Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, DC  20549**

 

### **FORM 10-Q**

### ** **

**(MARKONE)**

 

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

###### ** **

**Forthe Quarterly Period Ended September 30, 2009**

 

**OR**

 

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

 

**For thetransition period from               to               **

 

**CommissionFile Number:  000-50407**

 

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

(Exactname of registrant as specified in its charter)

 

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

 

#### **7North Market Street**

**Frederick,Maryland 21701**

(Address ofregistrant’s principal executive offices)

 

**301.620.1400**

(Registrant’stelephone number, including area code)

 

**N/A**

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

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  x Yes  o No

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).  x Yes  o No

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer or asmaller reporting company.  Seedefinition of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

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

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practical date.  There were 1,461,802 shares of Common Stockoutstanding as of October 31, 2009.

 

 

 

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Tableof Contents

 

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

**TABLE OFCONTENTS**

 
| **PART I**  | **FINANCIAL INFORMATION**                                                                                                       |   |
|------------------|---------------------------------------------------------------------------------------------------------------------------------|--------|
|             |                                                                                                                            |   |
| Item 1.          | Financial Statements (Unaudited)                                                                                                |   |
|             |                                                                                                                            |   |
|             | Consolidated****Balance Sheets, September 30, 2009  and December 31, 2008                                             |   |
|             |                                                                                                                            |   |
|             | Consolidated  Statements of Income, Three and Nine Months Ended September 30, 2009 and  2008                               |   |
|             |                                                                                                                            |   |
|             | Consolidated  Statements of Changes in Shareholders’ Equity, Three and Nine Months Ended  September 30, 2009 and 2008 |   |
|             |                                                                                                                            |   |
|             | Consolidated  Statements of Cash Flows, Nine Months Ended September 30, 2009 and 2008                                      |   |
|             |                                                                                                                            |   |
|             | Notes to  Unaudited Consolidated Financial Statements                                                                           |   |
|             |                                                                                                                            |   |
| Item 2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                     |   |
|             |                                                                                                                            |   |
| Item 3.          | Quantitative  and Qualitative Disclosures about Market Risk                                                                     |   |
|             |                                                                                                                            |   |
| Item 4.          | Controls and  Procedures                                                                                                        |   |
|             |                                                                                                                            |   |
| **PART II** | **OTHER INFORMATION**                                                                                                           |   |
|             |                                                                                                                            |   |
| Item 1.          | Legal Proceedings                                                                                                               |   |
|             |                                                                                                                            |   |
| Item 1A.         | Risk  Factors                                                                                                                   |   |
|             |                                                                                                                            |   |
| Item 2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                    |   |
|             |                                                                                                                            |   |
| Item 3.          | Defaults  upon Senior Securities                                                                                                |   |
|             |                                                                                                                            |   |
| Item 4.          | Submission  of Matters to a Vote of Security Holders                                                                            |   |
|             |                                                                                                                            |   |
| Item 5.          | Other Information                                                                                                               |   |
|             |                                                                                                                            |   |
| Item  6.         | Exhibits                                                                                                                        |   |
|             |                                                                                                                            |   |
|             | Signatures                                                                                                                      |   |
|                  |                                                                                                                                 |        |  |

 

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**Frederick County Bancorp, Inc. andSubsidiaries**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in thousands)**                                                                                                                  | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                  | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                      |       |                   |       |                  |       |
| Cash and due  from banks                                                                                                                    |       | $                      | 888        |                  | $          | 808 |   |
| Federal funds  sold                                                                                                                         |       | 1,146                  |       | 1,091                 |       |
| Interest-bearing  deposits in other banks                                                                                                   |       | 24,671                 |       | 14,156                |       |
| Cash and cash  equivalents                                                                                                                  |       | 26,705                 |       | 16,055                |       |
| Investment  securities available-for-sale at fair value                                                                                     |       | 22,752                 |       | 20,040                |       |
| Restricted stock                                                                                                                            |       | 1,566                  |       | 1,599                 |       |
| Loans                                                                                                                                       |       | 211,150                |       | 211,840               |       |
| Less: Allowance  for loan losses                                                                                                            |       | (3,210                 | )          | (3,120                | )          |
| Net loans                                                                                                                                   |       | 207,940                |       | 208,720               |       |
| Bank premises  and equipment                                                                                                                |       | 5,046                  |       | 5,221                 |       |
| Other assets                                                                                                                                |       | 2,798                  |       | 2,927                 |       |
| Total assets                                                                                                                                |       | $                      | 266,807    |                  | $          | 254,562 |   |
|                                                                                                                                        |       |                   |       |                  |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                  |       |                   |       |                  |       |
|                                                                                                                                        |       |                   |       |                  |       |
| **Liabilities**                                                                                                                             |       |                   |       |                  |       |
| Deposits:                                                                                                                                   |       |                   |       |                  |       |
| Noninterest-bearing  deposits                                                                                                               |       | $                      | 37,205     |                  | $          | 32,740 |   |
| Interest-bearing  deposits                                                                                                                  |       | 190,581                |       | 184,143               |       |
| Total deposits                                                                                                                              |       | 227,786                |       | 216,883               |       |
| Short-term  borrowings                                                                                                                      |       | 500                    |       | —                |       |
| Long-term  borrowings                                                                                                                       |       | 10,000                 |       | 10,000                |       |
| Junior  subordinated debentures                                                                                                             |       | 6,186                  |       | 6,186                 |       |
| Accrued interest  and other liabilities                                                                                                     |       | 932                    |       | 881                   |       |
| Total  liabilities                                                                                                                          |       | 245,404                |       | 233,950               |       |
|                                                                                                                                        |       |                   |       |                  |       |
| **Shareholders’  Equity**                                                                                                              |       |                   |       |                  |       |
| Common stock,  per share par value $.01; 10,000,000 shares authorized; 1,461,802 and  1,460,802 shares issued and outstanding, respectively |       | 15                     |       | 15                    |       |
| Additional  paid-in capital                                                                                                                 |       | 14,700                 |       | 14,690                |       |
| Retained  earnings                                                                                                                          |       | 6,482                  |       | 5,939                 |       |
| Accumulated  other comprehensive income (loss)                                                                                              |       | 206                    |       | (32                   | )          |
| Total  shareholders’ equity                                                                                                            |       | 21,403                 |       | 20,612                |       |
| Total  liabilities and shareholders’ equity                                                                                            |       | $                      | 266,807    |                  | $          | 254,562 |   |

 

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

 

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

**Consolidated Statements of Income(Unaudited)**

 
| ** **                                             | ** ** | **For the Three****Months Ended September 30,** | ** ** | **For the Nine****Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(dollars in thousands, except per share  amounts)**  | ** ** | **2009**                                             | ** ** | **2008**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest income:                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Interest and  fees on loans                            |       | $                                                    | 3,305      |                                                | $          | 3,554 |   | $ | 9,748 |   | $ | 10,601 |   |
| Interest and  dividends on investment securities:      |       |                                                 |       |                                                |       |   |   |   |   |
| Interest -  taxable                                    |       | 115                                                  |       | 185                                                 |       | 443 |   | 586 |   |
| Interest - tax  exempt                                 |       | 58                                                   |       | 87                                                  |       | 174 |   | 285 |   |
| Dividends                                              |       | 13                                                   |       | 25                                                  |       | 36 |   | 68 |   |
| Interest on  federal funds sold                        |       | 1                                                    |       | 46                                                  |       | 2 |   | 180 |   |
| Other interest  income                                 |       | 16                                                   |       | 3                                                   |       | 37 |   | 35 |   |
| Total interest  income                                 |       | 3,508                                                |       | 3,900                                               |       | 10,440 |   | 11,755 |   |
| Interest  expense:                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Interest on  deposits                                  |       | 1,087                                                |       | 1,446                                               |       | 3,501 |   | 4,815 |   |
| Interest on  short-term borrowings                     |       | 3                                                    |       | 18                                                  |       | 3 |   | 18 |   |
| Interest on  long-term borrowings                      |       | 117                                                  |       | 116                                                 |       | 346 |   | 347 |   |
| Interest on  junior subordinated debentures            |       | 101                                                  |       | 101                                                 |       | 303 |   | 303 |   |
| Total interest  expense                                |       | 1,308                                                |       | 1,681                                               |       | 4,153 |   | 5,483 |   |
| Net interest  income                                   |       | 2,200                                                |       | 2,219                                               |       | 6,287 |   | 6,272 |   |
| Provision for  loan losses                             |       | 275                                                  |       | 220                                                 |       | 875 |   | 460 |   |
| Net interest  income after provision for loan losses   |       | 1,925                                                |       | 1,999                                               |       | 5,412 |   | 5,812 |   |
| Noninterest  income:                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Securities gains                                       |       | —                                               |       | 26                                                  |       | 117 |   | 26 |   |
| (Loss) gain on  sale of foreclosed properties          |       | (5                                                   | )          | —                                              |       | (37 | ) | 15 |   |
| Service fees                                           |       | 98                                                   |       | 73                                                  |       | 267 |   | 193 |   |
| Other operating  income                                |       | 50                                                   |       | 54                                                  |       | 155 |   | 199 |   |
| Total  noninterest income                              |       | 143                                                  |       | 153                                                 |       | 502 |   | 433 |   |
| Noninterest  expense:                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Salaries and  employee benefits                        |       | 917                                                  |       | 966                                                 |       | 2,807 |   | 2,885 |   |
| Occupancy and  equipment expenses                      |       | 318                                                  |       | 308                                                 |       | 977 |   | 905 |   |
| Other operating  expenses                              |       | 453                                                  |       | 410                                                 |       | 1,369 |   | 1,190 |   |
| Total  noninterest expense                             |       | 1,688                                                |       | 1,684                                               |       | 5,153 |   | 4,980 |   |
| Income before  provision for income taxes              |       | 380                                                  |       | 468                                                 |       | 761 |   | 1,265 |   |
| Provision for  income tax expense                      |       | 121                                                  |       | 153                                                 |       | 218 |   | 381 |   |
| Net income                                             |       | $                                                    | 259        |                                                | $          | 315 |   | $ | 543 |   | $ | 884 |   |
| Basic earnings  per share                              |       | $                                                    | 0.18       |                                                | $          | 0.22 |   | $ | 0.37 |   | $ | 0.61 |   |
| Diluted earnings  per share                            |       | $                                                    | 0.18       |                                                | $          | 0.21 |   | $ | 0.37 |   | $ | 0.59 |   |
| Basic weighted  average number of shares outstanding   |       | 1,460,900                                            |       | 1,460,674                                           |       | 1,460,835 |   | 1,460,626 |   |
| Diluted weighted  average number of shares outstanding |       | 1,469,858                                            |       | 1,502,443                                           |       | 1,475,909 |   | 1,506,352 |   |

 

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

 

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

**ConsolidatedStatement of Changes in Shareholders’ Equity (Unaudited)**

 

*Three Months Ended September 30,*

 
| **(dollars in thousands)**                                                                                     | ** ** | **Shares****Outstanding** | ** ** | **Common****Stock** | ** ** | **Additional Paid-in  Capital** | ** ** | **Retained****Earnings** | ** ** | **Accumulated****Other Comprehensive Income (Loss)** | ** ** | **Total****Shareholders’ Equity** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------|------------|---------------------------------|------------|--------------------------|------------|------------------------------------------------------|------------|----------------------------------------|------------|
|                                                                                                           |       |                      |       |                |       |                            |       |                     |       |                                                 |       |                                   |       |
| Balance,  July 1, 2008                                                                                    |       | 1,460,602                 |       | $                   | 15         |                            | $          | 14,687                   |       | $                                                    | 5,470      |                                   | $          | (108 | ) | $ | 20,064 |   |
| Comprehensive  income:                                                                                         |       |                      |       |                |       |                            |       |                     |       |                                                 |       |                                   |       |
| Net income                                                                                                     |       | —                    |       | —              |       | —                          |       | 315                      |       | —                                               |       | 315                                    |       |
| Reclassification  adjustment for (gains) losses realized, net of income taxes of $10                           |       | —                    |       | —              |       | —                          |       | —                   |       | (16                                                  | )          | (16                                    | )          |
| Changes in net  unrealized gains (losses) on securities available for sale, net of income tax  benefits of $44 |       | —                    |       | —              |       | —                          |       | —                   |       | (67                                                  | )          | (67                                    | )          |
| Comprehensive  income                                                                                          |       | —                    |       | —              |       | —                          |       | —                   |       | —                                               |       | 232                                    |       |
| Shares issued  under stock option transactions                                                                 |       | 200                       |       | —              |       | 3                               |       | —                   |       | —                                               |       | 3                                      |       |
| Balance,  September 30, 2008                                                                              |       | 1,460,802                 |       | $                   | 15         |                            | $          | 14,690                   |       | $                                                    | 5,785      |                                   | $          | (191 | ) | $ | 20,299 |   |
| Balance,  July 1, 2009                                                                                    |       | 1,460,802                 |       | $                   | 15         |                            | $          | 14,690                   |       | $                                                    | 6,223      |                                   | $          | 19 |   | $ | 20,947 |   |
| Comprehensive  income:                                                                                         |       |                      |       |                |       |                            |       |                     |       |                                                 |       |                                   |       |
| Net income                                                                                                     |       | —                    |       | —              |       | —                          |       | 259                      |       | —                                               |       | 259                                    |       |
| Changes in net  unrealized gains (losses) on securities available for sale, net of income  taxes of $122       |       | —                    |       | —              |       | —                          |       | —                   |       | 187                                                  |       | 187                                    |       |
| Comprehensive  income                                                                                          |       |                      |       |                |       |                            |       |                     |       |                                                 |       | 446                                    |       |
| Shares issued  under stock option transactions                                                                 |       | 1,000                     |       | —              |       | 10                              |       | —                   |       | —                                               |       | 10                                     |       |
| Balance,  September 30, 2009                                                                              |       | 1,461,802                 |       | $                   | 15         |                            | $          | 14,700                   |       | $                                                    | 6,482      |                                   | $          | 206 |   | $ | 21,403 |   |

