**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**WASHINGTON, DC  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 March 31, 2006**     |
| ** **     |       | ** **                                                  |
| ** **     |       | **OR**                                                      |
| ** **     |       | ** **                                                  |
| **o**          | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d)** |
| ** **     | ** ** | **OF THE  SECURITIES EXCHANGE ACT OF 1934**                 |

###### ** **

###### **For the transition period from                     to                        **

**CommissionFile Number:  000-50407**

 

#### **FREDERICK COUNTY BANCORP, INC.**(Exact name of issuer as specified in its charter)

 

 
| **Maryland**                                                                        | ** ** | ** **                                                                                    | ** ** | **20-0049496**                        |
|-------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State of other  jurisdiction of  incorporation or organization)                    |       |                                                                                          |       | (I.R.S. Employer  Identification No.) |
|                                                                                |       |                                                                                          |       |                                  |
|                                                                                |       | **9 North  Market Street  Frederick, Maryland 21701**(Address of principal executive offices) |       |                                  |
| ** **                                                                          |       |                                                                                          |       |                                  |
|                                                                                |       | **301.620.1400**                                                                              |       |                                  |
| ** **                                                                          |       | (Issuer’s  telephone number)                                                             |       |                                  |
|                                                                                |       |                                                                                          |       |                                  |
|                                                                                |       | **N/A**                                                                                       |       |                                  |
| (Former name,  former address and former fiscal year, if changed since last report) |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 2 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yes  x      No     o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer. See definition of “large accelerated filer andaccelerated filer” in Rule 12b-2 of the Exchange Act.

Large acceleratedfiler o                          Acceleratedfiler o                          Non-acceleratedfiler x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes  o   No x

State the numberof shares of each of the issuer’s classes of common equity, as of the latestpractical date. There were 1,458,602 shares of Common Stock outstanding as of April 28,2006.

 

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#### **FREDERICK COUNTY BANCORP, INC. AND SUBSIDIARY**

**TABLEOF CONTENTS**
| **PART I**  | ** ** | **FINANCIAL INFORMATION**                                                                                         |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                        |
| Item 1.          |       | Financial Statements (Unaudited)                                                                                  |
|             |       |                                                                                                              |
|             |       | Consolidated Balance  Sheets, March 31, 2006 and December 31, 2005                                 |
|             |       |                                                                                                              |
|             |       | Consolidated Statements of Income, Three Months Ended  March 31, 2006 and 2005                               |
|             |       |                                                                                                              |
|             |       | Consolidated Statements of Changes in Shareholders’  Equity, Three Months Ended March 31, 2006 and 2005 |
|             |       |                                                                                                              |
|             |       | Consolidated Statements of Cash Flows, Three Months  Ended March 31, 2006 and 2005                           |
|             |       |                                                                                                              |
|             |       | Notes to Unaudited Consolidated Financial Statements                                                              |
|             |       |                                                                                                              |
| Item 2.          |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                       |
|             |       |                                                                                                              |
| Item 3.          |       | Quantitative  and Qualitative Disclosures About Market Risk                                                       |
|             |       | See “Market  Risk, Liquidity and Interest Rate Sensitivity” at Page 17.                            |
| Item  4.         |       | Controls  and Procedures                                                                                          |
|             |       |                                                                                                              |
| **PART II** | ** ** | **OTHER  INFORMATION**                                                                                            |
|             |       |                                                                                                              |
| Item  1.         |       | Legal  Proceedings                                                                                                |
|             |       |                                                                                                              |
| Item 1A.    |       | Risk Factors                                                                                                      |
|             |       |                                                                                                              |
| Item 2.          |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                      |
|             |       |                                                                                                              |
| Item 3.          |       | Defaults upon Senior Securities                                                                                   |
|             |       |                                                                                                              |
| Item 4.          |       | Submission of Matters to a Vote of Security Holders                                                               |
|             |       |                                                                                                              |
| Item 5.          |       | Other Information                                                                                                 |
|             |       |                                                                                                              |
| Item 6.          |       | Exhibits                                                                                                          |
|             |       |                                                                                                              |
|             |       | Signatures                                                                                                        |

 

2

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**FrederickCounty Bancorp, Inc. and SubsidiaryConsolidated Balance Sheets**

 
| ** **                                                                                                      | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                      | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ***(dollars in thousands)***                                                                          | ** ** | ** **         | ** ** | ** **            | ** ** |
| ASSETS                                                                                                          |       |               |       |                  |       |
| Cash and due from banks                                                                                         |       | $                  | 6,818      |                  | $          | 5,124 |   |
| Federal funds sold                                                                                              |       | 17,297             |       | 13,386                |       |
| Interest-bearing  deposits in other banks                                                                       |       | 9,354              |       | 10,000                |       |
| Cash and cash  equivalents                                                                                      |       | 33,469             |       | 28,510                |       |
| Investment securities  available-for-sale at fair value                                                         |       | 18,858             |       | 18,952                |       |
| Investment securities  held-to-maturity - fair value of $6,021 and $2,229                                       |       | 6,048              |       | 2,246                 |       |
| Restricted stock                                                                                                |       | 893                |       | 821                   |       |
| Loans                                                                                                           |       | 159,334            |       | 155,341               |       |
| Less: Allowance for  loan losses                                                                                |       | (2,013             | )          | (1,953                | )          |
| Net loans                                                                                                       |       | 157,321            |       | 153,388               |       |
| Bank premises and  equipment                                                                                    |       | 1,944              |       | 1,811                 |       |
| Other assets                                                                                                    |       | 1,882              |       | 1,812                 |       |
| Total assets                                                                                                    |       | $                  | 220,415    |                  | $          | 207,540 |   |
|                                                                                                            |       |               |       |                  |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                      |       |               |       |                  |       |
|                                                                                                            |       |               |       |                  |       |
| **Liabilities**                                                                                                 |       |               |       |                  |       |
| Deposits:                                                                                                       |       |               |       |                  |       |
| Noninterest-bearing  deposits                                                                                   |       | $                  | 32,975     |                  | $          | 31,484 |   |
| Interest-bearing  deposits                                                                                      |       | 169,658            |       | 158,571               |       |
| Total deposits                                                                                                  |       | 202,633            |       | 190,055               |       |
| Short-term borrowings                                                                                           |       | 450                |       | 450                   |       |
| Long-term debt                                                                                                  |       | 250                |       | 250                   |       |
| Accrued interest and  other liabilities                                                                         |       | 761                |       | 897                   |       |
| Total liabilities                                                                                               |       | 204,094            |       | 191,652               |       |
|                                                                                                            |       |               |       |                  |       |
| **Shareholders’ Equity**                                                                                   |       |               |       |                  |       |
| Common stock, per share  par value $.01; 10,000,000 shares authorized; 1,458,602 shares issued and  outstanding |       | 15                 |       | 15                    |       |
| Additional paid-in  capital                                                                                     |       | 14,652             |       | 14,652                |       |
| Retained earnings                                                                                               |       | 1,900              |       | 1,421                 |       |
| Accumulated other  comprehensive loss                                                                           |       | (246               | )          | (200                  | )          |
| Total  shareholders’ equity                                                                                |       | 16,321             |       | 15,888                |       |
| Total liabilities and  shareholders’ equity                                                                |       | $                  | 220,415    |                  | $          | 207,540 |   |

 

The accompanying notesare an integral part of these unaudited consolidated financial statements.

3

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**FrederickCounty Bancorp, Inc. and SubsidiaryConsolidated Statements of Income (Unaudited)**

 

 
|   | * * |
|--------|----------|

 
| ** **                                                                           | ** ** | **For the Three**Months EndedMarch 31, | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **(*dollars in thousands, except per share amounts)*** | ** ** | **2006**                                                   | ** ** | **2005** | ** ** |
| Interest income:                                                                     |       |                                                       |       |   |   |
| Interest and fees on loans                                                           |       | $                                                          | 2,723      |   | $ | 2,129 |   |
| Interest and dividends on investment securities:                                     |       |                                                       |       |   |   |
| Interest — taxable                                                              |       | 208                                                        |       | 155 |   |
| Interest — tax exempt                                                           |       | 34                                                         |       | 2 |   |
| Dividends                                                                            |       | 11                                                         |       | 9 |   |
| Interest on federal funds sold                                                       |       | 153                                                        |       | 56 |   |
| Other interest income                                                                |       | 45                                                         |       | 2 |   |
| Total interest income                                                                |       | 3,174                                                      |       | 2,353 |   |
| Interest  expense:                                                                   |       |                                                       |       |   |   |
| Interest on deposits                                                                 |       | 1,202                                                      |       | 618 |   |
| Interest on other short-term borrowings                                              |       | 7                                                          |       | 6 |   |
| Interest on long-term debt                                                           |       | 5                                                          |       | — |   |
| Total interest expense                                                               |       | 1,214                                                      |       | 624 |   |
| Net interest  income                                                                 |       | 1,960                                                      |       | 1,729 |   |
| Provision for  loan losses                                                           |       | 60                                                         |       | 150 |   |
| Net interest  income after provision for loan losses                                 |       | 1,900                                                      |       | 1,579 |   |
| Noninterest  income:                                                                 |       |                                                       |       |   |   |
| Service fees                                                                         |       | 39                                                         |       | 35 |   |
| Other operating income                                                               |       | 46                                                         |       | 27 |   |
| Total noninterest income                                                             |       | 85                                                         |       | 62 |   |
| Noninterest  expense:                                                                |       |                                                       |       |   |   |
| Salaries and employee benefits                                                       |       | 732                                                        |       | 636 |   |
| Occupancy and equipment expenses                                                     |       | 184                                                        |       | 156 |   |
| Other operating expenses                                                             |       | 269                                                        |       | 273 |   |
| Total noninterest expense                                                            |       | 1,185                                                      |       | 1,065 |   |
| Income before  provision for income taxes                                            |       | 800                                                        |       | 576 |   |
| Provision for  income taxes                                                          |       | 321                                                        |       | 60 |   |
| Net income                                                                           |       | $                                                          | 479        |   | $ | 516 |   |
| Basic earnings  per share                                                            |       | $                                                          | 0.33       |   | $ | 0.35 |   |
| Diluted earnings  per share                                                          |       | $                                                          | 0.31       |   | $ | 0.34 |   |
| Basic weighted  average number of shares outstanding                                 |       | 1,458,602                                                  |       | 1,457,626 |   |
| Diluted weighted  average number of shares outstanding                               |       | 1,527,730                                                  |       | 1,524,731 |   |

 

The accompanying notesare an integral part of these unaudited consolidated financial statements.

