SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
                                  FORM 10-KSB


                 ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                                 [FEE REQUIRED]


                  For the fiscal year ended December 31, 1996

[  ]     Transition Report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934 [No Fee Required]

For the transition period from ________________ to _______________

Commission File Number:  0-20990
                         -------

                         HARBOR BANKSHARES CORPORATION
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)

<TABLE>
<S><C>
                  Maryland                                 52-1786341
---------------------------------------------------------------------------------------
(State or other jurisdiction of incorporation)     (IRS Employer Identification Number)

           25 West Fayette Street                                 21201
            Baltimore, Maryland
---------------------------------------------------------------------------------------
  (Address of principal executive offices)                      (Zip Code)
---------------------------------------------------------------------------------------
       Registrant's telephone number:                         (410) 528-1800
</TABLE>


Securities registered pursuant to Section 12(g) of the Act:  None

                    Common Stock, Par Value $0.01 per share
                    ---------------------------------------
                                (Title of Class)

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934 during the  preceding  12 months,  and (2) has been  subject to such filing
requirements for the past 90 days.

         Yes          XXX                  No
             -----------------                -----------------

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. [X]

         The  number of shares  outstanding  of the  issuer's  classes of common
stock as of December  31,  1996,  was 633,444  shares with a par value of $0.01.
(Note: This information is required as of the latest practical date.)


<PAGE>



Documents Incorporated by Reference
-----------------------------------

         Portions of the Registrant's Annual Report to Shareholders for the year
ended  December  31,  1996  and  the  Registrant's   1997  Proxy  Statement  are
incorporated by reference into Parts I and II.


                                       2

<PAGE>



PART I
------
Harbor Bankshares Corporation
-----------------------------
Item 1.  Business
-----------------
         Harbor  Bankshares  Corporation  (the  Corporation)  is a bank  holding
company with one bank  subsidiary.  The Corporation was organized under the laws
of the State of  Maryland  in 1992.  On  November  2,  1992,  Harbor  Bankshares
Corporation  acquired all outstanding  stock of The Harbor Bank of Maryland (the
Bank), headquartered in Baltimore, Maryland.

         During June 1996, The  Corporation  completed a common stock  offering,
with total  sales of 198,481  shares and net  proceeds  of $2.8  million.  These
proceeds will be used for the expansion of the Corporation.


The Harbor Bank of Maryland
---------------------------
         The Harbor  Bank of Maryland is a state  chartered  institution  in the
State of Maryland.  The deposits of the Bank are insured by the Federal  Deposit
Insurance Corporation.

         The Harbor Bank of  Maryland  is a  commercial  bank  headquartered  in
Baltimore, Maryland. The Bank conducts a general commercial and retail business.
The Bank was opened on September 13, 1982 and was incorporated under the laws of
the State of  Maryland.  During  the  second  and third  quarters  of 1994,  the
Corporation,  through its subsidiary, The Harbor Bank of Maryland acquired three
(3) branch locations from the Resolution Trust  Corporation;  two (2) located in
Baltimore City, and one (1) located in Riverdale,  Prince George's County. A new
branch location was opened during December 1995 in Baltimore  County,  expanding
the  market  area  of the  Bank.  During  1996,  in a  partnership  with a local
supermarket  chain  located in  Baltimore  City,  a network of ATM  machines was
installed,  expanding the market of the Bank to different areas of the Baltimore
Metropolitan area. The total number of ATM machines, including the Bank's branch
locations is nineteen.

         Harbor  Financial  Services,  a company dealing with the sale of mutual
funds,  stocks,  insurance  etc.,  was  established  as a subsidiary of the Bank
during May 1996, in order to compete with that expanding market, the Company had
an operating loss of $72 thousand.

         The Bank  conducts  general  banking  business in six (6) locations and
serves primarily the Baltimore  Metropolitan  area. It offers checking,  savings
and  time  deposits,   commercial,  real  estate,  personal,  home  improvement,
automobile and other installment loans, credit cards and term loans. The Bank is
also a member of a local and national ATM network. The retail nature of the Bank
allows for full diversification of deposits and borrowers so it is not dependent
upon a single or a few customers.



                                       3

<PAGE>



Competition
-----------
         The  Corporation's  only  subsidiary,  The  Harbor  Bank  of  Maryland,
competes with virtually all banks and savings  institutions which offer services
in its market area.  The Bank  directly  competes  with  branches of most of the
State's largest banks,  each of which has greater  financial and other resources
to conduct large  advertising  campaigns and to allocate their investment assets
to regions of higher yield and demand.  To attract  business in this competitive
environment,  the Bank  relies  heavily  on  local  promotional  activities  and
personal  contact by its  officers and  directors  and by its ability to provide
personalized services.


Supervision and Regulation
--------------------------
         Harbor  Bankshares  Corporation  is a registered  bank holding  company
subject to regulation  and  examination by the board of governors of the Federal
Reserve  System  under the Bank  Holding  Company Act of 1956 (the  "Act").  The
Corporation is required to file with the board of governors quarterly and annual
reports and any  additional  information  that may be required  according to the
Act.  The Act also  requires  every  bank  holding  company  to obtain the prior
approval  of the  Federal  Reserve  Board  before  acquiring  direct or indirect
ownership  or control  of more than 5% of the voting  shares of any bank that is
not already majority owned. The Act also prohibits a bank holding company,  with
certain exceptions,  from engaging in or acquiring direct or indirect control of
more  than  5% of the  voting  shares  of any  company  engaged  in  non-banking
activities.  One of the principal exceptions to these provisions is for engaging
or  acquiring  shares of a company  engaged in  activities  found by the Federal
Reserve  Board to be so closely  related to  banking or  managing  banks to be a
proper incident thereto.

         The Harbor Bank of Maryland is a state chartered institution insured by
the Federal Deposit  Insurance  Corporation  ("FDIC") and subject to federal and
state laws  applicable to commercial  banks.  The Bank is examined  regularly by
FDIC and the State of Maryland Banking Commissioner's office.

         In accordance with Federal Reserve  regulation,  the Bank is limited as
to the amount it may loan  affiliates,  including the  Corporation,  unless such
loans are  collateralized  by specific  obligations.  Additionally,  banking law
limits the amount of dividends  that a bank can pay without prior  approval from
bank regulators.


Governmental Monetary Policies and Economic Controls
----------------------------------------------------
         The earnings and growth of the banking  industry and  ultimately of The
Harbor Bank of Maryland,  Harbor Bankshares  Corporation's sole subsidiary,  are
affected by the credit  policies of monetary  authorities  including the Federal
Reserve  System.  An  important  function  of the Federal  Reserve  System is to
regulate the national supply of bank credit in order to control recessionary and
inflationary  pressures.  Among the  instruments of monetary  policy used by the
Federal Reserve to implement these objectives are open market operations in U.S.
Government  securities,  changes in the discount rate of member bank borrowings,
and changes in reserve  requirements  against member bank deposits.  These means
are used in varying  combinations to influence  overall growth of bank loans and
investments and deposits, and may also affect interest rates charged on loans or
paid for deposits. The monetary policies of the Federal Reserve authorities have
had a  significant  effect on the operating  results of commercial  banks in the
past and are expected to continue to have such an effect in the future.

                                       4

<PAGE>



         In view of changing conditions in the national economy and in the money
markets,  as well as the effect of actions by monetary  and fiscal  authorities,
including the Federal Reserve  System,  no prediction can be made as to possible
future changes in interest  rates,  deposit  levels,  and loan demand,  or their
effect on the business and earnings of the Corporation and its subsidiary.


Employees
---------
         At December 31, 1996, Harbor Bankshares  Corporation and its subsidiary
employed  63  individuals,  of  which  20 were  officers  and 43 were  full-time
employees.


Executive Officers
------------------
         Information  concerning executive officers of the Corporation is listed
below:


Executive Officers           Age      Position
------------------           ---      --------


Joseph Haskins, Jr.           49      Chairman, President and Chief Executive
                                      Officer of the Bank and Corporation

John Paterakis                68      Chairman of the Executive Committee of the
                                      Corporation and the Bank

Teodoro J. Hernandez          51      Treasurer of the Corporation and Vice
                                      President and Cashier of the Bank

George F. Vaeth, Jr.          63      Secretary of the Corporation and the Bank



Statistical Information
-----------------------
         The  statistical  information  required in this section is incorporated
herein by reference from the Registrant's  Annual Report to Shareholders for the
year ended December 31, 1996 and from pages 9 through 21 of this form 10-KSB.


Item 2.  Properties
-------------------
         The  Corporation's  Headquarters  is located at 25 West Fayette Street,
Baltimore,   Maryland   21201.   The  lease   agreement  for  this  location  is
approximately  12,777 square feet with a term of ten (10) years, and a renewable
option of five (5) years.

         The Bank also maintains  another five (5) leased branch offices;  three
(3)  located in  Baltimore  City,  one (1)  located in Prince  George's  County,
Maryland and one (1) located in Baltimore County, Maryland.

                                       5

<PAGE>


Item 3.  Legal Proceedings
--------------------------
         The Corporation  and its  subsidiaries,  at times,  and in the ordinary
course of business,  are subject to legal actions.  Management  does not believe
the outcome of such matters will have a material adverse effect on the financial
condition or results of operations of the Corporation.

Item 4.  Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
         None


PART II
-------
Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters
------------------------------------------------------------------------------
         Information listed under "Shareholder Information" in the Annual Report
to Shareholders  for the year ended December 31, 1996 is incorporated  herein by
reference  with  respect to prices  for the  Registrant's  common  stock and the
dividends paid thereon.  The number of Shareholders of Record as of December 31,
1996 was 740.

Item 6.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations
--------------------------------------------------------------------------------
         Information  required by this item is  incorporated  by reference  from
information appearing under the caption,  "Corporate Financial Review" appearing
on pages 1 through 10 of the Management  Discussion and Analysis  section of the
Registrant's Annual Report to Shareholders for the year ended December 31, 1996,
and from pages 9 through 21 of this Form 10-KSB.


Item 7.  Financial Statements
-----------------------------
         Information  required  by  Item 7 is  incorporated  by  reference  from
information  appearing  on  pages  1  through  15 in  the  Audited  Consolidated
Financial  Statements section of the Registrant's  Annual Report to Shareholders
for the year ended December 31, 1996

Item 8.  Changes In and Disagreements with Accountants on Accounting and
         Financial Disclosure
------------------------------------------------------------------------
         None

PART III
--------

Item 9.  Directors and Executive Officers of the Registrant
-----------------------------------------------------------
         Information  required by this item is  incorporated  by reference  from
information appearing under the caption, "Election of Directors" on pages 2 to 7
of the  Registrant's  1997 Proxy  Statement  and page 5 of this report under the
caption of "Executive Officers" of the Registrant.

                                       6

<PAGE>



Item 10.  Executive Compensation
--------------------------------
         Information  required by this item is  incorporated  by reference  from
information  appearing under the caption "Executive  Compensation" on pages 7 to
10 of the Registrant's 1997 Proxy Statement.

Item 11.  Security ownership of certain beneficial owners and management
------------------------------------------------------------------------
         Information  required  by Item 11 is  incorporated  by  reference  from
information  appearing on pages 2 to 7 of the Registrant's 1997 Proxy Statement,
under the caption of "Election of Directors" of the Registrant.

Item 12.  Certain relationships and related transactions
--------------------------------------------------------
         The  information  required by Item 12 is incorporated by reference from
Note 11 on page 19 in the Audited  Consolidated  Financial Statements section of
the Registrant's Annual Report to Shareholders.

PART IV
-------
Item 13.  Exhibits and Reports on Form 8-K
------------------------------------------
(a)      Exhibits

         (1) The following  consolidated  financial statements of the Registrant
and its subsidiary,  included in the Annual Report to Shareholders  for the year
ended December 31, 1996, are incorporated herein by reference in Item 8:


         Consolidated Statements of Financial Condition
                  As of December 31, 1996 and 1995

         Consolidated Statements of Income
                  Years ended December 31, 1996, 1995 and 1994

         Consolidated Statements of Changes in Shareholders'  Equity Years ended
                  December 31, 1996, 1995 and 1994

         Consolidated Statements of Cash Flows
                  Years ended December 31, 1996, 1995 and 1994

         Notes to Consolidated Financial Statements

         Report of Ernst & Young, LLP, Independent Auditors

         Harbor Bankshares Corporation 1997 Proxy Statement



                                       7

<PAGE>



         All other schedules to the consolidated  financial  statements required
by  Article  9 of  Regulation  S-X  and all  other  schedules  to the  financial
statements of the  Registrant  required by Article 5 of  Regulation  S-X are not
required under the related instructions or are inapplicable and, therefore, have
been omitted.