 

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

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

 

*Nine Months Ended September 30,*

 
| **(dollars in thousands)**                                                                                     | ** ** | **Shares****Outstanding** | ** ** | **Common****Stock** | ** ** | **Additional Paid-in  Capital** | ** ** | **Retained****Earnings** | ** ** | **Accumulated****Other Comprehensive Income (Loss)** | ** ** | **Total****Shareholders’ Equity** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------|------------|---------------------------------|------------|--------------------------|------------|------------------------------------------------------|------------|----------------------------------------|------------|
|                                                                                                           |       |                      |       |                |       |                            |       |                     |       |                                                 |       |                                   |       |
| Balance,  January 1, 2008                                                                                 |       | 1,460,602                 |       | $                   | 15         |                            | $          | 14,687                   |       | $                                                    | 4,901      |                                   | $          | (23 | ) | $ | 19,580 |   |
| Comprehensive  income:                                                                                         |       |                      |       |                |       |                            |       |                     |       |                                                 |       |                                   |       |
| Net income                                                                                                     |       | —                    |       | —              |       | —                          |       | 884                      |       | —                                               |       | 884                                    |       |
| Reclassification  adjustment for (gains) losses realized, net of income taxes of $10                           |       | —                    |       | —              |       | —                          |       | —                   |       | (16                                                  | )          | (16                                    | )          |
| Changes in net  unrealized gains (losses) on securities available for sale, net of income tax  benefits of $99 |       | —                    |       | —              |       | —                          |       | —                   |       | (152                                                 | )          | (152                                   | )          |
| Comprehensive  income                                                                                          |       |                      |       |                |       |                            |       |                     |       |                                                 |       | 716                                    |       |
| Shares issued  under stock option transactions                                                                 |       | 200                       |       | —              |       | 3                               |       | —                   |       | —                                               |       | 3                                      |       |
| Balance,  September 30, 2008                                                                              |       | 1,460,802                 |       | $                   | 15         |                            | $          | 14,690                   |       | $                                                    | 5,785      |                                   | $          | (191 | ) | $ | 20,299 |   |
| Balance,  January 1, 2009                                                                                 |       | 1,460,802                 |       | $                   | 15         |                            | $          | 14,690                   |       | $                                                    | 5,939      |                                   | $          | (32 | ) | $ | 20,612 |   |
| Comprehensive  income:                                                                                         |       |                      |       |                |       |                            |       |                     |       |                                                 |       |                                   |       |
| Net income                                                                                                     |       | —                    |       | —              |       | —                          |       | 543                      |       | —                                               |       | 543                                    |       |
| Reclassification  adjustment for (gains) losses realized, net of income taxes of $46                           |       | —                    |       | —              |       | —                          |       | —                   |       | (71                                                  | )          | (71                                    | )          |
| Changes in net  unrealized gains (losses) on securities available for sale, net of income  taxes of $201       |       | —                    |       | —              |       | —                          |       | —                   |       | 309                                                  |       | 309                                    |       |
| Comprehensive  income                                                                                          |       | —                    |       | —              |       | —                          |       | —                   |       | —                                               |       | 781                                    |       |
| Shares issued  under stock option transactions                                                                 |       | 1,000                     |       | —              |       | 10                              |       | —                   |       | —                                               |       | 10                                     |       |
| Balance,  September 30, 2009                                                                              |       | 1,461,802                 |       | $                   | 15         |                            | $          | 14,700                   |       | $                                                    | 6,482      |                                   | $          | 206 |   | $ | 21,403 |   |

 

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

**Consolidated Statements ofCash Flows (Unaudited)**

 
| ** **                                                                                      | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **(dollars in thousands)**                                                                      | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| Cash flows from operating  activities:                                                          |       |                                      |       |   |   |
| Net income                                                                                      |       | $                                         | 543        |   | $ | 884 |   |
| Adjustments to reconcile net income to net cash provided by  operating  activities:             |       |                                      |       |   |   |
| Depreciation and amortization                                                                   |       | 245                                       |       | 250 |   |
| Deferred income tax benefits                                                                    |       | (10                                       | )          | (39 | ) |
| Provision for loan losses                                                                       |       | 875                                       |       | 460 |   |
| Securities gains                                                                                |       | (117                                      | )          | (26 | ) |
| Net premium amortization on investment securities                                               |       | 14                                        |       | 1 |   |
| Losses (gains) on sale of foreclosed properties                                                 |       | 37                                        |       | (15 | ) |
| Excess tax benefit from equity-based awards                                                     |       | —                                    |       | 1 |   |
| Decrease (increase) in accrued interest and other assets                                        |       | 251                                       |       | (32 | ) |
| (Decrease) increase in accrued interest and other liabilities                                   |       | (84                                       | )          | 252 |   |
| Net cash provided by operating activities                                                       |       | 1,754                                     |       | 1,736 |   |
| Cash flows from investing activities:                                                           |       |                                      |       |   |   |
| Purchases of investment securities available for sale                                           |       | (8,784                                    | )          | (3,053 | ) |
| Proceeds from sales of investment securities available for sale                                 |       | 4,115                                     |       | 5,040 |   |
| Proceeds from maturities, prepayments and calls  investment  securities available for sale      |       | 2,454                                     |       | 4,802 |   |
| Net redemption (purchases) of restricted stock                                                  |       | 33                                        |       | (159 | ) |
| Net increase in loans                                                                           |       | (749                                      | )          | (3,356 | ) |
| Purchases of bank premises and equipment                                                        |       | (70                                       | )          | (76 | ) |
| Proceeds from sale of foreclosed properties                                                     |       | 484                                       |       | 465 |   |
| Net cash (used in) provided by investing activities                                             |       | (2,517                                    | )          | 3,663 |   |
| Cash flows from financing activities:                                                           |       |                                      |       |   |   |
| Net increase in NOW, money market accounts, savings  accounts  and noninterest-bearing deposits |       | 26,544                                    |       | 7,251 |   |
| Net decrease in time deposits                                                                   |       | (15,641                                   | )          | (3,219 | ) |
| Net increase in short-term borrowings                                                           |       | 500                                       |       | — |   |
| Proceeds from issuance of common stock                                                          |       | 10                                        |       | 2 |   |
| Net cash provided by financing activities                                                       |       | 11,413                                    |       | 4,034 |   |
| Net increase in cash and cash equivalents                                                       |       | 10,650                                    |       | 9,433 |   |
| Cash and cash equivalents – beginning of period                                            |       | 16,055                                    |       | 12,366 |   |
| Cash and cash equivalents – end of period                                                  |       | $                                         | 26,705     |   | $ | 21,799 |   |
| Supplemental cash flow disclosures:                                                             |       |                                      |       |   |   |
| Interest paid                                                                                   |       | $                                         | 4,185      |   | $ | 5,554 |   |
| Income taxes paid                                                                               |       | $                                         | 250        |   | $ | 399 |   |
| Foreclosed properties acquired in settlement of loans                                           |       | $                                         | 654        |   | $ | — |   |

 

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

 

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

#### ** **

Notes toUnaudited Consolidated Financial Statements

 

**Note 1. General:**

 

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

 

The accompanying unaudited consolidatedfinancial statements of the Company have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information, the instructions for Form 10-Q, Regulation S-X, andgeneral practices within the banking industry. Accordingly, they do not include all of the information and disclosuresrequired by generally accepted accounting principles for complete financialstatements.  These statements should beread in conjunction with the consolidated financial statements and accompanyingfootnotes included in the Company’s 2008 Annual Report on Form 10-K.  In the opinion of management, alladjustments, consisting of normal recurring adjustments, considered necessaryfor a fair presentation have been included. The results shown in this interim report are not necessarily indicativeof results to be expected for any other period or for the full year ending December 31,2009.  The Company has evaluatedsubsequent events for potential recognition and/or disclosure through November 5, 2009, the datethe consolidated financial statements included in this Quarterly Report on Form 10-Qwere issued.

 

The preparation of financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period.  These estimates and assumptions are based oninformation available as of the date of the consolidated financial statementsand could differ from actual results.

 

**RecentAccounting Pronouncements**

 

During December 2007,the Financial Accounting Standards Board (“FASB”) issued new accountingguidance for business combinations in the Accounting Standards Codification (“ASC”).  This guidance is for business combinationswhich the acquisition date is on or after December 15, 2008.  These business combinations use “acquisitionaccounting” which recognizes and measures the goodwill acquired in the businesscombination and defines a bargain purchase, and requires the acquirer torecognize that excess as a gain attributable to the acquirer.  The Company adopted this new guidanceeffective March 31, 2009, and adoption did not have a material impact onthe Company’s consolidated financial statements.

 

During December 2007,the FASB issued accounting guidance for consolidations which establishesaccounting and reporting standards for the noncontrolling interest in asubsidiary and for the deconsolidation of a subsidiary. It clarifies that anoncontrolling interest in a subsidiary is an ownership interest in theconsolidated entity that should be reported as equity in the consolidatedfinancial statement, but separate from the parent’s equity.  Thisguidance is effective for fiscal years, and interim periods within those fiscalyears, beginning on or after December 15, 2008. Management adopted thisguidance effective March 31, 2009, and adoption did not have a materialimpact on the Company’s consolidated financial condition or results ofoperations.

 

In March 2008,the FASB issued new guidance regarding disclosures for derivatives.  This guidance requires qualitativedisclosures about objectives and strategies for using derivative, quantitativedisclosures about fair value amounts of and gains and losses on derivativeinstruments, and disclosures about credit-risk-related contingent features inderivative agreements. This guidance is effective for financial statementsissued for fiscal years and interim periods beginning after November 15,2008. Adoption of this new guidance, effective January 1, 2009, did nothave a material impact on the consolidated financial statements.

 

In June 2008,the FASB issued guidance regarding earnings per share which requires companiesto treat unvested share-based payment awards that have non-forfeitable rightsto dividend or dividend equivalents as a separate class of securities incalculating earnings per share. This guidance is effective for financialstatements issued for fiscal years and interim periods beginning after December 15,2008, and requires a company to retrospectively adjust its earnings per sharedata. The Company adopted this guidance effective March 31, 2009, andadoption did not have a material effect on consolidated results of operationsor earnings per share.

 

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In April 2009,the FASB issued guidance regarding the application of fair value accounting toaddress concerns regarding (1) determining whether a market is not activeand a transaction is not orderly, (2) recognition and presentation ofother-than-temporary impairments and (3) interim disclosures of fairvalues of financial instruments.  TheCompany adopted this guidance effective September 30, 2009, and adoptiondid not have a material effect on consolidated results of operations.

 

During May 2009,the FASB issued guidance regarding subsequent events.  The objective of this guidance is toestablish general standards of accounting for and disclosure of events thatoccur after the balance sheet date, but before financial statements are issuedor are available to be issued.  TheCompany adopted this guidance effective September 30, 2009, and adoptiondid not have a material impact on the Company’s consolidated financialcondition or results of operations.

 

During June 2009,the FASB issued guidance on the transfer and servicing of financialassets.  This guidance eliminates theconcept of a “qualifying special-purpose entity” from the original accountingguidance and removes the exception from applying FASB guidance on consolidationof variable interest entities*,*to qualifyingspecial-purpose entities.  This guidanceis effective at the beginning of a reporting entity’s first fiscal year thatbegins after November 15, 2009.  TheCompany does not anticipate that its adoption would have a material impact onthe Company’s consolidated financial condition or results of operations.