4

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**Frederick County Bancorp, Inc. and   SubsidiaryConsolidated Statement of Changes inShareholders’ Equity (Unaudited)**

** **
| ***(dollars in thousands, except   shares outstanding)***             | ** ** | **Shares  Outstanding** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings  (Deficit)** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total  Shareholders’  Equity** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|----------------------------------|------------|-----------------------------------|------------|---------------------------------------------|------------|---------------------------------------|------------|
|                                                                                           |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
|  Balance, December 31, 2004                                                          |       | 1,457,402               |       | $                 | 15         |                             | $          | 14,632                            |       | $                                           | (411       | )                                     | $          | (23 | ) | $ | 14,213 |   |
| Comprehensive  income:                                                                         |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
| Net income                                                                                     |       | —                  |       | —            |       | —                           |       | 516                               |       | —                                      |       | 516                                   |       |
| Changes in net unrealized losses on securities  available for sale, net of income taxes of $60 |       | —                  |       | —            |       | —                           |       | —                            |       | (95                                         | )          | (95                                   | )          |
| Comprehensive income                                                                           |       |                    |       |              |       |                             |       |                              |       |                                        |       | 421                                   |       |
| Shares issued under stock option transactions                                                  |       | 1,200                   |       | —            |       | 12                               |       | —                            |       | —                                      |       | 12                                    |       |
| Balance,  March 31, 2005                                                                  |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,644                            |       | $                                           | 105        |                                  | $          | (118 | ) | $ | 14,646 |   |
| Balance,  December 31, 2005                                                               |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,652                            |       | $                                           | 1,421      |                                  | $          | (200 | ) | $ | 15,888 |   |
| Comprehensive  income:                                                                         |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
| Net income                                                                                     |       | —                  |       | —            |       | —                           |       | 479                               |       | —                                      |       | 479                                   |       |
| Changes in net unrealized losses on securities  available for sale, net of income taxes of $28 |       | —                  |       | —            |       | —                           |       | —                            |       | (46                                         | )          | (46                                   | )          |
| Comprehensive income                                                                           |       | —                  |       | —            |       | —                           |       | —                            |       | —                                      |       | 433                                   |       |
| Balance, March 31,  2006                                                                  |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,652                            |       | $                                           | 1,900      |                                  | $          | (246 | ) | $ | 16,321 |   |

 

The accompanying notesare an integral part of these unaudited consolidated financial statements.

5

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**Frederick County Bancorp, Inc. and SubsidiaryConsolidated Statements of Cash Flows (Unaudited)**

 

 
| ** **                                                                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ***(dollars in thousands)***                                                               | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Cash flows from operating  activities:                                                               |       |                                                 |       |   |   |
| Net income                                                                                           |       | $                                                    | 479        |   | $ | 516 |   |
| Adjustments to reconcile net  income to net cash provided by  operating  activities:            |       |                                                 |       |   |   |
| Depreciation and amortization                                                                        |       | 41                                                   |       | 38 |   |
| Deferred income taxes                                                                                |       | (26                                                  | )          | — |   |
| Provision for loan losses                                                                            |       | 60                                                   |       | 150 |   |
| Net premium amortization on  investment securities                                                   |       | 12                                                   |       | 24 |   |
| Increase in other assets                                                                             |       | (15                                                  | )          | (239 | ) |
| Decrease in accrued interest  and other liabilities                                                  |       | (136                                                 | )          | (304 | ) |
| Net cash provided by operating  activities                                                           |       | 415                                                  |       | 185 |   |
| Cash flows from investing activities:                                                                |       |                                                 |       |   |   |
| Purchases of investment  securities available-for-sale                                               |       | (1,476                                               | )          | (1,513 | ) |
| Purchases of investment  securities held-to-maturity                                                 |       | (3,802                                               | )          | — |   |
| Proceeds from maturities of  investment securities available-for-sale                                |       | 1,483                                                |       | 1,057 |   |
| Purchases of restricted stock                                                                        |       | (72                                                  | )          | (95 | ) |
| Net increase in loans                                                                                |       | (3,993                                               | )          | (4,361 | ) |
| Purchases of bank premises and  equipment, net                                                       |       | (174                                                 | )          | (72 | ) |
| Net cash used in investing  activities                                                               |       | (8,034                                               | )          | (4,984 | ) |
| Cash flows from financing activities:                                                                |       |                                                 |       |   |   |
| Net increase in NOW, money  market accounts, savings accounts and  noninterest-bearing deposits |       | 4,789                                                |       | 6,063 |   |
| Net increase in time deposits                                                                        |       | 7,789                                                |       | 7,202 |   |
| Proceeds from issuance of  common stock                                                              |       | —                                               |       | 12 |   |
| Net cash provided by financing  activities                                                           |       | 12,578                                               |       | 13,277 |   |
| Net increase in cash and cash equivalents                                                            |       | 4,959                                                |       | 8,478 |   |
| Cash and cash equivalents — beginning of period                                                 |       | 28,510                                               |       | 16,639 |   |
| Cash and cash equivalents — end of period                                                       |       | $                                                    | 33,469     |   | $ | 25,117 |   |
| Supplemental cash flow disclosures:                                                                  |       |                                                 |       |   |   |
| Interest paid                                                                                        |       | $                                                    | 1,212      |   | $ | 609 |   |
| Income  taxes paid                                                                                   |       | $                                                    | 131        |   | $ | 230 |   |

 

The accompanying notesare an integral part of these unaudited consolidated financial statements.

6

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#### **FREDERICK COUNTY BANCORP, INC.**

Notes to UnauditedConsolidated Financial Statements

**Note 1. General:**

On September 30, 2003, theAgreement and Plan of Share Exchange (the “Exchange”) between the FrederickCounty Bancorp, Inc. (the “Bancorp”) and Frederick County Bank (the “Bank”and together with Bancorp, the “Company”), dated June 9, 2003, approved atthe Special Meeting of Shareholders of the Bank held on September 22,2003, became effective. Pursuant to the Exchange, each of the outstandingshares of common stock $10.00 par value of the Bank was converted into oneshare of the common stock $0.01 par value of Bancorp. As a result of theExchange, the Bank has become a wholly owned subsidiary of Bancorp, and Bancorprecognized the assets and liabilities transferred at the carrying amounts inthe accounts of the Bank as of January 1, 2003. During February 2004, the Company received approval from the FederalReserve Bank of Richmond to become a financial holding company.

The Bank provides its customerswith various banking services. The Bank offers various loan and depositproducts to their customers. The Bank’s customers include individuals andcommercial enterprises within its principal market area consisting of FrederickCounty, Maryland. Additionally, the Bank maintains correspondent bankingrelationships and transacts daily federal funds sales on an unsecured basiswith regional correspondent banks. Note 4 discusses the types of securities theBank invests in. Note 5 discusses the types of lending that the Bank engages in.The Bank does not have any significant concentrations to any one industry orcustomer.

The accompanying unaudited consolidated financialstatements of the Company have been prepared in accordance with accounting principles generally accepted inthe United States of America for interim financial information, theinstructions for Form 10-Q, regulation S-X, and general practiceswithin the banking industry. Accordingly, they do not include all of theinformation and disclosures required by generally accepted accountingprinciples for complete financial statements. These statements should be readin conjunction with the consolidated financial statements and accompanyingfootnotes included in the Company’s 2005 Annual Report on Form 10-K.In the opinion of management, all adjustments, consisting of normal recurringadjustments, considered necessary for a fair presentation have been included. Theresults shown in this interim report are not necessarily indicative of resultsto be expected for any other period or for the full year ending December 31,2006.

Thepreparation of financial statements requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. These estimates and assumptions are based on informationavailable as of the date of the consolidated financial statements and coulddiffer from actual results.

**Note2. Earnings Per Share:**

Earnings per share (“EPS”)are disclosed as basic and diluted. Basic EPS is generally computed by dividingnet income by the weighted-average number of common shares outstanding for theperiod, whereas diluted EPS essentially reflects the potential dilution inbasic EPS that could occur if other contracts to issue common stock wereexercised.

 
| ** **                                                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ***(dollars in thousands, except per share amounts)*** | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Net income                                                                           |       | $                                                | 479        |   | $ | 516 |   |
| Basic earnings  per share                                                            |       | $                                                | 0.33       |   | $ | 0.35 |   |
| Diluted earnings  per share                                                          |       | $                                                | 0.31       |   | $ | 0.34 |   |
| Basic weighted  average number of shares outstanding                                 |       | 1,458,602                                        |       | 1,457,626 |   |
| Effect of  dilutive securities — stock options                                  |       |  69,128                                     |       | 67,105 |   |
| Diluted weighted  average number of shares outstanding                               |       | 1,527,730                                        |       | 1,524,731 |   |

 

**Note3. Employee Stock Option Plan:**

The Companymaintains an Employee Stock Option Plan that provides for grants of incentiveand non-incentive stock options. This plan has been presented to and approvedby the Company’s shareholders. Through December 31, 2005, the Companyaccounted for this plan under the recognition and measurement principles ofAccounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees,*andrelated interpretations. Accordingly, no stock-based employee compensation costhas been recognized, as all options granted under this plan had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant. As of December 31, 2005, all outstanding stock options were fullyvested. No stock options were granted or vested during the first three monthsof 2006 or 2005 and, accordingly, net income and earnings per share would nothave been affected if compensation cost for the stock-based compensation planhad been determined based on the grant date fair values of awards (the 

7

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method describedin Statement of Financial Accounting Standards No. 123 *Accounting for Stock-Based Compensation*). Asof January 1, 2006, the Company adopted Statement of Financial AccountingStandards No. 123(R) *Share-BasedPayment* and any stock-based employee compensation for future grantswill be determined at that time using the Black-Scholes or another appropriateoption-pricing model with the following assumptions: option price, dividendyield, expected volatility, risk free interest rate and the expected life.

