**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC  20549**

 

**FORM 10-Q**

 

**(MARK ONE)**

 

**x        QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly PeriodEnded June 30, 2006**

 

**OR**

 

**o        TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom                          to                          **

 

**Commission FileNumber:  000-50407**

 

**FREDERICK COUNTY BANCORP, INC.**

(Exact name of issuer as specified in its charter)

 

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

 

**9 North Market Street**

**Frederick, Maryland 21701**

(Address of principal executive offices)

 

**301.620.1400**

(Issuer’s telephone number)

 

**N/A**

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

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding2 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  xYes  oNo

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer.  Seedefinition of “large accelerated filer and accelerated filer” in Rule 12b-2 ofthe Exchange Act.
| Large accelerated filer  o | Accelerated filer   o | Non-accelerated filer  x |
|---------------------------------|----------------------------|-------------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  oYes  xNo

State the numberof shares of each of the issuer’s classes of common equity, as of the latestpractical date.  There were 1,458,602shares of Common Stock outstanding as of July 14, 2006.

 

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

**TABLE OF CONTENTS**
| **PART I**  | **FINANCIAL  INFORMATION**                                                                                           |
|-------------|----------------------------------------------------------------------------------------------------------------------|
|        |                                                                                                                 |
| Item 1.     | Financial Statements (Unaudited)                                                                                     |
|        |                                                                                                                 |
|        | Consolidated Balance Sheets, June 30, 2006  and December 31, 2005                                               |
|        |                                                                                                                 |
|        | Consolidated  Statements of Income, Three and Six Months Ended June 30, 2006 and 2005                                |
|        |                                                                                                                 |
|        | Consolidated  Statements of Changes in Shareholders’ Equity, Three and Six Months Ended  June 30, 2006 and 2005 |
|        |                                                                                                                 |
|        | Consolidated  Statements of Cash Flows, Six Months Ended June 30, 2006 and 2005                                      |
|        |                                                                                                                 |
|        | Notes  to Unaudited Consolidated Financial Statements                                                                |
|        |                                                                                                                 |
| Item 2.     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                          |
|        |                                                                                                                 |
| Item 3.     | Quantitative  and Qualitative Disclosures About Market Risk                                                          |
|        | See “Market  Risk, Liquidity and Interest Rate Sensitivity” at Page 17.                                    |
|        |                                                                                                                 |
| Item 4.     | Controls and  Procedures                                                                                             |
|        |                                                                                                                 |
| **PART II** | **OTHER INFORMATION**                                                                                                |
|        |                                                                                                                 |
| Item 1.     | Legal  Proceedings                                                                                                   |
|        |                                                                                                                 |
| Item 1A.    | Risk Factors                                                                                                         |
|        |                                                                                                                 |
| Item 2.     | Unregistered  Sales of Equity Securities and Use of Proceeds                                                         |
|        |                                                                                                                 |
| Item 3.     | Defaults  upon Senior Securities                                                                                     |
|        |                                                                                                                 |
| Item 4.     | Submission  of Matters to a Vote of Security Holders                                                                 |
|        |                                                                                                                 |
| Item 5.     | Other Information                                                                                                    |
|        |                                                                                                                 |
| Item 6.     | Exhibits                                                                                                             |
|        |                                                                                                                 |
|        | Signatures                                                                                                           |

 

2

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**FrederickCounty Bancorp, Inc. and Subsidiary**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)**                                                                            | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| ** **                                                                                                      | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                                                                          | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and due from banks                                                                                         |       | $                 | 11,092     |                  | $          | 5,124 |   |
| Federal funds sold                                                                                              |       | 17,194            |       | 13,386                |       |
| Interest-bearing  deposits in other banks                                                                       |       | 4,790             |       | 10,000                |       |
| Cash and cash  equivalents                                                                                      |       | 33,076            |       | 28,510                |       |
| Investment securities  available-for-sale at fair value                                                         |       | 17,819            |       | 18,952                |       |
| Investment securities  held-to-maturity - fair value of $8,006 and $2,229                                       |       | 8,179             |       | 2,246                 |       |
| Restricted stock                                                                                                |       | 893               |       | 821                   |       |
| Loans                                                                                                           |       | 164,024           |       | 155,341               |       |
| Less: Allowance for  loan losses                                                                                |       | (2,073            | )          | (1,953                | )          |
| Net loans                                                                                                       |       | 161,951           |       | 153,388               |       |
| Bank premises and  equipment                                                                                    |       | 2,825             |       | 1,811                 |       |
| Other assets                                                                                                    |       | 1,986             |       | 1,812                 |       |
| Total assets                                                                                                    |       | $                 | 226,729    |                  | $          | 207,540 |   |
|                                                                                                            |       |              |       |                  |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                      | ** ** | ** **        | ** ** | ** **            | ** ** |
|                                                                                                            |       |              |       |                  |       |
| **Liabilities**                                                                                                 |       |              |       |                  |       |
| Deposits:                                                                                                       |       |              |       |                  |       |
| Noninterest-bearing  deposits                                                                                   |       | $                 | 33,267     |                  | $          | 31,484 |   |
| Interest-bearing  deposits                                                                                      |       | 175,464           |       | 158,571               |       |
| Total deposits                                                                                                  |       | 208,731           |       | 190,055               |       |
| Short-term borrowings                                                                                           |       | 450               |       | 450                   |       |
| Long-term debt                                                                                                  |       | 250               |       | 250                   |       |
| Accrued interest and  other liabilities                                                                         |       | 566               |       | 897                   |       |
| Total  liabilities                                                                                              |       | 209,997           |       | 191,652               |       |
|                                                                                                            |       |              |       |                  |       |
| **Shareholders’ Equity**                                                                                   |       |              |       |                  |       |
| Common stock, per share  par value $.01; 10,000,000 shares authorized; 1,458,602 shares issued and  outstanding |       | 15                |       | 15                    |       |
| Additional paid-in  capital                                                                                     |       | 14,652            |       | 14,652                |       |
| Retained earnings                                                                                               |       | 2,413             |       | 1,421                 |       |
| Accumulated other  comprehensive loss                                                                           |       | (348              | )          | (200                  | )          |
| Total shareholders’  equity                                                                                |       | 16,732            |       | 15,888                |       |
| Total liabilities and  shareholders’ equity                                                                |       | $                 | 226,729    |                  | $          | 207,540 |   |

 

The accompanying notes are an integral part of these unauditedconsolidated financial statements.

 

3

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

**ConsolidatedStatements of Income (Unaudited)**

 
| ** **                                                                         | ** ** | **For the Three  Months Ended  June 30,** | ** ** | **For the Six  Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| **(dollars in thousands, except per share amounts)** | ** ** | **2006**                                                      | ** ** | **2005**                                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Interest income:                                                                   |       |                                                          |       |                                                        |       |   |   |   |   |
| Interest and  fees on loans                                                        |       | $                                                             | 2,900      |                                                        | $          | 2,324 |   | $ | 5,623 |   | $ | 4,453 |   |
| Interest and  dividends on investment securities:                                  |       |                                                          |       |                                                        |       |   |   |   |   |
| Interest –  taxable                                                           |       | 198                                                           |       | 158                                                         |       | 406 |   | 313 |   |
| Interest – tax  exempt                                                        |       | 69                                                            |       | 5                                                           |       | 103 |   | 7 |   |
| Dividends                                                                          |       | 12                                                            |       | 11                                                          |       | 23 |   | 20 |   |
| Interest on  federal funds sold                                                    |       | 177                                                           |       | 71                                                          |       | 330 |   | 127 |   |
| Other interest  income                                                             |       | 84                                                            |       | 12                                                          |       | 129 |   | 14 |   |
| Total interest  income                                                             |       | 3,440                                                         |       | 2,581                                                       |       | 6,614 |   | 4,934 |   |
| Interest expense:                                                                  |       |                                                          |       |                                                        |       |   |   |   |   |
| Interest on  deposits                                                              |       | 1,343                                                         |       | 712                                                         |       | 2,545 |   | 1,330 |   |
| Interest on  other short-term borrowings                                           |       | 7                                                             |       | 7                                                           |       | 14 |   | 13 |   |
| Interest on  long-term debt                                                        |       | 5                                                             |       | —                                                      |       | 10 |   | — |   |
| Total interest  expense                                                            |       | 1,355                                                         |       | 719                                                         |       | 2,569 |   | 1,343 |   |
| Net interest income                                                                |       | 2,085                                                         |       | 1,862                                                       |       | 4,045 |   | 3,591 |   |
| Provision for loan  losses                                                         |       | 60                                                            |       | 150                                                         |       | 120 |   | 300 |   |
| Net interest income  after provision for loan losses                               |       | 2,025                                                         |       | 1,712                                                       |       | 3,925 |   | 3,291 |   |
| Noninterest income:                                                                |       |                                                          |       |                                                        |       |   |   |   |   |
| Securities gains  (losses)                                                         |       | —                                                        |       | (1                                                          | )          | — |   | (1 | ) |
| Service fees                                                                       |       | 37                                                            |       | 38                                                          |       | 76 |   | 73 |   |
| Other operating  income                                                            |       | 37                                                            |       | 41                                                          |       | 83 |   | 68 |   |
| Total  noninterest income                                                          |       | 74                                                            |       | 78                                                          |       | 159 |   | 140 |   |
| Noninterest expense:                                                               |       |                                                          |       |                                                        |       |   |   |   |   |
| Salaries and  employee benefits                                                    |       | 821                                                           |       | 676                                                         |       | 1,553 |   | 1,312 |   |
| Occupancy and  equipment expenses                                                  |       | 190                                                           |       | 180                                                         |       | 374 |   | 336 |   |
| Other operating  expenses                                                          |       | 291                                                           |       | 279                                                         |       | 560 |   | 552 |   |
| Total  noninterest expense                                                         |       | 1,302                                                         |       | 1,135                                                       |       | 2,487 |   | 2,200 |   |
| Income before provision  for income taxes                                          |       | 797                                                           |       | 655                                                         |       | 1,597 |   | 1,231 |   |
| Provision for income  taxes                                                        |       | 284                                                           |       | 255                                                         |       | 605 |   | 315 |   |
| Net income                                                                         |       | $                                                             | 513        |                                                        | $          | 400 |   | $ | 992 |   | $ | 916 |   |
| Basic earnings per  share                                                          |       | $                                                             | 0.35       |                                                        | $          | 0.27 |   | $ | 0.68 |   | $ | 0.63 |   |
| Diluted earnings per  share                                                        |       | $                                                             | 0.34       |                                                        | $          | 0.26 |   | $ | 0.65 |   | $ | 0.60 |   |
| Basic weighted average  number of shares outstanding                               |       | 1,458,602                                                     |       | 1,458,602                                                   |       | 1,458,602 |   | 1,458,117 |   |
| Diluted weighted average number of shares outstanding                              |       | 1,527,496                                                     |       | 1,527,663                                                   |       | 1,527,623 |   | 1,526,296 |   |

