**Table ofContents**

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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,DC  20549**

** **

### **FORM 10-Q**

### ** **

**(MARK ONE)**

 

| **x**      | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  | ** ** |
|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** ** | ** **                                                                                          | ** ** |
|       | **For  the Quarterly Period Ended September 30, 2008**                                         | ** ** |
|       |                                                                                                |       |
|       | **OR**                                                                                              | ** ** |
|       |                                                                                                |       |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |

###### ** **

**For the transition periodfrom                 to                 **

 

**Commission File Number:  000-50407**

 

#### **FREDERICKCOUNTY 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.) |

 

#### **9North Market Street**

**Frederick, Maryland 21701**

(Address of registrant’s principal executive offices)

 

**301.620.1400**

(Registrant’stelephone number, including area code)

 

**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 file suchreports), and (2) has been subject to such filing requirements for thepast 90 days.  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  x No

 

State the number ofshares of each of the issuer’s classes of common equity, as of the latestpractical date.  There were 1,460,802 sharesof Common Stock outstanding as of October 31, 2008.

 

 

----

 

#### **Tableof Contents**

 

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

**TABLEOF CONTENTS**

 
| **PART I                  FINANCIAL INFORMATION** |
|---------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                  | ** ** |
| Item 1.                                                                                                                                     | Financial Statements  (Unaudited) |
|                                                                                                                                        |   |
|                                                                                                                                        | Consolidated****Balance Sheets, September 30, 2008  and December 31, 2007 |
|                                                                                                                                        |   |
|                                                                                                                                        | Consolidated Statements of Income, Three and Nine  Months Ended September 30, 2008 and 2007 |
|                                                                                                                                        |   |
|                                                                                                                                        | Consolidated Statements of Changes in Shareholders’  Equity, Three and Nine Months Ended September 30, 2008 and 2007 |
|                                                                                                                                        |   |
|                                                                                                                                        | Consolidated Statements of Cash Flows, Nine Months  Ended September 30, 2008 and 2007 |
|                                                                                                                                        |   |
|                                                                                                                                        | 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 |

 

2

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Table of Contents

 

**Frederick County Bancorp, Inc. andSubsidiaries**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars  in thousands)**                                                                                                                      | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                       | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                       | ** ** | ** **             | ** ** | ** **            | ** ** |
| Cash and due  from banks                                                                                                                         |       | $                      | 3,393      |                  | $          | 3,828 |   |
| Federal funds  sold                                                                                                                              |       | 11,755                 |       | 6,864                 |       |
| Interest-bearing  deposits in other banks                                                                                                        |       | 6,651                  |       | 1,674                 |       |
| Cash and cash  equivalents                                                                                                                       |       | 21,799                 |       | 12,366                |       |
| Investment  securities available-for-sale at fair value                                                                                          |       | 20,470                 |       | 27,512                |       |
| Restricted stock                                                                                                                                 |       | 1,599                  |       | 1,440                 |       |
| Loans                                                                                                                                            |       | 211,517                |       | 209,011               |       |
| Less: Allowance  for loan losses                                                                                                                 |       | (2,700                 | )          | (2,640                | )          |
| Net loans                                                                                                                                        |       | 208,817                |       | 206,371               |       |
| Bank premises  and equipment                                                                                                                     |       | 5,338                  |       | 5,512                 |       |
| Other assets                                                                                                                                     |       | 2,971                  |       | 2,790                 |       |
| Total assets                                                                                                                                     |       | $                      | 260,994    |                  | $          | 255,991 |   |
|                                                                                                                                             |       |                   |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                   |       |                   |       |                  |       |
|                                                                                                                                             |       |                   |       |                  |       |
| **Liabilities**                                                                                                                                  | ** ** | ** **             | ** ** | ** **            | ** ** |
| Deposits:                                                                                                                                        |       |                   |       |                  |       |
| Noninterest-bearing  deposits                                                                                                                    |       | $                      | 36,160     |                  | $          | 33,357 |   |
| Interest-bearing  deposits                                                                                                                       |       | 187,100                |       | 185,871               |       |
| Total deposits                                                                                                                                   |       | 223,260                |       | 219,228               |       |
| Long-term  borrowings                                                                                                                            |       | 10,000                 |       | 10,000                |       |
| Junior  subordinated debentures                                                                                                                  |       | 6,186                  |       | 6,186                 |       |
| Accrued interest  and other liabilities                                                                                                          |       | 1,249                  |       | 997                   |       |
| Total  liabilities                                                                                                                               |       | 240,695                |       | 236,411               |       |
|                                                                                                                                             |       |                   |       |                  |       |
| **Shareholders’  Equity**                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| Common stock,  per share par value $.01; 10,000,000 shares authorized; 1,460,802 and  1,460,602 shares issued and outstanding, respectively |       | 15                     |       | 15                    |       |
| Additional  paid-in capital                                                                                                                      |       | 14,690                 |       | 14,687                |       |
| Retained  earnings                                                                                                                               |       | 5,785                  |       | 4,901                 |       |
| Accumulated  other comprehensive loss                                                                                                            |       | (191                   | )          | (23                   | )          |
| Total  shareholders’ equity                                                                                                                 |       | 20,299                 |       | 19,580                |       |
| Total  liabilities and shareholders’ equity                                                                                                 |       | $                      | 260,994    |                  | $          | 255,991 |   |

 

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

 

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**Frederick County Bancorp, Inc. and Subsidiaries**

**Consolidated Statements of Income (Unaudited)**

 
| ** **                                             | ** ** | **For the Three  Months Ended  September 30,** | ** ** | **For the Nine  Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| **(dollars in thousands, except per share amounts)**   | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest income:                                       |       |                                                |       |                                               |       |   |   |   |   |
| Interest and  fees on loans                            |       | $                                                   | 3,554      |                                               | $          | 3,758 |   | $ | 10,601 |   | $ | 10,417 |   |
| Interest and  dividends on investment securities:      |       |                                                |       |                                               |       |   |   |   |   |
| Interest —  taxable                               |       | 185                                                 |       | 233                                                |       | 586 |   | 700 |   |
| Interest — tax  exempt                            |       | 87                                                  |       | 100                                                |       | 285 |   | 298 |   |
| Dividends                                              |       | 25                                                  |       | 20                                                 |       | 68 |   | 55 |   |
| Interest on  federal funds sold                        |       | 46                                                  |       | 109                                                |       | 180 |   | 333 |   |
| Other interest  income                                 |       | 3                                                   |       | 45                                                 |       | 35 |   | 184 |   |
| Total interest  income                                 |       | 3,900                                               |       | 4,265                                              |       | 11,755 |   | 11,987 |   |
| Interest  expense:                                     |       |                                                |       |                                               |       |   |   |   |   |
| Interest on  deposits                                  |       | 1,446                                               |       | 1,938                                              |       | 4,815 |   | 5,408 |   |
| Interest on  other short-term borrowings               |       | 18                                                  |       | —                                             |       | 18 |   | 2 |   |
| Interest on  long-term borrowings                      |       | 116                                                 |       | 76                                                 |       | 347 |   | 117 |   |
| Interest on  junior subordinated debentures            |       | 101                                                 |       | 101                                                |       | 303 |   | 303 |   |
| Total interest  expense                                |       | 1,681                                               |       | 2,115                                              |       | 5,483 |   | 5,830 |   |
| Net interest  income                                   |       | 2,219                                               |       | 2,150                                              |       | 6,272 |   | 6,157 |   |
| Provision for  loan losses                             |       | 220                                                 |       | 50                                                 |       | 460 |   | 241 |   |
| Net interest  income after provision for loan losses   |       | 1,999                                               |       | 2,100                                              |       | 5,812 |   | 5,916 |   |
| Noninterest  income:                                   |       |                                                |       |                                               |       |   |   |   |   |
| Securities gains                                       |       | 26                                                  |       | —                                             |       | 26 |   | — |   |
| Gain on sale of  foreclosed properties                 |       | —                                              |       | —                                             |       | 15 |   | — |   |
| Service fees                                           |       | 73                                                  |       | 60                                                 |       | 193 |   | 149 |   |
| Other operating  income                                |       | 54                                                  |       | 40                                                 |       | 199 |   | 134 |   |
| Total  noninterest income                              |       | 153                                                 |       | 100                                                |       | 433 |   | 283 |   |
| Noninterest  expense:                                  |       |                                                |       |                                               |       |   |   |   |   |
| Salaries and  employee benefits                        |       | 966                                                 |       | 912                                                |       | 2,885 |   | 2,744 |   |
| Occupancy and  equipment expenses                      |       | 308                                                 |       | 264                                                |       | 905 |   | 771 |   |
| Other operating  expenses                              |       | 410                                                 |       | 422                                                |       | 1,190 |   | 1,136 |   |
| Total  noninterest expense                             |       | 1,684                                               |       | 1,598                                              |       | 4,980 |   | 4,651 |   |
| Income before  provision for income taxes              |       | 468                                                 |       | 602                                                |       | 1,265 |   | 1,548 |   |
| Provision for  income taxes                            |       | 153                                                 |       | 194                                                |       | 381 |   | 482 |   |
| Net income                                             |       | $                                                   | 315        |                                               | $          | 408 |   | $ | 884 |   | $ | 1,066 |   |
| Basic earnings  per share                              |       | $                                                   | 0.22       |                                               | $          | 0.28 |   | $ | 0.61 |   | $ | 0.73 |   |
| Diluted earnings  per share                            |       | $                                                   | 0.21       |                                               | $          | 0.27 |   | $ | 0.59 |   | $ | 0.70 |   |
| Basic weighted  average number of shares outstanding   |       | 1,460,674                                           |       | 1,460,602                                          |       | 1,460,626 |   | 1,459,965 |   |
| Diluted weighted  average number of shares outstanding |       | 1,502,443                                           |       | 1,515,716                                          |       | 1,506,352 |   | 1,520,638 |   |

 

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)**

 

