** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC  20549**

** **

**FORM 10-Q**

** **
| **(MARK ONE)**                                         |
|--------------------------------------------------------|
|                                                   |   |   |
| **x**                                                  | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                   |   |   |
| **For the  Quarterly Period Ended September 30, 2006** |
|                                                   | ** ** | ** ** |
| **OR**                                                 |
|                                                   | ** ** | ** ** |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

######  

**For the transition period from                     to                    **

**Commission FileNumber:  000-50407**

** **

**FREDERICK COUNTY BANCORP, INC.**

(Exact name of issuer as specified in its charter)

 

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

** **

**9 North Market Street**

**Frederick, Maryland 21701**

(Address of principal executive offices)

 

**301.620.1400**

(Issuer’s telephone number)

 

**N/A**

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

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 2 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. x Yes      o No

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer.  See definition of “large accelerated filerand accelerated filer” in Rule 12b-2 of the Exchange Act.

Large acceleratedfiler o            Acceleratedfiler  o            Non-acceleratedfiler 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

Statethe number of shares of each of the issuer’s classes of common equity, as ofthe latest practical date.  There were1,458,602 shares of Common Stock outstanding as of October 20, 2006.

 

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** **

**FREDERICK COUNTYBANCORP, INC. AND SUBSIDIARYTABLE OF CONTENTS**
| PART I        |   | FINANCIAL INFORMATION                                                                                                          |   |   |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|          |   |                                                                                                                           |   |   |
| Item 1.       |   | Financial Statements (Unaudited)                                                                                               |   |   |
|          |   |                                                                                                                           |   |   |
|          |   | ConsolidatedBalance Sheets, September 30, 2006  and December 31, 2005                                                          |   |   |
|          |   |                                                                                                                           |   |   |
|          |   | Consolidated Statements of Income, Three and Nine  Months Ended September 30, 2006 and 2005                                    |   |   |
|          |   |                                                                                                                           |   |   |
|          |   | Consolidated Statements of Changes in Shareholders’  Equity, Three and Nine Months Ended September 30, 2006 and 2005 |   |   |
|          |   |                                                                                                                           |   |   |
|          |   | Consolidated Statements of Cash Flows, Nine Months  Ended September 30, 2006 and 2005                                          |   |   |
|          |   |                                                                                                                           |   |   |
|          |   | Notes to Unaudited Consolidated Financial Statements                                                                           |   |   |
|          |   |                                                                                                                           |   |   |
| Item 2.       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                    |   |   |
|          |   |                                                                                                                           |   |   |
| Item 3.       |   | Quantitative  and Qualitative Disclosures About Market Risk                                                                    |   |   |
|          |   | See “Market Risk, Liquidity and Interest Rate  Sensitivity” at Page 20.                                              |   |   |
|          |   |                                                                                                                           |   |   |
| Item 4.       |   | Controls and  Procedures                                                                                                       |   |   |
|          |   |                                                                                                                           |   |   |
| PART II  |   | OTHER INFORMATION                                                                                                              |   |   |
|          |   |                                                                                                                           |   |   |
| Item 1.       |   | Legal  Proceedings                                                                                                             |   |   |
|          |   |                                                                                                                           |   |   |
| Item 1A. |   | Risk Factors                                                                                                                   |   |   |
|          |   |                                                                                                                           |   |   |
| Item 2.       |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                   |   |   |
|          |   |                                                                                                                           |   |   |
| Item 3.       |   | Defaults upon  Senior Securities                                                                                               |   |   |
|          |   |                                                                                                                           |   |   |
| Item 4.       |   | Submission of  Matters to a Vote of Security Holders                                                                           |   |   |
|          |   |                                                                                                                           |   |   |
| Item 5.       |   | Other  Information                                                                                                             |   |   |
|          |   |                                                                                                                           |   |   |
| Item  6.      |   | Exhibits                                                                                                                       |   |   |
|          |   |                                                                                                                           |   |   |
|          |   | Signatures                                                                                                                     |   |   |

 

2

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** **

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

**ConsolidatedBalance Sheets**

 
| *** ***                                                                                                    | *** *** | ***(Unaudited)***        | *** *** | *** ***            | ** ** |
|-----------------------------------------------------------------------------------------------------------------|--------------|--------------------------|--------------|-------------------------|------------|
| *** ***                                                                                                    | *** *** | ***September 30,*** | *** *** | ***December 31,*** | ** ** |
| ***(dollars in thousands)***                                                                          | *** *** | ***2006***               | *** *** | ***2005***              | ** ** |
| *** ***                                                                                                    | * *     | * *                 | * *     | * *                | * *   |
| **ASSETS**                                                                                                      |         |                     |         |                    |       |
| Cash and due from banks                                                                                         |         | $                        | 5,478        |                    | $          | 5,124 |   |
| Federal funds sold                                                                                              |         | 10,566                   |         | 13,386                  |       |
| Interest-bearing  deposits in other banks                                                                       |         | 4,828                    |         | 10,000                  |       |
| Cash and cash  equivalents                                                                                      |         | 20,872                   |         | 28,510                  |       |
| Investment securities  available-for-sale at fair value                                                         |         | 30,303                   |         | 18,952                  |       |
| Investment securities  held-to-maturity - fair value of $— and $2,229                                      |         | —                   |         | 2,246                   |       |
| Restricted stock                                                                                                |         | 893                      |         | 821                     |       |
| Loans                                                                                                           |         | 166,537                  |         | 155,341                 |       |
| Less: Allowance for  loan losses                                                                                |         | (2,133                   | )            | (1,953                  | )          |
| Net loans                                                                                                       |         | 164,404                  |         | 153,388                 |       |
| Bank premises and  equipment                                                                                    |         | 4,092                    |         | 1,811                   |       |
| Other assets                                                                                                    |         | 2,036                    |         | 1,812                   |       |
| Total assets                                                                                                    |         | $                        | 222,600      |                    | $          | 207,540 |   |
|                                                                                                            |         |                     |         |                    |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                  |         |                     |         |                    |       |
|                                                                                                            |         |                     |         |                    |       |
| **Liabilities**                                                                                                 |         |                     |         |                    |       |
| Deposits:                                                                                                       |         |                     |         |                    |       |
| Noninterest-bearing  deposits                                                                                   |         | $                        | 29,770       |                    | $          | 31,484 |   |
| Interest-bearing  deposits                                                                                      |         | 173,927                  |         | 158,571                 |       |
| Total deposits                                                                                                  |         | 203,697                  |         | 190,055                 |       |
| Short-term borrowings                                                                                           |         | 700                      |         | 450                     |       |
| Long-term debt                                                                                                  |         | —                   |         | 250                     |       |
| Accrued interest and  other liabilities                                                                         |         | 795                      |         | 897                     |       |
| Total  liabilities                                                                                              |         | 205,192                  |         | 191,652                 |       |
|                                                                                                            |         |                     |         |                    |       |
| Shareholders’ Equity                                                                                       |         |                     |         |                    |       |
| Common stock, per share  par value $.01; 10,000,000 shares authorized; 1,458,602 shares issued and  outstanding |         | 15                       |         | 15                      |       |
| Additional paid-in  capital                                                                                     |         | 14,652                   |         | 14,652                  |       |
| Retained earnings                                                                                               |         | 2,881                    |         | 1,421                   |       |
| Accumulated other  comprehensive loss                                                                           |         | (140                     | )            | (200                    | )          |
| Total  shareholders’ equity                                                                                |         | 17,408                   |         | 15,888                  |       |
| Total liabilities and  shareholders’ equity                                                                |         | $                        | 222,600      |                    | $          | 207,540 |   |

 

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

3

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

**ConsolidatedStatements of Income (Unaudited)**

 
| *** ***                                                                         | *** *** | ***For the Three  Months Ended  September 30,*** | *** *** | ***For the Nine  Months Ended  September 30,*** | *** *** |
|--------------------------------------------------------------------------------------|--------------|----------------------------------------------------------------------|--------------|---------------------------------------------------------------------|--------------|
| ***(dollars in thousands, except per share amounts)*** | *** *** | ***2006***                                                           | *** *** | ***2005***                                                          | *** *** | ***2006*** | *** *** | ***2005*** | *** *** |
| Interest income:                                                                     |         |                                                                 |         |                                                                |         |   |   |   |   |
| Interest and fees on loans                                                           |         | $                                                                    | 3,006        |                                                                | $            | 2,519 |   | $ | 8,629 |   | $ | 6,972 |   |
| Interest and dividends on investment securities:                                     |         |                                                                 |         |                                                                |         |   |   |   |   |
| Interest — taxable                                                              |         | 215                                                                  |         | 156                                                                 |         | 621 |   | 469 |   |
| Interest — tax exempt                                                           |         | 93                                                                   |         | 10                                                                  |         | 196 |   | 17 |   |
| Dividends                                                                            |         | 14                                                                   |         | 11                                                                  |         | 37 |   | 31 |   |
| Interest on federal funds sold                                                       |         | 143                                                                  |         | 78                                                                  |         | 473 |   | 205 |   |
| Other interest income                                                                |         | 63                                                                   |         | 8                                                                   |         | 192 |   | 22 |   |
| Total interest income                                                                |         | 3,534                                                                |         | 2,782                                                               |         | 10,148 |   | 7,716 |   |
| Interest  expense:                                                                   |         |                                                                 |         |                                                                |         |   |   |   |   |
| Interest on deposits                                                                 |         | 1,472                                                                |         | 845                                                                 |         | 4,017 |   | 2,175 |   |
| Interest on other short-term borrowings                                              |         | 12                                                                   |         | 10                                                                  |         | 26 |   | 23 |   |
| Interest on long-term debt                                                           |         | —                                                               |         | —                                                              |         | 10 |   | — |   |
| Total interest expense                                                               |         | 1,484                                                                |         | 855                                                                 |         | 4,053 |   | 2,198 |   |
| Net interest  income                                                                 |         | 2,050                                                                |         | 1,927                                                               |         | 6,095 |   | 5,518 |   |
| Provision for  loan losses                                                           |         | 60                                                                   |         | 150                                                                 |         | 180 |   | 450 |   |
| Net interest  income after provision for loan losses                                 |         | 1,990                                                                |         | 1,777                                                               |         | 5,915 |   | 5,068 |   |
| Noninterest  income:                                                                 |         |                                                                 |         |                                                                |         |   |   |   |   |
| Securities losses                                                                    |         | —                                                               |         | (7                                                                  | )            | — |   | (8 | ) |
| Service fees                                                                         |         | 44                                                                   |         | 30                                                                  |         | 120 |   | 103 |   |
| Other operating income                                                               |         | 36                                                                   |         | 43                                                                  |         | 119 |   | 111 |   |
| Total noninterest income                                                             |         | 80                                                                   |         | 66                                                                  |         | 239 |   | 206 |   |
| Noninterest  expense:                                                                |         |                                                                 |         |                                                                |         |   |   |   |   |
| Salaries and employee benefits                                                       |         | 849                                                                  |         | 723                                                                 |         | 2,402 |   | 2,035 |   |
| Occupancy and equipment expenses                                                     |         | 216                                                                  |         | 185                                                                 |         | 590 |   | 521 |   |
| Other operating expenses                                                             |         | 307                                                                  |         | 281                                                                 |         | 867 |   | 833 |   |
| Total noninterest expense                                                            |         | 1,372                                                                |         | 1,189                                                               |         | 3,859 |   | 3,389 |   |
| Income before  provision for income taxes                                            |         | 698                                                                  |         | 654                                                                 |         | 2,295 |   | 1,885 |   |
| Provision for  income taxes                                                          |         | 230                                                                  |         | 246                                                                 |         | 835 |   | 561 |   |
| Net income                                                                           |         | $                                                                    | 468          |                                                                | $            | 408 |   | $ | 1,460 |   | $ | 1,324 |   |
| Basic earnings  per share                                                            |         | $                                                                    | 0.32         |                                                                | $            | 0.28 |   | $ | 1.00 |   | $ | 0.91 |   |
| Diluted earnings  per share                                                          |         | $                                                                    | 0.31         |                                                                | $            | 0.27 |   | $ | 0.96 |   | $ | 0.87 |   |
| Basic weighted  average number of shares outstanding                                 |         | 1,458,602                                                            |         | 1,458,602                                                           |         | 1,458,602 |   | 1,458,280 |   |
| Diluted weighted  average number of shares outstanding                               |         | 1,526,297                                                            |         | 1,526,592                                                           |         | 1,527,193 |   | 1,526,404 |   |

