**Table ofContents**

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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

** **

**FORM 10-Q**

 

**(MARKONE)**

 
| **x**                                                  | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|--------------------------------------------------------|-----------------------------------------------------------------------------------------------------|
|                                                   |                                                                                                |
| **For  the Quarterly Period Ended June 30, 2009** |
|                                                   |                                                                                                |
| **OR**                                                 |
|                                                   |                                                                                                |
| **o**                                                  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

 

**For the transition period from                  to                  **

 

**Commission File Number:  000-50407**

 

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

(Exactname of registrant as specified in its charter)

 

| **Maryland**                     | ** ** | **20-0049496**       |
|----------------------------------|------------|----------------------|
| (State of other  jurisdiction of |       | (I.R.S. Employer     |
| incorporation or  organization)  |       | Identification  No.) |

 

#### **30 West Patrick Street**

**Frederick, Maryland 21701**

(Address of registrant’s principal executive offices)

 

**301.620.1400**

 (Registrant’s telephone number, including areacode)

 

**N/A**

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  x Yes o No

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this Chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files).  x Yes o No

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

| Large  accelerated filer o |   | Accelerated  filer o         |
|----------------------------|--------|------------------------------|
| Non-accelerated  filer o   |   | Smaller  reporting company x |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  o Yes xNo

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practical date.  There were1,460,802 shares of Common Stock outstanding as of July 31, 2009.

 

 

 

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Table of Contents

 

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

**TABLEOF CONTENTS**

 
| **PART I**  | **FINANCIAL INFORMATION**                                                                                                 |   |
|------------------|---------------------------------------------------------------------------------------------------------------------------|--------|
|             |                                                                                                                      |   |
| Item 1.          | Financial  Statements (Unaudited)                                                                                         |   |
|             |                                                                                                                      |   |
|             | Consolidated****Balance Sheets, June 30, 2009 and  December 31, 2008                                            |   |
|             |                                                                                                                      |   |
|             | Consolidated  Statements of Income, Three and Six Months Ended June 30, 2009 and 2008                                |   |
|             |                                                                                                                      |   |
|             | Consolidated  Statements of Changes in Shareholders’ Equity, Three and Six Months Ended  June 30, 2009 and 2008 |   |
|             |                                                                                                                      |   |
|             | Consolidated Statements of Cash Flows, Six Months  Ended June 30, 2009 and 2008                                      |   |
|             |                                                                                                                      |   |
|             | 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                                                               |   |
|             |                                                                                                                      |   |
| 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                                                                                                                |   |

 

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Table of Contents

 

**FrederickCounty Bancorp, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)**                                                                                                        | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                  | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                      |       |              |       |                  |       |
| Cash  and due from banks                                                                                                                    |       | $                 | 815        |                  | $          | 808 |   |
| Federal  funds sold                                                                                                                         |       | 453               |       | 1,091                 |       |
| Interest-bearing  deposits in other banks                                                                                                   |       | 29,678            |       | 14,156                |       |
| Cash  and cash equivalents                                                                                                                  |       | 30,946            |       | 16,055                |       |
| Investment  securities available-for-sale at fair value                                                                                     |       | 14,458            |       | 20,040                |       |
| Restricted  stock                                                                                                                           |       | 1,566             |       | 1,599                 |       |
| Loans                                                                                                                                       |       | 206,929           |       | 211,840               |       |
| Less:  Allowance for loan losses                                                                                                            |       | (3,038            | )          | (3,120                | )          |
| Net  loans                                                                                                                                  |       | 203,891           |       | 208,720               |       |
| Bank  premises and equipment                                                                                                                |       | 5,092             |       | 5,221                 |       |
| Other  assets                                                                                                                               |       | 2,295             |       | 2,927                 |       |
| Total  assets                                                                                                                               |       | $                 | 258,248    |                  | $          | 254,562 |   |
|                                                                                                                                        |       |              |       |                  |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                  |       |              |       |                  |       |
|                                                                                                                                        |       |              |       |                  |       |
| **Liabilities**                                                                                                                             |       |              |       |                  |       |
| Deposits:                                                                                                                                   |       |              |       |                  |       |
| Noninterest-bearing  deposits                                                                                                               |       | $                 | 35,837     |                  | $          | 32,740 |   |
| Interest-bearing  deposits                                                                                                                  |       | 184,353           |       | 184,143               |       |
| Total  deposits                                                                                                                             |       | 220,190           |       | 216,883               |       |
| Long-term  borrowings                                                                                                                       |       | 10,000            |       | 10,000                |       |
| Junior  subordinated debentures                                                                                                             |       | 6,186             |       | 6,186                 |       |
| Accrued  interest and other liabilities                                                                                                     |       | 925               |       | 881                   |       |
| Total  liabilities                                                                                                                          |       | 237,301           |       | 233,950               |       |
|                                                                                                                                        |       |              |       |                  |       |
| **Shareholders’ Equity**                                                                                                               |       |              |       |                  |       |
| Common  stock, per share par value $.01; 10,000,000 shares authorized; 1,460,802 and  1,460,802 shares issued and outstanding, respectively |       | 15                |       | 15                    |       |
| Additional  paid-in capital                                                                                                                 |       | 14,690            |       | 14,690                |       |
| Retained  earnings                                                                                                                          |       | 6,223             |       | 5,939                 |       |
| Accumulated  other comprehensive income (loss)                                                                                              |       | 19                |       | (32                   | )          |
| Total  shareholders’ equity                                                                                                            |       | 20,947            |       | 20,612                |       |
| Total  liabilities and shareholders’ equity                                                                                            |       | $                 | 258,248    |                  | $          | 254,562 |   |

 

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

 

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**FrederickCounty Bancorp, Inc. and Subsidiaries**

**Consolidated Statements of Income (Unaudited)**

 
| ** **                                             | ** ** | **For the Three****Months Ended June 30,** | ** ** | **For the Six****Months Ended June 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(dollars  in thousands, except per share amounts)**  | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest  income:                                      |       |                                            |       |                                          |       |   |   |   |   |
| Interest  and fees on loans                            |       | $                                               | 3,230      |                                          | $          | 3,437 |   | $ | 6,443 |   | $ | 7,047 |   |
| Interest  and dividends on investment securities:      |       |                                            |       |                                          |       |   |   |   |   |
| Interest  — taxable                               |       | 156                                             |       | 203                                           |       | 328 |   | 401 |   |
| Interest  — tax exempt                            |       | 58                                              |       | 99                                            |       | 116 |   | 198 |   |
| Dividends                                              |       | 12                                              |       | 21                                            |       | 23 |   | 43 |   |
| Interest  on federal funds sold                        |       | —                                          |       | 57                                            |       | 1 |   | 134 |   |
| Other  interest income                                 |       | 12                                              |       | 22                                            |       | 21 |   | 32 |   |
| Total  interest income                                 |       | 3,468                                           |       | 3,839                                         |       | 6,932 |   | 7,855 |   |
| Interest  expense:                                     |       |                                            |       |                                          |       |   |   |   |   |
| Interest  on deposits                                  |       | 1,165                                           |       | 1,595                                         |       | 2,414 |   | 3,369 |   |
| Interest  on long-term borrowings                      |       | 115                                             |       | 116                                           |       | 229 |   | 231 |   |
| Interest  on junior subordinated debentures            |       | 101                                             |       | 101                                           |       | 202 |   | 202 |   |
| Total  interest expense                                |       | 1,381                                           |       | 1,812                                         |       | 2,845 |   | 3,802 |   |
| Net  interest income                                   |       | 2,087                                           |       | 2,027                                         |       | 4,087 |   | 4,053 |   |
| Provision  for loan losses                             |       | 200                                             |       | 120                                           |       | 600 |   | 240 |   |
| Net  interest income after provision for loan losses   |       | 1,887                                           |       | 1,907                                         |       | 3,487 |   | 3,813 |   |
| Noninterest  income:                                   |       |                                            |       |                                          |       |   |   |   |   |
| Securities  gains                                      |       | 117                                             |       | —                                        |       | 117 |   | — |   |
| (Loss)  gain on sale of foreclosed properties          |       | —                                          |       | —                                        |       | (32 | ) | 15 |   |
| Service  fees                                          |       | 85                                              |       | 61                                            |       | 169 |   | 120 |   |
| Other  operating income                                |       | 49                                              |       | 68                                            |       | 105 |   | 145 |   |
| Total  noninterest income                              |       | 251                                             |       | 129                                           |       | 359 |   | 280 |   |
| Noninterest  expense:                                  |       |                                            |       |                                          |       |   |   |   |   |
| Salaries  and employee benefits                        |       | 911                                             |       | 960                                           |       | 1,890 |   | 1,919 |   |
| Occupancy  and equipment expenses                      |       | 328                                             |       | 298                                           |       | 659 |   | 597 |   |
| Other  operating expenses                              |       | 543                                             |       | 392                                           |       | 916 |   | 780 |   |
| Total  noninterest expense                             |       | 1,782                                           |       | 1,650                                         |       | 3,465 |   | 3,296 |   |
| Income  before provision for income taxes              |       | 356                                             |       | 386                                           |       | 381 |   | 797 |   |
| Provision  for income tax expense                      |       | 117                                             |       | 116                                           |       | 97 |   | 228 |   |
| Net  income                                            |       | $                                               | 239        |                                          | $          | 270 |   | $ | 284 |   | $ | 569 |   |
| Basic  earnings per share                              |       | $                                               | 0.16       |                                          | $          | 0.18 |   | $ | 0.19 |   | $ | 0.39 |   |
| Diluted  earnings per share                            |       | $                                               | 0.16       |                                          | $          | 0.18 |   | $ | 0.19 |   | $ | 0.38 |   |
| Basic  weighted average number of shares outstanding   |       | 1,460,802                                       |       | 1,460,602                                     |       | 1,460,802 |   | 1,460,602 |   |
| Diluted  weighted average number of shares outstanding |       | 1,481,786                                       |       | 1,507,087                                     |       | 1,478,696 |   | 1,508,066 |   |

 

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

 

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**FrederickCounty Bancorp, Inc. and Subsidiaries**

**Consolidated Statement of Changes in Shareholders’Equity****(Unaudited)**

 
| **Three Months Ended June 30,  (dollars in thousands, except****shares outstanding)**                | ** ** | **Shares****Outstanding** | ** ** | **Common****Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained****Earnings** | ** ** | **Accumulated****Other Comprehensive  Income (Loss)** | ** ** | **Total****Shareholders’ Equity** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------|------------|----------------------------------|------------|--------------------------|------------|-------------------------------------------------------|------------|----------------------------------------|------------|
|                                                                                                 |       |                      |       |                |       |                             |       |                     |       |                                                  |       |                                   |       |
| Balance,  April 1, 2008                                                                         |       | 1,460,602                 |       | $                   | 15         |                             | $          | 14,687                   |       | $                                                     | 5,200      |                                   | $          | 206 |   | $ | 20,108 |   |
| Comprehensive  income:                                                                               |       |                      |       |                |       |                             |       |                     |       |                                                  |       |                                   |       |
| Net  income                                                                                          |       | —                    |       | —              |       | —                           |       | 270                      |       | —                                                |       | 270                                    |       |
| Changes  in net unrealized gains on securities available for sale, net of income taxes  of $205      |       | —                    |       | —              |       | —                           |       | —                   |       | (314                                                  | )          | (314                                   | )          |
| Comprehensive  income                                                                                |       |                      |       |                |       |                             |       |                     |       |                                                  |       | (44                                    | )          |
| Balance,  June 30, 2008                                                                         |       | 1,460,602                 |       | $                   | 15         |                             | $          | 14,687                   |       | $                                                     | 5,470      |                                   | $          | (108 | ) | $ | 20,064 |   |
| Balance,  April 1, 2009                                                                         |       | 1,460,802                 |       | $                   | 15         |                             | $          | 14,690                   |       | $                                                     | 5,984      |                                   | $          | 104 |   | $ | 20,793 |   |
| Comprehensive  income:                                                                               |       |                      |       |                |       |                             |       |                     |       |                                                  |       |                                   |       |
| Net  income                                                                                          |       | —                    |       | —              |       | —                           |       | 239                      |       | —                                                |       | 239                                    |       |
| Reclassification  adjustment for (gains) losses realized, net of income taxes of $46                 |       |                      |       |                |       |                             |       |                     |       | (71                                                   | )          | (71                                    | )          |
| Changes  in net unrealized gains on securities available for sale, net of income tax  benefits of $9 |       | —                    |       | —              |       | —                           |       | —                   |       | (14                                                   | )          | (14                                    | )          |
| Comprehensive  income                                                                                |       |                      |       |                |       |                             |       |                     |       |                                                  |       | 154                                    |       |
| Balance,  June 30, 2009                                                                         |       | 1,460,802                 |       | $                   | 15         |                             | $          | 14,690                   |       | $                                                     | 6,223      |                                   | $          | 19 |   | $ | 20,947 |   |

 

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**FrederickCounty Bancorp, Inc. and Subsidiaries**

**Consolidated Statement of Changes in Shareholders’Equity****(Unaudited)**

 
| **Six Months Ended June 30,  (dollars in thousands, except****shares outstanding)**              | ** ** | **Shares****Outstanding** | ** ** | **Common****Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained****Earnings** | ** ** | **Accumulated****Other Comprehensive Income  (Loss)** | ** ** | **Total****Shareholders’ Equity** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------|------------|----------------------------------|------------|--------------------------|------------|------------------------------------------------------------|------------|----------------------------------------|------------|
|                                                                                                  |       |                      |       |                |       |                             |       |                     |       |                                                       |       |                                   |       |
| Balance,  January 1, 2008                                                                        |       | 1,460,602                 |       | $                   | 15         |                             | $          | 14,687                   |       | $                                                          | 4,901      |                                   | $          | (23 | ) | $ | 19,580 |   |
| Comprehensive  income:                                                                                |       |                      |       |                |       |                             |       |                     |       |                                                       |       |                                   |       |
| Net  income                                                                                           |       | —                    |       | —              |       | —                           |       | 569                      |       | —                                                     |       | 569                                    |       |
| Changes  in net unrealized gains on securities available for sale, net of income tax  benefits of $55 |       | —                    |       | —              |       | —                           |       | —                   |       | (85                                                        | )          | (85                                    | )          |
| Comprehensive  income                                                                                 |       |                      |       |                |       |                             |       |                     |       |                                                       |       | 484                                    |       |
| Balance,  June 30, 2008                                                                          |       | 1,460,602                 |       | $                   | 15         |                             | $          | 14,687                   |       | $                                                          | 5,470      |                                   | $          | (108 | ) | $ | 20,064 |   |
| Balance,  January 1, 2009                                                                        |       | 1,460,802                 |       | $                   | 15         |                             | $          | 14,690                   |       | $                                                          | 5,939      |                                   | $          | (32 | ) | $ | 20,612 |   |
| Comprehensive  income:                                                                                |       |                      |       |                |       |                             |       |                     |       |                                                       |       |                                   |       |
| Net  income                                                                                           |       | —                    |       | —              |       | —                           |       | 284                      |       | —                                                     |       | 284                                    |       |
| Reclassification  adjustment for (gains) losses realized, net of income taxes of $46                  |       |                      |       |                |       |                             |       |                     |       | (71                                                        | )          | (71                                    | )          |
| Changes  in net unrealized gains on securities available for sale, net of income taxes  of $79        |       |                      |       |                |       |                             |       |                     |       | 122                                                        |       | 122                                    |       |
| Comprehensive  income                                                                                 |       | —                    |       | —              |       | —                           |       | —                   |       | —                                                     |       | 335                                    |       |
| Balance,  June 30, 2009                                                                          |       | 1,460,802                 |       | $                   | 15         |                             | $          | 14,690                   |       | $                                                          | 6,223      |                                   | $          | 19 |   | $ | 20,947 |   |