**Note 4. InvestmentPortfolio:**

Thefollowing tables set forth certain information regarding the Company’sinvestment portfolio at March 31, 2006 and December 31, 2005:

## **Available-for-sale portfolio**

| ***March 31,  2006***                                          | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **         | ** ** |
|---------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------|------------|--------------------|------------|
| ***(dollars in thousands)***                              | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Estimated  Fair  Value** | ** ** | **Average  Yield** | ** ** |
| U.S. Treasury  and other U.S. government Agencies and corporations: |       |                |       |                        |       |                        |       |                       |       |               |       |
| Due after one year through five years                               |       | $                   | 2,441      |                        | $          | —                      |       | $                          | 38         |               | $          | 2,403 |   | 4.26 | % |
| Due after five years through ten years                              |       | 3,204               |       | —                      |       | 45                          |       | 3,159                      |       | 4.95               | %          |
| Mortgage-backed  debt securities                                    |       | 13,213              |       | 9                           |       | 326                         |       | 12,896                     |       | 4.40               | %          |
| Equity Securities                                                   |       | 400                 |       | —                      |       | —                      |       | 400                        |       | —             | %          |
|                                                                |       | $                   | 19,258     |                        | $          | 9                           |       | $                          | 409        |               | $          | 18,858 |   | 4.38 | % |

** **
| ***December 31, 2005***                                     | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **         | ** ** |
|-----------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------|------------|--------------------|------------|
| **(***dollars in thousands)*                                | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Estimated  Fair  Value** | ** ** | **Average  Yield** | ** ** |
| U.S. Treasury  and other U.S. government   Agencies and corporations: | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **         | ** ** |
| Due after one year through five years                                 |       | $                   | 1,500      |                        | $          | —                      |       | $                          | 19         |               | $          | 1,481 |   | 4.00 | % |
| Due after five years through ten years                                |       | 3,333               |       | —                      |       | 25                          |       | 3,308                      |       | 4.94               | %          |
| Mortgage-backed  debt securities                                      |       | 14,045              |       | 7                           |       | 289                         |       | 13,763                     |       | 4.29               | %          |
| Equity  securities                                                    |       | 400                 |       | —                      |       | —                      |       | 400                        |       | —             | %          |
|                                                                  |       | $                   | 19,278     |                        | $          | 7                           |       | $                          | 333        |               | $          | 18,952 |   | 4.29 | % |

 

## **Held-to-maturity portfolio**

| ***March 31, 2006***         | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **         | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------|------------|--------------------|------------|
| ***(dollars in thousands)*** | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Estimated  Fair  Value** | ** ** | **Average  Yield** | ** ** |
| State and  political subdivisions:     |       |                |       |                        |       |                        |       |                       |       |               |       |
| Due after five years through ten years |       | $                   | 1,209      |                        | $          | —                      |       | $                          | 14         |               | $          | 1,195 |   | 5.17 | % |
| Due after ten years                    |       | 4,839               |       | 1                           |       | 14                          |       | 4,826                      |       | 5.79               | %          |
|                                   |       | $                   | 6,048      |                        | $          | 1                           |       | $                          | 28         |               | $          | 6,021 |   | 5.67 | % |

** **
| ***December 31,  2005***                | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **         | ** ** |
|----------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------|------------|--------------------|------------|
| ***(dollars in thousands)***       | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Estimated  Fair  Value** | ** ** | **Average  Yield** | ** ** |
| State and  political subdivisions:           |       |                |       |                        |       |                        |       |                       |       |               |       |
|  Due after five years through ten years |       | $                   | 705        |                        | $          | —                      |       | $                          | 11         |               | $          | 694 |   | 5.08 | % |
|  Due after ten years                    |       | 1,541               |       | 1                           |       | 7                           |       | 1,535                      |       | 5.68               | %          |
|                                         |       | $                   | 2,246      |                        | $          | 1                           |       | $                          | 18         |               | $          | 2,229 |   | 5.49 | % |

** **

8

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** **

 
| ***March 31, 2006***                                     | ** ** | ** **                                                                                                    | ** **  | ** **                                                                                                      | ** ** | ** **      | ** ** | ** **                   | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|-------------|-----------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------------------|------------|
| ** **                                                         | ** ** | **Continuous unrealized   losses existing for   less than 12 months** | ** **  | **Continuous unrealized   losses existing for   12 months and greater** | ** ** | **Total**       | ** ** |
| ***(dollars in thousands)***                             | ** ** | **Fair  Value**                                                                                               | ** **  | **Unrealized  Losses**                                                                                          | ** ** | **Fair  Value** | ** ** | **Unrealized   Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized   Losses** | ** ** |
| U.S. Treasury  and other U.S. government agencies and corporations |       | $                                                                                                        | 5,078  |                                                                                                            | $     | 67         |       | $                       | 484        |   | $  | 16  |   | $  | 5,562 |   | $  | 83  |   |
| Mortgage-backed  debt securities                                   |       | 6,416                                                                                                         |        | 129                                                                                                             |       | 5,768           |       | 197                          |       | 12,184 |   | 326 |   |
| State and  political subdivisions                                  |       | 3,392                                                                                                         |        | 28                                                                                                              |       | —          |       | —                       |       | 3,392 |   | 28 |   |
| Total temporarily  impaired securities                             |       | $                                                                                                             | 14,886      |                                                                                                            | $          | 224             |       | $                            | 6,252      |   | $ | 213 |   | $ | 21,138 |   | $ | 437 |   |

 

 
| **December 31, 2005**                                    | ** ** | ** **                                                                                                    | ** **  | ** **                                                                                                  | ** ** | ** **      | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|-------------|-------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|
| ** **                                                         | ** ** | **Continuous unrealized   losses existing for   less than 12 months** | ** **  | **Continuous unrealized  losses existing   for 12 months   and greater** | ** ** | **Total**       | ** ** |
| ***(dollars in thousands)***                             | ** ** | **Fair  Value**                                                                                               | ** **  | **Unrealized   Losses**                                                                                | ** ** | **Fair  Value** | ** ** | **Unrealized   Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized   Losses** | ** ** |
| U.S. Treasury  and other U.S. government agencies and corporations |       | $                                                                                                        | 3,356  |                                                                                                        | $     | 27         |       | $  | 483 |   | $  | 17  |   | $  | 3,839 |   | $  | 44  |   |
| Mortgage-backed  debt securities                                   |       | 8,182                                                                                                         |        | 144                                                                                                         |       | 4,758           |       | 145 |   | 12,940 |   | 289 |   |
| State and  political subdivisions                                  |       | 2,078                                                                                                         |        | 18                                                                                                          |       | —          |       | — |   | 2,078 |   | 18 |   |
| Total temporarily impaired  securities                             |       | $                                                                                                             | 13,616      |                                                                                                        | $          | 189             |       | $ | 5,241 |   | $ | 162 |   | $ | 18,857 |   | $ | 351 |   |

 

Management evaluates securities for other-than-temporary impairment atleast on a quarterly basis, and more frequently when economic or marketconcerns warrant such evaluation. Consideration is given to (1) the lengthof time and the extent to which the fair value has been less than cost, (2) thefinancial condition and near-term prospects of the issuer, and (3) theintent and ability of the Company to retain its investment in the issuer for aperiod of time sufficient to allow for any anticipated recovery in fair value. TheCompany has not recognized any other-than-temporary impairment in connectionwith the unrealized losses reflected in the preceding tables.

## **Restricted Stock**

 

Thefollowing table shows the amounts of restricted stock as of March 31, 2006and December 31, 2005:
| ** **                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ***(dollars in thousands)*** | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Federal Home  Loan Bank of Atlanta     |       | $                  | 414        |                  | $          | 342 |   |
| Federal Reserve  Bank                  |       | 439                |       | 439                   |       |
| Atlantic Central  Bankers Bank         |       | 40                 |       | 40                    |       |
|                                   |       | $                  | 893        |                  | $          | 821 |   |

 

9

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** **

**Note 5. Loansand Allowance for Loan Losses:**

Loansconsist of the following:
| ***(dollars in thousands)***                                      | *** *** | **March 31,  2006** | ** ** | **% of  Loans** | ** ** | **December 31,  2005** | ** ** | **% of  Loans** | *** *** |
|-----------------------------------------------------------------------------|--------------|--------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------|--------------|
| Real estate  loans:                                                         |         |                     |       |                 |       |                        |       |                 |         |
| Construction and  land development                                          |         | $                        | 36,376     |                 | 23         | %                           | $          | 29,140               |         | 19 | % |
| Mortgage loans:                                                             |         |                     |       |                 |       |                        |       |                 |         |
| Secured by 1 to 4 family residential properties                             |         | 30,258                   |       | 19                   | %          | 31,128                      |       | 20                   | %            |
| Secured by multi-family (5 or more) residential  properties                 |         | 7,569                    |       | 5                    | %          | 3,942                       |       | 3                    | %            |
| Secured by commercial properties                                            |         | 55,266                   |       | 34                   | %          | 60,087                      |       | 39                   | %            |
| Secured by farm land                                                        |         | 4,339                    |       | 3                    | %          | 2,836                       |       | 2                    | %            |
| Total mortgage loans                                                        |         | 97,432                   |       | 61                   | %          | 97,993                      |       | 64                   | %            |
| Loans to farmers                                                            |         | —                   |       | —               | %          | 756                         |       | —               | %            |
| Commercial and  industrial loans                                            |         | 22,917                   |       | 14                   | %          | 25,140                      |       | 16                   | %            |
| Loans to  individuals for household, family and other personal expenditures |         | 2,609                    |       | 2                    | %          | 2,312                       |       | 1                    | %            |
|                                                                        |         | 159,334                  |       | 100                  | %          | 155,341                     |       | 100                  | %            |
| Less allowance for loan losses                                              |         | (2,013                   | )          |                 |       | (1,953                      | )          |                 |         |
|  Net loans                                                             |         | $                        | 157,321    |                 |       |                        | $          | 153,388              |         |   |   |