 

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

4

----

 

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

## **ConsolidatedStatement of Changes inShareholders’ Equity****(Unaudited)**

 

*SixMonths Ended June 30,*

 
| **(dollars in thousands, except  shares outstanding)**                      | ** ** | **Shares  Outstanding** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings  (Deficit)** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total  Shareholders’  Equity** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|----------------------------------|------------|-----------------------------------|------------|---------------------------------------------|------------|---------------------------------------|------------|
|                                                                                            |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
|  Balance, December 31, 2004                                                                |       | 1,457,402               |       | $                 | 15         |                             | $          | 14,632                            |       | $                                           | (411       | )                                     | $          | (23 | ) | $ | 14,213 |   |
| Comprehensive income:                                                                           |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
| Net income                                                                                      |       | —                  |       | —            |       | —                           |       | 916                               |       | —                                      |       | 916                                   |       |
| Changes in net  unrealized losses on securities available for sale, net of income taxes of  $14 |       | —                  |       | —            |       | —                           |       | —                            |       | (22                                         | )          | (22                                   | )          |
| Comprehensive  income                                                                           |       |                    |       |              |       |                             |       |                              |       |                                        |       | 894                                   |       |
| Shares issued  under stock option transactions                                                  |       | 1,200                   |       | —            |       | 12                               |       | —                            |       | —                                      |       | 12                                    |       |
| Balance, June 30, 2005                                                                          |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,644                            |       | $                                           | 505        |                                  | $          | (45 | ) | $ | 15,119 |   |
| Balance, December 31,  2005                                                                     |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,652                            |       | $                                           | 1,421      |                                  | $          | (200 | ) | $ | 15,888 |   |
| Comprehensive income:                                                                           |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
| Net income                                                                                      |       | —                  |       | —            |       | —                           |       | 992                               |       | —                                      |       | 992                                   |       |
| Changes in net  unrealized losses on securities available for sale, net of income taxes of  $93 |       |                    |       |              |       |                             |       |                              |       | (148                                        | )          | (148                                  | )          |
| Comprehensive income                                                                            |       |                    |       |              |       |                             |       |                              |       |                                        |       | 844                                   |       |
| Balance, June 30, 2006                                                                          |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,652                            |       | $                                           | 2,413      |                                  | $          | (348 | ) | $ | 16,732 |   |

 

The accompanying notes are an integral part of these unauditedconsolidated financial statements.

 

5

----

 

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

## **ConsolidatedStatement of Changes inShareholders’ Equity****(Unaudited)**

 

*ThreeMonths Ended June 30,*

 
| **(dollars in thousands, except  shares outstanding)**                            | ** ** | **Shares  Outstanding** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings  (Deficit)** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total  Shareholders’  Equity** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|----------------------------------|------------|-----------------------------------|------------|---------------------------------------------|------------|---------------------------------------|------------|
|                                                                                                  |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
| Balance, March  31, 2005                                                                              |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,644                            |       | $                                           | 105        |                                  | $          | (118 | ) | $ | 14,646 |   |
| Comprehensive income:                                                                                 |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
| Net income                                                                                            |       | —                  |       | —            |       | —                           |       | 400                               |       | —                                      |       | 400                                   |       |
| Changes in net unrealized losses on securities  available for sale, net of income tax benefits of $46 |       | —                  |       | —            |       | —                           |       | —                            |       | 73                                          |       | 73                                    |       |
| Comprehensive income                                                                                  |       |                    |       |              |       |                             |       |                              |       |                                        |       | 473                                   |       |
| Balance, June 30,  2005                                                                               |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,644                            |       | $                                           | 505        |                                  | $          | (45 | ) | $ | 15,119 |   |
| Balance, March  31, 2006                                                                              |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,652                            |       | $                                           | 1,900      |                                  | $          | (246 | ) | $ | 16,321 |   |
| Comprehensive  income:                                                                                |       |                    |       |              |       |                             |       |                              |       |                                        |       |                                  |       |
| Net income                                                                                            |       | —                  |       | —            |       | —                           |       | 513                               |       | —                                      |       | 513                                   |       |
| Changes in net unrealized losses on securities  available for sale, net of income taxes of $64        |       | —                  |       | —            |       | —                           |       | —                            |       | (102                                        | )          | (102                                  | )          |
| Comprehensive  income                                                                                 |       |                    |       |              |       |                             |       |                              |       |                                        |       | 411                                   |       |
| Balance, June 30, 2006                                                                                |       | 1,458,602               |       | $                 | 15         |                             | $          | 14,652                            |       | $                                           | 2,413      |                                  | $          | (348 | ) | $ | 16,732 |   |

 

The accompanying notes are an integral part of these unauditedconsolidated financial statements.

 

6

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**FrederickCounty Bancorp, Inc. and Subsidiary**

**ConsolidatedStatements of Cash Flows (Unaudited)**

 
| ** **                                                                                     | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **(dollars in thousands)**                                                           | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Cash flows from operating activities:                                                          |       |                                              |       |   |   |
| Net income                                                                                     |       | $                                                 | 992        |   | $ | 916 |   |
| Adjustments to reconcile net  income to net cash provided by (used in) operating activities:   |       |                                              |       |   |   |
| Depreciation and amortization                                                                  |       | 86                                                |       | 80 |   |
| Deferred income taxes  (benefits)                                                              |       | (48                                               | )          | — |   |
| Provision for loan losses                                                                      |       | 120                                               |       | 300 |   |
| Securities losses                                                                              |       | —                                            |       | 1 |   |
| Net premium amortization on  investment securities                                             |       | 22                                                |       | 49 |   |
| Increase in other assets                                                                       |       | (33                                               | )          | (1,267 | ) |
| Decrease in accrued interest  and other liabilities                                            |       | (331                                              | )          | (510 | ) |
| Net cash provided by (used in)  operating activities                                           |       | 808                                               |       | (431 | ) |
| Cash flows from investing activities:                                                          |       |                                              |       |   |   |
| Purchases of investment  securities available-for-sale                                         |       | (1,475                                            | )          | (4,139 | ) |
| Purchases of investment  securities held-to-maturity                                           |       | (5,933                                            | )          | (550 | ) |
| Proceeds from sale of  investment securities available-for-sale                                |       | —                                            |       | 691 |   |
| Proceeds from maturities of  investment securities available-for-sale                          |       | 2,345                                             |       | 2,187 |   |
| Purchases of restricted stock                                                                  |       | (72                                               | )          | (106 | ) |
| Net increase in loans                                                                          |       | (8,683                                            | )          | (12,848 | ) |
| Purchases of bank premises and  equipment, net                                                 |       | (1,100                                            | )          | (191 | ) |
| Net cash used in investing  activities                                                         |       | (14,918                                           | )          | (14,956 | ) |
| Cash flows from financing activities:                                                          |       |                                              |       |   |   |
| Net increase in NOW, money  market accounts, savings accounts and noninterest-bearing deposits |       | 10,734                                            |       | 7,925 |   |
| Net increase in time deposits                                                                  |       | 7,942                                             |       | 10,896 |   |
| Proceeds from issuance of  common stock                                                        |       | —                                            |       | 12 |   |
| Net cash provided by financing  activities                                                     |       | 18,676                                            |       | 18,833 |   |
| Net increase in cash and cash equivalents                                                      |       | 4,566                                             |       | 3,446 |   |
| Cash and cash equivalents – beginning of period                                           |       | 28,510                                            |       | 16,639 |   |
| Cash and cash equivalents – end of period                                                 |       | $                                                 | 33,076     |   | $ | 20,085 |   |
| Supplemental cash flow disclosures:                                                            |       |                                              |       |   |   |
| Interest paid                                                                                  |       | $                                                 | 2,569      |   | $ | 1,322 |   |
| Income taxes paid                                                                              |       | $                                                 | 778        |   | $ | 771 |   |

 

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

7

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

Notes to UnauditedConsolidated Financial Statements

**Note1.  General:**

On September 30, 2003, theAgreement and Plan of Share Exchange (the “Exchange”) between the FrederickCounty Bancorp, Inc. (the “Bancorp”) and Frederick County Bank (the “Bank” andtogether with Bancorp, the “Company”), dated June 9, 2003, approved at theSpecial Meeting of Shareholders of the Bank held on September 22, 2003, becameeffective.  Pursuant to the Exchange,each of the outstanding shares of common stock $10.00 par value of the Bank wasconverted into one share of the common stock $0.01 par value of Bancorp.  As a result of the Exchange, the Bank becamea wholly owned subsidiary of Bancorp, and Bancorp recognized the assets andliabilities transferred at the carrying amounts in the accounts of the Bank asof January 1, 2003.  During February 2004, the Company received approval from the FederalReserve Bank of Richmond to become a financial holding company.

The Bank provides its customerswith various banking services.  The Bankoffers various loan and deposit products to their customers.  The Bank’s customers includeindividuals and commercial enterprises within its principal market areaconsisting of Frederick County, Maryland. Additionally, the Bank maintains correspondent banking relationships andtransacts daily federal funds sales on an unsecured basis with regionalcorrespondent banks.  Note 4 discussesthe types of securities the Bank invests in. Note 5 discusses the types of lending that the Bank engages in.  The Bank does not have any significantconcentrations to any one industry or customer.