 

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

4

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

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

 
| *** ***                                                                                                                | *** *** | ***Three Months Ended September 30,*** | *** *** |
|-----------------------------------------------------------------------------------------------------------------------------|--------------|------------------------------------------------------------|--------------|
| ***(dollars in thousands, except shares outstanding)***                                            | *** *** | ***Shares  Outstanding***                                  | *** *** | ***Common  Stock*** | *** *** | ***Additional Paid-in  Capital*** | *** *** | ***Retained  Earnings*** | *** *** | ***Accumulated  Other  Comprehensive  Income (Loss)*** | *** *** | ***Total  Shareholders’  Equity*** | *** *** |
|                                                                                                                        |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
|  Balance, June 30, 2005                                                                                                |         | 1,458,602                                                  |         | $ | 15 |   | $ | 14,644 |   | $ | 505 |   | $ | (45 | ) | $ | 15,119 |   |
| Comprehensive income:                                                                                                       |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                                  |         | —                                                     |         | — |   | — |   | 408 |   | — |   | 408 |   |
| Changes in net  unrealized losses on securities available for sale, net of income tax  benefits of $35                      |         | —                                                     |         | — |   | — |   | — |   | (56 | ) | (56 | ) |
| Comprehensive income                                                                                                        |         |                                                       |         |   |   |   |   |   |   |   |   | 352 |   |
| Shares issued under  stock option transactions                                                                              |         | —                                                     |         | — |   | 8 |   | — |   | — |   | 8 |   |
| Balance, September 30,  2005                                                                                                |         | 1,458,602                                                  |         | $ | 15 |   | $ | 14,652 |   | $ | 913 |   | $ | (101 | ) | $ | 15,479 |   |
| Balance, June 30, 2006                                                                                                      |         | 1,458,602                                                  |         | $ | 15 |   | $ | 14,652 |   | $ | 2,413 |   | $ | (348 | ) | $ | 16,732 |   |
| Comprehensive income:                                                                                                       |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                                  |         | —                                                     |         | — |   | — |   | 468 |   | — |   | 468 |   |
| Changes in net  unrealized losses on securities available for sale, net of income taxes of  $182                            |         | —                                                     |         | — |   | — |   | — |   | 289 |   | 289 |   |
| Net unrealized  losses on transfer of held-to-maturity securities to available for sale, net  of income tax benefits of $51 |         |                                                       |         |   |   |   |   |   |   | (81 | ) | (81 | ) |
| Comprehensive income                                                                                                        |         |                                                       |         |   |   |   |   |   |   |   |   | 676 |   |
| Balance, September 30, 2006                                                                                                 |         | 1,458,602                                                  |         | $ | 15 |   | $ | 14,652 |   | $ | 2,881 |   | $ | (140 | ) | $ | 17,408 |   |

 

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

5

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

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

 
| *** ***                                                                                                                | *** *** | ***Nine Months Ended September 30,*** | *** *** |
|-----------------------------------------------------------------------------------------------------------------------------|--------------|-----------------------------------------------------------|--------------|
| ***(dollars in thousands, except shares outstanding)***                                            | *** *** | ***Shares  Outstanding***                                 | *** *** | ***Common  Stock*** | *** *** | ***Additional Paid-in  Capital*** | *** *** | ***Retained  Earnings  (Deficit)*** | *** *** | ***Accumulated  Other  Comprehensive  Income (Loss)*** | *** *** | ***Total  Shareholders’  Equity*** | *** *** |
|                                                                                                                        |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| Balance,  December 31, 2004                                                                                                 |         | 1,457,402                                                 |         | $ | 15 |   | $ | 14,632 |   | $ | (411 | ) | $ | (23 | ) | $ | 14,213 |   |
| Comprehensive  income:                                                                                                      |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                                  |         | —                                                    |         | — |   | — |   | 1,324 |   | — |   | 1,324 |   |
| Changes in net unrealized losses on securities  available for sale, net of income tax benefits of $49                       |         | —                                                    |         | — |   | — |   | — |   | (78 | ) | (78 | ) |
| Comprehensive income                                                                                                        |         |                                                      |         |   |   |   |   |   |   |   |   | 1,246 |   |
| Shares issued under stock option transactions                                                                               |         | 1,200                                                     |         | — |   | 20 |   | — |   | — |   | 20 |   |
| Balance,  September 30, 2005                                                                                                |         | 1,458,602                                                 |         | $ | 15 |   | $ | 14,652 |   | $ | 913 |   | $ | (101 | ) | $ | 15,479 |   |
| Balance,  December 31, 2005                                                                                                 |         | 1,458,602                                                 |         | $ | 15 |   | $ | 14,652 |   | $ | 1,421 |   | $ | (200 | ) | $ | 15,888 |   |
| Comprehensive  income:                                                                                                      |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                                  |         | —                                                    |         | — |   | — |   | 1,460 |   | — |   | 1,460 |   |
| Changes in net unrealized losses on securities  available for sale, net of income taxes of $89                              |         | —                                                    |         | — |   | — |   | — |   | 141 |   | 141 |   |
| Net unrealized losses on transfer of  held-to-maturity securities to available for sale, net of income tax benefits  of $51 |         |                                                      |         |   |   |   |   |   |   | (81 | ) | (81 | ) |
| Comprehensive  income                                                                                                       |         |                                                      |         |   |   |   |   |   |   |   |   | 1,520 |   |
| Balance, September 30,  2006                                                                                                |         | 1,458,602                                                 |         | $ | 15 |   | $ | 14,652 |   | $ | 2,881 |   | $ | (140 | ) | $ | 17,408 |   |

 

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

6

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** **

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

**ConsolidatedStatements of Cash Flows (Unaudited)**

 
| *** ***                                                                                   | *** *** | ***Nine Months Ended September 30,*** | *** *** |
|------------------------------------------------------------------------------------------------|--------------|-----------------------------------------------------------|--------------|
| ***(dollars in thousands)***                                                         | *** *** | ***2006***                                                | *** *** | ***2005*** | *** *** |
| Cash  flows from operating activities:                                                         |         |                                                      |         |   |   |
| Net income                                                                                     |         | $                                                         | 1,460        |   | $ | 1,324 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities:             |         |                                                      |         |   |   |
| Depreciation and amortization                                                                  |         | 146                                                       |         | 123 |   |
| Deferred income taxes (benefits)                                                               |         | (37                                                       | )            | — |   |
| Provision for loan losses                                                                      |         | 180                                                       |         | 450 |   |
| Securities losses                                                                              |         | —                                                    |         | 8 |   |
| Net premium amortization on investment securities                                              |         | 30                                                        |         | 76 |   |
| Increase in other assets                                                                       |         | (226                                                      | )            | (343 | ) |
| Decrease in accrued interest and other liabilities                                             |         | (102                                                      | )            | (308 | ) |
| Net cash provided by operating activities                                                      |         | 1,451                                                     |         | 1,330 |   |
| Cash  flows from investing activities:                                                         |         |                                                      |         |   |   |
| Purchases of investment securities available-for-sale                                          |         | (6,439                                                    | )            | (5,161 | ) |
| Purchases of investment securities held-to-maturity                                            |         | (5,933                                                    | )            | (1,208 | ) |
| Proceeds from sale of investment securities available-for-sale                                 |         | —                                                    |         | 1,208 |   |
| Proceeds from maturities of investment securities available-for-sale                           |         | 3,336                                                     |         | 3,799 |   |
| Purchases of restricted stock                                                                  |         | (72                                                       | )            | (106 | ) |
| Net increase in loans                                                                          |         | (11,196                                                   | )            | (16,053 | ) |
| Purchases of bank premises and equipment                                                       |         | (2,427                                                    | )            | (275 | ) |
| Net cash used in investing activities                                                          |         | (22,731                                                   | )            | (17,796 | ) |
| Cash  flows from financing activities:                                                         |         |                                                      |         |   |   |
| Net increase in NOW, money market accounts, savings accounts and  noninterest-bearing deposits |         | 5,935                                                     |         | 8,470 |   |
| Net increase in time deposits                                                                  |         | 7,707                                                     |         | 12,839 |   |
| Net increase in short-term borrowings                                                          |         | —                                                    |         | 250 |   |
| Proceeds from issuance of common stock                                                         |         | —                                                    |         | 20 |   |
| Net cash provided by financing activities                                                      |         | 13,642                                                    |         | 21,579 |   |
| Net (decrease) increase in cash and cash equivalents                                           |         | (7,638                                                    | )            | 5,113 |   |
| Cash and cash equivalents — beginning of period                                           |         | 28,510                                                    |         | 16,639 |   |
| Cash and cash equivalents — end of period                                                 |         | $                                                         | 20,872       |   | $ | 21,752 |   |
| Non-cash  activities:                                                                          |         |                                                      |         |   |   |
| Amortized cost of held-to-maturity securities transferred to  available-for-sale               |         | $                                                         | 8,179        |   | $ | — |   |
| Reclassification of long-term debt to short-term borrowings                                    |         | $                                                         | 250          |   | $ | — |   |
| Supplemental  cash flow disclosures:                                                           |         |                                                      |         |   |   |
| Interest paid                                                                                  |         | $                                                         | 4,013        |   | $ | 2,176 |   |
| Income  taxes paid                                                                             |         | $                                                         | 1,050        |   | $ | 1,010 |   |

 

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

7

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** **

**FREDERICK COUNTYBANCORP, INC.**

**Notes to UnauditedConsolidated Financial Statements**

**Note1.  General:**

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

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

Theaccompanying unaudited consolidated financial statements of the Company havebeen 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 2005 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 endingDecember 31, 2006.