         (2)  List of financial items attached:

              Consolidated Average Statements of Financial Condition
              Consolidated Statements of Income
              Consolidated Statements of Average Rates
              Interest Variance Analysis
              Investment Securities -- Book Value
              Investment Securities -- Weighted Rate by Maturity
              Investment Securities -- Market Value
              Investment Securities -- Maturities
              Loan Distribution
              Risk Elements of Loan Portfolio
              Summary of Loan Loss Experience
              Loan Maturities and Sensitivity
              Time Certificates -- $100,000 Maturities

(b)      No  reports on Form 8-K were  filed  during  the last  quarter of the
period covered by this report.

                                       8

<PAGE>


       CONSOLIDATED AVERAGE STATEMENTS OF FINANCIAL CONDITION AND RATIOS
                                   (in 000s)

<TABLE>
<CAPTION>

Year ended December 31,                                      1996               1995               1994
                                                             ----               ----               ----
<S><C>
ASSETS
      U.S. Treasury Securities                             $    ----          $   1,321          $  3,627
      U.S. Government Agencies                                14,880              8,944             7,717
      Interest-Bearing Deposits with Other Banks               7,064              7,712             9,190
      FHLB Stock and Other Securities                            561                418               270
      Federal Funds Sold                                       3,103              4,786            20,784
                                                           ---------          ---------          --------
                                                           $  25,608          $  23,181          $ 41,588
      Commercial Loans                                         7,451              4,862             3,324

      Real Estate Mortgages                                   70,697             67,508            37,062
      Consumer Loans                                           3,010              2,541             1,885
                                                           ---------          ---------          --------
      Loans Net of Unearned Income                            81,158             74,911            42,271
      Total Earning Assets                                   106,766             98,092            83,859
      Allowance for Possible Losses                             (880)              (817)             (499)
      Other Assets                                            10,410              9,584             5,566
                                                           ---------          ---------          --------
           TOTAL ASSETS                                    $ 116,296          $ 106,859          $ 88,926
                                                           =========          =========          ========

LIABILITIES AND SHAREHOLDERS' EQUITY
      Non-Interest Bearing Deposits                        $   9,316          $   8,991          $  8,640
      Interest-Bearing Transaction Accounts                   15,798             18,184            19,434
      Savings                                                 35,671             33,386            26,541
      Time - $100,000 or more                                 11,792              8,748             7,557
      Other Time                                              28,329             24,648            18,816
                                                           ---------          ---------          --------
      TOTAL Deposits                                       $ 100,906          $  93,957            80,988
      Other borrowed money                                     1,452              1,195              ----
      Notes payable                                            5,796              5,796             2,724

      Other Liabilities                                          888                593               584
                                                           ---------          ---------          --------
           TOTAL Liabilities                               $ 109,042          $ 101,541          $ 84,296
SHAREHOLDERS' EQUITY                                           7,254              5,318             4,630
                                                           ---------          ---------          --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                 $ 116,296          $ 106,859          $ 88,926
                                                           =========          =========          ========
</TABLE>


                                       9

<PAGE>


<TABLE>
<CAPTION>

RATIOS                                                1996                  1995                    1994
                                                      ----                  ----                    ----
<S><C>
Average Equity to Average Total Assets               6.24%                   4.98%                  5.21%
Return on Assets                                      .49%                    .64%                   .70%
Return on Equity                                     7.90%                   12.8%                  13.5%
Dividend Payout Ratio                                15.1%                   12.7%                  14.0%
</TABLE>


CAPITAL SCHEDULE

Risk-based  guidelines apply on a consolidated  basis to bank holding  companies
with  consolidated  assets of $150 million or more. For those holding  companies
with less than $150  million  in  assets,  the  guidelines  will be applied on a
bank-only basis. As Harbor Bankshares  Corporation had total consolidated assets
of $130 million and $113  million at December  31, 1996 and 1995,  respectively,
only the capital ratios of the Bank are disclosed below.



                        The Harbor Bank of Maryland      Regulatory Requirements

Primary Capital                       8.93%                   4.0%
Risk-Based Capital                   15.75%                   8.0%


                                       10

<PAGE>



                       CONSOLIDATED STATEMENTS OF INCOME
                          (000s except per share data)

<TABLE>
<CAPTION>

Year ended December 31,                                    1996                1995                 1994
                                                           ----                ----                 ----
<S><C>
INTEREST AND FEES ON LOANS
      Commercial Loans                                     $ 732               $ 512                $ 289
      Real Estate Mortgages                                6,702               6,339                4,034
      Consumer Loans                                         371                 311                  211
                                                         -------             -------              -------
TOTAL Interest and Fees on Loans(1)                      $ 7,805             $ 7,162              $ 4,534
Interest on Taxable Investment Securities                    976                 597                  558
Interest on Other Investments(2)                             400                 431                  508
Interest on Federal Funds Sold                               165                 300                  937
                                                         -------             -------              -------
      TOTAL Interest Income                                9,346               8,490                6,537
INTEREST EXPENSE
      Savings                                              1,235               1,018                  896
      Interest-Bearing Transaction Accounts                  412                 462                  490
      Time - $100,000 or more                                635                 463                  289
      Other Time                                           1,497               1,275                  727
      Other Borrowed Money                                    81                  78                 ----
       Interest on Notes Payable                             309                 335                  124
                                                         -------             -------              -------
      TOTAL Interest Expense                               4,169               3,631                2,526
Net Interest Income                                        5,177               4,859                4,011
Provision for Possible Credit Losses                          60                 183                  248
                                                         -------             -------              -------
Net Interest Income After Provision for Possible
Credit Losses                                              5,117               4,676                3,763
Other Income                                                 759                 635                  786
Investment Security Gains (Losses)                          ----                ----                 ----
Other Expenses                                             4,888               4,181                3,554
                                                         -------             -------              -------
Income Before Taxes                                          988               1,130                  995
Applicable Income Tax                                        415                 451                  370
                                                         -------             -------              -------
NET INCOME                                                 $ 573               $ 679                $ 625
                                                           =====               =====                =====

PER COMMON SHARE
      NET INCOME                                          $ 1.09              $ 1.59               $ 1.46
                                                          ======              ======               ======
      Dividends per Share                                 $  .20                 .20               $  .14
                                                          ======              ======               ======
</TABLE>


                                       11

<PAGE>



NOTES ON CONSOLIDATED STATEMENTS OF INCOME:

(1)   Loan fees, which are included in Interest Income, were $291 in 1996, $232
      in 1995, and $210 in 1994.

(2)   Certificates of Deposit with other financial institutions.



                                       12

<PAGE>



      The following is a chart that illustrates the average rates earned or paid
for the years 1996, 1994 and 1993:

<TABLE>
<CAPTION>

               Year ended December 31,                1996               1995               1994
                                                      ----               ----               ----
<S><C>
AVERAGE RATES EARNED
      Commercial Loans                                 9.82%             10.53%              8.69%
      Real Estate Mortgages                            9.48%              9.39%             10.88%
      Consumer Loans                                  12.33%             12.23%             11.19%
      Taxable Investment Securities                    6.56%              5.59%              4.92%
      Other Investments(1)                             5.66%              5.59%              5.53%
      Federal Funds Sold                               5.32%              6.27%              4.51%
                                                      ------             ------             ------
           TOTAL Earning Assets                        8.75%              8.65%              7.79%

AVERAGE RATES PAID
      Interest Bearing Transaction Accounts            2.61%              2.54%              2.52%
      Savings                                          3.46%              3.05%              3.38%
      Time - $100,000 or more                          5.39%              5.29%              3.82%
      Other Time                                       5.28%              5.17%              3.86%
      Other Borrowed Money                             5.58%              6.53%              ----
      Notes Payable                                    5.33%              5.78%              4.51%
                                                      ------             ------             ------
      TOTAL Interest Bearing Deposits                  4.55%              3.96%              3.46%
      NET YIELD ON EARNING ASSETS                      4.20%              4.69%              4.33%
</TABLE>


(1)   Certificates of Deposit with other financial institutions.


                                       13

<PAGE>



      The following table sets forth,  for the periods  indicated,  a summary of
the changes in interest  earned and  interest  paid  resulting  from  changes in
volume and changes in rates:

                           INTEREST VARIANCE ANALYSIS
                                   (in 000s)

<TABLE>
<CAPTION>
                                         1996 COMPARED TO 1995                           1995 COMPARED TO 1994
                                      Increase (Decrease) due to:                     Increase (Decrease) due to:
                            -------------------------------------------------------------------------------------------------
                              Volume           Rate             Net           Volume            Rate              Net
                              ------           ----             ---           ------            ----              ---
<S><C>
INTEREST INCOME
Loans                        $ 1,032         $ (389)          $ 643           $ 3,118          $(490)          $ 2,628
Investment Securities            268            111             379               (53)            92                39
Federal Funds Sold               (89)           (46)           (135)           (1,002)           365              (637)
Other Interest Bearing
Assets (1)                       (85)           (54)            (31)             (132)            55               (77)
                             -------         ------           -----           -------          -----           -------

      TOTAL Interest
      Income                 $ 1,126         $ (270)          $ 856           $ 1,931          $  22           $ 1,953
                             =======         =======          =====           =======          =====           =======

INTEREST EXPENSE
Interest-Bearing
Transaction Accounts         $  (182)        $  132           $ (50)          $   (66)         $  38           $   (28)

Savings                           80            137             217               210            (88)              122
Time - $100,000 or
more                             163              9             172                63            111               174
Other Time                       195             27             222               302            246               548
Other Borrowed Money              14            (11)              3                78           ----                78

Notes Payable                   ----            (26)            (26)              176             35               211
                             -------         ------           -----           -------          -----           -------
TOTAL Interest
Expense                      $   270         $  268           $ 538           $   763          $ 342           $ 1,105
                             =======         ======           =====           =======          =====           =======
NET INTEREST
INCOME                       $   856         $ (538)          $ 318           $ 1,168          $(320)          $   848
                             =======         =======          =====           =======          =====           =======
</TABLE>

Note:      Loan fees, which were included in interest income were $291 in 1996,
           $232 in 1995 and $210 in 1994. A change in Rate/Volume has been
           allocated to the change in rate.

(1)   Certificates of Deposit with other financial institutions.

                                       14

<PAGE>



      The following table shows the Corporation's  investment  security maturity
distribution as of December 31, 1996:

                             INVESTMENT SECURITIES
                                   (in 000s)
<TABLE>
<CAPTION>
                              U.S. Treasury      U.S. Government      Other Securities       TOTAL
                                                     Agencies
<S><C>
Maturing Within One Year              ----                 ----                ----          $ ----
Maturing After One But                ----             $ 15,992                ----         $15,992
Within Five Years
Maturing After Five But               ----                 ----                ----            ----
Within Ten Years
Maturing After Ten Years              ----                 ----               $ 593         $   593
                                      ----               ------               -----         -------
TOTAL                              $  ----             $ 15,992               $ 593         $16,585
                                   =======             ========               =====         =======
</TABLE>

      The  following  table  shows a  weighted  average  interest  rate  for the
Corporation's investment securities as of December 31, 1995:

                                               INVESTMENT SECURITIES
                                                (Weighted Average)
<TABLE>
<CAPTION>
                              U.S. Treasury      U.S. Government      Other Securities       TOTAL
                                                     Agencies
<S><C>
Maturing Within One Year             ----               ----                   ----           ----
Maturing After One But               ----              6.22%                   ----          6.22%
Within Five Years
Maturing After Five But              ----               ----                   ----           ----
Within Ten Years
Maturing After Ten Years             ----               ----                  7.38%          7.38%
                                   ------              -----                  -----          -----
TOTAL                                ----              6.22%                  7.38%          6.80%
                                   ======              =====                  =====          =====
</TABLE>



                                       15

<PAGE>



      The following table sets forth the carrying amount and the market value of
the Corporation's investment securities at the dates indicated:

                                               INVESTMENT SECURITIES
                                                     (in 000s)
<TABLE>
<CAPTION>
                                    1996                            1995                             1994
                                    ----                            ----                             ----
                            Book           Market           Book            Market           Book           Market
                            ----           ------           ----            ------           ----           ------
<S><C>
U.S. Treasury                 ----            ----            ----             ----         $ 3,002         $ 2,957
U.S. Government             15,992          15,876          10,447           10,485          10,493          10,283
Agency
Other Securities               593             593             447              447             300             300
                           -------         -------         -------          -------         -------         -------
TOTAL                      $16,585         $16,469         $10,894          $10,932         $13,795         $13,540
                           =======         =======         =======          =======         =======         =======
</TABLE>


                                       16

<PAGE>



      The following is a table that shows the Corporation's loan distribution at
the end of each of the last five years:


                               LOAN DISTRIBUTION
                                   (in 000s)
<TABLE>
<CAPTION>
     December 31           1996                1995               1994                1993               1992
                           ----                ----               ----                ----               ----
<S><C>
Commercial Loans          $ 9,612             $ 5,891            $ 3,761             $ 3,190            $ 2,854
Real Estate                72,017              69,414             52,418              31,156             27,914
Mortgages
Consumer Loans              3,713               2,804              2,122               1,734              1,527
                         --------            --------           --------            --------           --------
      TOTAL              $ 85,342            $ 78,109           $ 58,301            $ 36,080           $ 32,295
                         ========            ========           ========            ========           ========
</TABLE>


                                LOAN DISTRIBUTION
                                    (Percent)
<TABLE>
<CAPTION>
     December 31           1996                1995               1994                1993               1992
                           ----                ----               ----                ----               ----
<S><C>
Commercial Loans          11.26%               7.54%              6.45%               8.84%              8.84%
Real Estate Loans         84.39%              88.87%             89.91%              86.35%             86.43%
Consumer Loans             4.35%               3.59%              3.64%               4.81%              4.73%
                          ------              ------             ------              ------             ------
      TOTAL               100.0%              100.0%             100.0%              100.0%             100.0%
                          ======              ======             ======              ======             ======
</TABLE>


                                       17

<PAGE>



      The  following  is a  chart  that  gives  the  summary  of the  loan  loss
experience for each year in the five year period ended December 31, 1996:

                                          SUMMARY OF LOAN LOSS EXPERIENCE
                                                     (in 000s)
<TABLE>
<CAPTION>
     Year ended December 31,                   1996              1995              1994             1993              1992
                                               ----              ----              ----             ----              ----
<S><C>
Balance at Beginning of
Period                                        $ 817             $ 658             $ 428            $ 344             $ 286
Loans Charged Off:
      Commercial Loans                           14               ---                 4                1                27
      Real Estate Mortgages                       5                 6                19               16                15
      Consumer Loans                             34                29                 8               16                30
                                             ------            ------               ---             ----               ---
TOTAL Loans Charged Off                        $ 53              $ 35              $ 31             $ 33              $ 72

Recoveries of Loans:
      Commercial Loans                           57                 1                 2                1                 1
      Real Estate Mortgages                     ---                 6               ---                8                 2
      Consumer Loans                              8                 4                11               12                21
                                            -------           -------             -----            -----             -----
TOTAL Loans Recovered                            65                11                13               21                24
                                            -------           -------             -----            -----             -----
Net Loans Charged Off                          (12)                24                18               12                48
                                            -------           -------             -----            -----              ----
Provisions Charged to
Operations                                       60               183               248               96               106
                                              -----             -----             -----            -----             -----
Balance at End of Period                      $ 889             $ 817             $ 658            $ 428             $ 344
                                              =====             =====             =====            =====             =====
Daily Average Amount of
Loans                                      $ 81,158          $ 74,911          $ 42,271         $ 33,546            29,802
                                           ========          ========          ========         ========            ======
Allowance for Possible Loan
Losses to Loans Outstanding                   1.04%             1.09%             1.13%            1.18%             1.07%
                                              =====             =====             =====            =====             =====
Net Charge Offs to Average
Loans Outstanding                            (.01%)              .03%              .04%             .04%              .16%
                                             ======              ====              ====             ====              ====
</TABLE>


                                       18

<PAGE>




                        RISK ELEMENTS OF LOAN PORTFOLIO
                                   (in 000s)

       December 31         1996       1995        1994        1993       1992
                           ----       ----        ----        ----       ----
Non-Accrual Loans         $ 284       none       $ 200       $ 200       none
                          -----       ----       -----       -----       ----
Accruing Loans Past
Due 90 Days or More         276        481         143          34         42
                          -----       ----       -----       -----       ----
Restructured Loans         none       none        none        none       none
                          =====       ====       =====       =====       ====


      The following is information with respect to non-accrual loans at December
31, 1996 and December 31, 1995:

                                                          1996            1995
                                                          ----            ----
Interest Income that Would Have Been Recorded             $  22           $----
                                                          -----           -----
Under Original Terms
Interest Income Recorded during the Period                $   3            ----
                                                          -----           -----



      It is the policy of the Corporation to place a loan on non-accrual  status
whenever  there is  substantial  doubt  about the  ability of a borrower  to pay
principal  or interest on any  outstanding  credit.  Management  considers  such
factors as payment history,  the nature of the collateral securing the loan, and
the  overall  economic  situation  of the  borrower  when  making a  non-accrual
decision.  Non-accrual loans are closely monitored by management. A non-accruing
loan is restored to accrual  status when  principal  and interest  payments have
been  brought  current  or it  becomes  well-secured  or is in  the  process  of
collection  and the  prospects of future  contractual  payments are no longer in
doubt.

Potential Problem Loans

      At December 31, 1996, the  Corporation had $1.7 million in loans for which
the borrowers are experiencing financial  difficulties.  Those loans are subject
to constant management attention and their classification is reviewed monthly.

      As of December 31, 1996,  84.4% of the  Corporation's  loan  portfolio was
secured by real estate, mainly, 1-to-4 family residential properties.

      Management  analyzes the reserve for  possible  loan losses on a quarterly
basis.  Those  factors  considered  in  determining  the adequacy of the reserve
include specific  identification of known risk loans,  adequacy of collateral on
specific  past due and  non-accrual  loans,  past  experience,  the ratio of the
reserve to net loans and current and anticipated  economic conditions  affecting
the customer base in the area the Bank serves.

      Management allocates the reserve for possible loan losses by type of loan.
Both  performing  and  non-performing  loans are also reviewed  periodically  to
identify high risk assets and their potential impact upon the reserve.  Based on
all  information  known to date,  management  does not  expect  net  losses as a
percentage of average loans in 1997 to exceed the 1996 levels.


                                       19

<PAGE>


      The  following  is a table that shows the maturity of loans as of December
31, 1996:

<TABLE>
<CAPTION>
                                       Commercial             Real Estate           Consumer
                                          Loans                Mortgages              Loans             TOTAL
                                       ----------             -----------           --------            -----
<S><C>
Maturing Within One Year                 $ 7,603                $ 22,657                $ 684           $ 30,944
Maturing After One Year
But Within Five Years                      2,009                   8,729                  632           $ 11,370
Maturing After Five Years                    ---                  40,631                2,397           $ 43,028
                                          ------               ---------             --------           --------


TOTAL                                    $ 9,612                $ 72,017              $ 3,713           $ 85,342
                                         =======                ========              =======           ========
</TABLE>

Classified By Sensitivity To Changes In Interest Rates:

<TABLE>
<CAPTION>
                                                             Adjustable
                                      Fixed Interest          Interest
                                      Rate Loans             Rate Loans            TOTAL
                                      --------------         ----------            -----
<S><C>
Maturing Within One Year                 $  1,869              $ 29,075          $ 30,944
Maturing After One But Within
Five Years                                  7,585                 3,785            11,370
Maturing After Five Years                  43,028                  ----            43,028
                                         --------              --------          --------
TOTAL                                    $ 52,482              $ 32,860          $ 85,342
                                         ========              ========          ========
</TABLE>


                                       20

<PAGE>



      Maturities of time certificates of deposit of $100,000 or more outstanding
at December 31, 1996 and 1995 are summarized as follows:

                        TIME CERTIFICATES OVER $100,000
                                   (in 000s)

MATURING:                          1996               1995
                                   ----               ----
Three months or less              $ 3,434           $ 3,870
Three to six months                 2,354             3,310
Six to twelve months                3,283             3,494
Over twelve months                  8,309               674
                                 --------             -----
TOTAL                            $ 17,380          $ 11,348



Long and Short Term Borrowings

      Short  term  borrowings   consist  of  borrowings  from  the  FHLB.  These
borrowings reprice daily, have maturities of one year or less and may be prepaid
without  penalty.  Long term  borrowings  consist of a  five-year  note from the
Resolution Trust Company with quarterly interest payments based on Treasury Bill
rates and principal payment at the end of the fifth year. Principal payments can
be made without penalty before the maturity of the note.

      The  table  below  presents  certain   information  with  respect  to  the
borrowings:

                                                       Years ended December 31,
                                                       ------------------------
                                                        1996            1995
                                                        ----            ----
                                                        (Dollars in Thousands)

Amount outstanding at period-end:
      Long-term promissory note                         $ 5,796         $ 5,796
      Borrowings from FHLB                                  ---             ---

Average outstanding:
      Long-term promissory note                         $ 5,796         $ 5,796
      Borrowings from FHLB                                1,452           1,195
Weighted average interest rate during the period:
      Long-term promissory note                           5.33%           5.93%
      Borrowings from FHLB                                5.58%           6.56%


                                       21

<PAGE>




           Pursuant to the requirements of Section 13 or 15(D) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.


           HARBOR BANKSHARES CORPORATION


              /s/ Teodoro J. Hernandez
By:        __________________________________________________

                  Treasurer
Title:     __________________________________________________

                  March 27, 1997
Date:      __________________________________________________



Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant, and in the
capacities, and on the dates indicated:


              /s/ Stanley W. Tucker
By:        __________________________________________________

                  Director
Title:     __________________________________________________

                  March 27, 1997
Date:      __________________________________________________


              /s/ John Paterakis
By:        __________________________________________________

                  Director
Title:     __________________________________________________

                  March 27, 1997
Date:      ________________________________________________


              /s/ Louis J. Grasmick
By:        __________________________________________________

                  Director
Title:     __________________________________________________

                  March 27, 1997
Date:      __________________________________________________




                                       22

<PAGE>



               /s/Joseph Haskins, Jr.
By:        __________________________________________________

                  Chairman, President and CEO
Title:     __________________________________________________

                  March 27, 1997
Date:      __________________________________________________



                                       23

<PAGE>

                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operation

                           Corporate Financial Review

OVERVIEW

         Harbor  Bankshares  Corporation  continued its  expansion  during 1996,
through its  subsidiary,  The Harbor Bank of Maryland.  A network of fifteen ATM
Machines was established  during September 1996 in a partnership with Stop, Shop
and Save, a Supermarket  chain  located in Baltimore  City creating a new market
for the services of the Corporation.  In addition,  two other ATM locations were
added, bringing the total of machines in the network,  including existing branch
locations, to nineteen.

         During May of 1996, the Corporation's only subsidiary,  The Harbor Bank
of Maryland,  established Harbor Financial Services,  a company dealing with the
sales of Insurance,  Mutual Funds and other financial services.  The Company was
established  to provide  additional  financial  services to the Bank's  customer
base.

         During July 1996, a secondary  common stock  offering of 198,481 shares
was concluded. The net proceeds of $2.8 million were raised to help continue the
growth of the Corporation  through the  establishment of additional  branches to
better serve its customer base. The secondary offering of common stock increased
average shares  outstanding by  approximately  100,000  shares,  and accordingly
reduced earnings per share.

         Net earnings for Harbor Bankshares Corporation,  were $573 thousand for
1996,  compared  to $679 for 1995,  a decrease of $106  thousand  or 15.6%.  The
Corporation's only subsidiary, The Harbor Bank of Maryland, achieved earnings of
$777 thousand in 1996, with a Return on Average Assets of .67%.

                                       1

<PAGE>



HARBOR BANKSHARES CORORATION AND SUBSIDIARY

         The Corporation's Return on Average Assets (ROAA) was .49%, compared to
 .64% earned during 1995,  reflecting the cost of the expansions and the one time
assessment  fee from the FDIC which  totaled  $235  thousand.  Return on Average
Equity (ROAE) was 7.9% for 1996 compared to 12.8% for 1995.

         Earnings per average outstanding share, adjusted  retroactively for the
1 1/3% stock dividend  declared  January 15, 1997,  payable February 28, 1997 to
common  stockholders  or record on January 31, 1997 for the years ended 1996 and
1995, decreased to $1.07 in 1996 from $1.55 the previous year.

FDIC  ASSESSMENT AND ACQUISITIONS

         The FDIC has implemented a risk-related  assessment  system for deposit
insurance  premiums.  All depository  institutions  have been assigned to one of
nine risk assessment  classifications based upon certain capital and supervisory
measures.

         As a result of the  acquisition of branch  offices and related  insured
deposits of John Hanson Federal Savings Bank and Second National Federal Savings
Bank, approximately 49.5% of the Bank's "average assessment base" (as defined in
the FDIC's  regulations)  was  subject to the  deposit  assessment  rates of the
Savings  Association  Insurance  Fund  ("SAIF")  of the FDIC.  Because  the SAIF
remained substantially undercapitalized,  legislation was introduced in Congress
to  recapitalize  SAIF by a  one-time  special  assessment  on  SAIF  assessable
deposits (including those held by banks). The one-time assessment, recognized in
the Corporation's  consolidated  financial  statements as of September 30, 1996,
was $235 thousand.  This assessment had a negative  impact on the  Corporation's
earnings for 1996.