The accompanyingunaudited consolidated financial statements of the Company have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America for interim financial information, the instructions for Form10-Q, regulation S-X, and general practices within the banking industry.  Accordingly, they do not include all of theinformation and disclosures required by generally accepted accountingprinciples for complete financial statements. These statements should be read in conjunction with the consolidatedfinancial statements and accompanying footnotes included in the Company’s 2005Annual Report on Form 10-K.  In theopinion of management, all adjustments, consisting of normal recurringadjustments, considered necessary for a fair presentation have beenincluded.  The results shown in thisinterim report are not necessarily indicative of results to be expected for anyother period or for the full year ending December 31, 2006.

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

**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.
| ** **                                                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(dollars in thousands, except per share amounts)** | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                                                         |       | $                                               | 513        |                                          | $          | 400 |   | $ | 992 |   | $ | 916 |   |
| Basic earnings  per share                                                          |       | $                                               | 0.35       |                                          | $          | 0.27 |   | $ | 0.68 |   | $ | 0.63 |   |
| Diluted earnings  per share                                                        |       | $                                               | 0.34       |                                          | $          | 0.26 |   | $ | 0.65 |   | $ | 0.60 |   |
| Basic weighted  average number of shares outstanding                               |       | 1,458,602                                       |       | 1,458,602                                     |       | 1,458,602 |   | 1,458,117 |   |
| Effect of  dilutive securities – stock options                                |       | 68,894                                          |       | 69,061                                        |       | 69,021 |   | 68,179 |   |
| Diluted weighted  average number of shares outstanding                             |       | 1,527,496                                       |       | 1,527,663                                     |       | 1,527,623 |   | 1,526,296 |   |

 

**Note3.  Employee Stock Option Plan:**

The Companymaintains an Employee Stock Option Plan that provides for grants of incentiveand non-incentive stock options.  Thisplan has been presented to and approved by the Company’s shareholders.  Through December 31, 2005, the Companyaccounted for this plan under the recognition and measurement principles ofAccounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees,*and relatedinterpretations.  Accordingly, nostock-based employee compensation cost has been recognized, as all optionsgranted under this plan had an exercise price equal to the market value of theunderlying common stock on the date of grant. As of December 31, 2005, all outstanding stock options were fully vested.  No stock options were granted or vestedduring the first six months of 2006 or 2005 and, accordingly, net income andearnings per share would not have been affected if compensation cost for thestock-based compensation plan had been determined based on the grant date fairvalues of awards (the

8

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method describedin Statement of Financial Accounting Standards No. 123 *Accounting for Stock-Based Compensation*).  As of January 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123(R) *Share-Based Payment* and any stock-basedemployee compensation for future grants will be determined at that time usingthe Black-Scholes or another appropriate option-pricing model with thefollowing assumptions: option price, dividend yield, expected volatility, riskfree interest rate and the expected life.

**Note 4.  Investment Portfolio:**

Thefollowing tables set forth certain information regarding the Company’sinvestment portfolio at June 30, 2006 and December 31, 2005:

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

*June 30, 2006*
| **(dollars in thousands)**                                | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Estimated  Fair  Value** | ** ** | **Average  Yield** | ** ** |
|---------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------|------------|--------------------|------------|
| U.S. Treasury  and other U.S. government Agencies and corporations: | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **         | ** ** |
| Due after one year through five years                               |       | $                   | 2,407      |                        | $          | —                      |       | $                          | 51         |               | $          | 2,356 |   | 4.29 | % |
| Due after five years through ten years                              |       | 3,077               |       | —                      |       | 73                          |       | 3,004                      |       | 4.95               | %          |
| Mortgage-backed  debt securities                                    |       | 12,502              |       | 5                           |       | 448                         |       | 12,059                     |       | 4.40               | %          |
| Equity  securities                                                  |       | 400                 |       | —                      |       | —                      |       | 400                        |       | —             | %          |
|                                                                |       | $                   | 18,386     |                        | $          | 5                           |       | $                          | 572        |               | $          | 17,819 |   | 4.38 | % |

 

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

 

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

*June 30, 2006*
| **(dollars in thousands)**   | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Estimated  Fair  Value** | ** ** | **Average  Yield** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------|------------|----------------------------|------------|--------------------|------------|
| State and  political subdivisions:     | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **         | ** ** |
| Due after five years through ten years |       | $                   | 1,209      |                        | $          | —                      |       | $                          | 35         |               | $          | 1,174 |   | 5.17 | % |
| Due after ten years                    |       | 6,970               |       | —                      |       | 138                         |       | 6,832                      |       | 5.82               | %          |
|                                   |       | $                   | 8,179      |                        | $          | —                      |       | $                          | 173        |               | $          | 8,006 |   | 5.72 | % |

 

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

** **

9

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** **

*June 30, 2006*
| ** **                                                         | ** ** | **Continuous unrealized  losses existing for less than  12 months** | ** ** | **Continuous unrealized  losses existing for 12  months and greater** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|-----------|------------|
| ** **                                                         | ** ** | **Fair**                                                                                          | ** ** | **Unrealized**                                                                                      | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(dollars in thousands)**                               | ** ** | **Value**                                                                                         | ** ** | **Losses**                                                                                          | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| U.S. Treasury  and other U.S. government agencies and corporations |       | $                                                                                                 | 4,379      |                                                                                                | $          | 105       |       | $ | 981 |   | $ | 19 |   | $ | 5,360 |   | $ | 124 |   |
| Mortgage-backed  debt securities                                   |       | 1,361                                                                                             |       | 34                                                                                                  |       | 10,034    |       | 414 |   | 11,395 |   | 448 |   |
| State and  political subdivisions                                  |       | 6,950                                                                                             |       | 161                                                                                                 |       | 286       |       | 12 |   | 7,236 |   | 173 |   |
| Total temporarily  impaired securities                             |       | $                                                                                                 | 12,690     |                                                                                                | $          | 300       |       | $ | 11,301 |   | $ | 445 |   | $ | 23,991 |   | $ | 745 |   |

 

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

 

Management evaluates securities for other-than-temporary impairment atleast on a quarterly basis, and more frequently when economic or marketconcerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to whichthe fair value has been less than cost, (2) the financial condition andnear-term prospects of the issuer, and (3) the intent and ability of theCompany to retain its investment in the issuer for a period of time sufficientto allow for any anticipated recovery in fair value.  The Company has not recognized anyother-than-temporary impairment in connection with the unrealized lossesreflected in the preceding tables.  Allof these declines can be attributable to increases in interest rates and not achange in credit quality.

## **Restricted Stock**

The following table shows the amounts of restricted stock as of June 30,2006 and December 31, 2005:
|                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)** | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Federal Home Loan Bank of Atlanta    |       | $                 | 414        |                  | $          | 342 |   |
| Federal Reserve Bank                 |       | 439               |       | 439                   |       |
| Atlantic Central Bankers Bank        |       | 40                |       | 40                    |       |
|                                 |       | $                 | 893        |                  | $          | 821 |   |

 

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

Loans consist of the following:
| ** **                                                                  | ** ** | **June 30,** | ** ** | **% of** | ** ** | **December 31,** | ** ** | **% of** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------|------------|---------------|------------|-----------------------|------------|---------------|------------|
| **(dollars in thousands)**                                        | ** ** | **2006**          | ** ** | **Loans**     | ** ** | **2005**              | ** ** | **Loans**     | ** ** |
| Real estate  loans:                                                         |       |              |       |          |       |                  |       |          |       |
| Construction and  land development                                          |       | $                 | 36,385     |          | 22         | %                     | $          | 29,140        |       | 19 | % |
| Mortgage loans:                                                             |       |              |       |          |       |                  |       |          |       |
| Secured by 1 to  4 family residential properties                            |       | 32,568            |       | 20            | %          | 31,128                |       | 20            | %          |
| Secured by multi-family (5 or more) residential  properties                 |       | 7,888             |       | 5             | %          | 3,942                 |       | 3             | %          |
| Secured by commercial properties                                            |       | 56,073            |       | 34            | %          | 60,087                |       | 39            | %          |
| Secured by farm land                                                        |       | 4,307             |       | 3             | %          | 2,836                 |       | 2             | %          |
| Total mortgage loans                                                        |       | 100,836           |       | 62            | %          | 97,993                |       | 64            | %          |
| Loans to farmers                                                            |       | —            |       | —        | %          | 756                   |       | —        | %          |
| Commercial and  industrial loans                                            |       | 23,727            |       | 14            | %          | 25,140                |       | 16            | %          |
| Loans to  individuals for household, family and other personal expenditures |       | 3,076             |       | 2             | %          | 2,312                 |       | 1             | %          |
|                                                                        |       | 164,024           |       | 100           | %          | 155,341               |       | 100           | %          |
| Less allowance for loan losses                                              |       | (2,073            | )          |          |       | (1,953                | )          |          |       |
|  Net loans                                                             |       | $                 | 161,951    |          |       |                  | $          | 153,388       |       |   |   |

 

Transactions inthe allowance for loan losses are summarized as follows:
|                                                      | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|
| **(dollars in thousands)**                 | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Balance at  beginning of period                      |       | $                              | 1,953      |   | $ | 1,503 |   |
| Provision  charged to operating expenses             |       | 120                            |       | 300 |   |
| Recoveries of  loans previously charged-off          |       | —                         |       | — |   |
|                                                 |       | 2,073                          |       | 1,803 |   |
| Loans  charged-off                                   |       | —                         |       | — |   |
| Balance at end  of period                            |       | $                              | 2,073      |   | $ | 1,803 |   |
|  Average total loans outstanding during  period |       | $                              | 159,544    |   | $ | 139,542 |   |

 

**Note6.  Deposits**

The following table provides a summary of the Company’s deposit base atthe dates indicated.
|                                      | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **Balance**             | ** ** | **Balance**                 | ** ** |
| Noninterest-bearing  demand deposits |       | $                       | 33,267     |                        | $          | 31,484 |   |
| Interest-bearing  demand deposits:   |       |                    |       |                        |       |
| NOW accounts                         |       | 26,887                  |       | 20,090                      |       |
| Money market accounts                |       | 31,163                  |       | 28,844                      |       |
| Savings accounts                     |       | 2,567                   |       | 2,732                       |       |
| Certificates of  deposit:            |       |                    |       |                        |       |
| $100,000 or more                     |       | 57,896                  |       | 51,283                      |       |
| Less than $100,000                   |       | 56,951                  |       | 55,622                      |       |
| Total deposits                       |       | $                       | 208,731    |                        | $          | 190,055 |   |

