UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q


(Mark
One)


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


OF
THE SECURITIES EXCHANGE ACT OF 1934





For the
Quarterly Period Ended September 30, 2010





OR





o           TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934





For the
transition period from     to  ______





Commission
File Number 0-18279





Tri-County Financial
Corporation


(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          Noo





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).


oYes      oNo





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  o
            Accelerated
      Filer  oNon-accelerated
      Filer  o
            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 o         No
x





As of
October 27, 2010, the registrant had 2,990,520 shares of common stock
outstanding.





TRI-COUNTY
FINANCIAL CORPORATION





FORM
10-Q





INDEX





PagePART
      I - FINANCIAL INFORMATIONItem
      1 – Financial Statements (Unaudited)Consolidated
      Balance Sheets – September 30, 2010and
      December 31, 2009
                            3Consolidated
      Statements of Income -Three
      and Nine Months Ended September 30, 2010 and 2009
                            4Consolidated
      Statements of Cash Flows -Nine
      Months Ended September 30, 2010 and 2009
                            6Notes
      to Consolidated Financial Statements
                            8Item
      2 – Management’s Discussion and Analysis of Financial
      Conditionand
      Results of Operations
                            20Item
      3 – Quantitative and Qualitative Disclosures about Market
    Risk
                            33Item
      4 – Controls and Procedures
                            33PART
      II - OTHER INFORMATIONItem
      1 – Legal Proceedings
                            34Item
      1A – Risk Factors
                            34Item
      2 – Unregistered Sales of Equity Securities and Use of
      Proceeds
                            34Item
      3 – Defaults Upon Senior Securities
                            34Item
      4 – [Removed and Reserved]
                            34Item
      5 – Other Information
                            34Item
      6 – Exhibits
                            34SIGNATURES
                            35


2


PART
I FINANCIAL STATEMENTS


ITEM
I. FINANCIAL STATEMENTS


TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
BALANCE SHEETS SEPTEMBER 30, 2010 AND DECEMBER 31, 2009 (UNAUDITED)





September 30, 2010
                
                
                December 31, 2009AssetsCash
      and due from banks
                
                $
                13,457,724
                
                
                $
                9,960,787Federal
      funds sold
                
                
                1,610,000
                
                
                
                695,000Interest-bearing
      deposits with banks
                
                
                2,331,653
                
                
                
                592,180Securities
      available for sale, at fair value
                
                
                40,349,413
                
                
                
                53,926,109Securities
      held to maturity, at amortized cost
                
                
                138,835,921
                
                
                
                90,287,803Federal
      Home Loan Bank and Federal Reserve Bank stock - at cost
                
                
                6,518,700
                
                
                
                6,935,500Loans
      receivable - net of allowance for loan losses of $8,168,158 and
      $7,471,314, respectively
                
                
                623,875,637
                
                
                
                616,592,976Premises
      and equipment, net
                
                
                12,184,353
                
                
                
                11,987,690Foreclosed
      real estate
                
                
                11,621,846
                
                
                
                922,934Accrued
      interest receivable
                
                
                2,929,221
                
                
                
                2,925,271Investment
      in bank owned life insurance
                
                
                17,280,529
                
                
                
                10,943,396Other
      assets
                
                
                9,536,980
                
                
                
                9,272,888Total
      Assets
                
                $
                880,531,977
                
                
                $
                815,042,534Liabilities
      and Stockholders' EquityLiabilitiesDepositsNon-interest-bearing
      deposits
                
                $
                68,234,357
                
                
                $
                70,001,444Interest-bearing
      deposits
                
                
                649,356,412
                
                
                
                570,417,345Total
      deposits
                
                
                717,590,769
                
                
                
                640,418,789Short-term
      borrowings
                
                
                3,783,207
                
                
                
                13,080,530Long-term
      debt
                
                
                70,635,612
                
                
                
                75,669,630Guaranteed
      preferred beneficial interest in junior subordinated
      debentures
                
                
                12,000,000
                
                
                
                12,000,000Accrued
      expenses and other liabilities
                
                
                6,168,792
                
                
                
                5,683,736Total
      Liabilities
                
                
                810,178,380
                
                
                
                746,852,685Stockholders'
      EquityFixed
      Rate Cumulative Perpetual Preferred Stock, Series A - par value $1,000;
      authorized 15,540; issued 15,540
                
                
                15,540,000
                
                
                
                15,540,000Fixed
      Rate Cumulative Perpetual Preferred Stock, Series B - par value $1,000;
      authorized 777; issued 777
                
                
                777,000
                
                
                
                777,000Common
      stock - par value $.01; authorized - 15,000,000 shares; issued 2,986,279
      and 2,976,046 shares, respectively
                
                
                29,863
                
                
                
                29,760Additional
      paid in capital
                
                
                16,842,139
                
                
                
                16,754,627Retained
      earnings
                
                
                36,962,411
                
                
                
                35,193,958Accumulated
      other comprehensive income
                
                
                637,212
                
                
                
                284,474Unearned
      ESOP shares
                
                
                (435,028
                )
                
                
                (389,970
                )Total
      Stockholders' Equity
                
                
                70,353,597
                
                
                
                68,189,849Total
      Liabilities and Stockholders' Equity
                
                $
                880,531,977
                
                
                $
                815,042,534





See
notes to consolidated financial statements


3





TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF INCOME (UNAUDITED)


THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009





Three Months Ended September 30,
                
                
                Nine Months Ended September 30,2010
                
                
                2009
                
                
                2010
                
                
                2009INTEREST
      AND DIVIDEND INCOME:Loans,
      including fees
                
                $
                8,669,783
                
                
                $
                8,324,971
                
                
                $
                26,157,242
                
                
                $
                24,243,433Taxable
      interest and dividends on investment securities
                
                
                1,128,613
                
                
                
                1,286,507
                
                
                
                3,491,626
                
                
                
                3,914,458Interest
      on deposits with banks
                
                
                7,089
                
                
                
                9,017
                
                
                
                13,236
                
                
                
                16,045Total
      interest and dividend income
                
                
                9,805,485
                
                
                
                9,620,495
                
                
                
                29,662,104
                
                
                
                28,173,936INTEREST
      EXPENSES:Deposits
                
                
                2,702,183
                
                
                
                3,076,512
                
                
                
                8,213,306
                
                
                
                9,375,353Short-term
      borrowings
                
                
                6,821
                
                
                
                -
                
                
                
                23,700
                
                
                
                29,800Long-term
      debt
                
                
                663,943
                
                
                
                1,001,507
                
                
                
                1,944,698
                
                
                
                3,112,968Total
      interest expenses
                
                
                3,372,947
                
                
                
                4,078,019
                
                
                
                10,181,704
                
                
                
                12,518,121NET
      INTEREST INCOME
                
                
                6,432,538
                
                
                
                5,542,476
                
                
                
                19,480,400
                
                
                
                15,655,815PROVISION
      FOR LOAN LOSSES
                
                
                1,121,203
                
                
                
                515,555
                
                
                
                2,784,007
                
                
                
                1,977,928NET
      INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
                
                
                5,311,335
                
                
                
                5,026,921
                
                
                
                16,696,393
                
                
                
                13,677,887


4





TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF INCOME (UNAUDITED)


THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009


(continued)
                    
                    Three Months Ended September
      30,
                    
                    
                    Nine Months Ended September
    30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009NONINTEREST
      INCOME:Recognition
      of other than temporary declinein
      value of investment securities
                    
                    $
                    -
                    
                    
                    $
                    (458,530
                    )
                    
                    $
                    -
                    
                    
                    $
                    (577,274
                    )Less:
      Portion recorded as comprehensive income
                    
                    
                    -
                    
                    
                    
                    410,530
                    
                    
                    
                    -
                    
                    
                    
                    410,530Impairment
      loss on investment securities, net
                    
                    
                    -
                    
                    
                    
                    (48,000
                    )
                    
                    
                    -
                    
                    
                    
                    (166,744
                    )Loan
      appraisal, credit, and miscellaneous charges
                    
                    
                    182,321
                    
                    
                    
                    104,219
                    
                    
                    
                    436,121
                    
                    
                    
                    465,111Gain
      on sale of asset
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    22,500
                    
                    
                    
                    -Loss
      on sale of investment securities
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (12,863
                    )Income
      from bank owned life insurance
                    
                    
                    126,219
                    
                    
                    
                    96,105
                    
                    
                    
                    337,133
                    
                    
                    
                    297,578Service
      charges
                    
                    
                    471,277
                    
                    
                    
                    443,161
                    
                    
                    
                    1,317,932
                    
                    
                    
                    1,212,257Gain
      on sale of loans held for sale
                    
                    
                    214,942
                    
                    
                    
                    72,862
                    
                    
                    
                    386,642
                    
                    
                    
                    241,236Total
      noninterest income
                    
                    
                    994,759
                    
                    
                    
                    668,347
                    
                    
                    
                    2,500,328
                    
                    
                    
                    2,036,575NONINTEREST
      EXPENSE:Salary
      and employee benefits
                    
                    
                    2,450,743
                    
                    
                    
                    2,284,641
                    
                    
                    
                    7,212,098
                    
                    
                    
                    6,536,475Occupancy
      expense
                    
                    
                    403,892
                    
                    
                    
                    399,648
                    
                    
                    
                    1,297,934
                    
                    
                    
                    1,270,396Advertising
                    
                    
                    104,010
                    
                    
                    
                    144,854
                    
                    
                    
                    282,612
                    
                    
                    
                    374,816Data
      processing
                    
                    
                    269,500
                    
                    
                    
                    245,974
                    
                    
                    
                    764,317
                    
                    
                    
                    682,594Professional
      fees
                    
                    
                    143,839
                    
                    
                    
                    166,110
                    
                    
                    
                    588,072
                    
                    
                    
                    526,018Depreciation
      of furniture, fixtures, and equipment
                    
                    
                    138,729
                    
                    
                    
                    154,777
                    
                    
                    
                    400,672
                    
                    
                    
                    453,882Telephone
      communications
                    
                    
                    46,973
                    
                    
                    
                    33,698
                    
                    
                    
                    129,201
                    
                    
                    
                    101,871Office
      supplies
                    
                    
                    41,343
                    
                    
                    
                    37,076
                    
                    
                    
                    120,779
                    
                    
                    
                    124,461FDIC
      Insurance
                    
                    
                    318,762
                    
                    
                    
                    242,332
                    
                    
                    
                    1,065,527
                    
                    
                    
                    875,943Valuation
      allowance on foreclosed real estate
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    287,934
                    
                    
                    
                    -Other
                    
                    
                    519,634
                    
                    
                    
                    557,942
                    
                    
                    
                    1,426,321
                    
                    
                    
                    1,413,431Total
      noninterest expense
                    
                    
                    4,437,425
                    
                    
                    
                    4,267,052
                    
                    
                    
                    13,575,467
                    
                    
                    
                    12,359,887INCOME
      BEFORE INCOME TAXES
                    
                    
                    1,868,669
                    
                    
                    
                    1,428,216
                    
                    
                    
                    5,621,254
                    
                    
                    
                    3,354,575Income
      tax expense
                    
                    
                    669,335
                    
                    
                    
                    560,640
                    
                    
                    
                    2,021,412
                    
                    
                    
                    1,194,945NET
      INCOME
                    
                    
                    1,199,334
                    
                    
                    
                    867,576
                    
                    
                    
                    3,599,842
                    
                    
                    
                    2,159,630Preferred
      stock dividends
                    
                    
                    211,733
                    
                    
                    
                    211,733
                    
                    
                    
                    635,198
                    
                    
                    
                    635,198NET
      INCOME AVAILABLE TO COMMON SHAREHOLDERS
                    
                    $
                    987,601
                    
                    
                    $
                    655,843
                    
                    
                    $
                    2,964,644
                    
                    
                    $
                    1,524,432INCOME
      PER COMMON SHAREBasic
                    
                    $
                    0.33
                    
                    
                    $
                    0.22
                    
                    
                    $
                    0.99
                    
                    
                    $
                    0.52Diluted
                    
                    $
                    0.33
                    
                    
                    $
                    0.22
                    
                    
                    $
                    0.99
                    
                    
                    $
                    0.51Dividends
      paid per common share
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    0.40
                    