***ThreeMonths Ended September 30,***

 
| **(dollars in thousands, except  shares outstanding)**                                                         | ** ** | **Shares  Outstanding** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive (Loss)** | ** ** | **Total  Shareholders’  Equity** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|----------------------------------------------|------------|---------------------------------------|------------|
|                                                                                                           |       |                    |       |              |       |                             |       |                   |       |                                         |       |                                  |       |
| Balance,  June 30, 2007                                                                                   |       | 1,460,602               |       | $                 | 15         |                             | $          | 14,687                 |       | $                                            | 3,999      |                                  | $          | (294 | ) | $ | 18,407 |   |
| Comprehensive  income:                                                                                         |       |                    |       |              |       |                             |       |                   |       |                                         |       |                                  |       |
| Net income                                                                                                     |       | —                  |       | —            |       | —                           |       | 408                    |       | —                                       |       | 408                                   |       |
| Changes in net  unrealized gains (losses) on securities available for sale, net of income  taxes of $128       |       | —                  |       | —            |       | —                           |       | —                 |       | 204                                          |       | 204                                   |       |
| Comprehensive  income                                                                                          |       |                    |       |              |       |                             |       |                   |       |                                         |       | 612                                   |       |
| Balance,  September 30, 2007                                                                              |       | 1,460,602               |       | $                 | 15         |                             | $          | 14,687                 |       | $                                            | 4,407      |                                  | $          | (90 | ) | $ | 19,019 |   |
| Balance,  June 30, 2008                                                                                   |       | 1,460,602               |       | $                 | 15         |                             | $          | 14,687                 |       | $                                            | 5,470      |                                  | $          | (108 | ) | $ | 20,064 |   |
| Comprehensive  income:                                                                                         |       |                    |       |              |       |                             |       |                   |       |                                         |       |                                  |       |
| Net income                                                                                                     |       | —                  |       | —            |       | —                           |       | 315                    |       | —                                       |       | 315                                   |       |
| Changes in net  unrealized gains (losses) on securities available for sale, net of income tax  benefits of $54 |       | —                  |       | —            |       | —                           |       | —                 |       | (83                                          | )          | (83                                   | )          |
| Comprehensive  income                                                                                          |       |                    |       |              |       |                             |       |                   |       |                                         |       | 232                                   |       |
| Shares issued  under stock option transactions                                                                 |       | 200                     |       | —            |       | 3                                |       | —                 |       | —                                       |       | 3                                     |       |
| Balance,  September 30, 2008                                                                              |       | 1,460,802               |       | $                 | 15         |                             | $          | 14,690                 |       | $                                            | 5,785      |                                  | $          | (191 | ) | $ | 20,299 |   |

 

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**Frederick CountyBancorp, Inc. and SubsidiariesConsolidated Statement of Changes in Shareholders’ Equity (Unaudited)**

 

***Nine Months Ended September 30,***

 
| **(dollars in thousands, except  shares outstanding)**                                                          | ** ** | **Shares  Outstanding** | ** ** | **Common  Stock** | ** ** | **Additional Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive (Loss)** | ** ** | **Total  Shareholders’  Equity** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|---------------------------------|------------|------------------------|------------|----------------------------------------------|------------|---------------------------------------|------------|
|                                                                                                            |       |                    |       |              |       |                            |       |                   |       |                                         |       |                                  |       |
| Balance,  January 1, 2007                                                                                  |       | 1,458,602               |       | $                 | 15         |                            | $          | 14,652                 |       | $                                            | 3,341      |                                  | $          | (115 | ) | $ | 17,893 |   |
| Comprehensive  income:                                                                                          |       |                    |       |              |       |                            |       |                   |       |                                         |       |                                  |       |
| Net income                                                                                                      |       | —                  |       | —            |       | —                          |       | 1,066                  |       | —                                       |       | 1,066                                 |       |
| Changes in net unrealized  gains (losses) on securities available for sale, net of income taxes of $16          |       | —                  |       | —            |       | —                          |       | —                 |       | 25                                           |       | 25                                    |       |
| Comprehensive  income                                                                                           |       |                    |       |              |       |                            |       |                   |       |                                         |       | 1,091                                 |       |
| Shares issued  under stock option Transactions                                                                  |       | 2,000                   |       | —            |       | 35                              |       | —                 |       | —                                       |       | 35                                    |       |
| Balance,  September 30, 2007                                                                               |       | 1,460,602               |       | $                 | 15         |                            | $          | 14,687                 |       | $                                            | 4,407      |                                  | $          | (90 | ) | $ | 19,019 |   |
| Balance,  January 1, 2008                                                                                  |       | 1,460,602               |       | $                 | 15         |                            | $          | 14,687                 |       | $                                            | 4,901      |                                  | $          | (23 | ) | $ | 19,580 |   |
| Comprehensive  income:                                                                                          |       |                    |       |              |       |                            |       |                   |       |                                         |       |                                  |       |
| Net income                                                                                                      |       | —                  |       | —            |       | —                          |       | 884                    |       | —                                       |       | 884                                   |       |
| Changes in net  unrealized gains (losses) on securities available for sale, net of income tax  benefits of $109 |       | —                  |       | —            |       | —                          |       | —                 |       | (168                                         | )          | (168                                  | )          |
| Comprehensive  income                                                                                           |       |                    |       |              |       |                            |       |                   |       |                                         |       | 716                                   |       |
| Shares issued  under stock option transactions                                                                  |       | 200                     |       | —            |       | 3                               |       | —                 |       | —                                       |       | 3                                     |       |
| Balance,  September 30, 2008                                                                               |       | 1,460,802               |       | $                 | 15         |                            | $          | 14,690                 |       | $                                            | 5,785      |                                  | $          | (191 | ) | $ | 20,299 |   |

 

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

 

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**Frederick County Bancorp, Inc. and Subsidiaries**

**ConsolidatedStatements of Cash Flows (Unaudited)**

 
| ** **                                                                                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| **(dollars in thousands)**                                                                      | ** ** | **2008**                                 | ** ** | **2007** | ** ** |
| Cash flows from operating activities:                                                           |       |                                     |       |   |   |
| Net income                                                                                      |       | $                                        | 884        |   | $ | 1,066 |   |
| Adjustments to reconcile net income to net cash provided by  operating  activities:             |       |                                     |       |   |   |
| Depreciation and amortization                                                                   |       | 250                                      |       | 213 |   |
| Deferred income taxes (benefits)                                                                |       | (39                                      | )          | (83 | ) |
| Provision for loan losses                                                                       |       | 460                                      |       | 241 |   |
| Securities gains                                                                                |       | (26                                      | )          | — |   |
| Net premium amortization (discount accretion) on investment  securities                         |       | 1                                        |       | (5 | ) |
| Gain on sale of foreclosed property                                                             |       | (15                                      | )          | — |   |
| Excess tax benefit from equity-based awards                                                     |       | 1                                        |       | — |   |
| Decrease in accrued interest and other assets                                                   |       | (32                                      | )          | (312 | ) |
| Increase (decrease) in accrued interest and other liabilities                                   |       | 252                                      |       | (7 | ) |
| Net cash provided by operating activities                                                       |       | 1,736                                    |       | 1,113 |   |
| Cash flows from investing activities:                                                           |       |                                     |       |   |   |
| Purchases of investment securities available-for-sale                                           |       | (3,053                                   | )          | (3,116 | ) |
| Proceeds from sales of investment securities available for sale                                 |       | 5,040                                    |       | — |   |
| Proceeds from maturities, prepayments and calls of investment  securities  available-for-sale   |       | 4,802                                    |       | 3,953 |   |
| Purchases of restricted stock                                                                   |       | (159                                     | )          | (502 | ) |
| Net increase in loans                                                                           |       | (3,356                                   | )          | (36,417 | ) |
| Purchases of bank premises and equipment                                                        |       | (76                                      | )          | (1,457 | ) |
| Proceeds from sale of foreclosed property                                                       |       | 465                                      |       | — |   |
| Net cash provided by (used in) investing activities                                             |       | 3,663                                    |       | (37,539 | ) |
| Cash flows from financing activities:                                                           |       |                                     |       |   |   |
| Net increase in NOW, money market accounts, savings  accounts  and noninterest-bearing deposits |       | 7,251                                    |       | 6,184 |   |
| Net (decrease) increase in time deposits                                                        |       | (3,219                                   | )          | 13,475 |   |
| Net decrease in short-term borrowings                                                           |       | —                                   |       | (450 | ) |
| Repayment of long-term debt                                                                     |       | —                                   |       | 10,000 |   |
| Proceeds from issuance of common stock                                                          |       | 2                                        |       | 35 |   |
| Net cash provided by financing activities                                                       |       | 4,034                                    |       | 29,244 |   |
| Net increase (decrease) in cash and cash equivalents                                            |       | 9,433                                    |       | (7,182 | ) |
| Cash and cash equivalents — beginning of period                                            |       | 12,366                                   |       | 26,483 |   |
| Cash and cash equivalents — end of period                                                  |       | $                                        | 21,799     |   | $ | 19,301 |   |
| Supplemental cash flow disclosures:                                                             |       |                                     |       |   |   |
| Interest paid                                                                                   |       | $                                        | 5,554      |   | $ | 5,757 |   |
| Income taxes paid                                                                               |       | $                                        | 399        |   | $ | 491 |   |

 

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.  The Company alsohas a subsidiary 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 2007 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 31,2008.

 

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.

 

## **RecentAccounting Pronouncements**

## ** **

In September 2006, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)157, *Fair Value Measurements.*  SFAS 157 defines fair value, establishes aframework for measuring fair value, and expands disclosures about fair valuemeasurements.  It clarifies that fairvalue is the price that would be received to sell an asset or paid to transfera liability in an orderly transaction between market participants in the marketin which the reporting entity transacts. This Statement does not require any new fair value measurements, butrather, it provides enhanced guidance to other pronouncements that require orpermit assets or liabilities to be measured at fair value.  This Statement is effective for fiscal yearsbeginning after November 15, 2007, with earlier adoption permitted.  In February 2008, the FASB issued FASBStaff Position (“FSP”) FAS 157-2, *EffectiveDate of FASB Statement No.157.* This FSP defers the effective date of SFAS 157 for nonfinancial assetsand nonfinancial liabilities, except those that are recognized or disclosed atfair value in the financial statements on a recurring basis (at leastannually), to years beginning after November 15, 2008, and interim periodswithin those fiscal years.  The adoptionof this Statement did not have a material impact on the Company’s financialposition, results of operations or cash flows.

 

In December 2007,the FASB issued SFAS 141, Revised 2007 (SFAS 141R), *BusinessCombinations.*  SFAS 141R’sobjective is to improve the relevance, representational faithfulness, andcomparability of the information that a reporting entity provides in itsfinancial reports about a business combination and its effects.  SFAS 141R applies prospectively to businesscombinations for which the acquisition date is on or after December 31,2008.  The Company does not expect theimplementation of SFAS 141R to have a material impact on its consolidatedfinancial statements.