                                       2

<PAGE>



HARBOR BANKSHARES COPORATION AND SUBSIDIARY

NET INTEREST INCOME
         Net  interest  income is the  difference  between  interest  income and
related fees on earning  assets and the interest  expense  incurred on deposits.
Net Interest Income continued to be the  Corporation's  main source of earnings.
Net interest income increased to $5.2 million in 1996 from$4.9 million in 1995.

         Total  interest  income  increased  by $855  thousand  or 10.1% to $9.3
million for 1996 when compared to the $8.5 million  earned during 1995. A growth
in total average earning assets of 8.8%,  mainly in the loan portfolio,  was the
main reason for the increase.

         Total  interest  expense  increased  by $539  thousand or 14.8% to $4.2
million in 1996 from $3.6 million in 1995.  This  increase was mainly due to the
growth in interest  bearing deposits and higher interest rates paid on deposits,
used to fund the loan growth discussed above.

         Net interest margin for 1996 was 4.92% compared to 5.05% for 1995.




                                       3

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

         The following  table compares the components of the net interest margin
and the changes occurring in those components from 1996 to 1995.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------

                               Net Interest Margin
                         (as percent of earning assets)

                                                       1996              1995           Basis Point
                                                       ----              ------         -----------
                                                                                        Change
                                                                                        ------
<S><C>
Yield on earning assets                                8.75%             8.65%            .10%
Rate paid on interest bearing liabilities              4.22%             3.96%            .26%
Net benefit of non-interest bearing funds               .39%              .36%            .03%
Average cost of funds                                  3.83%             3.60%            .23%
Net interest margin                                    4.92%             5.05%          (.13%)
---------------------------------------------------------------------------------------------------
</TABLE>

PROVISION FOR LOAN LOSSES
         The  provision for loan losses was $60 thousand for 1996, a decrease of
$123  thousand  from the $183  thousand  provided in 1995.  The reserve level is
monitored  closely  by  management  on a  quarterly  basis  based on  charge-off
experience and management's  risk rating on past due and  non-performing  loans.
The  reserve  level  as of  December  31,  1996,  is  considered  adequate.  The
Corporation  maintains a highly  collateralized loan portfolio consisting mainly
of residential  and commercial  mortgage loans.  Charge-offs  increased from $35
thousand  in 1995 to $53  thousand  in 1996.  Recoveries  for 1996  totaled  $65
thousand  compared to $10 thousand for 1995.  The ratio of the loan loss reserve
to outstanding loans was 1.04% for 1996 compared to 1.05% for 1995.

OTHER OPERATING INCOME
         Non-interest  income  increased  by  $124  thousand  or  19.6%  to $760
thousand  in  1996.  Increased  fees  and  service  charges  contributed  to the
increase.

                                       4

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

OTHER OPERATING EXPENSES
         Non-interest  expenses,  at $4.9 million in 1996, increased by 17.5% as
compared to $4.2  million in 1995 . Salaries and benefit  expenses  increased to
$2.2  million in 1996 from $1.9  million  in 1995.  The  increase  was caused by
additional staff,  salary increases and benefit costs.  Other expenses increased
by $481 thousand or 21.1%.  The $235,000 FDIC assessment  discussed above caused
the  majority  of the  increase  in other  operating  expenses.  Costs  such as,
occupancy,  legal , and data processing fees due to higher account activity also
contributed to the increase in other operating expenses.

APPLICABLE INCOME TAXES
         Applicable  income taxes includes  current and deferred  portions which
are detailed in Note 8 of the audited consolidated financial statements. At $391
thousand,  taxes  represented  40.5% of  income  before  taxes for 1996 and $451
thousand or 39.9% for 1995.

CREDIT RISK ANALYSIS
         The Corporation,  through its subsidiary,  The Harbor Bank of Maryland,
has in place  credit  policies  and  procedures  designed to control and monitor
credit risk. Credit analysis and loan review functions have provided a check and
balance  system for  assessing  initial and  ongoing  risk  associated  with the
lending process.

         Non-performing  loans,  comprised  of  non-accruing  loans and accruing
loans 90 days or more  past  due,  were  $559  thousand  or .65% of gross  loans
outstanding  at the end of 1996.  This  compares  with $481  thousand or .62% of
gross loans outstanding at the end of 1995.


                                       5

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

         The reserve for possible  loan losses  increased  from $817 thousand at
the end of 1995 to $889 thousand at the end of 1996. As of year end, the reserve
represented  1.04% of gross  loans  outstanding.  Based  on  quarterly  analyses
conducted   throughout  the  year,  this  reserve  is  considered   adequate  by
management.

ASSET AND LIABILITY MANAGEMENT
Introduction
         The Investment  Committee of the Corporation reviews policies regarding
the sources and uses of funds,  maturity  distribution,  and associated interest
rate  sensitivities.  This effort is aimed at minimizing  risks  associated with
fluctuating interest rates, as well as maintaining sufficient liquidity.

Liquidity
         Liquidity  describes the ability of the  Corporation  to meet financial
obligations,  including lending commitments and contingencies, that arise during
the  normal  course  of  business.  Liquidity  is  primarily  needed to meet the
borrowing  and  deposit   withdrawal   requirements  of  the  customers  of  the
Corporation,  as  well  as  to  meet  current  and  planned  expenditures.   The
Corporation  through the Bank, is required to maintain  adequate sources of cash
in  order to meet its  financial  commitments  in an  organized  manner  without
incurring substantial losses. These commitments relate principally to changes in
the Bank's  deposit base through  withdrawals  and changes in funds  required to
meet normal and seasonal loan demands.  The Bank,  and thereby the  Corporation,
derives liquidity through the maturity distribution of the investment portfolio,
loan repayments and income from earning assets.  The Bank maintains a portion of
its investment  portfolio as a liquidity  reserve which can be converted to cash
on an immediate basis with minimal loss.

                                       6

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

           The Bank has also  established  secured lines of credit with the FHLB
as an  additional  source of liquidity.  Collateral  must be pledged to the FHLB
before  advances can be obtained.  At December 31,  1996,  The  Corporation  had
sufficient  collateral  in order to borrow up to an aggregate  of $13.0  million
from the FHLB under the established lines of credit, if necessary.  Liquidity is
also provided through the Corporation's  portfolio of liquid assets,  consisting
of cash  and due from  banks,  interest-bearing  deposits  in  other  banks  and
investment  securities  available for sale. Such assets totaled $12.5 million or
9.6% of total assets at December 31, 1996.

         The  Corporation  derives  its cash  from a  combination  of  operating
activities,  investing  activities and financing  activities as disclosed in the
consolidated  statement  of cash  flows.  Cash  flow from  operating  activities
consists of interest income collected on loans and investments, interest expense
paid on deposits  and other  borrowings,  other  income  collected  such as cash
received  relating to service  charges,  and cash  payments for other  operating
expenses  including income taxes. Cash flows from investing  activities  include
the purchase,  sale and maturity of investments and interest bearing deposits in
other banks,  the net increase in the level of loans,  and purchases of premises
and equipment.  Cash flows from financing activities consist of movements in the
level of deposits and other borrowings, proceeds from the issuance of stock, and
payment of cash dividends.



                                       7

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

         For the year ended  December 31, 1996,  net cash  provided by operating
activities totaled $1.1 million.  Net cash used in investing for the same period
totaled $11.6 million  resulting  primarily from a net increase in loans of $7.2
million  and  purchases  of  securities  totaling  $9.0  million  offset  by the
maturities of investments and interest  bearing deposits in other banks totaling
$5.4 million.  Purchases of premises and equipment  totaled $664  thousand.  Net
cash  provided by  financing  activities  for the year ended  December  31, 1996
totaled $15.8  million  resulting  primarily  from a net increase in deposits of
$8.3 million and net proceeds from the stock offering of $2.9 million.

INTEREST RATE SENSITIVITY
         Interest  rate  sensitivity  refers to the degree that earnings will be
affected by changes in the general level of interest rates.  Interest  sensitive
assets are  typically  loans  which  have  interest  rates  related to the prime
interest  rate or other  type of  index.  Interest  sensitive  liabilities  have
interest rates which likewise vary based upon market  changes.  Reducing the net
interest rate sensitivity of the Corporation's  balance sheet is the goal of the
asset/liability management process.

         One measure of interest  rate  sensitivity  is the  difference  between
interest  sensitive  assets  and  interest  sensitive  liabilities,  called  the
"interest  sensitivity  gap".  The  following  table  shows an  analysis  of the
Corporation's cumulative interest sensitivity gap position. In those time frames
where the interest  sensitive gap is negative,  a decline in interest rates will
improve the interest margins.  For those periods where the interest  sensitivity
gap is positive, the net interest margins should improve as interest rates rise.




                                       8

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

-------------------------------------------------------------------------------
                        Cumulative Interest Sensitive Gap

                                                Repricing or Maturity
                                      -----------------------------------------

December 31, 1996 (in millions)       3 months          6 months         1 year
                                      --------          --------         ------
Interest sensitive assets                $ 40              $ 45           $ 53
Interest sensitive liabilities             33                44             56
                                           --             -----         ------
Interest sensitivity gap                 $  7             $   1         $   (3)
                                         ====             =====         ======
Gap to total assets                       5.4%               .8%          (2.3%)
--------------------------------------------------------------------------------


LONG AND SHORT TERM BORROWINGS
         During  1994  the  Corporation   borrowed  from  the  Resolution  Trust
Corporation  $5.8 million to invest as tier one capital in its  subsidiary,  The
Harbor Bank of Maryland.  This  borrowing  was  necessary  to maintain  adequate
capital  levels due to the growth  achieved  through  the  purchase of three (3)
branches  from  the  Resolution  Trust  Corporation.  These  borrowings  require
quarterly interest payments based on Treasury bill rates and a principal payment
at the end of the fifth year.  Principal payments can be made at any time before
the end of the term.  The interest paid on the debt for 1996 was $309  thousand.
Short term  borrowings  consist of borrowings  from the FHLB.  These  borrowings
reprice daily,  have  maturities of one year or less and may be prepaid  without
penalty.  During  1996,  the Company  borrowed up to a total of $3.5  million of
these  short  term  borrowings  in  order to  finance  its  loan  demand.  These
borrowings  were  repaid  during  the  third  quarter  of  1996.  There  were no
outstanding short term borrowings as of year ended December 31, 1996.



                                       9

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

Capital Resources
         Shareholders'  equity  grew by $3.4  million or 59.9% to $9.0  million.
This  increase was mainly due to the stock  offering that took place during June
1996  which  increased  shareholders  equity by $2.8  million  and the  earnings
retained by the Corporation. Shareholder's equity was 6.9% of total assets as of
the year end. The Tier 1 capital  ratio as of December 31, 1996 was 15.75%,  and
the risk based  capital  ratio was  17.00%.  Both  ratios were above the minimum
requirements  established  by regulators  which were 4.0% for tier 1 capital and
8.0% for total risk based capital.  The book value of each share of common stock
rose  from  $13.17  at the end of  1995 to  $14.21  at the end of  1996,  a 7.9%
increase.

Changes in Financial Position
         The Corporation  through its  subsidiary,  The Harbor Bank of Maryland,
continued its growth during 1996.  An ATM network was  established  in Baltimore
City in partnership with a supermarket  chain, as well as the establishment of a
financial service company.

         Assets  grew by $16.3  million or 14.4% to $129.7  million  from $113.3
million in 1995.  Deposits increased by $13.0 million to $114.1 million or 12.9%
from $101.1  million in 1995,  and net loans  increased by $7.1 million to $84.5
million or 9.3% over $77.3 million in 1995.

         The  Corporation  plans to continued  its expansion  through  marketing
efforts by its management and board of directors.


                                       10

<PAGE>




HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

         Deposit growth  provided the major source of additional  funds.  Use of
these funds was reflected in the growth of the investment and loan portfolio.

FINANCIAL ANALYSIS - 1995 AND 1994
         Net income for 1995  increased by $54 thousand or 8.7% to $679 thousand
from $625 thousand in 1994.

         Stockholders'  equity  increased by 11.5% to $5.6 million  during 1995,
and assets  increased by 6.9% to $113.3  million.  Repricing of liabilities  and
substantial growth in earning assets contributed to the increase.

         On a per  share  basis,  adjusted  retroactively  for the 1 1/3%  stock
dividend  declared  January 15,  1997,  payable  February  28,  1997,  to common
stockholders  of record on January 31, 1997,  for the years ended 1995 and 1994,
net income was $1.55 in 1995 up $0.12 from $1.43 in 1994.

         Net interest  income for 1995  increased  by $848  thousand or 21.1% to
$4.9 million due to the growth in the loan and investment areas. Average earning
assets  increased  by $25.9  million  or 35.9% to  $98.1  million  in 1995.  The
increased net interest income during 1995, when compared to 1994, was mainly due
to the effect of increased balances in earning assets.