 

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**Note 7.  Noninterest Expense:**

Noninterestexpense consists of the following:

|                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(dollars in thousands)**    | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                    |       |                                            |       |                                          |       |   |   |   |   |
| Salaries                                |       | $                                               | 663        |                                          | $          | 571 |   | $ | 1,229 |   | $ | 1,096 |   |
| Bonus                                   |       | 99                                              |       | 40                                            |       | 182 |   | 53 |   |
| Deferred  Personnel Costs               |       | (45                                             | )          | (37                                           | )          | (91 | ) | (69 | ) |
| Payroll Taxes                           |       | 47                                              |       | 50                                            |       | 110 |   | 115 |   |
| Employee  Insurance                     |       | 28                                              |       | 25                                            |       | 62 |   | 61 |   |
| Other Employee Benefits                 |       | 29                                              |       | 27                                            |       | 61 |   | 56 |   |
| Depreciation                            |       | 45                                              |       | 42                                            |       | 86 |   | 80 |   |
| Rent                                    |       | 64                                              |       | 64                                            |       | 128 |   | 115 |   |
| Utilities                               |       | 12                                              |       | 15                                            |       | 30 |   | 30 |   |
| Repairs and  Maintenance                |       | 26                                              |       | 24                                            |       | 49 |   | 48 |   |
| ATM Expense                             |       | 18                                              |       | 15                                            |       | 35 |   | 30 |   |
| Other Occupancy  and Equipment Expenses |       | 25                                              |       | 20                                            |       | 46 |   | 33 |   |
| Postage and  Supplies                   |       | 15                                              |       | 15                                            |       | 29 |   | 29 |   |
| Data Processing                         |       | 70                                              |       | 98                                            |       | 134 |   | 185 |   |
| Advertising and  Promotion              |       | 58                                              |       | 48                                            |       | 119 |   | 89 |   |
| Legal                                   |       | 6                                               |       | 3                                             |       | 13 |   | 7 |   |
| Insurance                               |       | 9                                               |       | 7                                             |       | 17 |   | 14 |   |
| Consulting                              |       | 15                                              |       | 9                                             |       | 22 |   | 19 |   |
| Courier                                 |       | 12                                              |       | 10                                            |       | 22 |   | 20 |   |
| Audit Fees                              |       | 37                                              |       | 33                                            |       | 75 |   | 66 |   |
| Shareholder  Relations                  |       | —                                          |       | 5                                             |       | — |   | 6 |   |
| Other                                   |       | 69                                              |       | 51                                            |       | 129 |   | 117 |   |
|                                    |       | $                                               | 1,302      |                                          | $          | 1,135 |   | $ | 2,487 |   | $ | 2,200 |   |

 

**Note8.  401(k) Profit Sharing Plan:**

The Company has a Section 401(k) profit sharing plan covering employeesmeeting certain eligibility requirements as to minimum age and years ofservice.  Employees may make voluntarycontributions to the Plan through payroll deductions on a pre-tax basis.  The Company makes discretionary contributionsto the Plan based on the Company’s earnings. The Company’s contributions are subject to a vesting schedule (20percent per year) requiring the completion of five years of service with theCompany before these benefits are fully vested. A participant’s account under the Plan, together with investmentearnings thereon, is normally distributable, following retirement, death,disability or other termination of employment, in a single lump-sum payment.

The Company made contributions to the Plan in the amounts of $48,000 and$42,000 for the first six months of 2006 and 2005, respectively and $24,000 and$21,000 for the three months ended June 30, 2006 and 2005, respectively.

**Note9.  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 financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company and the Bankmust meet specific capital guidelines that involve quantitative measures of theCompany’s and the Bank’s assets, liabilities, and certain off-balance-sheetitems as calculated under regulatory accounting practices.  The Company’s and the Bank’s capital amountsand classification 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 followingtable) of total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined), and Tier 1 capital (as defined) to averageassets (as defined).  Management believesthat the Company and the Bank met all capital adequacy requirements to whichthey are subject as of June 30, 2006.

12

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As of June 30, 2006, themost recent notification from the regulatory agency categorized the Bank aswell capitalized under the regulatory framework for prompt correctiveaction.  To be categorized as wellcapitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based,and Tier 1 leverage ratios as set forth in the table.  There are no conditions or events since thatnotification which management believes have changed the Bank’s category.

The Company’s and the Bank’s actual capital amounts andratios at June 30, 2006 and December 31, 2005 are presented in the followingtables.

*June 30, 2006*
| ** **                           | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **Minimum To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| **(dollars in thousands)** | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Tier 1 Capital                       |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| To Risk-Weighted Assets              |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Company                              |       | $          | 17,080     |                                         | 9.35       | %                                                                                                             | $          | 7,307 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                                 |       | $          | 17,160     |                                         | 9.41       | %                                                                                                             | $          | 7,292 |   | 4.00 | % | $ | 10,938 |   | 6.00 | % |
|                                 |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Total Capital                        |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| To Risk-Weighted Assets              |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Company                              |       | $          | 19,153     |                                         | 10.48      | %                                                                                                             | $          | 14,614 |   | 8.00 | % | N/A |   | N/A |   |
| Bank                                 |       | $          | 19,233     |                                         | 10.55      | %                                                                                                             | $          | 14,583 |   | 8.00 | % | $ | 18,229 |   | 10.00 | % |
|                                 |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Tier 1 Capital                       |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| To Average Assets                    |       |       |       |                                         |       |                                                                                                          |       |   |   |   |   |   |   |
| Company                              |       | $          | 17,080     |                                         | 7.90       | %                                                                                                             | $          | 8,643 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                                 |       | $          | 17,160     |                                         | 7.96       | %                                                                                                             | $          | 8,627 |   | 4.00 | % | $ | 10,784 |   | 5.00 | % |

 

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

 

**Item2.    Management’sDiscussion and Analysis of Financial 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.(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

13

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products and to enter new markets, competitive challenges in the Company’smarket, legislative changes and other factors, and as such, there can be noassurance that future events will develop in accordance with theforward-looking statements contained herein. Readers are cautioned against placing undue reliance on any suchforward-looking statement.  In addition,the Company’s past results of operations do not necessarily indicate its futureresults.

**General**

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.

On September 30, 2003, theAgreement and Plan of Share Exchange (the “Exchange”) between the FrederickCounty Bancorp, Inc. (the “Bancorp”) and Frederick County Bank (the “Bank” andtogether with Bancorp, the “Company”), dated June 9, 2003, approved at theSpecial Meeting of Shareholders of the Bank held on September 22, 2003, becameeffective.  Pursuant to the Exchange,each of the outstanding shares of common stock $10.00 par value of the Bank wasconverted into one share of the common stock $0.01 par value of Bancorp.  As a result of the Exchange, the Bank hasbecome a wholly owned subsidiary of Bancorp, and Bancorp recognized the assetsand liabilities transferred at the carrying amounts in the accounts of the Bankas of January 1, 2003.  During February 2004, the Company received approval from the FederalReserve Bank of Richmond to become a financial holding company.

The Bank was incorporated onAugust 30, 2000, and in 2001 it became engaged in the developmental activitiesneeded to obtain a commercial bank charter in the State of Maryland.  The Bank received regulatory approval tocommence banking operations on October 18, 2001 and, accordingly, becameoperational during the year ended December 31, 2001.  The Bank provides its customers with variousbanking services.  The Bank offersvarious loan and deposit products to their customers.  The Bank’s customers includeindividuals and commercial enterprises within its principal market areaconsisting of Frederick County, Maryland.

The Company iscontinually looking for promising branch sites that will contribute to theCompany’s growth and profit expectations. While additional branching activity is anticipated, there can be noassurance as to when or if, additional branches will be established, whetherany such branches can be operated profitably, or whether such expansion willresult in increased assets, earnings, return on equity or shareholdervalue.  Two new branches, located at 200Commerce Drive, Walkersville, Maryland and 6910 Crestwood Boulevard, Frederick,Maryland, are currently under construction and the Company anticipates thatthese facilities will open in September 2006.

## **Critical Accounting Policies**

The Company’sfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”) and follow generalpractices within the industry in which it operates.  Application of these principles requiresmanagement to make estimates, assumptions, and judgments that affect the amountsreported 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 credit losses require that management make assumptionsabout matters 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$8.68 million, or 5.59%, from December 31, 2005 to a balance of $164.02 millionas of June 30, 2006 and by $15.51 million, or 10.66 % from June 30, 2005.  Loan demand for the Company has remainedrelatively constant over the past year.

## **Deposits**

Deposits grew by $18.68million, or 9.83%, from December 31, 2005 to a balance of $208.73 million as ofJune 30, 2006 and by $34.32 million, or 19.68% from June 30, 2005.  The Company’s deposit growth has mainly beenin certificates of deposit over the past year.

14

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## **Bank premises and equipment**

Bank premises andequipment increased by $1.01 million, or 55.99%, from December 31, 2005 to abalance of $2.83 million as of June 30, 2006. The Company has two new branch facilities under construction that willopen in September 2006 and the increase is primarily from the constructionpayments.

**Three Months Ended June 30, 2006 and 2005**

The net income was$513,000 for the quarter ended June 30, 2006 as compared to the $400,000 netearnings recorded for the same period in 2005. The basic earnings per share forthe three months ended June 30, 2006 and 2005 are $0.35 and $0.27,respectively, and are based on the weighted-average number of sharesoutstanding of 1,458,602.  The dilutedearnings per share for the three months ended June 30, 2006 and 2005 are $0.34and $0.26, respectively, and are based on the weighted-average number of sharesoutstanding of 1,527,496 and 1,527,663, respectively.  The Company recorded loan loss provisions of$60,000 and $150,000 for the three-month periods in 2006 and 2005,respectively.  The after-tax effect ofthis difference had a $55,000 favorable benefit to the 2006 earnings.

TheCompany experienced an annualized return on average assets of 0.95% and 0.90%for the three-month periods ended June 30, 2006 and 2005, respectively.  Additionally, the Company experienced anannualized return on average shareholders’ equity of 12.32% and 10.66% for thethree-month periods ended June 30, 2006 and 2005, respectively.