 

Transactions in theallowance for loan losses are summarized as follows:
| ** **                                     | ** ** | **Three Months   Ended  March 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------|------------|
| ***(dollars in thousands)***         | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| Balance at  beginning of period                |       | $                                                  | 1,953      |   | $ | 1,503 |   |
| Provision  charged to operating expenses       |       | 60                                                 |       | 150 |   |
| Recoveries of  loans previously charged-off    |       | —                                             |       | — |   |
|                                           |       | 2,013                                              |       | 1,653 |   |
| Loans  charged-off                             |       | —                                             |       | — |   |
| Balance at end  of period                      |       | $                                                  | 2,013      |   | $ | 1,653 |   |
| Average total loans  outstanding during period |       | $                                                  | 157,145    |   | $ | 136,935 |   |

 

10

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**Note 6. NoninterestExpense:**

Noninterest expenseconsists of the following:

* *
| ** **                              | ** ** | **Three Months   Ended  March 31,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------|------------|
| ***(dollars in thousands)***  | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
|                                    |       |                                               |       |   |   |
| Salaries                                |       | $                                                  | 566        |   | $ | 525 |   |
| Bonus                                   |       | 83                                                 |       | 13 |   |
| Deferred  Personnel Costs               |       | (46                                                | )          | (32 | ) |
| Payroll Taxes                           |       | 63                                                 |       | 65 |   |
| Employee  Insurance                     |       | 34                                                 |       | 36 |   |
| Other Employee Benefits                 |       | 32                                                 |       | 29 |   |
| Depreciation                            |       | 41                                                 |       | 38 |   |
| Rent                                    |       | 64                                                 |       | 51 |   |
| Utilities                               |       | 18                                                 |       | 15 |   |
| Repairs and  Maintenance                |       | 23                                                 |       | 24 |   |
| ATM Expense                             |       | 17                                                 |       | 15 |   |
| Other Occupancy  and Equipment Expenses |       | 21                                                 |       | 13 |   |
| Postage and  Supplies                   |       | 14                                                 |       | 14 |   |
| Data Processing                         |       | 64                                                 |       | 87 |   |
| Advertising and  Promotion              |       | 61                                                 |       | 41 |   |
| Legal                                   |       | 7                                                  |       | 4 |   |
| Insurance                               |       | 8                                                  |       | 7 |   |
| Consulting                              |       | 7                                                  |       | 10 |   |
| Courier                                 |       | 10                                                 |       | 10 |   |
| Audit Fees                              |       | 38                                                 |       | 33 |   |
| Shareholder  Relations                  |       | —                                             |       | 1 |   |
| Other                                   |       | 60                                                 |       | 66 |   |
|                                    |       | $                                                  | 1,185      |   | $ | 1,065 |   |

 

**Note 7. 401(k) ProfitSharing Plan:**

The Company has a Section 401(k) profit sharing plan coveringemployees meeting certain eligibility requirements as to minimum age and yearsof service. Employees may make voluntary contributions to the Plan throughpayroll deductions on a pre-tax basis. The Company makes discretionarycontributions to the Plan based on the Company’s earnings. The Company’s contributionsare subject to a vesting schedule (20 percent per year) requiring thecompletion of five years of service with the Company before these benefits arefully vested. A participant’s account under the Plan, together with investmentearnings thereon, is normally distributable, following retirement, death,disability or other termination of employment, in a single lump-sum payment.

The Company made contributions to the Plan in the amounts of $24,000 and$21,000 for the first three months of 2006 and 2005, respectively.

**Note 8. Shareholders’Equity:**

Capital:

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies. Failure to meet minimum capital requirements caninitiate certain mandatory - and possibly additional discretionary - actions byregulators that, if undertaken, could have a direct material effect on theCompany’s financial statements. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company and the Bankmust meet specific capital guidelines that involve quantitative measures of theCompany’s and the Bank’s assets, liabilities, and certain off-balance-sheetitems as calculated under regulatory accounting practices. The Company’s and theBank’s capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios (set forth in the followingtable) of total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined), and Tier 1 capital (as defined) to averageassets (as defined). Management believes that the Company and the Bank met allcapital adequacy requirements to which they are subject as of March 31,2006.

11

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As of March 31,2006, the most recent notification from the regulatory agency categorized theBank as well capitalized under the regulatory framework for prompt correctiveaction. To be categorized as well capitalized the Bank must maintain minimumtotal risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth inthe table. There are no conditions or events since that notification whichmanagement believes have changed the Bank’s category.

TheCompany’s and the Bank’s actual capital amounts and ratios at March 31,2006 and December 31, 2005 are presented in the following tables.

 
| ***March 31, 2006***                             | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                                    | ** ** |
|------------------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **Minimum To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
| ***(dollars in thousands)***                     | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Tier 1 Capital  To Risk-Weighted Assets Company            |       | $     | 16,567     |                                         | 9.29%      |                                                                                                          | $     | 7,134 |   | 4.00% |   | N/A |   | N/A |   |
| Bank                                                       |       | $          | 16,632     |                                         | 9.35%      |                                                                                                          | $          | 7,118 |   | 4.00% |   | $ | 10,677 |   | 6.00% |   |
|                                                       |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Total Capital  To Risk-Weighted Assets  Company  |       | $     | 18,580     |                                         | 10.42%     |                                                                                                          | $     | 14,268 |   | 8.00% |   | N/A |   | N/A |   |
| Bank                                                       |       | $          | 18,645     |                                         | 10.48%     |                                                                                                          | $          | 14,236 |   | 8.00% |   | $ | 17,795 |   | 10.00% |   |
|                                                       |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Tier 1 Capital    To Average Assets  Company     |       | $     | 16,567     |                                         | 8.06%      |                                                                                                          | $     | 8,219 |   | 4.00% |   | N/A |   | N/A |   |
| Bank                                                       |       | $          | 16,632     |                                         | 8.11%      |                                                                                                          | $          | 8,203 |   | 4.00% |   | $ | 10,254 |   | 5.00% |   |

 
| ***December 31, 2005***                           | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                                    | ** ** |
|-------------------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **Minimum To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
| ***(dollars in thousands)***                      | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Tier 1 Capital  To Risk-Weighted Assets Company             |       | $     | 16,088     |                                         | 9.36%      |                                                                                                          | $     | 6,877 |   | 4.00% |   | N/A |   | N/A |   |
| Bank                                                        |       | $          | 16,145     |                                         | 9.41%      |                                                                                                          | $          | 6,860 |   | 4.00% |   | $ | 10,290 |   | 6.00% |   |
|                                                        |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Total Capital  To Risk-Weighted Assets  Company   |       | $     | 18,041     |                                         | 10.49%     |                                                                                                          | $     | 13,753 |   | 8.00% |   | N/A |   | N/A |   |
| Bank                                                        |       | $          | 18,098     |                                         | 10.55%     |                                                                                                          | $          | 13,720 |   | 8.00% |   | $ | 17,150 |   | 10.00% |   |
|                                                        |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Tier 1 Capital  To Average  Assets  Company  |       | $     | 16,088     |                                         | 8.26%      |                                                                                                          | $     | 7,787 |   | 4.00% |   | N/A |   | N/A |   |
| Bank                                                        |       | $          | 16,145     |                                         | 8.31%      |                                                                                                          | $          | 7,772 |   | 4.00% |   | $ | 9,716 |   | 5.00% |   |

 

**Item 2.    Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

**Forward-LookingStatements**

This management’s discussion and analysis contains forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995, including statements relating to the Frederick County Bancorp, Inc.(the “Company”) beliefs, expectations, anticipations and plans regarding, amongother things, general economic trends, interest rates, product expansions andother matters. Such forward-looking statements are identified by terminologysuch as “may”, “will”, “believe”, “expect”, “estimate”, “anticipate”, “likely”,“unlikely”, “continue”, or similar terms and are subject to numerousuncertainties, such as federal monetary policy, inflation, employment,profitability and consumer confidence levels, both nationally and in theCompany’s market area, the health of the real estate and construction market inthe Company’s market area, the Company’s ability to develop and market new

12

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products and to enter new markets, competitive challenges in the Company’smarket, legislative changes and other factors, and as such, there can be no assurancethat future events will develop in accordance with the forward-lookingstatements contained herein. Readers are cautioned against placing unduereliance on any such forward-looking statement. In addition, the Company’s pastresults of operations do not necessarily indicate its future results.

**General**

The following paragraphs provide an overview of the financial conditionand results of operations of the Company. This discussion is intended to assistthe readers in their analysis of the accompanying financial statements andnotes thereto.

On September 30, 2003, theAgreement and Plan of Share Exchange (the “Exchange”) between the FrederickCounty Bancorp, Inc. (the “Bancorp”) and Frederick County Bank (the “Bank”and together with Bancorp, the “Company”), dated June 9, 2003, approved atthe Special Meeting of Shareholders of the Bank held on September 22,2003, became effective. Pursuant to the Exchange, each of the outstandingshares of common stock $10.00 par value of the Bank was converted into one shareof the common stock $0.01 par value of Bancorp. As a result of the Exchange,the Bank has become a wholly owned subsidiary of Bancorp, and Bancorprecognized the assets and liabilities transferred at the carrying amounts inthe accounts of the Bank as of January 1, 2003. During February 2004, the Company received approval from the FederalReserve Bank of Richmond to become a financial holding company.