                    
                    $
                    0.40





See notes
to consolidated financial statements


5




TRI-COUNTY
FINANCIAL CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)


NINE
MONTHS ENDED SEPTEMBER 30, 2010 AND 2009





Nine Months Ended September
    30,2010
                        
                        
                        2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                        
                        $
                        3,599,842
                        
                        
                        $
                        2,159,630Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                        
                        
                        2,784,007
                        
                        
                        
                        1,977,928Depreciation
      and amortization
                        
                        
                        775,545
                        
                        
                        
                        875,337Loans
      originated for resale
                        
                        
                        (10,464,412
                        )
                        
                        
                        (19,238,916
                        )Proceeds
      from sale of loans originated for sale
                        
                        
                        10,799,746
                        
                        
                        
                        18,412,708Gain
      on sale of loans held for sale
                        
                        
                        (386,642
                        )
                        
                        
                        (241,236
                        )Gain
      on sale of asset
                        
                        
                        (22,500
                        )
                        
                        
                        -Loss
      on sales of investment securities
                        
                        
                        -
                        
                        
                        
                        12,863Other
      than temporary decline in market value of investment
      securities
                        
                        
                        -
                        
                        
                        
                        166,744Net
      amortization of premium/discount on investment securities
                        
                        
                        (223,610
                        )
                        
                        
                        (134,621
                        )Increase
      in foreclosed real estate valuation allowance
                        
                        
                        287,934
                        
                        
                        
                        -Increase
      in cash surrender of bank owned life insurance
                        
                        
                        (6,337,133
                        )
                        
                        
                        (297,578
                        )Deferred
      income tax benefit
                        
                        
                        (816,555
                        )
                        
                        
                        (1,266,083
                        )(Increase)
      decrease in accrued interest receivable
                        
                        
                        (3,950
                        )
                        
                        
                        7,054(Increase)
      decrease in deferred loan fees
                        
                        
                        (16,236
                        )
                        
                        
                        349Increase
      (decrease) in accounts payable, accrued expenses, other
      liabilities
                        
                        
                        485,056
                        
                        
                        
                        (360,108
                        )Decrease
      in other assets
                        
                        
                        82,815
                        
                        
                        
                        347,374Net
      cash provided by operating activities
                        
                        
                        543,907
                        
                        
                        
                        2,421,445CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of investment securities available for sale
                        
                        
                        (98,504
                        )
                        
                        
                        (35,245,124
                        )Proceeds
      from redemption or principal payments of investment securities available
      for sale
                        
                        
                        14,401,001
                        
                        
                        
                        2,117,244Purchase
      of investment securities held to maturity
                        
                        
                        (82,113,950
                        )
                        
                        
                        (8,377,442
                        )Proceeds
      from maturities or principal payments of investment securities held to
      maturity
                        
                        
                        33,598,091
                        
                        
                        
                        21,101,505Net
      decrease (increase) of FHLB and Federal Reserve stock
                        
                        
                        416,800
                        
                        
                        
                        (482,500
                        )Loans
      originated or acquired
                        
                        
                        (171,318,179
                        )
                        
                        
                        (190,835,961
                        )Principal
      collected on loans
                        
                        
                        150,620,143
                        
                        
                        
                        144,719,136Purchase
      of premises and equipment
                        
                        
                        (972,208
                        )
                        
                        
                        (828,397
                        )Proceeds
      from sale of assets
                        
                        
                        22,500
                        
                        
                        
                        -Net
      cash used in investing activities
                        
                        
                        (55,444,306
                        )
                        
                        
                        (67,831,539
                        )


6




TRI-COUNTY
      FINANCIAL CORPORATIONCONSOLIDATED
      STATEMENTS OF CASH FLOWS (UNAUDITED)NINE MONTHS ENDED SEPTEMBER 30,
      2010 AND 2009
                                (continued)Nine Months Ended September
    30,2010
                              
                              
                              2009CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      increase in deposits
                              
                              $
                              77,171,980
                              
                              
                              $
                              101,828,228Proceeds
      from long-term borrowings
                              
                              
                              -
                              
                              
                              
                              750,000Payments
      of long-term borrowings
                              
                              
                              (5,034,018
                              )
                              
                              
                              (20,032,683
                              )Net
      decrease in short-term borrowings
                              
                              
                              (9,297,323
                              )
                              
                              
                              (1,328,618
                              )Exercise
      of stock options
                              
                              
                              31,858
                              
                              
                              
                              162,143Excess
      tax benefits on stock-based compensation
                              
                              
                              -
                              
                              
                              
                              14,947Dividends
      paid
                              
                              
                              (1,831,387
                              )
                              
                              
                              (
      1,742,122
                              )Net
      change in unearned ESOP shares
                              
                              
                              10,699
                              
                              
                              
                              (44,183
                              )Net
      cash provided by financing activities
                              
                              
                              61,051,809
                              
                              
                              
                              79,607,712INCREASE
      IN CASH AND CASH EQUIVALENTS
                              
                              $
                              6,151,410
                              
                              
                              $
                              14,197,618CASH
      AND CASH EQUIVALENTS - JANUARY 1
                              
                              
                              11,247,967
                              
                              
                              
                              14,474,532CASH
      AND CASH EQUIVALENTS - SEPTEMBER 30
                              
                              $
                              17,399,377
                              
                              
                              $
                              28,672,150SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during the nine months for:Interest
                              
                              $
                              10,370,713
                              
                              
                              $
                              13,566,054Income
      taxes
                              
                              $
                              3,398,891
                              
                              
                              $
                              1,776,676Issuance
      of  common stock for payment of compensation
                              
                              $
                              -
                              
                              
                              $
                              99,980Transfer
      from loans to foreclosed real estate
                              
                              $
                              10,986,846
                              
                              
                              $
                              922,934See
      notes to consolidated financial statements


7


NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS
(UNAUDITED)


NINE MONTHS ENDED
      SEPTEMBER 30, 2010 AND 2009





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, 2009 have been derived
from audited financial statements.  There have been no significant
changes to the Company’s accounting policies as disclosed in the 2009 Annual
Report.  The results of operations for the three and nine months ended
September 30, 2010 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 2010 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, 2009.





2.
            NATURE
      OF BUSINESS


The
Company provides a variety of financial services to individuals and small
businesses through its offices in Southern Maryland. Its primary deposit
products are demand, savings, and time deposits, and its primary lending
products are residential and commercial mortgage loans, construction and land
development loans, and commercial loans.





3.
            FAIR
      VALUE MEASUREMENTS


The
Company adopted the Financial Accounting Standards Board’s (“FASB”) Accounting
Standard’s Codification (“ASC”) Topic 820, “Fair Value Measurements” and FASB
ASC Topic 825, “The Fair Value Option for Financial Assets and Financial
Liabilities” which provides a framework for measuring and disclosing fair value
under generally accepted accounting principles. FASB ASC Topic 820 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).




FASB ASC
Topic 820 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 at the measurement date. FASB ASC Topic 820 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.




Under
FASB ASC Topic 820, 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:




8




Level 1
inputs - Unadjusted quoted prices 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.




Transfers
between levels of the fair value hierarchy are recognized on the actual date of
the event or circumstances that caused the transfer, which generally coincides
with the Company’s monthly or quarterly valuation process.




There
were no transfers between levels of the fair value hierarchy and the Company had
no Level 3 fair value assets or liabilities for the nine months ended September
30, 2010 and 2009, respectively.




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




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 (‘GSEs”),
municipal bonds and corporate debt securities. Securities classified as Level 3
include asset-backed securities in less liquid markets.





Loans
Receivable


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. Management estimates the fair value of impaired loans
using one of several methods, including the collateral value, market value of
similar debt, enterprise value, liquidation value and discounted cash flows.
Impaired loans not requiring a specific allowance represent loans for which the
fair value of expected repayments or collateral exceed the recorded investment
in such loans. At September 30, 2010, substantially all of the impaired loans
were evaluated based upon the fair value of the collateral. In accordance with
FASB ASC 820, 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.





Loans
Held for Sale


Loans
originated and intended for sale in the secondary market are carried at the
lower of cost or estimated fair value, in the aggregate. Fair value is derived
from secondary market quotations for similar instruments. Net unrealized losses,
if any, are recognized through a valuation allowance by charges to
income.




Mortgage
loans held for sale are generally sold with the mortgage servicing rights
retained by the Company. The carrying value of mortgage loans sold is reduced by
the cost allocated to the associated servicing rights. Gains or losses on sales
of mortgage loans are recognized based on the difference between the selling
price and the carrying value of the related mortgage loans sold, using the
specific identification method.




9


Foreclosed
Real Estate


Foreclosed
real estate is adjusted for fair value upon transfer of the loans to foreclosed
real estate. Subsequently, foreclosed real estate is carried at the lower of
carrying value or fair value. Fair value is based upon independent market
prices, appraised value of the collateral or management’s estimation of the
value of the 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 as nonrecurring Level 3.





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


The table
below presents the recorded amount of assets and liabilities, as of September
30, 2010 measured at fair value on a recurring basis.





Fair Value MeasurementsAt September 30, 2010Using:Estimated 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 AssetSecurities available for sale:Asset-backed
      securities issued by GSEsCMOs
                    
                    $
                    32,506,872
                    
                    
                    $
                    -
                    
                    
                    $
                    32,506,872
                    
                    
                    $
                    -MBS
                    
                    
                    3,928,347
                    
                    
                    
                    -
                    
                    
                    
                    3,928,347
                    
                    
                    
                    -Corporate
      equity securities
                    
                    
                    37,357
                    
                    
                    
                    -
                    
                    
                    
                    37,357
                    
                    
                    
                    -Bond
      mutual funds
                    
                    
                    3,876,837
                    
                    
                    
                    -
                    
                    
                    
                    3,876,837
                    
                    
                    
                    -Total
      securities available for sale
                    
                    $
                    40,349,413
                    
                    
                    $
                    -
                    
                    
                    $
                    40,349,413
                    
                    
                    $
                    -


10


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


The
Company may be required from time to time, to measure certain assets at fair
value on a nonrecurring basis in accordance with U.S. generally accepted
accounting principles.  These include assets that are measured at the
lower of cost or market that were recognized at fair value below cost at the end
of the period.  Assets measured at fair value on a nonrecurring basis
as of September 30, 2010 are included in the table below:





Fair Value MeasurementsAt September 30, 2010Using:Estimated 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:Commercial
      real estate
                
                $
                3,833,919
                
                
                $
                -
                
                
                $
                3,833,919
                
                
                $
                -Residential
      construction
                
                
                1,084,857
                
                
                
                -
                
                
                
                1,084,857
                
                
                
                -Commercial
      lines of credit
                
                
                4,416,554
                
                
                
                -
                
                
                
                4,416,554
                
                
                
                -Total
      impaired loans
                
                $
                9,335,330
                
                
                $
                -
                
                
                $
                9,335,330
                
                
                $
                -Foreclosed
      Real Estate
                
                $
                11,621,846
                
                
                $
                -
                
                
                $
                11,621,846
                
                
                $
                -





4.
            INCOME
      TAXES


The
Company files a consolidated federal income tax return with its subsidiaries.
Deferred tax assets and liabilities are determined using the liability (or
balance sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary differences
between the book and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in tax rates and laws. It
is the Company’s policy to recognize accrued interest and penalties related to
unrecognized tax benefits as a component of tax expense.