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

**Note2. Earnings Per Share:**

Earnings per share (“EPS”)are disclosed as basic and diluted. Basic EPS is generally computed by dividing net income by theweighted-average number of common shares outstanding for the period, whereasdiluted EPS essentially reflects the potential dilution in basic EPS that couldoccur if other contracts to issue common stock were exercised.
| *** ***                                                                         | *** *** | ***Three Months Ended  September 30,*** | *** *** | ***Nine Months Ended  September 30,*** | *** *** |
|--------------------------------------------------------------------------------------|--------------|--------------------------------------------------------|--------------|-------------------------------------------------------|--------------|
| ***(dollars in thousands, except per share amounts)*** | *** *** | ***2006***                                             | *** *** | ***2005***                                            | *** *** | ***2006*** | *** *** | ***2005*** | *** *** |
| Net income                                                                           |         | $                                                      | 468          |                                                  | $            | 408 |   | $ | 1,460 |   | $ | 1,324 |   |
| Basic earnings  per share                                                            |         | $                                                      | 0.32         |                                                  | $            | 0.28 |   | $ | 1.00 |   | $ | 0.91 |   |
| Diluted earnings  per share                                                          |         | $                                                      | 0.31         |                                                  | $            | 0.27 |   | $ | 0.96 |   | $ | 0.87 |   |
| Basic weighted  average number of shares outstanding                                 |         | 1,458,602                                              |         | 1,458,602                                             |         | 1,458,602 |   | 1,458,280 |   |
| Effect of  dilutive securities — stock options                                  |         | 67,695                                                 |         | 67,990                                                |         | 68,591 |   | 68,124 |   |
| Diluted weighted  average number of shares outstanding                               |         | 1,526,297                                              |         | 1,526,592                                             |         | 1,527,193 |   | 1,526,404 |   |

 

**Note3.  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.  Through December 31, 2005, the Companyaccounted for this plan under the recognition and measurement principles ofAccounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees,*and relatedinterpretations.  Accordingly, nostock-based employee compensation cost has been recognized, as all optionsgranted under this plan had an exercise price equal to the market value of the underlying common stock on the date ofgrant.  As of December 31, 2005, alloutstanding stock options were fully vested. No stock options were granted or vested during the first nine months of2006 or 2005 and, accordingly, net income and earnings per share would not havebeen affected if compensation cost for the stock-based compensation plan hadbeen determined based on the grant date fair values of awards (the 

8

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

**Note 4.  Investment Portfolio:**

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

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

| *** ***                                                        | *** *** | ***September 30, 2006*** | *** *** |
|---------------------------------------------------------------------|--------------|--------------------------|--------------|
| ***(dollars in thousands)***                              | *** *** | ***Amortized  Cost***    | *** *** | ***Gross  Unrealized  Gain*** | *** *** | ***Gross  Unrealized  Loss*** | *** *** | ***Estimated  Fair  Value*** | *** *** | ***Average  Yield*** | *** *** |
| U.S. Treasury  and other U.S. government Agencies and corporations: | ** **   | ** **               | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Due within one year                                                 |         | $                        | 500          |   | $ | — |   | $ | 11 |   | $ | 489 |   | 2.37 | % |
| Due after one year through five years                               |         | 2,855                    |         | 2 |   | 15 |   | 2,842 |   | 4.97 | % |
| Due after five years through ten years                              |         | 2,957                    |         | — |   | 37 |   | 2,920 |   | 4.95 | % |
| State and  political subdivisions:                                  |         |                     |         |   |   |   |   |   |   |   |   |
| Due after five years through ten years                              |         | 1,400                    |         | — |   | 11 |   | 1,389 |   | 5.23 | % |
| Due after ten years                                                 |         | 8,423                    |         | 92 |   | — |   | 8,515 |   | 5.88 | % |
| Mortgage-backed  debt securities                                    |         | 13,996                   |         | 17 |   | 265 |   | 13,748 |   | 4.69 | % |
| Equity  securities                                                  |         | 400                      |         | — |   | — |   | 400 |   | — | % |
|                                                                |         | $                        | 30,531       |   | $ | 111 |   | $ | 339 |   | $ | 30,303 |   | 4.99 | % |

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

 

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

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

 

InAugust 2006, the Company reclassified all remaining held-to-maturity securitiesto the available-for-sale portfolio.  Thetotal amortized cost for the securities transferred was $8.18 million and suchsecurities had an unrealized loss of $132,000. The after-tax unrealized loss transferred to other comprehensive incomewas $81,000 after recognizing deferred income taxes of $51,000.  This reclassification was made recognizing thatthe primary purpose of the securities portfolio is liquidity.  The Company does not anticipate classifyingany securities as held-to-maturity in the future.

9

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** **
| *** ***                                                       | *** *** | ***September 30, 2006***                                                                  | *** *** |
|--------------------------------------------------------------------|--------------|-----------------------------------------------------------------------------------------------------|--------------|
| *** ***                                                       | *** *** | ***Continuous unrealized  losses existing  for less than 12 months*** | *** *** | ***Continuous unrealized  losses existing  for 12 months and greater*** | *** *** | ***Total*** | *** *** |
| ***(dollars in thousands)***                             | *** *** | ***Fair****Value*                                                                                   | *** *** | ***Unrealized  Losses*** | *** *** | ***Fair  Value*** | *** *** | ***Unrealized  Losses*** | *** *** | ***Fair  Value*** | *** *** | ***Unrealized  Losses*** | *** *** |
| U.S. Treasury  and other U.S. government agencies and corporations |         | $                                                                                                   | 3,467        |   | $ | 34 |   | $ | 1,808 |   | $ | 29 |   | $ | 5,275 |   | $ | 63 |   |
| State and  political subdivisions                                  |         | 681                                                                                                 |         | 2 |   | 558 |   | 9 |   | 1,239 |   | 11 |   |
| Mortgage-backed  debt securities                                   |         | 1,234                                                                                               |         | 11 |   | 9,583 |   | 254 |   | 10,817 |   | 265 |   |
| Total temporarily  impaired securities                             |         | $                                                                                                   | 5,382        |   | $ | 47 |   | $ | 11,949 |   | $ | 292 |   | $ | 17,331 |   | $ | 339 |   |

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

 

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

## **Restricted Stock**

Thefollowing table shows the amounts of restricted stock as of September 30, 2006and December 31, 2005:

 

|                                        | *** *** | ***September 30,*** | *** *** | ***December 31,*** | ** ** |
|----------------------------------------|--------------|--------------------------|--------------|-------------------------|------------|
| ***(dollars in thousands)*** | *** *** | ***2006***               | *** *** | ***2005***              | ** ** |
| Federal Home  Loan Bank of Atlanta     |         | $                        | 414          |                    | $          | 342 |   |
| Federal Reserve  Bank                  |         | 439                      |         | 439                     |       |
| Atlantic Central  Bankers Bank         |         | 40                       |         | 40                      |       |
|                                   |         | $                        | 893          |                    | $          | 821 |   |

 

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

Loansconsist of the following:
| ** **                                                                  | ** **   | **September 30,** | ** **   | **% of** | ** **   | **December 31,** | ** **   | **% of** | ** **   |
|-----------------------------------------------------------------------------|--------------|------------------------|--------------|---------------|--------------|-----------------------|--------------|---------------|--------------|
| **(dollars in thousands)**                                        | *** *** | ***2006***             | *** *** | ***Loans***   | *** *** | ***2005***            | *** *** | ***Loans***   | *** *** |
| Real estate  loans:                                                         |         |                   |         |          |         |                  |         |          |         |
| Construction and  land development                                          |         | $                      | 38,206       |          | 23           | %                     | $            | 29,140        |         | 19 | % |
| Mortgage loans:                                                             |         |                   |         |          |         |                  |         |          |         |
| Secured by 1 to 4 family residential properties                             |         | 32,383                 |         | 19            | %            | 31,128                |         | 20            | %            |
| Secured by multi-family (5 or more) residential  properties                 |         | 8,263                  |         | 5             | %            | 3,942                 |         | 3             | %            |
| Secured by commercial properties                                            |         | 57,337                 |         | 35            | %            | 60,087                |         | 39            | %            |
| Secured by farm land                                                        |         | 5,500                  |         | 3             | %            | 2,836                 |         | 2             | %            |
| Total mortgage loans                                                        |         | 103,483                |         | 62            | %            | 97,993                |         | 63            | %            |
| Loans to farmers                                                            |         | 6                      |         | —        | %            | 756                   |         | —        | %            |
| Commercial and  industrial loans                                            |         | 22,108                 |         | 13            | %            | 25,140                |         | 16            | %            |
| Loans to  individuals for household, family and other personal expenditures |         | 2,734                  |         | 2             | %            | 2,312                 |         | 1             | %            |
|                                                                        |         | 166,537                |         | 100           | %            | 155,341               |         | 100           | %            |
| Less allowance for loan losses                                              |         | (2,133                 | )            |          |         | (1,953                | )            |          |         |
|  Net loans                                                             |         | $                      | 164,404      |          |         |                  | $            | 153,388       |         |   |   |

 