 

During June 2009,the FASB guidance on the consolidation of variable interest entities.  This amends the original guidance*,*to require an enterprise to perform an analysis todetermine whether the enterprise’s variable interest or interests give it acontrolling financial interest in a variable interest entity (VIE).  This analysis identifies the primarybeneficiary of a VIE as the enterprise that has both (a) the power todirect the activities of a VIE that most significantly impact the entity’seconomic performance, and (b) the obligation to absorb losses of theentity that could potentially be significant to the VIE.  Additionally, this new guidance requires anenterprise to assess whether it has an implicit financial responsibility toensure that a VIE operates as designed when determining it has the power todirect the activities of the VIE that most significantly impact the entity’seconomic performance.  It is effective atthe beginning of a company’s first fiscal year that begins after November 15,2009.  The Company does not anticipatethat its adoption would have a material impact on the Company’s consolidatedfinancial condition or results of operations.

 

**Note 2. Earnings Per Share:**

 

Earnings per share (“EPS”) are disclosed as basic and diluted.  Basic EPS is generally computed by dividingnet income by the weighted-average number of common shares outstanding for theperiod, whereas diluted EPS essentially reflects the potential dilution inbasic EPS that could occur if other contracts to issue common stock wereexercised.  As of September 30, 2009and 2008, no common stock equivalents were excluded from the diluted EPScalculation.

 
| ** **                                             | ** ** | **Three Months Ended****September 30,** | ** ** | **Nine Months Ended****September 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|
| **(dollars in thousands, except per share  amounts)**  | ** ** | **2009**                                     | ** ** | **2008**                                    | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net income                                             |       | $                                            | 259        |                                        | $          | 315 |   | $ | 543 |   | $ | 884 |   |
| Basic earnings  per share                              |       | $                                            | 0.18       |                                        | $          | 0.22 |   | $ | 0.37 |   | $ | 0.61 |   |
| Diluted earnings  per share                            |       | $                                            | 0.18       |                                        | $          | 0.21 |   | $ | 0.37 |   | $ | 0.59 |   |
| Basic weighted  average number of shares outstanding   |       | 1,460,900                                    |       | 1,460,674                                   |       | 1,460,835 |   | 1,460,626 |   |
| Effect of  dilutive securities – stock options    |       | 8,958                                        |       | 41,769                                      |       | 15,074 |   | 45,726 |   |
| Diluted weighted  average number of shares outstanding |       | 1,469,858                                    |       | 1,502,443                                   |       | 1,475,909 |   | 1,506,352 |   |

 

**Note 3.  Employee Stock Option Plan:**

 

The Company maintains anEmployee Stock Option Plan that provides for grants of incentive andnon-incentive stock options.  This planhas been presented to and approved by the Company’s shareholders.  The Company follows the stock compensationguidance of the ASC.   As of December 31, 2007, all outstandingstock options were fully vested.  Nostock options were granted in 2008 or 2009 and, accordingly, net income has notbeen affected by stock-based compensation.  Any stock-based employee compensation for future grants will bedetermined at that time using the Black-Scholes or another appropriateoption-pricing model.

 

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**Note 4. Investment Portfolio:**

 

The following tables set forth certaininformation regarding the Company’s investment portfolio at September 30, 2009and December 31, 2008:

 

## **Available-for-saleportfolio**

 

*September 30, 2009*

 
| **(dollars in thousands)**                                          | ** ** | **Amortized  Cost** | ** ** | **Gross********Unrealized********Gains** | ** ** | **Gross********Unrealized********Losses** | ** ** | **Estimated   Fair   Value** | ** ** | **Average   Yield** | ** ** |
|---------------------------------------------------------------------|------------|---------------------|------------|------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|---------------------|------------|
| U.S. Treasury and other U.S. government agencies  and corporations: | ** ** | ** **          | ** ** | ** **                               | ** ** | ** **                                | ** ** | ** **                   | ** ** | ** **          | ** ** |
| Due within one year                                                 |       | $                   | 520        |                                     | $          | 7                                         |       | $                            | —     |                | $          | 527 |   | 4.46 | % |
| Due after one year through five years                               |       | 3,329               |       | 72                                       |       | —                                    |       | 3,401                        |       | 4.11                | %          |
| Due after five years through ten years                              |       | 520                 |       | 10                                       |       | —                                    |       | 530                          |       | 4.99                | %          |
| State and political subdivisions:                                   |       |                |       |                                     |       |                                      |       |                         |       |                |       |
| Due after five years through ten years                              |       | 605                 |       | 6                                        |       | 4                                         |       | 607                          |       | 5.36                | %          |
| Due after ten years                                                 |       | 5,081               |       | 78                                       |       | —                                    |       | 5,159                        |       | 5.94                | %          |
| Mortgage-backed debt securities                                     |       | 12,056              |       | 181                                      |       | 9                                         |       | 12,228                       |       | 3.96                | %          |
| Equity securities                                                   |       | 300                 |       | —                                   |       | —                                    |       | 300                          |       | —              | %          |
|                                                                |       | $                   | 22,411     |                                     | $          | 354                                       |       | $                            | 13         |                | $          | 22,752 |   | 4.35 | % |

 

*December 31, 2008*

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

 

*September 30, 2009*

 
| ** **                             | ** ** | **Continuous unrealized  losses existing for less than   12 months** | ** ** | **Continuous unrealized   losses existing for 12   months and greater** | ** ** | **Total**                    | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|------------------------------|------------|
| **(dollars  in thousands)**            | ** ** | **Estimated    Fair****Value**                                       | ** ** | **Unrealized  Losses**                                                  | ** ** | **Estimated  Fair****Value** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair****Value** | ** ** | **Unrealized  Losses** | ** ** |
| Mortgage-backed debt  securities       |       | $                                                                    | 1,721      |                                                                    | $          | 9                            |       | $ | — |   | $ | — |   | $ | 1,721 |   | 9 |   |
| State and  political subdivisions      |       | —                                                               |       | —                                                                  |       | 151                          |       | 4 |   | 151 |   | 4 |   |
| Total  temporarily impaired securities |       | $                                                                    | 1,721      |                                                                    | $          | 9                            |       | $ | 151 |   | $ | 4 |   | $ | 1,872 |   | $ | 13 |   |
|                                        |            |                                                                      |            |                                                                         |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*December 31, 2008*

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

 

Management evaluates securities forother-than-temporary impairment at least on a quarterly basis, and morefrequently when economic or market concerns warrant such evaluation.  Consideration is given to (1) the lengthof time and the extent to which the fair value has been less than cost, (2) thefinancial condition and near-term prospects of the issuer, and (3) theintent and ability of the Company to retain its investment in the issuer for aperiod of time sufficient to allow for any anticipated recovery in fairvalue.  The Company has not recognizedany other-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.  As Managementhas the ability and intent to hold debt securities until maturity or until theunrealized loss is recouped, no declines are deemed to be other than temporary.

 

## **Restricted Stock**

## ** **

The following table shows the amounts ofrestricted stock as of September 30, 2009 and December 31, 2008:

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

 

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

 

Loans consist of the following:

 
| ** **                                                                  | ** ** | **September 30,** | ** ** | **% of**  | ** ** | **December 31,** | ** ** | **% of**  | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------|------------|-----------|------------|-----------------------|------------|-----------|------------|
| **(dollars in thousands)**                                                  | ** ** | **2009**               | ** ** | **Loans** | ** ** | **2008**              | ** ** | **Loans** | ** ** |
| Real estate loans:                                                          |       |                   |       |      |       |                  |       |      |       |
| Construction and land development                                           |       | $                      | 22,794     |      | 11         | %                     | $          | 17,049    |       | 8 | % |
| Mortgage loans:                                                             |       |                   |       |      |       |                  |       |      |       |
| Secured by 1 to 4 family residential properties                             |       | 39,375                 |       | 19        | %          | 36,986                |       | 17        | %          |
| Secured by multi-family (5 or more) residential properties                  |       | 12,243                 |       | 6         | %          | 8,856                 |       | 4         | %          |
| Secured by commercial properties                                            |       | 98,585                 |       | 46        | %          | 105,637               |       | 51        | %          |
| Secured by farm land                                                        |       | 7,433                  |       | 4         | %          | 6,747                 |       | 3         | %          |
| Total mortgage loans                                                        |       | 157,636                |       | 75        | %          | 158,226               |       | 75        | %          |
| Loans to farmers                                                            |       | 47                     |       | —    | %          | 48                    |       | —    | %          |
| Commercial and industrial loans                                             |       | 28,618                 |       | 13        | %          | 34,779                |       | 16        | %          |
| Loans to individuals for household, family and other personal  expenditures |       | 2,055                  |       | 1         | %          | 1,738                 |       | 1         | %          |
|                                                                        |       | 211,150                |       | 100       | %          | 211,840               |       | 100       | %          |
| Less allowance for loan losses                                              |       | (3,210                 | )          |      |       | (3,120                | )          |      |       |
| Net loans                                                                   |       | $                      | 207,940    |      |       |                  | $          | 208,720   |       |   |   |

 

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Transactions in the allowance for loan losses are summarized asfollows:

 
| ** **                                     | ** ** | **Three  Months Ended****September 30,** | ** ** | **Nine  Months Ended****September 30,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| **(dollars in thousands)**                     | ** ** | **2009**                                      | ** ** | **2008**                                     | ** ** | **2009** | ** ** | **2008** | ** ** |
| Average total  loans outstanding during period |       | $                                             | 208,906    |                                         | $          | 213,884 |   | $ | 209,434 |   | $ | 211,353 |   |
| Balance at  beginning of period                |       | $                                             | 3,038      |                                         | $          | 2,584 |   | $ | 3,120 |   | $ | 2,640 |   |
| Recoveries of  loans previously charged-off    |       | —                                        |       | —                                       |       | 4 |   | 9 |   |
| Loans  charged-off (commercial and industrial) |       | (72                                           | )          | (104                                         | )          | (298 | ) | (327 | ) |
| Loans charged-off  (commercial real estate)    |       | (31                                           | )          | —                                       |       | (479 | ) | (76 | ) |
| Loans  charged-off (residential real estate)   |       | —                                        |       | —                                       |       | — |   | (6 | ) |
| Loans  charged-off (consumer)                  |       | —                                        |       | —                                       |       | (12 | ) | — |   |
| Net charge-offs                                |       | (103                                          | )          | (104                                         | )          | (785 | ) | (400 | ) |
| Provision  charged to operating expenses       |       | 275                                           |       | 220                                          |       | 875 |   | 460 |   |
| Balance at end  of period                      |       | $                                             | 3,210      |                                         | $          | 2,700 |   | $ | 3,210 |   | $ | 2,700 |   |
| Ratios of net  charge-offs to average loans    |       | 0.05                                          | %          | 0.05                                         | %          | 0.37 | % | 0.19 | % |

 

**Note 6.  Deposits**

 

The following table provides a summary of theCompany’s deposit base at the dates indicated.

 
| ** **                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in thousands)**          | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Noninterest-bearing demand deposits |       | $                      | 37,205     |                  | $          | 32,740 |   |
| Interest-bearing demand deposits:   |       |                   |       |                  |       |
| NOW accounts                        |       | 16,572                 |       | 11,472                |       |
| Money market accounts               |       | 54,952                 |       | 38,600                |       |
| Savings accounts                    |       | 4,515                  |       | 3,888                 |       |
| Certificates of deposit:            |       |                   |       |                  |       |
| $100,000 or more                    |       | 46,263                 |       | 57,835                |       |
| Less than $100,000                  |       | 68,279                 |       | 72,348                |       |
| Total deposits                      |       | $                      | 227,786    |                  | $          | 216,883 |   |

 

**Note 7. Trust preferred securities/juniorsubordinated debentures and other long-term borrowings:**

 

In December 2006, Bancorp completed theprivate placement of an aggregate of $6,000,000 of trust preferred securitiesthrough FCBI Statutory Trust I (the “Trust”), a newly formed trust subsidiaryorganized under Connecticut law, of which Bancorp owns all of the commonsecurities of $186,000. The principal asset of the Trust is a similar amount ofBancorp’s junior subordinated debentures. The junior subordinated debenturesbear interest at a fixed rate of 6.5375% until December 15, 2011, at whichtime the interest rate becomes a variable rate, adjusted quarterly, equal to163 basis points over three-month LIBOR. The junior subordinated debenturesmature on December 15, 2036, and may be redeemed at par, at Bancorp’soption, on any interest payment date commencing December 15, 2011. Thesecurities are redeemable prior to December 15, 2011, at a premium rangingup to 103.525% of the principal amount thereof, upon the occurrence of certainregulatory or legal events. The obligations of Bancorp with respect to theTrust’s preferred securities constitute a full and unconditional guarantee byBancorp of Trust’s obligations with respect to the trust preferred securitiesto the extent set forth in the related guarantee. Subject to certain exceptionsand limitations, Bancorp may elect from time to time to defer interest paymentson the junior subordinated debentures, resulting in a deferral of distributionpayments on the related trust preferred securities.   If the Company defers interest payments on the junior subordinateddebentures, or otherwise is in default of the obligations, the Company would beprohibited from making dividend payments to its shareholders.