 

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**Frederick County Bancorp, Inc. andSubsidiaries**

**ConsolidatedStatements of Cash Flows (Unaudited)**

 
| ** **                                                                                     | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(dollars in thousands)**                                                                     | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| Cash flows from operating  activities:                                                         |       |                               |       |   |   |
| Net income                                                                                     |       | $                                  |  284  |   | $ |  569 |   |
| Adjustments to reconcile net income to net cash  provided by  operating activities:            |       |                               |       |   |   |
| Depreciation and amortization                                                                  |       | 165                                |       | 166 |   |
| Deferred income taxes (benefits)                                                               |       | 58                                 |       | (12 | ) |
| Provision for loan losses                                                                      |       | 600                                |       | 240 |   |
| Securities gains                                                                               |       | (117                               | )          | — |   |
| Net premium amortization (discount accretion) on  investment  securities                       |       | 5                                  |       | (2 | ) |
| Loss (gain) on sale of foreclosed properties                                                   |       | 32                                 |       | (15 | ) |
| Decrease in accrued interest and other assets                                                  |       | 554                                |       | 368 |   |
| Increase in accrued interest and other liabilities                                             |       | 31                                 |       | 1,259 |   |
| Net cash provided by operating activities                                                      |       | 1,612                              |       | 2,573 |   |
| Cash flows from investing activities:                                                          |       |                               |       |   |   |
| Purchases of investment securities available for sale                                          |       | —                             |       | (3,053 | ) |
| Proceeds from sales of investment securities available  for sale                               |       | 4,115                              |       | — |   |
| Proceeds from maturities, prepayments and calls  investment  securities available for sale     |       | 1,663                              |       | 3,965 |   |
| Purchases of restricted stock                                                                  |       | 33                                 |       | (69 | ) |
| Net decrease (increase) in loans                                                               |       | 3,866                              |       | (1,704 | ) |
| Purchases of bank premises and equipment                                                       |       | (36                                | )          | (39 | ) |
| Proceeds from sale of foreclosed properties                                                    |       | 331                                |       | 465 |   |
| Net cash provided by (used in) investing activities                                            |       | 9,972                              |       | (435 | ) |
| Cash flows from financing activities:                                                          |       |                               |       |   |   |
| Net increase in NOW, money market accounts, savings  accounts and noninterest-bearing deposits |       | 8,703                              |       | 7,530 |   |
| Net decrease in time deposits                                                                  |       | (5,396                             | )          | (2,771 | ) |
| Net cash provided by financing activities                                                      |       | 3,307                              |       | 4,759 |   |
| Net increase in cash and cash equivalents                                                      |       | 14,891                             |       | 6,897 |   |
| Cash and cash equivalents — beginning of period                                           |       | 16,055                             |       | 12,366 |   |
| Cash and cash equivalents — end of period                                                 |       | $                                  | 30,946     |   | $ | 19,263 |   |
| Supplemental cash flow disclosures:                                                            |       |                               |       |   |   |
| Interest paid                                                                                  |       | $                                  | 2,877      |   | $ | 3,858 |   |
| Income taxes paid                                                                              |       | $                                  | 230        |   | $ | 254 |   |

 

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

 

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#### **FREDERICKCOUNTY BANCORP, INC.**

 

Notes to UnauditedConsolidated Financial Statements

 

**Note1.  General:**

 

Frederick County Bancorp, Inc. (the “Bancorp”), theparent company for its wholly-owned subsidiary Frederick County Bank (the “Bank”and together with Bancorp, the “Company”), was organized in September 2003.The Bank was incorporated under the laws of the state of Maryland in August 2000and commenced banking operations in October 2001.  The Bank provides its customers with variousbanking services.  The Bank offersvarious loan and deposit products to its customers.  The Bank’s customers include individuals andcommercial enterprises within its principal market area consisting of FrederickCounty, Maryland.  Additionally, the Bankmaintains correspondent banking relationships and transacts daily federal fundssales on an unsecured basis with regional correspondent banks.  Note 4 discusses the types of securities theBank invests in.  Note 5 discusses thetypes of lending that the Bank engages in. The Bank does not have any significant concentrations to any oneindustry or customer.  Bancorp also has asubsidiary called FCBI Statutory Trust I. See Note 7 for additional disclosures.

 

The accompanying unaudited consolidated financialstatements of the Company have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information, the instructions for Form 10-Q, Regulation S-X, andgeneral practices within the banking industry. Accordingly, they do not include all of the information and disclosuresrequired by generally accepted accounting principles for complete financialstatements.  These statements should beread in conjunction with the consolidated financial statements and accompanyingfootnotes included in the Company’s 2008 Annual Report on Form 10-K.  In the opinion of management, alladjustments, consisting of normal recurring adjustments, considered necessaryfor a fair presentation have been included. The results shown in this interim report are not necessarily indicativeof results to be expected for any other period or for the full year ending December 31,2009.  The Company has evaluatedsubsequent events for potential recognition and/or disclosure through August 7,2009, the date the consolidated financial statements included in this QuarterlyReport on Form 10-Q were issued.

 

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 andassumptions are based on information available as of the date of theconsolidated financial statements and could differ from actual results.

 

**Recent Accounting Pronouncements**

 

*Statement of Financial AccountingStandards No. 141 (Revised 2007), Business Combinations (“SFAS 141(R)”).* During December 2007, the FASBissued SFAS 141(R). SFAS 141(R) recognizes and measures the goodwillacquired in the business combination and defines a bargain purchase, andrequires the acquirer to recognize that excess as a gain attributable to theacquirer. In contrast, Statement 141 required the “negative goodwill” amount tobe allocated as a pro rata reduction of the amounts assigned to assetsacquired. SFAS 141(R) applies prospectively to business combinations forwhich the acquisition date is on or after December 15, 2008. The Companyadopted SFAS No. 141R effective March 31, 2009, and adoption did nothave a material impact on the Company’s consolidated financial statements.

 

*Statement of Financial AccountingStandards No. 160, Noncontrolling Interests in Consolidated FinancialStatements — an amendment of ARB No. 51 (“SFAS 160”).* During December 2007, the FASBissued SFAS 160 to establish accounting and reporting standards for thenoncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary. It clarifies that a noncontrolling interest in a subsidiary is anownership interest in the consolidated entity that should be reported as equityin the consolidated financial statement, but separate from the parent’sequity.  SFAS 160 is effective for fiscal years, and interim periodswithin those fiscal years, beginning on or after December 15, 2008.Management adopted this Statement effective March 31, 2009, and adoptiondid not have a material impact on the Company’s consolidated financialcondition or results of operations.

 

*Statement of Financial AccountingStandards No. 161, Disclosures about Derivative Instruments and HedgingActivities — an amendment of FASB Statement No. 133 (“SFAS 161”)* . SFAS 161 requires qualitativedisclosures about objectives and strategies for using derivative, quantitativedisclosures about fair value amounts of and gains and losses on derivativeinstruments, and disclosures about credit-risk-related contingent features inderivative agreements. SFAS 161 is effective for financial statements issuedfor fiscal years and interim periods beginning after November 15, 2008.Adoption of SFAS No. 161, effective January 1, 2009, did not have amaterial impact on the consolidated financial statements.

 

*Statement of Financial AccountingStandards, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”).* During May 2008, the FASB issuedSFAS 162. This Statement identifies the sources of accounting principles andthe framework for selecting

 

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the principles to be used in the preparation offinancial statements of nongovernmental entities that are presented inconformity with generally accepted accounting principles (GAAP) in the UnitedStates. Adoption of SFAS 162 was not a change in the Company’s currentaccounting practices; therefore, it did not have a material impact on theCompany’s consolidated financial condition or results of operations.

 

*FASB Staff Position EITF 03-6-1,Determining Whether Instruments Granted in Share-Based Payment Transactions areParticipating Securities (“FSP EITF 03-6-1”).* FSP EITF 03-6-1 requires companies to treat unvestedshare-based payment awards that have non-forfeitable rights to dividend ordividend equivalents as a separate class of securities in calculating earningsper share. FSP EITF 03-6-1 is effective for financial statements issued forfiscal years and interim periods beginning after December 15, 2008, andrequires a company to retrospectively adjust its earnings per share data. TheCompany adopted FSP EITF 03-6-1 March 31, 2009, and adoption did not havea material effect on consolidated results of operations or earnings per share.

 

*FASB Staff Positions FAS 107-1 andAPB 28-1, FAS 157-4, FAS 115-2 and FAS 124-2, Other Than Temporary Impairment.* FASB has issued FSPs to address concernsregarding (1) determining whether a market is not active and a transactionis not orderly, (2) recognition and presentation of other-than-temporaryimpairments and (3) interim disclosures of fair values of financialinstruments.  The Company adopted theFSPs effective June 30, 2009, and adoption did not have a material effecton consolidated results of operations.

 

*Statement of Financial AccountingStandards, Subsequent Events (“SFAS 165”).*  During May 2009,the FASB issued SFAS 165.  The objectiveof SFAS 165 is to establish general standards of accounting for and disclosureof events that occur after the balance sheet date, but before financialstatements are issued or are available to be issued.  The Company adopted SFAS 165 effective June 30,2009, and adoption did not have a material impact on the Company’s consolidatedfinancial condition or results of operations.

 

*Statement of Financial AccountingStandards, Accounting for Transfers of Financial Assets (“SFAS 166”).* During June 2009, the FASB issued SFAS 166.  This statement eliminates the concept of a “qualifyingspecial-purpose entity” from SFAS 140 and removes the exception from applyingFASB Interpretation No. 46 (revised December 2003), *Consolidation of Variable Interest Entities,*to qualifyingspecial-purpose entities.  SFAS 166 iseffective at the beginning of a reporting entity’s first fiscal year thatbegins after November 15, 2009.  TheCompany does not anticipate that the adoption of SFAS 166 would have a materialimpact on the Company’s consolidated financial condition or results ofoperations.

 

*Statement of Financial AccountingStandards, Amendments to FASB Interpretation No. 46(R) (“SFAS 167”).* During June 2009, the FASB issued SFAS 167.  This statement amends FASB Interpretation No. 46(revised December 2003), *Consolidation of VariableInterest Entities,*to require an enterprise to perform an analysisto determine whether the enterprise’s variable interest or interests give it acontrolling financial interest in a variable interest entity (VIE).  This analysis identifies the primarybeneficiary of a VIE as the enterprise that has both (a) the power todirect the activities of a VIE that most significantly impact the entity’seconomic performance, and (b) the obligation to absorb losses of theentity that could potentially be significant to the VIE.  Additionally, SFAS 167 requires an enterpriseto assess whether it has an implicit financial responsibility to ensure that aVIE operates as designed when determining it has the power to direct theactivities of the VIRE that most significantly impact the entity’s economicperformance.   SFAS 167 is effective atthe beginning of a company’s first fiscal year that begins after November 15,2009.  The Company does not anticipatethat the adoption of SFAS 167 would have a material impact on the Company’sconsolidated financial condition or results of operations.

 

**Note2. Earnings Per Share:**

 

Earnings per share (“EPS”)are disclosed as basic and diluted. Basic EPS is generally computed by dividing net income by theweighted-average number of common shares outstanding for the period, whereasdiluted EPS essentially reflects the potential dilution in basic EPS that couldoccur if other contracts to issue common stock were exercised.  As of June 30, 2009 and 2008, no commonstock equivalents were excluded from the diluted EPS calculation.

 
| ** **                                             | ** ** | **Three  Months Ended****June 30,** | ** ** | **Six  Months Ended****June 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| **(dollars  in thousands, except per share amounts)**  | ** ** | **2009**                                 | ** ** | **2008**                               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net income                                             |       | $                                        | 239        |                                   | $          | 270 |   | $ | 284 |   | $ | 569 |   |
| Basic earnings per share                               |       | $                                        | 0.16       |                                   | $          | 0.18 |   | $ | 0.19 |   | $ | 0.39 |   |
| Diluted earnings per share                             |       | $                                        | 0.16       |                                   | $          | 0.18 |   | $ | 0.19 |   | $ | 0.38 |   |
| Basic weighted average number of shares outstanding    |       | 1,460,802                                |       | 1,460,602                              |       | 1,460,802 |   | 1,460,602 |   |
| Effect of dilutive securities — stock options     |       | 20,984                                   |       | 46,485                                 |       | 17,894 |   | 47,464 |   |
| Diluted weighted average number of shares  outstanding |       | 1,481,786                                |       | 1,507,087                              |       | 1,478,696 |   | 1,508,066 |   |

 

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**Note3.  Employee Stock Option Plan:**

 

The Company maintains an Employee Stock Option Plan that provides forgrants of incentive and non-incentive stock options.  This plan has been presented to and approvedby the Company’s shareholders.  TheCompany follows the guidance of the Statements of Financial AccountingStandards No. 123 *Accounting forStock-Based Compensation* and No. 123(R) *Share-Based Payment. * As of December 31,2007, all outstanding stock options were fully vested.  No stock options were granted in 2008 or 2009and, accordingly, net income has not been affected by stock-based compensation.   Any stock-based employee compensation forfuture grants will be determined at that time using the Black-Scholes oranother appropriate option-pricing model.