The Bank was incorporated on August 30,2000, and in 2001 it became engaged in the developmental activities needed toobtain a commercial bank charter in the State of Maryland. The Bank receivedregulatory approval to commence banking operations on October 18, 2001and, accordingly, became operational during the year ended December 31,2001. The Bank provides its customers with various banking services. The Bankoffers various loan and deposit products to their customers. The Bank’scustomers include individuals and commercial enterprises within its principalmarket area consisting of Frederick County, Maryland.

The Company iscontinually looking for promising branch sites that will contribute to theCompany’s growth and profit expectations. While additional branching activityis anticipated, there can be no assurance as to when or if, additional brancheswill be established, whether any such branches can be operated profitably, orwhether such expansion will result in increased assets, earnings, return onequity or shareholder value. Two new branches, located at 200 Commerce Drive,Walkersville, Maryland and 6910 Crestwood Boulevard, Frederick, Maryland, arecurrently under construction and the Company anticipates that these facilitieswill open in the third and fourth quarters of 2006.

## Critical Accounting Policies

The Company’sfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”) and follow generalpractices within the industry in which it operates. Application of theseprinciples requires management to make estimates, assumptions, and judgmentsthat affect the amounts reported in the financial statements and accompanyingnotes. These estimates, assumptions, and judgments are based on informationavailable as of the date of the financial statements; accordingly, as thisinformation changes, the financial statements could reflect differentestimates, assumptions, and judgments. Certain policies inherently have agreater reliance on the use of estimates, assumptions, and judgments and assuch have a greater possibility of producing results that could be materiallydifferent than originally reported. Estimates, assumptions, and judgments arenecessary when assets and liabilities are required to be recorded at fairvalue, when a decline in the value of an asset not carried on the financialstatements at fair value warrants an impairment write-down or valuation reserveto be established, or when an asset or liability needs to be recordedcontingent upon a future event. Carrying assets and liabilities at fair valueinherently results in more financial statement volatility. The fair values andthe information used to record valuation adjustments for certain assets andliabilities are based either on quoted market prices or are provided by otherthird-party sources, when available. The estimates used in management’sassessment of the adequacy of the allowance for credit losses require thatmanagement make assumptions about matters that are uncertain at the time ofestimation. Differences in these assumptions and differences between the estimatedand actual losses could have a material effect. For discussions related to thecritical accounting policies of the Company, refer to the sections in thisManagement’s Discussion and Analysis entitled “Income Taxes” and “Allowance forLoan Losses.”

## Deposits

Deposits grew by $12.58million, or 6.62%, from December 31, 2005 to a balance of $202.63 millionas of March 31, 2006 and by $33.78 million, or 20.00% from March 31,2005. The Company’s deposit growth strategy is to increase deposits in responseto loan demand.

 

13

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**Three Months Ended March 31,2006 and 2005**

The net income was$479,000 for the three months ended March 31, 2006 as compared to the$516,000 net earnings recorded for the same period in 2005. It should be notedthat the Company recognized $321,000 of income tax expense during this periodin 2006, whereas, only $60,000 of income tax expense was incurred for the sameperiod in 2005 due to the release of the valuation allowance associated withthe net operating loss****carryforwards available at that time. The basicearnings per share for the three months ended March 31, 2006 and 2005 are$0.33 and $0.35, respectively, and are based on the weighted-average number ofshares outstanding of 1,458,602 in 2006 and 1,457,626, in 2005. The dilutedearnings per share for the three months ended March 31, 2006 and 2005 are$0.31 and $0.34, respectively, and are based on the weighted-average number ofshares outstanding of 1,527,730 and 1,524,731, respectively.

TheCompany experienced an annualized return on average assets of 0.93% and 1.22%for the three-month periods ended March 31, 2006 and 2005, respectively. Additionally,the Company experienced an annualized return on average shareholders’ equity of11.80% and 14.17% for the three-month periods ended March 31, 2006 and 2005,respectively.

**Distributionof Assets, Liabilities and Shareholders’ Equity; Interest Rates and InterestDifferential**

The following table showsaverage balances of asset and liability categories, interest income andinterest expense, and average yields and rates for the periods indicated.
| ***Three months ended March 31,*** | ** ** | **2006**                    | ** ** | **2005**                       | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| **(*dollars in thousands)***                 | ** ** | **Average  daily  balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Average  Yield/  rate** | ** ** | **Average  daily  balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Average  Yield/  rate** | ** ** |
| Assets                                                 |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                              |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Federal funds sold                                     |       | $                           | 13,650     |                           | $          | 153 |   | 4.55 | % | $ | 8,773 |   | $ | 56 |   | 2.59 | % |
| Interest bearing deposits in other banks               |       | 4,004                       |       | 45                             |       | 4.56 |   | 467 |   | 2 |   | 1.74 |   |
| Investment securities (1):                             |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Taxable                                                |       | 20,870                      |       | 219                            |       | 4.26 |   | 17,442 |   | 164 |   | 3.81 |   |
| Tax-exempt (2)                                         |       | 3,512                       |       | 52                             |       | 6.00 |   | 299 |   | 3 |   | 4.07 |   |
| Loans (3)                                              |       | 157,145                     |       | 2,727                          |       | 7.04 |   | 136,935 |   | 2,133 |   | 6.32 |   |
| Total interest-earning assets                          |       | 199,181                     |       | 3,196                          |       | 6.51 |   | 163,916 |   | 2,358 |   | 5.83 |   |
| Noninterest-earning  assets                            |       | 6,305                       |       |                           |       |   |   | 5,074 |   |   |   |   |   |
| Total  assets                                          |       | $                           | 205,486    |                           |       |   |   |   | $ | 168,990 |   |   |   |   |   |
|                                                   |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Liabilities  and Shareholders’ Equity             |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities                          |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| NOW accounts                                           |       | $                           | 13,055     |                           | 6          |   | 0.19 | % | $ | 15,911 |   | 7 |   | 0.18 | % |
| Savings accounts                                       |       | 2,806                       |       | 3                              |       | 0.43 |   | 3,040 |   | 4 |   | 0.53 |   |
| Money market accounts                                  |       | 31,237                      |       | 190                            |       | 2.47 |   | 28,605 |   | 76 |   | 1.08 |   |
| Certificates of deposit $100,000 or more               |       | 52,180                      |       | 499                            |       | 3.88 |   | 41,373 |   | 263 |   | 2.58 |   |
| Certificates of deposit less than $100,000             |       | 57,710                      |       | 504                            |       | 3.54 |   | 42,697 |   | 268 |   | 2.55 |   |
| Short-term borrowings                                  |       | 450                         |       | 7                              |       | 6.31 |   | 450 |   | 6 |   | 5.41 |   |
| Long-term debt                                         |       | 250                         |       | 5                              |       | 8.11 |   | — |   | — |   | — |   |
| Total  interest-bearing liabilities                    |       | 157,688                     |       | 1,214                          |       | 3.12 |   | 132,076 |   | 624 |   | 1.92 |   |
| Noninterest-bearing  deposits                          |       | 30,956                      |       |                           |       |   |   | 21,747 |   |   |   |   |   |
| Noninterest-bearing  liabilities                       |       | 608                         |       |                           |       |   |   | 604 |   |   |   |   |   |
| Total  liabilities                                     |       | 189,252                     |       |                           |       |   |   | 154,427 |   |   |   |   |   |
| Total  shareholders’ equity                       |       | 16,234                      |       |                           |       |   |   | 14,563 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity       |       | $                           | 205,486    |                           |       |   |   |   | $ | 168,990 |   |   |   |   |   |
| Net  interest income                                   |       |                        |       | $                              | 1,982      |   |   |   |   |   | $ | 1,734 |   |   |   |
| Net  interest spread                                   |       |                        |       |                           |       | 3.39 | % |   |   |   |   | 3.92 | % |
| Net interest margin                                    |       |                        |       |                           |       | 4.04 | % |   |   |   |   | 4.29 | % |

(1)             Yieldson securities available-for-sale have been calculated on the basis ofhistorical cost and do not give effect to changes in the fair value of thosesecurities, which is reflected as a component of shareholders’ equity.

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(2)             Presentedon a taxable-equivalent basis using the statutory federal income tax rate of34%. Taxable-equivalent adjustments of $18,000 in 2006 and $1,000 in 2005 areincluded in the calculation of the tax-exempt investment interest income.

(3)             Presentedon a taxable-equivalent basis using the statutory federal income tax rate of34%. Taxable-equivalent adjustments of $4,000 in 2006 and $4,000 in 2005 areincluded in the calculation of the loan interest income. Net loan origination income(expenses) in interest income totaled $7,000 in 2006 and $(5,000) in 2005.

## **Net Interest Income**

Net interest income is generated from the Company’s lending andinvestment activities, and is the most significant component of the Company’searnings. Net interest income is the difference between interest andrate-related fee income on earning assets (primarily loans and investmentsecurities) and the interest paid on the funds (primarily deposits) supportingthem. While the Company currently relies almost entirely on deposits to fundloans and investments, with minimal short term borrowings, in future periods itmay utilize a higher level of short-term borrowings, including borrowings fromthe Federal Home Loan Bank, federal funds lines with correspondent banks andrepurchase agreements, to fund operations, depending on economic conditions,deposit availability and pricing, interest rates and other factors.

The Bank commenced operations on October 18, 2001. Since it’sopening, Management has been pleased with the Bank’s asset growth. Core depositrelationships are being developed within the local market place, driven bycompetitive pricing and excellent customer service.