         During 1995,  the provision  for possible loan losses  decreased by $65
thousand or 26.1%. The decrease in 1995 reflects the need for less provision due
to the quality of the loan portfolio,  although,  outstanding  loans continue to
increase during the year.

                                       11

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

         Non-interest  income  decreased  by $151  thousand or 19.2% during 1995
when  compared to 1994.  During  1994,  revenues  due to the sale of real estate
loans totaled $218 thousand. There were no sale of loans during 1995.

         Non-interest  expenses  increased  by $627  thousand  or 17.6% over the
previous year.  Salaries and benefits increased by $352 thousand or 22.7% due to
increased  staff,  and salary  increases for existing staff.  Occupancy  expense
increased  by $77 thousand or 21.7% over the previous  year,  equipment  expense
increased by $79 thousand or 64.5% and other expenses increased by $119 thousand
or 7.8%. These increases were mainly related to branch  expansions,  as a result
of the opening of one branch during  December 1995 and the  acquisition of three
branch locations from the Resolution Trust Corporation during June and September
1994.  The full cost of the  operations  of the three  locations  purchased,  is
reflected in the 1995 operating expenses.

         Applicable income taxes for 1995 increased by $81 thousand or 21.7% due
to increased earnings.

         Deposits grew by $6.4 million or 6.7%.  This increase was the result of
the continued effort of the Corporation to attract new business.

         Net  loans  increased  by  $19.6  million  or  34.1%,   and  investment
securities  decreased by $2.9 million or 20.9%.  Both of these asset  categories
were the main user of the source of funds provided by the deposit growth.

         Shareholders'  Equity  grew by $583  thousand  or 11.5% due to retained
earnings.

                                       12

<PAGE>



HARBOR BANKSHARES CORPORATION AND SUBSIDIARY

         The Tier 1 capital  ratio as of December  31, 1995 was 11.92%,  and the
risk based  capital ratio was 13.17%;  both were well above  minimum  regulatory
requirements.

OTHER INFORMATION
         Effective  January  1,  1996,  the  Corporation  adopted  Statement  of
Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived  Assets and for  Long-Lived  Assets to be Disposed of," SFAS No. 122,
"Accounting for Mortgage  Servicing  Rights - an Amendment of SFAS 65," and SFAS
No. 123,  "Accounting for Stock Based  Compensation."  The adoption of these new
accounting  pronouncements  did not have a material  effect on the  consolidated
financial statements of the Corporation.

In June of 1996, the Financial  Accounting  Standards Board issued SFAS No. 125,
Accounting for Transfers and Servicing of Financial  Assets and  Extinguishments
of Liabilities, which provides new accounting and reporting standards for sales,
securitization  and  servicing of  receivables  and other  financial  assets and
extinguishments  of  liabilities.  The  provisions  of the  Statement  are to be
applied to  transactions  occurring  after December 31, 1996. The Corporation is
currently  reviewing the provisions of the Statement to determine  what, if any,
impact there will be on the Corporation.

         The Corporation  continues with its plans for expansion  during 1997. A
branch  location is planned for early  Spring near the Inner Harbor in Baltimore
City.  The  addition  of  other  ATM  machines  to the  network  is  also  being
considered.




                                       13

<PAGE>



                  CONSOLIDATED FIVE-YEAR FINANCIAL HIGHLIGHTS
                  HARBOR BANKSHARES CORPORATION AND SUBISDIARY
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)          1996              1995              1994             1993              1992
<S><C>
BALANCE SHEET DATA
Total Assets                                 $129,651          $113,316          $106,069         $ 61,741          $ 56,575
Deposits                                      114,124           101,098            94,726           56,868            52,037
Total Net Loans                                84,453            77,292            57,643           35,653            31,951
Total Shareholders' Equity                      9,001             5,641             5,059            4,479             4,046
----------------------------------------------------------------------------------------------------------------------------
OPERATING DATA (for the full year)
Interest Income                              $  9,345          $  8,490          $  6,537         $  4,369          $  4,163
Interest Expense                                4,170             3,631             2,526            1,659             1,907
                                             --------          --------          --------         --------          --------
Net Interest Income                          $  5,175          $  4,859          $  4,011         $  2,710          $  2,256
Provision for Loan Losses                          60               183               248               96               106
Other Operating Income                            760               635               786              515               517
Other Operating Expenses                        4,912             4,181             3,554            2,343             2,100
                                             --------          --------          --------         --------          --------
Income Before Taxes                          $    963          $  1,130          $    995         $    786          $    567

Income Taxes                                      390               451               370              311               221
                                             --------          --------          --------         --------          --------
Net Income                                   $    573          $    679          $    625         $    475          $    346
                                             ========          ========          ========         ========          ========
----------------------------------------------------------------------------------------------------------------------------
PER SHARE DATA
Net Income(*)                                $   1.07          $   1.55          $   1.43         $   1.09          $   0.80
Dividend                                     $    .20          $    .20          $    .14         $    .10          $    ---
Book Value                                   $  14.21          $  13.17          $  11.77         $  10.51          $   9.50
</TABLE>

(*)Net income per share is based upon average shares outstanding, adjusted
retroactively for the 1 1/3% stock dividend declared January 15, 1997, payable
February 28, 1997 to common stockholders of record on January 31, 1997 for all
years presented.

                                       14

<PAGE>

                              AUDITED CONSOLIDATED FINANCIAL STATEMENTS

                              Harbor Bankshares
                              Corporation


                              Years ended December 31, 1996, 1995 and 1994
                              with Report of Independent Auditors




<PAGE>


                         Harbor Bankshares Corporation

                   Audited Consolidated Financial Statements


                  Years ended December 31, 1996, 1995 and 1994




                                    Contents


Report of Independent Auditors ............................................ 1

Audited Consolidated Financial Statements

Consolidated Statements of Condition....................................... 2
Consolidated Statements of Income.......................................... 3
Consolidated Statements of Changes in Shareholders' Equity................. 4
Consolidated Statements of Cash Flows...................................... 5
Notes to Consolidated Financial Statements................................. 6




<PAGE>



                         Report of Independent Auditors


To the Shareholders and the Board of Directors
Harbor Bankshares Corporation

We have audited the accompanying  consolidated statements of condition of Harbor
Bankshares  Corporation  and subsidiary as of December 31, 1996 and 1995 and the
related consolidated  statements of income,  shareholders' equity and cash flows
for  each of the  three  years in the  period  ended  December  31,  1996  These
financial statements are the responsibility of the Corporation's management. Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects,  the consolidated financial position of Harbor Bankshares
Corporation  and  subsidiary  at  December  31, 1996 and 1995 and the results of
their  operations and their cash flows for each of the three years in the period
ended  December  31,  1996 in  conformity  with  generally  accepted  accounting
principles.

As described in Note 1 to the financial  statements,  effective January 1, 1994,
the Corporation changed its method of accounting for investments.

                                /s/ Ernst & Young LLP
                                ---------------------




March 7, 1997


<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                      Consolidated Statements of Condition

<TABLE>
<CAPTION>
                                                                                 December 31
                                                                           1996                1995
                                                                   ----------------------------------------
<S><C>
Assets
Cash and due from banks                                                $   5,372,949         $ 6,682,427
Federal funds sold                                                        10,929,028           4,308,285
Interest bearing deposits in other banks                                   5,573,829           7,517,733
Investment securities:
   Held to maturity at amortized cost (market value of
     $14,889,839 in 1996 and $9,653,542 in 1995)                          15,015,715           9,437,205
   Available for sale (at market value, amortized cost in 1996
     of $1,583,000 and $1,443,708 in 1995)                                 1,569,400           1,460,861
                                                                   ----------------------------------------
Total investment securities                                               16,585,115          10,898,066

Loans                                                                     85,509,102          78,238,442
Unearned income                                                             (166,895)           (129,754)
Reserve for possible loan losses                                            (889,391)           (816,853)
                                                                   ----------------------------------------
Net loans                                                                 84,452,816          77,291,835
Property and equipment--net                                                1,058,155             805,669
Goodwill--net                                                              4,162,586           4,493,858
Accrued interest receivable                                                  993,481             775,911
Other assets                                                                 523,459             542,516
                                                                   ----------------------------------------
Total assets                                                            $129,651,418       $ 113,316,300
                                                                   ========================================

Liabilities and shareholders' equity
Liabilities:
   Deposits:
     Noninterest bearing demand                                        $   8,953,672       $  12,682,591
     Interest bearing transaction accounts                                13,755,550          15,337,116
     Savings                                                              40,989,551          34,139,846
     Time, $100,000 or more                                               17,380,717          11,348,015
     Other time                                                           33,044,015          27,590,556
                                                                   ----------------------------------------
Total deposits                                                           114,123,505         101,098,124
Accrued interest payable                                                     520,837             639,541
Notes payable                                                              5,795,547           5,795,547
Other liabilities                                                            210,323             141,256
                                                                   ----------------------------------------
Total liabilities                                                        120,650,212         107,674,468

Shareholders' equity:
Common stock--par value $.01 per share: authorized 10,000,000
   shares; 633,444 and 428,488 shares issued and outstanding at
   December 31, 1996 and 1995, respectively                                    6,334               4,285
Capital surplus                                                            5,720,069           2,829,026
Retained earnings                                                          3,283,153           2,796,918
Net unrealized gain (loss) on investment securities available
   for sale, net of taxes                                                     (8,350)             11,603
                                                                   ----------------------------------------
Total shareholders' equity                                                 9,001,206           5,641,832
                                                                   ----------------------------------------
Total liabilities and shareholders' equity                              $129,651,418       $ 113,316,300
                                                                   ========================================
</TABLE>

See accompanying notes.

                                       2

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                       Consolidated Statements of Income


<TABLE>
<CAPTION>
                                                                         Year ended December 31
                                                            --------------------------------------------------
                                                                  1996             1995            1994
                                                            --------------------------------------------------
<S><C>
Interest income
Interest and fees on loans                                       $7,804,575      $7,161,412      $4,533,975
Interest on investments - taxable                                   976,471         597,379         557,588
Interest on deposits in other banks                                 399,686         431,602         508,113
Interest on federal funds sold                                      164,826         300,152         937,193
                                                            --------------------------------------------------
Total interest income                                             9,345,558       8,490,545       6,536,869

Interest expense
Interest bearing transaction accounts                               412,014         383,347         359,960
Savings                                                           1,235,344       1,470,806       1,025,994
Time, $100,000 or more                                              635,499         463,330         288,650
Other time                                                        1,497,072         900,462         727,445
Notes payable                                                       309,205         334,778         123,558
Interest on federal funds purchased                                  80,806          78,349
                                                            --------------------------------------------------
Total interest expense                                            4,169,940       3,631,072       2,525,607
                                                            --------------------------------------------------
Net interest income                                               5,175,618       4,859,473       4,011,262
Provision for possible loan losses                                   60,000         183,337         248,000
                                                            --------------------------------------------------
Net interest income after provision for possible loan losses      5,115,618       4,676,136       3,763,262

Other operating income
Service charges on deposit accounts                                 591,003         490,842         464,303
Other service charges                                               165,940          92,955          98,347
Gain on sales of loans                                                                              218,329
Other income                                                          2,818          51,559           5,370
                                                            --------------------------------------------------
                                                                    759,761         635,356         786,349

Other operating expenses
Salaries and employee benefits                                    2,152,040       1,902,807       1,550,403
Occupancy expense of premises                                       533,285         433,764         356,431
Data processing fees                                                397,696         338,077         267,192
Equipment expense                                                   249,376         201,249         122,371
FDIC insurance                                                      318,097         165,991         147,381
Stationery and supplies                                             173,939         138,895          94,479
Professional fees                                                   100,646          99,032          95,982
Postage                                                              66,162          64,038          65,823
Courier transportation                                               74,160          68,972          61,016
Goodwill amortization                                               331,272         331,272         143,970
Other expense                                                       515,228         437,160         649,004
                                                            --------------------------------------------------
                                                                  4,911,901       4,181,257       3,554,052
                                                            --------------------------------------------------
Income before income taxes                                          963,478       1,130,235         995,559
Applicable income taxes                                             390,701         450,804         370,449
                                                            --------------------------------------------------
Net income                                                      $   572,777     $   679,431     $   625,110
                                                            ==================================================
Net income per share                                            $     1.07      $     1.55      $     1.43
                                                            ==================================================
</TABLE>

See accompanying notes.