 

**Note 4.  Investment Portfolio:**

 

Thefollowing tables set forth certain information regarding the Company’sinvestment portfolio at June 30, 2009 and December 31, 2008:

 

**Available-for-sale portfolio**

** **
| **June 30, 2009  (dollars in thousands)**                     | ** ** | **Amortized   Cost** | ** ** | **Gross********Unrealized********Gains** | ** ** | **Gross********Unrealized********Losses** | ** ** | **Estimated   Fair   Value** | ** **   | **Average   Yield** | ** ** |
|--------------------------------------------------------------------|------------|----------------------|------------|------------------------------------------|------------|-------------------------------------------|------------|------------------------------|--------------|---------------------|------------|
| U.S. Treasury and other U.S. government agencies and corporations: | ** ** | ** **           | ** ** | ** **                               | ** ** | ** **                                | ** ** | ** **                   | ** **   | ** **          | ** ** |
| Due within one year                                                |       | $                    |  563  |                                     | $          |  7                                   |       | $                            |  — |                | $          |  570 |   | 4.52 | % |
| Due after one year through five years                              |       | 1,422                |       | 39                                       |       | —                                    |       | 1,461                        |         | 4.94                | %          |
| Due after five years through ten years                             |       | 557                  |       | 27                                       |       | —                                    |       | 584                          |         | 4.98                | %          |
| State and political subdivisions:                                  |       |                 |       |                                     |       |                                      |       |                         |         |                |       |
| Due after five years through ten years                             |       | 405                  |       | 1                                        |       | 10                                        |       | 396                          |         | 5.25                | %          |
| Due after ten years                                                |       | 5,281                |       | —                                   |       | 134                                       |       | 5,147                        |         | 5.93                | %          |
| Mortgage-backed debt securities                                    |       | 5,898                |       | 115                                      |       | 13                                        |       | 6,000                        |         | 4.45                | %          |
| Equity securities                                                  |       | 300                  |       | —                                   |       | —                                    |       | 300                          |         | —              | %          |
|                                                               |       | $                    | 14,426     |                                     | $          | 189                                       |       | $                            | 157          |                | $          | 14,458 |   | 4.82 | % |

 
| **December 31, 2008  (dollars in thousands)**                 | ** ** | ******Amortized   Cost** | ** **  | **Gross********Unrealized********Gains** | ** ** | **Gross********Unrealized********Losses** | ** ** | **Estimated   Fair   Value** | ** ** | **Average   Yield** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------|-------------|------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|---------------------|------------|
| U.S. Treasury and other U.S. government agencies and corporations: | ** ** | ** **               | ** **  | ** **                               | ** ** | ** **                                | ** ** | ** **                   | ** ** | ** **          | ** ** |
| Due after one year through five years                              |       | $                        |  2,283 |                                     | $          |  20                                  |       | $                            |  1    |                | $          |  2,302 |   | 4.81 | % |
| Due after five years through ten years                             |       | 645                      |        | 5                                        |       | —                                    |       | 650                          |       | 5.00                | %          |
| State and political subdivisions:                                  |       |                     |        |                                     |       |                                      |       |                         |       |                |       |
| Due after five years through ten years                             |       | 405                      |        | —                                   |       | 13                                        |       | 392                          |       | 5.25                | %          |
| Due after ten years                                                |       | 5,281                    |        | 15                                       |       | 202                                       |       | 5,094                        |       | 5.93                | %          |
| Mortgage-backed debt securities                                    |       | 11,178                   |        | 166                                      |       | 42                                        |       | 11,302                       |       | 5.11                | %          |
| Equity securities                                                  |       | 300                      |        | —                                   |       | —                                    |       | 300                          |       | —              | %          |
|                                                               |       | $                        | 20,092      |                                     | $          | 206                                       |       | $                            | 258        |                | $          | 20,040 |   | 5.21 | % |

 
| ** **                                                         | ** ** | **Continuous unrealized   losses existing for less than   12 months** | ** ** | **Continuous unrealized   losses existing for 12   months and greater** | ** ** | **Total**                    | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|------------------------------|------------|
| **June 30, 2009  (dollars in thousands)**                     | ** ** | **Estimated  Fair****Value**                                          | ** ** | **Unrealized  Losses**                                                  | ** ** | **Estimated  Fair****Value** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair****Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S.  Treasury and other U.S. government agencies and corporations |       | $                                                                     | —     |                                                                    | $          | —                       |       | $ | — |   | $ | — |   | $ |  — |   | $ |  — |   |
| Mortgage-backed  debt securities                                   |       | 1,047                                                                 |       | 13                                                                      |       | —                       |       | — |   | 1,047 |   | 13 |   |
| State  and political subdivisions                                  |       | 3,808                                                                 |       | 94                                                                      |       | 1,178                        |       | 50 |   | 4,986 |   | 144 |   |
| Total  temporarily impaired securities                             |       | $                                                                     | 4,855      |                                                                    | $          | 107                          |       | $ | 1,178 |   | $ | 50 |   | $ | 6,033 |   | $ | 157 |   |

 

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| ** **                                                         | ** ** | **Continuous unrealized   losses existing for less than   12 months** | ** ** | **Continuous unrealized   losses existing for 12   months and greater** | ** ** | **Total**                    | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|------------------------------|------------|
| **December 31, 2008  (dollars in thousands)**                 | ** ** | **Estimated  Fair****Value**                                          | ** ** | **Unrealized  Losses**                                                  | ** ** | **Estimated  Fair****Value** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair****Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S.  Treasury and other U.S. government agencies and corporations |       | $                                                                     |  942  |                                                                    | $          |  1                      |       | $ |  — |   | $ |  — |   | $ |  942 |   | $ |  1 |   |
| State  and political subdivisions                                  |       | 3,299                                                                 |       | 204                                                                     |       | 192                          |       | 11 |   | 3,491 |   | 215 |   |
| Mortgage-backed  debt securities                                   |       | 2,448                                                                 |       | 42                                                                      |       | —                       |       | — |   | 2,448 |   | 42 |   |
| Total  temporarily impaired securities                             |       | $                                                                     | 6,689      |                                                                    | $          | 247                          |       | $ | 192 |   | $ | 11 |   | $ | 6,881 |   | $ | 258 |   |

 

Management evaluates securities for other-than-temporary impairment atleast on a quarterly basis, and more frequently when economic or marketconcerns warrant such evaluation.  Considerationis given to (1) the length of time and the extent to which the fair valuehas been less than cost, (2) the financial condition and near-termprospects of the issuer, and (3) the intent and ability of the Company toretain its investment in the issuer for a period of time sufficient to allowfor any anticipated recovery in fair value. The Company has not recognized any other-than-temporary impairment inconnection with the unrealized losses reflected in the preceding tables.  All of these declines can be attributable toincreases in interest rates and not a change in credit quality.  As Management has the ability and intent tohold debt securities until maturity or until the unrealized loss is recouped,no declines are deemed to be other than temporary.

 

## **Restricted Stock**

## ** **

Thefollowing table shows the amounts of restricted stock as of June 30, 2009and December 31, 2008:

 
| ** **                         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars  in thousands)**        | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Federal  Home Loan Bank of Atlanta |       | $                 |  952  |                  | $          | 1,000 |   |
| Federal  Reserve Bank              |       | 574               |       | 559                   |       |
| Atlantic  Central Bankers Bank     |       | 40                |       | 40                    |       |
|                               |       | $                 | 1,566      |                  | $          | 1,599 |   |

 

**Note 5.  Loans and Allowance for Loan Losses:**

 

Loansconsist of the following:

 
| ** **                                                                  | ** ** | **June 30,** | ** ** | **% of**  | ** ** | **December 31,** | ** ** | **% of**     | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------|------------|-----------|------------|-----------------------|------------|--------------|------------|
| **(dollars in thousands)**                                                  | ** ** | **2009**          | ** ** | **Loans** | ** ** | **2008**              | ** ** | **Loans**    | ** ** |
| Real estate loans:                                                          |       |              |       |      |       |                  |       |         |       |
| Construction and land development                                           |       | $                 | 21,817     |      | 11         | %                     | $          |  17,049 |       | 8 | % |
| Mortgage loans:                                                             |       |              |       |      |       |                  |       |         |       |
| Secured by 1 to 4 family residential properties                             |       | 38,435            |       | 19        | %          | 36,986                |       | 17           | %          |
| Secured by multi-family (5 or more) residential  properties                 |       | 8,115             |       | 4         | %          | 8,856                 |       | 4            | %          |
| Secured by commercial properties                                            |       | 101,304           |       | 49        | %          | 105,637               |       | 51           | %          |
| Secured by farm land                                                        |       | 7,442             |       | 4         | %          | 6,747                 |       | 3            | %          |
| Total mortgage loans                                                        |       | 155,296           |       | 75        | %          | 158,226               |       | 75           | %          |
| Loans to farmers                                                            |       | 47                |       | —    | %          | 48                    |       | —       | %          |
| Commercial and industrial loans                                             |       | 27,918            |       | 13        | %          | 34,779                |       | 16           | %          |
| Loans to individuals for household, family and  other personal expenditures |       | 1,851             |       | 1         | %          | 1,738                 |       | 1            | %          |
|                                                                        |       | 206,929           |       | 100       | %          | 211,840               |       | 100          | %          |
| Less allowance for loan losses                                              |       | (3,038            | )          |      |       | (3,120                | )          |         |       |
| Net loans                                                                   |       | $                 | 203,891    |      |       |                  | $          | 208,720      |       |   |   |

 

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Transactions in theallowance for loan losses are summarized as follows:

 
| ** **                                     | ** ** | **Three  Months Ended****June 30,** | ** ** | **Six  Months Ended****June 30,** | ** ** |
|------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| **(dollars  in thousands)**                    | ** ** | **2009**                                 | ** ** | **2008**                               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Average  total loans outstanding during period |       | $                                        | 207,559    |                                   | $          | 209,712 |   | $ | 209,703 |   | $ | 210,074 |   |
| Balance  at beginning of period                |       | $                                        | 2,838      |                                   | $          | 2,470 |   | $ | 3,120 |   | $ | 2,640 |   |
| Recoveries  of loans previously charged-off    |       | —                                   |       | —                                 |       | 3 |   | 9 |   |
| Loans  charged-off (commercial and industrial) |       | —                                   |       | —                                 |       | (226 | ) | (223 | ) |
| Loans  charged-off (commercial real estate)    |       | —                                   |       | —                                 |       | (448 | ) | (76 | ) |
| Loans  charged-off (residential real estate)   |       | —                                   |       | (6                                     | )          | — |   | (6 | ) |
| Loans  charged-off (consumer)                  |       | —                                   |       | —                                 |       | (11 | ) | — |   |
| Net  charge-offs                               |       | —                                   |       | (6                                     | )          | (682 | ) | (296 | ) |
| Provision  charged to operating expenses       |       | 200                                      |       | 120                                    |       | 600 |   | 240 |   |
| Balance  at end of period                      |       | $                                        | 3,038      |                                   | $          | 2,584 |   | $ | 3,038 |   | $ | 2,584 |   |
| Ratios  of net charge-offs to average loans    |       | —                                   | %          | —                                 | %          | 0.33 | % | 0.14 | % |

 

**Note 6.   Deposits**

 

Thefollowing table provides a summary of the Company’s deposit base at the datesindicated.

 
| ** **                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)**          | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Noninterest-bearing demand deposits |       | $                 | 35,837     |                  | $          | 32,740 |   |
| Interest-bearing demand deposits:   |       |              |       |                  |       |
| NOW accounts                        |       | 13,755            |       | 11,472                |       |
| Money market accounts               |       | 41,315            |       | 38,600                |       |
| Savings accounts                    |       | 4,496             |       | 3,888                 |       |
| Certificates of deposit:            |       |              |       |                  |       |
| $100,000 or more                    |       | 50,756            |       | 57,835                |       |
| Less than $100,000                  |       | 74,031            |       | 72,348                |       |
| Total deposits                      |       | $                 | 220,190    |                  | $          | 216,883 |   |

 

**Note 7. Trust preferredsecurities/junior subordinated debentures and other long-term borrowings:**

 

InDecember 2006, Bancorp completed the private placement of an aggregate of$6,000,000 of trust preferred securities through FCBI Statutory Trust I (the “Trust”),a newly formed trust subsidiary organized under Connecticut law, of whichBancorp owns all of the common securities of $186,000. The principal asset ofthe Trust is a similar amount of Bancorp’s junior subordinated debentures. Thejunior subordinated debentures bear interest at a fixed rate of 6.5375% until December 15,2011, at which time the interest rate becomes a variable rate, adjustedquarterly, equal to 163 basis points over three-month LIBOR. The juniorsubordinated debentures mature on December 15, 2036, and may be redeemedat par, at Bancorp’s option, on any interest payment date commencing December 15,2011. The securities are redeemable prior to December 15, 2011, at apremium ranging up to 103.525% of the principal amount thereof, upon theoccurrence of certain regulatory or legal events. The obligations of Bancorpwith respect to the Trust’s preferred securities constitute a full andunconditional guarantee by Bancorp of Trust’s obligations with respect to thetrust preferred securities to the extent set forth in the related guarantee.Subject to certain exceptions and limitations, Bancorp may elect from time totime to defer interest payments on the junior subordinated debentures,resulting in a deferral of distribution payments on the related trust preferredsecurities.   If the Company defers interest payments on the juniorsubordinated debentures, or otherwise is in default of the obligations, theCompany would be prohibited from making dividend payments to its shareholders.

 

The trust preferredsecurities may be included in Tier 1 capital for regulatory capital adequacypurposes up to 25% of Tier 1 capital, net of goodwill after its inclusion. Theportion of the trust preferred securities not qualifying as Tier 1 capital maybe included as part of total qualifying capital in Tier 2 capital, subject tolimitation.

 

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AtJune 30, 2009 and December 31, 2008, the Company had $10,000,000 inborrowings under its credit facility from the Federal Home Loan Bank of Atlanta(“FHLB”).  Both are in the amount of$5,000,000 with the first being a 4.56% fixed rate advance that matures on April 27,2012 and the second being a 4.56% convertible advance with a maturity date of September 4,2012, unless called on September 4, 2010 by the FHLB.  Outstanding advances are secured bycollateral consisting of a blanket lien on qualifying loans in the Bank’sresidential mortgage loan portfolio.