 

In December 2007,the FASB issued SFAS 160, *Noncontrolling Interestsin Consolidated Financial Statements.*  SFAS 160’s objective is to improve therelevance, comparability, and transparency of the financial information that areporting entity provides in its consolidated financial statements byestablishing accounting and reporting standards for the noncontrolling interestin a subsidiary and for the deconsolidation of a subsidiary.  SFAS 160 shall be effective for fiscal yearsand interim periods within those fiscal years, beginning on or after December 15,2008.  The Company does not expect theimplementation of SFAS 160 to have a material impact on its consolidatedfinancial statements.

 

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In March 2008, theFASB issued SFAS 163, *Disclosures aboutDerivative Instruments and Hedging Activities*, an amendment of SFAS133.  SFAS 163 establishes, among otherthings, the disclosure requirements for derivative instruments and for hedgingactivities.  SFAS 163 amends and expandsthe disclosure requirements of SFAS 133 with the intent to provide usersfinancial statements with enhanced understanding of: (a) How and why anentity uses derivatives instruments; (b) How derivative instruments andrelated hedged items are accounted for under SFAS 133 and its relatedinterpretations; and (c) how derivative instruments and related hedgeditems affect an entity’s financial position, financial performance, and cashflows.  SFAS 163 shall be effective forfinancial statements issued for fiscal years and interim periods beginningafter November 15, 2008.  TheCompany does not expect the implementation of SFAS 163 to have a materialimpact on its consolidated financial statements.

 

In May 2008, theFASB issued SFAS 162, *The Hierarchy of GenerallyAccepted Accounting Principles*. SFAS 162 identifies the sources of accounting principles and theframework for selecting the principles used in the preparation of financialstatements of nongovernmental entities that are presented in conformity withgenerally accepted accounting principles in the United States.  The implementation of SFAS 162 did not have amaterial impact on its consolidated financial statements.

 

**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 September 30, 2008 and 2007, nocommon stock equivalents were excluded from the diluted EPS calculation.

 
| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(dollars in thousands, except per share amounts)**   | ** ** | **2008**                                   | ** ** | **2007**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                             |       | $                                          | 315        |                                      | $          | 408 |   | $ | 884 |   | $ | 1,066 |   |
| Basic earnings  per share                              |       | $                                          | 0.22       |                                      | $          | 0.28 |   | $ | 0.61 |   | $ | 0.73 |   |
| Diluted earnings  per share                            |       | $                                          | 0.21       |                                      | $          | 0.27 |   | $ | 0.59 |   | $ | 0.70 |   |
| Basic weighted  average number of shares outstanding   |       | 1,460,674                                  |       | 1,460,602                                 |       | 1,460,626 |   | 1,459,965 |   |
| Effect of  dilutive securities — stock options    |       | 41,769                                     |       | 55,114                                    |       | 45,726 |   | 60,673 |   |
| Diluted weighted  average number of shares outstanding |       | 1,502,443                                  |       | 1,515,716                                 |       | 1,506,352 |   | 1,520,638 |   |

 

**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.  The Companyfollows the guidance of the Statements of Financial Accounting Standards No. 123*Accounting for Stock-Based Compensation*and No. 123(R) *Share-BasedPayment. * As of December 31, 2006, all outstandingstock options were fully vested.  Nostock options were granted in 2007 or 2008 and, accordingly, net income andearnings per share have 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.

 

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**Note 4.  Investment Portfolio:**

 

Thefollowing tables set forth certain information regarding the Company’sinvestment portfolio at September 30, 2008 and December 31, 2007:

 

## **Available-for-saleportfolio**

** **
| **September 30, 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                              |       | $ | 2,338 |   | $ | 15 |   | $ | 1 |   | $ | 2,352 |   | 4.81 | % |
| Due after five  years through ten years                             |       | 659 |   | — |   | 7 |   | 652 |   | 5.00 | % |
| State and  political subdivisions:                                  |       |   |   |   |   |   |   |   |   |   |   |
| Due after five  years through ten years                             |       | 405 |   | — |   | 9 |   | 396 |   | 5.25 | % |
| Due after ten  years                                                |       | 5,281 |   | — |   | 347 |   | 4,934 |   | 5.93 | % |
| Mortgage-backed  debt securities                                    |       | 11,802 |   | 79 |   | 45 |   | 11,836 |   | 5.01 | % |
| Equity  securities                                                  |       | 300 |   | — |   | — |   | 300 |   | — | % |
|                                                                |       | $ | 20,785 |   | $ | 94 |   | $ | 409 |   | $ | 20,470 |   | 5.15 | % |

** **
| **December 31, 2007**                                          | ** ** |
|---------------------------------------------------------------------|------------|
| **(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                                                |       | $ | 1,495 |   | $ | — |   | $ | 1 |   | $ | 1,494 |   | 5.09 | % |
| Due after one  year through five years                              |       | 3,549 |   | 13 |   | 13 |   | 3,549 |   | 4.96 | % |
| Due after five  years through ten years                             |       | 718 |   | — |   | 15 |   | 703 |   | 4.99 | % |
| State and  political subdivisions:                                  |       |   |   |   |   |   |   |   |   |   |   |
| Due within one  year through five years                             |       | 200 |   | — |   | 6 |   | 194 |   | 4.64 | % |
| Due after five  years through ten years                             |       | 3,186 |   | 24 |   | 13 |   | 3,197 |   | 5.57 | % |
| Due after ten  years                                                |       | 6,435 |   | 32 |   | 61 |   | 6,406 |   | 5.94 | % |
| Mortgage-backed  debt securities                                    |       | 11,666 |   | 70 |   | 67 |   | 11,669 |   | 4.77 | % |
| Equity  securities                                                  |       | 300 |   | — |   | — |   | 300 |   | — | % |
|                                                                |       | $ | 27,549 |   | $ | 139 |   | $ | 176 |   | $ | 27,512 |   | 5.13 | % |

** **
| **September 30, 2008**                                        | ** ** | **Continuous unrealized  losses existing for less than  12 months** | ** ** | **Continuous unrealized  losses existing for  12 months and greater** | ** ** | **Total**                 | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------|------------|
| **(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 |       | $                                                                   | 967        |                                                                  | $          | 1                         |       | $ | 659 |   | $ | 7 |   | $ | 1,626 |   | $ | 8 |   |
| Mortgage-backed  debt securities                                   |       | 5,705                                                               |       | 35                                                                    |       | 400                       |       | 10 |   | 6,105 |   | 45 |   |
| State and  political subdivisions                                  |       | 5,687                                                               |       | 356                                                                   |       | —                    |       | — |   | 5,687 |   | 356 |   |
| Total  temporarily impaired securities                             |       | $                                                                   | 12,359     |                                                                  | $          | 392                       |       | $ | 1,059 |   | $ | 17 |   | $ | 13,418 |   | $ | 409 |   |

 

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| **December 31, 2007**                                         | ** ** | **Continuous unrealized  losses existing for less than  12 months** | ** ** | **Continuous unrealized  losses existing for  12 months and greater** | ** ** | **Total**                 | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------|------------|
| **(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 |       | $                                                                   | 2,547      |                                                                  | $          | 7                         |       | $ | 1,439 |   | $ | 22 |   | $ | 3,986 |   | $ | 29 |   |
| State and  political subdivisions                                  |       | 4,748                                                               |       | 71                                                                    |       | 290                       |       | 9 |   | 5,038 |   | 80 |   |
| Mortgage-backed  debt securities                                   |       | 813                                                                 |       | 2                                                                     |       | 5,382                     |       | 65 |   | 6,195 |   | 67 |   |
| Total  temporarily impaired securities                             |       | $                                                                   | 8,108      |                                                                  | $          | 80                        |       | $ | 7,111 |   | $ | 96 |   | $ | 15,219 |   | $ | 176 |   |

 

Management evaluates securities for other-than-temporary impairment atleast on a quarterly basis, and more frequently when economic or marketconcerns warrant such evaluation. Consideration is given to (1) the length of time and the extent towhich the fair value has been less than cost, (2) the financial conditionand near-term prospects of the issuer, and (3) the intent and ability ofthe Company to retain its investment in the issuer for a period of timesufficient to allow for any anticipated recovery in fair value.  The Company has not recognized any other-than-temporaryimpairment in connection with the unrealized losses reflected in the precedingtables.  All of these declines can beattributable to increases 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 September 30,2008 and December 31, 2007:

 
| ** **                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in thousands)**         | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Federal Home  Loan Bank of Atlanta |       | $                      | 1,000      |                  | $          | 871 |   |
| Federal Reserve  Bank              |       | 559                    |       | 529                   |       |
| Atlantic Central  Bankers Bank     |       | 40                     |       | 40                    |       |
|                               |       | $                      | 1,599      |                  | $          | 1,440 |   |

 

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

 

Loansconsist of the following:

 
| ** **                                                                  | ** ** | **September 30,** | ** ** | **% of**  | ** ** | **December 31,** | ** ** | **% of**  | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------|------------|-----------|------------|-----------------------|------------|-----------|------------|
| **(dollars in thousands)**                                                  | ** ** | **2008**               | ** ** | **Loans** | ** ** | **2007**              | ** ** | **Loans** | ** ** |
| Real estate  loans:                                                         |       |                   |       |      |       |                  |       |      |       |
| Construction and  land development                                          |       | $                      | 21,874     |      | 10         | %                     | $          | 28,077    |       | 13 | % |
| Mortgage loans:                                                             |       |                   |       |      |       |                  |       |      |       |
| Secured by 1 to  4 family residential properties                            |       | 36,443                 |       | 17        | %          | 38,414                |       | 18        | %          |
| Secured by  multi-family (5 or more) residential properties                 |       | 8,298                  |       | 4         | %          | 5,926                 |       | 3         | %          |
| Secured by  commercial properties                                           |       | 107,406                |       | 51        | %          | 101,920               |       | 49        | %          |
| Secured by farm  land                                                       |       | 7,632                  |       | 4         | %          | 5,570                 |       | 3         | %          |
| Total mortgage  loans                                                       |       | 159,779                |       | 76        | %          | 151,830               |       | 73        | %          |
| Loans to farmers                                                            |       | 48                     |       | —    | %          | 50                    |       | —    | %          |
| Commercial and  industrial loans                                            |       | 27,843                 |       | 13        | %          | 27,281                |       | 13        | %          |
| Loans to  individuals for household, family and other personal expenditures |       | 1,973                  |       | 1         | %          | 1,773                 |       | 1         | %          |
|                                                                        |       | 211,517                |       | 100       | %          | 209,011               |       | 100       | %          |
| Less allowance  for loan losses                                             |       | (2,700                 | )          |      |       | (2,640                | )          |      |       |
| Net loans                                                                   |       | $                      | 208,817    |      |       |                  | $          | 206,371   |       |   |   |