## **ThreeMonths Ended March 31, 2006 and 2005**

The net interest income (on a taxable-equivalent basis) of $1.98 millionin 2006 was $248,000, or 14.30% higher than the amount recognized in 2005. Thisincrease in interest income is due to the growth in average earning assets andincreased yields on earning assets. Average earning assets increased by  $35.27 million, or 21.51%, since March 31,2005. The yield on earning assets in 2006 increased to 6.51% from 5.83% in 2005.This increase in yield is attributable to the impact of the increase inshort-term rates by the Federal Reserve. However, the increase by 120 basispoints in the rate paid on interest earning liabilities, primarily a result ofprior Federal Reserve increases of the discount rate and stiff competition fordeposits, more than offset the increase in yield on interest earning assets. TheCompany’s net interest margin was 4.04% and 4.29% and the net interest spreadwas 3.39% and 3.92% for the three-month periods ended March 31, 2006 and2005, respectively. Average loans as a percentage of average interest-earningsassets decreased to 78.90% for the three months ended March 31, 2006, ascompared to 83.54% for the same period in 2005. The decline in average loans asa percentage of average earning assets is in part reflective of the Company’spreference to not make loans rather than assume riskier loans for which theCompany will not be adequately compensated.

The interest expense increased 94.55% from $624,000 in 2005 to $1.21million in 2006 due to the 19.39% increase in volume of interest-bearingliabilities, along with the increase in the related rates paid on suchinterest-bearing liabilities, which increased to 3.12% in 2006 from 1.92% in2005.

# **Noninterest Income**

Noninterest income was $85,000 and $62,000 for the three-month periodsended March 31, 2006 and 2005, respectively.

The Company’s management is committed to developing and offeringinnovative, market-driven products and services that will generate additionalsources of noninterest income. However, the future results of any of theseproducts or services cannot be predicted at this time.

## **Noninterest Expense**

SeeNote 6 to the unaudited consolidated financial statements for a scheduleshowing a detailed breakdown of the Company’s noninterest expense.

**Three Months Ended March 31, 2006 and 2005**

Noninterest expense amounted to $1.19 million and $1.07 million for thesethree-month periods in 2006 and 2005, respectively. The changes in noninterestexpense are principally related to an increase in personnel costs. Salariesexpense in 2006 was $566,000, up $41,000 from the salaries expense incurred inthe same period in 2005. This increase of 7.81% is for employee pay increasesand to make various employee salaries competitive with the current employmentenvironment.

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**Income Taxes**

During the three monthsended March 31, 2006, the Company incurred $321,000 of income tax expensecompared to only $60,000 during the same period in 2005 due to the netoperating loss carryforwards available at that time. At December 31, 2004,the Company recorded a valuation allowance of $158,000 to reduce the carryingvalue of the net deferred tax assets carried in the consolidated balance sheet.Valuation allowances are provided for deferred tax assets when in Management’sjudgment a portion, or all, of the deferred tax assets may not be realized. Duringthe first quarter of 2005, Management’s judgment changed and, accordingly, nolonger believed a valuation allowance was needed. The primary factorinfluencing management’s judgment was the existence of sustained periods oftaxable income. As of March 31, 2006, the Company was not required tomaintain a valuation allowance.

The effective tax ratesfor the first three months of 2006 and 2005 were 40.13% and 10.42%. The ratefor 2005 was positively impacted by the elimination of the $158,000 valuationallowance during that period. Excluding the effects of the valuation allowance,the effective tax rate would have been 37.85%.

**MarketRisk, Liquidity and Interest Rate Sensitivity**

Asset/liabilitymanagement involves the funding and investment strategies necessary to maintainan appropriate balance between interest sensitive assets and liabilities. Italso involves providing adequate liquidity while sustaining stable growth innet interest income. Regular review and analysis of deposit and loan trends,cash flows in various categories of loans, and monitoring of interest spreadrelationships are vital to this process.

The conduct of ourbanking business requires that we maintain adequate liquidity to meet changesin the composition and volume of assets and liabilities due to seasonal,cyclical or other reasons. Liquidity describes the ability of the Company tomeet financial obligations that arise during the normal course of business. Liquidityis primarily needed to meet the borrowing and deposit withdrawal requirementsof the customers of the Company, as well as for meeting current and futureplanned expenditures. This liquidity is typically provided by the fundsreceived through customer deposits, investment maturities, loan repayments,borrowings, and income. Management considers the current liquidity position tobe adequate to meet the needs of the Company and its customers.

The Company seeksto limit the risks associated with interest rate fluctuations by managing thebalance between interest sensitive assets and liabilities. Managing to mitigateinterest rate risk is, however, not an exact science. Not only does theinterval until repricing of interest rates on assets and liabilities changefrom day to day as the assets and liabilities change, but for some assets andliabilities, contractual maturity and the actual maturity experienced are notthe same. Similarly, NOW and money market accounts, by contract, may bewithdrawn in their entirety upon demand and savings deposits may be withdrawnon seven days notice. While these contracts are extremely short, it is theCompany’s belief that these accounts turn over at the rate of five percent (5%)per year. The Company therefore treats them as having maturities staggered overall periods. If all of the Company’s NOW, money market, and savings accountswere treated as repricing in one year or less, the cumulative gap at one yearor less would be $(50.49) million.

Interest ratesensitivity is an important factor in the management of the composition andmaturity configurations of the Company’s earning assets and funding sources. AnAsset/Liability Committee manages the interest rate sensitivity position inorder to maintain an appropriate balance between the maturity and repricingcharacteristics of assets and liabilities that is consistent with the Company’sliquidity analysis, growth, and capital adequacy goals. It is the objective ofthe Asset/Liability Committee to maximize net interest margins during periodsof both volatile and stable interest rates, to attain earnings growth, and tomaintain sufficient liquidity to satisfy depositors’ requirements and meetcredit needs of customers.

The table below, “InterestRate Sensitivity Gap Analysis,” summarizes, as of March 31, 2006, theanticipated maturities or repricing of the Company’s interest-earning assetsand interest-bearing liabilities, the Company’s interest rate sensitivity gap(interest-earning assets less interest-bearing liabilities), the Company’scumulative interest rate sensitivity gap, and the Company’s cumulative interestsensitivity gap ratio (cumulative interest rate sensitivity gap divided bytotal assets). A negative gap for any time period means that moreinterest-bearing liabilities will reprice or mature during that time periodthan interest-earning assets. During periods of rising interest rates, anegative gap position would generally decrease earnings, and during periods ofdeclining interest rates, a negative gap position would generally increaseearnings. The converse would be true for a positive gap position. Therefore, apositive gap for any time period means that more interest-earning assets willreprice or mature during that time period than interest-bearing liabilities. Duringperiods of rising interest rates, a positive gap position would generallyincrease earnings, and during periods of declining interest rates, a positivegap position would generally decrease earnings.

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It is important tonote that the following table represents the static gap position for interestsensitive assets and liabilities at March 31, 2006. The table does notgive effect to prepayments or extensions of loans as a result of changes ingeneral market interest rates. Moreover, while the table does indicate theopportunities to reprice assets and liabilities within certain time frames, itdoes not account for timing differences that occur during periods of repricing.For example, changes to deposit rates tend to lag in a rising rate environmentand lead in a falling rate environment.

**InterestRate Sensitivity Gap Analysis**

**March 31,2006**
| ** **                                            | ** ** | **Expected Repricing or Maturity Date** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ***(dollars in thousands)***                | ** ** | **Within  One Year**                                   | ** ** | **One to  Three Years** | ** ** | **Three to  Five Years** | ** ** | **After  Five Years** | ** ** | **Total** | ** ** |
| Assets                                                |       |                                                        |       |   |   |   |   |   |   |   |   |
| Federal funds sold                                    |       | $                                                           | 17,297     |   | $ | — |   | $ | — |   | $ | — |   | $ | 17,297 |   |
| Interest-bearing deposits in other banks              |       | 9,354                                                       |       | — |   | — |   | — |   | 9,354 |   |
| Investment securities(1)                              |       | 711                                                         |       | 4,393 |   | 4,464 |   | 14,938 |   | 24,506 |   |
| Loans                                                 |       | 51,917                                                      |       | 36,404 |   | 53,842 |   | 17,171 |   | 159,334 |   |
| Total  interest-earning assets                        |       | 79,279                                                      |       | 40,797 |   | 58,306 |   | 32,109 |   | 210,491 |   |
|                                                  |       |                                                        |       |   |   |   |   |   |   |   |   |
| Liabilities                                           |       |                                                        |       |   |   |   |   |   |   |   |   |
| Savings and NOW Accounts                              |       | 1,165                                                       |       | 2,330 |   | 2,330 |   | 17,479 |   | 23,304 |   |
| Money Market Accounts                                 |       | 1,583                                                       |       | 3,166 |   | 3,166 |   | 23,746 |   | 31,661 |   |
| Certificates of Deposit                               |       | 74,100                                                      |       | 34,834 |   | 5,759 |   | — |   | 114,693 |   |
| Short-term borrowings                                 |       | 450                                                         |       | — |   | — |   | — |   | 450 |   |
| Long-term debt                                        |       | 250                                                         |       | — |   | — |   | — |   | 250 |   |
| Total  interest-bearing liabilities                   |       | 77,548                                                      |       | 40,330 |   | 11,255 |   | 41,225 |   | 170,358 |   |
| Interest rate  sensitivity gap                        |       | $                                                           | 1,731      |   | $ | 467 |   | $ | 47,051 |   | $ | (9,116 | ) | $ | 40,133 |   |
| Cumulative  interest rate sensitivity gap             |       | $                                                           | 1,731      |   | $ | 2,198 |   | $ | 49,249 |   | $ | 40,133 |   |   |   |
| Cumulative gap ratio as  a percentage of total assets |       | 0.79                                                        | %          | 1.00 | % | 22.34 | % | 18.21 | % |   |   |

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(1)             Excludesequity securities.

In addition to theInterest Rate Sensitivity Gap Analysis, the Company also uses an earningssimulation model on a quarterly basis to closely monitor interest sensitivityand to expose its balance sheet and income statement to different scenarios. Themodel is based on current Company data and adjusted by assumptions as to growthpatterns, noninterest income and noninterest expense and interest ratesensitivity, based on historical data, for both assets and liabilitiesprojected for a one-year period. The model is then subjected to a “shock test”assuming a sudden interest rate increase of 200 basis points or a decrease of200 basis points, but not below zero. The results show that with a 200 basispoint rise in interest rates the Company’s net interest income would decline by8.41% and net income would decline by 18.05%. With a decrease in interest ratesof 200 basis points the Company’s net interest income would increase by 5.40%and net income would increase by 11.58%.