                                       3

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

           Consolidated Statements of Changes in Shareholders' Equity


<TABLE>
<CAPTION>
                                       Common       Capital         Retained        Unrealized     Shareholders'
                                       Stock        Surplus         Earnings       Gain (Loss)        Equity
                                    -------------------------------------------------------------------------------
<S><C>
Balance at January 1, 1994             $4,261     $ 2,836,309      $ 1,638,224      $      -        $ 4,478,794

Adjustment to beginning balance for
   change in accounting method, net
   of income taxes of $7,801                                                          12,399             12,399

Net income for the year                                                625,110                          625,110
Exercise of stock options                  36          23,988                                            24,024
Cash dividends - $ .14 per share                                       (59,905)                         (59,905)
Change in unrealized gain (loss) on
   investment securities available
   for sale, net of income tax
   benefit of $13,481                                                                (21,427)           (21,427)
                                    -------------------------------------------------------------------------------
Balance at December 31, 1994            4,297       2,860,297        2,203,429        (9,028)         5,058,995

Net income for the year                                                679,431                          679,431
Exercise of stock options                  30          24,970                                            25,000
Retirement of treasury stock              (42)        (56,241)                                          (56,283)
Cash dividends - $.20 per share                                        (85,942)                         (85,942)
Change in unrealized gain (loss) on
   investment securities available
   for sale, net of income taxes of
   $11,230                                                                            20,631             20,631
                                    -------------------------------------------------------------------------------
Balance at December 31, 1995            4,285       2,829,026        2,796,918        11,603          5,641,832

Net income for the year                                                572,777                          572,777
Exercise of stock options                  65          45,435                                            45,500
Proceeds from issuance of common
   stock                                1,984       2,845,608                                         2,847,592
Cash dividends - $.20 per share                                        (86,542)                         (86,542)
Change in unrealized gain (loss) on
   investment securities available
   for sale, net of income tax
   benefit of $7,706                                                                 (19,953)           (19,953)
                                    -------------------------------------------------------------------------------
 Balance at December 31, 1996          $6,334      $5,720,069       $3,283,153      $ (8,350)       $ 9,001,206
                                    ===============================================================================
</TABLE>

See accompanying notes.

                                       4

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                      Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                              Year ended December 31
                                                                     1996               1995             1994
                                                              -------------------------------------------------------
<S><C>
Operating activities
Net income                                                       $     572,777     $    679,431       $     625,110
Adjustments to reconcile net income to net cash provided by
   operating activities:
     Provision for possible loan losses                                 60,000          183,337             248,000
     Depreciation and amortization                                     598,541          537,681             319,993
     Gains on sales of loans                                                                               (218,329)
     (Increase) decrease in interest receivable and other             (198,513)          47,629            (568,095)
       assets
     Increase in interest payable and other liabilities                 60,067          321,583              64,942
                                                              -------------------------------------------------------
Net cash provided by operating activities                            1,092,872        1,769,661             471,621

Investing activities
Net decrease in deposits at other banks                              1,943,904        1,272,519             933,257
Purchases of investment securities held to maturity                 (8,113,716)      (7,947,964)         (5,872,816)
Purchases of investment securities available for sale               (1,000,000)        (165,857)           (986,880)
Proceeds from maturities of investment securities
   available for sale                                                1,000,000        1,000,000           1,000,000
Proceeds from maturities of investment securities held to
   maturity                                                          2,426,667       10,000,000           1,000,000
Purchase of branches                                                                                     (4,969,100)
Purchase of loans                                                                   (17,319,820)        (32,340,441)
Net increase in loans                                               (7,160,981)      (2,506,881)         (5,273,641)
Proceeds from sales of loans                                                                             15,449,407
Purchases of premises and equipment                                   (663,912)        (523,054)           (228,542)
                                                              -------------------------------------------------------
Net cash used in investing activities                              (11,568,038)     (16,191,057)        (31,288,756)

Financing activities
Net (decrease) increase in noninterest bearing transaction
   accounts                                                         (3,728,919)       3,975,713           1,736,682
Net (decrease) increase  in interest bearing transaction
   accounts                                                         (1,581,566)      (2,147,732)          8,869,268
Net increase (decrease) in savings deposits                          6,849,705       (3,030,972)         15,336,109
Net increase in time deposits                                       11,486,161        7,575,007          11,916,205
Proceeds from common stock issuance                                  2,847,592           25,000              24,024
Proceeds from issuance of notes payable                                                                   5,795,547
Payments of cash dividends                                             (86,542)         (85,942)            (59,905)
Acquisition of common stock                                                             (56,283)
                                                              -------------------------------------------------------
Net cash provided by financing activities                           15,786,431        6,254,791          43,617,930
                                                              -------------------------------------------------------
Increase (decrease) in cash and cash equivalents                     5,311,265       (8,166,605)         12,800,795
Cash and cash equivalents at beginning of year                      10,990,712       19,157,317           6,356,522
                                                              -------------------------------------------------------
Cash and cash equivalents at end of year                         $  16,301,977     $ 10,990,712       $  19,157,317
                                                              =======================================================
</TABLE>

See accompanying notes.

                                       5

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                   Notes to Consolidated Financial Statements



1. Summary of Significant Accounting Policies

Business

Harbor  Bankshares  Corporation  (the  Corporation),  is a bank holding  company
organized under the laws of the State of Maryland in 1992. The Corporation  owns
all of the  outstanding  stock of the Harbor  Bank of Maryland  (the Bank),  the
Corporation's sole subsidiary.

The Bank is a commercial bank headquartered in Baltimore, Maryland. The deposits
of the Bank are insured by the FDIC. The Bank conducts  general banking business
in six locations and primarily serves the Baltimore, Maryland metropolitan area.
The Bank also has a branch in Riverdale,  Prince George's County,  Maryland.  It
offers checking,  savings and time deposits,  commercial real estate,  personal,
home improvement,  automobile, and other installment and term loans. The Bank is
also a member of a local and national ATM network. The retail nature of the Bank
allows for diversification of deposits and borrowers so it is not dependent upon
a single or a few customers.

Basis of Presentation

The accompanying  consolidated  financial statements include the accounts of the
Corporation  and the Bank and have been  prepared in accordance  with  generally
accepted accounting principles.  All significant  intercompany activity has been
eliminated.

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of assets  and  liabilities  and  disclosure  of
contingent  assets and  liabilities at the date of the financial  statements and
the  reported  amounts of revenues  and expenses  during the  reporting  period.
Actual   results  could  differ  from  those   estimates.   Estimates  that  are
particularly  susceptible  to change in the near term  relate to the reserve for
possible loan losses.

Investment Securities

The  Corporation  accounts for its  investment  securities  in  accordance  with
Statement of Financial  Accounting  Standards ("SFAS") No. 115,  "Accounting for
Certain  Investments in Debt and Equity  Securities".  Debt  securities that the
Corporation has the intent and ability to hold until maturity, are classified as
"held to maturity" and are carried at

                                       6

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



1. Summary of Significant Accounting Policies (continued)

Investment Securities (continued)

historical  cost  adjusted  for any  amortization  of  premium or  accretion  of
discount. Trading securities are carried at fair value with unrealized gains and
losses  included  in  earnings.  (The  Corporation  does not  maintain a trading
securities  portfolio).  Marketable  equity securities and debt securities which
are not  classified as held to maturity or trading are  classified as "available
for sale" and are  carried at fair value with the  unrealized  gains and losses,
net of tax,  reported  as a  separate  component  of  shareholders'  equity.  In
accordance with the Statement,  prior period financial  statements have not been
restated to reflect the change in accounting principle. The cumulative effect as
of January 1, 1994 of adopting the Statement  increased  the opening  balance of
shareholders'  equity by $12,399  (net of $7,801 in  deferred  income  taxes) to
reflect the net unrealized  holding gains on securities  classified as available
for sale which were  previously  carried at  amortized  cost or lower of cost or
market value.

Realized  gains  and  losses  and  declines  in value  judged  to be other  than
temporary  are  included in  earnings.  The  specific  identification  method is
utilized in determining the cost of a security which has been sold. Premiums and
discounts  are amortized  and  accreted,  respectively,  as an adjustment of the
securities' yield using the interest method.

Loans

Loans are generally stated at their outstanding  unpaid principal balance net of
any  deferred  fees or costs on  originated  loans,  and net of any  unamortized
premiums  or  discounts  on  purchased  loans.  Interest  income is accrued  and
recognized  as  income  based  upon  the  principal  amount  outstanding.   Loan
origination  and  commitment  fees net of certain direct  origination  costs are
deferred,  and the net amounts are amortized  over the  contractual  life of the
loans  as  adjustments  of  the  yield.   The  accrual  of  interest  income  is
discontinued  when  reasonable  doubt  exists as to the full  collectibility  of
interest or principal.

Reserve for Possible Loan

The reserve for possible loan losses is established through a provision for loan
losses charged to income. Losses are charged against the reserve when management
believes that the collectibility of a loan's principal is unlikely.  The reserve
is an amount that management believes will be adequate to absorb possible losses
on existing loans that may

                                       7

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



1. Summary of Significant Accounting Policies (continued)

Reserve for Possible Loan (continued)

become uncollectible,  based upon evaluations of the collectibility of loans and
prior  loan  loss   experience.   Evaluations   of   collectibility   take  into
consideration  such  factors  as  changes  in the  nature and volume of the loan
portfolio,  overall  portfolio  quality,  review of specific  problem  loans and
current economic conditions that may affect the borrowers' ability to pay.

Effective January 1, 1995, the Corporation adopted SFAS No. 114,  "Accounting by
Creditors for Impairment of a Loan," and SFAS No. 118,  "Accounting by Creditors
for  Impairment of a Loan - Income  Recognition  and  Disclosures."  Under these
Statements,  reserves  for  possible  loan loss  related to  impaired  loans are
required to be measured based on the present value of expected future cash flows
discounted  at the  loan's  effective  interest  rate or the  fair  value of the
collateral for collateral  dependent  loans.  Since the total amount of impaired
loans was not significant,  the adoption of the new standards did not materially
impact the Corporation's financial condition or results of operations.

Property and Equipment

Property and  equipment  are stated at cost less  accumulated  depreciation  and
amortization. Depreciation and amortization are computed using the straight-line
method. Maintenance and repairs are charged to operations when incurred, and the
cost of improvements is capitalized.

Goodwill

Goodwill  represents  the premium paid in excess of the fair value of assets and
liabilities  acquired in branch purchase  transactions with the Resolution Trust
Corporation  (RTC).  These premiums are being amortized on a straight line basis
over 15 years.

Income Taxes

The  Corporation  uses the  liability  method of  accounting  for income  taxes
in  accordance  with SFAS No.  109, "Accounting for Income Taxes."


                                       8

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                   Notes to Financial Statements (continued)



 1.   Summary of Significant Accounting Policies (continued)

Income Taxes (continued)

Under the liability  method,  deferred tax assets and liabilities are determined
based upon the differences  between financial statement carrying amounts and the
tax bases of existing assets and  liabilities.  These temporary  differences are
measured  at  prevailing  enacted  tax rates  that  will be in  effect  when the
differences  are settled or realized.  The Corporation and its subsidiary file a
consolidated federal income tax return.

Statements of Cash Flows

The Corporation has defined cash and cash  equivalents in the statements of cash
flows as those  amounts  included in the  consolidated  statements  of condition
captions "Cash and due from banks" and "Federal funds sold".

For the years ended December 31, 1996,  1995 and 1994, the Company paid interest
of $4,288,644  $3,339,027,  and  $2,456,487,  respectively,  and income taxes of
$410,029 $443,991, and $537,674, respectively.

Other Real Estate Owned

Other real  estate  owned  represents  assets  that have been  acquired  through
foreclosure.  These assets are recorded on the books of the  Corporation  at the
lower of cost or fair value less estimated costs to dispose.

Earnings Per Share

Earnings per share is based upon average shares outstanding of 527,045, 429,404,
and  427,644,  adjusted  retroactively  for the 1 1/3% stock  dividend  declared
January 15, 1997, payable February 28, 1997 to common  stockholders of record on
January  31,  1997,  for the  years  ended  December  31,  1996,  1995 and 1994,
respectively.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year
presentation.

                                       9

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                   Notes to Financial Statements (continued)



1. Summary of Significant Accounting Policies (continued)

Reclassifications (continued)

Recently Issued Accounting Guidance

In June 1996, the Financial Accounting Standards Board issued Statement No. 125,
"Accounting for Transfers and Servicing of Financial Assets and  Extinguishments
of  Liabilities."  The  Corporation  is  required  to adopt  this  standard  for
transactions occurring after December 31, 1996. The impact of adopting Statement
No. 125 will not have a material effect on the Corporation's  financial position
and results of operations.

2. Acquisitions

In 1994, the Corporation  purchased  approximately  $32.3 million in real estate
mortgage loans from the RTC. $15.4 million of these loans were subsequently sold
to a third party for a gain of  $218,329.  In  February  1995,  the  Corporation
purchased an  additional  $17.3 million in real estate  mortgage  loans from the
RTC.  There  remains  $1,001,868  of  unamortized  discounts on purchased  loans
retained by the Corporation at December 31, 1996.