**Six Months Ended June 30, 2006 and 2005**

The net income was$992,000 for the six months ended June 30, 2006 as compared to the $916,000 netearnings recorded for the same period in 2005. It should be noted that the Company recognized $605,000 of income taxexpense during this period in 2006, whereas, only $315,000 of income taxexpense was incurred for the same period in 2005 due to the release of thevaluation allowance associated with the net operating loss****carryforwards available at that time.  The basic earnings per share for the sixmonths ended June 30, 2006 and 2005 are $0.68 and $0.63, respectively, and arebased on the weighted-average number of shares outstanding of 1,458,602 in 2006and 1,458,117, in 2005.  The dilutedearnings per share for the three months ended June 30, 2006 and 2005 are $0.65and $0.60, respectively, and are based on the weighted-average number of sharesoutstanding of 1,527,623 and 1,526,296, respectively.  The Company recorded loan loss provisions of$120,000 and $300,000 for the six-month periods in 2006 and 2005, respectively.  The after-tax effect of this difference had a$110,000 favorable benefit to the 2006 earnings.

TheCompany experienced an annualized return on average assets of 0.94% and 1.05%for the six-month periods ended June 30, 2006 and 2005, respectively.  Additionally, the Company experienced anannualized return on average shareholders’ equity of 12.06% and 12.39% for thesix-month periods ended June 30, 2006 and 2005, respectively.

15

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**Distribution ofAssets, Liabilities and Shareholders’ Equity; Interest Rates and InterestDifferential**

The following tables show average balances of assetand liability categories, interest income and interest expense, and averageyields and rates for the periods indicated.

*Three Months Ended June 30,*
| ** **                                      | ** ** | **2006**                    | ** ** | **2005**                       | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| **(dollars in thousands)**            | ** ** | **Average  daily  balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Average  Yield/  rate** | ** ** | **Average  daily  balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Average  Yield/  rate** | ** ** |
| Assets                                          |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                       |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Federal funds sold                              |       | $                           | 14,466     |                           | $          | 177 |   | 4.91 | % | $ | 9,928 |   | $ | 71 |   | 2.87 | % |
| Interest bearing deposits in other banks        |       | 7,015                       |       | 84                             |       | 4.80 |   | 1,740 |   | 12 |   | 2.77 |   |
| Investment securities (1):                      |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Taxable                                         |       | 19,769                      |       | 210                            |       | 4.26 |   | 18,195 |   | 169 |   | 3.73 |   |
| Tax-exempt (2)                                  |       | 6,987                       |       | 105                            |       | 6.03 |   | 465 |   | 8 |   | 6.90 |   |
| Loans (3)                                       |       | 161,916                     |       | 2,904                          |       | 7.19 |   | 142,120 |   | 2,328 |   | 6.57 |   |
| Total interest-earning assets                   |       | 210,153                     |       | 3,480                          |       | 6.64 |   | 172,448 |   | 2,588 |   | 6.02 |   |
| Noninterest-earning  assets                     |       | 5,917                       |       |                           |       |   |   | 6,194 |   |   |   |   |   |
| Total assets                                    |       | $                           | 216,070    |                           |       |   |   |   | $ | 178,642 |   |   |   |   |   |
|                                            |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Liabilities  and Shareholders’ Equity      |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities                   |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| NOW accounts                                    |       | $                           | 14,361     |                           | 6          |   | 0.17 | % | $ | 18,514 |   | 8 |   | 0.17 | % |
| Savings accounts                                |       | 2,753                       |       | 4                              |       | 0.58 |   | 3,102 |   | 4 |   | 0.52 |   |
| Money market accounts                           |       | 31,302                      |       | 214                            |       | 2.74 |   | 26,781 |   | 98 |   | 1.47 |   |
| Certificates of deposit $100,000 or more        |       | 57,115                      |       | 574                            |       | 4.03 |   | 42,457 |   | 291 |   | 2.75 |   |
| Certificates of deposit less than $100,000      |       | 58,427                      |       | 545                            |       | 3.74 |   | 45,832 |   | 311 |   | 2.72 |   |
| Short-term borrowings                           |       | 450                         |       | 7                              |       | 6.24 |   | 450 |   | 7 |   | 6.24 |   |
| Long-term debt                                  |       | 250                         |       | 5                              |       | 8.02 |   | — |   | — |   | — |   |
| Total interest-bearing liabilities              |       | 164,658                     |       | 1,355                          |       | 3.30 |   | 137,136 |   | 719 |   | 2.10 |   |
| Noninterest-bearing  deposits                   |       | 34,166                      |       |                           |       |   |   | 26,007 |   |   |   |   |   |
| Noninterest-bearing  liabilities                |       | 584                         |       |                           |       |   |   | 489 |   |   |   |   |   |
| Total liabilities                               |       | 199,408                     |       |                           |       |   |   | 163,632 |   |   |   |   |   |
| Total shareholders’ equity                 |       | 16,662                      |       |                           |       |   |   | 15,010 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | $                           | 216,070    |                           |       |   |   |   | $ | 178,642 |   |   |   |   |   |
| Net  interest income                            |       |                        |       | $                              | 2,125      |   |   |   |   |   | $ | 1,869 |   |   |   |
| Net  interest spread                            |       |                        |       |                           |       | 3.34 | % |   |   |   |   | 3.92 | % |
| Net interest margin                             |       |                        |       |                           |       | 4.06 | % |   |   |   |   | 4.35 | % |

 

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

(2)             Presentedon a taxable-equivalent basis using the statutory federal income tax rate of34%. Taxable-equivalent adjustments of $36,000 in 2006 and $3,000 in 2005 areincluded in the calculation of the tax-exempt investment interest income.

(3)             Presented on ataxable-equivalent basis using the statutory federal income tax rate of 34%.Taxable-equivalent adjustments of $4,000 in 2006 and $4,000 in 2005 areincluded in the calculation of the loan interest income. Net loan originationincome in interest income totaled $3,000 in 2006 and $5,000 in 2005.

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*Six Months Ended June 30,*
| ** **                                       | ** ** | **2006**                    | ** ** | **2005**                       | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| **(dollars in thousands)**             | ** ** | **Average  daily  balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Average  Yield/  rate** | ** ** | **Average  daily  balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Average  Yield/  rate** | ** ** |
| Assets                                           |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Interest-earning assets:                         |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Federal funds sold                               |       | $                           | 14,068     |                           | $          | 330 |   | 4.73 | % | $ | 9,318 |   | $ | 127 |   | 2.75 | % |
| Interest bearing deposits in  other banks        |       | 5,518                       |       | 129                            |       | 4.71 |   | 1,107 |   | 14 |   | 2.55 |   |
| Investment securities (1):                       |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Taxable                                          |       | 20,316                      |       | 429                            |       | 4.26 |   | 17,821 |   | 333 |   | 3.77 |   |
| Tax-exempt (2)                                   |       | 5,259                       |       | 156                            |       | 5.98 |   | 382 |   | 11 |   | 5.81 |   |
| Loans (3)                                        |       | 159,544                     |       | 5,630                          |       | 7.12 |   | 139,542 |   | 4,460 |   | 6.45 |   |
| Total interest-earning assets                    |       | 204,705                     |       | 6,674                          |       | 6.57 |   | 168,170 |   | 4,945 |   | 5.93 |   |
| Noninterest-earning assets                       |       | 6,104                       |       |                           |       |   |   | 5,673 |   |   |   |   |   |
| Total assets                                     |       | $                           | 210,809    |                           |       |   |   |   | $ | 173,843 |   |   |   |   |   |
|                                             |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity        |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities                     |       |                        |       |                           |       |   |   |   |   |   |   |   |   |
| NOW accounts                                     |       | $                           | 13,712     |                           | 12         |   | 0.18 | % | $ | 17,220 |   | 15 |   | 0.18 | % |
| Savings accounts                                 |       | 2,780                       |       | 7                              |       | 0.51 |   | 3,071 |   | 8 |   | 0.53 |   |
| Money market accounts                            |       | 31,269                      |       | 404                            |       | 2.61 |   | 27,688 |   | 173 |   | 1.26 |   |
| Certificates of deposit $100,000  or more        |       | 54,661                      |       | 1,074                          |       | 3.96 |   | 41,918 |   | 554 |   | 2.67 |   |
| Certificates of deposit less  than $100,000      |       | 58,070                      |       | 1,048                          |       | 3.64 |   | 44,274 |   | 580 |   | 2.64 |   |
| Short-term borrowings                            |       | 450                         |       | 14                             |       | 6.27 |   | 450 |   | 13 |   | 5.83 |   |
| Long-term debt                                   |       | 250                         |       | 10                             |       | 8.07 |   | — |   | — |   | — |   |
| Total interest-bearing  liabilities              |       | 161,192                     |       | 2,569                          |       | 3.21 |   | 134,621 |   | 1,343 |   | 2.01 |   |
| Noninterest-bearing deposits                     |       | 32,570                      |       |                           |       |   |   | 23,889 |   |   |   |   |   |
| Noninterest-bearing liabilities                  |       | 599                         |       |                           |       |   |   | 547 |   |   |   |   |   |
| Total liabilities                                |       | 194,361                     |       |                           |       |   |   | 159,057 |   |   |   |   |   |
| Total shareholders’ equity                  |       | 16,448                      |       |                           |       |   |   | 14,786 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |       | $                           | 210,809    |                           |       |   |   |   | $ | 173,843 |   |   |   |   |   |
| Net interest income                              |       |                        |       | $                              | 4,105      |   |   |   |   |   | $ | 3,602 |   |   |   |
| Net interest spread                              |       |                        |       |                           |       | 3.36 | % |   |   |   |   | 3.92 | % |
| Net  interest margin                             |       |                        |       |                           |       | 4.04 | % |   |   |   |   | 4.32 | % |

 

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(1)             Yields on securitiesavailable-for-sale have been calculated on the basis of historical cost and donot give effect to changes in the fair value of those securities, which isreflected as a component of shareholders’ equity.

(2)             Presented on ataxable-equivalent basis using the statutory federal income tax rate of 34%.Taxable-equivalent adjustments of $53,000 in 2006 and $4,000 in 2005 areincluded in the calculation of the tax-exempt investment interest income.