 

**Note 8.  Noninterest Expense:**

 

Noninterest expenseconsists of the following:

* *
| ** **                              | ** ** | **Three Months Ended****June 30,** | ** ** | **Six Months Ended****June 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| **(dollars  in thousands)**             | ** ** | **2009**                                | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                    |       |                                    |       |                                  |       |   |   |   |   |
| Salaries                                |       | $                                       | 814        |                                  | $          | 825 |   | $ | 1,628 |   | $ | 1,637 |   |
| Deferred  Personnel Costs               |       | (20                                     | )          | (25                                   | )          | (33 | ) | (51 | ) |
| Payroll  Taxes                          |       | 58                                      |       | 60                                    |       | 125 |   | 128 |   |
| Employee  Insurance                     |       | 55                                      |       | 55                                    |       | 118 |   | 112 |   |
| Other Employee Benefits                 |       | 4                                       |       | 45                                    |       | 52 |   | 93 |   |
| Depreciation                            |       | 81                                      |       | 84                                    |       | 165 |   | 166 |   |
| Rent                                    |       | 97                                      |       | 75                                    |       | 194 |   | 154 |   |
| Utilities                               |       | 25                                      |       | 25                                    |       | 53 |   | 51 |   |
| Repairs  and Maintenance                |       | 63                                      |       | 51                                    |       | 124 |   | 109 |   |
| ATM  Expense                            |       | 27                                      |       | 27                                    |       | 54 |   | 50 |   |
| Other  Occupancy and Equipment Expenses |       | 35                                      |       | 36                                    |       | 69 |   | 67 |   |
| Postage  and Supplies                   |       | 14                                      |       | 15                                    |       | 33 |   | 32 |   |
| Data  Processing                        |       | 111                                     |       | 87                                    |       | 208 |   | 175 |   |
| Advertising  and Promotion              |       | 38                                      |       | 86                                    |       | 72 |   | 167 |   |
| Legal                                   |       | 6                                       |       | 2                                     |       | 17 |   | 14 |   |
| Insurance                               |       | 9                                       |       | 13                                    |       | 21 |   | 25 |   |
| Consulting                              |       | 6                                       |       | 1                                     |       | 17 |   | 2 |   |
| Courier                                 |       | 4                                       |       | 4                                     |       | 8 |   | 9 |   |
| Audit  Fees                             |       | 51                                      |       | 62                                    |       | 96 |   | 123 |   |
| Other                                   |       | 304                                     |       | 122                                   |       | 444 |   | 233 |   |
|                                    |       | $                                       | 1,782      |                                  | $          | 1,650 |   | $ | 3,465 |   | $ | 3,296 |   |

 

**Note 9.  401(k) Profit Sharing Plan:**

 

TheCompany has a Section 401(k) profit sharing plan covering employeesmeeting certain eligibility requirements as to minimum age and years ofservice.  Employees may make voluntarycontributions to the Plan through payroll deductions on a pre-tax basis.  The Company has the discretion to makematching contributions of 100% of the employee’s contributions up to 4% of theemployee’s salary.  A participant’saccount under the Plan, together with investment earnings thereon, is normallydistributable, following retirement, death, disability or other termination ofemployment, in a single lump-sum payment.

 

TheCompany made contributions to the Plan in the amounts of $36,000 for the secondquarter of 2008 and for the first six months in 2009 and 2008, $30,000 and$71,000, respectively.  On April 1,2009, the Company suspended its discretionary matching contribution andtherefore, there was no contribution made in the second quarter of 2009.

 

**Note 10.  Shareholders’ Equity:**

 

Capital:

 

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory - and possiblyadditional discretionary - actions by regulators that, if undertaken, couldhave a direct material effect on the Company’s consolidated financialstatements.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCompany, once it exceeds $500 million in assets, and the Bank must meetspecific capital guidelines that involve quantitative measures of the Company’sand the Bank’s assets, liabilities, and certain off-balance-sheet items ascalculated under regulatory accounting practices.  The Company’s and the Bank’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

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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 believesthat the Company and the Bank met all capital adequacy requirements to whichthey are subject as of June 30, 2009.

 

As of June 30, 2009,the most recent notification from the regulatory agency categorized the Bank aswell capitalized under the regulatory framework for prompt correctiveaction.  To be categorized as wellcapitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based,and Tier 1 leverage ratios as set forth in the table.  There are no conditions or events since thatnotification which management believes have changed the Bank’s category.

 

TheCompany’s and the Bank’s actual capital amounts and ratios at June 30,2009 and December 31, 2008 are presented in the following tables.

 
| ** **                  | ** ** | ** ** | ** ** | ** **             | ** ** | ** **             | ** ** | **Minimum  To Be Well** | ** ** |
|-----------------------------|------------|------------|------------|------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | ** ** | ** ** | ** **             | ** ** | ** **             | ** ** | **Capitalized  Under**  | ** ** |
| ** **                  | ** ** | ** ** | ** ** | ** **             | ** ** | **For  Capital**       | ** ** | **Prompt  Corrective**  | ** ** |
| **June 30,  2009**          | ** ** | **Actual** | ** ** | **Adequacy  Purposes** | ** ** | **Action  Provisions** | ** ** |
| **(dollars  in thousands)** | ** ** | **Amount** | ** ** | **Ratio**              | ** ** | **Amount**             | ** ** | **Ratio**               | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Tier 1 Capital              |       |       |       |                   |       |                   |       |                    |       |   |   |   |   |
| To Risk-Weighted  Assets    |       |       |       |                   |       |                   |       |                    |       |   |   |   |   |
| Company                     |       | $          | 26,928     |                   | 12.10      | %                      | $          | 8,902                   |       | 4.00 | % | N/A |   | N/A |   |
| Bank                        |       | $          | 26,056     |                   | 11.74      | %                      | $          | 8,879                   |       | 4.00 | % | $ | 13,318 |   | 6.00 | % |
|                        |       |       |       |                   |       |                   |       |                    |       |   |   |   |   |
| Total Capital               |       |       |       |                   |       |                   |       |                    |       |   |   |   |   |
| To Risk-Weighted  Assets    |       |       |       |                   |       |                   |       |                    |       |   |   |   |   |
| Company                     |       | $          | 29,710     |                   | 13.35      | %                      | $          | 17,805                  |       | 8.00 | % | N/A |   | N/A |   |
| Bank                        |       | $          | 28,831     |                   | 12.99      | %                      | $          | 17,758                  |       | 8.00 | % | $ | 22,197 |   | 10.00 | % |
|                        |       |       |       |                   |       |                   |       |                    |       |   |   |   |   |
| Tier 1 Capital              |       |       |       |                   |       |                   |       |                    |       |   |   |   |   |
| To Average  Assets          |       |       |       |                   |       |                   |       |                    |       |   |   |   |   |
| Company                     |       | $          | 26,928     |                   | 10.51      | %                      | $          | 10,247                  |       | 4.00 | % | N/A |   | N/A |   |
| Bank                        |       | $          | 26,056     |                   | 10.19      | %                      | $          | 10,227                  |       | 4.00 | % | $ | 12,784 |   | 5.00 | % |

 
| ** **                           | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | **Minimum To Be Well** | ** ** |
|--------------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                           | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **            | ** ** | **Capitalized Under**  | ** ** |
| ** **                           | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| **December 31, 2008**                | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **(dollars in thousands)** | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | **Ratio**             | ** ** | **Amount**             | ** ** | **Ratio** | ** ** |
| Tier  1 Capital                      |       |       |       |                  |       |                  |       |                  |       |                   |       |   |   |
| To  Risk-Weighted Assets             |       |       |       |                  |       |                  |       |                  |       |                   |       |   |   |
| Company                              |       | $          | 26,644     |                  | 11.59      | %                     | $          | 9,194                 |       | 4.00                   | %          | N/A |   | N/A |   |
| Bank                                 |       | $          | 25,637     |                  | 11.18      | %                     | $          | 9,174                 |       | 4.00                   | %          | $ | 13,761 |   | 6.00 | % |
|                                 |       |       |       |                  |       |                  |       |                  |       |                   |       |   |   |
| Total  Capital                       |       |       |       |                  |       |                  |       |                  |       |                   |       |   |   |
| To  Risk-Weighted Assets             |       |       |       |                  |       |                  |       |                  |       |                   |       |   |   |
| Company                              |       | $          | 29,517     |                  | 12.84      | %                     | $          | 18,387                |       | 8.00                   | %          | N/A |   | N/A |   |
| Bank                                 |       | $          | 28,504     |                  | 12.43      | %                     | $          | 18,348                |       | 8.00                   | %          | $ | 22,936 |   | 10.00 | % |
|                                 |       |       |       |                  |       |                  |       |                  |       |                   |       |   |   |
| Tier  1 Capital                      |       |       |       |                  |       |                  |       |                  |       |                   |       |   |   |
| To  Average Assets                   |       |       |       |                  |       |                  |       |                  |       |                   |       |   |   |
| Company                              |       | $          | 26,644     |                  | 10.31      | %                     | $          | 10,338                |       | 4.00                   | %          | N/A |   | N/A |   |
| Bank                                 |       | $          | 25,637     |                  | 9.94       | %                     | $          | 10,319                |       | 4.00                   | %          | $ | 12,899 |   | 5.00 | % |

 

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On June 26, 2007,the Company authorized the repurchase of up to 146,000 shares of its commonstock, for an aggregate expenditure of not more than $4.5 million, through June 30,2012, or earlier termination of the program by the Board of Directors.  Repurchases, if any, by the Company pursuantto this authorization are expected to enable the Company to repurchase itsshares at an attractive price, and to provide a source of liquidity for theCompany’s shares.  As of June 30,2009, there have been no shares repurchased by the Company.

 

**Note 11.  Fair Value Measurements**

 

The Company follows theguidance of Statement of Financial Accounting Standards (“SFAS”) 159, *The**Fair Value Option forFinancial Assets and Liabilities*. This Statement permits entities tomeasure many financial instruments and certain other items at fair value.  The objective is to improve financialreporting by providing entities with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting provisions.  The election to use the fair value option isavailable when an entity first recognizes a financial asset or financialliability or upon entering into a Company commitment.  Subsequent changes must be recorded in earnings.  The Company has yet to apply the fair valueoption to any assets or liabilities.  Inconjunction with SFAS 159, the Company also follows the guidance of SFAS 157, *Fair Value Measurements*. SFAS 157 clarifies that fair value is an exit price, representing theamount that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction between market participants.  Under SFAS 157, fair value measurements arenot adjusted for transaction costs.  SFAS157 establishes a fair value hierarchy that prioritizes the inputs to valuationtechniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices inactive markets for identical assets or liabilities (Level 1 measurements) andthe lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchyunder SFAS 157 are described below.

 
| Level 1 |   | Valuations for assets  and liabilities traded in active exchange markets.  Valuations are  obtained from readily available pricing sources for market transactions  involving identical assets or liabilities.                                                                                                                                                                                                                                                                                                                    |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| Level 2 |   | Valuations for assets  and liabilities traded in less active dealer or broker  markets.  Valuations are obtained from third party pricing services  for identical or comparable assets or liabilities which use observable inputs  other than Level 1 prices, such as quoted prices for similar assets or  liabilities; quoted prices in active markets that are not active; or other  inputs that are observable or can be corroborated by observable market data  for substantially the full term of the assets or liabilities. |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| Level 3 |   | Unobservable inputs  that are supported by little or no market activity and that are significant  to the fair value of the assets or liabilities.                                                                                                                                                                                                                                                                                                                                                                                           |

 

A financial instrument’slevel within the fair value hierarchy is based on the lowest level of inputthat is significant to the fair value measurement.

 

The types of instrumentsvalued based on quoted market prices in active markets include most U.S.government and agency securities, liquid mortgage products, active listedequities and most money market securities. Such instruments are generally classified within Level 1 or Level 2 ofthe fair value hierarchy.  As required bySFAS 157, the Company does not adjust the quoted price for such instruments.

 

The types of instrumentsvalued based on quoted prices in markets that are not active, broker or dealerquotations, or alternative pricing sources with reasonable levels of pricetransparency include most investment-grade and high-yield corporate bonds, lessliquid mortgage products, less liquid equities, state, municipal and provincialobligations.  Such instruments aregenerally classified within Level 2 of the fair value hierarchy.

 

Level 3 is for positionsthat are not traded in active markets or are subject to transfer restrictions,valuations are adjusted to reflect illiquidity and/or non-transferability, andsuch adjustments are generally based on available market evidence.  In the absence of such evidence, management’sbest estimate is used.

 

Impaired loans areevaluated and valued at the time the loan is identified as impaired, at thelower of cost or market value.  Marketvalue is measured based on the value of the collateral securing these loans andis classified at a Level 3 in the fair value hierarchy.  Collateral may be real estate and/or businessassets including equipment, inventory and/or accounts receivable.  The value of real estate collateral isdetermined based on appraisal by qualified licensed appraisers hired by theCompany.  The value of businessequipment, inventory and accounts receivable collateral is based on the netbook value on the business’ financial statements and, if necessary, discountedbased on management’s review and analysis. Appraised and reported values may be discounted based on management’shistorical knowledge, changes in market conditions from the time of valuation,and/or management’s expertise and knowledge of the client and client’sbusiness.  Impaired loans are reviewedand evaluated on at least a quarterly basis for additional impairment andadjusted accordingly, based on the same factors identified above.

 

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The following tables setforth the Company’s financial assets and liabilities that were accounted for ordisclosed at fair value on a recurring and nonrecurring basis as of June 30,2009.

 

The following tables showdetails of the financial instruments as of June 30, 2009 for which fairvalue accounting was applied:

 

*Recurring basis*

 
| ** **                           | ** ** | ** **   | ** ** | ** **         | ** ** | **Significant**    | ** ** | ** **       | ** ** |
|--------------------------------------|------------|--------------|------------|--------------------|------------|--------------------|------------|------------------|------------|
| ** **                           | ** ** | **Carrying** | ** ** | ** **         | ** ** | **Other**          | ** ** | **Significant**  | ** ** |
| ** **                           | ** ** | **Value**    | ** ** | **Quoted**         | ** ** | **Observable**     | ** ** | **Unobservable** | ** ** |
| ** **                           | ** ** | **(Fair**    | ** ** | **Prices**         | ** ** | **Inputs**         | ** ** | **Inputs**       | ** ** |
| **(dollars in thousands)** | ** ** | **Value)**   | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level  3)**   | ** ** |
| Securities  available for sale       |       | $            | 14,458     |               | $          | —             |       | $                | 14,458     |   | $ | — |   |
|                                      |            |              |            |                    |            |                    |            |                  |            |  |  |  |  |

 

*Nonrecurringbasis*

 
| ** **                           | ** ** | ** **   | ** ** | ** **         | ** ** | **Significant**    | ** ** | ** **         | ** ** |
|--------------------------------------|------------|--------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|
| ** **                           | ** ** | **Carrying** | ** ** | ** **         | ** ** | **Other**          | ** ** | **Significant**    | ** ** |
| ** **                           | ** ** | **Value**    | ** ** | **Quoted**         | ** ** | **Observable**     | ** ** | **Unobservable**   | ** ** |
| ** **                           | ** ** | **(Fair**    | ** ** | **Prices**         | ** ** | **Inputs**         | ** ** | **Inputs**         | ** ** |
| **(dollars in thousands)** | ** ** | **Value)**   | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Impaired  loans                      |       | $            | 14,899     |               | $          | —             |       | $                  | —     |   | $ | 14,899 |   |
|                                      |            |              |            |                    |            |                    |            |                    |            |  |  |  |  |

 

**Note 12.  Fair Value of Financial Instruments**

 

In accordance with thedisclosure requirements of SFAS 107, the estimated fair values of the Company’sfinancial instruments are as follows:

 
| ** **                                | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|-------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                | ** ** | **Carrying   Amount**  | ** ** | **Fair Value**             | ** ** | **Carrying   Amount** | ** ** | **Fair Value** | ** ** |
| FINANCIAL  ASSETS                         |       |                   |       |                       |       |   |   |   |   |
| Cash  and cash equivalents                |       | $                      | 30,946     |                       | $          | 30,946 |   | $ | 16,055 |   | $ | 16,055 |   |
| Investment  securities available for sale |       | 14,458                 |       | 14,458                     |       | 20,040 |   | 20,040 |   |
| Restricted  stock                         |       | 1,566                  |       | 1,566                      |       | 1,599 |   | 1,599 |   |
| Net  loans                                |       | 203,891                |       | 202,497                    |       | 208,720 |   | 207,678 |   |
| Accrued  interest receivable              |       | 747                    |       | 747                        |       | 821 |   | 821 |   |
|                                      |       |                   |       |                       |       |   |   |   |   |
| FINANCIAL  LIABILITIES                    |       |                   |       |                       |       |   |   |   |   |
| Deposits                                  |       | $                      | 220,190    |                       | $          | 228,610 |   | $ | 216,883 |   | $ | 223,718 |   |
| Long-term  borrowings                     |       | 10,000                 |       | 10,726                     |       | 10,000 |   | 10,914 |   |
| Junior  subordinated debentures           |       | 6,186                  |       | 5,956                      |       | 6,186 |   | 6,048 |   |
| Accrued  interest payable                 |       | 258                    |       | 258                        |       | 290 |   | 290 |   |

 

The following methods andassumptions were used to estimate the fair value disclosures for financialinstruments as of June 30, 2009 and December 31, 2008:

 

Cash and cashequivalents:

 

The fair value of cashand cash equivalents is estimated to approximate the carrying amounts.

