephone
      communications
                  
                  
                  34,898
                  
                  
                  
                  18,846
                  
                  
                  
                  16,052
                  
                  
                  
                  85.17
                  %Office
      supplies
                  
                  
                  37,673
                  
                  
                  
                  34,991
                  
                  
                  
                  2,682
                  
                  
                  
                  7.66
                  %FDIC
      Insurance
                  
                  
                  543,947
                  
                  
                  
                  70,769
                  
                  
                  
                  473,178
                  
                  
                  
                  668.62
                  %Other
                  
                  
                  431,319
                  
                  
                  
                  444,139
                  
                  
                  
                  (12,820
                  )
                  
                  
                  (2.89
                  )%Total
      noninterest expense
                  
                  $
                  4,278,673
                  
                  
                  $
                  3,794,220
                  
                  
                  $
                  484,453
                  
                  
                  
                  12.77
                  %





Occupancy
expense increased due to the new branch which opened in
2008.  Telephone communications expense increased as the Bank used
additional services to facilitate data transmission in 2009.  As noted
above, the FDIC insurance expense reflects a one-time assessment of $343,600 in
the current quarter as well as the usage of credits to decrease expense and
$129,624 attributable to increase in assessment rate in 2008. Other expenses
decreased due to a decrease in certain costs including printing, seminars and
meetings.  Income tax expenses decreased due to the decrease in pretax
income and an increase in the amount of tax exempt income at the state and
federal levels.




23




FINANCIAL
CONDITION





Assets


June 30, 2009
                          
                          
                          December 31, 2008
                          
                          
                          $ Change
                          
                          
                          % ChangeCash
      and due from banks
                          
                          $
                          22,193,413
                          
                          
                          $
                          5,071,614
                          
                          
                          $
                          17,121,799
                          
                          
                          
                          337.60
                          %Federal
      Funds sold
                          
                          
                          3,485,055
                          
                          
                          
                          989,754
                          
                          
                          
                          2,495,301
                          
                          
                          
                          252.11
                          %Interest-bearing
      deposits with banks
                          
                          
                          1,697,372
                          
                          
                          
                          8,413,164
                          
                          
                          
                          (6,715,792
                          )
                          
                          
                          (79.82
                          )%Securities
      available for sale, at fair value
                          
                          
                          23,889,888
                          
                          
                          
                          14,221,674
                          
                          
                          
                          9,668,214
                          
                          
                          
                          67.98
                          %Securities
      held to maturity, at amortized cost
                          
                          
                          104,553,145
                          
                          
                          
                          108,712,281
                          
                          
                          
                          (4,159,136
                          )
                          
                          
                          (3.83
                          )%Federal
      Home Loan Bank andFederal
      Reserve Bank stock - at cost
                          
                          
                          6,472,300
                          
                          
                          
                          6,453,000
                          
                          
                          
                          19,300
                          
                          
                          
                          0.30
                          %Loans
      held for sale
                          
                          
                          2,058,951
                          
                          
                          
                          -
                          
                          
                          
                          2,058,951
                          
                          
                          
                          -Loans
      receivable - net of allowance for loanlosses
      of $6,381,048  and $5,145,673, respectively
                          
                          
                          583,671,431
                          
                          
                          
                          542,977,138
                          
                          
                          
                          40,694,293
                          
                          
                          
                          7.49
                          %Premises
      and equipment, net
                          
                          
                          12,433,413
                          
                          
                          
                          12,235,999
                          
                          
                          
                          197,414
                          
                          
                          
                          1.61
                          %Accrued
      interest receivable
                          
                          
                          2,887,865
                          
                          
                          
                          2,965,813
                          
                          
                          
                          (77,948
                          )
                          
                          
                          (2.63
                          )%Investment
      in bank owned life insurance
                          
                          
                          10,727,759
                          
                          
                          
                          10,526,286
                          
                          
                          
                          201,473
                          
                          
                          
                          1.91
                          %Other
      assets
                          
                          
                          4,313,181
                          
                          
                          
                          4,118,187
                          
                          
                          
                          194,994
                          
                          
                          
                          4.73
                          %$
                          778,383,773
                          
                          
                          $
                          716,684,910
                          
                          
                          $
                          61,698,863
                          
                          
                          
                          8.61
                          %





The
Company increased its most liquid assets which are cash and due from banks,
federal funds sold, and interest- bearing deposits with banks to have more
liquidity on hand.  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. 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 held for
sale will be reduced by future sales to investors with servicing rights retained
by the Bank.  The loan portfolio increased as a result of increases in
commercial real estate loans, residential first mortgage loans, residential
construction loans, and commercial lines of credit. These increases were
partially offset by decreases in consumer, second mortgage, and commercial
equipment loans.