 

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Transactions in theallowance for loan losses are summarized as follows:

 
| ** **                                             | ** ** | **Three Months Ended****September 30,** | ** ** | **Nine Months Ended****September 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|
| **(dollars in thousands)**                             | ** ** | **2008**                                     | ** ** | **2007**                                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| Average total  loans outstanding during period         |       | $                                            | 213,884    |                                        | $          | 203,863 |   | $ | 211,353 |   | $ | 190,190 |   |
| Balance at  beginning of period                        |       | $                                            | 2,584      |                                        | $          | 2,351 |   | $ | 2,640 |   | $ | 2,166 |   |
| Recoveries of  loans previously charged-off (consumer) |       | —                                       |       | —                                      |       | 9 |   | — |   |
| Loans  charged-off (commercial and industrial)         |       | (104                                         | )          | —                                      |       | (327 | ) | — |   |
| Loans  charged-off (commercial real estate)            |       | —                                       |       | —                                      |       | (76 | ) | — |   |
| Loans  charged-off (residential real estate)           |       | —                                       |       | —                                      |       | (6 | ) | — |   |
| Loans  charged-off (consumer)                          |       | —                                       |       | —                                      |       | — |   | (6 | ) |
| Net charge-offs                                        |       | (104                                         | )          | —                                      |       | (400 | ) | (6 | ) |
| Provision  charged to operating expenses               |       | 220                                          |       | 50                                          |       | 460 |   | 241 |   |
| Balance at end  of period                              |       | $                                            | 2,700      |                                        | $          | 2,401 |   | $ | 2,700 |   | $ | 2,401 |   |
| Ratios of net  charge-offs to average loans            |       | 0.05                                         | %          | —                                      | %          | 0.19 | % | — | % |

 

**Note 6.  Deposits**

 

The following table provides a summary of the Company’s deposit base atthe dates indicated.

 
| ** **                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in thousands)**           | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Noninterest-bearing  demand deposits |       | $                      | 36,160     |                  | $          | 33,357 |   |
| Interest-bearing  demand deposits:   |       |                   |       |                  |       |
| NOW accounts                         |       | 14,047                 |       | 12,197                |       |
| Money market  accounts               |       | 40,710                 |       | 38,179                |       |
| Savings accounts                     |       | 3,795                  |       | 3,727                 |       |
| Certificates of  deposit:            |       |                   |       |                  |       |
| $100,000 or more                     |       | 56,887                 |       | 60,556                |       |
| Less than  $100,000                  |       | 71,661                 |       | 71,212                |       |
| Total deposits                       |       | $                      | 223,260    |                  | $          | 219,228 |   |

 

**Note 7.  Trust preferred securities/junior subordinateddebentures 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 itsshareholders.  The proceeds from thisissuance were used to repay a $450,000 short-term debt obligation that maturedin January 2007 and the remaining proceeds have been used to supplementthe Company’s capital for continued growth and other general corporatepurposes.

 

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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AtSeptember 30, 2008 and December 31, 2007, the Company had $10,000,000in borrowings under its credit facility from the Federal Home Loan Bank ofAtlanta (“FHLB”).  There are twoconvertible advances in the amounts of $5,000,000 each, which are both at arate of 4.56%, with a maturity dates of April 27, 2012 and September 4,2012, unless called on April 27, 2009 or September 4, 2010,respectively, by the FHLB.  Outstandingadvances are secured by collateral consisting of a blanket lien on qualifyingloans in the Bank’s residential mortgage loan portfolio.

 

**Note8.  Noninterest Expense:**

 

Noninterest expenseconsists of the following:

* *
| ** **                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(dollars in thousands)**              | ** ** | **2008**                                   | ** ** | **2007**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                    |       |                                       |       |                                      |       |   |   |   |   |
| Salaries                                |       | $                                          | 835        |                                      | $          | 799 |   | $ | 2,472 |   | $ | 2,351 |   |
| Bonus                                   |       | —                                     |       | 20                                        |       | — |   | 59 |   |
| Deferred  Personnel Costs               |       | (28                                        | )          | (49                                       | )          | (79 | ) | (127 | ) |
| Payroll Taxes                           |       | 56                                         |       | 51                                        |       | 184 |   | 189 |   |
| Employee  Insurance                     |       | 59                                         |       | 56                                        |       | 171 |   | 149 |   |
| Other Employee Benefits                 |       | 44                                         |       | 35                                        |       | 137 |   | 123 |   |
| Depreciation                            |       | 84                                         |       | 71                                        |       | 250 |   | 213 |   |
| Rent                                    |       | 85                                         |       | 74                                        |       | 239 |   | 190 |   |
| Utilities                               |       | 23                                         |       | 25                                        |       | 74 |   | 76 |   |
| Repairs and  Maintenance                |       | 58                                         |       | 48                                        |       | 167 |   | 145 |   |
| ATM Expense                             |       | 25                                         |       | 21                                        |       | 75 |   | 63 |   |
| Other Occupancy  and Equipment Expenses |       | 33                                         |       | 25                                        |       | 100 |   | 84 |   |
| Postage and  Supplies                   |       | 14                                         |       | 34                                        |       | 46 |   | 79 |   |
| Data Processing                         |       | 90                                         |       | 89                                        |       | 265 |   | 271 |   |
| Advertising and  Promotion              |       | 54                                         |       | 89                                        |       | 221 |   | 215 |   |
| Legal                                   |       | 2                                          |       | 8                                         |       | 16 |   | 18 |   |
| Insurance                               |       | 16                                         |       | 14                                        |       | 41 |   | 37 |   |
| Consulting                              |       | 7                                          |       | 21                                        |       | 9 |   | 42 |   |
| Courier                                 |       | 5                                          |       | 11                                        |       | 14 |   | 34 |   |
| Audit Fees                              |       | 62                                         |       | 59                                        |       | 185 |   | 176 |   |
| Other                                   |       | 160                                        |       | 97                                        |       | 393 |   | 264 |   |
|                                    |       | $                                          | 1,684      |                                      | $          | 1,598 |   | $ | 4,980 |   | $ | 4,651 |   |

 

**Note9.  401(k) Profit Sharing Plan:**

 

The Company has a Section 401(k) profit sharing plan coveringemployees meeting certain eligibility requirements as to minimum age and yearsof service.  Employees may make voluntarycontributions to the Plan through payroll deductions on a pre-tax basis.  The Company makes matching contributions of100% of the employee’s contributions up to 4% of the employee’s salary.  A participant’s account under the Plan,together with investment earnings thereon, is normally distributable, followingretirement, death, disability or other termination of employment, in a singlelump-sum payment.

 

The Company made contributions to the Plan in the amounts of $106,000 and$100,000 for the first nine-months in 2008 and 2007, respectively; and $35,000and $29,000 for the three-month periods ended September 30, 2008 and 2007,respectively.

 

**Note10.  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 

 

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capital amounts andclassification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios (set forth in the following table)of total and Tier 1 capital (as defined in the regulations) to risk-weightedassets (as defined), and Tier 1 capital (as defined) to average assets (asdefined).  Management believes that theCompany and the Bank met all capital adequacy requirements to which they aresubject as of September 30, 2008.

 

As of September 30,2008, the most recent notification from the regulatory agency categorized theBank as well 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.

 

The Company’s and theBank’s actual capital amounts and ratios at September 30, 2008 and December 31,2007 are presented in the following tables.

 
| **September 30, 2008** | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **Minimum To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|-----------------------------|------------|------------|------------|------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| **(dollars in thousands)**  | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                                      | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Tier 1 Capital              |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| To Risk-Weighted  Assets    |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Company                     |       | $          | 26,255     |                               | 11.20      | %                                                                               | $          | 9,375 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                        |       | $          | 24,922     |                               | 10.66      | %                                                                               | $          | 9,356 |   | 4.00 | % | $ | 14,034 |   | 6.00 | % |
|                        |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Total Capital               |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| To Risk-Weighted Assets     |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Company                     |       | $          | 28,955     |                               | 12.35      | %                                                                               | $          | 18,750 |   | 8.00 | % | N/A |   | N/A |   |
| Bank                        |       | $          | 27,622     |                               | 11.81      | %                                                                               | $          | 18,712 |   | 8.00 | % | $ | 23,390 |   | 10.00 | % |
|                        |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Tier 1 Capital              |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| To Average Assets           |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Company                     |       | $          | 26,255     |                               | 10.16      | %                                                                               | $          | 10,341 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                        |       | $          | 24,922     |                               | 9.66       | %                                                                               | $          | 10,321 |   | 4.00 | % | $ | 12,902 |   | 5.00 | % |

 
| **December 31, 2007** | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **Minimum To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|----------------------------|------------|------------|------------|------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| **(dollars in thousands)** | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                                      | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Tier 1  Capital       |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| To Risk-Weighted  Assets   |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Company                    |       | $          | 25,603     |                               | 11.14      | %                                                                               | $          | 9,193 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 23,834     |                               | 10.39      | %                                                                               | $          | 9,173 |   | 4.00 | % | $ | 13,760 |   | 6.00 | % |
|                       |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Total Capital         |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| To Risk-Weighted Assets    |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Company                    |       | $          | 28,243     |                               | 12.29      | %                                                                               | $          | 18,385 |   | 8.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 26,474     |                               | 11.54      | %                                                                               | $          | 18,347 |   | 8.00 | % | $ | 22,933 |   | 10.00 | % |
|                       |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Tier 1 Capital        |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| To Average Assets          |       |       |       |                               |       |                                                                            |       |   |   |   |   |   |   |
| Company                    |       | $          | 25,603     |                               | 9.88       | %                                                                               | $          | 10,368 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 23,834     |                               | 9.21       | %                                                                               | $          | 10,348 |   | 4.00 | % | $ | 12,935 |   | 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 September 30,2008, there have been no shares repurchased by the Company.