Transactions in theallowance for loan losses are summarized as follows:

|                                                      | *** *** | ***Nine Months Ended****September 30,* | *** *** |
|------------------------------------------------------|--------------|-------------------------------------------------------|--------------|
| ***(dollars in thousands)***               | *** *** | ***2006***                                            | *** *** | ***2005*** | *** *** |
| Balance at  beginning of period                      |         | $                                                     | 1,953        |   | $ | 1,503 |   |
| Provision  charged to operating expenses             |         | 180                                                   |         | 450 |   |
| Recoveries of  loans previously charged-off          |         | —                                                |         | — |   |
|                                                 |         | 2,133                                                 |         | 1,953 |   |
| Loans charged-off                                    |         | —                                                |         | — |   |
| Balance at end  of period                            |         | $                                                     | 2,133        |   | $ | 1,953 |   |
|  Average total loans outstanding during  period |         | $                                                     | 161,042      |   | $ | 142,972 |   |

 

**Note6.   Deposits**

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

|                                      | *** *** | ***September 30,  2006*** | *** *** | ***December 31,  2005*** | ** ** |
|--------------------------------------|--------------|--------------------------------|--------------|-------------------------------|------------|
| *** ***                         | *** *** | ***Balance***                  | *** *** | ***Balance***                 | ** ** |
| Noninterest-bearing  demand deposits |         | $                              | 29,770       |                          | $          | 31,484 |   |
| Interest-bearing  demand deposits:   |         |                           |         |                          |       |
| NOW accounts                         |         | 21,948                         |         | 20,090                        |       |
| Money market accounts                |         | 34,978                         |         | 28,844                        |       |
| Savings accounts                     |         | 2,390                          |         | 2,732                         |       |
| Certificates of  deposit:            |         |                           |         |                          |       |
| $100,000 or more                     |         | 56,891                         |         | 51,283                        |       |
| Less than $100,000                   |         | 57,720                         |         | 55,622                        |       |
| Total deposits                       |         | $                              | 203,697      |                          | $          | 190,055 |   |

 

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**Note7.  Noninterest Expense:**

Noninterest expenseconsists of the following:
| *** ***                            | *** *** | ***Three Months Ended  September 30,*** | *** *** | ***Nine Months Ended  September 30,*** | *** *** |
|-----------------------------------------|--------------|--------------------------------------------------------|--------------|-------------------------------------------------------|--------------|
| ***(dollars in thousands)***  | *** *** | ***2006***                                             | *** *** | ***2005***                                            | *** *** | ***2006*** | *** *** | ***2005*** | *** *** |
|                                    |         |                                                   |         |                                                  |         |   |   |   |   |
| Salaries                                |         | $                                                      | 719          |                                                  | $            | 584 |   | $ | 1,948 |   | $ | 1,680 |   |
| Bonus                                   |         | 51                                                     |         | 85                                                    |         | 233 |   | 138 |   |
| Deferred  Personnel Costs               |         | (41                                                    | )            | (38                                                   | )            | (132 | ) | (107 | ) |
| Payroll Taxes                           |         | 46                                                     |         | 35                                                    |         | 156 |   | 150 |   |
| Employee  Insurance                     |         | 46                                                     |         | 32                                                    |         | 108 |   | 93 |   |
| Other Employee Benefits                 |         | 28                                                     |         | 25                                                    |         | 89 |   | 81 |   |
| Depreciation                            |         | 59                                                     |         | 43                                                    |         | 145 |   | 123 |   |
| Rent                                    |         | 61                                                     |         | 67                                                    |         | 189 |   | 182 |   |
| Utilities                               |         | 24                                                     |         | 14                                                    |         | 54 |   | 44 |   |
| Repairs and  Maintenance                |         | 29                                                     |         | 26                                                    |         | 78 |   | 74 |   |
| ATM Expense                             |         | 22                                                     |         | 16                                                    |         | 57 |   | 46 |   |
| Other Occupancy  and Equipment Expenses |         | 21                                                     |         | 19                                                    |         | 67 |   | 52 |   |
| Postage and  Supplies                   |         | 29                                                     |         | 13                                                    |         | 58 |   | 42 |   |
| Data Processing                         |         | 82                                                     |         | 95                                                    |         | 216 |   | 280 |   |
| Advertising and  Promotion              |         | 61                                                     |         | 56                                                    |         | 180 |   | 145 |   |
| Legal                                   |         | 2                                                      |         | 5                                                     |         | 15 |   | 12 |   |
| Insurance                               |         | 12                                                     |         | 9                                                     |         | 29 |   | 23 |   |
| Consulting                              |         | 17                                                     |         | 9                                                     |         | 39 |   | 28 |   |
| Courier                                 |         | 11                                                     |         | 9                                                     |         | 33 |   | 29 |   |
| Audit Fees                              |         | 37                                                     |         | 33                                                    |         | 112 |   | 99 |   |
| Shareholder  Relations                  |         | —                                                 |         | —                                                |         | — |   | 6 |   |
| Other                                   |         | 56                                                     |         | 52                                                    |         | 185 |   | 169 |   |
|                                    |         | $                                                      | 1,372        |                                                  | $            | 1,189 |   | $ | 3,859 |   | $ | 3,389 |   |

 

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

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

The Company made contributions to the Plan in the amounts of $72,000 and$63,000 for the first nine months of 2006 and 2005, respectively, and $24,000and $21,000 for the three months ended September 30, 2006 and 2005,respectively.

**Note9.  Shareholders’ Equity:**

Capital:

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory - and possiblyadditional discretionary - actions by regulators that, if undertaken, couldhave a direct material effect on the Company’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company and the Bankmust meet specific capital guidelines that involve quantitative measures of theCompany’s and the Bank’s assets, liabilities, and certain off-balance-sheetitems as calculated under regulatory accounting practices.  The Company’s and the Bank’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios (set forth in the followingtable) of total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined), and Tier 1 capital (as defined) to averageassets (as defined).  Management believesthat the Company and the Bank met all capital adequacy requirements to whichthey are subject as of September 30, 2006.

12

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** **

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

TheCompany’s and the Bank’s actual capital amounts and ratios at September 30,2006 and December 31, 2005 are presented in the following tables.
| *** ***                            | *** *** | ***September 30, 2006*** | *** *** |
|-----------------------------------------|--------------|------------------------------------|--------------|
| *** ***                            | *** *** | ***Actual***                       | *** *** | ***For Capital  Adequacy Purposes*** | *** *** | ***Minimum To Be Well  Capitalized Under  Prompt Corrective  Action Provisions*** | *** *** |
| ***(dollars in thousands)***  | *** *** | ***Amount***                       | *** *** | ***Ratio*** | *** *** | ***Amount*** | *** *** | ***Ratio*** | *** *** | ***Amount*** | *** *** | ***Ratio*** | *** *** |
| Tier 1 Capital To  Risk-Weighted Assets |         |                               |         |   |   |   |   |   |   |   |   |   |   |
| Company                                 |         | $                                  | 17,548       |   | 9.28 | % | $ | 7,568 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                                    |         | $                                  | 17,641       |   | 9.34 | % | $ | 7,552 |   | 4.00 | % | $ | 11,328 |   | 6.00 | % |
|                                    |         |                               |         |   |   |   |   |   |   |   |   |   |   |
| Total  Capital To Risk-Weighted Assets  |         |                               |         |   |   |   |   |   |   |   |   |   |   |
| Company                                 |         | $                                  | 19,681       |   | 10.40 | % | $ | 15,136 |   | 8.00 | % | N/A |   | N/A |   |
| Bank                                    |         | $                                  | 19,774       |   | 10.47 | % | $ | 15,104 |   | 8.00 | % | $ | 18,879 |   | 10.00 | % |
|                                    |         |                               |         |   |   |   |   |   |   |   |   |   |   |
| Tier  1 Capital To Average Assets       |         |                               |         |   |   |   |   |   |   |   |   |   |   |
| Company                                 |         | $                                  | 17,548       |   | 8.08 | % | $ | 8,689 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                                    |         | $                                  | 17,641       |   | 8.14 | % | $ | 8,673 |   | 4.00 | % | $ | 10,841 |   | 5.00 | % |

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

 

**Item2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

**Forward-LookingStatements**

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

13

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

**General**

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

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

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

Two new branches, locatedat 200 Commerce Drive, Walkersville, Maryland and 6910 Crestwood Boulevard,Frederick, Maryland opened in September 2006. The Company is continually looking for promising branch sites that willcontribute to the Company’s growth and profit expectations.  While additional branching activity is anticipated,there can be no assurance as to when or if, additional branches will beestablished, whether any such branches can be operated profitably, or whethersuch expansion will result in increased assets, earnings, return on equity orshareholder value.

## **Critical Accounting Policies**

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

## **Loans**

Loans increased by$11.20 million, or 7.21%, from December 31, 2005 to a balance of $166.54million as of September 30, 2006, and by $14.82 million, or 9.77% fromSeptember 30, 2005.  During the thirdquarter of 2006, loans increased by $2.51 million, or 1.53%.  Due to the slowing economy, loan demand forthe Company has been slowing for the past several months.

14

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## **Deposits**

Deposits grew by $13.64million, or 7.18%, from December 31, 2005 to a balance of $203.70 million as ofSeptember 30, 2006, and by $26.80 million, or 15.15% from September 30,2005.  During the third quarter of 2006,deposits decreased by $5.03 million, or 2.47%. Due to the slowing of the local real estate market and the decrease inreal estate settlements, the Company’s customers that own title companies haveseen the average deposit balances decline over the past quarter.  It is not anticipated that the decreases inthese deposit totals will continue.   TheCompany’s deposit growth has mainly been in certificates of deposit over thepast year.

## **Bank premises and equipment**

Bank premises andequipment increased by $2.28 million, or 125.95%, from December 31, 2005 to abalance of $4.09 million as of September 30, 2006.  The Company opened two new branch facilitiesduring September 2006 and the increase is primarily from the constructioncosts.

**ThreeMonths Ended September 30, 2006 and 2005**

The net income was$468,000 for the quarter ended September 30, 2006 as compared to the $408,000net income for the same period in 2005, and $513,000 for the second quarter of2006.  The decrease in earnings for thethird quarter of 2006 compared to the second quarter is primarily related tothe increase in personnel and occupancy expenses for the two new branchesopened during the third quarter.  The basic earnings per share for the threemonths ended September 30, 2006 and 2005 were $0.32 and $0.28, respectively,and were based on the weighted-average number of shares outstanding of1,458,602.  The diluted earnings pershare for the three months ended September 30, 2006 and 2005 were $0.31 and$0.27, respectively, and were based on the weighted-average number of sharesoutstanding of 1,526,297 and 1,526,592, respectively.   The Company recorded loan loss provisions of$60,000 and $150,000 for the three-month periods ended September 30, 2006 and2005, respectively.  The after-tax effectof this decrease had a $55,000 favorable benefit to the 2006 earnings.