(3)             Presented on ataxable-equivalent basis using the statutory federal income tax rate of 34%.Taxable-equivalent adjustments of $7,000 in 2006 and $7,000 in 2005 areincluded in the calculation of the loan interest income. Net loan originationincome in interest income totaled $10,000 in 2006 and none in 2005.

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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. Thechange in interest due to the combined rate-volume variance has been allocatedentirely to the change in rate.
| ** **                                 | ** ** | **Three Months Ended June 30,  2006 compared to 2005** | ** ** | **Six Months Ended June 30,  2006 compared to 2005** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **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                         |       | $                                                                                         | 33         |                                                                                    | $          | 73 |   | $ | 106 |   | $ | 65 |   | $ | 138 |   | $ | 203 |   |
| Interest-bearing deposits in other banks   |       | 36                                                                                        |       | 36                                                                                      |       | 72 |   | 56 |   | 59 |   | 115 |   |
| Investment securities:                     |       |                                                                                      |       |                                                                                    |       |   |   |   |   |   |   |   |   |
| Taxable                                    |       | 15                                                                                        |       | 26                                                                                      |       | 41 |   | 47 |   | 49 |   | 96 |   |
| Tax-exempt                                 |       | 113                                                                                       |       | (16                                                                                     | )          | 97 |   | 142 |   | 3 |   | 145 |   |
| Loans                                      |       | 325                                                                                       |       | 251                                                                                     |       | 576 |   | 645 |   | 525 |   | 1,170 |   |
| Total interest income                      |       | 521                                                                                       |       | 371                                                                                     |       | 892 |   | 955 |   | 774 |   | 1,729 |   |
|                                       |       |                                                                                      |       |                                                                                    |       |   |   |   |   |   |   |   |   |
| Interest expense                           |       |                                                                                      |       |                                                                                    |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:             |       |                                                                                      |       |                                                                                    |       |   |   |   |   |   |   |   |   |
| NOW accounts                               |       | —                                                                                    |       | (2                                                                                      | )          | (2 | ) | — |   | (3 | ) | (3 | ) |
| Savings accounts                           |       | —                                                                                    |       | —                                                                                  |       | — |   | (1 | ) | — |   | (1 | ) |
| Money market accounts                      |       | 17                                                                                        |       | 99                                                                                      |       | 116 |   | 23 |   | 208 |   | 231 |   |
| Certificates of deposit $100,000 or more   |       | 101                                                                                       |       | 182                                                                                     |       | 283 |   | 170 |   | 350 |   | 520 |   |
| Certificates of deposit less than $100,000 |       | 86                                                                                        |       | 148                                                                                     |       | 234 |   | 182 |   | 286 |   | 468 |   |
| Short-term borrowings                      |       | —                                                                                    |       | —                                                                                  |       | — |   | — |   | 1 |   | 1 |   |
| Long-term debt                             |       | 5                                                                                         |       | —                                                                                  |       | 5 |   | 10 |   | — |   | 10 |   |
| Total interest  expense                    |       | 208                                                                                       |       | 428                                                                                     |       | 636 |   | 384 |   | 842 |   | 1,226 |   |
| Net interest income                        |       | $                                                                                         | 314        |                                                                                    | $          | (58 | ) | $ | 256 |   | $ | 571 |   | $ | (68 | ) | $ | 503 |   |

 

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(1)             Thevolume/rate variance is allocated entirely to change in rates.

**Net InterestIncome**

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

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

**Three Months Ended June 30, 2006 and 2005**

Thenet interest income (on a taxable-equivalent basis) of $2.13 million in 2006was $256,000, or 13.70% higher than the amount recognized in 2005. Thisincrease in interest income is due to the growth in average earning assets andincreased yields on earning assets. Average earning assets increased by $37.71million, or 21.86%, since June 30, 2005. The yield on earning assets in 2006increased to 6.64% from 6.02% in 2005. This increase in yield is attributableto the impact of the increase in short-term rates by the Federal Reserve.However, the increase by 120 basis points in the rate paid on interest earningliabilities, primarily a result of Federal Reserve increases of the federalfunds rate and stiff competition for deposits, more than offset the increase inyield on interest earning 

18

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assets. The Company’s net interest margin was 4.06%and 4.35% and the net interest spread was 3.34% and 3.92% for the three-monthperiods ended June 30, 2006 and 2005, respectively. Average loans as apercentage of average interest-earnings assets decreased to 77.05% for thethree months ended June 30, 2006, as compared to 82.41% for the same period in2005. The decline in average loans as a percentage of average earning assets isin part reflective of the Company’s preference to not make loans rather thanassume riskier loans for which the Company will not be adequately compensated.

The interest expense increased 88.46% from $719,000 in 2005 to $1.36million in 2006 due to the 20.07% increase in volume of averageinterest-bearing liabilities, along with the increase in the related rates paidon such interest-bearing liabilities, which increased to 3.30% in 2006 from2.10% in 2005.

**Six Months Ended June 30, 2006 and 2005**

The net interest income (on a taxable-equivalentbasis) of $4.11 million in 2006 was $503,000, or 13.96% higher than the amountrecognized in 2005. This increase in interest income is due to the growth inaverage earning assets and increased yields on earning assets. Average earningassets increased by $36.54 million, or 21.73%, since June 30, 2005. The yieldon earning assets in 2006 increased to 6.57% from 5.93% in 2005. This increasein yield is attributable to the impact of the increase in short-term rates bythe Federal Reserve. However, the increase by 120 basis points in the rate paidon interest earning liabilities, primarily a result of prior Federal Reserveincreases of the discount rate and stiff competition for deposits, more thanoffset the increase in yield on interest earning assets. The Company’s netinterest margin was 4.04% and 4.32% and the net interest spread was 3.36% and3.92% for the six-month periods ended June 30, 2006 and 2005, respectively.Average loans as a percentage of average interest-earnings assets decreased to77.94% for the six months ended June 30, 2006, as compared to 82.98% for thesame period in 2005. The decline in average loans as a percentage of averageearning assets is in part reflective of the Company’s preference to not makeloans rather than assume riskier loans for which the Company will not beadequately compensated.

The interest expense increased 91.29% from $1.34million in 2005 to $2.57 million in 2006 due to the 19.74% increase in volumeof average interest-bearing liabilities, along with the increase in the relatedrates paid on such interest-bearing liabilities, which increased to 3.21% in2006 from 2.01% in 2005.

**Noninterest Income**

Noninterest income was $74,000 and $78,000 for thethree-month periods and $159,000 and $140,000 for the six-month periods endedJune 30, 2006 and 2005, respectively.

The Company’s management is committed to developingand offering innovative, market-driven products and services that will generateadditional sources of noninterest income. However, the future results of any ofthese products or services cannot be predicted at this time.

**NoninterestExpense**

See Note 7 to the unaudited consolidated financialstatements for a schedule showing a detailed breakdown of the Company’snoninterest expense.

**Three Months Ended June 30, 2006 and 2005**

Noninterest expense amounted to $1.30 million and $1.14 million for thethree-month periods in 2006 and 2005, respectively. The changes in noninterestexpense are principally related to an increase in personnel costs. Salariesexpense in 2006 was $663,000, up $92,000 from the salaries expense incurred inthe same period in 2005. This increase of 16.11% is for employee pay increasesand to make various employee salaries competitive with the current employmentenvironment.

**Six Months Ended June 30, 2006 and 2005**

Noninterestexpense amounted to $2.49 million and $2.20 million for the six-month periodsin 2006 and 2005, respectively. The changes in noninterest expense areprincipally related to an increase in personnel costs. Salaries expense in 2006was $1.23 million, up $133,000 from the salaries expense incurred in the sameperiod in 2005. This increase of 12.14% is for the hiring of four (4) full-timeequivalent employees, employee pay increases and to make various employeesalaries competitive with the current employment environment.

19

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**Income Taxes**

**Three Months Ended June 30, 2006 and 2005**

During the three months ended June 30, 2006, theCompany incurred $284,000 of income tax expense compared to $255,000 during thesame period in 2005. The effective tax rates for these three-months in 2006 and2005 were 35.63% and 38.93%. The effective tax rate for 2006 has beenpositively impacted by the addition of tax-free municipal securities to theCompany’s investment portfolio.

**Six Months Ended June 30, 2006 and 2005**

During the six months ended June 30, 2006, the Companyincurred $605,000 of income tax expense compared to only $315,000 during thesame period in 2005 due to the net operating loss carryforwards availableduring the first quarter of 2005. At December 31, 2004, the Company recorded avaluation allowance of $158,000 to reduce the carrying value of the netdeferred tax assets carried in the consolidated balance sheet. Valuationallowances are provided for deferred tax assets when in Management’s judgment aportion, or all, of the deferred tax assets may not be realized. During thefirst quarter of 2005, Management’s judgment changed and, accordingly, nolonger believed a valuation allowance was needed. The primary factorinfluencing management’s judgment was the existence of sustained periods oftaxable income. As of June 30, 2006 and 2005, the Company was not required tomaintain a valuation allowance.

The effective tax rates for the first six months of2006 and 2005 were 37.88% and 25.59%. The rate for 2005 was positively impactedby the elimination of the $158,000 valuation allowance during that period. Excludingthe effects of the valuation allowance, the effective tax rate would have been38.42%.

**Market Risk,Liquidity and Interest Rate Sensitivity**

Asset/liability management involves the funding andinvestment strategies necessary to maintain an appropriate balance betweeninterest sensitive assets and liabilities. It also involves providing adequateliquidity while sustaining stable growth in net interest income. Regular reviewand analysis of deposit and loan trends, cash flows in various categories ofloans, and monitoring of interest spread relationships are vital to thisprocess.

The conduct of our banking business requires that wemaintain adequate liquidity to meet changes in the composition and volume ofassets 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 theborrowing and deposit withdrawal requirements of the customers of the Company,as well as for meeting current and future planned expenditures. This liquidityis typically provided by the funds received through customer deposits,investment maturities, loan repayments, borrowings, and income. Managementconsiders the current liquidity position to be adequate to meet the needs ofthe Company and its customers.