 

The trust preferred securities may be included in Tier 1 capital forregulatory capital adequacy purposes up to 25% of Tier 1 capital, net ofgoodwill after its inclusion. The portion of the trust preferred securities notqualifying as Tier 1 capital may be included as part of total qualifyingcapital in Tier 2 capital, subject to limitation.

 

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At September 30, 2009 and December 31,2008, the Company had $10,000,000 in borrowings under its credit facility fromthe Federal Home Loan Bank of Atlanta (“FHLB”). Both are in the amount of $5,000,000 with the first being a 4.56% fixedrate advance that matures on April 27, 2012 and the second being a 4.56%convertible advance  with a maturity dateof September 4, 2012, unless called on September 4, 2010 by theFHLB.  Outstanding advances are securedby collateral consisting of a blanket lien on qualifying loans in the Bank’sresidential mortgage loan portfolio and certain commercial real estate loans.

 

**Note 8. Noninterest Expense:**

 

Noninterest expense consists of the following:

* *
| ** **                              | ** ** | **Three Months Ended****September 30,** | ** ** | **Nine Months Ended****September 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|
| **(dollars in thousands)**              | ** ** | **2009**                                     | ** ** | **2008**                                    | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                    |       |                                         |       |                                        |       |   |   |   |   |
| Salaries                                |       | $                                            | 817        |                                        | $          | 835 |   | $ | 2,445 |   | $ | 2,472 |   |
| Deferred  Personnel Costs               |       | (20                                          | )          | (28                                         | )          | (53 | ) | (79 | ) |
| Payroll Taxes                           |       | 54                                           |       | 56                                          |       | 179 |   | 184 |   |
| Employee  Insurance                     |       | 55                                           |       | 59                                          |       | 173 |   | 171 |   |
| Other Employee Benefits                 |       | 11                                           |       | 44                                          |       | 63 |   | 137 |   |
| Depreciation                            |       | 80                                           |       | 84                                          |       | 245 |   | 250 |   |
| Rent                                    |       | 96                                           |       | 85                                          |       | 290 |   | 239 |   |
| Utilities                               |       | 24                                           |       | 23                                          |       | 77 |   | 74 |   |
| Repairs and  Maintenance                |       | 59                                           |       | 58                                          |       | 183 |   | 167 |   |
| ATM Expense                             |       | 25                                           |       | 25                                          |       | 79 |   | 75 |   |
| Other Occupancy  and Equipment Expenses |       | 34                                           |       | 33                                          |       | 103 |   | 100 |   |
| Postage and  Supplies                   |       | 17                                           |       | 14                                          |       | 50 |   | 46 |   |
| Data Processing                         |       | 102                                          |       | 90                                          |       | 310 |   | 265 |   |
| Advertising and  Promotion              |       | 50                                           |       | 54                                          |       | 122 |   | 221 |   |
| Legal                                   |       | 6                                            |       | 2                                           |       | 23 |   | 16 |   |
| Insurance                               |       | 13                                           |       | 16                                          |       | 34 |   | 41 |   |
| Consulting                              |       | 2                                            |       | 7                                           |       | 19 |   | 9 |   |
| Courier                                 |       | 4                                            |       | 5                                           |       | 12 |   | 14 |   |
| Audit Fees                              |       | 45                                           |       | 62                                          |       | 141 |   | 185 |   |
| Other                                   |       | 214                                          |       | 160                                         |       | 658 |   | 393 |   |
|                                    |       | $                                            | 1,688      |                                        | $          | 1,684 |   | $ | 5,153 |   | $ | 4,980 |   |

 

**Note 9.  401(k) ProfitSharing Plan:**

 

The Company has a Section 401(k) profitsharing plan covering employees meeting certain eligibility requirements as tominimum age and years of service. Employees may make voluntary contributions to the Plan through payrolldeductions on a pre-tax basis.  TheCompany has the discretion to make matching contributions of 100% of theemployee’s contributions up to 4% of the employee’s salary.  A participant’s account under the Plan,together with investment earnings thereon, is normally distributable, followingretirement, death, disability or other termination of employment, in a singlelump-sum payment.

 

The Company made contributions to the Plan inthe amounts of $0 and $35,000 for the three months ended September 30,2009 and 2008, respectively, and $30,000 and $106,000, for the nine months thenended, respectively.  On April 1,2009, the Company suspended its discretionary matching contribution andtherefore, there was no contribution made in the third quarter of 2009.

 

**Note 10. Shareholders’ Equity:**

 

Capital:

 

The Company and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory - and possibly additional discretionary -actions by regulators that, if undertaken, could have a direct material effecton the Company’s consolidated financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company, once it exceeds$500 million in assets, and the Bank must meet specific capital guidelines thatinvolve quantitative measures of the Company’s and the Bank’s assets,liabilities, and certain off-balance-sheet items as calculated under regulatoryaccounting practices.  The Company’s andthe Bank’s capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.

 

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Quantitative measures established by regulation to ensure capitaladequacy require the Company and the Bank to maintain minimum amounts andratios (set forth in the following table) of total and Tier 1 capital (asdefined in the regulations) to risk-weighted assets (as defined), and Tier 1capital (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 September 30,2009.

 

As of September 30, 2009, the most recent notification from theregulatory agency categorized the Bank as well capitalized under the regulatoryframework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimumtotal risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth inthe table.  There are no conditions orevents since that notification which management believes have changed the Bank’scategory.

 

The Company’s and the Bank’s actual capitalamounts and ratios at September 30, 2009 and December 31, 2008 arepresented in the following tables.

 

*September 30, 2009*

 
| ** **                 | ** ** | **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                    |       | $          | 27,196     |                                 | 11.88      | %                                                                               | $          | 9,154 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 26,398     |                                 | 11.59      | %                                                                               | $          | 9,114 |   | 4.00 | % | $ | 13,671 |   | 6.00 | % |
|                       |       |       |       |                                 |       |                                                                            |       |   |   |   |   |   |   |
| Total Capital              |       |       |       |                                 |       |                                                                            |       |   |   |   |   |   |   |
| To Risk-Weighted Assets    |       |       |       |                                 |       |                                                                            |       |   |   |   |   |   |   |
| Company                    |       | $          | 30,057     |                                 | 13.13      | %                                                                               | $          | 18,308 |   | 8.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 29,246     |                                 | 12.84      | %                                                                               | $          | 18,228 |   | 8.00 | % | $ | 22,785 |   | 10.00 | % |
|                       |       |       |       |                                 |       |                                                                            |       |   |   |   |   |   |   |
| Tier 1 Capital             |       |       |       |                                 |       |                                                                            |       |   |   |   |   |   |   |
| To Average Assets          |       |       |       |                                 |       |                                                                            |       |   |   |   |   |   |   |
| Company                    |       | $          | 27,196     |                                 | 10.37      | %                                                                               | $          | 10,492 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 26,398     |                                 | 10.10      | %                                                                               | $          | 10,456 |   | 4.00 | % | $ | 13,070 |   | 5.00 | % |

 

*December 31, 2008*

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

 

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

 

**Note 11.  Fair Value Measurements**

 

The Companyfollows the guidance of ASC regarding fair value measurements and disclosurestopic.  This guidance permits entities tomeasure many financial instruments and certain other items at fair value.  The objective is to improve financialreporting by providing entities with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting provisions.  The election to use the fair value option isavailable when an entity first recognizes a financial asset or financialliability or upon entering into a Company commitment.  Subsequent changes must be recorded inearnings.  The Company has yet to applythe fair value option to any assets or liabilities.  This guidance clarifies that fair value is anexit price, representing the amount that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants.  Under this guidance, fairvalue measurements are not adjusted for transaction costs.  This guidance establishes a fair value hierarchythat prioritizes the inputs to valuation techniques used to measure fairvalue.  The hierarchy gives the highestpriority to unadjusted quoted prices in active markets for identical assets orliabilities (Level 1 measurements) and the lowest priority to unobservableinputs (Level 3 measurements).  The threelevels of the fair value hierarchy under this guidance are described below.

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

 

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

 

The types of instrumentsvalued based on quoted market prices in active markets include most U.S. governmentand agency securities, liquid mortgage products, active listed equities andmost money market securities.  Suchinstruments are generally classified within Level 1 or Level 2 of the fairvalue hierarchy.  As required by fairvalue measurement and disclosures guidance, the Company does not adjust thequoted price for such instruments.

 

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

 

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

 

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

 

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The followingtables set forth the Company’s financial assets and liabilities that wereaccounted for or disclosed at fair value on a recurring and nonrecurring basisas of September 30, 2009.

 
| ** **                           | ** ** | ** **   | ** ** | ** **         | ** ** | **Significant**    | ** ** | ** **       | ** ** |
|--------------------------------------|------------|--------------|------------|--------------------|------------|--------------------|------------|------------------|------------|
| ** **                           | ** ** | **Carrying** | ** ** | ** **         | ** ** | **Other**          | ** ** | **Significant**  | ** ** |
| ** **                           | ** ** | **Value**    | ** ** | **Quoted**         | ** ** | **Observable**     | ** ** | **Unobservable** | ** ** |
| **Recurring basis**                  | ** ** | **(Fair**    | ** ** | **Prices**         | ** ** | **Inputs**         | ** ** | **Inputs**       | ** ** |
| **(dollars in thousands)** | ** ** | **Value)**   | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level  3)**   | ** ** |
| Securities available for sale        |       | $            | 22,752     |               | $          | —             |       | $                | 22,752     |   | $ | — |   |
|                                      |            |              |            |                    |            |                    |            |                  |            |  |  |  |  |

 
| ** **                           | ** ** | ** **   | ** ** | ** **         | ** ** | **Significant**    | ** ** | ** **       | ** ** |
|--------------------------------------|------------|--------------|------------|--------------------|------------|--------------------|------------|------------------|------------|
| ** **                           | ** ** | **Carrying** | ** ** | ** **         | ** ** | **Other**          | ** ** | **Significant**  | ** ** |
| ** **                           | ** ** | **Value**    | ** ** | **Quoted**         | ** ** | **Observable**     | ** ** | **Unobservable** | ** ** |
| **Nonrecurring basis**               | ** ** | **(Fair**    | ** ** | **Prices**         | ** ** | **Inputs**         | ** ** | **Inputs**       | ** ** |
| **(dollars in thousands)** | ** ** | **Value)**   | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level  3)**   | ** ** |
| Impaired loans                       |       | $            | 11,193     |               | $          | —             |       | $                | —     |   | $ | 11,193 |   |
| Foreclosed properties                |       | $            | 495        |               | $          | —             |       | $                | —     |   | $ | 495 |   |

 

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

 

In accordance with thedisclosure requirements of ASC financial instruments topic, the estimated fairvalues of the Company’s financial instruments are as follows:

 
| ** **                               | ** ** | **September 30, 2009** | ** **   | **December 31, 2008** | ** ** |
|------------------------------------------|------------|-----------------------------|--------------|----------------------------|------------|
| **(dollars in thousands)**               | ** ** | **Carrying   Amount**       | ** **   | **Fair Value**             | ** ** | **Carrying   Amount** | ** ** | **Fair Value** | ** ** |
| FINANCIAL ASSETS                         |       |                        |         |                       |       |   |   |   |   |
| Cash  and cash equivalents          |       | $                           |  26,705 |                       | $          |  26,705 |   | $ |  16,055 |   | $ |  16,055 |   |
| Investment securities available for sale |       | 22,752                      |         | 22,752                     |       | 20,040 |   | 20,040 |   |
| Restricted stock                         |       | 1,566                       |         | 1,566                      |       | 1,599 |   | 1,599 |   |
| Net loans                                |       | 207,940                     |         | 205,496                    |       | 208,720 |   | 207,678 |   |
| Accrued interest receivable              |       | 783                         |         | 783                        |       | 821 |   | 821 |   |
|                                     |       |                        |         |                       |       |   |   |   |   |
| FINANCIAL LIABILITIES                    |       |                        |         |                       |       |   |   |   |   |
| Deposits                                 |       | $                           | 227,786      |                       | $          | 236,145 |   | $ | 216,883 |   | $ | 223,718 |   |
| Short-term borrowings                    |       | 500                         |         | 500                        |       | — |   | — |   |
| Long-term borrowings                     |       | 10,000                      |         | 10,773                     |       | 10,000 |   | 10,914 |   |
| Junior subordinated debentures           |       | 6,186                       |         | 5,973                      |       | 6,186 |   | 6,048 |   |
| Accrued interest payable                 |       | 217                         |         | 217                        |       | 290 |   | 290 |   |

 

The followingmethods and assumptions were used to estimate the fair value disclosures forfinancial instruments as of September 30, 2009 and December 31, 2008:

 

Cash and cashequivalents:

 

The fair value ofcash and cash equivalents is estimated to approximate the carrying amounts.