TheCompany experienced an annualized return on average assets of 0.86% and 0.88%for the three-month periods ended September 30, 2006 and 2005,respectively.  Additionally, the Companyexperienced an annualized return on average shareholders’ equity of 10.90% and 10.58%for the three-month periods ended September 30, 2006 and 2005, respectively.

**NineMonths Ended September 30, 2006 and 2005**

The net income was $1.46million for the nine months ended September 30, 2006 as compared to the $1.32million net earnings recorded for the same period in 2005.  It should be noted that the Companyrecognized $835,000 of income tax expense during this period in 2006, whereas,only $561,000 of income tax expense was incurred for the same period in 2005due to the release of the valuation allowance associated with the net operatingloss****carryforwards available at that time. The basic earnings per share for the nine months ended September 30,2006 and 2005 are $1.00 and $0.91, respectively, and are based on theweighted-average number of shares outstanding of 1,458,602 in 2006 and1,458,280, in 2005.  The diluted earningsper share for the nine months ended September 30, 2006 and 2005 are $0.96 and$0.87, respectively, and are based on the weighted-average number of sharesoutstanding of 1,527,193 and 1,526,404, respectively.   The Company recorded loan loss provisions of$180,000 and $450,000 for the nine-month periods in 2006 and 2005,respectively.  The after-tax effect ofthis difference had a $166,000 favorable benefit to the 2006 earnings.

TheCompany experienced an annualized return on average assets of 0.91% and 0.99%for the nine-month periods ended September 30, 2006 and 2005,respectively.  Additionally, the Companyexperienced an annualized return on average shareholders’ equity of 11.67% and11.76% for the nine-month periods ended September 30, 2006 and 2005,respectively.

15

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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,*** | *** *** |
|--------------------------------------------------|--------------|------------------------------------------------------------|--------------|
| *** ***                                     | *** *** | ***2006***                                                 | *** *** | ***2005*** | *** *** |
| ***(dollars in thousands)***           | *** *** | ***Average  daily  balance***                              | *** *** | ***Interest  Income/  Expense*** | *** *** | ***Average  Yield/  rate*** | *** *** | ***Average  daily  balance*** | *** *** | ***Interest  Income/  Expense*** | *** *** | ***Average  Yield/  rate*** | *** *** |
| Assets                                           |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                         |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold                               |         | $                                                          | 10,915       |   | $ | 143 |   | 5.20 | % | $ | 8,883 |   | $ | 78 |   | 3.48 | % |
| Interest bearing deposits in  other banks        |         | 4,779                                                      |         | 63 |   | 5.23 |   | 1,010 |   | 8 |   | 3.14 |   |
| Investment securities (1):                       |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
| Taxable                                          |         | 20,871                                                     |         | 229 |   | 4.35 |   | 18,326 |   | 167 |   | 3.62 |   |
| Tax-exempt (2)                                   |         | 9,297                                                      |         | 141 |   | 6.02 |   | 1,163 |   | 15 |   | 5.12 |   |
| Loans (3)                                        |         | 163,989                                                    |         | 3,010 |   | 7.28 |   | 149,721 |   | 2,523 |   | 6.69 |   |
| Total interest-earning assets                    |         | 209,851                                                    |         | 3,586 |   | 6.78 |   | 179,103 |   | 2,791 |   | 6.18 |   |
| Noninterest-earning assets                       |         | 7,367                                                      |         |   |   |   |   | 5,874 |   |   |   |   |   |
| Total assets                                     |         | $                                                          | 217,218      |   |   |   |   |   | $ | 184,977 |   |   |   |   |   |
|                                             |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity        |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                    |         |                                                       |         |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                     |         | $                                                          | 15,866       |   | 7 |   | 0.18 | % | $ | 15,664 |   | 7 |   | 0.18 | % |
| Savings accounts                                 |         | 2,474                                                      |         | 3 |   | 0.48 |   | 2,978 |   | 4 |   | 0.53 |   |
| Money market accounts                            |         | 33,196                                                     |         | 237 |   | 2.83 |   | 28,045 |   | 129 |   | 1.82 |   |
| Certificates of deposit$100,000  or more         |         | 57,521                                                     |         | 636 |   | 4.39 |   | 43,788 |   | 340 |   | 3.08 |   |
| Certificates of deposit less  than $100,000      |         | 57,134                                                     |         | 589 |   | 4.09 |   | 48,742 |   | 365 |   | 2.97 |   |
| Short-term borrowings                            |         | 700                                                        |         | 12 |   | 6.80 |   | 608 |   | 10 |   | 6.53 |   |
| Total interest-bearing  liabilities              |         | 166,891                                                    |         | 1,484 |   | 3.53 |   | 139,825 |   | 855 |   | 2.43 |   |
| Noninterest-bearing deposits                     |         | 32,507                                                     |         |   |   |   |   | 29,278 |   |   |   |   |   |
| Noninterest-bearing  liabilities                 |         | 680                                                        |         |   |   |   |   | 448 |   |   |   |   |   |
| Total liabilities                                |         | 200,078                                                    |         |   |   |   |   | 169,551 |   |   |   |   |   |
| Total shareholders’ equity                  |         | 17,140                                                     |         |   |   |   |   | 15,426 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |         | $                                                          | 217,218      |   |   |   |   |   | $ | 184,977 |   |   |   |   |   |
| Net interest income                              |         |                                                       |         | $ | 2,102 |   |   |   |   |   | $ | 1,936 |   |   |   |
| Net interest spread                              |         |                                                       |         |   |   | 3.25 | % |   |   |   |   | 3.76 | % |
| Net interest margin                              |         |                                                       |         |   |   | 3.97 | % |   |   |   |   | 4.29 | % |

----

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

(2)             Presentedon a taxable-equivalent basis using the statutory federal income tax rate of34%.  Taxable-equivalent adjustments of$48,000 in 2006 and $5,000 in 2005 are included in the calculation of thetax-exempt investment interest income.

(3)             Presentedon a taxable-equivalent basis using the statutory federal income tax rate of34%.  Taxable-equivalent adjustments of$4,000 in 2006 and $4,000 in 2005 are included in the calculation of the loaninterest income.  Net loan originationincome (expense) in interest income totaled $3,000 in 2006 and $(4,000) in2005.

16

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| *** ***                                     | *** *** | ***Nine Months Ended September 30,*** | *** *** |
|--------------------------------------------------|--------------|-----------------------------------------------------------|--------------|
| *** ***                                     | *** *** | ***2006***                                                | *** *** | ***2005*** | *** *** |
| ***(dollars in thousands)***           | *** *** | ***Average  daily  balance***                             | *** *** | ***Interest  Income/  Expense*** | *** *** | ***Average  Yield/  rate*** | *** *** | ***Average  daily  balance*** | *** *** | ***Interest  Income/  Expense*** | *** *** | ***Average  Yield/  rate*** | *** *** |
| Assets                                           |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                         |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold                               |         | $                                                         | 13,031       |   | $ | 473 |   | 4.85 | % | $ | 9,171 |   | $ | 205 |   | 2.99 | % |
| Interest bearing deposits in  other banks        |         | 5,269                                                     |         | 192 |   | 4.87 |   | 1,075 |   | 22 |   | 2.74 |   |
| Investment securities (1):                       |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| Taxable                                          |         | 20,503                                                    |         | 658 |   | 4.29 |   | 17,991 |   | 500 |   | 3.72 |   |
| Tax-exempt (2)                                   |         | 6,620                                                     |         | 297 |   | 6.00 |   | 646 |   | 26 |   | 5.38 |   |
| Loans (3)                                        |         | 161,042                                                   |         | 8,640 |   | 7.17 |   | 142,972 |   | 6,983 |   | 6.53 |   |
| Total interest-earning assets                    |         | 206,465                                                   |         | 10,260 |   | 6.64 |   | 171,855 |   | 7,736 |   | 6.02 |   |
| Noninterest-earning assets                       |         | 6,500                                                     |         |   |   |   |   | 5,744 |   |   |   |   |   |
| Total assets                                     |         | $                                                         | 212,965      |   |   |   |   |   | $ | 177,599 |   |   |   |   |   |
|                                             |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’  Equity       |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                    |         |                                                      |         |   |   |   |   |   |   |   |   |   |   |
| NOW accounts                                     |         | $                                                         | 14,438       |   | 19 |   | 0.18 | % | $ | 16,696 |   | 22 |   | 0.18 | % |
| Savings accounts                                 |         | 2,676                                                     |         | 10 |   | 0.50 |   | 3,040 |   | 12 |   | 0.53 |   |
| Money market accounts                            |         | 31,919                                                    |         | 641 |   | 2.68 |   | 27,809 |   | 303 |   | 1.46 |   |
| Certificates of deposit $100,000  or more        |         | 55,625                                                    |         | 1,709 |   | 4.11 |   | 42,548 |   | 894 |   | 2.81 |   |
| Certificates of deposit less  than $100,000      |         | 57,756                                                    |         | 1,638 |   | 3.79 |   | 45,779 |   | 944 |   | 2.76 |   |
| Short-term borrowings                            |         | 534                                                       |         | 26 |   | 6.51 |   | 503 |   | 23 |   | 6.11 |   |
| Long-term debt                                   |         | 166                                                       |         | 10 |   | 8.05 |   | — |   | — |   | — |   |
| Total interest-bearing  liabilities              |         | 163,114                                                   |         | 4,053 |   | 3.32 |   | 136,375 |   | 2,198 |   | 2.15 |   |
| Noninterest-bearing deposits                     |         | 32,549                                                    |         |   |   |   |   | 25,705 |   |   |   |   |   |
| Noninterest-bearing  liabilities                 |         | 629                                                       |         |   |   |   |   | 509 |   |   |   |   |   |
| Total liabilities                                |         | 196,292                                                   |         |   |   |   |   | 162,589 |   |   |   |   |   |
| Total shareholders’ equity                  |         | 16,673                                                    |         |   |   |   |   | 15,010 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |         | $                                                         | 212,965      |   |   |   |   |   | $ | 177,599 |   |   |   |   |   |
| Net interest income                              |         |                                                      |         | $ | 6,207 |   |   |   |   |   | $ | 5,538 |   |   |   |
| Net interest spread                              |         |                                                      |         |   |   | 3.32 | % |   |   |   |   | 3.86 | % |
| Net interest margin                              |         |                                                      |         |   |   | 4.02 | % |   |   |   |   | 4.31 | % |

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

(2)             Presentedon a taxable-equivalent basis using the statutory federal income tax rate of34%.  Taxable-equivalent adjustments of$101,000 in 2006 and $9,000 in 2005 are included in the calculation of thetax-exempt investment interest income.