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





June 30, 2009
                        
                        
                        
                        
                        
                        December 31, 2008Amount
                        
                        
                        %
                        
                        
                        Amount
                        
                        
                        %Real
      Estate LoansCommercial
                        
                        $
                        262,992,395
                        
                        
                        
                        44.55
                        %
                        
                        $
                        236,409,990
                        
                        
                        
                        43.11
                        %Residential
      first mortgages
                        
                        
                        111,531,210
                        
                        
                        
                        18.88
                        %
                        
                        
                        104,607,136
                        
                        
                        
                        19.07
                        %Residential
      construction
                        
                        
                        62,414,106
                        
                        
                        
                        10.57
                        %
                        
                        
                        57,564,710
                        
                        
                        
                        10.50
                        %Second
      mortgage loans
                        
                        
                        24,973,595
                        
                        
                        
                        4.23
                        %
                        
                        
                        25,412,415
                        
                        
                        
                        4.63
                        %Commercial
      lines of credit
                        
                        
                        106,767,151
                        
                        
                        
                        18.09
                        %
                        
                        
                        101,935,520
                        
                        
                        
                        18.59
                        %Consumer
      loans
                        
                        
                        1,571,942
                        
                        
                        
                        0.27
                        %
                        
                        
                        2,045,838
                        
                        
                        
                        0.37
                        %Commercial
      equipment
                        
                        
                        20,102,215
                        
                        
                        
                        3.41
                        %
                        
                        
                        20,458,092
                        
                        
                        
                        3.73
                        %590,502,614
                        
                        
                        
                        100.00
                        %
                        
                        
                        548,433,701
                        
                        
                        
                        100.00
                        %Less:Deferred
      loan fees
                        
                        
                        300,135
                        
                        
                        
                        0.05
                        %
                        
                        
                        310,890
                        
                        
                        
                        0.06
                        %Allowance
      for loan loss
                        
                        
                        6,381,048
                        
                        
                        
                        1.08
                        %
                        
                        
                        5,145,673
                        
                        
                        
                        0.94
                        %6,681,183
                        
                        
                        
                        
                        
                        
                        
                        5,456,563$
                        583,821,431
                        
                        
                        
                        
                        
                        
                        $
                        542,977,138




24







At June
30, 2009, the Bank’s allowance for loan losses totaled $6,381,048, or 1.08% 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.





Six
      Months Ended
                    
                    
                    Six
      Months EndedJune 30, 2009
                    
                    
                    June 30, 2008Beginning
      Balance
                    
                    $
                    5,145,673
                    
                    
                    $
                    4,482,483Charge
      Offs
                    
                    
                    226,998
                    
                    
                    
                    36,400Recoveries
                    
                    
                    -
                    
                    
                    
                    1,467Net
      Charge Offs
                    
                    
                    226,998
                    
                    
                    
                    34,933Additions
      Charged to Operations
                    
                    
                    1,462,373
                    
                    
                    
                    154,745Balance
      at the end of the Period
                    
                    $
                    6,381,048
                    
                    
                    $
                    4,602,295





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





Balances
      as of
                          
                          
                          Balances
      as ofJune
      30, 2009
                          
                          
                          December
      31, 2008Restructured
      Loans
                          
                          $
                          -
                          
                          
                          $
                          -Accruing
      loans which are contractuallypast
      due 90 days or more:
                          
                          $
                          -
                          
                          
                          $
                          -Loans
      accounted for on a nonaccrual basis
                          
                          $
                          13,478,732
                          
                          
                          $
                          4,936,000Total
      non-performing loans
                          
                          $
                          13,478,732
                          
                          
                          $
                          4,936,000Non-performing
      loans to total loans
                          
                          
                          2.28
                          %
                          
                          
                          0.90
                          %Allowance
      for loan losses to non performing loans
                          
                          
                          47.34
                          %
                          
                          
                          104.25
                          %





As of
June 30, 2009 and December 31, 2008, $13,478,732 and $1,520,100 in loans were
considered impaired under SFAS 114, respectively.