 

Investmentsecurities and restricted stock:

 

Fair values arebased on quoted market prices, exceptfor certain restricted stocks where fair value equals par value becauseof certain redemption restrictions.

 

Loans:

 

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

 

The fair value ofperforming loans is calculated by discounting estimated cash flows usingcurrent rates at which similar loans would 

 

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be made toborrowers with similar credit ratings and for the same remainingmaturities.  The estimated cash flows donot anticipate prepayments.

 

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

 

Deposits:

 

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

 

Short-termborrowings:

 

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

 

Long-termborrowings:

 

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

 

Juniorsubordinated debentures:

 

The juniorsubordinated debentures are unsecured obligations of the Company and aresubordinate and junior in right of payment to all present and future seniorindebtedness of the Company.  The Companyhas entered into a guarantee, which together with its obligations under thejunior subordinated debentures and the declaration of trust governing the Trustprovides a full and unconditional guarantee of the Trust’s preferredsecurities.  The fair value of juniorsubordinated debentures is determined using rates currently available to theCompany for debt with similar terms and remaining maturities.  See Note 7 for additional disclosures.

 

Accrued Interest:

 

The carryingamounts of accrued interest approximate fair value.

 

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

 

**Forward-LookingStatements**

 

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

 

**General**

 

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

 

Bancorp, the parent company for the Bank, its wholly-ownedsubsidiary, was organized in September 2003. The Bank was incorporatedunder the laws of the state of Maryland in August 2000 and commencedbanking operations in October 2001. The Bank provides its 

 

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customers with various banking services.  The Bank offers various loan and depositproducts to their customers.  The Bank’scustomers include individuals and commercial enterprises within its principalmarket area consisting of Frederick County, Maryland.  Additionally, the Bank maintainscorrespondent banking relationships and transacts daily federal funds sales onan unsecured basis with regional correspondent banks.  Note 4 discusses the types of securities inwhich the Bank invests.  Note 5 discussesthe types of lending in which the Bank engages. The Bank does not have any significant concentrations to any oneindustry or customer.  Bancorp also has asubsidiary called FCBI Statutory Trust I. See Note 7 for additional disclosures.

 

## **Critical Accounting Policies**

## ** **

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

 

**Loans**

 

Loans decreased by$690,000, or (0.33)%, from December 31, 2008, to a balance of $211.15million as of September 30, 2009, and by $367,000, or (0.17)% from September 30,2008.  The Company has taken a low tomoderate loan growth strategy to maintain its strong capital and liquiditypositions during these current uncertain economic times, which may result inthe periodic contraction of the loan portfolio.

 

## **Deposits**

## ** **

Deposits increased by$10.90 million, or 5.03%, from December 31, 2008 to a balance of $227.79million as of September 30, 2009, and by $4.53 million, or 2.03% from September 30,2008.  The Company’s deposit strategyinvolves reducing the Company’s reliance on higher cost certificates of depositand placing more emphasis on noninterest-bearing demand deposits and otherlower cost NOW and money market accounts. The balance of certificates of deposit dropped to $114.54 million as of September 30,2009 from $130.18 million as of December 31, 2008; whilenoninterest-bearing demand deposits increased to $37.21 million from $32.74million, NOW and savings accounts increased to $21.09 million from $15.36million, and money market accounts increased to $54.95 million from $38.60million, all for the same periods.

 

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

 

Net income was $259,000for the quarter ended September 30, 2009, as compared to $315,000 of netincome for the same period in 2008.  Thedecrease in earnings for this quarter in 2009 is primarily related to a $55,000increase in provision for loan losses and no securities gains, while there were$26,000 in securities gains in the same quarter of 2008.  Basicearnings per share for the three months ended September 30, 2009 and 2008were $0.18 and $0.22, respectively, and were based on weighted-average numberof shares outstanding of 1,460,900 and 1,460,674, respectively.  Diluted earnings per share for the threemonths ended September 30, 2009 and 2008 were $0.18 and $0.21,respectively, and were based on weighted-average number of shares outstandingof 1,469,858 and 1,502,443, respectively.

 

TheCompany experienced an annualized return on average assets of 0.39% and 0.49%for the three-month periods ended September 30, 2009 and 2008,respectively.  Additionally, the Companyexperienced an annualized return on average shareholders’ equity of 4.86% and 6.25%for the three-month periods ended September 30, 2009 and 2008,respectively.

 

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**NineMonths Ended September 30, 2009 and 2008**

 

Net income was $543,000for the nine months ended September 30, 2009, as compared to $884,000 ofnet income for the same period in 2008. The decrease in earnings for this period in 2009 is primarily related toa $415,000 increase in provision for loan losses.  Included in this nine-month period in 2009are securities gains of $117,000, which were generated to offset the impact ofthe Federal Deposit InsuranceCorporation (“FDIC”) one-time special assessment fee of $115,000.  Basicearnings per share for the nine months ended September 30, 2009 and 2008were $0.37 and $0.61, respectively, and were based on weighted-average numberof shares outstanding of 1,460,835 and 1,460,626, respectively.  Diluted earnings per share for the nine monthsended September 30, 2009 and 2008 were $0.37 and $0.59, respectively, andwere based on weighted-average number of shares outstanding of 1,475,909 and1,506,352, respectively.

 

TheCompany experienced an annualized return on average assets of 0.28% and 0.45%for the nine-month periods ended September 30, 2009 and 2008,respectively.  Additionally, the Companyexperienced an annualized return on average shareholders’ equity of 3.43% and5.84% for the nine-month periods ended September 30, 2009 and 2008, respectively.

 

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

 

The following tables showaverage balances of asset and liability categories, interest income andinterest expense, and average yields and rates for the periods indicated.

 

*Three Months Ended September 30,*

 
| ** **                                       | ** ** | **2009**                     | ** **   | **2008**                         | ** ** |
|--------------------------------------------------|------------|------------------------------|--------------|----------------------------------|------------|
| **(dollars in thousands)**                       | ** ** | **Average****daily balance** | ** **   | **Interest****Income/  Expense** | ** ** | **Average****Yield/ rate** | ** ** | **Average****daily balance** | ** ** | **Interest****Income/ Expense** | ** ** | **Average****Yield/ rate** | ** ** |
| Assets                                           |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Interest-earning assets:                         |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Federal funds sold                               |       | $                            |  1,072  |                             | $          |  1 |   | 0.37 | % | $ |  8,782 |   | $ |  46 |   | 2.08 | % |
| Interest bearing deposits in other banks         |       | 28,310                       |         | 16                               |       | 0.22 |   | 816 |   | 3 |   | 1.46 |   |
| Investment securities (1):                       |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Taxable                                          |       | 12,735                       |         | 128                              |       | 3.99 |   | 16,916 |   | 210 |   | 4.93 |   |
| Tax-exempt (2)                                   |       | 5,686                        |         | 88                               |       | 6.14 |   | 8,670 |   | 132 |   | 6.04 |   |
| Loans (3)                                        |       | 208,906                      |         | 3,329                            |       | 6.32 |   | 213,884 |   | 3,568 |   | 6.62 |   |
| Total interest-earning assets                    |       | 256,709                      |         | 3,562                            |       | 5.51 |   | 249,068 |   | 3,959 |   | 6.31 |   |
| Noninterest-earning assets                       |       | 5,589                        |         |                             |       |   |   | 9,336 |   |   |   |   |   |
| Total assets                                     |       | $                            | 262,298      |                             |       |   |   |   | $ | 258,404 |   |   |   |   |   |
|                                             |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity        |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                    |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| NOW accounts                                     |       | $                            |  14,927 |                             | 7          |   | 0.19 | % | $ |  10,699 |   | 9 |   | 0.33 | % |
| Savings accounts                                 |       | 4,464                        |         | 1                                |       | 0.09 |   | 3,823 |   | 5 |   | 0.52 |   |
| Money market accounts                            |       | 47,417                       |         | 143                              |       | 1.20 |   | 40,678 |   | 168 |   | 1.64 |   |
| Certificates of deposit $100,000 or more         |       | 49,907                       |         | 398                              |       | 3.16 |   | 55,910 |   | 556 |   | 3.95 |   |
| Certificates of deposit less than $100,000       |       | 70,468                       |         | 538                              |       | 3.03 |   | 71,572 |   | 708 |   | 3.92 |   |
| Short-term borrowings                            |       | 228                          |         | 3                                |       | 5.22 |   | 2,978 |   | 18 |   | 2.40 |   |
| Long-term borrowings                             |       | 10,000                       |         | 117                              |       | 4.64 |   | 10,000 |   | 116 |   | 4.60 |   |
| Junior subordinated debentures                   |       | 6,186                        |         | 101                              |       | 6.48 |   | 6,186 |   | 101 |   | 6.48 |   |
| Total interest-bearing liabilities               |       | 203,597                      |         | 1,308                            |       | 2.55 |   | 201,846 |   | 1,681 |   | 3.30 |   |
| Noninterest-bearing deposits                     |       | 36,466                       |         |                             |       |   |   | 35,604 |   |   |   |   |   |
| Noninterest-bearing liabilities                  |       | 931                          |         |                             |       |   |   | 805 |   |   |   |   |   |
| Total liabilities                                |       | 240,994                      |         |                             |       |   |   | 238,255 |   |   |   |   |   |
| Total shareholders’ equity                  |       | 21,304                       |         |                             |       |   |   | 20,149 |   |   |   |   |   |
| Total liabilities and shareholders’  equity |       | $                            | 262,298      |                             |       |   |   |   | $ | 258,404 |   |   |   |   |   |
| Net interest income                              |       |                         |         | $                                | 2,254      |   |   |   |   |   | $ | 2,278 |   |   |   |
| Net interest spread                              |       |                         |         |                             |       | 2.96 | % |   |   |   |   | 3.01 | % |
| Net interest margin                              |       |                         |         |                             |       | 3.48 | % |   |   |   |   | 3.63 | % |

 

----

| (1) |   | Yields on securities  available-for-sale have been calculated on the basis of historical cost and  do not give effect to changes in the fair value of those securities, which is  reflected as a component of shareholders’ equity.                                                                                                    |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Presented on a  taxable-equivalent basis using the statutory federal income tax rate of  34%.  Taxable-equivalent adjustments of  $30,000 in 2009 and $45,000 in 2008 are included in the calculation of the  tax-exempt investment interest income.                                                                                   |
| (3) |   | Presented on a  taxable-equivalent basis using the statutory federal income tax rate of  34%.  Taxable-equivalent adjustments of  $24,000 in 2009 and $14,000 in 2008 are included in the calculation of the  loan interest income.  Net loan origination  income in interest income totaled $24,000 in 2009 and $10,000 in 2008. |

 