(3)             Presentedon a taxable-equivalent basis using the statutory federal income tax rate of34%.  Taxable-equivalent adjustments of$11,000 in 2006 and $10,000 in 2005 are included in the calculation of the loaninterest income.  Net loan originationincome (expense) in interest income totaled $13,000 in 2006 and $(4,000) nonein 2005.

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** **

**Rate/VolumeAnalysis**

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

 
| *** ***                                | *** *** | ***Three Months Ended September 30,  2006 compared to 2005*** | *** *** | ***Nine Months Ended September 30,  2006 compared to 2005*** | *** *** |
|---------------------------------------------|--------------|--------------------------------------------------------------------------------------------------|--------------|-------------------------------------------------------------------------------------------------|--------------|
| *** ***                                | *** *** | ***Increase (decrease)  due to***                                                      | *** *** | ***Net Increase***                                                                         | *** *** | ***Increase (decrease)  due to*** | *** *** | ***Net Increase*** | *** *** |
| ***(dollars in thousands)***      | *** *** | ***Volume***                                                                                     | *** *** | ***Rate(1)***                                                                                   | *** *** | ***(decrease)*** | *** *** | ***Volume*** | *** *** | ***Rate(1)*** | *** *** | ***(decrease)*** | *** *** |
| Interest income                             |         |                                                                                             |         |                                                                                            |         |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                   |         |                                                                                             |         |                                                                                            |         |   |   |   |   |   |   |   |   |
| Federal funds  sold                         |         | $                                                                                                | 18           |                                                                                            | $            | 47 |   | $ | 65 |   | $ | 154 |   | $ | 114 |   | $ | 268 |   |
| Interest-bearing  deposits in other banks   |         | 30                                                                                               |         | 25                                                                                              |         | 55 |   | 153 |   | 17 |   | 170 |   |
| Investment  securities:                     |         |                                                                                             |         |                                                                                            |         |   |   |   |   |   |   |   |   |
| Taxable                                     |         | 23                                                                                               |         | 39                                                                                              |         | 62 |   | 124 |   | 34 |   | 158 |   |
| Tax-exempt                                  |         | 104                                                                                              |         | 22                                                                                              |         | 126 |   | 429 |   | (158 | ) | 271 |   |
| Loans                                       |         | 238                                                                                              |         | 249                                                                                             |         | 487 |   | 1,573 |   | 84 |   | 1,657 |   |
| Total interest  income                      |         | 413                                                                                              |         | 382                                                                                             |         | 795 |   | 2,433 |   | 91 |   | 2,524 |   |
|                                        |         |                                                                                             |         |                                                                                            |         |   |   |   |   |   |   |   |   |
| Interest expense                            |         |                                                                                             |         |                                                                                            |         |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:              |         |                                                                                             |         |                                                                                            |         |   |   |   |   |   |   |   |   |
| NOW accounts                                |         | —                                                                                           |         | —                                                                                          |         | — |   | — |   | (3 | ) | (3 | ) |
| Savings accounts                            |         | (1                                                                                               | )            | —                                                                                          |         | (1 | ) | (3 | ) | 1 |   | (2 | ) |
| Money market  accounts                      |         | 24                                                                                               |         | 84                                                                                              |         | 108 |   | 80 |   | 258 |   | 338 |   |
| Certificates of  deposit $100,000 or more   |         | 106                                                                                              |         | 190                                                                                             |         | 296 |   | 490 |   | 325 |   | 815 |   |
| Certificates of  deposit less than $100,000 |         | 62                                                                                               |         | 162                                                                                             |         | 224 |   | 440 |   | 254 |   | 694 |   |
| Short-term  borrowings                      |         | 2                                                                                                |         | —                                                                                          |         | 2 |   | 3 |   | — |   | 3 |   |
| Long-term debt                              |         | —                                                                                           |         | —                                                                                          |         | — |   | — |   | 10 |   | 10 |   |
| Total interest  expense                     |         | 193                                                                                              |         | 436                                                                                             |         | 629 |   | 1,010 |   | 845 |   | 1,855 |   |
| Net interest income                         |         | $                                                                                                | 220          |                                                                                            | $            | (54 | ) | $ | 166 |   | $ | 1,423 |   | $ | (754 | ) | $ | 669 |   |

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

## **Net Interest 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. While the Company currently relies almost entirely on deposits to fundloans and investments, with minimal short term borrowings, in future periods itmay utilize a higher level of short-term borrowings, including borrowings fromthe Federal Home Loan Bank, federal funds lines with correspondent banks andrepurchase agreements, to fund operations, depending on economic conditions,deposit availability and pricing, interest rates and other factors.

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

## **ThreeMonths Ended September 30, 2006 and 2005**

The net interest income (on a taxable-equivalent basis) of $2.10 millionin 2006 was $166,000, or 8.57% higher than the amount recognized in 2005.  This increase in interest income is due tothe growth in average earning assets and increased yields on earningassets.  Average earning assets increasedby  $30.75 million, or 17.17%, sinceSeptember 30, 2005.  The yield on earningassets in 2006 increased to 6.78% from 6.18% in 2005.  This increase in yield is attributable to theimpact of the increase in short-term rates by the Federal Reserve.  However, the increase by 110 basis points inthe rate paid on interest earning liabilities, primarily a result of FederalReserve increases of the federal funds rate and stiff competition for deposits,more than offset the increase in yield on interest earning assets.  The Company’s net interest margin was 3.97%and 4.29%, and the net interest spread was 3.25% and 3.76%, for the 

18

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three-month periods ended September 30, 2006 and 2005, respectively.  The net interest margin for the secondquarter of 2006 was 4.06%, resulting in a decline of 9 basis points for thethird quarter.  This decrease relatesprimarily to the increased costs of funds as a result of more funding of highercosts certificates of deposit and the reduced average balances of the low costtitle company deposits as discussed above. Average loans as a percentage of average interest-earnings assetsdecreased to 78.15% for the three months ended September 30, 2006, as comparedto 83.59% for the same period in 2005. The decline in average loans as a percentage of average earning assetsis in part reflective of the Company’s preference to not make loans rather thanassume riskier loans for which the Company will not be adequately compensated.

The interest expense increased 73.57% from $855,000 in 2005 to $1.48million in 2006 due to the 19.36% increase in volume of averageinterest-bearing liabilities, along with the increase in the related rates paidon such interest-bearing liabilities, which increased to 3.53% in 2006 from2.43% in 2005.

## **NineMonths Ended September 30, 2006 and 2005**

The net interest income (on a taxable-equivalent basis) of $6.21 millionin 2006 was $669,000, or 12.08% higher than the amount recognized in 2005.  This increase in interest income is due tothe growth in average earning assets and increased yields on earningassets.  Average earning assets increasedby  $34.61 million, or 20.14%, sinceSeptember 30, 2005.  The yield on earningassets in 2006 increased to 6.64% from 6.02% in 2005.  This increase in yield is attributable to theimpact of the increase in short-term rates by the Federal Reserve.  However, the increase by 117 basis points inthe rate paid on interest earning liabilities, primarily a result of priorFederal Reserve increases of the discount rate and stiff competition fordeposits, more than offset the increase in yield on interest earningassets.  The Company’s net interestmargin was 4.02% and 4.31%, and the net interest spread was 3.32% and 3.86%,for the nine-month periods ended September 30, 2006 and 2005,respectively.  Average loans as apercentage of average interest-earnings assets decreased to 78.00% for the ninemonths ended September 30, 2006, as compared to 83.19% for the same period in2005.  The decline in average loans as apercentage of average earning assets is in part reflective of the Company’spreference to not make loans rather than assume riskier loans for which theCompany will not be adequately compensated.

The interest expense increased 84.39% from $2.20 million in 2005 to $4.05million in 2006 due to the 19.61% increase in volume of averageinterest-bearing liabilities, along with the increase in the related rates paidon such interest-bearing liabilities, which increased to 3.32% in 2006 from2.15% in 2005.

# **Noninterest Income**

Noninterest income was $80,000 and $66,000 for the three-month periodsand $239,000 and $206,000 for the nine-month periods ended September 30, 2006and 2005, respectively.

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

## **Noninterest Expense**

SeeNote 7 to the unaudited consolidated financial statements for a scheduleshowing a detailed breakdown of the Company’s noninterest expense.

**ThreeMonths Ended September 30, 2006 and 2005**

Noninterest expense amounted to $1.37 million and $1.19 million for thethree-month periods in 2006 and 2005, respectively.  The changes in noninterest expense areprincipally related to an increase in personnel costs.  Salaries expense in 2006 was $719,000, up$135,000 from the salaries expense incurred in the same period in 2005.  This increase of 23.12% is for the additionalcosts of adding the average of seventeen (17) full-time equivalent employeesfor this quarter which are primarily for the new branches, employee payincreases and to make various employee salaries competitive with the currentemployment environment.

**NineMonths Ended September 30, 2006 and 2005**

Noninterest expense amounted to $3.86 million and $3.39 million for thenine-month periods in 2006 and 2005, respectively.  The changes in noninterest expense areprincipally related to an increase in personnel costs.  Salaries expense in 2006 was $1.95 million,up $268,000 from the salaries expense incurred in the same period in 2005.  This increase of 15.95% is for the additionalcosts of adding the average of seven (7) full-time equivalent employees forthis nine-month period which are primarily for the new branches, employee payincreases and to make various employee salaries competitive with the currentemployment environment.

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**IncomeTaxes**

**ThreeMonths Ended September 30, 2006 and 2005**

During the three monthsended September 30, 2006, the Company incurred $230,000 of income tax expensecompared to $246,000 during the same period in 2005.  The effective tax rates for thesethree-months in 2006 and 2005 were 33.00% and 37.61%.  The effective tax rate for 2006 has beenpositively impacted by the addition of tax-free municipal securities to theCompany’s investment portfolio.