Certainshortcomings are inherent in this method of analysis. For example, althoughcertain assets and liabilities may have similar maturities or repricingperiods, they may react in different degrees to changes in market interestrates. Also, the interest rates on certain types of assets and liabilities mayfluctuate in advance of changes in market interest rates, while interest rateson other types may lag behind changes in market rates. Additionally, certainassets, such as adjustable-rate mortgage loans, have features that restrictchanges in interest rates on a short-term basis and over the life of the loan. Further,in the event of a change in interest rates, prepayment and early withdrawallevels could deviate significantly from those assumed. Finally, the ability ofmany borrowers to service their debt may decrease in the event of a significantinterest rate increase.

**Critical Accounting Policy:**

**Allowancefor Loan Losses**

The Company makesprovisions for loan losses in amounts deemed necessary to maintain theallowance for loan losses at an appropriate level. The provision for loanlosses is determined based upon Management’s estimate of the amount required tomaintain an adequate allowance for loan losses reflective of the risks in theCompany’s loan portfolio. The Company’s provision for loan losses for the firstthree months of 2006 and 2005 were $60,000 and $150,000, respectively. The loangrowth was $3.99 million for the first three months of 2006 as compared to$4.36 million for the same period in 2005. Due to the increased exposure tocommercial

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and commercial realestate loans in early 2005, Management deemed it necessary to increase theprovision for loan losses during the first quarter of 2005. During 2006,Management feels that it is not necessary to have as large of a provision asthe prior year, even though the new loan volume is about the same. At March 31,2006 and December 31, 2005, the allowance for loan losses was $2.01million and $1.95 million, respectively.

TheCompany prepares a quarterly analysis of the allowance for loan losses, withthe objective of quantifying portfolio risk into a dollar amount of inherentlosses. The determination of the allowance for loan losses is based on eightqualitative factors and one quantitative factor for each category and type ofloan along with any specific allowance for adversely classified loans withineach category. Each factor is assigned a percentage weight and that totalweight is applied to each loan category. Factors are different for eachcategory. Qualitative factors include: levels and trends in delinquencies andnonaccrual loans; trends in volumes and terms of loans; effects of any changesin lending policies, the experience, ability and depth of management; nationaland local economic trends and conditions; concentrations of credit; quality ofthe Company’s loan review system; and regulatory requirements. The totalallowance required thus changes as the percentage weight assigned to eachfactor increased or decreased due to the particular circumstances, as thevarious types and categories of loans change as a percentage of total loans andas specific allowances are required due to increases in adversely classified loans.

Theallowance for loan losses is established as losses are estimated to haveoccurred through a provision for loan losses charged to earnings. The allowanceis based on two basic principles of accounting: (i) SFAS No. 5, *Accounting for Contingencies*, whichrequires that losses be accrued when they are probable of occurring andestimatable and (ii) SFAS No. 114, *Accountingby Creditors for Impairment of a Loan*, which requires that losses beaccrued based on the differences between the loan balance and either the valueof collateral, or the present value of future cash flows, or the loan’s valueas observable in the secondary market. A loan is considered impaired when,based on current information and events, it is probable that the Bank will beunable to collect the scheduled payments of principal or interest when dueaccording to the contractual terms of the loan agreement. Factors considered byManagement in determining impairment include payment status, collateral value,and the probability of collecting scheduled principal and interest paymentswhen due. Loans that experience insignificant payment delays and paymentshortfalls generally are not classified as impaired. Management determines thesignificance of payment delays and payment shortfalls on a case-by-case basis.,taking into consideration all of the circumstances surrounding the loan andborrower, including the length of the delay, the reason for the delay, theborrower’s prior payment record, and the amount of the shortfall in relation tothe principal and interest owed. The provision for loan losses included in thestatements of operations serve to maintain the allowance at a level Managementconsiders adequate.

TheCompany’s allowance for loan losses has three basic components: the specificallowance, the formula allowance and the pooled allowance. Each of thesecomponents is determined based upon estimates that can and do change when theactual events occur. As a result of the uncertainties inherent in theestimation process, Management’s estimate of loan losses and the relatedallowance could change in the near term.

Thespecific allowance component is used to individually establish an allowance forloans identified for impairment testing. When impairment is identified, aspecific reserve may be established based on the Company’s calculation of theestimated loss embedded in the individual loan. Impairment testing includesconsideration of the borrower’s overall financial condition, resources andpayment record, support available from financial guarantors and the fair marketvalue of collateral. These factors are combined to estimate the probability andseverity of inherent losses. Large groups of smaller balance, homogeneous loansare collectively evaluated for impairment. Accordingly, the Company does notseparately identify individual consumer and residential loans for impairment.  At March 31, 2006 there were no loansdeemed to be impaired.

Theformula allowance component is used for estimating the loss on internally riskrated loans and those loans identified for impairment testing. The loansmeeting the Company’s internal criteria for classification, such as specialmention, substandard, doubtful and loss are segregated from performing loanswithin the portfolio. These internally classified loans are then grouped byloan type (commercial, commercial real estate, commercial construction,residential real estate, residential construction or installment). Each loantype is assigned an allowance factor based on Management’s estimate of the associatedrisk, complexity and size of the individual loans within the particular loancategory. Classified loans are assigned a higher allowance factor thannon-classified loans due to Management’s concerns regarding collectability orManagement’s knowledge of particular elements surrounding the borrower.Allowance factors increase with the worsening of the internal risk rating.

Thepooled formula component is used to estimate the losses inherent in the poolsof non-classified loans. These loans are then also segregated by loan type andallowance factors are assigned by Management based on delinquencies, losshistory, trends in volume and terms of loans, effects of changes in lendingpolicy, the experience and depth of Management, national and local economic trends,concentrations of credit, quality of loan review system and the effect ofexternal factors (i.e. competition and regulatory requirements). The allowancefactors assigned differ by loan type.

Allowancefactors and overall size of the allowance may change from period to periodbased on Management’s assessment of the above-described factors and therelative weights given to each factor. In addition, various regulatory agenciesperiodically review the

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allowancefor loan losses. These agencies may require the Bank to make additions to theallowance for loan losses based on their judgments of collectibility based oninformation available to them at the time of their examination.

Managementbelieves that the allowance for loan losses is adequate. There can be noassurance, however, that additional provisions for loan losses will not berequired in the future, including as a result of changes in the economicassumptions underlying Management’s estimates and judgments, adversedevelopments in the economy, on a national basis or in the Company’s marketarea, or changes in the circumstances of particular borrowers.

As ofMarch 31, 2006, the real estate loan portfolio constituted 84% of thetotal loan portfolio. While this exceeds the 10% threshold for determining aconcentration of credit risk within an industry, we do not consider this to bea concentration with adverse risk characteristics given the diversity ofborrowers within the real estate portfolio and other sources of repayment. Anindustry for this purpose is defined as a group of counterparties that areengaged in similar activities and have similar economic characteristics thatwould cause their ability to meet contractual obligations to be similarlyaffected by changes in economic or other conditions. Additionally, the loanportfolio does not include concentrations of credit risk in loan products thatpermit the deferral of principal payments that are smaller than normal interestaccruals (negative amortization); loans with high loan-to-value ratios; orloans, such as option adjustable-rate mortgages, that may expose the borrowerto future increases in repayments that are in excess of increases that wouldresult solely from increases in market interest rates.  The Company has $6.00 million of interest onlyhome equity lines of credit at March 31, 2006.
| ** **                                     | ** ** | **March 31,** | ** ** |
|------------------------------------------------|------------|--------------------|------------|
| **(*dollars in thousands)***         | ** ** | **2006**           | ** ** | **2005** | ** ** |
| Balance at  beginning of period                |       | $                  | 1,953      |   | $ | 1,503 |   |
| Provision  charged to operating expenses       |       | 60                 |       | 150 |   |
| Recoveries of  loans previously charged-off    |       | —             |       | — |   |
| Loans  charged-off                             |       | —             |       | — |   |
| Balance at end  of period                      |       | $                  | 2,013      |   | $ | 1,653 |   |
| Average total loans  outstanding during period |       | $                  | 157,145    |   | $ | 136,935 |   |

 

The allocation of the allowance, presented in the following table, isbased primarily on the factors discussed above in evaluating the adequacy ofthe allowance as a whole. Since all of those factors are subject to change, theallocation is not necessarily indicative of the category of recognized loanlosses, and does not restrict the use of the allowance to absorb losses in anycategory.

** **
| **Allocation of Allowance for Loan Losses**        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                  | ** ** | **2006**           | ** ** | **% of  Loans**  | ** ** | **2005** | ** ** | **% of  Loans** | ** ** |
| Real  estate-construction                                                   |       | $                  | 306        |                  | 23         | % | $ | 318 |   | 19 | % |
| Real  estate-mortgage                                                       |       | 1,270              |       | 61                    | %          | 1,171 |   | 64 | % |
| Commercial and  industrial loans                                            |       | 380                |       | 14                    | %          | 408 |   | 16 | % |
| Loans to  individuals for household, family and other personal expenditures |       | 57                 |       | 2                     | %          | 56 |   | 1 | % |
|                                                                        |       | $                  | 2,013      |                  | 100        | % | $ | 1,953 |   | 100 | % |

** **
| ** **                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Nonaccrual loans                      |       | $                  | 7          |                  | $          | 8 |   |
| Loans 90 days  past due               |       | —             |       | —                |       |
| Total nonperforming loans             |       | 7                  |       | 8                     |       |
| Other real  estate owned              |       | —             |       | —                |       |
| Total nonperforming assets            |       | $                  | 7          |                  | $          | 8 |   |
| Nonperforming assets to  total assets |       | 0.00               | %          | 0.00                  | %          |

 

There were noother interest-bearing assets at March 31, 2006 or December 31, 2005classified as past due 90 days or more and still accruing, restructured orproblem assets, and no loans which were currently performing in accordance withtheir terms, but as to which information known to Management caused it to haveserious doubts about the ability of the borrower to comply with the loan ascurrently written.