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*Nine Months Ended September 30,*

 
| ** **                                       | ** ** | **2009**                     | ** **   | **2008**                         | ** ** |
|--------------------------------------------------|------------|------------------------------|--------------|----------------------------------|------------|
| **(dollars in thousands)**                       | ** ** | **Average****daily balance** | ** **   | **Interest****Income/  Expense** | ** ** | **Average****Yield/ rate** | ** ** | **Average****daily balance** | ** ** | **Interest****Income/ Expense** | ** ** | **Average****Yield/ rate** | ** ** |
| Assets                                           |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Interest-earning assets:                         |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Federal funds sold                               |       | $                            |  1,103  |                             | $          |  2 |   | 0.24 | % | $ |  9,570 |   | $ |  180 |   | 2.51 | % |
| Interest bearing deposits in other banks         |       | 22,328                       |         | 37                               |       | 0.22 |   | 2,199 |   | 35 |   | 2.12 |   |
| Investment securities (1):                       |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Taxable                                          |       | 14,449                       |         | 479                              |       | 4.43 |   | 17,720 |   | 654 |   | 4.92 |   |
| Tax-exempt (2)                                   |       | 5,686                        |         | 264                              |       | 6.21 |   | 9,434 |   | 432 |   | 6.10 |   |
| Loans (3)                                        |       | 209,434                      |         | 9,805                            |       | 6.26 |   | 211,353 |   | 10,643 |   | 6.71 |   |
| Total interest-earning assets                    |       | 253,000                      |         | 10,587                           |       | 5.59 |   | 250,276 |   | 11,944 |   | 6.36 |   |
| Noninterest-earning assets                       |       | 5,445                        |         |                             |       |   |   | 9,029 |   |   |   |   |   |
| Total assets                                     |       | $                            | 258,445      |                             |       |   |   |   | $ | 259,305 |   |   |   |   |   |
|                                             |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity        |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                    |       |                         |         |                             |       |   |   |   |   |   |   |   |   |
| NOW accounts                                     |       | $                            |  13,064 |                             | 20         |   | 0.20 | % | $ |  11,767 |   | 28 |   | 0.32 | % |
| Savings accounts                                 |       | 4,296                        |         | 6                                |       | 0.19 |   | 3,974 |   | 15 |   | 0.50 |   |
| Money market accounts                            |       | 42,452                       |         | 373                              |       | 1.17 |   | 40,462 |   | 591 |   | 1.95 |   |
| Certificates of deposit $100,000 or more         |       | 52,461                       |         | 1,327                            |       | 3.38 |   | 57,976 |   | 1,883 |   | 4.33 |   |
| Certificates of deposit less than $100,000       |       | 72,914                       |         | 1,775                            |       | 3.25 |   | 71,970 |   | 2,298 |   | 4.25 |   |
| Short-term borrowings                            |       | 77                           |         | 3                                |       | 5.21 |   | 1,000 |   | 18 |   | 2.40 |   |
| Long-term borrowings                             |       | 10,000                       |         | 346                              |       | 4.63 |   | 10,000 |   | 347 |   | 4.62 |   |
| Junior subordinated debentures                   |       | 6,186                        |         | 303                              |       | 6.55 |   | 6,186 |   | 303 |   | 6.52 |   |
| Total interest-bearing liabilities               |       | 201,450                      |         | 4,153                            |       | 2.76 |   | 203,335 |   | 5,483 |   | 3.59 |   |
| Noninterest-bearing deposits                     |       | 35,087                       |         |                             |       |   |   | 34,935 |   |   |   |   |   |
| Noninterest-bearing liabilities                  |       | 792                          |         |                             |       |   |   | 842 |   |   |   |   |   |
| Total liabilities                                |       | 237,329                      |         |                             |       |   |   | 239,112 |   |   |   |   |   |
| Total shareholders’ equity                  |       | 21,116                       |         |                             |       |   |   | 20,193 |   |   |   |   |   |
| Total liabilities and shareholders’  equity |       | $                            | 258,445      |                             |       |   |   |   | $ | 259,305 |   |   |   |   |   |
| Net interest income                              |       |                         |         | $                                | 6,434      |   |   |   |   |   | $ | 6,461 |   |   |   |
| Net interest spread                              |       |                         |         |                             |       | 2.83 | % |   |   |   |   | 2.77 | % |
| Net interest margin                              |       |                         |         |                             |       | 3.40 | % |   |   |   |   | 3.44 | % |

 

----

| (1) |   | Yields on securities  available-for-sale have been calculated on the basis of historical cost and  do not give effect to changes in the fair value of those securities, which is  reflected as a component of shareholders’ equity.                                                                                                    |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Presented on a  taxable-equivalent basis using the statutory federal income tax rate of  34%.  Taxable-equivalent adjustments of  $90,000 in 2009 and $147,000 in 2008 are included in the calculation of the  tax-exempt investment interest income.                                                                                  |
| (3) |   | Presented on a  taxable-equivalent basis using the statutory federal income tax rate of  34%.  Taxable-equivalent adjustments of  $57,000 in 2009 and $42,000 in 2008 are included in the calculation of the  loan interest income.  Net loan  origination income in interest income totaled $18,000 in 2009 and $8,000 in  2008. |

 

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**Rate/VolumeAnalysis**

 

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

 
| *** ***                               | *** *** | **Three Months Ended September 30,****2009 compared to 2008** | *** *** | **Nine Months Ended September 30,****2009 compared to 2008** | *** *** |
|--------------------------------------------|--------------|--------------------------------------------------------------------|--------------|-------------------------------------------------------------------|--------------|
| *** ***                               | ** **   | **Increase (decrease)  Due to**                                    | ** **   | **Net  increase (decrease)**                                      | ** **   | **Increase (decrease)  Due to** | ** ** | **Net  increase (decrease)** | ** ** |
| **(dollars  in thousands)**                | ** **   | **Volume**                                                         | ** **   | **Rate**                                                          | ** **   | ** ** | ** ** | **Volume** | ** ** | **Rate** | ** ** | ** ** | ** ** |
| Interest income                            |         |                                                               |         |                                                              |         |   |   |   |   |   |   |   |   |
| Interest-earning assets:                   |         |                                                               |         |                                                              |         |   |   |   |   |   |   |   |   |
| Federal funds sold                         |         | $                                                                  | (40          | )                                                                 | $            |  (5 | ) | $ |  (45 | ) | $ | (283 | ) | $ |  105 |   | $ |  (178 | ) |
| Interest-bearing deposits in other banks   |         | 100                                                                |         | (87                                                               | )            | 13 |   | 569 |   | (567 | ) | 2 |   |
| Investment securities:                     |         |                                                               |         |                                                              |         |   |   |   |   |   |   |   |   |
| Taxable                                    |         | (51                                                                | )            | (31                                                               | )            | (82 | ) | (214 | ) | 39 |   | (175 | ) |
| Tax-exempt                                 |         | (45                                                                | )            | 1                                                                 |         | (44 | ) | (305 | ) | 137 |   | (168 | ) |
| Loans                                      |         | (82                                                                | )            | (157                                                              | )            | (239 | ) | (172 | ) | (666 | ) | (838 | ) |
| Total interest income                      |         | (118                                                               | )            | (279                                                              | )            | (397 | ) | (405 | ) | (952 | ) | (1,357 | ) |
|                                       |         |                                                               |         |                                                              |         |   |   |   |   |   |   |   |   |
| Interest expense                           |         |                                                               |         |                                                              |         |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:              |         |                                                               |         |                                                              |         |   |   |   |   |   |   |   |   |
| NOW accounts                               |         | —                                                             |         | (2                                                                | )            | (2 | ) | — |   | (8 | ) | (8 | ) |
| Savings accounts                           |         | 1                                                                  |         | (5                                                                | )            | (4 | ) | 2 |   | (11 | ) | (9 | ) |
| Money market accounts                      |         | 28                                                                 |         | (53                                                               | )            | (25 | ) | 52 |   | (270 | ) | (218 | ) |
| Certificates of deposit $100,000 or more   |         | (59                                                                | )            | (99                                                               | )            | (158 | ) | (318 | ) | (238 | ) | (556 | ) |
| Certificates of deposit less than $100,000 |         | (11                                                                | )            | (159                                                              | )            | (170 | ) | 54 |   | (577 | ) | (523 | ) |
| Short-term borrowings                      |         | (16                                                                | )            | 1                                                                 |         | (15 | ) | (30 | ) | 15 |   | (15 | ) |
| Long-term borrowings                       |         | —                                                             |         | 1                                                                 |         | 1 |   | — |   | (1 | ) | (1 | ) |
| Total interest expense                     |         | (57                                                                | )            | (316                                                              | )            | (373 | ) | (240 | ) | (1,090 | ) | (1,330 | ) |
| Net interest income                        |         | $                                                                  | (61          | )                                                                 | $            |  37 |   | $ |  (24 | ) | $ | (165 | ) | $ |  138 |   | $ |  (27 | ) |

 

## **NetInterest Income**

## ** **

Netinterest income is generated from the Company’s lending and investmentactivities, and is the most significant component of the Company’searnings.  Net interest income is thedifference between interest and rate-related fee income on earning assets(primarily loans and investment securities) and the interest paid on the funds(primarily deposits) supporting them. The Company primarily utilizes deposits to fund loans and investments,with a small amount of additional funding from junior subordinated debenturesand minimal short-term and long-term borrowings.  In future periods, the Company may utilize ahigher level of short-term and long-term borrowings, including borrowings fromthe Federal Home Loan Bank, federal funds lines with correspondent banks andrepurchase agreements, to fund operations, depending on economic conditions,deposit availability and pricing, interest rates and other factors.

 

**Three Months Ended September 30, 2009 and2008**

 

Net interest income (on a taxable-equivalent basis) was $2.25 million in2009 and $2.28 million in 2008.  Thechange in net interest income was primarily driven by lower rates paid on alldeposit categories, which was primarily offset by lower yields on the loanportfolio and interest-bearing deposits in other banks.  Average earning assets increased by $7.64million, or 3.07%, since September 30, 2008.  The yield on earning assets in 2009 decreasedto 5.51% from 6.31% in 2008, or 80 basis points, primarily as a result of theFederal Reserve’s decrease in the federal funds rate of 400 bps since January 1,2008.  The decrease of 75 basis points inthe rate paid on interest-bearing liabilities primarily is the result of thelower rates paid on money market accounts and certificates of deposit.  The Company’s net interest margin was 3.48%and 3.63%, and the net interest spread was 2.96% and 3.01%, for the three-monthperiods ended September 30, 2009 and 2008, respectively.

 

Interest expense decreased 22.19% from $1.68 million in 2008 to $1.318million in 2009 due to the reduced rates paid on interest-bearing liabilities,which decreased to 2.55% in 2009 from 3.30% in 2008 primarily as a result indeclines in rates on and volumes of

 

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certificatesof deposit.

 

**NineMonths Ended September 30, 2009 and 2008**

 

Netinterest income (on a taxable-equivalent basis) was $6.43 and $6.46 million in2009 and 2008, respectively.  The impactto the net interest income of lower rates paid on all deposit categories, wastotally offset by lower yields on the loan portfolio and interest-bearingdeposits in other banks,.  Averageearning assets increased by $2.72 million, or 1.09%, since September 30,2008.  The yield on earning assets in2009 decreased to 5.59% from 6.36% in 2008, or 77 basis points, primarily as aresult of the Federal Reserve’s decrease in the federal funds rate of 400 bpssince January 1, 2008.  The decreaseof 83 basis points in the rate paid on interest-bearing liabilities primarilyis the result of the lower rates paid on money market accounts and certificatesof deposit.  The Company’s net interestmargin was 3.40% and 3.44%, and the net interest spread was 2.83% and 2.77%,for the nine-month periods ended September 30, 2009 and 2008,respectively.

 

Interestexpense decreased 24.26% from $5.48 million in 2008 to $4.15 million in 2009due to the reduced rates paid on interest-bearing liabilities, which decreasedto 2.76% in 2009 from 3.59% in 2008.

 

**NoninterestIncome**

 

## **Noninterest income was $143,000 in 2009 and $153,000in 2008 for the respective quarters ended September 30.  Noninterest income for the first nine monthsof 2009 and 2008 was $502,000 and $433,000, respectively.  Included in the nine-month period in 2009 aresecurities gains of $117,000 and losses on the sale of foreclosed propertiesthat amount to $37,000, whereas, there was a gain of $15,000 on the sale of aforeclosed property, and only $26,000 in securities gains for the same periodin 2008.**

 

**Noninterest Expense**

 

Noninterestexpense amounted to $1.69 million and $1.68 million for the three-month periodsended September 30, 2009 and 2008, respectively, and $5.15 million and $4.98million for the nine-month periods ended September 30, 2009 and 2008,respectively.  Included in the nine-monthperiod in 2009 is a $115,000 charge for the FDIC special assessment fee.  In addition, the regular FDIC insurance premiumswere $206,000 and $119,000 for the nine months ended September 30, 2008and 2009, respectively, and were $80,000 and $40,000 for the three months endedSeptember 30, 2009 and 2008, respectively.

 

**IncomeTaxes**

 

During the three months ended September 30, 2009, the Company recognizeda $121,000 income tax expense compared to a $153,000 income tax expense duringthe same period in 2008.  The effectivetax rate for the three-month periods in 2009 and 2008 were 31.84% and 32.69%,respectively.  For the nine months ended September 30,2009, the Company recognized a $218,000 income tax expense compared to a$381,000 income tax expense during the same period in 2008.  The effective tax rate for the nine-monthperiods in 2009 and 2008 were 28.65% and 30.12%, respectively. The decline inincome tax expense is due to the lower pre-tax income and the larger proportionof tax-free income to pre-tax income in 2009.

 

**Market Risk, Liquidity and Interest RateSensitivity**

 

Asset/liabilitymanagement involves the funding and investment strategies necessary to maintainan appropriate balance between interest sensitive assets and liabilities.  It also involves providing adequate liquiditywhile sustaining stable growth in net interest income.  Regular review and analysis of deposit andloan trends, cash flows in various categories of loans, and monitoring ofinterest spread relationships are vital to this process.

 

The conduct of ourbanking business requires that we maintain adequate liquidity to meet changesin the composition and volume of assets and liabilities due to seasonal,cyclical or other reasons.  Liquiditydescribes the ability of the Company to meet financial obligations that ariseduring the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawalrequirements of the customers of the Company, as well as for meeting currentand future planned expenditures.  Thisliquidity is typically provided by the funds received through customerdeposits, investment maturities, loan repayments, borrowings, and income.  Management considers the current liquidityposition to be adequate to meet the needs of the Company and its customers.