 

**Note11.  Fair Value**

 

We group financial assetsand financial liabilities measured at fair value in three levels, based on themarkets in which the assets and liabilities are traded and the reliability ofthe assumptions used to determine fair value.  These levels are:

 
| 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.                                                                                                                                                                                                                                                                                                                                                                                           |

 

The following table showsdetails of the financial instruments as of September 30, 2008 for whichfair value accounting was applied:

 

| ** **                           | ** ** | ** **   | ** ** | ** **         | ** ** | **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       |       | $            | 20,470     |               | $          | —             |       | $                | 20,470     |   | $ | — |   |
| Other real  estate owned             |       | 452          |       | —             |       | —             |       | 452              |       |
| Impaired loans                       |       | 1,371        |       | —             |       | —             |       | 1,371            |       |
|                                      |            |              |            |                    |            |                    |            |                  |            |  |  |  |  |

 

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

 

**Forward-LookingStatements**

 

This management’s discussion and analysis contains forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995, including statements relating to Frederick County Bancorp, Inc.’s(“Bancorp”) and Frederick County Bank’s (the “Bank” and together with Bancorp,the “Company”) beliefs, expectations, anticipations and plans regarding, amongother things, general economic trends, interest rates, product expansions andother matters.  Such forward-lookingstatements are identified by terminology such as “may”, “will”, “believe”, “expect”,“estimate”, “anticipate”, “likely”, “unlikely”, “continue”, or similar termsand are subject to numerous uncertainties, such as federal monetary policy,inflation, employment, profitability and consumer confidence levels, bothnationally and in the Company’s market area, the health of the real estate andconstruction market in the Company’s market area, the Company’s ability todevelop and market new products and to enter new markets, competitivechallenges in the Company’s market, legislative changes and other factors, andas such, there can be no assurance that future events will develop in accordancewith the forward-looking statements contained herein.  Readers are cautioned against placing unduereliance on any such forward-looking statement. In addition, the Company’s past results of operations do not necessarilyindicate its future results.

 

**General**

 

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

 

Bancorp, the parent company for the Bank, its wholly-ownedsubsidiary, was organized in September 2003. The Bank was incorporatedunder the laws of the state of Maryland in August 2000 and commencedbanking operations in October 2001. The Bank provides its customers with various banking services.  The Bank offers various loan and depositproducts to their customers.  The Bank’scustomers include individuals and commercial enterprises within its principalmarket area consisting of Frederick County, Maryland.  Additionally, the Bank maintainscorrespondent banking relationships and transacts daily federal funds sales onan unsecured basis with regional 

 

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correspondent banks. Note 4 discusses the types of securities in which the Bank invests.  Note 5 discusses the types of lending inwhich the Bank engages.  The Bank doesnot have any significant concentrations to any one industry or customer.  The Company also has a subsidiary called FCBIStatutory Trust I.  See Note 7 foradditional disclosures.

 

## **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,when available. The estimates used in management’s assessment of the adequacyof the allowance for loan losses require that management make assumptions aboutmatters that are uncertain at the time of estimation.  Differences in these assumptions anddifferences between the estimated and actual losses could have a materialeffect.  For discussions related to thecritical accounting policies of the Company, refer to the sections in thisManagement’s Discussion and Analysis entitled “Income Taxes” and “Allowance forLoan Losses.”

 

## **Loans**

## ** **

Loans increased by$2.51 million, or 1.20%, from December 31, 2007, to a balance of $211.52million as of September 30, 2008, and by $1.15 million, or 0.55% from September 30,2007.  Due to the current stresses on theeconomy, along with the tightening of the credit markets, the Company hascontinued to take a more conservative lending approach which has slowed therate of loan growth.  The Company doesnot anticipate much loan growth over the next few quarters, and possibly willshrink the loan portfolio to maintain adequate liquidity.

 

## **Deposits**

## ** **

Deposits grew by $4.03million, or 1.84%, from December 31, 2007 to a balance of $223.26 millionas of September 30, 2008, but dropped by $5.78 million, or 2.52% from September 30,2007.  During the fourth quarter of 2007,the Company decided to slow its deposit growth in response to the slower loangrowth as discussed above.  Since thedeposit growth during the past year has mainly been in certificates of deposit,it was decided to lower these rates to slow the rate of growth in, or to reducethe aggregate amount of these deposits by allowing some of the higher ratecertificates of deposit to mature without being renewed.

 

                **Three Months Ended September 30,2008 and 2007**

 

Net income was $315,000for the quarter ended September 30, 2008, as compared to $408,000 of netincome for the same period in 2007.  Thedecrease in earnings for this quarter in 2008 is primarily related to a$170,000 increase in provision for loan losses, an increase in operatingexpenses of $86,000 that was partially offset by an increase in noninterestincome of $53,000 and lower taxes in the amount of $41,000.  Basicearnings per share for the three months ended September 30, 2008 and 2007were $0.22 and $0.28, respectively, and were based on weighted-average numberof shares outstanding of 1,460,674 and 1,460,602, respectively.  Diluted earnings per share for the threemonths ended September 30, 2008 and 2007 were $0.21 and $0.27,respectively, and were based on weighted-average number of shares outstandingof 1,502,443 and 1,515,716, respectively.

 

TheCompany experienced an annualized return on average assets of 0.49% and 0.64%for the three-month periods ended September 30, 2008 and 2007,respectively.  Additionally, the Companyexperienced an annualized return on average shareholders’ equity of 6.25% and8.68% for the three-month periods ended September 30, 2008 and 2007,respectively.

 

**                NineMonths Ended September 30, 2008 and 2007**

 

Net income was $884,000for the nine months ended September 30, 2008, as compared to $1.07 millionof net income for the same period in 2007. The decrease in earnings for this period in 2008 is primarily related toan increase in the provision for loan losses of $219,000, an increase inoperating expenses of $329,000 that was partially offset by an increase innoninterest income of $150,000 and lower taxes in the amount of $101,000.  Basicearnings per share for the nine months ended September 30, 2008 and 2007were 

 

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$0.61and $0.73, respectively, and were based on weighted-average number of sharesoutstanding of 1,460,626 and 1,459,965, respectively.  Diluted earnings per share for the nine monthsended September 30, 2008 and 2007 were $0.59 and $0.70, respectively, andwere based on weighted-average number of shares outstanding of 1,506,352 and1,520,638, respectively.

 

TheCompany experienced an annualized return on average assets of 0.45% and 0.59%for the nine-month periods ended September 30, 2008 and 2007,respectively.  Additionally, the Companyexperienced an annualized return on average shareholders’ equity of 5.84% and7.68% for the nine-month periods ended September 30, 2008 and 2007,respectively.

 

**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.

** **
| **Three Months Ended  September  30,**      | ** ** | **2008**                    | ** ** | **2007**                       | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| **(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                               |       | $                           | 8,782      |                           | $          | 46 |   | 2.08 | % | $ | 8,094 |   | $ | 109 |   | 5.34 | % |
| Interest bearing deposits in other banks         |       | 816                         |       | 3                              |       | 1.46 |   | 3,541 |   | 45 |   | 5.04 |   |
| Investment securities (1):                       |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Taxable                                          |       | 16,916                      |       | 210                            |       | 4.93 |   | 20,341 |   | 253 |   | 4.93 |   |
| Tax-exempt (2)                                   |       | 8,670                       |       | 132                            |       | 6.02 |   | 9,822 |   | 152 |   | 6.14 |   |
| Loans (3)                                        |       | 213,884                     |       | 3,568                          |       | 6.62 |   | 203,863 |   | 3,773 |   | 7.34 |   |
| Total interest-earning assets                    |       | 249,068                     |       | 3,959                          |       | 6.31 |   | 245,661 |   | 4,332 |   | 7.00 |   |
| Noninterest-earning assets                       |       | 9,336                       |       |                           |       |   |   | 8,609 |   |   |   |   |   |
| Total assets                                     |       | $                           | 258,404    |                           |       |   |   |   | $ | 254,270 |   |   |   |   |   |
|                                             |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity        |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                    |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| NOW accounts                                     |       | $                           | 10,699     |                           | 9          |   | 0.33 | % | $ | 12,017 |   | 6 |   | 0.20 | % |
| Savings accounts                                 |       | 3,823                       |       | 5                              |       | 0.52 |   | 3,088 |   | 4 |   | 0.51 |   |
| Money market accounts                            |       | 40,678                      |       | 168                            |       | 1.64 |   | 37,121 |   | 265 |   | 2.83 |   |
| Certificates of deposit  $100,000 or more        |       | 55,910                      |       | 556                            |       | 3.95 |   | 67,159 |   | 822 |   | 4.86 |   |
| Certificates of deposit  less than $100,000      |       | 71,572                      |       | 708                            |       | 3.92 |   | 69,680 |   | 841 |   | 4.79 |   |
| Short-term borrowings                            |       | 2,978                       |       | 18                             |       | 2.40 |   | — |   | — |   | — |   |
| Long-term borrowings                             |       | 10,000                      |       | 116                            |       | 4.60 |   | 6,467 |   | 76 |   | 4.66 |   |
| Junior subordinated debentures                   |       | 6,186                       |       | 101                            |       | 6.48 |   | 6,186 |   | 101 |   | 6.48 |   |
| Total interest-bearing liabilities               |       | 201,846                     |       | 1,681                          |       | 3.30 |   | 201,718 |   | 2,115 |   | 4.16 |   |
| Noninterest-bearing deposits                     |       | 35,604                      |       |                           |       |   |   | 32,760 |   |   |   |   |   |
| Noninterest-bearing liabilities                  |       | 805                         |       |                           |       |   |   | 996 |   |   |   |   |   |
| Total liabilities                                |       | 238,255                     |       |                           |       |   |   | 235,474 |   |   |   |   |   |
| Total shareholders’ equity                  |       | 20,149                      |       |                           |       |   |   | 18,796 |   |   |   |   |   |
| Total liabilities and shareholders’  equity |       | $                           | 258,404    |                           |       |   |   |   | $ | 254,270 |   |   |   |   |   |
| Net interest income                              |       |                        |       | $                              | 2,278      |   |   |   |   |   | $ | 2,217 |   |   |   |
| Net interest spread                              |       |                        |       |                           |       | 3.01 | % |   |   |   |   | 2.84 | % |
| Net interest margin                              |       |                        |       |                           |       | 3.63 | % |   |   |   |   | 3.58 | % |

----

(1)         Yields on securities available-for-sale have beencalculated on the basis of historical cost and do not give effect to changes inthe fair value of those securities, which is reflected as a component ofshareholders’ equity.