**NineMonths Ended September 30, 2006 and 2005**

During the nine monthsended September 30, 2006, the Company incurred $835,000 of income tax expensecompared to only $561,000 during the same period in 2005 due to the benefitrealized during the first quarter of 2005 related to the reversal of a deferredtax valuation allowance.  At December 31,2004, the Company recorded a valuation allowance of $158,000 to reduce thecarrying value of the net deferred tax assets carried in the consolidated balancesheet.  Valuation allowances are providedfor deferred tax assets when in Management’s judgment a portion, or all, of thedeferred tax assets may not be realized. During the first quarter of 2005, Management’s judgment changed and,accordingly, no longer believed a valuation allowance was needed.  The primary factor influencing management’sjudgment was the existence of sustained periods of taxable income.  As of September 30, 2006 and 2005, theCompany determined that it was not necessary to maintain a valuation allowance.

The effective tax ratesfor the first nine months of 2006 and 2005 were 36.40% and 29.76%.  The rate for 2005 was positively impacted bythe elimination of the $158,000 valuation allowance during that period.  Excluding the effects of the valuationallowance, the effective tax rate would have been 38.14%.

**MarketRisk, Liquidity and Interest Rate Sensitivity**

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

The conduct of ourbanking business requires that we maintain adequate liquidity to meet changesin the composition and volume of assets and liabilities due to seasonal,cyclical or other reasons.  Liquiditydescribes the ability of the Company to meet financial obligations that ariseduring the normal course of business. Liquidity is primarily needed to meet the borrowing and depositwithdrawal requirements of the customers of the Company, as well as for meetingcurrent and future planned expenditures. This liquidity is typically provided by the funds received throughcustomer deposits, investment maturities, loan repayments, borrowings, andincome.  Management considers the currentliquidity position to be adequate to meet the needs of the Company and itscustomers.

The Company seeksto limit the risks associated with interest rate fluctuations by managing thebalance between interest sensitive assets and liabilities.  Managing to mitigate interest rate risk is,however, not an exact science.  Not onlydoes the interval until repricing of interest rates on assets and liabilitieschange from day to day as the assets and liabilities change, but for someassets and liabilities, contractual maturity and the actual maturityexperienced are not the same.  Similarly,NOW and money market accounts, by contract, may be withdrawn in their entiretyupon demand and savings deposits may be withdrawn on seven days notice.  While these contracts are extremely short, itis the Company’s belief that these accounts turn over at the rate of fivepercent (5%) per year. The Company therefore treats them as having maturitiesstaggered over all periods.  If all ofthe Company’s NOW, money market, and savings accounts were treated as repricingin one year or less, the cumulative gap at one year or less would be $(76.21)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, 2006, theanticipated maturities or repricing of the Company’s interest-earning assetsand interest-bearing liabilities, the Company’s interest rate sensitivity gap(interest-

20

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earning assetsless interest-bearing liabilities), the Company’s cumulative interest ratesensitivity gap, and the Company’s cumulative interest sensitivity gap ratio(cumulative interest rate sensitivity gap divided by total assets).  A negative gap for any time period means thatmore interest-bearing liabilities will reprice or mature during that timeperiod than interest-earning assets. During periods of rising interest rates, a negative gap position wouldgenerally decrease earnings, and during periods of declining interest rates, anegative gap position would generally increase earnings.  The converse would be true for a positive gapposition.  Therefore, a positive gap forany time period means that more interest-earning assets will reprice or matureduring that time period than interest-bearing liabilities.  During periods of rising interest rates, apositive gap position would generally increase earnings, and during periods ofdeclining interest rates, a positive gap position would generally decreaseearnings.

It is important tonote that the following table represents the static gap position for interestsensitive assets and liabilities at September 30, 2006.  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.

**Interest RateSensitivity Gap AnalysisSeptember 30, 2006**

 
| *** ***                                          | *** *** | ***Expected Repricing or Maturity Date*** | ** **   |
|-------------------------------------------------------|--------------|---------------------------------------------------------------|--------------|
| ***(dollars in thousands)***                | *** *** | ***Within  One Year***                                   | *** *** | ***One to  Three Years*** | *** *** | ***Three to  Five Years*** | *** *** | ***After  Five Years*** | *** *** | ***Total*** | ** ** |
| Assets                                                | ** **   | ** **                                                    | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal funds sold                                    |         | $                                                             | 10,566       |   | $ | — |   | $ | — |   | $ | — |   | $ | 10,566 |   |
| Interest-bearing deposits in other banks              |         | 4,828                                                         |         | — |   | — |   | — |   | 4,828 |   |
| Investment securities(1)                              |         | 1,012                                                         |         | 6,180 |   | 4,031 |   | 18,680 |   | 29,903 |   |
| Loans                                                 |         | 57,628                                                        |         | 42,473 |   | 46,810 |   | 19,626 |   | 166,537 |   |
| Total interest-earning assets                         |         | 74,034                                                        |         | 48,653 |   | 50,841 |   | 38,306 |   | 211,834 |   |
|                                                  | ** **   | ** **                                                    | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Liabilities                                           |         |                                                          | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Savings and NOW accounts                              |         | 1,217                                                         |         | 2,434 |   | 2,434 |   | 18,253 |   | 24,338 |   |
| Money Market accounts                                 |         | 1,749                                                         |         | 3,498 |   | 3,498 |   | 26,233 |   | 34,978 |   |
| Certificates of deposit                               |         | 90,227                                                        |         | 20,138 |   | 4,246 |   | — |   | 114,611 |   |
| Short-term borrowings                                 |         | 700                                                           |         | — |   | — |   | — |   | 700 |   |
| Long-term debt                                        |         | —                                                        |         | — |   | — |   | — |   | — |   |
| Total interest-bearing liabilities                    |         | 93,893                                                        |         | 26,070 |   | 10,178 |   | 44,486 |   | 174,627 |   |
| Interest rate sensitivity gap                         |         | $                                                             | (19,859      | ) | $ | 22,583 |   | $ | 40,663 |   | $ | (6,180 | ) | $ | 37,207 |   |
| Cumulative interest rate sensitivity gap              |         | $                                                             | (19,859      | ) | $ | 2,724 |   | $ | 43,387 |   | $ | 37,207 |   |   |   |
| Cumulative gap  ratio as a percentage of total assets |         | (8.92                                                         | )%           | 1.22 | % | 19.49 | % | 16.71 |   |   |   |

----

(1)             Excludesequity securities.

In addition to theInterest Rate Sensitivity Gap Analysis, the Company also uses an earningssimulation model on a quarterly basis to closely monitor interest sensitivityand to expose its balance sheet and income statement to differentscenarios.  The model is based on currentCompany data and adjusted by assumptions as to growth patterns, noninterestincome and noninterest expense and interest rate sensitivity, based on historicaldata, for both assets and liabilities projected for a one-year period.  The model is then subjected to a “shock test”assuming a sudden interest rate increase of 200 basis points or a decrease of200 basis points, but not below zero. The results show that with a 200 basis point rise in interest rates theCompany’s net interest income would decline by 9.39% and net income woulddecline by 17.48%.  With a decrease ininterest rates of 200 basis points the Company’s net interest income wouldincrease by 5.62% and net income would increase by 10.45%.

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.

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**CriticalAccounting Policy:**

**Allowancefor Loan Losses**

The Company makes provisionsfor loan losses in amounts deemed necessary to maintain the allowance for loanlosses at an appropriate level.  Theprovision for loan losses is determined based upon Management’s estimate of theamount required to maintain an adequate allowance for loan losses reflective ofthe risks in the Company’s loan portfolio. The Company’s provision for loan losses for the first nine months of2006 and 2005 was $180,000 and $450,000, respectively.  The loan growth was $11.20 million for thefirst nine months of 2006 as compared to $16.05 million for the same period in2005.  Due to the increased exposure tocommercial and commercial real estate loans in early 2005, Management deemed itnecessary to increase the provision for loan losses during the first half of2005.  The Company’s provision for loanlosses for the three months ended September 30, 2006 and 2005 were $60,000 and$150,000, respectively.  At September 30,2006 and December 31, 2005, the allowance for loan losses was $2.13 million and$1.95 million, respectively.

The Company prepares a quarterly analysis of theallowance for loan losses, with the objective of quantifying portfolio riskinto a dollar amount of inherent losses. The determination of the allowance for loan losses is based on eight qualitativefactors and one quantitative factor for each category and type of loan alongwith any specific allowance for adversely classified loans within eachcategory.  Each factor is assigned apercentage weight and 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 each factorincreased or decreased due to the particular circumstances, as the varioustypes and categories of loans change as a percentage of total loans and asspecific allowances are required due to increases in adversely classifiedloans.

The allowance for loan losses is established aslosses are estimated to have occurred through a provision for loan lossescharged to earnings.  The allowance isbased on two basic principles of accounting: (i) SFAS No. 5, *Accounting for Contingencies*, whichrequires that losses be accrued when they are probable of occurring andestimatable and (ii) SFAS No. 114, *Accountingby Creditors for Impairment of a Loan*, which requires that losses beaccrued based on the differences between the loan balance and either the valueof collateral, or the present value of future cash flows, or the loan’s valueas observable in the secondary market.  Aloan is considered impaired when, based on current information and events, itis probable that the Bank will be unable to collect the scheduled payments ofprincipal or interest when due according to the contractual terms of the loanagreement.  Factors considered byManagement in determining impairment include payment status, collateral value,and the probability of collecting scheduled principal and interest paymentswhen due.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis., taking into consideration all of the circumstancessurrounding the loan and borrower, including the length of the delay, thereason for the delay, the borrower’s prior payment record, and the amount ofthe shortfall in relation to the principal and interest owed.  The provision for loan losses included in thestatements of operations serve to maintain the allowance at a level Managementconsiders adequate.

The Company’s allowance for loan losses has threebasic components: the specific allowance, the formula allowance and the pooledallowance.  Each of these components isdetermined based upon estimates that can and do change when the actual eventsoccur.  As a result of the uncertaintiesinherent in the estimation process, Management’s estimate of loan losses andthe related allowance could change in the near term.

The specific allowance component is used toindividually establish an allowance for loans identified for impairmenttesting.  When impairment is identified,a specific reserve may be established based on the Company’s calculation of theestimated loss embedded in the individual loan. Impairment testing includes consideration of the borrower’s overallfinancial condition, resources and payment record, support available fromfinancial guarantors and the fair market value of collateral. These factors arecombined to estimate the probability and severity of inherent losses.  Large groups of smaller balance, homogeneousloans are collectively evaluated for impairment. Accordingly, the Company doesnot separately identify individual consumer and residential loans forimpairment.   At September 30, 2006 therewere no loans deemed to be impaired.