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**Off-Balance Sheet Arrangements**

The Company is aparty to financial instruments with off-balance sheet risk in the normal courseof business to meet the financing needs of its customers. These financialinstruments include commitments to extend credit, including unused portions oflines of credit, and standby letters of credit. The Company has also enteredinto long-term lease obligations for some of its premises and equipment, theterms of which generally include options to renew. The above instruments andobligations involve, to varying degrees, elements of off-balance sheet risk inexcess of the amount recognized in the consolidated statements of financialcondition. None of these instruments or obligations have or are reasonablylikely to have a current or future effect on the Company’s financial condition,revenues or expenses, results of operations, liquidity, capital expenditures orcapital resources that is material to investors.

Commitments to extend credit and standby letters ofcredit as of March 31, 2006 were as follows:

 
| ** **                                                                       | ** ** | **March 31,**      | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                       | ** ** | **2006**                | ** ** |
| ***(dollars in thousands)***                                           | ** ** | **Contractual  Amount** | ** ** |
| Financial instruments  whose notional or contract amounts represent credit risk: |       |                    |       |
| Commitments to extend credit                                                     |       | $                       | 29,286     |   |
| Standby letters  of credit                                                       |       | 2,451                   |       |
| Total                                                                            |       | $                       | 31,737     |   |

 

See Note 8 to the Notes to the Consolidated Financial Statementsincluded in the Company’s Annual Report on Form 10-K for the yearended December 31, 2005 for additional information regarding the Company’slong-term lease obligations.

**CapitalResources**

The ability of theCompany to grow is dependent on the availability of capital with which to meetregulatory requirements, discussed below. To the extent the Company issuccessful it may need to acquire additional capital through the sale ofadditional common stock, other qualifying equity instruments or subordinateddebt, or through incurrence of debt which does not qualify as holding companycapital, but which can be contributed as capital to the Bank or utilized forother corporate purposes. There can be no assurance that additional capitalwill be available to the Company on a timely basis or on attractive terms. At March 31,2006, the Company had an outstanding unsecured loan from an unaffiliated thirdparty in the amount of $450,000 with a fixed interest rate of 6.00% and matureson January 27, 2007. In addition, the Company has an unsecured revolvingline of credit borrowing arrangement with an unaffiliated financial institutionin the amount of $2.00 million with an outstanding balance of $250,000 as of March 31,2006. This facility matures on May 1, 2007, has a floating interest rateequal to the Wall Street Journal Prime Rate and requires monthly interestpayments only. The purpose of this facility is to provide capital to the Bank,as needed.

The Board of Directors ofthe Company has authorized management to investigate and take such actions asmay be necessary to effect a private issuance of up to $5.0 million of trustpreferred securities at such time as management shall deem appropriate. TheCompany has not determined when such securities would be issued, and the termsof such securities would be subject to determination at the time of issuance. Therecan be no assurance that the Company will issue any trust preferred securities.

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies. Failure to meet minimum capital requirements caninitiate certain mandatory - and possibly additional discretionary - actions byregulators that, if undertaken, could have a direct material effect on theCompany’s financial statements. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company and the Bankmust meet specific capital guidelines that involve quantitative measures of theCompany’s and the Bank’s assets, liabilities, and certain off-balance-sheetitems as calculated under regulatory accounting practices. The Company’s and theBank’s capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.

Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum amounts and ratios of total and Tier 1capital (as defined in the regulations) to risk-weighted assets (as defined),and Tier 1 capital (as defined) to average assets (as defined).  Management believes that the Company and theBank met all capital adequacy requirements to which they are subject as of March 31,2006. See Note 8 to the unauditedconsolidated financial statements for a table depicting compliance withregulatory capital requirements.

As of March 31,2006, the most recent notification from the regulatory agency categorized theBank as well capitalized under the regulatory framework for prompt correctiveaction. To be categorized as well capitalized the Bank must maintain minimumtotal risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth inthe table in Note 8. There are no conditions or events since that notificationwhich Management believes have changed the Bank’s category.

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Additionally, theCompany has not repurchased any outstanding shares of its common stock, nordoes it have an approved repurchase program at this time.

**Inflation**

The effect of changing prices on financialinstitutions is typically different than on non-banking companies sincevirtually all of a Company’s assets and liabilities are monetary in nature. Inparticular, interest rates are significantly affected by inflation, but neitherthe timing nor magnitude of the changes are directly related to price levelindices; therefore, the Company can best counter inflation over the long termby managing net interest income and controlling net increases in noninterestincome and expenses.

**Item3.**                       Quantitativeand Qualitative Disclosures About Market Risk

See “Market Risk, Liquidity and Interest Rate Sensitivity” at Page 17.

**Item4.**                          Controlsand Procedures

The Company’s management, under the supervision andwith the participation of the Company’s Chief Executive Officer and ChiefFinancial Officer, evaluated, as of the last day of the period covered by thisreport, the effectiveness of the design and operation of the Company’sdisclosure controls and procedures, as defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934. Based on that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were effective. There were no changes in theCompany’s internal control over financial reporting (as defined in Rule 13a-15under the Securities Act of 1934) during the quarter ended March 31, 2006that has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

**PART II — Other Information**

**Item 1.**                       LegalProceedings    None

**Item 1A. RiskFactors   There have been no materialchanges to the risk factors as of March 31, 2006 from those disclosed inthe Company’s 2005Annual Report on Form 10-K.**

**Item 2**                          UnregisteredSales of Equity Securities and Use of Proceeds

(a)            Salesof Unregistered Securities.   None

(b)           *Use of Proceeds.*Not Applicable.

(c)            *Registrant**Purchases of Securities   *None

**Item 3.**                          Defaultsupon Senior Securities    None

**Item 4.**                          Submissionof Matters to a Vote of Security Holders    None

**Item 5.**                          OtherInformation

(a)            Information which should have been Reported on Form 8-K.   None

(b)           Material Changes to Procedures for Director Nomination by Shareholders.   None

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**Item 6. Exhibits**
| Exhibit No. | ** ** | **Description  of Exhibits**                                                                                                                           | ** ** | ** ** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 3(a)             |       | Articles of Incorporation of the Company, as  amended(1)                                                                                               |       |       |
| 3(b)             |       | Bylaws of the Company(2)                                                                                                                               |       |       |
| 10(a)            |       | 2001 Stock Option Plan(3)                                                                                                                              |       |       |
| 10(b)            |       | Employment Agreement between the Bank and Martin S.  Lapera(4)                                                                                         |       |       |
| 10(c)            |       | Employment Agreement between the Bank and William R.  Talley, Jr. (5)                                                                             |       |       |
| 10(d)            |       | Consulting Agreement between the Bank and Raymond  Raedy (6)                                                                                           |       |       |
| 10(e)            |       | 2002 Executive and Director Deferred Compensation  Plan (7)                                                                                            |       |       |
| 10(f)            |       | Amendment No. 1 to the 2002 Executive and  Director Deferred Compensation Plan (7)                                                                |       |       |
| 10(g)            |       | Loan Agreement with Atlantic Central Bankers Bank(8)                                                                                                   |       |       |
| 10(h)            |       | Promissory Note with Atlantic Central Bankers Bank  (8)                                                                                                |       |       |
| 11               |       | Statement Regarding Computation of Per Share Income  — Please refer to Note 2 to the unaudited consolidated financial statements  included herein |       |       |
| 31(a)            |       | Certification of Martin S. Lapera, President and  Chief Executive Officer                                                                              |       |       |
| 31(b)            |       | Certification of William R. Talley, Jr.,  Executive Vice President and Chief Financial Officer                                                    |       |       |
| 32(a)            |       | Certification of Martin S. Lapera, President and  Chief Executive Officer                                                                              |       |       |
| 32(b)            |       | Certification of William R. Talley, Jr.,  Executive Vice President and Chief Financial Officer                                                    |       |       |

 

(1)             Incorporatedby reference to exhibit of the same number to the Company’s Quarterly Report onForm 10-QSB for the quarter ended March 31, 2004, as filed withthe Securities and Exchange Commission.

(2)             Incorporatedby reference to exhibit of the same number to the Company’s Quarterly Report onForm 10-QSB for the quarter ended September 30, 2003, as filedwith the Securities and Exchange Commission.

(3)             Incorporatedby reference to exhibit 4 to the Company’s Registration Statement on Form S-8(No. 333-111761).

(4)             Incorporatedby reference to Exhibit 10.1 to the Company’s Current Report on Form 8-Kfiled on May 24, 2005.

(5)             Incorporatedby reference to Exhibit 10.2 to the Company’s Current Report on Form 8-Kfiled on May 24, 2005.

(6)             Incorporatedby reference to exhibit of the same number to the Bank’s Registration Statementon Form 10-SB as filed with the Board of Governors of the FederalReserve System.

(7)             Incorporatedby reference to exhibit of the same number to the Company’s Annual Report on Form 10-KSBfor the year ended December 31, 2004, as filed with the Securities andExchange Commission.

(8)             Incorporatedby reference to exhibit of the same number to the Company’s Quarterly Report onForm 10-QSB for the quarter ended March 31, 2005, as filed withthe Securities and Exchange Commission.

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**SIGNATURES**

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto duly authorized.
|                |   | FREDERICK COUNTY BANCORP, INC                        |
|----------------|--------|------------------------------------------------------|
|           |   |                                                 |
|           |   |                                                 |
| Date: 05/04/06 | By:    | /s/ Martin S. Lapera                                 |
|           |   | Martin S. Lapera                                     |
|           |   | President and Chief Executive Officer                |   |
|           |   |                                                 |
|           |   |                                                 |
|           |   |                                                 |
| Date: 05/04/06 | By:    | /s/ William R. Talley, Jr.                      |
|           |   | William R. Talley, Jr.                          |
|           |   | Executive Vice President and Chief Financial Officer |

 

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