 

(2)         Presented on a taxable-equivalent basis using thestatutory federal income tax rate of 34%. Taxable-equivalent adjustments of $45,000 in 2008 and $52,000 in 2007are included in the calculation of the tax-exempt investment interest income.

 

(3)         Presented on a taxable-equivalent basis using thestatutory federal income tax rate of 34%. Taxable-equivalent adjustments of $14,000 in 2008 and $15,000 in 2007are included in the calculation of the loan interest income.  Net loan origination income (expense) ininterest income totaled $10,000 in 2008 and $(2,000) in 2007.

 

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| **Nine Months Ended  September 30,**        | ** ** | **2008**                    | ** ** | **2007**                       | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| **(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                               |       | $                           | 9,570      |                           | $          | 180 |   | 2.51 | % | $ | 8,397 |   | $ | 333 |   | 5.30 | % |
| Interest bearing deposits in other banks         |       | 2,199                       |       | 35                             |       | 2.12 |   | 4,687 |   | 184 |   | 5.25 |   |
| Investment securities (1):                       |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Taxable                                          |       | 17,720                      |       | 654                            |       | 4.92 |   | 21,120 |   | 755 |   | 4.78 |   |
| Tax-exempt (2)                                   |       | 9,434                       |       | 432                            |       | 6.10 |   | 9,822 |   | 452 |   | 6.15 |   |
| Loans (3)                                        |       | 211,353                     |       | 10,643                         |       | 6.71 |   | 190,190 |   | 10,456 |   | 7.35 |   |
| Total interest-earning assets                    |       | 250,276                     |       | 11,944                         |       | 6.36 |   | 234,216 |   | 12,180 |   | 6.95 |   |
| Noninterest-earning assets                       |       | 9,029                       |       |                           |       |   |   | 8,353 |   |   |   |   |   |
| Total assets                                     |       | $                           | 259,305    |                           |       |   |   |   | $ | 242,569 |   |   |   |   |   |
|                                             |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity        |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                    |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| NOW accounts                                     |       | $                           | 11,767     |                           | 28         |   | 0.32 | % | $ | 12,425 |   | 17 |   | 0.18 | % |
| Savings accounts                                 |       | 3,974                       |       | 15                             |       | 0.50 |   | 2,897 |   | 11 |   | 0.51 |   |
| Money market accounts                            |       | 40,462                      |       | 591                            |       | 1.95 |   | 33,540 |   | 697 |   | 2.78 |   |
| Certificates of deposit  $100,000 or more        |       | 57,976                      |       | 1,883                          |       | 4.33 |   | 65,154 |   | 2,333 |   | 4.79 |   |
| Certificates of deposit  less than $100,000      |       | 71,970                      |       | 2,298                          |       | 4.25 |   | 67,192 |   | 2,350 |   | 4.68 |   |
| Short-term borrowings                            |       | 1,000                       |       | 18                             |       | 2.40 |   | 41 |   | 2 |   | 6.52 |   |
| Long-term borrowings                             |       | 10,000                      |       | 347                            |       | 4.62 |   | 3,370 |   | 117 |   | 4.64 |   |
| Junior subordinated debentures                   |       | 6,186                       |       | 303                            |       | 6.52 |   | 6,186 |   | 303 |   | 6.55 |   |
| Total interest-bearing liabilities               |       | 203,335                     |       | 5,483                          |       | 3.59 |   | 190,805 |   | 5,830 |   | 4.09 |   |
| Noninterest-bearing deposits                     |       | 34,935                      |       |                           |       |   |   | 32,504 |   |   |   |   |   |
| Noninterest-bearing liabilities                  |       | 842                         |       |                           |       |   |   | 747 |   |   |   |   |   |
| Total liabilities                                |       | 239,112                     |       |                           |       |   |   | 224,056 |   |   |   |   |   |
| Total shareholders’ equity                  |       | 20,193                      |       |                           |       |   |   | 18,513 |   |   |   |   |   |
| Total liabilities and shareholders’  equity |       | $                           | 259,305    |                           |       |   |   |   | $ | 242,569 |   |   |   |   |   |
| Net interest income                              |       |                        |       | $                              | 6,461      |   |   |   |   |   | $ | 6,350 |   |   |   |
| Net interest spread                              |       |                        |       |                           |       | 2.77 | % |   |   |   |   | 2.86 | % |
| Net interest margin                              |       |                        |       |                           |       | 3.44 | % |   |   |   |   | 3.62 | % |

----

(1)         Yields on securities available-for-sale have beencalculated on the basis of historical cost and do not give effect to changes inthe fair value of those securities, which is reflected as a component ofshareholders’ equity.

 

(2)         Presented on a taxable-equivalent basis using thestatutory federal income tax rate of 34%. Taxable-equivalent adjustments of $147,000 in 2008 and $154,000 in 2007are included in the calculation of the tax-exempt investment interest income.

 

(3)         Presented on a taxable-equivalent basis using thestatutory federal income tax rate of 34%. Taxable-equivalent adjustments of $42,000 in 2008 and $39,000 in 2007are included in the calculation of the loan interest income.  Net loan origination income in interestincome totaled $8,000 in 2008 and $17,000 in 2007.

 

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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 September 30,  2008 compared to 2007** | ** ** | **Nine Months Ended September 30,  2008 compared to 2007** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Increase (decrease)  Due to**                                  | ** ** | **Net  Increase**                                               | ** ** | **Increase (decrease)  Due to** | ** ** | **Net  Increase** | ** ** |
| **(dollars in thousands)**                   | ** ** | **Volume**                                                       | ** ** | **Rate(1)**                                                     | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate(1)** | ** ** | **(Decrease)** | ** ** |
| Interest income                              |       |                                                             |       |                                                            |       |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                    |       |                                                             |       |                                                            |       |   |   |   |   |   |   |   |   |
| Federal funds  sold                          |       | $                                                                | 9          |                                                            | $          | (72 | ) | $ | (63 | ) | $ | 83 |   | $ | (236 | ) | $ | (153 | ) |
| Interest-bearing  deposits in other banks    |       | (34                                                              | )          | (8                                                              | )          | (42 | ) | (174 | ) | 25 |   | (149 | ) |
| Investment  securities:                      |       |                                                             |       |                                                            |       |   |   |   |   |   |   |   |   |
| Taxable                                      |       | (42                                                              | )          | (1                                                              | )          | (43 | ) | (217 | ) | 116 |   | (101 | ) |
| Tax-exempt                                   |       | (18                                                              | )          | (2                                                              | )          | (20 | ) | (32 | ) | 12 |   | (20 | ) |
| Loans                                        |       | 184                                                              |       | (389                                                            | )          | (205 | ) | 2,074 |   | (1,887 | ) | 187 |   |
| Total interest  income                       |       | 99                                                               |       | (472                                                            | )          | (373 | ) | 1,734 |   | (1,970 | ) | (236 | ) |
|                                         |       |                                                             |       |                                                            |       |   |   |   |   |   |   |   |   |
| Interest expense                             |       |                                                             |       |                                                            |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:               |       |                                                             |       |                                                            |       |   |   |   |   |   |   |   |   |
| NOW accounts                                 |       | —                                                           |       | 3                                                               |       | 3 |   | — |   | 11 |   | 11 |   |
| Savings accounts                             |       | 1                                                                |       | —                                                          |       | 1 |   | 7 |   | (3 | ) | 4 |   |
| Money market  accounts                       |       | 25                                                               |       | (122                                                            | )          | (97 | ) | 256 |   | (362 | ) | (106 | ) |
| Certificates of  deposit  $100,000 or more   |       | (137                                                             | )          | (129                                                            | )          | (266 | ) | (458 | ) | 8 |   | (450 | ) |
| Certificates of  deposit  less than $100,000 |       | 23                                                               |       | (156                                                            | )          | (133 | ) | 298 |   | (350 | ) | (52 | ) |
| Short-term  borrowings                       |       | 18                                                               |       | —                                                          |       | 18 |   | 83 |   | (67 | ) | 16 |   |
| Long-term  borrowings                        |       | 41                                                               |       | (1                                                              | )          | 40 |   | 410 |   | (180 | ) | 230 |   |
| Total interest  expense                      |       | (29                                                              | )          | (405                                                            | )          | (434 | ) | 596 |   | (943 | ) | (347 | ) |
| Net interest  income                         |       | $                                                                | 128        |                                                            | $          | (67 | ) | $ | 61 |   | $ | 1,138 |   | $ | (1,027 | ) | $ | 111 |   |

----

(1)         The volume/rate variance is allocated entirely tochange in rates.

 

## **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 it mayutilize a higher level of short-term and long-term borrowings, includingborrowings from the Federal Home Loan Bank, federal funds lines withcorrespondent banks and repurchase agreements, to fund operations, depending oneconomic conditions, deposit availability and pricing, interest rates and otherfactors.

 

**                Three Months Ended September 30,2008 and 2007**

 

Net interest income (on a taxable-equivalent basis) was $2.28 million in2008 and $2.22 million in 2007.  Theincrease in net interest income was primarily driven by a higher volume ofloans, even at a lower yield, and in addition by the impact of lower rates paidon interest-bearing liabilities.  Averageearning assets increased by $3.41 million, or 1.39%, since September 30,2007.  The yield on earning assets in2008 decreased to 6.31% from 7.00% in 2007, primarily as a result of theFederal Reserve’s decrease in the federal funds rate of 350 bps since September 2007.  The decrease of 86 basis points in the ratepaid on interest-bearing liabilities primarily is the result of the lower ratespaid on money market accounts and certificates of deposit.  The Company’s net interest margin was 3.63%and 3.58%, and the net interest spread was 3.00% and 2.84%, for the three-monthperiods ended September 30, 2008 and 2007, respectively.  This increase relates primarily to thereduced rates paid on the money market accounts and certificates of deposit.

 

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Interest expense decreased 20.52% from $2.12 million in 2007 to $1.68million in 2008 due to the reduced rates paid on interest-bearing liabilities,which decreased to 3.30% in 2008 from 4.16% in 2007.