3. Fair Value of Financial Instruments

The  following  discloses  the fair value of financial  instruments  held by the
Corporation,  whether  or not  recognized  in  the  Consolidated  Statements  of
Condition.  In cases in which  quoted  market  prices were not  available,  fair
values  were  based  upon  estimates  using  present  value or  other  valuation
techniques.  These  techniques  were  significantly  affected by the assumptions
used,  including the discount  rate and  estimates of cash flows.  Consequently,
these fair  values  cannot be  substantiated  by  comparisons  with  independent
markets and, in many cases,  may not be realized upon the immediate  sale of the
instrument.  Since  generally  accepted  accounting  principles  exclude certain
financial  instruments and all nonfinancial  instruments from this presentation,
the aggregated  fair value amounts do not represent the underlying  value of the
Corporation.

The  carrying  amounts  reported  under the caption  "Cash and due from  banks",
"Interest  bearing  time  deposits in other  banks",  and  "Federal  funds sold"
approximate the fair value of those assets.

                                       10

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                   Notes to Financial Statements (continued)



3. Fair Value of Financial Instruments (continued)

Investment Securities

The fair values of  investment  securities  are based upon quoted  market prices
when available. If quoted market prices are not available, fair values are based
upon quoted market prices of comparable instruments.

Loans

The fair values of fixed and  variable-rate  loans that reprice within one year,
with no significant credit risk, are based upon their carrying amounts. The fair
values of all other loans are estimated  using  discounted  cash flow  analysis,
which  utilizes  interest rates  currently  being offered for loans with similar
terms to  borrowers of similar  credit  quality.  The reserve for possible  loan
losses  is  allocated  to the  various  components  of  the  loan  portfolio  in
determining the fair value.

Deposits

The fair  values for demand  deposits  are, by  definition,  equal to the amount
payable on demand at the reporting date. The carrying  amounts for variable rate
deposits and  fixed-rate  certificates  of deposit that reprice  within one year
approximate their fair values at the reporting date. Fair values for longer-term
fixed-rate  certificates  of deposit are estimated  using  discounted  cash flow
analysis that applies interest rates currently being offered on certificates.

Accrued Interest Payable

Accrued  interest  payable  includes  interest  expensed  but not yet  paid  for
deposits and notes payable. The carrying amount approximates its fair value.

Notes Payable

Notes  payable  have  interest  rates  that  vary in line  with the 5 week  U.S.
Treasury Bill rate. The carrying amount of the notes payable  approximates their
fair value.


                                       11

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                    Notes to Financial Statements (continued)



3. Fair Value of Financial Instruments (continued)

Off-Balance Sheet Financial Instruments

In the normal course of business,  the Corporation  makes  commitments to extend
credit and issues commercial  letters of credit. As a result of excessive costs,
the  Corporation  considers  estimation of fair values for commitments to extend
credit and commercial letters of credit to be impracticable.

The carrying  values and estimated  fair values of the  Corporation's  financial
assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                December 31, 1996                December 31, 1995
                                         ------------------------------------------------------------------
                                            Carrying           Fair          Carrying           Fair
                                              Value           Value            Value           Value
-----------------------------------------------------------------------------------------------------------
<S><C>                                            (in thousands)                   (in thousands)
Financial assets:
   Cash and due from banks                 $ 5,372,949     $  5,372,947    $  6,682,427    $  6,682,427
   Federal funds sold                       10,929,028       10,929,028       4,308,285       4,308,285
   Interest bearing deposits in other        5,573,829        5,573,829       7,517,733       7,517,733
     banks
   Investment securities                    16,585,115       16,459,239      10,898,066      11,114,403
   Loans, net of reserves                   84,452,816       86,464,868      77,291,835      78,902,525
   Accrued interest receivable                 993,481          993,481         775,911         775,911
Financial Liabilities:
   Deposits                                114,123,505      116,689,961     101,098,124     101,236,104
   Accrued interest payable                    520,837          520,837         639,541         639,541
   Notes payable                             5,795,547        5,795,547       5,795,547       5,795,547

</TABLE>

                                       12

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                    Notes to Financial Statements (continued)



4. Investment Securities

The amortized cost and estimated market values of investments  securities are as
follows:

<TABLE>
<CAPTION>
                                           Amortized               Gross         Gross               Estimated
                                              Cost                Unrealized    Unrealized          Market Value
                                --------------------------------                           ------------------------------
                                      Debt          Equity         Gains         Losses         Debt          Equity
                                -----------------------------------------------------------------------------------------
<S><C>
Balance at December 31, 1996
Investment securities available
  for sale:
     U.S. Treasury and
       government and agencies    $  1,000,000    $          -   $          -  $  (13,600)   $    986,400   $         -
     Other securities                        -         583,000              -           -               -       583,000
                                -----------------------------------------------------------------------------------------
Total                             $  1,000,000    $    583,000              -  $  (13,600)   $    986,400   $   583,000
                                =========================================================================================

Investment securities held to
  maturity:
     U.S. Treasury and
       government agencies        $ 15,015,715    $          -              -  $ (125,876)   $ 14,889,839
                                -----------------------------------------------------------------------------------------
Totals                            $ 15,015,715    $          -              -  $ (125,876)   $ 14,889,839   $         -
                                =========================================================================================

Balance at December 31, 1995
Investment securities available
  for sale:
     U.S. Treasury and
       government and agencies     $   997,222     $         -    $   17,153    $       -       $1,014,375  $         -
     Other securities                        -         446,486             -            -                -      446,486
                                -----------------------------------------------------------------------------------------
Total                              $   997,222     $   446,486    $   17,153    $       -       $1,014,375  $   446,486
                                =========================================================================================

Investment securities held to
  maturity:
     U.S. Treasury and
       government agencies         $ 9,437,205     $         -    $  216,962    $    (625)      $9,653,542   $        -
                                -----------------------------------------------------------------------------------------
Total                              $ 9,437,205     $         -    $  216,962    $    (625)    $  9,653,542   $        -
                                =========================================================================================
</TABLE>

                                       13

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                   Notes to Financial Statements (continued)



4. Investment Securities (continued)

The amortized cost and estimated market value of debt securities at December 31,
1996, by contractual  maturity,  are shown below. Expected maturities may differ
from contractual  maturities  because  borrowers have the right to call or repay
obligations without call or prepayment penalties.

<TABLE>
<CAPTION>
                                        Debt Securities                         Debt Securities
                                      Available for sale                        Held to maturity
                             -----------------------------------    ------------------------------------------
                                  Amortized           Market            Amortized               Market
                                     cost             Value                cost                 Value
                             ----------------    ---------------    ------------------   ---------------------
<S><C>
Due in one year or less         $           -      $          -      $              -      $              -
Due after one year through
   five years                       1,000,000           986,400            15,006,026            14,880,150
                             ----------------    ----------------   ------------------   ---------------------
                                $   1,000,000      $    986,400      $     15,006,026      $     14,880,150
                             ================    ================   ==================   =====================
</TABLE>

There were no sales of investment securities during 1996 or 1995.

5. Loans and Reserve for Possible Loan Losses

The composition of loans at December 31 is as follows:

                                                 1996                1995
                                       ----------------------------------------

Real estate--mortgage                        $72,183,697          $69,569,648
Commercial                                     9,611,937            5,785,876
Consumer                                       2,494,111            2,032,206
Credit card loans                              1,219,357              850,712
                                       ----------------------------------------
                                             $85,509,102          $78,238,442
                                       ========================================

Transactions in the reserve for possible loan losses are summarized as follows:

<TABLE>
<CAPTION>
                                                   1996      1995        1994
                                             -------------------------------------
<S><C>
Balance at January 1                            $816,853   $658,387     $427,664
Provision charged to operating expense            60,000    183,337      248,000
Loans charged-off                                (53,313)   (34,957)     (30,828)
Recovery on loans previously charged-off          65,851     10,086       13,550
                                             -------------------------------------
Net loans charged-off                             12,538    (24,871)     (17,278)
                                             -------------------------------------

Balance at December 31                          $889,391   $816,853     $658,386
                                             =====================================
</TABLE>

                                       14

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

                   Notes to Financial Statements (continued)



5. Loans and Reserve for Possible Loan Losses (continued)

The following is an analysis of interest on non accruing loans:

<TABLE>
<CAPTION>
                                                         1996          1995          1994
                                                    -------------------------------------------
<S><C>
Non accruing loans at December 31                      $284,295      $    -         $199,998
Interest income which would have been recognized
   under original terms                                  22,126           -           26,000
Interest income recognized during the period              2,671           -                -

6. Property and Equipment

The major classes of property and equipment are summarized as follows:


</TABLE>
<TABLE>
<CAPTION>
                                                               December 31
                                                         1996                1995
                                                   ------------------------------------
<S><C>
Furniture, fixtures and equipment                      $1,788,990         $1,297,967
Leasehold improvements                                    441,036            411,566
                                                   ------------------------------------
                                                        2,230,026          1,709,533
Less accumulated depreciation and amortization          1,171,871            903,864
                                                   ------------------------------------
Total                                                  $1,058,155         $  805,669
                                                   ====================================
</TABLE>

Depreciation expense was $211,375,  $150,286, and $110,846, for the years ended
December 31,  1996, 1995, and 1994, respectively.

The Bank leases its branch and office  facilities.  The lease agreements provide
for the payment of utilities and taxes by the lessee. Future minimum payments in
the  aggregate  and for each of the five  succeeding  years under  noncancelable
operating leases consisted of the following at December 31, 1996:

              1997                                               $  362,646
              1998                                                  332,237
              1999                                                  316,875
              2000                                                  273,228
              2001 and thereafter                                   421,082
                                                               -------------
              Total minimum lease payments                       $1,706,068
                                                               =============

Total rental expense under operating leases amounted to $279,055  $216,733,  and
$203,009,  in 1996, 1995 and 1994, respectively.

                                       15

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



7. Restrictions on Cash and Due from Banks

The Bank is required by the Federal  Reserve to maintain a reserve balance based
principally on deposit  liabilities.  The balance maintained is included in cash
and due from banks.  The reserve  balances were kept at the Federal Reserve Bank
during 1996.

8. Income Tax

The Corporation's provision for income taxes for the years ended December 31, is
summarized as follows:

                                      1996           1995            1994
                                   -----------------------------------------

Taxes currently payable             $369,330       $504,849        $449,198
Deferred taxes (benefit)              21,371        (54,045)        (78,749)
                                   -----------------------------------------
Income tax expense for the year     $390,701       $450,804        $370,449
                                   =========================================

A reconciliation between the total income tax expense and the income tax expense
computed by applying the statutory  Federal  income tax rate to earnings  before
income taxes is as follows:

<TABLE>
<CAPTION>
                                                               1996             1995            1994
                                                          -----------------------------------------------
<S><C>
Income before income taxes                                   $963,478        $1,130,235       $995,559
Statutory income tax rate                                          34%               34%            34%
                                                          -----------------------------------------------
Income tax at statutory rate                                  327,583           384,280        338,490
State franchise tax, net of federal tax benefit                67,443            73,903         50,500
Other                                                          (4,325)           (7,379)       (18,541)
                                                          -----------------------------------------------
Income tax expense for the year                              $390,701        $  450,804       $370,449
                                                          ===============================================
</TABLE>

                                       16

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



8. Income Tax (continued)

Deferred  income  taxes  reflect  the net tax effects of  temporary  differences
between the carrying  amounts of assets and liabilities for financial  reporting
purposes and the amounts used for income tax purposes. Significant components of
the Corporation's deferred tax liabilities and assets are as follows:

<TABLE>
<CAPTION>
                                                                                 December 31
                                                                             1996           1995
                                                                       ------------------------------
<S><C>
Deferred tax liabilities:
   Deferred loan origination fees                                          $ (77,172)     $      -
   Prepaid expenses                                                          (18,490)      (14,527)
   Unrealized gain on investment securities available for sale                     -        (7,964)
   Other                                                                     (12,260)      (12,253)
                                                                       ------------------------------
Total deferred tax liabilities                                              (107,922)      (34,744)

Deferred tax assets:
   Loan loss reserve                                                         288,371       265,852
   Depreciation                                                               39,157         1,595
   Unrealized loss on investment securities available for sale                 5,252             -
   Other                                                                       6,793         7,134
                                                                       ------------------------------
Total deferred tax assets                                                    339,573       274,581
                                                                       ------------------------------
Net deferred tax asset                                                     $ 231,651      $239,837
                                                                       ==============================
</TABLE>

No valuation  allowance was recorded for the deferred tax assets at December 31,
1996 or 1995.