The Company seeks to limit the risks associated withinterest rate fluctuations by managing the balance between interest sensitiveassets and liabilities. Managing to mitigate interest rate risk is, however,not an exact science. Not only does the interval until repricing of interestrates on assets and liabilities change from day to day as the assets andliabilities change, but for some assets and liabilities, contractual maturityand the actual maturity experienced are not the same. Similarly, NOW and moneymarket accounts, by contract, may be withdrawn in their entirety upon demandand savings deposits may be withdrawn on seven days notice. While thesecontracts are extremely short, it is the Company’s belief that these accountsturn over at the rate of five percent (5%) per year. The Company thereforetreats them as having maturities staggered over all periods. If all of theCompany’s NOW, money market, and savings accounts were treated as repricing inone year or less, the cumulative gap at one year or less would be $(58.31)million.

Interest rate sensitivity is an important factor inthe management of the composition and maturity configurations of the Company’searning assets and funding sources. An Asset/Liability Committee manages theinterest rate sensitivity position in order to maintain an appropriate balancebetween the maturity and repricing characteristics of assets and liabilitiesthat is consistent with the Company’s liquidity analysis, growth, and capitaladequacy goals. It is the objective of the Asset/Liability Committee tomaximize net interest margins during periods of both volatile and stableinterest rates, to attain earnings growth, and to maintain sufficient liquidityto satisfy depositors’ requirements and meet credit needs of customers.

Thetable below, “Interest Rate Sensitivity Gap Analysis,” summarizes, as of June30, 2006, the anticipated maturities or repricing of the Company’sinterest-earning assets and interest-bearing liabilities, the Company’sinterest rate sensitivity gap (interest-earning assets less interest-bearingliabilities), the Company’s cumulative interest rate sensitivity gap, and theCompany’s cumulative interest sensitivity gap ratio (cumulative interest ratesensitivity gap divided by total assets). A negative gap for any time periodmeans that more interest-bearing liabilities will reprice or mature during thattime period than interest-earning assets. During periods of rising interestrates, a negative gap position would generally decrease earnings, and duringperiods of declining interest rates, a negative gap position would generallyincrease earnings. The converse would be true for a positive gap position.Therefore, a positive gap for any 

20

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time period means that more interest-earning assetswill reprice or mature during that time period than interest-bearingliabilities. During periods of rising interest rates, a positive gap positionwould generally increase earnings, and during periods of declining interestrates, a positive gap position would generally decrease earnings.

It is important tonote that the following table represents the static gap position for interestsensitive assets and liabilities at June 30, 2006. The table does not giveeffect to prepayments or extensions of loans as a result of changes in generalmarket interest rates. Moreover, while the table does indicate theopportunities to reprice assets and liabilities within certain time frames, itdoes not account for timing differences that occur during periods of repricing.For example, changes to deposit rates tend to lag in a rising rate environmentand lead in a falling rate environment.

**Interest RateSensitivity Gap AnalysisJune 30, 2006**
| ** **                                            | ** ** | **Expected Repricing or Maturity Date** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| **(dollars in thousands)**                  | ** ** | **Within  One Year**                                   | ** ** | **One to  Three Years** | ** ** | **Three to  Five Years** | ** ** | **After  Five Years** | ** ** | **Total** | ** ** |
| Assets                                                | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal funds sold                                    |       | $                                                           | 17,194     |   | $ | — |   | $ | — |   | $ | — |   | $ | 17,194 |   |
| Interest-bearing deposits in other banks              |       | 4,790                                                       |       | — |   | — |   | — |   | 4,790 |   |
| Investment securities(1)                              |       | 1,148                                                       |       | 3,682 |   | 4,219 |   | 16,549 |   | 25,598 |   |
| Loans                                                 |       | 53,506                                                      |       | 41,786 |   | 50,263 |   | 18,469 |   | 164,024 |   |
| Total  interest-earning assets                        |       | 76,638                                                      |       | 45,468 |   | 54,482 |   | 35,018 |   | 211,606 |   |
|                                                  | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Liabilities                                           |       |                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Savings and NOW accounts                              |       | 1,473                                                       |       | 2,945 |   | 2,945 |   | 22,091 |   | 29,454 |   |
| Money Market accounts                                 |       | 1,558                                                       |       | 3,116 |   | 3,117 |   | 23,372 |   | 31,163 |   |
| Certificates of deposit                               |       | 73,627                                                      |       | 35,967 |   | 5,253 |   | — |   | 114,847 |   |
| Short-term borrowings                                 |       | 450                                                         |       | — |   | — |   | — |   | 450 |   |
| Long-term debt                                        |       | 250                                                         |       | — |   | — |   | — |   | 250 |   |
| Total  interest-bearing liabilities                   |       | 77,358                                                      |       | 42,028 |   | 11,315 |   | 45,463 |   | 176,164 |   |
| Interest rate  sensitivity gap                        |       | $                                                           | (720       | ) | $ | 3,440 |   | $ | 43,167 |   | $ | (10,445 | ) | $ | 35,442 |   |
| Cumulative  interest rate sensitivity gap             |       | $                                                           | (720       | ) | $ | 2,720 |   | $ | 45,887 |   | $ | 35,442 |   |   |   |
| Cumulative gap ratio as  a percentage of total assets |       | -0.32                                                       | %          | 1.20 | % | 20.24 | % | 15.63 | % |   |   |

 

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(1)             Excludesequity securities.

In addition to the Interest Rate Sensitivity GapAnalysis, the Company also uses an earnings simulation model on a quarterlybasis to closely monitor interest sensitivity and to expose its balance sheetand income statement to different scenarios. The model is based on currentCompany data and adjusted by assumptions as to growth patterns, noninterestincome and noninterest expense and interest rate sensitivity, based onhistorical data, for both assets and liabilities projected for a one-yearperiod. The model is then subjected to a “shock test” assuming a suddeninterest rate increase of 200 basis points or a decrease of 200 basis points,but not below zero. The results show that with a 200 basis point rise ininterest rates the Company’s net interest income would decline by 7.49% and netincome would decline by 12.27%. With a decrease in interest rates of 200 basispoints the Company’s net interest income would increase by 3.70% and net incomewould increase by 6.07%.

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

21

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** **

**CriticalAccounting Policy:**

Allowance for Loan Losses

The Company makesprovisions for loan losses in amounts deemed necessary to maintain theallowance for loan losses at an appropriate level.  The provision for loan losses is determinedbased upon Management’s estimate of the amount required to maintain an adequateallowance for loan losses reflective of the risks in the Company’s loanportfolio.  The Company’s provision forloan losses for the first six months of 2006 and 2005 were $120,000 and$300,000, respectively.  The loan growthwas $8.68 million for the first six months of 2006 as compared to $12.85million for the same period in 2005.  Dueto the increased exposure to commercial and commercial real estate loans inearly 2005, Management deemed it necessary to increase the provision for loanlosses during the first half of 2005. The Company’s provision for loan losses for the three months ended June30, 2006 and 2005 were $60,000 and $150,000, respectively.  At June 30, 2006 and December 31, 2005, theallowance for loan losses was $2.07 million and $1.95 million, respectively.

TheCompany prepares a quarterly analysis of the allowance for loan losses, withthe objective of quantifying portfolio risk into a dollar amount of inherentlosses.  The determination of 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 forContingencies*, which requires that losses be accrued when they areprobable of occurring and estimatable and (ii) SFAS No. 114, *Accounting by Creditors for Impairment of a Loan*, whichrequires that losses be accrued based on the differences between the loanbalance and either the value of collateral, or the present value of future cashflows, or the loan’s value as observable in the secondary market.  A loan is considered impaired when, based oncurrent information and events, it is probable that the Bank will be unable tocollect the scheduled payments of principal or interest when due according tothe contractual terms of the loan agreement. Factors considered by Management in determining impairment includepayment status, collateral value, and the probability of collecting scheduledprincipal and interest payments when due. Loans that experience insignificant payment delays and paymentshortfalls generally are not classified as impaired.  Management determines the significance of paymentdelays 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 serve tomaintain the allowance at a level Management considers adequate.

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

Thespecific allowance component is used to individually establish an allowance forloans identified for impairment testing. When impairment is identified, a specific reserve may be establishedbased on the Company’s calculation of the estimated loss embedded in theindividual loan.  Impairment testingincludes consideration of the borrower’s overall financial condition, resourcesand payment record, support available from financial guarantors and the fairmarket value of collateral. These factors are combined to estimate theprobability and severity of inherent losses. Large groups of smaller balance, homogeneous loans are collectivelyevaluated for impairment. Accordingly, the Company does not separately identifyindividual consumer and residential loans for impairment.   At June 30, 2006 there were no loans deemedto be impaired.

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 concerns regardingcollectability or Management’s knowledge of particular elements surrounding theborrower. Allowance factors increase with the worsening of the internal riskrating.

22

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The pooled formula component is used to estimate thelosses inherent in the pools of non-classified loans.  These loans are then also segregated by loantype and allowance factors are assigned by Management based on delinquencies,loss history, trends in volume and terms of loans, effects of changes inlending policy, the experience and depth of Management, national and localeconomic trends, concentrations of credit, quality of loan review system andthe effect of external factors (i.e. competition and regulatoryrequirements).  The allowance factorsassigned 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.