 

Investment securities andrestricted stock:

 

Fair values are based onquoted market prices, except forcertain restricted stocks where fair value equals par value because ofcertain redemption restrictions.

 

Loans:

 

Fair values are estimatedfor portfolios of loans with similar financial characteristics.  Each portfolio is further segmented intofixed and adjustable rate interest terms by performing and non-performingcategories.

 

The fair value ofperforming loans is calculated by discounting estimated cash flows usingcurrent rates at which similar loans would be made to borrowers with similarcredit ratings and for the same remaining maturities.  The estimated cash flows do not anticipateprepayments.

 

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Management has madeestimates of fair value discount rates that it believes to be reasonable.  However, because there is no market for manyof these financial instruments, management has no basis to determine whetherthe fair value presented for loans would be indicative of the value negotiatedin an actual sale.

 

Deposits:

 

The fair value ofdeposits with no stated maturity, such as noninterest-bearing demand deposits,savings, NOW accounts and money market accounts, is equal to the amount payableon demand at the reporting date (that is, their carrying amounts).  The fair value of certificates of deposit isbased on the discounted value of contractual cash flows.  The discount rate is estimated using therates currently offered for deposits of similar remaining maturities.  The fair value estimates do not include thebenefit that results from the low-cost funding provided by the depositliabilities compared to the cost of borrowing funds in the market.

 

Short-term borrowings:

 

The fair value ofshort-term borrowings is determined using rates currently available to theCompany for debt with similar terms and remaining maturities.

 

Long-term borrowings:

 

The fair value of thelong-term borrowings is determined using rates currently available to theCompany for debt with similar terms and remaining maturities.

 

Junior subordinateddebentures:

 

The junior subordinateddebentures are unsecured obligations of the Company and are subordinate andjunior in right of payment to all present and future senior indebtedness of theCompany.  The Company has entered into aguarantee, which together with its obligations under the junior subordinated debenturesand the declaration of trust governing the Trust provides a full andunconditional guarantee of the Trust’s preferred securities.  The fair value of junior subordinateddebentures is determined using rates currently available to the Company for debtwith similar terms and remaining maturities. See Note 7 for additional disclosures.

 

Accrued Interest:

 

The carrying amounts ofaccrued interest approximate fair value.

 

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

 

**Forward-LookingStatements**

 

Thismanagement’s discussion and analysis contains forward-looking statements withinthe meaning of the Private Securities Litigation Reform Act of 1995, includingstatements relating to Frederick County Bancorp, Inc.’s (“Bancorp”) andFrederick County Bank’s (the “Bank” and together with Bancorp, the “Company”)beliefs, expectations, anticipations and plans regarding, among other things,general economic trends, interest rates, product expansions and other matters.  Such forward-looking statements areidentified by terminology such as “may”, “will”, “believe”, “expect”, “estimate”,“anticipate”, “likely”, “unlikely”, “continue”, or similar terms and aresubject to numerous uncertainties, such as federal monetary policy, inflation,employment, profitability and consumer confidence levels, both nationally andin the Company’s market area, the health of the real estate and constructionmarket in the Company’s market area, the Company’s ability to develop andmarket new products and to enter new markets, competitive challenges in theCompany’s market, legislative changes and other factors, and as such, there canbe no assurance that future events will develop in accordance with theforward-looking statements contained herein. Readers are cautioned against placing undue reliance on any suchforward-looking statement.  In addition,the Company’s past results of operations do not necessarily indicate its futureresults.

 

**General**

 

Thefollowing paragraphs provide an overview of the financial condition and resultsof operations of the Company.  Thisdiscussion is intended to assist the readers in their analysis of theaccompanying financial statements and notes thereto.

 

Bancorp, the parentcompany for the Bank, its wholly-owned subsidiary, was organized in September 2003.The Bank was incorporated under the laws of the state of Maryland in August 2000and commenced banking operations in October 2001.  The Bank provides its customers with variousbanking services.  The Bank offersvarious loan and deposit products to their customers.  The Bank’s customers include individuals andcommercial enterprises within its principal market area consisting of FrederickCounty, Maryland.  Additionally, 

 

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the Bank maintainscorrespondent banking relationships and transacts daily federal funds sales onan unsecured basis with regional correspondent banks.  Note 4 discusses the types of securities inwhich the Bank invests.  Note 5 discussesthe types of lending in which the Bank engages. The Bank does not have any significant concentrations to any oneindustry or customer.  Bancorp also has asubsidiary called FCBI Statutory Trust I. See Note 7 for additional disclosures.

 

**Recent Developments**

** **

On July 22, 2009,the Company renewed the unsecured revolving line of credit borrowingarrangement with an unaffiliated financial institution increasing the amount to$4.00 million.  This facility matures on July 22,2010 and has a floating interest rate equal to the Wall Street Journal primerate plus 0.50%, subject to a minimum rate of 4.25%.

 

**Critical Accounting Policies**

** **

The Company’sconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) andfollow general practices within the industry in which it operates.  Application of these principles requiresmanagement to make estimates, assumptions, and judgments that affect theamounts reported in the financial statements and accompanying notes.  These estimates, assumptions, and judgmentsare based on information available as of the date of the financial statements;accordingly, as this information changes, the financial statements couldreflect different estimates, assumptions, and judgments.  Certain policies inherently have a greaterreliance on the use of estimates, assumptions, and judgments and as such have agreater possibility of producing results that could be materially differentthan originally reported.  Estimates,assumptions, and judgments are necessary when assets and liabilities arerequired to be recorded at fair value, when a decline in the value of an assetnot carried on the financial statements at fair value warrants an impairmentwrite-down or valuation reserve to be established, or when an asset orliability needs to be recorded contingent upon a future event.  Carrying assets and liabilities at fair valueinherently results in more financial statement volatility.  The fair values and the information used torecord valuation adjustments for certain assets and liabilities are basedeither on quoted market prices or are provided by other third-party sources, whenavailable. The estimates used in management’s assessment of the adequacy of theallowance for loan losses require that management make assumptions aboutmatters that are uncertain at the time of estimation.  Differences in these assumptions and differencesbetween the estimated and actual losses could have a material effect.  For discussions related to the criticalaccounting policies of the Company, refer to the sections in this Management’sDiscussion and Analysis entitled “Income Taxes” and “Allowance for Loan Losses.”

 

**Loans**

** **

Loans decreased by $4.91million, or (2.32)%, from December 31, 2008, to a balance of $206.93million as of June 30, 2009, and by $3.04 million, or (1.45)% from June 30,2008.  The Company has taken a low tomoderate loan growth strategy to maintain its strong capital and liquiditypositions during these current uncertain economic times, which may result inthe loan portfolio contracting at various times.

 

**Deposits**

** **

Deposits increased by$3.31 million, or 1.52%, from December 31, 2008 to a balance of $220.19million as of June 30, 2009, but dropped by $3.80 million, or (1.70)% fromJune 30, 2008.  The Company’sdeposit strategy involves reducing the Company’s reliance on higher costcertificates of deposit, by reducing the rates paid on this type of deposit tothe lower end of the range of rates being paid in the local market, and placingmore emphasis on noninterest-bearing demand deposits and other lower cost NOWand money market accounts.  The balanceof certificates of deposit dropped to $124.79 million as of June 30, 2009from $130.18 million as of December 31, 2008; while noninterest-bearingdemand deposits increased to $35.84 million from $32.74 million, NOW andsavings accounts increased to $18.25 million from $15.36 million, and moneymarket accounts increased to $41.32 million from $38.60 million, all for thesame periods.

 

**ThreeMonths Ended June 30, 2009 and 2008**

 

Net income was $239,000for the quarter ended June 30, 2009, as compared to $270,000 of net incomefor the same period in 2008.  Thedecrease in earnings for this quarter in 2009 is primarily related to an$80,000 increase in provision for loan losses. Included in this quarter are securities gains of $117,000, which wererealized, in part, to offset the impact of the Federal Deposit Insurance Corporation (“FDIC”) special assessmentof $115,000.  Basic earnings per share for the three months ended June 30, 2009 and2008 were $0.16 and $0.18, respectively, and were based on weighted-averagenumber of shares outstanding of 1,460,802 and 1,460,602, respectively.  Diluted earnings per share for the threemonths ended June 30, 2009 and 2008 were $0.16 and $0.18, respectively,and were based on weighted-average number of shares outstanding of 1,481,786and 1,507,087, respectively.

 

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TheCompany experienced an annualized return on average assets of 0.37% and 0.41%for the three-month periods ended June 30, 2009 and 2008,respectively.  Additionally, the Companyexperienced an annualized return on average shareholders’ equity of 4.67% and5.33% for the three-month periods ended June 30, 2009 and 2008,respectively.

 

**SixMonths Ended June 30, 2009 and 2008**

 

Net income was $284,000for the six months ended June 30, 2009, as compared to $569,000 of netincome for the same period in 2008.  Thedecrease in earnings for this period in 2009 is primarily related to a $360,000increase in provision for loan losses. Included in this six-month period in 2009 are securities gains of$117,000, which were realized, in part, to offset the impact of the FDIC special assessment of $115,000.  Basicearnings per share for the six months ended June 30, 2009 and 2008 were$0.19 and $0.39, respectively, and were based on weighted-average number ofshares outstanding of 1,460,802 and 1,460,602, respectively.  Diluted earnings per share for the six monthsended June 30, 2009 and 2008 were $0.19 and $0.38, respectively, and werebased on weighted-average number of shares outstanding of 1,478,696 and1,508,066, respectively.

 

TheCompany experienced an annualized return on average assets of 0.22% and 0.44%for the six-month periods ended June 30, 2009 and 2008, respectively.  Additionally, the Company experienced anannualized return on average shareholders’ equity of 2.58% and 5.66% for thesix-month periods ended June 30, 2009 and 2008, respectively.

 

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**Distribution of Assets,Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential**

 

The followingtables show average balances of asset and liability categories, interest incomeand interest expense, and average yields and rates for the periods indicated.

** **
| ** **                                                    | ** ** | **2009**                     | ** ** | **2008**                         | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| **Three  Months Ended June 30,  (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                                            |       | $                            | 1,111      |                             | $          | — |   | — | % | $ | 10,311 |   | $ | 57 |   | 2.22 | % |
| Interest bearing deposits in other banks                      |       | 21,449                       |       | 12                               |       | 0.22 |   | 4,411 |   | 22 |   | 2.00 |   |
| Investment securities (1):                                    |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| Taxable                                                       |       | 14,529                       |       | 168                              |       | 4.64 |   | 18,120 |   | 224 |   | 4.96 |   |
| Tax-exempt (2)                                                |       | 5,686                        |       | 88                               |       | 6.21 |   | 9,820 |   | 150 |   | 6.13 |   |
| Loans (3)                                                     |       | 207,559                      |       | 3,246                            |       | 6.27 |   | 209,712 |   | 3,451 |   | 6.60 |   |
| Total interest-earning assets                                 |       | 250,334                      |       | 3,514                            |       | 5.63 |   | 252,374 |   | 3,904 |   | 6.20 |   |
| Noninterest-earning assets                                    |       | 5,349                        |       |                             |       |   |   | 8,945 |   |   |   |   |   |
| Total assets                                                  |       | $                            | 255,683    |                             |       |   |   |   | $ | 261,319 |   |   |   |   |   |
|                                                          |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity                     |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                 |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| NOW accounts                                                  |       | $                            | 12,315     |                             | 6          |   | 0.20 | % | $ | 12,379 |   | 13 |   | 0.42 | % |
| Savings accounts                                              |       | 4,285                        |       | 2                                |       | 0.19 |   | 3,922 |   | 5 |   | 0.51 |   |
| Money market accounts                                         |       | 41,086                       |       | 115                              |       | 1.12 |   | 41,916 |   | 188 |   | 1.80 |   |
| Certificates of deposit $100,000 or more                      |       | 51,703                       |       | 440                              |       | 3.41 |   | 58,300 |   | 628 |   | 4.32 |   |
| Certificates of deposit less than $100,000                    |       | 74,131                       |       | 602                              |       | 3.26 |   | 72,147 |   | 761 |   | 4.23 |   |
| Long-term borrowings                                          |       | 10,000                       |       | 115                              |       | 4.61 |   | 10,000 |   | 116 |   | 4.65 |   |
| Junior subordinated debentures                                |       | 6,186                        |       | 101                              |       | 6.55 |   | 6,186 |   | 101 |   | 6.55 |   |
| Total interest-bearing liabilities                            |       | 199,706                      |       | 1,381                            |       | 2.77 |   | 204,850 |   | 1,812 |   | 3.55 |   |
| Noninterest-bearing deposits                                  |       | 34,599                       |       |                             |       |   |   | 35,408 |   |   |   |   |   |
| Noninterest-bearing liabilities                               |       | 897                          |       |                             |       |   |   | 785 |   |   |   |   |   |
| Total liabilities                                             |       | 235,202                      |       |                             |       |   |   | 241,043 |   |   |   |   |   |
| Total shareholders’ equity                               |       | 20,481                       |       |                             |       |   |   | 20,276 |   |   |   |   |   |
| Total liabilities and shareholders’  equity              |       | $                            | 255,683    |                             |       |   |   |   | $ | 261,319 |   |   |   |   |   |
| Net interest income                                           |       |                         |       | $                                | 2,133      |   |   |   |   |   | $ | 2,092 |   |   |   |
| Net interest spread                                           |       |                         |       |                             |       | 2.86 | % |   |   |   |   | 2.65 | % |
| Net interest margin                                           |       |                         |       |                             |       | 3.42 | % |   |   |   |   | 3.32 | % |