Liabilities:





June 30, 2009
                
                
                December 31, 2008
                
                
                $ Change
                
                
                % ChangeDepositsNon-interest-bearing
      deposits
                
                $
                67,088,136
                
                
                $
                50,642,273
                
                
                $
                16,445,863
                
                
                
                32.47
                %Interest-bearing
      deposits
                
                
                525,776,084
                
                
                
                474,525,293
                
                
                
                51,250,791
                
                
                
                10.80
                %Total
      deposits
                
                
                592,864,220
                
                
                
                525,167,566
                
                
                
                67,696,654
                
                
                
                12.89
                %Short-term
      borrowings
                
                
                641,990
                
                
                
                1,522,367
                
                
                
                (880,377
                )
                
                
                (57.83
                )%Long-term
      debt
                
                
                100,691,749
                
                
                
                104,963,428
                
                
                
                (4,271,679
                )
                
                
                (4.07
                )%Guaranteed
      preferred beneficial interest in junior subordinated
      debentures
                
                
                12,000,000
                
                
                
                12,000,000
                
                
                
                -
                
                
                
                0.00
                %Accrued
      expenses and other liabilities
                
                
                5,274,134
                
                
                
                5,917,130
                
                
                
                (642,996
                )
                
                
                (10.87
                )%Total
      Liabilities
                
                $
                711,472,093
                
                
                $
                649,570,491
                
                
                $
                61,901,602
                
                
                
                9.53
                %





Deposit
balances increased primarily in certificates of deposits 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 a maturing $5,000,000 advance 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 short-term debt.


25





Stockholders’
Equity





June 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
                    
                    
                    29,597
                    
                    
                    
                    29,478
                    
                    
                    
                    119
                    
                    
                    
                    0.40
                    %Additional
      paid in capital
                    
                    
                    16,588,665
                    
                    
                    
                    16,517,649
                    
                    
                    
                    71,016
                    
                    
                    
                    0.43
                    %Retained
      earnings
                    
                    
                    34,042,384
                    
                    
                    
                    34,280,719
                    
                    
                    
                    (238,335
                    )
                    
                    
                    (0.70
                    )%Accumulated
      other comprehensive gain
                    
                    
                    222,236
                    
                    
                    
                    229,848
                    
                    
                    
                    (7,612
                    )
                    
                    
                    (3.31
                    )%Unearned
      ESOP shares
                    
                    
                    (288,202
                    )
                    
                    
                    (260,275
                    )
                    
                    
                    (27,927
                    )
                    
                    
                    10.73
                    %Total
      Stockholders’ Equity
                    
                    $
                    66,911,680
                    
                    
                    $
                    67,114,419
                    
                    
                    $
                    (202,739
                    )
                    
                    
                    (0.30
                    )%





Common
stock and additional paid in capital increased due to the exercise of options.
Retained earnings decreased because of dividends on preferred and common stock
offset by earnings.  Book value per common share decreased from $17.23
per common share to $17.09 reflecting the total change in 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, the payment of interest and principal on debentures,
and the repurchase of common shares.  The Company's principal sources
of liquidity are cash on hand and dividends received from the Bank. The Bank is
subject to various regulatory restrictions on the payment of
dividends.





The
Bank’s principal sources of funds for investments and operations are net income,
deposits from its primary market area, principal and interest payments on loans,
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 June 30, 2009, the maximum available
under this line was $310,478,974, while outstanding advances totaled
$100,691,749. 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
June 30, 2009, the Bank had pledged collateral sufficient to draw an additional
$54,361,135 under the line for a total current possible outstanding of
$155,052,884.  The Bank also has collateral available, which is
currently unpledged, which would provide additional borrowing capacity of
$52,066,798 under this arrangement. In addition, the Bank has established, with
separate collateral, other lines of credit totaling $29,102,158.





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.