The formula allowance component is used forestimating the loss on internally risk rated loans and those loans identifiedfor impairment testing.  The loansmeeting the Company’s internal criteria for classification, such as specialmention, substandard, doubtful and loss are segregated from performing loanswithin the portfolio. These internally classified loans are then grouped byloan type (commercial, commercial real estate, commercial construction,residential real estate, residential construction or installment).  Each loan type is assigned an allowancefactor based on Management’s estimate of the associated risk, complexity andsize of the 

22

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individual loans within the particular loancategory. Classified loans are assigned a higher allowance factor thannon-classified loans due to Management’s concerns regarding collectability orManagement’s knowledge of particular elements surrounding the borrower.Allowance factors increase with the worsening of the internal risk rating.

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

Allowance factors and overall size of the allowancemay change from period to period based on Management’s assessment of theabove-described factors and the relative weights given to each factor.  In addition, various regulatory agenciesperiodically review the allowance for loan losses.  These agencies may require the Bank to makeadditions to the allowance for loan losses based on their judgments ofcollectibility based on information available to them at the time of theirexamination.

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, 2006, the real estate loan portfolio constituted 85% of the totalloan portfolio.  While this exceeds the10% threshold for determining a concentration of credit risk within anindustry, we do not consider this to be a concentration with adverse riskcharacteristics given the diversity of borrowers within the real estateportfolio and other sources of repayment. An industry for this purpose is defined as a group of counterpartiesthat are engaged in similar activities and have similar economiccharacteristics that would cause their ability to meet contractual obligationsto be similarly affected by changes in economic or other conditions.  Additionally, the loan portfolio does notinclude concentrations of credit risk in loan products that permit the deferralof principal payments that are smaller than normal interest accruals (negativeamortization); loans with high loan-to-value ratios; or loans, such as optionadjustable-rate mortgages, that may expose the borrower to future increases inrepayments that are in excess of increases that would result solely fromincreases in market interest rates.   TheCompany has $6.00 million of interest only home equity lines of credit atSeptember 30, 2006.

** **
| *** ***                                   | *** *** | ***Three Months Ended*** | *** *** | ***Nine Months Ended*** | *** *** |
|------------------------------------------------|--------------|------------------------------------|--------------|-----------------------------------|--------------|
| ***(dollars in thousands)***         | *** *** | ***September 30,****2006*     | *** *** | ***September 30,****2005*    | *** *** | ***September 30,****2006* | *** *** | ***September 30,****2005* | *** *** |
| Balance at  beginning of period                |         | $                                  | 2,073        |                              | $            | 1,803 |   | $ | 1,953 |   | $ | 1,503 |   |
| Provision  charged to operating expenses       |         | 60                                 |         | 150                               |         | 180 |   | 450 |   |
| Recoveries of  loans previously charged-off    |         | —                             |         | —                            |         | — |   | — |   |
| Loans  charged-off                             |         | —                             |         | —                            |         | — |   | — |   |
| Balance at end  of period                      |         | $                                  | 2,133        |                              | $            | 1,953 |   | $ | 2,133 |   | $ | 1,953 |   |
| Average total loans  outstanding during period |         | $                                  | 163,989      |                              | $            | 149,721 |   | $ | 161,042 |   | $ | 142,972 |   |

 

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

**Allocation of Allowance for Loan Losses**
| *** ***                                                                | *** *** | ***September 30,*** | *** *** | ***December 31,*** | *** *** |
|-----------------------------------------------------------------------------|--------------|--------------------------|--------------|-------------------------|--------------|
| *** ***                                                                | *** *** | *******2006*             | *** *** | ***% of  Loans***  | *** *** | ***2005*** | *** *** | ***% of  Loans*** | *** *** |
| Real  estate-construction                                                   |         | $                        | 312          |                    | 23           | % | $ | 318 |   | 19 | % |
| Real  estate-mortgage                                                       |         | 1,429                    |         | 62                      | %            | 1,171 |   | 64 | % |
| Commercial and  industrial loans                                            |         | 353                      |         | 13                      | %            | 408 |   | 16 | % |
| Loans to  individuals for household, family and other personal expenditures |         | 39                       |         | 2                       | %            | 56 |   | 1 | % |
|                                                                        |         | $                        | 2,133        |                    | 100          | % | $ | 1,953 |   | 100 | % |

 

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|                                            | *** *** | ***September 30,*** | *** *** | ***December 31,*** | *** *** |
|--------------------------------------------|--------------|--------------------------|--------------|-------------------------|--------------|
| *** ***                               | *** *** | ***2006***               | *** *** | ***2005***              | *** *** |
| Nonaccrual loans                           |         | $                        | 73           |                    | $            | 8 |   |
| Loans 90 days  past due and still accruing |         | —                   |         | —                  |         |
| Total nonperforming loans                  |         | 73                       |         | 8                       |         |
| Other real  estate owned                   |         | —                   |         | —                  |         |
| Total nonperforming assets                 |         | $                        | 73           |                    | $            | 8 |   |
| Nonperforming assets to  total assets      |         | 0.04                     | %            | 0.00                    | %            |

 

There were noother interest-bearing assets at September 30, 2006 or December 31, 2005classified as past due 90 days or more and still accruing, restructured orproblem assets, and no loans which were currently performing in accordance withtheir terms, but as to which information known to Management caused it to haveserious doubts about the ability of the borrower to comply with the loan ascurrently written.

**Off-Balance Sheet Arrangements**

The Company is aparty to financial instruments with off-balance sheet risk in the normal courseof business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit, including unused portions of lines of credit, andstandby letters of credit.  The Companyhas also entered into long-term lease obligations for some of its premises andequipment, the terms of which generally include options to renew.  The above instruments and obligationsinvolve, to varying degrees, elements of off-balance sheet risk in excess ofthe amount recognized in the consolidated statements of financial condition.  None of these instruments or obligations haveor are reasonably likely to have a current or future effect on the Company’sfinancial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources that is material to investors.

Commitments to extend credit and standby letters ofcredit as of September 30, 2006 were as follows:

 

|                                                                                  | *** *** | ***September 30,***      | *** *** |
|----------------------------------------------------------------------------------|--------------|-------------------------------|--------------|
| *** ***                                                                     | *** *** | ***2006***                    | *** *** |
| ***(dollars in thousands)***                                           | *** *** | ***Contractual Amount*** | *** *** |
| Financial  instruments whose notional or contract amounts represent credit risk: |         |                          |         |
| Commitments to extend credit                                                     |         | $                             | 36,182       |   |
| Standby letters of credit                                                        |         | 3,390                         |         |
| Total                                                                            |         | $                             | 39,572       |   |

 

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

**CapitalResources**

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

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

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The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory - and possiblyadditional discretionary - actions by regulators that, if undertaken, couldhave a direct material effect on the Company’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company and the Bankmust meet specific capital guidelines that involve quantitative measures of theCompany’s and the Bank’s assets, liabilities, and certain off-balance-sheetitems as calculated under regulatory accounting practices.  The Company’s and the Bank’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum amounts and ratios of total and Tier 1capital (as defined in the regulations) to risk-weighted assets (as defined),and Tier 1 capital (as defined) to average assets (as defined).   Management believes that the Company and theBank met all capital adequacy requirements to which they are subject as ofSeptember 30, 2006.  See Note 9 to the unaudited consolidatedfinancial statements for a table depicting compliance with regulatory capitalrequirements.

As of September30, 2006, the most recent notification from the regulatory agency categorizedthe Bank as well capitalized under the regulatory framework for promptcorrective action.  To be categorized aswell capitalized the Bank must maintain minimum total risk-based, Tier 1risk-based, and Tier 1 leverage ratios as set forth in the table in Note9.  There are no conditions or eventssince that notification which Management believes have changed the Bank’scategory.

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

## **Inflation**

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

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

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

**Item 4.**                          Controlsand Procedures

The Company’s management, under the supervision andwith the participation of the Company’s Chief Executive Officer and ChiefFinancial Officer, evaluated, as of the last day of the period covered by thisreport, the effectiveness of the design and operation of the Company’sdisclosure controls and procedures, as defined in Rule 13a-15(e) 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, 2006that has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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** **

## **PART II — Other Information**

|          |     |                                                                                                                                                                                    |
|---------------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.       |     | Legal Proceedings      None                                                                                                                                         |
|          |     |                                                                                                                                                                                    |
| Item 1A. |     | Risk Factors   There have been no material  changes to the risk factors as of September 30, 2006 from those disclosed in  the Company’s 2005 Annual Report on Form 10-K. |
|          |     |                                                                                                                                                                                    |
| Item 2        |     | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                                                                            |
|          |     |                                                                                                                                                                                    |
| (a)           | * * | *Sales of Unregistered Securities.  *   *None*                                                                                                                      |
|          | * * | * *                                                                                                                                                                                |
| (b)           | * * | *Use of Proceeds.*   *   Not Applicable.*                                                                                                                           |
|          | * * | * *                                                                                                                                                                                |
| (c)           | * * | *Registrant**Purchases of Securities*   *    None*                                                                                                                  |
|          | * * | * *                                                                                                                                                                                |
| Item 3.       |     | Defaults upon Senior Securities       None                                                                                                                          |
|          |     |                                                                                                                                                                                    |
| Item 4.       |     | Submission of Matters to a Vote of Security Holders      None                                                                                                       |
|          |     |                                                                                                                                                                                    |
| Item 5.       |     | Other Information                                                                                                                                                                       |
|          |     |                                                                                                                                                                                    |
| (a)           |     | Information which should have been Reported on Form  8-K.      None                                                                                                 |
|          |     |                                                                                                                                                                                    |
| (b)           |     | Material Changes to Procedures for Director  Nomination by Shareholders.      None                                                                                  |

 

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** **

Item 6.  Exhibits

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

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

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

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

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

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

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

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

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

27

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**SIGNATURES**

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.
|                        |   | FREDERICK COUNTY BANCORP, INC. |
|------------------------|--------|--------------------------------|
|                   |   |                           |
|                   |   |                           |   |   |
| Date: November 2, 2006 |   | By:                            |   | /s/ Martin S. Lapera |
|                   |   |                           |   | Martin S. Lapera |
|                   |   |                           |   | President and Chief Executive Officer |
|                   |   |                           |   |   |
| Date: November 2, 2006 |   | By:                            |   | /s/ William R. Talley, Jr. |
|                   |   |                           |   | William R. Talley, Jr. |
|                   |   |                           |   | Executive Vice President and Chief Financial Officer |

 

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