 

----

| (1) |   | Yields on  securities available-for-sale have been calculated on the basis of historical  cost and do not give effect to changes in the fair value of those securities,  which is reflected as a component of shareholders’ equity.                                                                                      |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Presented on a  taxable-equivalent basis using the statutory federal income tax rate of 34%.  Taxable-equivalent adjustments of $30,000 in 2009 and $51,000 in 2008 are  included in the calculation of the tax-exempt investment interest income.                                                                            |
| (3) |   | Presented on a  taxable-equivalent basis using the statutory federal income tax rate of 34%.  Taxable-equivalent adjustments of $16,000 in 2009 and $14,000 in 2008 are  included in the calculation of the loan interest income. Net loan origination  expense in interest income totaled $2,000 in 2009 and $6,000 in 2008. |

 

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| ** **                                                  | ** ** | **2009**                     | ** ** | **2008**                         | ** ** |
|-------------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| **Six  Months Ended June 30,  (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                                          |       | $                            | 1,119      |                             | $          | 1 |   | 0.18 | % | $ | 9,968 |   | $ | 134 |   | 2.70 | % |
| Interest bearing deposits in other banks                    |       | 20,288                       |       | 21                               |       | 0.21 |   | 2,898 |   | 32 |   | 2.21 |   |
| Investment securities (1):                                  |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| Taxable                                                     |       | 15,319                       |       | 351                              |       | 4.62 |   | 17,826 |   | 444 |   | 5.00 |   |
| Tax-exempt (2)                                              |       | 5,686                        |       | 176                              |       | 6.24 |   | 9,820 |   | 300 |   | 6.13 |   |
| Loans (3)                                                   |       | 209,703                      |       | 6,475                            |       | 6.23 |   | 210,074 |   | 7,075 |   | 6.75 |   |
| Total interest-earning assets                               |       | 252,115                      |       | 7,024                            |       | 5.62 |   | 250,586 |   | 7,985 |   | 6.39 |   |
| Noninterest-earning assets                                  |       | 5,373                        |       |                             |       |   |   | 9,067 |   |   |   |   |   |
| Total assets                                                |       | $                            | 257,488    |                             |       |   |   |   | $ | 259,653 |   |   |   |   |   |
|                                                        |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity                   |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                               |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| NOW accounts                                                |       | $                            | 12,117     |                             | 13         |   | 0.22 | % | $ | 12,307 |   | 19 |   | 0.31 | % |
| Savings accounts                                            |       | 4,211                        |       | 5                                |       | 0.24 |   | 4,050 |   | 10 |   | 0.50 |   |
| Money market accounts                                       |       | 39,928                       |       | 230                              |       | 1.16 |   | 40,353 |   | 423 |   | 2.10 |   |
| Certificates of deposit $100,000 or more                    |       | 53,759                       |       | 929                              |       | 3.48 |   | 59,015 |   | 1,328 |   | 4.51 |   |
| Certificates of deposit less than $100,000                  |       | 74,158                       |       | 1,237                            |       | 3.36 |   | 72,172 |   | 1,589 |   | 4.42 |   |
| Long-term borrowings                                        |       | 10,000                       |       | 229                              |       | 4.62 |   | 10,000 |   | 231 |   | 4.63 |   |
| Junior subordinated debentures                              |       | 6,186                        |       | 202                              |       | 6.58 |   | 6,186 |   | 202 |   | 6.55 |   |
| Total interest-bearing liabilities                          |       | 200,359                      |       | 2,845                            |       | 2.86 |   | 204,083 |   | 3,802 |   | 3.74 |   |
| Noninterest-bearing deposits                                |       | 34,386                       |       |                             |       |   |   | 34,602 |   |   |   |   |   |
| Noninterest-bearing liabilities                             |       | 720                          |       |                             |       |   |   | 859 |   |   |   |   |   |
| Total liabilities                                           |       | 235,465                      |       |                             |       |   |   | 239,544 |   |   |   |   |   |
| Total shareholders’ equity                             |       | 22,023                       |       |                             |       |   |   | 20,109 |   |   |   |   |   |
| Total liabilities and shareholders’  equity            |       | $                            | 257,488    |                             |       |   |   |   | $ | 259,653 |   |   |   |   |   |
| Net interest income                                         |       |                         |       | $                                | 4,179      |   |   |   |   |   | $ | 4,183 |   |   |   |
| Net interest spread                                         |       |                         |       |                             |       | 2.76 | % |   |   |   |   | 2.65 | % |
| Net interest margin                                         |       |                         |       |                             |       | 3.34 | % |   |   |   |   | 3.35 | % |

 

----

| (1) |   | Yields on  securities available-for-sale have been calculated on the basis of historical  cost and do not give effect to changes in the fair value of those securities,  which is reflected as a component of shareholders’ equity.                                                                                      |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Presented on a  taxable-equivalent basis using the statutory federal income tax rate of 34%.  Taxable-equivalent adjustments of $60,000 in 2009 and $102,000 in 2008 are  included in the calculation of the tax-exempt investment interest income.                                                                           |
| (3) |   | Presented on a  taxable-equivalent basis using the statutory federal income tax rate of 34%.  Taxable-equivalent adjustments of $32,000 in 2009 and $28,000 in 2008 are  included in the calculation of the loan interest income. Net loan origination  expense in interest income totaled $6,000 in 2009 and $2,000 in 2008. |

 

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**Rate/VolumeAnalysis**

 

The followingtables indicate the changes in interest income and interest expense that areattributable to changes in average volume and average rates, in comparison withthe same period in the preceding year on a fully taxable equivalent basis.  The change in interest due to the combinedrate-volume variance has been allocated entirely to the change in rate.

 
| ** **                                 | ** ** | **Three  Months Ended June 30,****2009 compared to 2008** | ** ** | **Six  Months Ended June 30,****2009 compared to 2008** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| *** ***                               | ** ** | **Increase (decrease)  Due to**                                | ** ** | **Net  increase**                                            | ** ** | **Increase (decrease)  Due to** | ** ** | **Net  increase** | ** ** |
| **(dollars  in thousands)**                | ** ** | **Volume**                                                     | ** ** | **Rate**                                                     | ** ** | **(decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **(decrease)** | ** ** |
| Interest income                            |       |                                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
| Interest-earning assets:                   |       |                                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
| Federal funds sold                         |       | $                                                              | (51        | )                                                            | $          | (6 | ) | $ | (57 | ) | $ | (119 | ) | $ | (14 | ) | $ | (133 | ) |
| Interest-bearing deposits in other banks   |       | 85                                                             |       | (95                                                          | )          | (10 | ) | 193 |   | (204 | ) | (11 | ) |
| Investment securities:                     |       |                                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
| Taxable                                    |       | (45                                                            | )          | (11                                                          | )          | (56 | ) | (63 | ) | (30 | ) | (93 | ) |
| Tax-exempt                                 |       | (63                                                            | )          | 1                                                            |       | (62 | ) | (127 | ) | 3 |   | (124 | ) |
| Loans                                      |       | (36                                                            | )          | (169                                                         | )          | (205 | ) | (13 | ) | (587 | ) | (600 | ) |
| Total interest income                      |       | (110                                                           | )          | (280                                                         | )          | (390 | ) | (129 | ) | (832 | ) | (961 | ) |
|                                       |       |                                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
| Interest expense                           |       |                                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:              |       |                                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
| NOW accounts                               |       | —                                                         |       | (7                                                           | )          | (7 | ) | — |   | (6 | ) | (6 | ) |
| Savings accounts                           |       | —                                                         |       | (3                                                           | )          | (3 | ) | — |   | (5 | ) | (5 | ) |
| Money market accounts                      |       | (4                                                             | )          | (69                                                          | )          | (73 | ) | (4 | ) | (189 | ) | (193 | ) |
| Certificates of deposit $100,000 or more   |       | (71                                                            | )          | (117                                                         | )          | (188 | ) | (119 | ) | (280 | ) | (399 | ) |
| Certificates of deposit less than $100,000 |       | 21                                                             |       | (180                                                         | )          | (159 | ) | 44 |   | (396 | ) | (352 | ) |
| Long-term borrowings                       |       | —                                                         |       | (1                                                           | )          | (1 | ) | — |   | (2 | ) | (2 | ) |
| Junior subordinated debentures             |       | —                                                         |       | —                                                       |       | — |   | 202 |   | (202 | ) | — |   |
| Total interest expense                     |       | (54                                                            | )          | (377                                                         | )          | (431 | ) | $ | 123 |   | $ | (1,080 | ) | $ | (957 | ) |
| Net interest income                        |       | $                                                              | (56        | )                                                            | $          | 97 |   | $ | 41 |   | $ | (252 | ) | $ | 248 |   | $ | (4 | ) |

 

## **NetInterest Income**

## ** **

Netinterest income is generated from the Company’s lending and investmentactivities, and is the most significant component of the Company’searnings.  Net interest income is thedifference between interest and rate-related fee income on earning assets(primarily loans and investment securities) and the interest paid on the funds(primarily deposits) supporting them. The Company primarily utilizes deposits to fund loans and investments,with a small amount of additional funding from junior subordinated debenturesand minimal short-term and long-term borrowings.  In future periods, the Company may utilize ahigher level of short-term and long-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.

 

**ThreeMonths Ended June 30, 2009 and 2008**

 

Net interest income (on a taxable-equivalent basis) was $2.13 million in2009 and $2.09 million in 2008.  Theincrease in net interest income was primarily driven by lower rates paid on alldeposit categories, which was primarily offset by lower yields on the loanportfolio and interest-bearing deposits in other banks.  Average earning assets decreased by $2.04million, or (0.81)%, since June 30, 2008. The yield on earning assets in 2009 decreased to 5.63% from 6.20% in2008, or 57 basis points, primarily as a result of the Federal Reserve’sdecrease in the federal funds rate of 400 basis points since January 1,2008.  The decrease of 78 basis points inthe rate paid on interest-bearing liabilities primarily is the result of thelower rates paid on money market accounts and certificates of deposit.  The Company’s net interest margin was 3.42%and 3.32%, and the net interest spread was 2.86% and 2.65%, for the three-monthperiods ended June 30, 2009 and 2008, respectively.

 

Interest expense decreased 23.79% from $1.81 million in 2008 to $1.38million in 2009 due to the reduced rates paid on interest-bearing liabilities,which decreased to 2.77% in 2009 from 3.55% in 2008.

 

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**SixMonths Ended June 30, 2009 and 2008**

 

Net interest income (on a taxable-equivalent basis) was $4.18 million in2009 and 2008.  The impact to the netinterest income of lower rates paid on all deposit categories, was totallyoffset by lower yields on the loan portfolio and interest-bearing deposits inother banks.  Average earning assetsincreased by $1.53 million, or 0.61%, since June 30, 2008.  The yield on earning assets in 2009 decreasedto 5.62% from 6.39% in 2008, or 77 basis points, primarily as a result of theFederal Reserve’s decrease in the federal funds rate of 400 basis points since January 1,2008.  The decrease of 88 basis points inthe rate paid on interest-bearing liabilities primarily is the result of thelower rates paid on money market accounts and certificates of deposit.  The Company’s net interest margin was 3.34%and 3.35%, and the net interest spread was 2.76% and 2.65%, for the six-monthperiods ended June 30, 2009 and 2008, respectively.

 

Interest expense decreased 25.17% from $3.80 million in 2008 to $2.85million in 2009 due to the reduced rates paid on interest-bearing liabilities,which decreased to 2.86% in 2009 from 3.74% in 2008.

 

**NoninterestIncome**

 

## **Noninterest income was $251,000 in 2009 and $129,000in 2008 for the respective quarters ended June 30.  Noninterest income for the first half of 2009and 2008 was $359,000 and $280,000, respectively.  The three and six month periods in 2009include securities gains of $117,000. The six-month period in 2009 includes a loss on the sale of a foreclosedproperty in the amount of $32,000, whereas, there was a gain of $15,000 on thesale of a foreclosed property for the same period in 2008.**

## ** **

## **Noninterest Expense**

## ** **

Noninterest expense amounted to $1.78 million and $1.65 million for thethree-month periods ended June 30, 2009 and 2008, respectively, and $3.47million and $3.30 million for the six-month periods ended June 30, 2009and 2008, respectively.  The three andsix month periods in 2009 includes a $115,000 charge for the FDIC specialassessment.

 

**IncomeTaxes**

 

During the three monthsended June 30, 2009, the Company recognized an $117,000 income tax expensecompared to an $116,000 income tax expense during the same period in 2008.  The effective tax rate for the three-monthperiods in 2009 and 2008 were 32.87% and 30.05%, respectively.  For the six months ended June 30, 2009,the Company recognized a $97,000 income tax expense compared to a $228,000income tax expense during the same period in 2008.  The effective tax rate for the six-monthperiods in 2009 and 2008 were 25.46% and 28.61%, respectively. The decline inincome tax expense is due to the lower pre-tax income and the larger relativeproportion of tax-free income to pre-tax income in 2009.

 

**Market Risk, Liquidity andInterest Rate Sensitivity**

 

Asset/liabilitymanagement involves the funding and investment strategies necessary to maintainan appropriate balance between interest sensitive assets and liabilities.  It also involves providing adequate liquiditywhile sustaining stable growth in net interest income.  Regular review and analysis of deposit andloan trends, cash flows in various categories of loans, and monitoring ofinterest spread relationships 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.  Liquiditydescribes the ability of the Company to meet financial obligations that ariseduring the normal course of business. Liquidity is primarily needed to meet the borrowing and depositwithdrawal requirements of the customers of the Company, as well as for meetingcurrent and future planned expenditures. This liquidity is typically provided by the funds received throughcustomer deposits, investment maturities, loan repayments, borrowings, andincome.  Management considers the currentliquidity position to be adequate to meet the needs of the Company and itscustomers.