5.
            EARNINGS
      PER COMMON SHARE


Basic
earnings per common share are computed by dividing net income less dividends on
preferred shares, by the weighted average number of common shares outstanding
during the period. Diluted earnings per share are computed by dividing net
income less dividends on preferred shares, by the weighted average number of
common shares outstanding during the period, including any potential dilutive
common shares outstanding, such as options and warrants. As of September 30,
2010 and 2009, there were 253,359 and 216,804 shares,
respectively, excluded from the diluted net income per share computation
because the exercise price of the stock options were greater than the market
price, and thus were anti-dilutive.  Basic and diluted earnings per
share have been computed based on weighted-average common and common equivalent
shares outstanding as follows:




Three Months Ended
                
                
                Nine Months EndedSeptember 30,
                
                
                September 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Net
      Income
                
                $
                1,199,334
                
                
                $
                867,576
                
                
                $
                3,599,842
                
                
                $
                2,159,630Less:
      Dividends payable on preferred stock
                
                
                (211,733
                )
                
                
                (211,733
                )
                
                
                (635,198
                )
                
                
                (635,198
                )Net
      income available to common shareholders
                
                $
                987,601
                
                
                $
                655,843
                
                
                $
                2,964,644
                
                
                $
                1,524,432Average
      number of common shares outstanding
                
                
                2,986,279
                
                
                
                2,965,332
                
                
                
                2,983,187
                
                
                
                2,958,336Effect
      of dilutive options
                
                
                19,892
                
                
                
                27,802
                
                
                
                19,431
                
                
                
                31,708Average
      number of shares used to calculate diluted earnings per
    share
                
                
                3,006,171
                
                
                
                2,993,134
                
                
                
                3,002,618
                
                
                
                2,990,044


11


6.
            COMPREHENSIVE
      INCOME


Comprehensive
income is net income adjusted for net unrealized holding gains or losses and
other than temporary impairment for the period.


Three Months Ended
                    September 30,
                  
                  
                  Nine Months Ended
                    September 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Net
      Income
                  
                  $
                  1,199,334
                  
                  
                  $
                  867,576
                  
                  
                  $
                  3,599,842
                  
                  
                  $
                  2,159,630Other
      comprehensive income net of tax:Other-than-
      temporary impairment on held to maturity securities
                  
                  
                  -
                  
                  
                  
                  (270,950
                  )
                  
                  
                  -
                  
                  
                  
                  (270,950
                  )Net
      unrealized holding gains arising during period
                  
                  
                  146,121
                  
                  
                  
                  100,808
                  
                  
                  
                  352,738
                  
                  
                  
                  93,196Comprehensive
      income
                  
                  $
                  1,345,455
                  
                  
                  $
                  697,434
                  
                  
                  $
                  3,952,580
                  
                  
                  $
                  1,981,876





7.
            STOCK-BASED
      COMPENSATION


The
Company has stock-based incentive compensation plans to attract and retain key
personnel in order to promote the success of the business.  These
plans are described in Note 13 to the consolidated financial statements included
in our Annual Report to Stockholders for the year ended December 31,
2009.   There was no stock-based compensation expense for the
nine months ended September 30, 2010 compared to $31,702 for the nine months
ended September 30, 2009. The Company and the Bank currently maintain incentive
plans which provide for payments to be made in cash, stock, or stock
options.  The Company has accrued the full amounts due under these
plans, but currently it is not possible to identify the portion that will be
paid out in the form of stock–based compensation because such payments are
subject to the future election of the recipient. A summary of the Company’s
stock option plans as of September 30, 2010 and changes during the nine-month
period then ended is presented below:





Weighted
                    
                    
                    
                    
                    
                    Weighted-AverageAverage
                    
                    
                    Aggregate
                    
                    
                    Contractual LifeExercise
                    
                    
                    Intrinsic
                    
                    
                    Remaining InShares
                    
                    
                    Price
                    
                    
                    Value
                    
                    
                    YearsOutstanding
      at December 31, 2009
                    
                    
                    329,243
                    
                    
                    $
                    16.04
                    
                    
                    $
                    222,607Granted
      at fair value
                    
                    
                    -
                    
                    
                    
                    -Exercised
                    
                    
                    (8,493
                    )
                    
                    
                    7.89
                    
                    
                    
                    38,331Expired
                    
                    
                    -
                    
                    
                    
                    -Forfeited
                    
                    
                    (1
                    )
                    
                    
                    7.90Outstanding
      at September 30, 2010
                    
                    
                    320,749
                    
                    
                    $
                    16.26
                    
                    
                    $
                    539,187
                    
                    
                    
                    1.6Exercisable
      at September 30, 2010
                    
                    
                    320,749
                    
                    
                    $
                    16.26
                    
                    
                    $
                    539,187
                    
                    
                    
                    1.6





The
following table summarizes restricted stock award activity for the Company under
the 2006 Equity Plan for the nine months ended September 30, 2010:


Number
                    of Shares
                  
                  
                  WeightedAverage Grant
                    Date Fair
                    ValueNonvested
      at January 1, 2010
                  
                  
                  5,360
                  
                  
                  $
                  11.90Granted
                  
                  
                  -
                  
                  
                  
                  -Vested
                  
                  
                  (2,640
                  )
                  
                  
                  11.90Cancelled
                  
                  
                  -
                  
                  
                  
                  -Nonvested
      at September 30, 2010
                  
                  
                  2,720
                  
                  
                  $
                  11.90


12


8.
            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
variable-rate capital in a private pooled transaction. The variable rate is
based on the 90-day LIBOR rate plus 1.70%. The Trust used the proceeds from this
issuance, along with the $155,000 for Capital Trust II’s common securities, to
purchase $5,155,000 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.





On July
22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business
trust formed, funded and wholly owned by the Company, issued $7,000,000 of
variable-rate capital securities in a private pooled transaction. The variable
rate is based on the 90-day LIBOR rate plus 2.60%. The Trust used the proceeds
from this issuance, along with the Company’s $217,000 capital contribution for
Capital Trust I’s common securities, to purchase $7,217,000 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 debentures 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.





9.
            PREFERRED
      STOCK


On
December 19, 2008, the United States Department of the Treasury (“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”) issued by 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
(defined below), 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 a warrant to purchase Fixed Rate Cumulative Perpetual Preferred Stock,
Series B Preferred Stock (“Series B Preferred Stock”) in the amount of 5% of the
Series A Preferred Stock or 777 shares with a par value of $777,000. The warrant
had an exercise price of $.01 per share. The Series B Preferred Stock has the
same rights, preferences and privileges as the Series A Preferred Stock except,
the Series B Preferred Stock has a dividend rate of 9%. This warrant was
immediately exercised.





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


13


10.
            SECURITIES





September 30, 2010Amortized
                
                
                GrossUnrealized
                
                
                GrossUnrealized
                
                
                EstimatedCost
                
                
                Gains
                
                
                Losses
                
                
                Fair
      ValueSecurities
      available for saleAsset-backed
      securities issued by GSEs
                
                $
                35,416,444
                
                
                $
                1,018,954
                
                
                $
                179
                
                
                $
                36,435,219Corporate
      equity securities
                
                
                37,310
                
                
                
                328
                
                
                
                281
                
                
                
                37,357Bond
      mutual funds
                
                
                3,666,553
                
                
                
                210,284
                
                
                
                -
                
                
                
                3,876,837Total
      securities available for sale
                
                $
                39,120,307
                
                
                $
                1,229,566
                
                
                $
                460
                
                
                $
                40,349,413Securities
      held to maturityAsset-backed
      securities issued by:GSEs
                
                $
                123,126,654
                
                
                $
                2,001,506
                
                
                $
                298,919
                
                
                $
                124,829,241Other
                
                
                14,954,177
                
                
                
                136,933
                
                
                
                2,000,906
                
                
                
                13,090,204Total
      debt securities held to maturity
                
                
                138,080,831
                
                
                
                2,138,439
                
                
                
                2,299,825
                
                
                
                137,919,445U.S.
      Government obligations
                
                
                754,003
                
                
                
                -
                
                
                
                -
                
                
                
                754,003Other
      investments
                
                
                1,087
                
                
                
                -
                
                
                
                -
                
                
                
                1,087Total
      securities held to maturity
                
                $
                138,835,921
                
                
                $
                2,138,439
                
                
                $
                2,299,825
                
                
                $
                138,674,535





December 31, 2009Amortized
                
                
                Gross
      Unrealized
                
                
                Gross
      Unrealized
                
                
                EstimatedCost
                
                
                Gains
                
                
                Losses
                
                
                Fair
      ValueSecurities
      available for saleAsset-backed
      securities issued by GSEs
                
                $
                49,617,856
                
                
                $
                646,198
                
                
                $
                30,628
                
                
                $
                50,233,426Corporate
      equity securities
                
                
                37,310
                
                
                
                1,416
                
                
                
                163
                
                
                
                38,563Bond
      mutual funds
                
                
                3,568,050
                
                
                
                86,070
                
                
                
                -
                
                
                
                3,654,120Total
      securities available for sale
                
                $
                53,223,216
                
                
                $
                733,684
                
                
                $
                30,791
                
                
                $
                53,926,109Securities
      held to maturityAsset-backed
      securities issued by:GSEs
                
                $
                71,276,709
                
                
                $
                1,689,252
                
                
                $
                137,919
                
                
                $
                72,828,042Other
                
                
                19,005,847
                
                
                
                12,088
                
                
                
                3,353,964
                
                
                
                15,663,971Total
      debt securities held to maturity
                
                
                90,282,556
                
                
                
                1,701,340
                
                
                
                3,491,883
                
                
                
                88,492,013U.S.
      Government obligations
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Other
      investments
                
                
                5,247
                
                
                
                -
                
                
                
                -
                
                
                
                5,247Total
      securities held to maturity
                
                $
                90,287,803
                
                
                $
                1,701,340
                
                
                $
                3,491,883
                
                
                $
                88,497,260





At
September 30, 2010, certain other securities with a carrying value of
$26,630,294 were pledged to secure certain deposits. At September 30, 2010,
securities with a carrying value of $33,888,256 were pledged as collateral for
advances from the Federal Home Loan Bank of Atlanta.


14


Gross
unrealized losses and estimated fair value by length of time that the individual
available for sale securities have been in a continuous unrealized loss position
at September 30, 2010 are as follows:





Less Than 12
                
                
                More Than 12Months
                
                
                Months
                
                
                TotalFair
                  Value
                
                
                Unrealized
                  Loss
                
                
                Fair
                  Value
                
                
                Unrealized
                  Loss
                
                
                Fair
                  Value
                
                
                Unrealized
                  LossAsset-backed
      securities issued by GSEs
                
                $
                1,522,997
                
                
                $
                179
                
                
                $
                -
                
                
                $
                -
                
                
                $
                1,522,997
                
                
                $
                179Corporate
      Equity Securities
                
                
                30
                
                
                
                281
                
                
                
                -
                
                
                
                -
                
                
                
                30
                
                
                
                281$
                1,523,027
                
                
                $
                460
                
                
                $
                -
                
                
                $
                -
                
                
                $
                1,523,027
                
                
                $
                460





The
available for sale investment portfolio has a fair value of $40,349,413 of which
$1,523,027 of the securities have some unrealized losses from their amortized
cost. Of these securities, $1,522,997 are mortgage-backed securities issued by
GSEs. 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.





Total
unrealized losses on these investments are small (less than 1%). We believe that
the losses in the equity securities are temporary. Persistent losses may require
a reevaluation of these losses. Because our intention is not to sell the
investments and it is not more likely than not that we will be required to sell
the investments before recovery of their amortized cost basis, which may be
maturity, management does not consider these investments to be
other-than-temporarily impaired at September 30, 2010.