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 ofJune 30, 2006, the real estate loan portfolio constituted 84% of the total loanportfolio.  While this exceeds the 10%threshold for determining a concentration of credit risk within an industry, wedo not consider this to be a concentration with adverse risk characteristicsgiven the diversity of borrowers within the real estate portfolio and othersources of repayment.  An industry forthis purpose is defined as a group of counterparties that are engaged insimilar activities and have similar economic characteristics that would causetheir ability to meet contractual obligations to be similarly affected bychanges in economic or other conditions. Additionally, the loan portfolio does not include concentrations ofcredit risk in loan products that permit the deferral of principal paymentsthat are smaller than normal interest accruals (negative amortization); loanswith high loan-to-value ratios; or loans, such as option adjustable-ratemortgages, that may expose the borrower to future increases in repayments thatare in excess of increases that would result solely from increases in market interestrates.   The Company has $6.00 million ofinterest only home equity lines of credit at June 30, 2006.

|                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(dollars in thousands)**           | ** ** | **June 30,**

**2006**           | ** ** | **June 30,**

**2005**         | ** ** | **June 30,**

**2006** | ** ** | **June 30,**

**2005** | ** ** |
| Balance at  beginning of period                |       | $                                | 2,013      |                           | $          | 1,653 |   | $ | 1,953 |   | $ | 1,503 |   |
| Provision  charged to operating expenses       |       | 60                               |       | 150                            |       | 120 |   | 300 |   |
| Recoveries of  loans previously charged-off    |       | —                           |       | —                         |       | — |   | — |   |
| Loans  charged-off                             |       | —                           |       | —                         |       | — |   | — |   |
| Balance at end  of period                      |       | $                                | 2,073      |                           | $          | 1,803 |   | $ | 2,073 |   | $ | 1,803 |   |
| Average total loans  outstanding during period |       | $                                | 161,916    |                           | $          | 142,120 |   | $ | 159,544 |   | $ | 139,542 |   |

 

The allocation of the allowance, presented in the following table, isbased primarily on the factors discussed above in evaluating the adequacy ofthe allowance as a whole.  Since all ofthose factors are subject to change, the allocation is not necessarilyindicative of the category of recognized loan losses, and does not restrict theuse of the allowance to absorb losses in any category.

|                                                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **Allocation of Allowance for Loan Losses**        | ** ** | **2006**          | ** ** | **% of  Loans**       | ** ** | **2005** | ** ** | **% of  Loans** | ** ** |
| Real  estate-construction                                                   |       | $                 | 278        |                  | 22         | % | $ | 318 |   | 19 | % |
| Real  estate-mortgage                                                       |       | 1,362             |       | 62                    | %          | 1,171 |   | 64 | % |
| Commercial and  industrial loans                                            |       | 390               |       | 14                    | %          | 408 |   | 16 | % |
| Loans to  individuals for household, family and other personal expenditures |       | 43                |       | 2                     | %          | 56 |   | 1 | % |
|                                                                        |       | $                 | 2,073      |                  | 100        | % | $ | 1,953 |   | 100 | % |

 

23

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** **
|                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Nonaccrual loans                      |       | $                 | 6          |                  | $          | 8 |   |
| Loans 90 days  past due               |       | —            |       | —                |       |
| Total nonperforming loans             |       | 6                 |       | 8                     |       |
| Other real  estate owned              |       | —            |       | —                |       |
| Total nonperforming assets            |       | $                 | 6          |                  | $          | 8 |   |
| Nonperforming assets to  total assets |       | 0.00              | %          | 0.00                  | %          |

 

There were noother interest-bearing assets at June 30, 2006 or December 31, 2005 classifiedas past due 90 days or more and still accruing, restructured or problem assets,and no loans which were currently performing in accordance with their terms,but as to which information known to Management caused it to have seriousdoubts about the ability of the borrower to comply with the loan as currentlywritten.

**Off-Balance Sheet Arrangements**

The Company is aparty to financial instruments with off-balance sheet risk in the normal courseof business to meet the financing needs of its customers.  These 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 financial condition.  None of these instruments or obligations haveor 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 June 30, 2006 were as follows:

|                                                                                  | ** ** | **June 30,**       | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                       | ** ** | **2006**                | ** ** |
| **(dollars in thousands)**                                             | ** ** | **Contractual  Amount** | ** ** |
| Financial  instruments whose notional or contract amounts represent credit risk: |       |                    |       |
| Commitments to extend credit                                                     |       | $                       | 29,418     |   |
| Standby letters of credit                                                        |       | 2,782                   |       |
| Total                                                                            |       | $                       | 32,200     |   |

 

See Note 8 to the Notes to the Consolidated Financial Statementsincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005 for additional information regarding the Company’s long-termlease obligations.

**CapitalResources**

The ability of theCompany to grow is dependent on the availability of capital with which to meetregulatory requirements, discussed below. To the extent the Company is successful it may need to acquireadditional capital through the sale of additional common stock, otherqualifying equity instruments or subordinated debt, or through incurrence ofdebt which does not qualify as holding company capital, but which can becontributed as capital to the Bank or utilized for other corporatepurposes.  There can be no assurance thatadditional capital will be available to the Company on a timely basis or onattractive terms.  At June 30, 2006, theCompany had an outstanding unsecured loan from an unaffiliated third party inthe amount of $450,000 with a fixed interest rate of 6.00% and matures onJanuary 27, 2007.  In addition, theCompany has an unsecured revolving line of credit borrowing arrangement with anunaffiliated financial institution in the amount of $2.00 million with anoutstanding balance of $250,000 as of June 30, 2006.  This facility matures on May 1, 2007, has afloating interest rate equal to the Wall Street Journal Prime Rate and requiresmonthly interest payments only.  Thepurpose of this facility is to provide capital to the Bank, as needed.

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

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure to meetminimum capital requirements can initiate certain mandatory - and possiblyadditional discretionary - actions by

24

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regulators that, ifundertaken, could have a direct material effect on the Company’s financialstatements.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCompany and the Bank must meet specific capital guidelines that involvequantitative measures of the Company’s and the Bank’s assets, liabilities, andcertain off-balance-sheet items as calculated under regulatory accountingpractices.  The Company’s and the Bank’scapital amounts and classification are also subject to qualitative judgments bythe regulators about components, risk weightings, and other factors.

Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum amounts and ratios of total and Tier 1capital (as defined in the regulations) to risk-weighted assets (as defined),and Tier 1 capital (as defined) to average assets (as defined).   Management believes that the Company and theBank met all capital adequacy requirements to which they are subject as of June30, 2006.  See Note 9 to the unaudited consolidated financial statements for a tabledepicting compliance with regulatory capital requirements.

As of June 30,2006, the most recent notification from the regulatory agency categorized theBank as well capitalized under the regulatory framework for prompt correctiveaction.  To be categorized as 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 9.  There are no conditions or events since thatnotification which Management believes have changed the Bank’s category.

Additionally, the Companyhas not repurchased any outstanding shares of its common stock, nor does ithave an approved repurchase program at this time.

**Inflation**

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

###### **Item3.  Quantitative and QualitativeDisclosures About Market Risk**

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

###### **Item 4.    Controls and Procedures**

## The Company’s management, under thesupervision and with the participation of the Company’s Chief Executive Officerand Chief Financial Officer, evaluated, as of the last day of the periodcovered by this report, the effectiveness of the design and operation of theCompany’s disclosure controls and procedures, as defined in Rule 13a-15(e)under the Securities Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures were effective.  There were nochanges in the Company’s internal control over financial reporting (as definedin Rule 13a-15 under the Securities Act of 1934) during the quarter ended June30, 2006 that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

25

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##  

**PART II – OtherInformation**

Item 1.    Legal Proceedings None

Item1A.  Risk Factors   There have been no material changes to therisk factors as of June 30, 2006 from those disclosed in the Company’s 2005 Annual Report on Form 10-K.

Item 2     Unregistered Sales ofEquity Securities and Use of Proceeds

(a)  *Sales of Unregistered Securities.    *None

(b)  *Use of Proceeds.    *NotApplicable.

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

Item 3.    Defaults upon SeniorSecurities    None

Item 4.    Submission of Matters toa Vote of Security Holders

On April 11, 2006, the annual meeting of shareholdersof the Company was held for the purpose of electing eleven (11) directors toserve until the next annual meeting and until their successors are duly electedand qualified.

The name of each directorelected at the meeting, and the votes cast for such persons, who constitute theentire Board of Directors in office following the meeting, are set forth below:

| DIRECTOR                | ** ** | **FOR**   | ** ** | **WITHHOLD** | ** ** | **BROKER   NON-VOTES** | ** ** |
|-------------------------|------------|-----------|------------|--------------|------------|-----------------------------|------------|
| Emil D. Bennett         |       | 1,130,920 |       | 516          |       | None                        |       |
| John N. Burdette        |       | 1,130,920 |       | 516          |       | None                        |       |
| John Denham Crum        |       | 1,130,920 |       | 516          |       | None                        |       |
| George E.  Dredden, Jr. |       | 1,130,920 |       | 516          |       | None                        |       |
| William S. Fout         |       | 1,130,920 |       | 516          |       | None                        |       |
| Helen G. Hahn           |       | 1,130,420 |       | 1,016        |       | None                        |       |
| William J.  Kissner     |       | 1,130,920 |       | 516          |       | None                        |       |
| Martin S. Lapera        |       | 1,130,920 |       | 516          |       | None                        |       |
| Kenneth G.  McCombs     |       | 1,130,846 |       | 590          |       | None                        |       |
| Farhad  Memarsadeghi    |       | 1,129,420 |       | 2,016        |       | None                        |       |
| Raymond Raedy           |       | 1,130,920 |       | 516          |       | None                        |       |

 

Item 5.             OtherInformation

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

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

26

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Item 6.  Exhibits

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

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(1)             Incorporated byreference to exhibit of the same number to the Company’s Quarterly Report onForm 10-QSB for the quarter ended March 31, 2004, as filed with the Securitiesand Exchange Commission.

(2)             Incorporated byreference to exhibit of the same number to the Company’s Quarterly Report onForm 10-QSB for the quarter ended September 30, 2003, as filed with theSecurities and Exchange Commission.

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

(4)             Incorporated byreference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed onMay 24, 2005.

(5)             Incorporated byreference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed onMay 24, 2005.

(6)             Incorporated byreference to exhibit of the same number to the Bank’s Registration Statement onForm 10-SB as filed with the Board of Governors of the Federal Reserve System.

(7)             Incorporated byreference to exhibit of the same number to the Company’s Annual Report on Form10-KSB for the year ended December 31, 2004, as filed with the Securities andExchange Commission.

(8)             Incorporated byreference to exhibit of the same number to the Company’s Quarterly Report onForm 10-QSB for the quarter ended March 31, 2005, as filed with the Securitiesand Exchange Commission.

27

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** **

**SIGNATURES**

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.
|                     | FREDERICK COUNTY BANCORP, INC. |
|---------------------|--------------------------------|
|                |                           |   |
|                |                           |   |
| Date: July 25, 2006 | By:                            | /s/ Martin S. Lapera |
|                |                           | Martin S. Lapera |
|                |                           | President and Chief Executive Officer |
|                |                           |   |
|                |                           |   |
| Date: July 25, 2006 | By:                            | /s/ William R. Talley, Jr. |
|                |                           | William R. Talley, Jr. |
|                |                           | Executive Vice President and Chief Financial Officer |

 

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