 

The Company seeksto limit the risks associated with interest rate fluctuations by managing thebalance between interest sensitive assets and liabilities.  Managing to mitigate interest rate risk is,however, not an exact science.  Not onlydoes the interval until repricing of interest rates on assets and liabilitieschange from day to day as the assets and liabilities change, but for someassets and liabilities, contractual maturity and the actual maturityexperienced are not the same.  Similarly,NOW and money market accounts, by contract, may be withdrawn in their entiretyupon demand and savings deposits may be withdrawn on seven days notice.  While these contracts are extremely short, itis the Company’s belief that these accounts turn over at the rate of fivepercent (5%) per year. The Company therefore treats them as having maturitiesstaggered over all periods.  If all ofthe Company’s NOW, money market, and savings accounts were treated as repricingin one year or less, the cumulative gap at one year or less would be $(52.94)million.

 

Interest ratesensitivity is an important factor in the management of the composition andmaturity configurations of the Company’s earning assets and fundingsources.  An Asset/Liability Committeemanages the interest rate sensitivity position in order to maintain 

 

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an appropriatebalance between the maturity and repricing characteristics of assets andliabilities that is consistent with the Company’s liquidity analysis, growth,and capital adequacy goals.  It is theobjective of the Asset/Liability Committee to maximize net interest margins duringperiods of both volatile and stable interest rates, to attain earnings growth,and to maintain sufficient liquidity to satisfy depositors’ requirements andmeet credit needs of customers.

 

The table below, “InterestRate Sensitivity Gap Analysis,” summarizes, as of June 30, 2009, 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 anytime period means that more interest-bearing liabilities will reprice or matureduring that time period than 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 fora 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.  During periods of rising interest rates, apositive gap position would generally increase earnings, and during periods ofdeclining interest rates, a positive gap position would generally decreaseearnings.

 

It is important tonote that the following table represents the static gap position for interestsensitive assets and liabilities at June 30, 2009.  The table does not give effect to prepaymentsor extensions of loans as a result of changes in general market interestrates.  Moreover, while the table doesindicate the opportunities to reprice assets and liabilities within certaintime frames, it does not account for timing differences that occur duringperiods of repricing.  For example,changes to deposit rates tend to lag in a rising rate environment and lead in afalling rate environment, although this will not always be the case.  Nor does it account for the effects ofcompetition on pricing of deposits and loans. For example, under current market conditions, market rates paid ondeposits may not be able to adjust by the full amount of downward adjustmentsin the federal funds target rate, while rates on loans will tend to adjust bythe full amount, subject to certain limitations.  In response to the weak economic climate, theCompany has maintained a higher level of liquidity over the past year, mostlyin interest-bearing deposits in other banks with the majority being funds heldat the Federal Reserve that are earning interest.

 

**InterestRate Sensitivity Gap Analysis********June 30, 2009**

 
| ** **                                            | ** ** | **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                                   |       | $                                       | 453        |   | $ | — |   | $ | — |   | $ | — |   | $ | 453 |   |
| Interest-bearing  deposits in other banks             |       | 29,678                                  |       | — |   | — |   | — |   | 29,678 |   |
| Investment  securities(1)                             |       | 3,420                                   |       | 756 |   | 1,924 |   | 8,058 |   | 14,158 |   |
| Loans                                                 |       | 77,130                                  |       | 70,270 |   | 40,738 |   | 18,791 |   | 206,929 |   |
| Total  interest-earning assets                        |       | 110,681                                 |       | 71,026 |   | 42,662 |   | 26,849 |   | 251,218 |   |
|                                                  | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Liabilities                                           |       |                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Savings  and NOW accounts                             |       | 913                                     |       | 1,825 |   | 1,825 |   | 13,688 |   | 18,251 |   |
| Money  Market accounts                                |       | 2,065                                   |       | 4,132 |   | 4,132 |   | 30,986 |   | 41,315 |   |
| Certificates  of deposit                              |       | 104,056                                 |       | 19,637 |   | 1,094 |   | — |   | 124,787 |   |
| Long-term  borrowings                                 |       | —                                  |       | 10,000 |   | — |   | — |   | 10,000 |   |
| Junior  subordinated debentures                       |       | —                                  |       | 6,186 |   | — |   | — |   | 6,186 |   |
| Total  interest-bearing liabilities                   |       | 107,034                                 |       | 41,780 |   | 7,051 |   | 44,674 |   | 200,539 |   |
| Interest  rate sensitivity gap                        |       | $                                       | 3,647      |   | $ | 29,246 |   | $ | 35,611 |   | $ | (17,825 | ) | $ | 50,679 |   |
| Cumulative  interest rate sensitivity gap             |       | $                                       | 3,647      |   | $ | 32,893 |   | $ | 68,504 |   | $ | 50,679 |   |   |   |
| Cumulative  gap ratio as a percentage of total assets |       | 1.41                                    | %          | 12.74 | % | 26.53 | % | 19.62 | % |   |   |

 

----

(1) Excludes equitysecurities.

 

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 differentscenarios.  The model is based on currentCompany data and adjusted by assumptions as to growth patterns, noninterestincome and noninterest expense and interest rate sensitivity, based onhistorical data, for both assets and liabilities projected for a one-yearperiod.  The model is then subjected to a“shock test” assuming a sudden prime interest rate increase of 200 basis pointsor a decrease of 200 basis points, but not below 

 

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zero.  The results show that with a 200 basis pointrise in the prime interest rate the Company’s net interest income wouldincrease by 1.03%.  However, a decreasein the prime interest rate of 200 basis was not considered to be feasible sincethis would infer that the federal funds interest rate would fall below zero.

 

Certain shortcomingsare inherent in this method of analysis. For example, although certain assets and liabilities may have similarmaturities or repricing periods, they may react in different degrees to changesin market interest rates.  Also, theinterest rates on certain types of assets and liabilities may fluctuate inadvance of changes in market interest rates, while interest rates on othertypes may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans,have features that restrict changes in interest rates on a short-term basis andover the life of the loan.  Further, inthe event of a change in interest rates, prepayment and early withdrawal levelscould deviate significantly from those assumed. Finally, the ability of many borrowers to service their debt maydecrease in the event of a significant interest rate increase.

 

**CriticalAccounting Policy:**

 

**Allowance for Loan Losses**

** **

The Company makesprovisions for loan losses in amounts deemed necessary to maintain the allowancefor loan losses at an appropriate level. The Company’s provision for loan losses for the three months ended June 30,2009 and 2008 was $200,000 and $120,000, respectively, and for the six monthsended June 30, 2009 and 2008 was $600,000 and $240,000, respectively.  The provision for loan losses is determinedbased upon Management’s estimate of the amount required to maintain an adequateallowance for loan losses reflective of the risks in the Company’s loanportfolio.  At June 30, 2009 and December 31,2008, the allowance for loan losses was $3.04 million and $3.12 million,respectively.  The decrease in theallowance from December 31, 2008, reflects the provision of $600,000 lessnet charge-offs of $682,000, as compared to a provision of $240,000 less netcharge-offs of $296,000 in the same period of 2008.  The increase in charge-offs in 2009 is aresult of two (2) commercial real estate relationships in the amount of$448,000, three (3) commercial and industrial loan relationships for$226,000 and three (3) consumer loan relationships which totaled$11,000.  In 2009, the allowance for loanlosses is down because we charged off $682,000 of higher loss potential ratedloans in the first quarter and had a reduction in the level of nonperformingassets, which overall led to a reduction in the level of the reserve.

 

The Company prepares aquarterly analysis of the allowance for loan losses, with the objective ofquantifying portfolio risk into a dollar amount of inherent losses.  The determination of the allowance for loanlosses is based on eight qualitative factors and one quantitative factor foreach category and type of loan along with any specific allowance for adverselyclassified loans within each category. Each factor is assigned a percentage weight and that total weight isapplied to each loan category.  Factorsare different for each category. 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 total allowance required thus changes asthe percentage weight assigned to each factor increased or decreased due to theparticular circumstances, as the various types and categories of loans changeas a percentage of total loans and as specific allowances are required due toincreases 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 allowance is based on two basicprinciples of accounting: (i) SFAS No. 5, *Accounting for Contingencies*, which requires that losses beaccrued when they are probable of occurring and estimable and (ii) SFAS No. 114,*Accounting by Creditors for Impairment of aLoan*, which requires that losses be accrued based on the differencesbetween the loan balance and either the value of collateral, or the presentvalue of future cash flows, or the loan’s value as observable in the secondarymarket.  A loan is considered impairedwhen, based on current information and events, it is probable that the Bankwill be unable to collect the scheduled payments of principal or interest whendue according to the contractual terms of the loan agreement.  Factors considered by Management indetermining impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments whendue.  Loans that experience insignificantpayment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance ofpayment delays and payment shortfalls on a case-by-case basis, taking intoconsideration all of the circumstances surrounding the loan and borrower,including the length of the delay, the reason for the delay, the borrower’sprior payment record, and the amount of the shortfall in relation to theprincipal and interest owed.  Theprovision for loan losses included in the statements of operations serves tomaintain the allowance at a level Management considers adequate.

 

TheCompany’s allowance for loan losses has three basic components: the specificallowance, the formula allowance and the pooled allowance.  Each of these components is determined basedupon estimates that can and do change when the actual events occur.  As a result of the uncertainties inherent inthe estimation 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, a specific reserve may be establishedbased on the Company’s calculation of the estimated loss embedded in 

 

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theindividual loan.  Impairment testingincludes consideration of the borrower’s overall financial condition, resourcesand payment record, support available from financial guarantors and the fairmarket value of collateral. These factors are combined to estimate theprobability and severity of inherent losses. Large groups of smaller balance, homogeneous loans are collectivelyevaluated for impairment. Accordingly, the Company does not separately identifyindividual consumer and residential mortgage loans for impairment.  At June 30, 2009 there were only fourcommercial real estate loans in the amount of $910,000, which were in anonaccrual status, that were deemed to be impaired and had specific reserves of$120,000, compared with $1.86 million in nonaccrual loans, that were deemed tobe impaired and had specific reserves of $294,000 at June 30, 2008.  These loans at June 30, 2008 amounted to$1.57 million in commercial real estate for three relationships and $307,000 incommercial and industrial loans for two relationships.  All of the impaired loan relationshipsdiscussed are in different types of businesses.

 

Theformula allowance component is used for estimating the loss on internally riskrated loans and those loans identified for impairment testing.  The loans meeting the Company’s internalcriteria for classification, such as special mention, substandard, doubtful andloss are segregated from performing loans within the portfolio. Theseinternally classified loans are then grouped by loan type (commercial,commercial real estate, commercial construction, residential real estate,residential construction or installment). Each loan type is assigned an allowance factor based on Management’sestimate of the associated risk, complexity and size of the individual loanswithin the particular loan category. Classified loans are assigned a higherallowance factor than non-classified loans due to Management’s concernsregarding collectability or Management’s knowledge of particular elementssurrounding the borrower. Allowance factors increase with the worsening of theinternal risk rating.

 

Thepooled formula component is used to estimate the losses inherent in the poolsof non-classified loans.  These loans arethen also segregated by loan type and allowance factors are assigned byManagement based on delinquencies, loss history, trends in volume and terms ofloans, effects of changes in lending policy, the experience and depth ofManagement, national and local economic trends, concentrations of credit, qualityof loan review system and the effect of external factors (i.e. competition andregulatory requirements).  The allowancefactors assigned differ by loan type.

 

Allowancefactors and overall size of the allowance may change from period to period basedon Management’s assessment of the above-described factors and the relativeweights given to each factor.  Inaddition, various regulatory agencies periodically review the allowance forloan losses.  These agencies may requirethe Bank to make additions to the allowance for loan losses based on theirjudgments of collectibility based on information available to them at the timeof their examination.

 

Managementbelieves that the allowance for loan losses is adequate.  There can be no assurance, however, thatadditional provisions for loan losses will not be required in the future,including as a result of changes in the economic assumptions underlyingManagement’s estimates and judgments, adverse developments in the economy, on anational basis or in the Company’s market area, or changes in the circumstancesof particular borrowers.

 

As of June 30,2009, the real estate loan portfolio constituted 86% of the total loanportfolio, as compared to 83% at December 31, 2008.  While this exceeds the 10% threshold fordetermining a concentration of credit risk within an industry, we do notconsider this to be a concentration with adverse risk characteristics given thediversity of borrowers within the real estate portfolio and other sources ofrepayment.  An industry for this purposeis defined as a group of counterparties that are engaged in similar activitiesand have similar economic characteristics that would cause their ability tomeet contractual obligations to be similarly affected by changes in economic orother conditions.  Additionally, the loanportfolio does not include concentrations of credit risk in residential loanproducts that permit the deferral of principal payments that are smaller thannormal interest accruals (negative amortization); loans with high loan-to-valueratios; or loans, such as option adjustable-rate mortgages, that may expose theborrower to future increases in repayments that are in excess of increases thatwould result solely from increases in market interest rates.  However, the Company does have interest onlyhome equity lines of credit with outstanding balances of $8.16 million of at June 30,2009.

 

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| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(dollars in thousands)**                   | ** ** | **June 30,********2009**    | ** ** | **June 30,********2008**  | ** ** | **June 30,********2009** | ** ** | **June 30,********2008** | ** ** |
| Average  total loans outstanding during period         |       | $                                | 207,559    |                           | $          | 209,712 |   | $ | 209,703 |   | $ | 210,074 |   |
| Balance  at beginning of period                        |       | $                                | 2,838      |                           | $          | 2,470 |   | $ | 3,120 |   | $ | 2,640 |   |
| Recoveries  of loans previously charged-off (consumer) |       | —                           |       | —                         |       | 3 |   | 9 |   |
| Loans  charged-off (commercial and industrial)         |       | —                           |       | —                         |       | (226 | ) | (223 | ) |
| Loans  charged-off (commercial real estate)            |       | —                           |       | —                         |       | (448 | ) | (76 | ) |
| Loans  charged-off (residential)                       |       | —                           |       | (6                             | )          | — |   | (6 | ) |
| Loans  charged-off (consumer)                          |       | —                           |       | —                         |       | (11 | ) | — |   |
| Net  charge-offs                                       |       | —                           |       | (6                             | )          | (682 | ) | (296 | ) |
| Provision  charged to operating expenses               |       | 200                              |       | 120                            |       | 600 |   | 240 |   |
| Balance  at end of period                              |       | $                                | 3,038      |                           | $          | 2,584 |   | $ | 3,038 |   | $ | 2,584 |   |
| Ratios  of net charge-offs to average loans            |       | —                           | %          | —                         | %          | 0.33 | % | 0.14 | % |

 

Theallocation of the allowance, presented in the following table, is basedprimarily on the factors discussed above in evaluating the adequacy of theallowance as a whole.  Since all of thosefactors are subject to change, the allocation is not necessarily indicative ofthe category of recognized loan losses, and does not restrict the use of theallowance to absorb losses in any category.