Gross
unrealized losses and estimated fair value by length of time that the individual
held to maturity securities have been in a continuous unrealized loss position
at September 30, 2010 are as follows:





Less Than 12
                  
                  
                  More Than 12Months
                  
                  
                  Months
                  
                  
                  TotalFair
                    Value
                  
                  
                  Unrealized
                    Loss
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    Loss
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    LossAsset-backed
      securities issued by GSEs
                  
                  $
                  18,775,432
                  
                  
                  $
                  295,246
                  
                  
                  $
                  5,049,187
                  
                  
                  $
                  3,673
                  
                  
                  $
                  23,824,619
                  
                  
                  $
                  298,919Asset-backed
      securities issued by others
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  9,719,123
                  
                  
                  
                  2,000,906
                  
                  
                  
                  9,719,123
                  
                  
                  
                  2,000,906$
                  18,775,432
                  
                  
                  $
                  295,246
                  
                  
                  $
                  14,768,310
                  
                  
                  $
                  2,004,579
                  
                  
                  $
                  33,543,742
                  
                  
                  $
                  2,299,825





The held
to maturity investment portfolio has an estimated fair value of $138,674,535 of
which $33,543,742 or 24%, of the securities have unrealized losses from their
amortized cost. Of these securities, $23,824,619 or 71%, are mortgage-backed
securities issued by GSEs and the remaining $9,719,123 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. Because our intention is not to sell the investments
and it is not more likely than not that we will be required to sell the
investments before recovery of their amortized cost basis, which may be
maturity, management consider the unrealized losses in the held to maturity
portfolio to be temporary.





The
securities issued by GSEs are guaranteed by the issuer. The average unrealized
loss on GSE issued held to maturity securities is small (less than 1%). We
believe that the securities will either recover in market value or be paid off
as agreed.


15


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 of 2.3 years and
an average duration of 1.6 years.  Total unrealized losses are
$2,000,906 or 17%, of $11,720,028 amortized cost on the asset-backed securities
issued by others for securities with continuous unrealized losses. We believe
that the securities will either recover in market value or be paid off as
agreed.





The table
below presents the Standard & Poor’s credit rating of available for sale and
held to maturity asset-backed securities issued by GSEs and others at September
30, 2010:





Credit
      Rating
                    
                    AmountAAA
                    
                    $
                    165,791,830AA+
                    
                    
                    462,726AA-
                    
                    
                    2,207,432A-
                    
                    
                    1,183,040BBB+
                    
                    
                    104,761BBB-
                    
                    
                    888,230B+
                    
                    
                    665,222CCC+
                    
                    
                    3,212,809Total
                    
                    $
                    174,516,050





There
were no sales of available for sale securities during the nine-month period
ended September 30, 2010 compared to sales of $73,200 during the nine-month
period ended September 30, 2009. These sales resulted in a net loss of $12,863
for the nine-month period ended September 30, 2009. Asset-backed securities are
comprised of mortgage-backed securities as well as mortgage-derivative
securities such as collateralized mortgage obligations and real estate mortgage
investment conduits.





11.
            FORECLOSED
      REAL ESTATE


Foreclosed
assets are presented net of an allowance for losses. An analysis of the
allowance for losses on foreclosed assets is as follows.




Nine Months Ended September 30,2010
                      
                      
                      2009Balance
      at beginning of year
                      
                      $
                      922,934
                      
                      
                      $
                      -Additions
      to underlying property
                      
                      
                      10,986,846
                      
                      
                      
                      922,934Valuation
      allowance
                      
                      
                      (287,934
                      )
                      
                      
                      -Balance
      at end of period
                      
                      $
                      11,621,846
                      
                      
                      $
                      922,934





Expenses
applicable to foreclosed assets include the following.




Three Months Ended
                
                
                Nine Months EndedSeptember 30,
                
                
                September 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Valuation
      allowance
                
                $
                -
                
                
                $
                -
                
                
                $
                287,934
                
                
                $
                -Operating
      expenses
                
                
                51,461
                
                
                
                43,575
                
                
                
                101,389
                
                
                
                55,698$
                51,461
                
                
                $
                43,575
                
                
                $
                389,323
                
                
                $
                55,698


16


12.
            NEW
      ACCOUNTING STANDARDS


FASB ASC
TOPIC 310, “Receivables” - In April 2010, FASB issued ASU No.
2010-18, Effect of a Loan
Modification When the Loan is Part of a Pool That is Accounted for as a Single
Asset.Modifications of loans that are accounted for within a pool do not
result in the removal of those loans from the pool even if the modification of
those loans would otherwise be considered a troubled debt restructuring. ASU No.
2010-18 is effective for modifications of loans accounted for within pools for
the first interim or annual period ending on or after July 15, 2010 and are to
be applied prospectively although early application is permitted. The Company
adopted this guidance effective July 1, 2010, and adoption did not have an
impact on the Company’s consolidated financial position, results of operations
or cash flows.




ASU No.
2010-20 (ASC Topic 310): Disclosures about the Credit Quality
of Financing Receivables and the Allowance for Credit Losses.In July 2010, FASB
issued ASU No. 2010-20, Receivables (Topic 310):  Disclosures about
the Credit Quality of Financing Receivables and the Allowance for Credit Losses.
ASU 2010-20 requires that more information be disclosed about the credit quality
of a company’s loans and the allowance for loan losses held against those loans.
A company will need to disaggregate new and existing disclosure based on how it
develops its allowance for loan losses and how it manages credit exposures.
Existing disclosures to be presented on a disaggregated basis include a
roll-forward of the allowance for loan losses, the related recorded investment
in such loans, the nonaccrual status of loans, and impaired loans. Additional
disclosure is also required about the credit quality indicators of loans by
class at the end of the reporting period, the aging of past due loans,
information about troubled debt restructurings, and significant purchases and
sales of loans during the reporting period by class.ASU
2010-20 requires certain disclosures as of the end of a reporting period
effective for periods ending on or after December 15, 2010. Other required
disclosures about activity that occurs during a reporting period are effective
for periods beginning on or after December 15, 2010. The Company anticipates
that adoption of these additional disclosures will not have a material effect on
its financial position or results of operations.




FASB ASC
Topic 820, “Fair Value Measurements and Disclosures” defines fair value,
establishes a framework for measuring fair value in GAAP and expands disclosures
about fair value measurements. Additional guidance (ASU No. 2010-06)
issued  under ASC Topic 820  requires expanded disclosures
related to fair value measurements including (i) the amounts of significant
transfers of assets or liabilities between Levels 1 and 2 of the fair value
hierarchy and the reasons for the transfers, (ii) the reasons for transfers of
assets or liabilities in or out of Level 3 of the fair value hierarchy, with
significant transfers disclosed separately, (iii) the policy for determining
when transfers between levels of the fair value hierarchy are recognized and
(iv) for recurring fair value measurements of assets and liabilities in Level 3
of the fair value hierarchy, a gross presentation of information about
purchases, sales, issuances and settlements. ASU 2010-06 further clarifies that
(i) fair value measurement disclosures should be provided for each class of
assets and liabilities (rather than major category), which would generally be a
subset of assets or liabilities within a line item in the statement of financial
position and (ii) company’s should provide disclosures about the valuation
techniques and inputs used to measure fair value for both recurring and
nonrecurring fair value measurements for each class of assets and liabilities
included in Levels 2 and 3 of the fair value hierarchy. The disclosures related
to the gross presentation of purchases, sales, issuances and settlements of
assets and liabilities included in Level 3 of the fair value hierarchy will be
required for the Company beginning January 1, 2011. The remaining disclosure
requirements and clarifications made by ASU 2010-06 became effective for the
Company on January 1, 2010.




FASB ASC
TOPIC 860, “Transfers and Servicing” provides guidance that eliminates the
concept of a “qualifying special-purpose entity” from the original accounting
guidance and removes the exception from applying FASB guidance on consolidation
of variable interest entities, to qualifying special-purpose
entities.  This guidance is effective at the beginning of a reporting
entity’s first fiscal year that begins after November 15,
2009.  Adoption of this new guidance, effective January 1, 2010, did
not have a material impact on the Company’s consolidated financial
statements.




17


13.
            FAIR
      VALUE OF FINANCIAL INSTRUMENTS


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





September 30, 2010
                
                
                December 31, 2009Estimated
                
                
                
                
                
                EstimatedCarrying
                
                
                Fair
                
                
                Carrying
                
                
                FairAmount
                
                
                Value
                
                
                Amount
                
                
                ValueAssetsCash
      and cash equivalents
                
                $
                17,399,377
                
                
                $
                17,399,377
                
                
                $
                11,247,967
                
                
                $
                11,247,967Investment
      securities and stock in FHLB and FRB
                
                
                185,704,034
                
                
                
                185,544,946
                
                
                
                151,149,412
                
                
                
                148,049,000Loans
      receivable, net (including loans held for sale)
                
                
                623,875,637
                
                
                
                639,580,000
                
                
                
                616,592,976
                
                
                
                610,998,000Foreclosed
      real estate
                
                
                11,621,846
                
                
                
                11,621,846
                
                
                
                922,934
                
                
                
                922,934LiabilitiesSavings,
      NOW, and money market accounts
                
                
                276,373,479
                
                
                
                276,373,479
                
                
                
                259,160,873
                
                
                
                246,139,000Time
      certificates
                
                
                441,217,290
                
                
                
                449,260,000
                
                
                
                381,257,916
                
                
                
                384,848,000Long-term
      debt and other borrowed funds
                
                
                74,418,819
                
                
                
                73,812,000
                
                
                
                88,750,160
                
                
                
                83,381,000Guaranteed
      preferred beneficial interest in junior
                  subordinated
      securities
                
                
                12,000,000
                
                
                
                2,400,000
                
                
                
                12,000,000
                
                
                
                2,400,000





At
September 30, 2010, the Company had outstanding loan commitments and standby
letters of credit of $22.2 million and $23.8 million, respectively. Based on the
short-term lives of these instruments, the Company does not believe that the
fair value of these instruments differs significantly from their carrying
values.





Valuation
Methodology





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





Investment Securities- Fair
values are based on quoted market prices or dealer quotes. If a quoted market
price is not available, fair value is estimated using quoted market prices for
similar securities.  FHLB and FRB stock are carried and valued at
cost.





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.





Foreclosed Real Estate-Fair value is based upon
independent market prices, appraised value of the collateral or management’s
estimation of the value of the collateral.





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


18


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 September 30, 2010 and December 31, 2009. 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.


19


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, loan demand, 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, 2009 (the “Form 10-K”) and Part II of the Quarterly Report on Form
10-Q for the quarter ended June 30, 2010, under “Item 1A. Risk
Factors.”  Because of these uncertainties, there can be no assurance
that the 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, paying its subordinated debt and preferred stock
obligations, and directing the business of the Bank.  Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to the Bank and its subsidiaries.





The Bank
serves Southern Maryland through its main office and nine branches located in
Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, Prince
Frederick, Lusby, and California, Maryland.  The Bank is engaged in
the commercial and retail banking business as authorized by the banking statutes
of the State of Maryland and applicable Federal regulations.  The Bank
accepts deposits and uses these funds, along with funds generated from
operations and borrowings from the Federal Home Loan Bank (the “FHLB”), to fund
loan originations to individuals, associations, partnerships and corporations
and to invest in securities. The Bank makes real estate loans including
residential first and second mortgage loans, home equity lines of credit,
commercial mortgage loans, 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 and commercial real estate lending as well as the level
of transactional deposits.  Management recognizes that the shift in
composition of the Bank’s loan portfolio away from residential first mortgage
lending has and will continue 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 and 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, 2009.





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.


20




Interest
rates can directly influence the Bank’s funding costs and loan and investment
yields, and also act to increase or decrease general economic activity. The
federal funds target rate increased for much of 2006 and 2007, hitting a
multi-year peak on September 29, 2007 of 5.25%. Shortly afterwards, it became
clear that the U.S. economy suffered from an over-extension of credit in many
sectors. This realization led to a sudden, dramatic decline in the availability
of credit to many borrowers which deflated a housing price bubble and threatened
to create a credit crisis.  The Federal Reserve reacted by cutting the
Federal Funds rate by 50 basis points in September 2007.  Despite
further Federal Reserve rate cuts, the crisis in housing, which was once
confined to subprime mortgage loans continued to spread.  The U.S.
Treasury responded by injecting capital directly into banks by using the Capital
Purchase Program (“CPP”) of the Troubled Asset Repurchase Program
(“TARP”).  The Federal Reserve, Treasury, FDIC and other governmental
bodies chose to guarantee various forms of debt issuance to stave off a total
collapse of credit markets.  In addition, the U.S. government provided
cash and debt guarantees to many private companies.  In addition to
these policy moves, the Federal Reserve reduced the Federal Funds rate to a
range of 0% to 0.25% in December 2008. The Federal Funds rate remains at this
level as of September 30, 2010.