 

The Company seeksto limit the risks associated with interest rate fluctuations by managing thebalance between interest sensitive assets and liabilities.  Managing to mitigate interest rate risk is,however, not an exact science.  Not onlydoes the interval until repricing of interest rates on assets and liabilitieschange from day to day as the assets and liabilities change, but for someassets and liabilities, contractual maturity and the actual maturityexperienced are not the same.  Similarly,NOW and money market accounts, by contract, may be withdrawn in their entiretyupon demand and savings deposits may be withdrawn on seven days notice.  While these 

 

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contracts areextremely short, it is the Company’s belief that these accounts turn over atthe rate of five percent (5%) per year. The Company therefore treats them ashaving maturities staggered over all periods. If all of the Company’s NOW, money market, and savings accounts weretreated as repricing in one year or less, the cumulative gap at one year orless would be $(60.62) million.

 

Interest ratesensitivity is an important factor in the management of the composition andmaturity configurations of the Company’s earning assets and fundingsources.  An Asset/Liability Committeemanages the interest rate sensitivity position in order to maintain anappropriate balance between the maturity and repricing characteristics ofassets and liabilities that is consistent with the Company’s liquidityanalysis, growth, and capital adequacy goals. It is the objective of the Asset/Liability Committee to maximize netinterest margins during periods of both volatile and stable interest rates, toattain earnings growth, and to maintain sufficient liquidity to satisfydepositors’ requirements and meet credit needs of customers.

 

The table below, “InterestRate Sensitivity Gap Analysis,” summarizes, as of September 30, 2009, theanticipated maturities or repricing of the Company’s interest-earning assetsand interest-bearing liabilities, the Company’s interest rate sensitivity gap(interest-earning assets less interest-bearing liabilities), the Company’scumulative interest rate sensitivity gap, and the Company’s cumulative interestsensitivity gap ratio (cumulative interest rate sensitivity gap divided bytotal assets).  A negative gap for anytime period means that more interest-bearing liabilities will reprice or matureduring that time period than interest-earning assets.  During periods of rising interest rates, anegative gap position would generally decrease earnings, and during periods ofdeclining interest rates, a negative gap position would generally increaseearnings.  The converse would be true fora positive gap position.  Therefore, apositive gap for any time period means that more interest-earning assets willreprice or mature during that time period than interest-bearingliabilities.  During periods of risinginterest rates, a positive gap position would generally increase earnings, andduring periods of declining interest rates, a positive gap position wouldgenerally decrease earnings.

 

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

 

**Interest Rate Sensitivity GapAnalysis**

**September 30, 2009**

 
| ** **                                            | ** ** | **Expected Repricing or Maturity Date** | ** **   |
|-------------------------------------------------------|------------|-----------------------------------------|--------------|
| **(dollars in thousands)**                            | ** ** | **Within  One Year**                    | ** **   | **One to****Three Years** | ** ** | **Three to****Five Years** | ** ** | **After****Five Years** | ** ** | **Total** | ** ** |
| Assets                                                | ** ** | ** **                              | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal funds  sold                                   |       | $                                       |  1,146  |   | $ |  — |   | $ |  — |   | $ |  — |   | $ |  1,146 |   |
| Interest-bearing  deposits in other banks             |       | 24,671                                  |         | — |   | — |   | — |   | 24,671 |   |
| Investment  securities(1)                             |       | 3,141                                   |         | 2,310 |   | 4,131 |   | 12,870 |   | 22,452 |   |
| Loans                                                 |       | 79,080                                  |         | 77,046 |   | 36,935 |   | 18,089 |   | 211,150 |   |
| Total  interest-earning assets                        |       | 108,038                                 |         | 79,356 |   | 41,066 |   | 30,959 |   | 259,419 |   |
|                                                  | ** ** | ** **                              | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Liabilities                                           |       |                                    | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Savings and NOW  accounts                             |       | 1,054                                   |         | 2,109 |   | 2,109 |   | 15,815 |   | 21,087 |   |
| Money Market  accounts                                |       | 2,748                                   |         | 5,495 |   | 5,495 |   | 41,214 |   | 54,952 |   |
| Certificates of  deposit                              |       | 87,116                                  |         | 25,443 |   | 1,983 |   | — |   | 114,542 |   |
| Short-term  borrowings                                |       | 500                                     |         | — |   | — |   | — |   | 500 |   |
| Long-term  borrowings                                 |       | 5,000                                   |         | 5,000 |   | — |   | — |   | 10,000 |   |
| Junior  subordinated debentures                       |       | —                                  |         | 6,186 |   | — |   | — |   | 6,186 |   |
| Total  interest-bearing liabilities                   |       | 96,418                                  |         | 44,233 |   | 9,587 |   | 57,029 |   | 207,267 |   |
| Interest rate  sensitivity gap                        |       | $                                       |  11,620 |   | $ | 35,123 |   | $ | 31,479 |   | $ | (26,070 | ) | $ |  52,152 |   |
| Cumulative  interest rate sensitivity gap             |       | $                                       | 11,620       |   | $ | 46,743 |   | $ | 78,222 |   | $ | 52,152 |   |   |   |
| Cumulative gap  ratio as a percentage of total assets |       | 4.36                                    | %            | 17.52 | % | 29.32 | % | 19.55 | % |   |   |

 

----

(1) Excludes equity securities.

 

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In addition to theInterest Rate Sensitivity Gap Analysis, the Company also uses an earningssimulation model on a quarterly basis to closely monitor interest sensitivityand to expose its balance sheet and income statement to differentscenarios.  The model is based on currentCompany data and adjusted by assumptions as to growth patterns, noninterestincome and noninterest expense and interest rate sensitivity, based onhistorical data, for both assets and liabilities projected for a one-yearperiod.  The model is then subjected to a“shock test” assuming a sudden prime interest rate increase of 200 basis pointsor a decrease of 200 basis points, but not below zero.  The results show that with a 200 basis pointrise in the prime interest rate the Company’s net interest income woulddecrease by 0.21%.  However, a decreasein the prime interest rate of 200 basis was not considered to be feasible sincethis would infer that the federal funds interest rate would fall below zero.

 

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

 

**Critical Accounting Policy:**

 

**Allowance for Loan Losses**

** **

The Company makes provisions for loan losses in amounts deemednecessary to maintain the allowance for loan losses at an appropriatelevel.  The Company’s provision for loanlosses for the three months ended September 30, 2009 and 2008 was $275,000and $220,000, respectively, and for the nine months ended September 30,2009 and 2008 was $875,000 and $460,000, respectively.  The provision for loan losses is determinedbased upon Management’s estimate of the amount required to maintain an adequateallowance for loan losses reflective of the risks in the Company’s loanportfolio.  At September 30, 2009and December 31, 2008, the allowance for loan losses was $3.21 million and$3.12 million, respectively.  Theincrease in the allowance from December 31, 2008 reflects the provision of$875,000 less net charge-offs of $785,000, as compared to a provision of$460,000 less net charge-offs of $400,000 in the same period of 2008.  The increase in charge-offs in 2009 is aresult of three (3) commercial real estate relationships in the amount of$479,000, three (3) commercial and industrial loan relationships for$298,000 and three (3) consumer loan relationships which totaled $12,000.

 

The Company prepares a quarterly analysis of the allowance for loanlosses, with the objective of quantifying portfolio risk into a dollar amountof inherent losses.  The determination ofthe allowance 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) ASC Contingencies Topic, which requires thatlosses be accrued when they are probable of occurring and estimable and (ii) ASCReceivables Topic, which requires that losses be accrued based on thedifferences between the loan balance and either the value of collateral, or thepresent value of future cash flows, or the loan’s value as observable in thesecondary market.  A loan is consideredimpaired when, based on current information and events, it is probable that theBank will be unable to collect the scheduled payments of principal or interestwhen due according to the contractual terms of the loan agreement.  Factors considered by Management indetermining impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments whendue.  Loans that experience insignificantpayment delays and payment shortfalls generally are not classified asimpaired.  Management determines thesignificance of payment delays and payment shortfalls on a case-by-case basis,taking into consideration all of the circumstances surrounding the loan andborrower, including the length of the delay, the reason for the delay, theborrower’s prior payment record, and the amount of the shortfall in relation tothe principal and interest owed.  Theprovision for loan losses included in the statements of operations serves tomaintain the allowance at a level Management considers adequate.

 

TheCompany’s allowance for loan losses has three basic components: the specificallowance, the formula allowance and the pooled allowance.  Each of these components is determined basedupon estimates that can and do change when the actual events occur.  As a 

 

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resultof the uncertainties inherent in the estimation process, Management’s estimateof loan losses and the related allowance 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 mortgage loans for impairment.  At September 30, 2009 there were onlyfour commercial real estate loans in the amount of $817,000, which were in anonaccrual status, that were deemed to be impaired and had specific reserves of$224,000, compared with $1.37 million in nonaccrual loans, that were deemed tobe impaired and had specific reserves of $365,000 at September 30,2008.  These loans at September 30, 2008amounted to $1.28 million in commercial real estate for three relationships and$95,000 in commercial and industrial loans for two relationships.  All of the impaired loan relationshipsdiscussed are in different types of businesses.

 

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

 

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

 

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

 

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 ofSeptember 30, 2009, the real estate loan portfolio constituted 86% of thetotal loan portfolio, as compared to 83% at December 31, 2008.  While this exceeds the 10% threshold fordetermining a concentration of credit risk within an industry, we do notconsider this to be a concentration with adverse risk characteristics given thediversity of borrowers within the real estate portfolio and other sources ofrepayment.  An industry for this purposeis defined as a group of counterparties that are engaged in similar activitiesand have similar economic characteristics that would cause their ability tomeet contractual obligations to be similarly affected by changes in economic orother conditions.  Additionally, the loanportfolio does not include concentrations of credit risk in residential loanproducts that permit the deferral of principal payments that are smaller thannormal interest accruals (negative amortization); loans with high loan-to-valueratios; or loans, such as option adjustable-rate mortgages, that may expose theborrower to future increases in repayments that are in excess of increases thatwould result solely from increases in market interest rates.  However, the Company does have interest onlyhome equity lines of credit with outstanding balances of $8.64 million of at September 30,2009.

 

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| ** **                                             | ** ** | **Three Months Ended**         | ** ** | **Nine Months Ended**          | ** ** |
|--------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| **(dollars in thousands)**                             | ** ** | **September 30,****2009** | ** ** | **September 30,****2008** | ** ** | **September 30,****2009** | ** ** | **September 30,****2008** | ** ** |
| Average total  loans outstanding during period         |       | $                              | 208,906    |                           | $          | 213,884 |   | $ | 209,434 |   | $ | 211,353 |   |
| Balance at  beginning of period                        |       | $                              | 3,038      |                           | $          | 2,584 |   | $ | 3,120 |   | $ | 2,640 |   |
| Recoveries of  loans previously charged-off (consumer) |       | —                         |       | —                         |       | 4 |   | 9 |   |
| Loans  charged-off (commercial and industrial)         |       | (72                            | )          | (104                           | )          | (298 | ) | (327 | ) |
| Loans  charged-off (commercial real estate)            |       | (31                            | )          | —                         |       | (479 | ) | (76 | ) |
| Loans  charged-off (residential)                       |       | —                         |       | —                         |       | — |   | (6 | ) |
| Loans  charged-off (consumer)                          |       | —                         |       | —                         |       | (12 | ) | — |   |
| Net charge-offs                                        |       | (103                           | )          | (104                           | )          | (785 | ) | (400 | ) |
| Provision  charged to operating expenses               |       | 275                            |       | 220                            |       | 875 |   | 460 |   |
| Balance at end  of period                              |       | $                              | 3,210      |                           | $          | 2,700 |   | $ | 3,210 |   | $ | 2,700 |   |
| Ratios of net  charge-offs to average loans            |       | 0.05                           | %          | 0.05                           | %          | 0.37 | % | 0.19 | % |

 

The allocation of the allowance, presented in thefollowing table, is based primarily on the factors discussed above inevaluating the adequacy of the allowance as a whole.  Since all of those factors are subject tochange, the allocation is not necessarily indicative of the category ofrecognized loan losses, and does not restrict the use of the allowance toabsorb losses in any category.