 

**Allocation of Allowance for LoanLosses**

** **
| ** **                                                                  | ** ** | **June 30,** | ** ** | **December 31,**          | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------|------------|--------------------------------|------------|
| ** **                                                                  | ** ** | **2009**          | ** ** | **%****of**** ****Loans** | ** ** | **2008** | ** ** | **% of********Loans** | ** ** |
| Real  estate-construction                                                   |       | $                 | 448        |                           | 11         | % | $ | 333 |   | 8 | % |
| Real  estate-mortgage                                                       |       | 2,025             |       | 75                             | %          | 2,278 |   | 75 | % |
| Commercial  and industrial loans                                            |       | 522               |       | 13                             | %          | 472 |   | 16 | % |
| Loans  to individuals for household, family and other personal expenditures |       | 43                |       | 1                              | %          | 37 |   | 1 | % |
|                                                                        |       | $                 | 3,038      |                           | 100        | % | $ | 3,120 |   | 100 | % |

** **
| ** **                                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Nonaccrual loans                           |       | $                 | 1,051      |                  | $          | 1,197 |   |
| Loans 90 days past due and  still accruing |       | —            |       | —                |       |
| Total nonperforming  loans                 |       | 1,051             |       | 1,197                 |       |
| Foreclosure properties                     |       | —            |       | 363                   |       |
| Total nonperforming  assets                |       | $                 | 1,051      |                  | $          | 1,560 |   |
| Nonperforming assets to  total assets      |       | 0.41              | %          | 0.61                  | %          |

 

There were noother interest-bearing assets at June 30, 2009 or December 31, 2008classified 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.

 

**Off-BalanceSheet Arrangements**

** **

The Company is a party tofinancial instruments with off-balance sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit, including unused portions of lines of credit, andstandby letters of credit.  The Companyhas also entered into long-term lease obligations for some of its premises andequipment, the terms of which generally include options to renew.  The above instruments and obligationsinvolve, to varying degrees, elements of off-balance sheet risk in excess ofthe amount recognized in the consolidated statements of financialcondition.  With the exception of theseinstruments and the Company’s obligations relating to its trust preferredsecurities, the Company does not have any off balance sheet arrangements thathave or are reasonably likely to have a current or future effect on the Company’sfinancial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources that is material to investors.

 

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Commitments to extend credit and standby letters ofcredit as of June 30, 2009 were as follows:

 
| ** **                                                                       | ** ** | **June 30,**       | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                       | ** ** | **2009**                | ** ** |
| **(dollars in thousands)**                                             | ** ** | **Contractual  Amount** | ** ** |
| Financial  instruments whose notional or contract amounts represent credit risk: |       |                    |       |
| Commitments  to extend credit                                                    |       | $                       | 28,510     |   |
| Standby  letters of credit                                                       |       | 2,889                   |       |
| Total                                                                            |       | $                       | 31,399     |   |

 

SeeNote 9 to the Notes to the Consolidated Financial Statements included in theCompany’s Annual Report on Form 10-K for the year ended December 31,2008 for additional information regarding the Company’s long-term leaseobligations.

 

**CapitalResources**

 

Theability of the Company to grow is dependent on the availability of capital withwhich to meet regulatory capital requirements, discussed below.  To the extent the Company is successful itmay need to acquire additional capital through the sale of additional commonstock, other qualifying equity instruments or subordinated debt.  There can be no assurance that additionalcapital will be available to the Company on a timely basis or on attractiveterms.  On December 15, 2006, theCompany completed the issuance of $6.00 million of trust preferred securities,as discussed above that can be recognized as capital for regulatorypurposes.  The Company has an unsecured revolving line of creditborrowing arrangement with an unaffiliated financial institution in the amountof $3.00 million with no outstanding balance as of June 30, 2009 or December 31,2008.  This facility matures on September 1,2009, has a floating interest rate equal to the Wall Street Journal prime rateand requires monthly interest payments only. The purpose of this facility is to provide capital to the Bank, asneeded.  The Bank expects to have thiscredit facility renewed, but there can be no assurance.  See Recent Developments section for moreinformation on the unsecured borrowing.

 

The Bank is subject tovarious regulatory capital requirements administered by the federal bankingagencies.  The Company will be subject tosuch requirements when its assets exceed $500 million, it has publicly issueddebt or it engages in certain highly leveraged activities.  Failure to meet minimum capital requirementscan initiate certain mandatory - and possibly additional discretionary -actions by regulators that, if undertaken, could have a direct material effecton the Company’s consolidated financial statements.

 

Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The Bank’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum amounts and ratios of total and Tier 1 capital (as defined inthe regulations) to risk-weighted assets (as defined), and Tier 1 capital (asdefined) to average assets (as defined). Management believes that the Bank met all capital adequacy requirementsto which it is subject as of June 30, 2009 and that the Company would meetsuch requirements if applicable.  SeeNote 10 to the consolidated financial statements for a table depictingcompliance with regulatory capital requirements.

 

As of June 30, 2009,the most recent notification from the regulatory agency categorized the Bank aswell capitalized under the regulatory framework for prompt correctiveaction.  To be categorized as wellcapitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based,and Tier 1 leverage ratios as set forth in the table in Note 10.  There are no conditions or events since thatnotification which management believes have changed the Bank’s category.

 

On June 26, 2007,the Company authorized the repurchase of up to 146,000 shares of its common stock,for an aggregate expenditure of not more than $4.5 million, through June 30,2012, or earlier termination of the program by the Board of Directors.  Repurchases, if any, by the Company pursuantto this authorization are expected to enable the Company to repurchase itsshares at an attractive price, and to provide a source of liquidity for theCompany’s shares.  As of June 30,2009, there have been no shares repurchased by the Company.

 

## **Inflation**

## ** **

The effect of changingprices on financial institutions is typically different than on non-bankingcompanies since virtually all of a Company’s assets and liabilities aremonetary in nature. In particular, interest rates are significantly affected byinflation, but neither the timing nor magnitude of the changes are directlyrelated to price level indices; therefore, the Company can best counterinflation over the long term by managing net interest income and controllingnet increases in noninterest income and expenses.

 

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###### **Item 3. Quantitative and Qualitative Disclosures About Market Risk**

###### ** **

See“Market Risk, Liquidity and Interest Rate Sensitivity” at Page 23.

 

###### **Item 4.    Controlsand Procedures**

###### ** **

## **The Company’s management, under the supervision and withthe participation of the Company’s Chief Executive Officer and Chief FinancialOfficer, evaluated, as of the last day of the period covered by this report,the effectiveness of the design and operation of the Company’s disclosurecontrols and procedures, as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934.  Basedon that evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures wereeffective.  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 June 30, 2009that has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.**

 

**PART II — Other Information**

 

Item 1.    Legal Proceedings.  None

 

Item 1A.Risk Factors.  NotApplicable.

 

Item 2.    Unregistered Sales of Equity Securitiesand Use of Proceeds

 

(a)   *Sales of Unregistered Securities. *None

 

(b)   *Use of Proceeds. *NotApplicable.

 

(c)   *Registrant**Purchases of Securities*

 

The followingtable provides information on the Company’s purchases of its common stockduring the quarter ended June 30, 2009.

 
| **Period**            | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price Paid  per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs(1)** | ** ** | **Maximum Number of  Shares that may yet be  Purchased Under the  Plans or Programs** | ** ** |
|-----------------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 1-30, 2009 |       | 0                                                    |       | N/A                                              |       | 0                                                                                                                                   |       | 0                                                                                                                                       |       |
| May 1-31, 2009   |       | 0                                                    |       | N/A                                              |       | 0                                                                                                                                   |       | 0                                                                                                                                       |       |
| June 1-30, 2009  |       | 0                                                    |       | N/A                                              |       | 0                                                                                                                                   |       | 146,000                                                                                                                                 | (2)        |

 

----

(1)   On June 26, 2007, the Company’sBoard of Directors approved a share repurchase program that authorizes therepurchase of up to 146,000 shares of the Company’s outstanding common stock,subject to a maximum expenditure of $4.5 million.  Repurchases under the program may be made onthe open market and in privately negotiated transactions from time to timeuntil June 30, 2012, or earlier termination of the program by the Board.

 

(2)   Subject to a maximum expenditure of $4.5million.  Number of shares indicated isthe remaining number of shares authorized for repurchase as of the end of theindicated period.

 

Item 3.    Defaults upon Senior Securities.  None

 

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Item 4.    Submission of Matters to a Vote ofSecurity Holder.

 

On April 14,2009, the annual meeting of shareholders of the Company was held for thepurpose of electing eleven (11) directors to serve until the next annualmeeting and until their successors are duly elected and qualified.

 

The name of eachdirector elected at the meeting, and the votes cast for such persons, whoconstitute the entire Board of Directors in office following the meeting, areset forth below:

 
| **DIRECTOR**                 | ** ** | **FOR**   | ** ** | **WITHHOLD** | ** ** | **BROKER**** NON-VOTES** | ** ** |
|------------------------------|------------|-----------|------------|--------------|------------|-------------------------------|------------|
| Emil D. Bennett              |       | 1,062,234 |       | 3,100        |       | None                          |       |
| John N. Burdette             |       | 1,062,634 |       | 2,700        |       | None                          |       |
| John Denham Crum             |       | 1,062,834 |       | 2,500        |       | None                          |       |
| George E.  Dredden, Jr. |       | 1,062,634 |       | 2,700        |       | None                          |       |
| William S. Fout              |       | 1,062,634 |       | 2.700        |       | None                          |       |
| Helen G. Hahn                |       | 1,062,634 |       | 2,700        |       | None                          |       |
| William J. Kissner           |       | 1,062,634 |       | 2,700        |       | None                          |       |
| Martin S. Lapera             |       | 1,062,634 |       | 2,700        |       | None                          |       |
| Kenneth G. McCombs           |       | 1,062,634 |       | 2,700        |       | None                          |       |
| Farhad Memarsadeghi          |       | 1,062,384 |       | 2,950        |       | None                          |       |
| Raymond Raedy                |       | 1,062,634 |       | 2,700        |       | None                          |       |

 

Item 5.    Other Information            None

 

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)                                                                                                                                                                                                                      |
| 4(a)                 |       | Indenture, dated as of  December 15, 2006 between Frederick County Bancorp, Inc. and U.S.  Bank National Association, as trustee(3)                                                                                                  |
| 4(b)                 |       | Amended and Restated  Declaration of Trust, dated as December 15, 2006 between Frederick  County Bancorp, Inc. and U.S. Bank National Association, as trustee, and  Martin S. Lapera and William R. Talley, Jr. as Administrators(3) |
| 4(c)                 |       | Guarantee Agreement  dated as of December 15, 2006 between Frederick County  Bancorp, Inc. and U.S. Bank National Association, as Guarantee  Trustee(3)                                                                              |
| 10(a)                |       | 2001 Stock  Option Plan(4)                                                                                                                                                                                                                     |
| 10(b)                |       | Employment  Agreement between the Bank and Martin S. Lapera(5)                                                                                                                                                                                 |
| 10(c)                |       | Employment  Agreement between the Bank and William R. Talley, Jr. (6)                                                                                                                                                                     |
| 10 (d)               |       | Amendment to Employment  Agreement between the Bank and Martin S. Lapera (7)                                                                                                                                                                   |
| 10 (e)               |       | Amendment to Employment  Agreement between the Bank and William R. Talley, Jr. (8)                                                                                                                                                        |
| 10(f)                |       | 2002 Executive and  Director Deferred Compensation Plan, as amended(9)                                                                                                                                                                         |
| 10(g)                |       | Amendment No. 1 to  the 2002 Executive and Director Deferred Compensation Plan(9)                                                                                                                                                         |
| 10(h)                |       | Loan Agreement with  Atlantic Central Bankers Bank (10)                                                                                                                                                                                        |
| 10(i)                |       | Promissory Note with  Atlantic Central Bankers Bank (10)                                                                                                                                                                                       |
| 10(j)                |       | Amendment to Line of  Credit with Atlantic Central Bankers Bank(11)                                                                                                                                                                            |
| 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                                                                                                                                           |

 

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| (1) |   | Incorporated by  reference to exhibit of the same number to the Company’s Quarterly Report on  Form 10-QSB for the quarter ended June 30, 2004, as filed with the  Securities and Exchange Commission.      |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Incorporated by  reference to exhibit of the same number to the Company’s Quarterly Report on  Form 10-QSB for the quarter ended September 30, 2003, as filed with  the Securities and Exchange Commission. |

 

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| (3)  |   | Not filed in  accordance with the provision of Item 601(b)(4)(v) of Regulation SK. The  Company agrees to provide a copy of these documents to the Commission upon request.                                                |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (4)  |   | Incorporated by  reference to exhibit 4 to the Company’s Registration Statement on  Form S-8 (No. 333-111761).                                                                                                   |
| (5)  |   | Incorporated by  reference to Exhibit 10.1 to the Company’s Current Report on  Form 8-K filed on May 24, 2005.                                                                                              |
| (6)  |   | Incorporated by  reference to Exhibit 10.2 to the Company’s Current Report on  Form 8-K filed on May 24, 2005.                                                                                              |
| (7)  |   | Incorporated by  reference to Exhibit 99.1 to the Company’s Current Report on  Form 8-K filed on December 12, 2007.                                                                                         |
| (8)  |   | Incorporated by  reference to Exhibit 99.2 to the Company’s Current Report on  Form 8-K filed on December 12, 2007.                                                                                         |
| (9)  |   | Incorporated by  reference to Exhibit of the same number to the Company’s Annual Report  on Form 10-KSB for the year ended December 31, 2004, as filed with  the Securities and Exchange Commission.        |
| (10) |   | Incorporated by  reference to Exhibit of the same number to the Company’s Quarterly  Report on Form 10-QSB for the quarter ended June 30, 2005, as filed  with the Securities and Exchange Commission.      |
| (11) |   | Incorporated by reference  to Exhibit of the same number to the Company’s Quarterly Report on  Form 10-QSB for the quarter ended September 30, 2008, as filed with  the Securities and Exchange Commission. |

 

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**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 

 
|                                                    | FREDERICK COUNTY  BANCORP, INC. |
|---------------------------------------------------------|---------------------------------|
|                                                    |                            |
|                                                    |                            |
| Date:     August 7,  2009 | By:                             | /s/ Martin S. Lapera |
|                                                    |                            | Martin S. Lapera |
|                                                    |                            | President and Chief  Executive Officer |
|                                                    |                            |
|                                                    |                            |
| Date:     August 7,  2009 | By:                             | /s/ William R.  Talley, Jr. |
|                                                    |                            | William R.  Talley, Jr. |
|                                                    |                            | Executive Vice President  and Chief Financial Officer |

 

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