 

**                Nine Months Ended September 30,2008 and 2007**

 

Net interest income (on a taxable-equivalent basis) was $6.46 million in2008 and $6.35 million in 2007.  Theincrease in net interest income was primarily driven by the reduced rates paidon the interest-bearing liabilities along with an increased loan volume, whichwas partially offset by lower yields earned on the loan portfolio.  Average earning assets increased by $16.06million, or 6.86%, since September 30, 2007.  The yield on earning assets in 2008 decreasedto 6.36% from 6.95% in 2007, primarily as a result of the Federal Reserve’sdecrease in the federal funds rate of 350 basis points since September 2007.  The decrease of 50 basis points in the ratepaid on interest-bearing liabilities primarily is the result of lower ratespaid on the money market accounts and certificates of deposit, along with lessreliance on jumbo certificates of deposit. The Company’s net interest margin was 3.44% and 3.62%, and the netinterest spread was 2.77% and 2.86%, for the nine-month periods ended September 30,2008 and 2007, respectively.  Thisdecrease relates primarily to the reduced yields earned on the loan portfolioand federal funds sold.

 

Interest expense decreased 5.95% from $5.83 million in 2007 to $5.48million in 2008 due to the reduced rates paid on interest-bearing liabilities,which decreased to 3.59% in 2008 from 4.09% in 2007.

 

**NoninterestIncome**

 

## **Noninterest income was $153,000 and $100,000 for thethree-month periods ended September 30, 2008 and 2007, respectively, andwas $433,000 and $283,000 for the nine-month periods ended September 30,2008 and 2007, respectively.  For thethree-month periods the most significant increases relate to NSF fees, sweepmanagement fees, and ATM interchange fees, which increased $10,000, $9,000, and$9,000, respectively.  For the nine-monthperiods the most significant increases relate to NSF fees, sweep managementfees, and ATM interchange fees, which increased $30,000, $28,000, and $26,000,respectively.  Also included in noninterestincome are securities gains of $26,000 for the three and nine month periodsended September 30, 2008, along with a gain on sale of foreclosedproperties of $15,000 for the nine months ended September 30, 2008.**

## ** **

## **Noninterest Expense**

## ** **

SeeNote 8 to the unaudited consolidated financial statements for a scheduleshowing a detailed breakdown of the Company’s noninterest expense.

 

Noninterest expense amounted to $1.68 million and $1.60 million for thethree-month periods in 2008 and 2007, respectively, and was $4.98 million and$4.65 million for the nine-month periods ended September 30, 2008 and2007, respectively.  For the three-monthperiods the changes in noninterest expense are principally related to anincrease in personnel costs and depreciation. Salaries expense in 2008 was $835,000, up $36,000 from the salariesexpense incurred in the same period in 2007. For the nine-month periods the changes in noninterest expense areprincipally related to an increase in personnel costs, rent anddepreciation.  Salaries expense in 2008was $2.47 million, up $121,000 from the salaries expense incurred in the sameperiod in 2007.  The major reason for theincrease in rent expense is due to the new Antietam Office which relocated to alarger facility after the fire destroyed the previous location in February 2007.

 

**IncomeTaxes**

 

During the three monthsended September 30, 2008, the Company incurred $153,000 of income taxexpense compared to $194,000 during the same period in 2007.  During the nine months ended September 30,2008, the Company incurred $381,000 of income tax expense compared to $482,000during the same period in 2007.  Theeffective tax rates for the three-month periods in 2008 and 2007 were 32.69%and 32.23% and for the nine month periods in 2008 and 2007 were 30.12% and31.14%.  The decline in income taxexpense for the three months is due to the lower pre-tax income in 2008 and forthe nine months the lower pre-tax income in 2008 along with an income taxbenefit of $19,000 the Company recognized on $2.36 million of deferred taxassets as a result of the change in the Maryland income tax rate from 7.0% to8.25% which became effective January 1, 2008.

 

**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.

 

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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 maturity experiencedare not the same.  Similarly, NOW andmoney market accounts, by contract, may be withdrawn in their entirety upondemand 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 $(48.81)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 anappropriate balance between the maturity and repricing characteristics ofassets and liabilities that is consistent with the Company’s liquidityanalysis, growth, and capital adequacy goals. It is the objective of the Asset/Liability Committee to maximize netinterest margins during periods of both volatile and stable interest rates, toattain earnings growth, and to maintain sufficient liquidity to satisfydepositors’ requirements and meet credit needs of customers.

 

The table below, “InterestRate Sensitivity Gap Analysis,” summarizes, as of September 30, 2008, 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-bearingliabilities.  During periods of risinginterest rates, a positive gap position would generally increase earnings, andduring periods of declining interest rates, a positive gap position wouldgenerally decrease earnings.

 

It is important tonote that the following table represents the static gap position for interestsensitive assets and liabilities at September 30, 2008.  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 of competitionon pricing of deposits and loans.  Forexample, under current market conditions, market rates paid on deposits may notbe able to adjust by the full amount of downward adjustments in the federalfunds target rate, while rates on loans will tend to adjust by the full amount,subject to certain limitations.

 

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**InterestRate Sensitivity Gap Analysis**

**September 30,2008**

 
| ** **                                            | ** ** | **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                                   |       | $                                       | 11,755     |   | $ | — |   | $ | — |   | $ | — |   | $ | 11,755 |   |
| Interest-bearing  deposits in other banks             |       | 6,651                                   |       | — |   | — |   | — |   | 6,651 |   |
| Investment  securities(1)                             |       | 2,525                                   |       | 2,894 |   | 3,849 |   | 10,902 |   | 20,170 |   |
| Loans                                                 |       | 86,459                                  |       | 47,095 |   | 58,112 |   | 19,851 |   | 211,517 |   |
| Total  interest-earning assets                        |       | 107,390                                 |       | 49,989 |   | 61,961 |   | 30,753 |   | 250,093 |   |
|                                                  |       |                                    |       |   |   |   |   |   |   |   |   |
| Liabilities                                           |       |                                    |       |   |   |   |   |   |   |   |   |
| Savings and NOW  accounts                             |       | 892                                     |       | 1,784 |   | 1,784 |   | 13,382 |   | 17,842 |   |
| Money Market  accounts                                |       | 2,035                                   |       | 4,071 |   | 4,071 |   | 30,533 |   | 40,710 |   |
| Certificates of  deposit                              |       | 92,643                                  |       | 35,312 |   | 593 |   | — |   | 128,548 |   |
| Long-term  borrowings                                 |       | 5,000                                   |       | 5,000 |   | — |   | — |   | 10,000 |   |
| Junior  subordinated debentures                       |       | —                                  |       | — |   | 6,186 |   | — |   | 6,186 |   |
| Total  interest-bearing liabilities                   |       | 100,570                                 |       | 46,167 |   | 12,634 |   | 43,915 |   | 203,286 |   |
| Interest rate  sensitivity gap                        |       | $                                       | 6,820      |   | $ | 3,822 |   | $ | 49,327 |   | $ | (13,162 | ) | $ | 46,807 |   |
| Cumulative  interest rate sensitivity gap             |       | $                                       | 6,820      |   | $ | 10,642 |   | $ | 59,969 |   | $ | 46,807 |   |   |   |
| Cumulative gap  ratio as a percentage of total assets |       | 2.62                                    | %          | 4.08 | % | 23.00 | % | 17.95 | % |   |   |

----

(1)         Excludes equity securities.

 

In addition to theInterest Rate Sensitivity Gap Analysis, the Company also uses an earningssimulation model on a quarterly basis to closely monitor interest sensitivityand to expose its balance sheet and income statement to 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 on historicaldata, for both assets and liabilities projected for a one-year period.  The model is then subjected to a “shock test”assuming a sudden interest rate increase of 200 basis points or a decrease of200 basis points, but not below zero. The results show that with a 200 basis point rise in interest rates theCompany’s net interest income would decline by 2.16%.  With a decrease in interest rates of 200basis points the Company’s net interest income would increase by 2.04%.

 

Certainshortcomings are inherent in this method of analysis.  For example, although certain assets andliabilities may have similar maturities or repricing periods, they may react indifferent degrees to changes in market interest rates.  Also, the interest rates on certain types of assetsand liabilities may fluctuate in advance of changes in market interest rates,while interest rates on other types may lag behind changes in marketrates.  Additionally, certain assets,such as adjustable-rate mortgage loans, have features that restrict changes ininterest rates on a short-term basis and over the life of the loan.  Further, in the event of a change in interestrates, prepayment and early withdrawal levels could deviate significantly fromthose assumed.  Finally, the ability ofmany borrowers to service their debt may decrease in the event of a significantinterest rate increase.

 

**CriticalAccounting Policy:**

 

**Allowance for Loan Losses**

** **

The Company’s provisionfor loan losses for the three months ended September 30, 2008 and 2007 was$220,000 and $50,000, respectively, and for the nine-month periods was $460,000and $241,000, respectively.  The loangrowth was $2.51 million since December 31, 2007 and $1.15 million since September 30,2007.  The provision for loan losses isdetermined based upon Management’s estimate of the amount required to maintainan adequate allowance for loan losses reflective of the risks in the Company’sloan portfolio.  At September 30,2008 and December 31, 2007, the allowance for loan losses was $2.70million and $2.64 million, respectively. The increase in the allowance from December 31, 2007, reflects theprovision of $460,000 less net charge-offs of $400,000, as compared to netcharge-offs of $6,000 in the same period of 2007.  The increase in charge-offs is a result ofone unsecured relationship in the amount of $223,000, commercial and industrialloan for $104,000 and the write-down on foreclosed property in the amount of$76,000 when transferred to other real estate owned.

 

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TheCompany prepares a quarterly analysis of the allowance for loan losses, withthe objective of quantifying portfolio risk into a dollar amount of inherentlosses.  The determination of theallowance for loan losses is based on eight qualitative factors and onequantitative factor for each category and type of loan along with any specificallowance for adversely classified loans within each category.  Each factor is assigned a percentage weightand that total weight is applied to each loan category.  Factors are different for each category.  Qualitative factors include: levels andtrends in delinquencies and nonaccrual loans; trends in volumes and terms ofloans; effects of any changes in lending policies, the experience, ability anddepth of management; national and local economic trends and conditions;concentrations of credit; quality of the Company’s loan review system; andregulatory requirements.  The totalallowance required thus changes as the percentage weight assigned to eachfactor increased or decreased due to the particular circumstances, as thevarious types and categories of loans change as a percentage of total loans andas specific allowances are required due to increases in adversely classifiedloans.

 

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 in theestimation process, Management’s estimate of loan losses and the relatedallowance could change in the near term.