SELECTED
FINANCIAL DATA


Three Months Ended
                    
                    
                    Nine Months EndedSeptember 30,
                    
                    
                    September 30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Condensed
      Income StatementInterest
      and dividend income
                    
                    $
                    9,805,485
                    
                    
                    $
                    9,620,495
                    
                    
                    $
                    29,662,104
                    
                    
                    $
                    28,173,936Interest
      expense
                    
                    
                    3,372,947
                    
                    
                    
                    4,078,019
                    
                    
                    
                    10,181,704
                    
                    
                    
                    12,518,121Net
      interest income
                    
                    
                    6,432,538
                    
                    
                    
                    5,542,476
                    
                    
                    
                    19,480,400
                    
                    
                    
                    15,655,815Provision
      for loan loss
                    
                    
                    1,121,203
                    
                    
                    
                    515,555
                    
                    
                    
                    2,784,007
                    
                    
                    
                    1,977,928Noninterest
      income
                    
                    
                    994,759
                    
                    
                    
                    668,347
                    
                    
                    
                    2,500,328
                    
                    
                    
                    2,036,575Noninterest
      expense
                    
                    
                    4,437,425
                    
                    
                    
                    4,267,052
                    
                    
                    
                    13,575,467
                    
                    
                    
                    12,359,887Income
      before income taxes
                    
                    
                    1,868,669
                    
                    
                    
                    1,428,216
                    
                    
                    
                    5,621,254
                    
                    
                    
                    3,354,575Income
      taxes
                    
                    
                    669,335
                    
                    
                    
                    560,640
                    
                    
                    
                    2,021,412
                    
                    
                    
                    1,194,945Net
      income
                    
                    
                    1,199,334
                    
                    
                    
                    867,576
                    
                    
                    
                    3,599,842
                    
                    
                    
                    2,159,630Net
      income available to common shareholders
                    
                    
                    987,601
                    
                    
                    
                    655,843
                    
                    
                    
                    2,964,644
                    
                    
                    
                    1,524,432Per
      Common ShareBasic
      earnings
                    
                    $
                    0.33
                    
                    
                    $
                    0.22
                    
                    
                    $
                    0.99
                    
                    
                    $
                    0.52Diluted
      earnings
                    
                    $
                    0.33
                    
                    
                    $
                    0.22
                    
                    
                    $
                    0.99
                    
                    
                    $
                    0.51Book
      value
                    
                    $
                    18.09
                    
                    
                    $
                    17.24
                    
                    
                    $
                    18.09
                    
                    
                    $
                    17.24





RESULTS
OF OPERATIONS – NINE MONTHS ENDED SEPTEMBER 30, 2010





Net
income for the nine-month period ended September 30, 2010 totaled $3,599,842
($0.99 basic and diluted earnings per common share), compared to $2,159,630
($0.52 basic and $0.51 diluted earnings per common share) for the same period in
the prior year. Net income available to common shareholders for the nine-month
period ended September 30, 2010 totaled $2,964,644 compared to $1,524,432 for
the same period in the prior year.  The increase of $1,440,212, or
66.69% for net income or 94.48% for net income available to common shareholders,
was due to increases in net interest income of $3,824,585 and noninterest income
of $463,753 offset by increases in the provision for loan losses of $806,079,
noninterest expense of $1,215,580 and income taxes of $826,467.


21





Nine Months EndedSeptember 30,2010
                  
                  
                  2009
                  
                  
                  $ Change
                  
                  
                  % ChangeInterest
      and dividend income
                  
                  $
                  29,662,104
                  
                  
                  $
                  28,173,936
                  
                  
                  $
                  1,488,168
                  
                  
                  
                  5.28
                  %Interest
      expense
                  
                  
                  10,181,704
                  
                  
                  
                  12,518,121
                  
                  
                  
                  (2,336,417
                  )
                  
                  
                  (18.66
                  )%Net
      interest income
                  
                  
                  19,480,400
                  
                  
                  
                  15,655,815
                  
                  
                  
                  3,824,585
                  
                  
                  
                  24.43
                  %Provision
      for loan losses
                  
                  
                  2,784,007
                  
                  
                  
                  1,977,928
                  
                  
                  
                  806,079
                  
                  
                  
                  40.75
                  %





Interest
and dividend income increased due to higher average balances in loans and
investments, which were partially offset by lower interest rate yields on loans
and investments. The growth of the loan portfolio by 14.90% since January 1,
2009 has resulted in an increase in interest income, while the Company has
limited the effect of the lower interest rate environment on loan rates through
pricing. The yield on interest-earning assets for the nine months ended
September 30, 2010 was 5.12%, a decrease of 10 basis points since the first
quarter of 2010. The decrease was primarily due to lower yields on investments
as loan rates have marginally decreased from 5.72% to 5.71% since the first
quarter.





Interest
expense decreased due to lower interest rates paid on deposits and borrowings
partially offset by higher average balances of deposits. The Company has been
successful in increasing its core deposits and reducing its cost of funds in the
low interest-rate environment over the last year. The cost of interest-bearing
liabilities for the nine months ended September 30, 2010 was 1.97%, a decrease
of 9 basis points since the first quarter of 2010 and a 69 basis points decrease
from 2.66% for the nine months ended September 30, 2009. The Company’s net
interest margin increased to 3.36% for the nine months ended September 30, 2010
from 2.95% for the nine months ended September 30, 2009.





The
increase in the provision for loan losses was principally attributable to an
increase in net charge-offs.  Net charge-offs increased $1,755,470 up
from $331,693 for the nine months ended September 30, 2009 to $2,087,163 for the
nine months ended September 30, 2010. The Company’s allowance for loan losses
increased from 1.20% of loan balances at December 31, 2009 to 1.29% of loan
balances at September 30, 2010. The provision was adjusted for economic
conditions that affected the loss factors used to compute the allowance as well
as changes in the circumstances of specific impaired loans and increases in the
level of delinquencies, charge-offs and nonperforming loans.





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





Nine Months EndedSeptember 30,2010
                    
                    
                    2009
                    
                    
                    $ Change
                    
                    
                    % ChangeNONINTEREST
      INCOME:Recognition
      of other than temporary declinein
      value of investment securities
                    
                    $
                    -
                    
                    
                    $
                    (577,274
                    )
                    
                    $
                    577,274
                    
                    
                    
                    (100.00
                    )%Less:
      portion recorded as comprehensive income
                    
                    
                    -
                    
                    
                    
                    410,530
                    
                    
                    
                    (410,530
                    )
                    
                    
                    (100.00
                    )%Impairment
      loss on investment securities, net
                    
                    
                    -
                    
                    
                    
                    (166,744
                    )
                    
                    
                    166,744
                    
                    
                    
                    (100.00
                    )%Loan
      appraisal, credit, and miscellaneous charges
                    
                    
                    436,121
                    
                    
                    
                    465,111
                    
                    
                    
                    (28,990
                    )
                    
                    
                    (6.23
                    )%Gain
      on sale of asset
                    
                    
                    22,500
                    
                    
                    
                    -
                    
                    
                    
                    22,500
                    
                    
                    
                    n/aLoss
      on sale investment securities
                    
                    
                    -
                    
                    
                    
                    (12,863
                    )
                    
                    
                    12,863
                    
                    
                    
                    (100.00
                    )%Income
      from bank owned life insurance
                    
                    
                    337,133
                    
                    
                    
                    297,578
                    
                    
                    
                    39,555
                    
                    
                    
                    13.29
                    %Service
      charges
                    
                    
                    1,317,932
                    
                    
                    
                    1,212,257
                    
                    
                    
                    105,675
                    
                    
                    
                    8.72
                    %Gain
      on loans held for sale
                    
                    
                    386,642
                    
                    
                    
                    241,236
                    
                    
                    
                    145,406
                    
                    
                    
                    60.28
                    %Total
      noninterest income
                    
                    $
                    2,500,328
                    
                    
                    $
                    2,036,575
                    
                    
                    $
                    463,753
                    
                    
                    
                    22.77
                    %


22


Growth of
noninterest income was primarily due to increases in service charge income
related to the size and number of deposits and increases in per item charges on
certain transactions and gains on the sale of loans held for sale. Additionally,
noninterest income increased because the prior year noninterest income included
investment security impairment charges taken of $166,744 for the nine months
ended September 30, 2009 compared to no impairment charges for the nine months
ended September 30, 2010.





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





Nine Months Ended September 30,2010
                
                
                2009
                
                
                $ Change
                
                
                % ChangeNONINTEREST
      EXPENSE:Salary
      and employee benefits
                
                $
                7,212,098
                
                
                $
                6,536,475
                
                
                $
                675,623
                
                
                
                10.34
                %Occupancy
                
                
                1,297,934
                
                
                
                1,270,396
                
                
                
                27,538
                
                
                
                2.17
                %Advertising
                
                
                282,612
                
                
                
                374,816
                
                
                
                (92,204
                )
                
                
                (24.60
                )%Data
      processing
                
                
                764,317
                
                
                
                682,594
                
                
                
                81,723
                
                
                
                11.97
                %Professional
      fees
                
                
                588,072
                
                
                
                526,018
                
                
                
                62,054
                
                
                
                11.80
                %Depreciation
      of furniture, fixtures, and equipment
                
                
                400,672
                
                
                
                453,882
                
                
                
                (53,210
                )
                
                
                (11.72
                )%Telephone
      communications
                
                
                129,201
                
                
                
                101,871
                
                
                
                27,330
                
                
                
                26.83
                %Office
      supplies
                
                
                120,779
                
                
                
                124,461
                
                
                
                (3,682
                )
                
                
                (2.96
                )%FDIC
      Insurance
                
                
                1,065,527
                
                
                
                875,943
                
                
                
                189,584
                
                
                
                21.64
                %Valuation
      allowance on foreclosed real estate
                
                
                287,934
                
                
                
                -
                
                
                
                287,934
                
                
                
                n/aOther
                
                
                1,426,321
                
                
                
                1,413,431
                
                
                
                12,890
                
                
                
                0.91
                %Total
      noninterest expenses
                
                $
                13,575,467
                
                
                $
                12,359,887
                
                
                $
                1,215,580
                
                
                
                9.83
                %





The
Company’s noninterest expense increased by $1,215,580 or 9.83% from the
comparable period in the prior year primarily due to increased costs associated
with the asset growth of the Bank, the rising cost of regulatory compliance,
increased FDIC assessments and the valuation allowance on foreclosed real
estate. Salary and employee benefits expense increased as the Bank added
additional employees to support the Bank’s balance sheet growth. Advertising
expense decreased mainly due to marketing campaign expenses incurred in the
first quarter of 2009. Professional fees reflect the increased cost of
regulatory compliance. The FDIC levied a one-time special assessment of $343,600
during the three months ended June 30, 2009 and FDIC insurance assessment rates
increased during the second half of 2009.  Increased FDIC insurance
costs include an increased assessment base due to customer deposit increases of
$192.4 million since January 1, 2009 and $90.6 million since September 30, 2009.
Total foreclosed real estate expenses totaled $389,323, inclusive of a valuation
adjustment of $287,934 for the nine months ended September 30, 2010 compared to
$55,698 incurred in the comparable period of 2009.





The
Company recorded income tax expense of $2,021,412 or 36.0%, of pretax earnings
of $5,621,254 for the nine months ended September 30, 2010 compared with
$1,194,945 or 35.6%, of pretax earnings of $3,354,575 for the nine months ended
September 30, 2009. The increase in the effective tax rate was the result of tax
exempt income being relatively lower to total income in 2010.