26


Cash,
cash equivalents, and interest-bearing deposits with banks as of June 30, 2009
totaled $27,375,840, an increase of $12,901,308, or 89.13%, from the December
31, 2008 total of $14,474,532.  This increase was due to an increase
in deposits offset by decreases in 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 six
months of 2009, all financing activities provided $61,057,417 in cash compared
to $44,586,196 for the same period in 2008. The increase in cash flows was
principally due to the growth of the net increase in deposits in 2009 compared
to the same period in 2008. This was partially offset by much smaller proceeds
from long-term borrowings compared to the prior year.  In the first
six months of 2009, the Company had a net increase in deposits of $67,696,654
compared to $19,386,640 for the same period in 2008.  In the first
quarter of 2008, the Company had net positive cash flows related to long-term
borrowings of $18,979,171, which was comprised of borrowings of $24,000,000
partially offset by payments of $5,020,829.  In the same period in
2009, the Company had net negative cash flows of $4,271,679 for long-term
borrowings, which was comprised of borrowings of $750,000 offset by payments of
$5,021,679.  Operating activities provided cash of $321,650 in the
first six months of 2009 compared to $1,929,655 provided in the same period of
2008. The change was caused primarily by the $16,624,790 of origination of loans
held for resale and decline in net income offset by $14,671,153 increase in
proceeds from sale of loans held for sale.





The
Bank’s principal use of cash has been in investments in loans, investment
securities and other assets.  During the six months ended June 30,
2009, the Bank invested a total of $48,477,759 compared to $49,254,449 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 also 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 June 30, 2009,
the Bank’s tangible, leverage and risk-based capital ratios were 10.19%, 12.62%
and 13.67%, 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 June 30, 2009, the Company’s tangible, leverage and
risk-based capital ratios were 10.41%, 12.86% and 13.91%,
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)
Statement on Financial Accounting Standards (“SFAS”) No. 5, “Accounting for
Contingencies,” which requires that losses be accrued when they are probable of
occurring and are estimable and (b) SFAS No. 114, “Accounting by Creditors for
Impairment of a Loan,” 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, or values observable in the secondary
markets.


27





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.





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 history
of write-offs and recoveries 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 by increasing or decreasing 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 SFAS
No. 5, “Accounting for Contingencies,” as well as SFAS No. 144 “Accounting for
the Impairment or Disposal 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.


28


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.





There
were no changes in the Company’s internal control over financial reporting
during the six months ended June 30, 2009 that have materially affected, or are
reasonable likely to materially affect, the Company’s internal control over
financial reporting.


29





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
      June 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





At the
Company’s Annual Meeting of Stockholders (the “Meeting”) held on May 11, 2009,
all the nominees for director proposed by the Company were
elected.  The votes cast for each nominee were as
follows:





For
                    
                    
                    Against
                    
                    
                    AbstainHerbert
      N. Redmond, Jr.
                    
                    
                    1,705,851
                    
                    
                    
                    91,038
                    
                    
                    
                    8,599Austin
      J. Slater, Jr.
                    
                    
                    1,758,331
                    
                    
                    
                    26,872
                    
                    
                    
                    20,285Joseph
      V. Stone, Jr.
                    
                    
                    1,774,699
                    
                    
                    
                    20,150
                    
                    
                    
                    10,639


30





Also at
the Meeting, the stockholders approved a non-binding advisory vote on executive
compensation.  The votes cast were as follows:


BrokerFor
                          
                          Against
                          
                          
                          Abstain
                          
                          
                          Non-Votes1,509,798
                          
                          
                          201,109
                          
                          
                          
                          94,581
                          
                          
                          
                          112,361





Also at
the Meeting, the stockholders ratified the appointment of Stegman & Company
as the independent registered public accounting firm for fiscal year ending
December 31, 2009.  The votes cast were as follows:





For
                          
                          Against
                          
                          
                          Abstain1,762,524
                          
                          
                          15,615
                          
                          
                          
                          7,566





Item 5 -
Other Information — None





Item 6 -
Exhibits





Exhibit 31 Rule 13a-14(a)
Certifications





Exhibit 32 Section 1350
Certifications


31





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:
      August 7, 2009
                  By:
                  /s/
      Michael L. MiddletonMichael
      L. Middleton, President, ChiefExecutive
      Officer and Chairman of theBoardDate:
      August 7, 2009
                  By:
                  /s/
      William J. PasenelliWilliam
      J. Pasenelli, Executive VicePresident
      and Chief Financial
Officer


32