 

Thespecific allowance component is used to individually establish an allowance forloans identified for impairment testing. When impairment is identified, a specific reserve may be establishedbased on the Company’s calculation of the estimated loss embedded in 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 collectively evaluatedfor impairment. Accordingly, the Company does not separately identifyindividual consumer and residential mortgage loans for impairment.   At September 30, 2008 there were $1.37million of loans deemed to be impaired, which had specific reserves of$365,000.  This included $1.37 million innonaccrual loans.  These loans amount to$1.28 million in commercial real estate for three relationships and $95,000 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 the internalrisk 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,quality of loan review system and the effect of external factors (i.e.competition and regulatory requirements). The allowance factors assigned differ by loan type.

 

Allowancefactors and overall size of the allowance may change from period to periodbased on Management’s assessment of the above-described factors and therelative weights given to each factor. In addition, various regulatory agencies periodically review theallowance for loan losses.  Theseagencies may require the Bank to make additions to the allowance for loanlosses based on their judgments of collectibility based on informationavailable to them at the time of their examination.

 

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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 September 30,2008, the real estate loan portfolio constituted 86% of the total loan portfolio.  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 to meetcontractual 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 $7.39 million of at September 30,2008.

** **
| ** **                                     | ** ** | **Three Months Ended**         | ** ** | **Nine Months Ended**          | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| **(dollars in thousands)**                     | ** ** | **September 30,****2008** | ** ** | **September 30,****2007** | ** ** | **September 30,****2008** | ** ** | **September 30,****2007** | ** ** |
| Average total  loans outstanding during period |       | $                              | 213,884    |                           | $          | 203,863 |   | $ | 211,353 |   | $ | 190,190 |   |
| Balance at  beginning of period                |       | 2,584                          |       | 2,351                          |       | 2,640 |   | 2,166 |   |
| Recoveries of  loans previously charged-off    |       | —                         |       | —                         |       | 9 |   | — |   |
| Loans  charged-off (commercial and industrial) |       | (104                           | )          | —                         |       | (327 | ) | — |   |
| Loans  charged-off (commercial real estate)    |       | —                         |       | —                         |       | (76 | ) | — |   |
| Loans  charged-off (residential real estate)   |       | —                         |       | —                         |       | (6 | ) | — |   |
| Loans  charged-off (consumer)                  |       | —                         |       | —                         |       | — |   | (6 | ) |
| Net charge-offs                                |       | (104                           | )          | —                         |       | (400 | ) | (6 | ) |
| Provision  charged to operating expenses       |       | 220                            |       | 50                             |       | 460 |   | 241 |   |
| Balance at end  of period                      |       | $                              | 2,700      |                           | $          | 2,401 |   | $ | 2,700 |   | $ | 2,401 |   |
| Ratios of net  charge-offs to average loans    |       | 0.05                           | %          | —                         | %          | 0.19 | % | — | % |

 

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.

** **
| ** **                                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **Allocation of Allowance for Loan Losses**                                 | ** ** | **2008**               | ** ** | **% of  Loans**       | ** ** | **2007** | ** ** | **% of  Loans** | ** ** |
| Real  estate-construction                                                   |       | $                      | 276        |                  | 10         | % | $ | 240 |   | 13 | % |
| Real  estate-mortgage                                                       |       | 1,952                  |       | 76                    | %          | 1,774 |   | 73 | % |
| Commercial and  industrial loans                                            |       | 435                    |       | 13                    | %          | 532 |   | 13 | % |
| Loans to  individuals for household, family and other personal expenditures |       | 37                     |       | 1                     | %          | 94 |   | 1 | % |
|                                                                        |       | $                      | 2,700      |                  | 100        | % | $ | 2,640 |   | 100 | % |

 

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** **
| ** **                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Nonaccrual loans                           |       | $                      | 1,371      |                  | $          | 310 |   |
| Loans 90 days  past due and still accruing |       | —                 |       | —                |       |
| Total  nonperforming loans                 |       | 1,371                  |       | 310                   |       |
| Other real  estate owned                   |       | 452                    |       | —                |       |
| Total  nonperforming assets                |       | 1,823                  |       | $                     | 310        |   |
| Nonperforming  assets to total assets      |       | 0.69                   | %          | 0.12                  | %          |
|                                            |            |                        |            |                       |            |  |  |

 

There were noother interest-bearing assets at September 30, 2008 or December 31, 2007classified 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.

 

Commitments to extend credit and standby letters ofcredit as of September 30, 2008 were as follows:

 
| ** **                                                                       | ** ** | **September 30,**  | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                       | ** ** | **2008**                | ** ** |
| **(dollars in thousands)**                                                       | ** ** | **Contractual  Amount** | ** ** |
| Financial  instruments whose notional or contract amounts represent credit risk: |       |                    |       |
| Commitments to  extend credit                                                    |       | $                       | 30,181     |   |
| Standby letters  of credit                                                       |       | 3,449                   |       |
| Total                                                                            |       | $                       | 33,630     |   |

 

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 31,2007 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 September 30, 2008 or December 31,2007.  This facility matures on May 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.

 

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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, and otherfactors.

 

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 September 30, 2008 and that the Company wouldmeet such requirements if applicable. See Note 10 to the consolidated financial statements for a tabledepicting compliance with regulatory capital requirements.

 

As of September 30,2008, the most recent notification from the regulatory agency categorized theBank as well 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 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 September 30,2008, 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.

 

###### **Item 3.   Quantitativeand Qualitative Disclosures About Market Risk**

###### ** **

See“Market Risk, Liquidity and Interest Rate Sensitivity” at Page 20.

 

###### **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 September 30,2008 that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.**

 

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## **Tableof Contents**

 

## **PART II— Other Information**

## ** **

Item 1.   Legal Proceedings.   None

 

Item 1A.  RiskFactors   There have been no materialchanges to the risk factors as of September 30, 2008 from those disclosedin the Company’s 2007Annual Report on Form 10-K.

 

Item 2.   Unregistered Sales of Equity Securities andUse of Proceeds

 

                        (a)   *Sales of Unregistered Securities.  *None

 

                        (b)   *Use of Proceeds.  *NotApplicable.

 

                        (c)   *Registrant**Purchasesof Securities*

 

                                                The following table provides informationon the Company’s purchases of its common stock during the quarter ended September 30,2008.

 
| **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** | ** ** |
|----------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| July 1-31,  2008      |       | 0                                     |       | N/A                               |       | 0                                                                                                |       | 0                                                                                     |       |
| August 1-31,  2008    |       | 0                                     |       | N/A                               |       | 0                                                                                                |       | 0                                                                                     |       |
| September 1-30,  2008 |       | 0                                     |       | N/A                               |       | 0                                                                                                |       | 146,000                                                                               | (2)        |

----

                                                (1)   OnJune 26, 2007, the Company’s Board of Directors approved a sharerepurchase program that authorizes the repurchase of up to 146,000 shares ofthe Company’s outstanding common stock, subject to a maximum expenditure of$4.5 million.  Repurchases under theprogram may be made on the open market and in privately negotiated transactionsfrom time to time until June 30, 2012, or earlier termination of theprogram by the Board.

 

                                                (2)   Subjectto a maximum expenditure of $4.5 million. Number of shares indicated is the remaining number of shares authorizedfor repurchase as of the end of the indicated period.

 

Item 3.         Defaults upon Senior Securities.    None

 

Item 4.   Submission of Matters to a Vote of SecurityHolder.    None

 

Item 5.         Other Information   None

 

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Item 6.  Exhibits

 
| **Exhibit No.** | ** ** | **Description of Exhibits**                                                                                                                                                                                                                         |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3(a)                 |       | Articles of  Incorporation of the Company, as amended(1)                                                                                                                                                                                            |
| 3(b)                 |       | Bylaws of the  Company(2)                                                                                                                                                                                                                           |
| 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, filed herewith                                                                                                                                                                     |
| 11                   |       | Statement Regarding  Computation of Per Share Income — Please refer to Note 2 to the unaudited  consolidated financial statements included herein                                                                                              |
| 31(a)                |       | Certification of  Martin S. Lapera, President and Chief Executive Officer                                                                                                                                                                           |
| 31(b)                |       | Certification of  William R. Talley, Jr., Executive Vice President and Chief Financial  Officer                                                                                                                                                |
| 32(a)                |       | Certification of  Martin S. Lapera, President and Chief Executive Officer                                                                                                                                                                           |
| 32(b)                |       | Certification of  William R. Talley, Jr., Executive Vice President and Chief Financial  Officer                                                                                                                                                |

----

(1)              Incorporated by reference to exhibit of the samenumber to the Company’s Quarterly Report on Form 10-QSB for the quarterended March 31, 2004, as filed with the Securities and ExchangeCommission.

 

(2)              Incorporated by reference to exhibit of the samenumber to the Company’s Quarterly Report on Form 10-QSB for the quarterended September 30, 2003, as filed with the Securities and ExchangeCommission.

 

(3)              Not filed in accordance with the provision of Item601(b)(4)(v) of Regulation SK.  TheCompany agrees to provide a copy of these documents to the Commission uponrequest.

 

(4)              Incorporated by reference to exhibit 4 to the Company’sRegistration Statement on Form S-8 (No. 333-111761).

 

(5)              Incorporated by reference to Exhibit 10.1 to theCompany’s Current Report on Form 8-K filed on May 24, 2005.

 

(6)              Incorporated by reference to Exhibit 10.2 to theCompany’s Current Report on Form 8-K filed on May 24, 2005.

 

(7)              Incorporated by reference to Exhibit 99.1to the Company’s Current Report on Form 8-K filed on December 12,2007.

 

(8)              Incorporated by reference to Exhibit 99.2 to theCompany’s Current Report on Form 8-K filed on December 12, 2007.

 

(9)              Incorporated by reference to Exhibit of the samenumber 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 ofthe same number to the Company’s Quarterly Report on Form 10-QSB for thequarter ended March 31, 2005, as filed with the Securities and ExchangeCommission.

 

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**SIGNATURES**

 

                In accordance with the requirements of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                                          | FREDERICK COUNTY  BANCORP, INC. |
|-----------------------------------------------|---------------------------------|
|                                          |                            |
|                                          |                            |
|                                          |                            |
| Date:   October 31,  2008 | By:                             | /s/ Martin S. Lapera |
|                                          |                            | Martin S. Lapera |
|                                          |                            | President and Chief  Executive Officer |
|                                          |                            |   |
|                                          |                            |   |
|                                          |                            |   |
| Date:   October 31,  2008 | By:                             | /s/ William R.  Talley, Jr. |
|                                          |                            | William R.  Talley, Jr. |
|                                          |                            | Executive Vice  President and Chief Financial Officer |

 

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