23


RESULTS
OF OPERATIONS – THREE MONTHS ENDED SEPTMEBER 30, 2010





Net
income for the three-month period ended September 30, 2010 totaled $1,199,334
($0.33 basic and diluted earnings per common share), compared to $867,576 ($0.22
basic and diluted earnings per common share) for the same period in the prior
year. Net income available to common shareholders for the three-month period
ended September 30, 2010 totaled $987,601 compared to $655,843 for the same
period in the prior year.  The increase of $331,758, or 38.24%, for
net income or 50.58% for net income available to common shareholders, was due to
increases in net interest income of $890,062 and noninterest income of $326,412
offset by increases in the provision for loan losses of $605,648, noninterest
expense of $170,373 and income taxes of $108,695.





Three Months EndedSeptember 30,2010
                  
                  
                  2009
                  
                  
                  $ Change
                  
                  
                  % ChangeInterest
      and dividend income
                  
                  $
                  9,805,485
                  
                  
                  $
                  9,620,495
                  
                  
                  $
                  184,990
                  
                  
                  
                  1.92
                  %Interest
      expense
                  
                  
                  3,372,947
                  
                  
                  
                  4,078,019
                  
                  
                  
                  (705,072
                  )
                  
                  
                  (17.29
                  )%Net
      interest income
                  
                  
                  6,432,538
                  
                  
                  
                  5,542,476
                  
                  
                  
                  890,062
                  
                  
                  
                  16.06
                  %Provision
      for loan losses
                  
                  
                  1,121,203
                  
                  
                  
                  515,555
                  
                  
                  
                  605,648
                  
                  
                  
                  117.47
                  %





The
decrease in the Company’s cost of funds continues to be the key driver of
positive growth in the third quarter of 2010. Interest and dividend income
increased due to higher average balances in loans and investments, which were
partially offset by lower interest rate yields on loans and investments. The
year to date average size of the loan portfolio was $43.9 million more than the
nine months ended September 30, 2009 and resulted in an increase in interest
income. Interest expense decreased due to lower interest rates paid on deposits
and borrowings and a reduction in net borrowings offset by higher average
balances of deposits.





The
increase in the provision for loan losses was principally attributable to an
adjustment in the provision for economic conditions that affected the loss
factors used to compute the allowance as well as changes in the circumstances of
specific impaired loans, increases in the level of delinquencies, charge-offs
and nonperforming loans. Third quarter 2010 net charge-offs were $850,012
compared to $104,695 for the third quarter of 2009. As stated above, the
Company’s allowance for loan losses increased from 1.20% of loan balances at
December 31, 2009 to 1.29% of loan balances at September 30, 2010.





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





Three Months Ended September 30,2010
                    
                    
                    2009
                    
                    
                    $ Change
                    
                    
                    % ChangeNONINTEREST
      INCOME:Recognition
      of other than temporary declinein
      value of investment securities
                    
                    $
                    -
                    
                    
                    $
                    (458,530
                    )
                    
                    $
                    458,530
                    
                    
                    
                    (100.00
                    )%Less:
      Portion recorded as comprehensive income
                    
                    
                    -
                    
                    
                    
                    410,530
                    
                    
                    
                    (410,530
                    )
                    
                    
                    (100.00
                    )%Impairment
      loss on investment securities, net
                    
                    
                    -
                    
                    
                    
                    (48,000
                    )
                    
                    
                    48,000
                    
                    
                    
                    (100.00
                    )%Loan
      appraisal, credit, and miscellaneous charges
                    
                    
                    182,321
                    
                    
                    
                    104,219
                    
                    
                    
                    78,102
                    
                    
                    
                    74.94
                    %Income
      from bank owned life insurance
                    
                    
                    126,219
                    
                    
                    
                    96,105
                    
                    
                    
                    30,114
                    
                    
                    
                    31.33
                    %Service
      charges
                    
                    
                    471,277
                    
                    
                    
                    443,161
                    
                    
                    
                    28,116
                    
                    
                    
                    6.34
                    %Gain
      on loans held for sale
                    
                    
                    214,942
                    
                    
                    
                    72,862
                    
                    
                    
                    142,080
                    
                    
                    
                    95.00
                    %Total
      noninterest income
                    
                    $
                    994,759
                    
                    
                    $
                    668,347
                    
                    
                    $
                    326,412
                    
                    
                    
                    48.84
                    %





Noninterest
income increased as a result of increased gains on the sale of loans held for
sale and increased loan fees compared with the comparable period in 2009.
Additionally, noninterest income increased because the prior year noninterest
income included investment security impairment charges taken of $48,000 for the
three months ended September 30, 2009 compared to no impairment charges for the
three months ended September 30, 2010.


24





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


Three Months Ended September 30,2010
                
                
                2009
                
                
                $ Change
                
                
                % ChangeNONINTEREST
      EXPENSE:Salary
      and employee benefits
                
                $
                2,450,743
                
                
                $
                2,284,641
                
                
                $
                166,102
                
                
                
                7.27
                %Occupancy
                
                
                403,892
                
                
                
                399,648
                
                
                
                4,244
                
                
                
                1.06
                %Advertising
                
                
                104,010
                
                
                
                144,854
                
                
                
                (40,844
                )
                
                
                (28.20
                )%Data
      processing
                
                
                269,500
                
                
                
                245,974
                
                
                
                23,526
                
                
                
                9.56
                %Professional
      fees
                
                
                143,839
                
                
                
                166,110
                
                
                
                (22,271
                )
                
                
                (13.41
                )%Depreciation
      of furniture, fixtures, and equipment
                
                
                138,729
                
                
                
                154,777
                
                
                
                (16,048
                )
                
                
                (10.37
                )%Telephone
      communications
                
                
                46,973
                
                
                
                33,698
                
                
                
                13,275
                
                
                
                39.39
                %Office
      supplies
                
                
                41,343
                
                
                
                37,076
                
                
                
                4,267
                
                
                
                11.51
                %FDIC
      Insurance
                
                
                318,762
                
                
                
                242,332
                
                
                
                76,430
                
                
                
                31.54
                %Other
                
                
                519,634
                
                
                
                557,942
                
                
                
                (38,308
                )
                
                
                (6.87
                )%Total
      noninterest expense
                
                $
                4,437,425
                
                
                $
                4,267,052
                
                
                $
                170,373
                
                
                
                3.99
                %





The
Company’s noninterest expense increased from the comparable period in the prior
year primarily due to costs associated with the asset growth of the Bank and the
rising cost of regulatory compliance. Salary and employee benefits expense
increased as the Bank added additional employees to support the Bank’s balance
sheet growth. FDIC insurance expense increased due to higher average customer
deposits for the three months ended September 30, 2010 compared with the three
months ended September 30, 2009.  As noted above, FDIC insurance
assessment rates increased during the second half of 2009.





The
Company recorded income tax expense of $669,335 or 35.8%, of pretax earnings of
$1,868,669 for the three months ended September 30, 2010 compared with $560,640
or 39.3%, of pretax earnings of $1,428,216 for the three months ended September
30, 2009.





FINANCIAL
CONDITION


September 30, 2010
                
                
                December 31, 2009
                
                
                $ Change
                
                
                % ChangeAssetsCash
      and due from banks
                
                $
                13,457,724
                
                
                $
                9,960,787
                
                
                $
                3,496,937
                
                
                
                35.11
                %Federal
      funds sold
                
                
                1,610,000
                
                
                
                695,000
                
                
                
                915,000
                
                
                
                131.65
                %Interest-bearing
      deposits with banks
                
                
                2,331,653
                
                
                
                592,180
                
                
                
                1,739,473
                
                
                
                293.74
                %Securities
      available for sale, at fair value
                
                
                40,349,413
                
                
                
                53,926,109
                
                
                
                (13,576,696
                )
                
                
                (25.18
                )%Securities
      held to maturity, at amortized cost
                
                
                138,835,921
                
                
                
                90,287,803
                
                
                
                48,548,118
                
                
                
                53.77
                %Federal
      Home Loan Bank and Federal Reserve Bank stock - at cost
                
                
                6,518,700
                
                
                
                6,935,500
                
                
                
                (416,800
                )
                
                
                (6.01
                )%Loans
      receivable - net of allowance for loan losses of $8,168,158 and
      $7,471,314, respectively
                
                
                623,875,637
                
                
                
                616,592,976
                
                
                
                7,282,661
                
                
                
                1.18
                %Premises
      and equipment, net
                
                
                12,184,353
                
                
                
                11,987,690
                
                
                
                196,663
                
                
                
                1.64
                %Foreclosed
      real estate
                
                
                11,621,846
                
                
                
                922,934
                
                
                
                10,698,912
                
                
                
                1159.23
                %Accrued
      interest receivable
                
                
                2,929,221
                
                
                
                2,925,271
                
                
                
                3,950
                
                
                
                0.14
                %Investment
      in bank owned life insurance
                
                
                17,280,529
                
                
                
                10,943,396
                
                
                
                6,337,133
                
                
                
                57.91
                %Other
      assets
                
                
                9,536,980
                
                
                
                9,272,888
                
                
                
                264,092
                
                
                
                2.85
                %Total
      Assets
                
                $
                880,531,977
                
                
                $
                815,042,534
                
                
                $
                65,489,443
                
                
                
                8.04
                %


25





The
Company increased some of its most liquid assets with increases to federal funds
sold and interest-bearing deposits with banks. The securities available for sale
portfolio decreased due to the maturing of asset-backed securities issued by
government-sponsored entities. The securities held to maturity portfolio
increased due to additional purchases of securities offset by principal
paydowns, primarily of asset-backed securities issued by government-sponsored
entities. The differences in allocations between the different cash and
investment categories reflect operational needs.





The
increase in net loans outstanding was impacted by the resolution of five problem
loan relationships that transferred $11.0 million into foreclosed real estate.
Greater than 90% of the increase in foreclosed real estate represents two
construction and land development properties that were recorded at fair value
upon transfer of the loans to foreclosed real estate. Three properties represent
93% of the foreclosed real estate balance. Foreclosed real estate carrying
amounts reflect current appraisals and management’s conservative estimate of the
realizable value of these properties in a period of declining real estate
values.  Investments in bank owned life insurance increased based on
the business needs of the Company.





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





September 30, 2010
                  
                  
                  
                  
                  
                  December 31, 2009Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %Real
      Estate Loans:Commercial
                  
                  $
                  321,165,837
                  
                  
                  
                  50.74
                  %
                  
                  $
                  292,987,963
                  
                  
                  
                  46.88
                  %Residential
      first mortgages
                  
                  
                  125,111,308
                  
                  
                  
                  19.76
                  %
                  
                  
                  116,225,733
                  
                  
                  
                  18.59
                  %Construction
      and land development
                  
                  
                  40,816,321
                  
                  
                  
                  6.45
                  %
                  
                  
                  62,509,558
                  
                  
                  
                  10.00
                  %Home
      equity and second mortgage
                  
                  
                  25,107,923
                  
                  
                  
                  3.97
                  %
                  
                  
                  25,133,155
                  
                  
                  
                  4.02
                  %Commercial
      loans
                  
                  
                  100,436,884
                  
                  
                  
                  15.87
                  %
                  
                  
                  108,657,910
                  
                  
                  
                  17.38
                  %Consumer
      loans
                  
                  
                  1,394,072
                  
                  
                  
                  0.22
                  %
                  
                  
                  1,607,765
                  
                  
                  
                  0.26
                  %Commercial
      equipment
                  
                  
                  18,969,663
                  
                  
                  
                  3.00
                  %
                  
                  
                  17,916,655
                  
                  
                  
                  2.87
                  %633,002,008
                  
                  
                  
                  100.00
                  %
                  
                  
                  625,038,739
                  
                  
                  
                  100.00
                  %Less:Deferred
      loan fees, net
                  
                  
                  958,213
                  
                  
                  
                  0.15
                  %
                  
                  
                  974,449
                  
                  
                  
                  0.16
                  %Allowance
      for loan loss
                  
                  
                  8,168,158
                  
                  
                  
                  1.29
                  %
                  
                  
                  7,471,314
                  
                  
                  
                  1.20
                  %9,126,371
                  
                  
                  
                  
                  
                  
                  
                  8,445,763$
                  623,875,637
                  
                  
                  
                  
                  
                  
                  $
                  616,592,976





The loan
portfolio increased as a result of increases in commercial real estate loans,
residential first mortgage loans and commercial equipment loans. These increases
were partially offset by decreases in construction and land development loans,
commercial loans and consumer loans.