 

**Allocation of Allowance for Loan Losses**

 
| ** **                                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                  | ** ** | **2009**               | ** ** | **% of********Loans** | ** ** | **2008** | ** ** | **% of********Loans** | ** ** |
| Real  estate-construction                                                   |       | $                      | 303        |                  | 11         | % | $ | 333 |   | 8 | % |
| Real  estate-mortgage                                                       |       | 2,258                  |       | 75                    | %          | 2,278 |   | 75 | % |
| Commercial and  industrial loans                                            |       | 627                    |       | 13                    | %          | 472 |   | 16 | % |
| Loans to  individuals for household, family and other personal expenditures |       | 22                     |       | 1                     | %          | 37 |   | 1 | % |
|                                                                        |       | $                      | 3,210      |                  | 100        | % | $ | 3,120 |   | 100 | % |

** **
| ** **                                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Nonaccrual loans:                         |       |                   |       |                  |       |
| Commercial and industrial                 |       | $                      | 121        |                  | $          | 94 |   |
| Commercial real estate                    |       | 696                    |       | 1,103                 |       |
| Total nonaccrual loans                    |       | 817                    |       | 1,197                 |       |
| Loans 90 days past due and still accruing |       | —                 |       | —                |       |
| Total nonperforming loans                 |       | 817                    |       | 1,197                 |       |
| Foreclosure properties                    |       | 495                    |       | 363                   |       |
| Total nonperforming assets                |       | $                      | 1,312      |                  | $          | 1,560 |   |
| Nonperforming assets to total assets      |       | 0.49                   | %          | 0.61                  | %          |

 

There were noother interest-bearing assets at September 30, 2009 or December 31,2008 classified as past due 90 days or more and still accruing, restructured orproblem assets, and no loans which were currently performing in accordance withtheir terms, but as to which information known to Management caused it to haveserious doubts about the ability of the borrower to comply with the loan ascurrently written.

 

**Off-BalanceSheet Arrangements**

** **

The Company is a party to financial instruments with off-balance sheetrisk in the normal course of business to meet the financing needs of itscustomers.  These financial instrumentsinclude commitments to extend credit, including unused portions of lines ofcredit, and standby letters of credit. The Company has also entered into long-term lease obligations for someof its premises and equipment, the terms of which generally include options torenew.  The above instruments andobligations involve, to varying degrees, elements of off-balance sheet risk inexcess of the amount recognized in the consolidated statements of financial condition.  With the exception of these instruments andthe Company’s obligations relating to its trust preferred securities, theCompany does not have any off 

 

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balance sheet arrangements that have or are reasonably likely to have acurrent or future effect on the Company’s financial condition, revenues orexpenses, results of operations, liquidity, capital expenditures or capitalresources that is material to investors.

 

Commitments toextend credit and standby letters of credit as of September 30, 2009 wereas follows:

 
| ** **                                                                                                     | ** ** | **September 30,**  | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                     | ** ** | **2009**                | ** ** |
| **(dollars  in thousands)**                                                                                    | ** ** | **Contractual  Amount** | ** ** |
| Financial  instruments whose notional or contract amounts represent credit risk:  Commitments to extend credit |       | $                       | 29,591     |   |
| Standby letters  of credit                                                                                     |       | 2,580                   |       |
| Total                                                                                                          |       | $                       | 32,171     |   |

 

See Note 9 to the Notes to the ConsolidatedFinancial Statements included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2008 for additional information regardingthe Company’s long-term lease obligations.

 

**CapitalResources**

 

The ability of the Company to grow isdependent on the availability of capital with which to meet regulatory capitalrequirements, discussed below.  To theextent the Company is successful it may need to acquire additional capitalthrough the sale of additional common stock, other qualifying equityinstruments or subordinated debt.  Therecan be no assurance that additional capital will be available to the Company ona timely basis or on attractive terms. On December 15, 2006, the Company completed the issuance of $6.00million of trust preferred securities, as discussed above, that can berecognized as capital for regulatory purposes. The Company hasan unsecured revolving line of credit borrowing arrangement with anunaffiliated financial institution in the amount of $4.00 million with a$500,000 outstanding balance as of September 30, 2009 and no outstandingbalance as of December 31, 2008. This facility matures on July 22, 2010, has a floating interestrate equal to the Wall Street Journal prime rate plus 0.50%, subject to aminimum rate of 4.25%, and requires monthly interest payments only.  The purpose of this facility is to providecapital to the Bank, as needed.  The Bankexpects to have this credit facility renewed, but there can be no assurance.

 

The Bank is subject to various regulatory capitalrequirements administered by the federal banking agencies.  The Company will be subject to such requirementswhen its assets exceed $500 million, it has publicly issued debt or it engagesin certain highly leveraged activities. Failure to meet minimum capital requirements can initiate certainmandatory - and possibly additional discretionary - actions by regulators that,if undertaken, could have a direct material effect on the Company’sconsolidated financial statements.

 

Under capital adequacy guidelines and the regulatoryframework for prompt corrective action, the Bank must meet specific capital guidelinesthat involve quantitative measures of the Bank’s assets, liabilities, andcertain off-balance-sheet items as calculated under regulatory accountingpractices.  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 Bank tomaintain minimum amounts and ratios of total and Tier 1 capital (as defined inthe regulations) to risk-weighted assets (as defined), and Tier 1 capital (asdefined) to average assets (as defined). Management believes that the Bank met all capital adequacy requirementsto which it is subject as of September 30, 2009 and that the Company wouldmeet such requirements if applicable. See Note 10 to the consolidated financial statements for a tabledepicting compliance with regulatory capital requirements.

 

As of September 30, 2009, the most recent notification from theregulatory agency categorized the Bank as well capitalized under the regulatoryframework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimumtotal risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth inthe table in Note 10.  There are noconditions or events since that notification which management believes havechanged the Bank’s category.

 

On June 26, 2007, the Company authorized the repurchase of up to146,000 shares of its common stock, for an aggregate expenditure of not morethan $4.5 million, through September 30, 2012, or earlier termination ofthe program by the Board of Directors. Repurchases, if any, by the Company pursuant to this authorization areexpected to enable the Company to repurchase its shares at an attractive price,and to provide a source of liquidity for the Company’s shares.  As of September 30, 2009, there havebeen no shares repurchased by the Company.

 

## **Inflation**

## ** **

Theeffect of changing prices on financial institutions is typically different thanon non-banking companies since virtually all of a 

 

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Company’sassets and liabilities are monetary in nature. In particular, interest ratesare significantly affected by inflation, but neither the timing nor magnitudeof the changes are directly related to price level indices; therefore, theCompany can best counter inflation over the long term by managing net interestincome and controlling net increases in noninterest income and expenses.

 

###### **Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

###### ** **

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

 

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

###### ** **

## **The Company’s management, under the supervision and withthe participation of the Company’s Chief Executive Officer and Chief FinancialOfficer, evaluated, as of the last day of the period covered by this report,the effectiveness of the design and operation of the Company’s disclosurecontrols and procedures, as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934.  Basedon that evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures wereeffective.  There were no changes in theCompany’s internal control over financial reporting (as defined in Rule 13a-15under the Securities Act of 1934) during the quarter ended September 30,2009 that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.**

## ** **

## **PART II— Other Information**

## ** **

Item 1.    Legal Proceedings.  None

 

Item 1A.  RiskFactors.  Not Applicable.

 

Item 2.    Unregistered Sales of Equity Securities andUse of Proceeds

 

(a)          *Sales of Unregistered Securities. *None

 

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

 

(c)          *Registrant**Purchases of Securities*

 

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

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

 

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(1)          On June 26, 2007, the Company’s Board ofDirectors approved a share repurchase program that authorizes the repurchase ofup to 146,000 shares of the Company’s outstanding common stock, subject to amaximum expenditure of $4.5 million. Repurchases under the program may be made on the open market and inprivately negotiated transactions from time to time until September 30,2012, or earlier termination of the program by the Board.

 

(2)          Subject to a maximum expenditure of $4.5 million.  Number of shares indicated is the remainingnumber of shares authorized for repurchase as of the end of the indicatedperiod.

 

Item 3.             Defaults upon Senior Securities.  None

 

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

 

Item 5.             Other Information        None

 

Item 6.  Exhibits

 
| **Exhibit No.** | ** ** | **Description  of Exhibits**                                                                                                                                                                                                                        |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3(a)                 |       | Articles of Incorporation of the Company, as  amended(1)                                                                                                                                                                                            |
| 3(b)                 |       | Bylaws of the Company(2)                                                                                                                                                                                                                            |
| 4(a)                 |       | Indenture, dated as of December 15, 2006  between Frederick County Bancorp, Inc. and U.S. Bank National  Association, as trustee(3)                                                                                                       |
| 4(b)                 |       | Amended and Restated Declaration of Trust, dated as  December 15, 2006 between Frederick County Bancorp, Inc. and U.S.  Bank National Association, as trustee, and Martin S. Lapera and William R. Talley, Jr.  as Administrators(3) |
| 4(c)                 |       | Guarantee Agreement dated as of December 15,  2006 between Frederick County Bancorp, Inc. and U.S. Bank National  Association, as Guarantee Trustee(3)                                                                                    |
| 10(a)                |       | 2001 Stock Option Plan(4)                                                                                                                                                                                                                           |
| 10(b)                |       | Employment Agreement between the Bank and Martin S.  Lapera(5)                                                                                                                                                                                      |
| 10(c)                |       | Employment Agreement between the Bank and William R.  Talley, Jr. (6)                                                                                                                                                                          |
| 10(f)                |       | 2002 Executive and Director Deferred Compensation  Plan, as amended(7)                                                                                                                                                                              |
| 10(g)                |       | Amendment No. 1 to the 2002 Executive and  Director Deferred Compensation Plan(7)                                                                                                                                                              |
| 10(h)                |       | Loan Agreement with Atlantic Central Bankers Bank  (8)                                                                                                                                                                                              |
| 10(i)                |       | Promissory Note with Atlantic Central Bankers Bank  (8)                                                                                                                                                                                             |
| 10(j)                |       | Amendment to Line of Credit with Atlantic Central  Bankers Bank(9)                                                                                                                                                                                  |
| 11                   |       | Statement Regarding Computation of Per Share Income  — Please refer to Note 2 to the unaudited consolidated financial statements  included herein                                                                                              |
| 31(a)                |       | Certification of Martin S. Lapera, President and  Chief Executive Officer                                                                                                                                                                           |
| 31(b)                |       | Certification of William R. Talley, Jr.,  Executive Vice President and Chief Financial Officer                                                                                                                                                 |
| 32(a)                |       | Certification of Martin S. Lapera, President and  Chief Executive Officer                                                                                                                                                                           |
| 32(b)                |       | Certification of William R. Talley, Jr.,  Executive Vice President and Chief Financial Officer                                                                                                                                                 |

 

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| (1) | Incorporated by reference to exhibit of the same  number to the Company’s Quarterly Report on Form 10-QSB for the quarter  ended September 30, 2004, as filed with the Securities and Exchange  Commission.      |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Incorporated by reference to exhibit of the same  number to the Company’s Quarterly Report on Form 10-QSB for the quarter  ended September 30, 2003, as filed with the Securities and Exchange  Commission.      |
| (3) | Not filed in accordance with the provision of Item  601(b)(4)(v) of Regulation SK. The Company agrees to provide a copy of these  documents to the Commission upon request.                                                |
| (4) | Incorporated by reference to exhibit 4 to the  Company’s Registration Statement on Form S-8 (No. 333-111761).                                                                                                    |
| (5) | Incorporated by reference to Exhibit 10.1 to  the Company’s Current Report on Form 8-K filed on September 29,  2009.                                                                                        |
| (6) | Incorporated by reference to Exhibit 10.2 to  the Company’s Current Report on Form 8-K filed on September 29,  2009.                                                                                        |
| (7) | Incorporated by reference to Exhibit of the  same number to the Company’s Annual Report on Form 10-KSB for the year  ended December 31, 2004, as filed with the Securities and Exchange  Commission.        |
| (8) | Incorporated by reference to Exhibit of the  same number to the Company’s Quarterly Report on Form 10-QSB for the  quarter ended September 30, 2005, as filed with the Securities and  Exchange Commission. |
| (9) | Incorporated by reference to Exhibit of the  same number to the Company’s Quarterly Report on Form 10-QSB for the  quarter ended September 30, 2008, as filed with the Securities and  Exchange Commission. |

 

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**SIGNATURES**

 

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

 

 
|                        | FREDERICK COUNTY BANCORP, INC. |
|-----------------------------|--------------------------------|
|                        |                           |
|                        |                           |
| Date: November 5, 2009 | By:                            | /s/ Martin S. Lapera |
|                        |                           | Martin S. Lapera |
|                        |                           | President and Chief Executive Officer |
|                        |                           |   |
|                        |                           |   |
| Date: November 5, 2009 | By:                            | /s/ William R. Talley, Jr. |
|                        |                           | William R. Talley, Jr. |
|                        |                           | Executive Vice President and Chief Financial Officer |

 

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