9. Notes Payable

Notes payable consists of two notes totaling $5,795,547 which are payable to the
Resolution  Trust  Corporation  on June 10, 1999.  The notes each have a term of
five years and have  interest  rates  indexed to the 13 week U.S.  Treasury Bill
rate.  At December 31, 1996 the interest  rate on the notes was 5.18%.  Interest
payments are made  quarterly.  No  principal  repayments  are required  prior to
maturity.  These loans were made by the Resolution  Trust  Corporation to assist
the Corporation in financing the branch acquisitions discussed in Note 2.

                                       17

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



10. Stock Option Plan

Under the 1992 Stock Option Plan, the  Corporation has reserved 30,000 shares of
common stock for options granted or available for grant to certain directors and
officers.  Options granted under this plan become  exercisable  over a period of
four to five years on a cumulative  basis,  beginning on the date of grant,  and
expiring ten years after the date of grant.

In September 1995, the  Corporation  adopted the 1995 Director Stock Option Plan
for certain directors and officers.  Under the plan,  directors and officers may
be granted  options to purchase 44,579 shares of the Bank's  outstanding  common
stock. Options granted under this plan become exercisable one year from the date
of grant and expire ten years after the date of grant.

Stock option transactions, adjusted for stock dividends, under the Plans were as
follows:

                                             Year Ended December 31
                                     1996              1995             1994
                                  ----------------------------------------------
Options outstanding at
    beginning of year               64,338            22,799            26,487
Options granted at $15.00
    per share                            -            44,579                 -
Options exercised at $6.60 to
    $8.33 per share                 (6,586)           (3,040)           (3,688)
Options forfeited                        -                 -                 -
                                  ----------------------------------------------
Options outstanding at end of
    year                            57,752            64,338            22,799
                                  ==============================================
Options exercisable at
    December 31 at $6.60 to
    $15.00 per share                57,752
                                  ==========


In October 1995, the Financial  Accounting  Standards Board issued Statement of
Financial  Accounting Standards No. 123,  "Accounting  for  Stock-Based
Compensation"  (SFAS No.  123),  which  defines a  fair-value  based method of
accounting for stock options granted to employees.

Pro forma information regarding net income and earnings per share is required by
SFAS No. 123 and has been determined as if the Corporation had accounted for its
employee  stock options  under the minimum  value method.  The minimum value for
these

                                       18

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



10. Stock Option Plan

options was estimated at the date of grant by calculating the excess of the fair
value  of the  stock at the date of  grant  over the  present  value of both the
exercise  price and the  expected  dividend  payments,  each  discounted  at the
risk-free  interest  rate,  over the expected life of the option.  The following
weighted  average  assumptions were used for 1996 and 1995:  risk-free  interest
rate of 6%, weighted  average expected life of the options of 5 years; and 1.33%
dividend yield.

For purpose of pro forma disclosures, the estimated minimum value of the options
is amortized to expense over the options' vesting period.  Note that the effects
of applying  SFAS No. 123 for pro forma  disclosure  in the current year are not
necessarily  representative  of the  effects  on pro forma net income for future
years.

Options  under the Plans are granted  with an  exercise  price equal to the fair
value of the shares of the date of grant.  As allowed by SFAS No. 123,  the Bank
has elected to continue  applying  Accounting  Principals  Board Opinion No. 25.
Accordingly,  no  compensation  cost  has been  recognized  for the  Plans.  Had
compensation  cost for the Plans been  determined  consistent with SFAS No. 123,
the  Corporation's  net income and earnings per share on a pro forma basis would
have been as follows:

                                              1996             1995
                                        -----------------------------------

    Pro forma net income                     $513,140        $651,077
    Pro forma earnings per share             $   0.96        $   1.49

11. Loans to Related Parties

The Bank has granted  loans to certain  officers  and  directors of the Bank and
their associates.  Related party loans are made on substantially the same terms,
including  interest rates and  collateral,  as those  prevailing at the time for
comparable  transactions with unrelated persons and do not involve more than the
normal risk of  collectibility.  The aggregate  dollar amount of these loans was
$3,705,346  and $1,922,609 at December 31, 1996 and 1995,  respectively.  During
1996, $2,507,000 of new loans were made while repayments totaled $724,263.


                                       19

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



12.  Financial Arrangements with Off-Balance-Sheet Risk

In the  normal  course of  business,  the  Corporation  is a party to  financial
arrangements with off-balance-sheet risk designed to meet the financing needs of
its customers. These financial arrangements include commitments to extend credit
and  commercial  letters of credit.  The Bank uses the same  credit  policies in
making commitments and conditional  obligations as it does for  on-balance-sheet
arrangements.

Financial arrangements whose contract amounts involve credit risk at December 31
are as follows:

<TABLE>
<CAPTION>
                                                                  1996           1995
                                                               -------------------------
<S><C>
Unused commitments to extend credit:
   Revolving open-end lines secured by residential properties  $  705,336    $   917,075
   Credit card lines                                            1,191,599      1,128,041
   Commercial real estate & construction                        2,810,000      3,011,300
   Other unused commitments                                     5,359,000      2,600,000
Commercial letters of credit                                      360,319        516,319
</TABLE>

Management  conducts  regular  reviews of the above  credit  arrangements  on an
individual  customer  basis,  and the results are  considered  in assessing  the
adequacy of the Bank's allowance for possible loan losses.

13. Contingent Liabilities

The  Corporation  and its  subsidiary  at times,  and in the ordinary  course of
business, are subject to legal actions.  Management does not believe the outcome
of such matters will have a material adverse effect on the financial  condition,
results of operations, or cash flows of the Corporation.

14. Stockholders' Equity

The Bank is subject to various regulatory capital  requirements  administered by
the FDIC. Failure to meet minimum capital  requirements can initiate  mandatory,
and  possible  additional   discretionary,   actions  by  regulators,   that  if
undertaken,  could have a direct material effect on the  consolidated  financial
statements.  Under capital adequacy guidelines and the regulatory  framework for
prompt corrective  action,  the Bank must meet specific capital  guidelines that
involve  quantitative  measures  of  their  assets,  liabilities,   and  certain
off-balance sheet items as calculated under regulatory accounting practices. The
Bank's

                                       20

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



14. Stockholders' Equity (continued)

capital amounts and classification are also subject to qualitative  judgments by
the regulators about components, risk weightings, and other factors.

Quantitative  measures  established  by  regulation to ensure  capital  adequacy
require the Bank to maintain  minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital to risk-weighted  assets,  and Tier 1 capital
to average  assets as defined in the  regulations.  Management  believes that at
December 31, 1996, the Bank meet all capital  adequacy  requirements to which it
is subject.

At December 31, 1996, the most recent notification from the FDIC categorized the
Bank as well capitalized  under the regulatory  framework for prompt  corrective
action.  There  were no  conditions  or  events  since  that  notification  that
management believes have changed the Bank's category.

                                       21

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



14. Stockholders' Equity (continued)

The Bank's actual capital amounts and ratios as compared to capital requirements
are presented in the following table.

<TABLE>
<CAPTION>
                                                                                          To Be Well Capitalized
                                                                                               Under Prompt
                                                                    For Capital              Corrective Action
                                             Actual              Adequacy Purposes              Provisions
                                   --------------------------------------------------------------------------------
                                                                   Minimum Required          Minimum Required
                                       Amount        Ratio        Amount       Ratio       Amount        Ratio
                                   --------------------------------------------------------------------------------
<S><C>
As of December 31, 1996:
  Total Capital (to risk-weighted
    total assets)
      Harbor Bank of Maryland          $11,209       17.00%         $5,275       8.0%       $6,594        10.0%

  Tier 1 capital (to risk weighted
    assets)
      Harbor Bank of Maryland           10,384       15.75           2,638       4.0         6,956         6.0

  Tier 1 capital (to average
   assets)
      Harbor Bank of Maryland           10,384        8.93           4,652       4.0         5,816         5.0

As of December 31, 1995:
  Total Capital (to risk-weighted
    total assets)
      Harbor Bank of Maryland            7,564       13.17           4,609       8.0         5,761        10.0

  Tier 1 capital (to risk weighted
   assets)
      Harbor Bank of Maryland            6,845       11.92           2,304       4.0         3,457         6.0

  Tier 1 capital (to average
   assets)
      Harbor Bank of Maryland            6,845        6.41           4,274       4.0         5,343         5.0

</TABLE>

Risk-based  guidelines apply on a consolidated  basis to bank holding  companies
with  consolidated  assets of $150 million or more. For those holding  companies
with less than $150  million  in  assets,  the  guidelines  will be applied on a
bank-only basis. As Harbor Bankshares  Corporation had total consolidated assets
of $130 million and $113  million at December  31, 1996 and 1995,  respectively,
only the capital ratios of the Bank are disclosed above.


                                       22


<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



14. Stockholders' Equity (continued)

The  ability  of the  Corporation  to pay  dividends  is limited by the level of
dividends  which  can be  paid  by the  Bank.  The  ability  of the  Bank to pay
dividends  is limited by the  provisions  of Maryland  law,  which  requires the
maintenance  of a  capital  surplus  account  equal  to  the  par  value  of the
outstanding common stock.

The Bank may make dividend  distributions  to the  Corporation up to 100% of its
net income in the  calendar  year.  At December 31,  1996,  the total  allowable
dividend distribution was $572,777.

15. Parent Company Only Financial Statements

                       Condensed Statements of Condition
<TABLE>
<CAPTION>
                                                                December 31
                                                          1996                1995
                                                    -------------------------------------
<S><C>
Assets:
   Investment in bank subsidiary                       $14,537,615         $11,334,122
   Other                                                   334,807             240,176
                                                    -------------------------------------
Total assets                                           $14,872,422         $11,574,298
                                                    =====================================

Liabilities and shareholders' equity Liabilities:
   Notes payable                                       $ 5,795,547         $ 5,795,547
   Other                                                    75,669             136,919
                                                    -------------------------------------
Total liabilities                                        5,871,216           5,932,466

Shareholders' equity                                     9,001,206           5,641,832
                                                    -------------------------------------
Total liabilities and shareholders' equity             $14,872,422         $11,574,298
                                                    =====================================
</TABLE>

                                       23

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)


15. Parent Company Only Financial Statements (continued)

                         Condensed Statements of Income
<TABLE>
<CAPTION>

                                                           Year ended           Year ended          For the period
                                                           December 31,         December 31,        Nov. 2 through
                                                              1996                  1995           December 31, 1994
                                                     -------------------------------------------------------------------
<S><C>
Dividend from subsidiary                                $     395,747          $    420,720            $    111,007
Interest expense                                             (309,205)             (334,778)               (123,558)
Income tax benefit                                            105,138               113,824                  45,716
Equity in undistributed income of subsidiary                  381,097               479,665                 591,945
                                                     -------------------------------------------------------------------
Net income                                              $     572,777          $    679,431            $    625,110
                                                     ===================================================================
</TABLE>
                       Condensed Statements of Cash Flows
<TABLE>
<CAPTION>
                                                         Year ended        Year ended        For the period
                                                         December 31,      December 31,      Nov. 2 through
                                                            1996              1995          December 31, 1994
                                                     ----------------------------------------------------------
<S><C>
Operating activities
Net income                                             $   572,777         $ 679,431          $   625,110
Adjustment to reconcile net income to net cash
   provided by operating activities:
     Increase in other (assets) liabilities, net          (105,138)          (57,541)              26,740
     Equity in undistributed income of subsidiary
                                                          (381,097)         (479,665)            (591,945)
                                                    -----------------------------------------------------------
Net cash provided by operating activities                   86,542           142,225               59,905
                                                    -----------------------------------------------------------

Investing activities
Investment in subsidiary                                (2,920,929)          (25,000)          (5,819,571)
                                                    -----------------------------------------------------------
Net cash provided by (used in) investing activities
                                                        (2,920,929)          (25,000)          (5,819,571)
                                                    -----------------------------------------------------------

Financing activities
Acquisition of treasury stock                                   -            (56,283)                   -
Proceeds from issuance of note payable                          -                  -            5,795,547
Cash dividends                                            (86,542)           (85,942)             (59,905)
Proceeds from common stock issuance                      2,920,929            25,000               24,024
                                                    -----------------------------------------------------------
Net cash provided by (used in) financing activities
                                                         2,834,387          (117,225)           5,759,666
                                                    -----------------------------------------------------------

Change in cash and cash equivalents                             -                  -                    -
Cash and cash equivalents at beginning of year
                                                                -                  -                    -
                                                    -----------------------------------------------------------
Cash and cash equivalents at end of year               $        -          $       -          $         -
                                                    ===========================================================
</TABLE>

                                       24

<PAGE>


                  Harbor Bankshares Corporation and Subsidiary

             Notes to Consolidated Financial Statements (continued)



16. Subsequent Events

On January 15, 1997, the  Corporation  declared a 1 1/3% stock dividend  payable
February 28, 1997 to common  stockholders of record on January 31, 1997. All per
share and stock  option  data has been  retroactively  adjusted  for this  stock
dividend.


                                       25