The
allowance for loan losses increased $696,844 to $8,168,158 or 1.29% of loan
balances at September 30, 2010 from $7,471,314 or 1.20% of loan balances at
December 31, 2009. Nonperforming loans as a percentage of total loans amounted
to 2.36% at September 30, 2010 compared to 3.09% at December 31, 2009.The Company had 36
nonperforming loans at September 30, 2010 of which 58% of nonperforming loan
balances were concentrated with three customers.The Company’s
nonperforming assets as a percentage of total assets, which includes
nonperforming loans and foreclosed real estate, increased from 2.48% at December
31, 2009 to 3.02% at September 30, 2010.The current
year increase in nonperforming assets was primarily due to two foreclosed
construction and land development properties that require court ratification
before the Company is able to pursue the next steps of resolution.





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, 2009.


26





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





Nine Months Ended
                  
                  
                  Nine Months EndedSeptember 30, 2010
                  
                  
                  September 30, 2009Beginning
      Balance
                  
                  $
                  7,471,314
                  
                  
                  $
                  5,145,673Add:Provision
      charged to operations
                  
                  
                  2,784,007
                  
                  
                  
                  1,977,928Recoveries
                  
                  
                  6,176
                  
                  
                  
                  100Less:Charge
      Offs
                  
                  
                  2,093,339
                  
                  
                  
                  331,793Balance
      at the end of the period
                  
                  $
                  8,168,158
                  
                  
                  $
                  6,791,908





The
Company incurred $2,093,339 in charge-offs for the nine months ended September
30, 2010, which represented a total of $75,000 of consumer loans and equity
lines, $63,000 of residential first mortgages, $1,173,000 for construction and
land development loans, $118,000 for commercial real estate loans, $453,000 for
commercial loans and $211,000 for commercial equipment loans.





The
following table provides information with respect to our nonperforming loans at
the dates indicated.





Balances as of
                      
                      
                      Balances as ofSeptember 30, 2010
                      
                      
                      December 31, 2009Troubled
      debt restructurings (TDRs)
                      
                      $
                      16,306,269
                      
                      
                      $
                      11,601,215Nonperforming loansImpaired
      loans on which recognition of interest has been
    discontinued
                      
                      $
                      5,690,917
                      
                      
                      $
                      8,947,173Loans
      on which recognition of interest has been discontinued
                      
                      
                      9,256,657
                      
                      
                      
                      10,340,310Total
      nonperforming loans
                      
                      $
                      14,947,574
                      
                      
                      $
                      19,287,483Impaired loansPerforming
      loans
                      
                      $
                      6,438,992
                      
                      
                      $
                      1,675,000Loans
      accounted for on a nonaccrual basis
                      
                      
                      5,690,917
                      
                      
                      
                      8,947,173Total
      impaired loans
                      
                      $
                      12,129,909
                      
                      
                      $
                      10,622,173Nonperforming
      loans to total loans
                      
                      
                      2.36
                      %
                      
                      
                      3.09
                      %Allowance
      for loan losses to nonperforming loans
                      
                      
                      54.65
                      %
                      
                      
                      38.74
                      %Nonperforming
      assets to total assets
                      
                      
                      3.02
                      %
                      
                      
                      2.48
                      %Nonperforming
      assets and TDRs to total assets
                      
                      
                      4.87
                      %
                      
                      
                      3.90
                      %


27


At
September 30, 2010 and December 31, 2009, impaired loans totaled $12,129,909 and
$10,622,173, respectively. Impaired loans include performing loans in the amount
of $6,438,992 at September 30, 2010 and $1,675,000 at December 31,
2009.  Impaired loans had specific allocations within the allowance
for loan losses or have been reduced by charge-offs to recoverable values.
Allocations of the allowance for loan losses relative to impaired loans at
September 30, 2010 and December 31, 2009 were $2,794,579 and $1,837,345,
respectively. Loans on which the recognition of interest has been discontinued,
which were not considered impaired under FASB ASC 820 amounted to $9,256,657 and
$10,340,310 at September 30, 2010 and December 31, 2009, respectively. At
September 30, 2010 98% of customer troubled debt restructures are
performing.





Nonperforming loans by loan typeSeptember 30, 2010
                
                
                December 31, 2009Dollars
                
                
                Number of Loans
                
                
                Dollars
                
                
                Number of LoansReal
      Estate Loans:Commercial
                
                $
                6,612,904
                
                
                
                10
                
                
                $
                6,366,672
                
                
                
                8Residential
      first mortgages
                
                
                1,742,358
                
                
                
                6
                
                
                
                338,806
                
                
                
                1Construction
      and land development
                
                
                2,320,258
                
                
                
                3
                
                
                
                9,504,414
                
                
                
                5Home
      equity and second mortgage
                
                
                168,868
                
                
                
                3
                
                
                
                -
                
                
                
                -Commercial
      loans
                
                
                4,098,456
                
                
                
                11
                
                
                
                2,192,308
                
                
                
                5Consumer
      loans
                
                
                4,730
                
                
                
                3
                
                
                
                22,884
                
                
                
                2Commercial
      equipment
                
                
                -
                
                
                
                -
                
                
                
                862,399
                
                
                
                3$
                14,947,574
                
                
                
                36
                
                
                $
                19,287,483
                
                
                
                24





As of
September 30, 2010, the largest dollar concentrations of nonperforming loans are
commercial real estate loans, which have been impacted by economic conditions in
our local market mainly due to higher than expected vacancies in commercial
office space. Delinquencies in residential first mortgages have increased
primarily due to specific customer issues with unemployment and other
circumstances requiring the liquidation of family
assets.  Nonperforming construction and land development loans
decreased $7,184,156 during the nine months ended September 30, 2010 as the
Company has resolved problem loans with foreclosures and workouts. Construction
and land development loans have been particularly affected by economic factors
which have slowed absorption of finished lots and homes.  The current
year increase of $1,906,148 for nonperforming commercial loans is primarily with
one borrower. Commercial equipment loans have primarily decreased due to a
charge-off of $468,000 and a loan restructure. Management continues to monitor
these loans and is working to resolve these loans in a manner that will preserve
the most value for the Company.





September 30, 2010
                  
                  
                  December 31, 2009
                  
                  
                  $ Change
                  
                  
                  % ChangeLiabilitiesDepositsNon-interest-bearing
      deposits
                  
                  $
                  68,234,357
                  
                  
                  $
                  70,001,444
                  
                  
                  $
                  (1,767,087
                  )
                  
                  
                  (2.52
                  )%Interest-bearing
      deposits
                  
                  
                  649,356,412
                  
                  
                  
                  570,417,345
                  
                  
                  
                  78,939,067
                  
                  
                  
                  13.84
                  %Total
      deposits
                  
                  
                  717,590,769
                  
                  
                  
                  640,418,789
                  
                  
                  
                  77,171,980
                  
                  
                  
                  12.05
                  %Short-term
      borrowings
                  
                  
                  3,783,207
                  
                  
                  
                  13,080,530
                  
                  
                  
                  (9,297,323
                  )
                  
                  
                  (71.08
                  )%Long-term
      debt
                  
                  
                  70,635,612
                  
                  
                  
                  75,669,630
                  
                  
                  
                  (5,034,018
                  )
                  
                  
                  (6.65
                  )%Guaranteed
      preferred beneficial interestin
      junior subordinated debentures
                  
                  
                  12,000,000
                  
                  
                  
                  12,000,000
                  
                  
                  
                  -
                  
                  
                  
                  0.00
                  %Accrued
      expenses and other liabilities
                  
                  
                  6,168,792
                  
                  
                  
                  5,683,736
                  
                  
                  
                  485,056
                  
                  
                  
                  8.53
                  %Total
      Liabilities
                  
                  $
                  810,178,380
                  
                  
                  $
                  746,852,685
                  
                  
                  $
                  63,325,695
                  
                  
                  
                  8.48
                  %





At
September 30, 2010, non-brokered deposits totaled $692,674,423 or 96.53% of
total deposits. The increases in total deposits are due to the Bank’s continuing
efforts to increase its market share through branch improvements and marketing
efforts. Long-term debt and short-term borrowings decreased by $14,331,341, or
16.15%, from $88,750,160 at December 31, 2009 to $74,418,819 at September 30,
2010, as growing retail deposits replaced debt. The increases in deposits were
used to increase the balances of cash and cash equivalents and investments, fund
net loan growth and reduce long and short-term debt.


28





September 30, 2010
                
                
                December 31, 2009
                
                
                $ Change
                
                
                % ChangeStockholders'
      EquityPerpetual
      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
                
                
                29,863
                
                
                
                29,760
                
                
                
                103
                
                
                
                0.35
                %Additional
      paid in capital
                
                
                16,842,139
                
                
                
                16,754,627
                
                
                
                87,512
                
                
                
                0.52
                %Retained
      earnings
                
                
                36,962,411
                
                
                
                35,193,958
                
                
                
                1,768,453
                
                
                
                5.02
                %Accumulated
      other comprehensive gain
                
                
                637,212
                
                
                
                284,474
                
                
                
                352,738
                
                
                
                124.00
                %Unearned
      ESOP shares
                
                
                (435,028
                )
                
                
                (389,970
                )
                
                
                (45,058
                )
                
                
                11.55
                %Total
      Stockholders' Equity
                
                $
                70,353,597
                
                
                $
                68,189,849
                
                
                $
                2,163,748
                
                
                
                3.17
                %





The
change in stockholders’ equity was primarily due to net income of $3,599,842
offset by the payment of preferred stock dividends of $635,198 and common stock
dividends of $1,196,188. Common stockholders' equity of $54,036,597 resulted in
a book value of $18.09 per common share at September 30, 2010, an increase of
$0.66 per share from December 31, 2009.





LIQUIDITY AND CAPITAL
RESOURCES





The
Company currently conducts no business other than holding the stock of the Bank
and paying interest on its subordinated debentures and preferred
stock.  Its primary uses of funds are for the payment of dividends on
common and preferred stock and the payment of interest and principal on
debentures.  The Company's principal sources of liquidity are cash on
hand and dividends received from the Bank. The Bank is subject to various
regulatory restrictions on the payment of dividends.





The
Bank’s principal sources of funds for investments and operations are net income,
deposits from its primary market area, principal and interest payments on loans,
proceeds from the sale of loans, advances and other borrowings, interest
received on investment securities and proceeds from the sale and maturity of
investment securities. Its principal funding commitments are 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, which are required to be
supported by certain eligible loans held by the Bank. Under the terms of an
Agreement for Advances and Security Agreement with Blanket Floating Lien (the
“Agreement”), the Company maintained eligible collateral consisting of
one-to-four family residential first mortgage loans equal to 100% of its total
outstanding long and short-term Federal Home Loan Bank advances. During 2003 and
2004, the Bank entered into addendums to the Agreement that expanded the types
of eligible collateral under the Agreement to include certain commercial real
estate and second mortgage loans. These loans are subject to eligibility rules,
and eligible collateral values of the unpaid loan principal balances are
established at 90% of residential first mortgages, at 50% for commercial real
estate and at 40% for second mortgage loans. In addition, only 50% of total
collateral for Federal Home Loan Bank advances may consist of commercial real
estate loans. Additionally, the Bank has pledged its Federal Home Loan Bank
stock of $5,400,800 and securities with a carrying value of $33,888,256 as
additional collateral for its advances at September 30, 2010.





The Bank
is limited to total advances of up to 40% of assets or $352,000,000. At
September 30, 2010, the Bank had filed collateral statements identifying
collateral sufficient to borrow $64,000,000 in addition to amounts already
outstanding. In addition, the Bank had additional collateral in safekeeping at
the Federal Home Loan Bank of Atlanta that had not been specifically pledged to
the Federal Home Loan Bank or for other purposes. This collateral was sufficient
to provide an additional $102,000,000 in borrowing capacity.  The Bank
also has established a short-term credit facility with the Federal Reserve Bank
of Richmond under its Borrower in Custody program. The Bank has segregated
collateral sufficient to draw $25,000,000 under this agreement. In addition, the
Bank has established short-term credit facilities with other commercial banks
totaling $7,000,000 at September 30, 2010. No amounts were outstanding under the
Borrower in Custody or short-term credit facilities at September 30,
2010.


29





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, anticipated future
deposit flows and loan funding needs.





Cash,
cash equivalents, and interest-bearing deposits with banks as of September 30,
2010 totaled $17,399,377, an increase of $6,151,410, or 54.69%, from the
December 31, 2009 total of $11,247,967.  The increase to cash was
primarily due to increases in deposits partially offset by funds used to pay
down short-term borrowings and long-term debt, investment activity that used
cash to purchase additional securities and net cash used for loan activities, as
net loans originated exceeded principal collected on loans.





The
Bank’s principal sources of cash flows are its financing activities including
deposits and borrowings.  During the first nine months of 2010, all
financing activities provided $61,051,809 in cash compared to $79,607,712 for
the same period in 2009. The decrease in cash provided of $18,555,903 or 23.31%,
was primarily due to a reduction in the net increase in deposits partially
offset  by a decrease in the use of cash to pay down short-term
borrowings and long-term debt. Net increases in deposits were reduced to
$77,171,980 for the nine months ended September 30, 2010 from $101,828,228 for
the same period in the prior year. The pay down of debt decreased to $14,331,341
for the nine months ended September 30, 2010 from $21,361,301 for the same
period in the prior year.





Operating
activities provided cash of $543,907 in the first nine months of 2010 compared
to $2,421,445 provided in the same period of 2009, a decrease in cash provided
of $1,877,538. The decrease in cash was primarily due to decreases to cash from
an increase in bank owned life insurance partially offset by increases in net
income and a decrease in the difference between loans originated for resale and
proceeds from the sale of loans.





The
Bank’s principal use of cash has been in investments in loans, investment
securities and other assets. Investing activities used cash of $55,444,306 in
the first nine months of 2010 compared to $67,831,539 of cash used in the same
period of 2009.  For the nine months ended September 30, 2010, the
primary causes for the cash used by investing activities were loan originations
exceeding principal repayments by $20,698,036 and net purchases from security
transactions of $34,213,362. For the nine months ended September 30, 2009, the
primary causes for the cash used were investments in loans exceeding principal
repayments on loans and net purchases from security
transactions.


30


REGULATORY
MATTERS





The Bank
is subject to Federal Reserve Board capital requirements as well as statutory
capital requirements imposed under Maryland law.  To be categorized as
well-capitalized, the Bank must maintain minimum total risk-based, Tier 1
risk-based and Tier 1 leverage ratios as set forth in the table. The Company’s
and the Bank’s actual capital amounts and ratios at September 30, 2010 are
presented in the following table.





Actual
                                  
                                  
                                  Required for Capital
                                    Adequacy Purposes
                                  
                                  
                                  To be Considered Well
                                    Capitalized Under
                                    Prompt
                                    Corrective Action(in thousands)At September 30, 2010Total
      Capital (to risk weighted assets)The
      Company
                                  
                                  $
                                  89,910
                                  
                                  
                                  
                                  13.17
                                  %
                                  
                                  $
                                  54,625
                                  
                                  
                                  
                                  8.00
                                  %The
      Bank
                                  
                                  $
                                  87,759
                                  
                                  
                                  
                                  12.89
                                  %
                                  
                                  $
                                  54,436
                                  
                                  
                                  
                                  8.00
                                  %
                                  
                                  $
                                  68,045
                                  
                                  
                                  
                                  10.00
                                  %Tier
      1 Capital (to risk weighted assets)The
      Company
                                  
                                  $
                                  81,717
                                  
                                  
                                  
                                  11.97
                                  %
                                  
                                  $
                                  27,313
                                  
                                  
                                  
                                  4.00
                                  %The
      Bank
                                  
                                  $
                                  79,566
                                  
                                  
                                  
                                  11.69
                                  %
                                  
                                  $
                                  27,218
                                  
                                  
                                  
                                  4.00
                                  %
                                  
                                  $
                                  40,827
                                  
                                  
                                  
                                  6.00
                                  %Tier
      1 Capital (to average assets)The
      Company
                                  
                                  $
                                  81,717
                                  
                                  
                                  
                                  9.56
                                  %
                                  
                                  $
                                  34,195
                                  
                                  
                                  
                                  4.00
                                  %The
      Bank
                                  
                                  $
                                  79,566
                                  
                                  
                                  
                                  9.33
                                  %
                                  
                                  $
                                  34,103
                                  
                                  
                                  
                                  4.00
                                  %
                                  
                                  $
                                  42,629
                                  
                                  
                                  
                                  5.00
                                  %





CRITICAL
ACCOUNTING POLICIES





Critical
accounting policies are defined as those that involve significant judgments and
uncertainties, and could potentially result in materially different results
under different assumptions and conditions. The Company considers its
determination of the allowance for loan losses, the valuation of foreclosed real
estate and the valuation of deferred tax assets to be 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 this 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.





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.


31


Other
Than Temporary Impairment of Securities


The
Company evaluates securities to determine whether a decline in their value is
other than temporary. The term “other than temporary” means the prospects for a
near term recovery of value are not favorable or there is limited market
information supporting the fair value of the securities at an amount greater or
equal to the carrying value of the investment. Management reviews the underlying
reasons for the decline and criteria such as the credit quality of the issuer
and the size and duration of the decline. When a decline in value is deemed to
be other than temporary, the value of the security is reduced and a charge to
earnings is recognized.





If
management concludes an unrealized loss is temporary and our intention is to
hold the investments until recovery of the amortized cost basis, which may be
maturity, no charge to earnings is recorded.





Allowance
for Loan Losses


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: (1)
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) Topic 450 “Contingencies,” which requires that losses be accrued when
they are probable of occurring and are estimable and (2) FASB ASC 310
“Receivables”, which requires that losses be accrued when it is probable that
the Company will not collect all principal and interest payments according to
the contractual terms of the loan. The loss, if any, is determined by the
difference between the loan balance and the value of collateral, the present
value of expected future cash flows and values observable in the secondary
markets.





The
allowance for loan loss 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. Management assesses the ability of the borrower to repay
the loan based upon all information available. Loans are examined to determine a
specific allowance based upon the borrower’s payment history, economic
conditions specific to the loan or borrower, and other factors that would impact
the borrower’s ability to repay the loan on its contractual
basis.  Depending on the assessment of the borrower’s ability to pay
and 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
historical loss experience (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 that are
increasing or decreasing in size.  Based upon these factors, 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 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 5 of the Consolidated Financial Statements as presented in the Company’s
Form 10-K for the year ended December 31, 2009.





Foreclosed
Real Estate


The
Company 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 FASB ASC 450 “Contingencies” as
well as the accounting guidance on impairment of long-lived assets. These
statements require that the Company establish a valuation allowance when it has
determined that the carrying amount of a foreclosed asset exceeds its fair
value.  Fair value of a foreclosed asset is measured by the cash flows
expected to be realized from its subsequent disposition.  These cash
flows should be reduced for the costs of selling or otherwise disposing of the
asset.


32





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.
For example, 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.





Deferred
Tax Assets


The
Company accounts for income taxes in accordance with FASB ASC 740, “Income
Taxes,” which requires that deferred tax assets and liabilities be recognized
using enacted tax rates for the effect of temporary differences between the book
and tax bases of recorded assets and liabilities. FASB ASC 740 requires that
deferred tax assets be reduced by a valuation allowance if it is more likely
than not that some portion or the entire deferred tax asset will not be
realized. At September 30, 2010, management determined that it is more likely
than not that the entire amount of such assets will be realized.





The
Company periodically evaluates the ability of the Company to realize the value
of its deferred tax asset.  If the Company were to determine that it
was not more likely than not that the Company would realize the full amount of
the deferred tax asset, it would establish a valuation allowance to reduce the
carrying value of the deferred tax asset to the amount it believes would be
realized.  The factors used to assess the likelihood of realization
are the Company’s forecast of future taxable income and available tax-planning
strategies that could be implemented to realize the net deferred tax
assets.





Failure
to achieve forecasted taxable income might affect the ultimate realization of
the net deferred tax assets.  Factors that may affect the Company’s
ability to achieve sufficient forecasted taxable income include, but are not
limited to, the following: increased competition, a decline in net interest
margin, a loss of demand for financial services and national and regional
economic conditions.





The
Company’s provision for income taxes and the determination of the resulting
deferred tax assets and liabilities involve a significant amount of management
judgment and are based on the best information available at the time. The
Company operates within federal and state taxing jurisdictions and is subject to
audit in these jurisdictions.





For
additional information regarding the deferred tax assets, refer to Note 11 in
the Consolidated Financial Statements as presented in the Company’s Form 10-K
for the year ended December 31, 2009.





ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET
RISK





Not
applicable as the Company is a smaller reporting company.





ITEM
4.  CONTROLS AND PROCEDURES





As of the
end of the period covered by this report, management of the Company carried out
an evaluation, under the supervision and with the participation of the Company’s
principal executive officer and principal financial officer, of the
effectiveness of the Company’s disclosure controls and procedures. Based on this
evaluation, the Company’s principal executive officer and principal financial
officer concluded that the Company’s disclosure controls and procedures are
effective in ensuring that information required to be disclosed by the Company
in reports that it files or submits under the Securities Exchange Act of 1934,
as amended, (1) is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission’s rules and forms
and (2) is accumulated and communicated to the Company’s management, including
its principal executive and financial officers as appropriate to allow timely
decisions regarding required disclosure. It should be noted that the design of
the Company’s disclosure controls and procedures is based in part upon certain
reasonable assumptions about the likelihood of future events, and there can be
no reasonable assurance that any design of disclosure controls and procedures
will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote, but the Company’s principal executive and
financial officers have concluded that the Company’s disclosure controls and
procedures are, in fact, effective at a reasonable assurance level.




There
were no changes in the Company’s internal control over financial reporting
during the three months ended September 30, 2010 that have materially affected,
or are reasonable likely to materially affect, the Company’s internal control
over financial reporting.


33


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 and Part II of the Quarterly Report on Form 10-Q for the quarter ended June
30, 2010, which could materially affect our business, financial condition or
future results.  The risks described in the Form 10-K and Form 10-Q
are not the only risks that we face.  Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, financial
condition and/or operating results.





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





(a)
            Not
      applicable





(b)
            Not
      applicable





(c)
            The
      Company did not repurchase any shares of common stock in the quarter ended
      September 30, 2010.  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 Relief 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 -
[Removed and Reserved]





Item 5 -
Other Information - None





Item 6 -
Exhibits





Exhibit 31 - Rule 13a-14(a)
Certifications


Exhibit 32 - Section 1350
Certifications


34





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:
      October 29,
      2010
                    
                    By:
                    /s/
      Michael L. MiddletonMichael
      L. Middleton, President, ChiefExecutive
      Officer and Chairman of theBoardDate:
      October 29,
      2010
                    
                    By:
                    /s/ William J. PasenelliWilliam
      J. Pasenelli, Executive VicePresident
      and Chief Financial
Officer


35