Exhibit 13.0

ANNAPOLIS BANCORP, INC.

Corporate Profile

Annapolis Bancorp, Inc. (the Company), formerly Annapolis National Bancorp, Inc. and Maryland Publick Banks, Inc., is a bank holding company, incorporated in May 1988 for the purpose of acquiring and holding all of the
outstanding stock of BankAnnapolis (the Bank) (formerly Annapolis National Bank), a federally insured community-oriented bank and one of two independent commercial banks headquartered in Annapolis, Maryland. The Bank currently operates
as a full service commercial bank from its headquarters in Annapolis, its five branches located in Anne Arundel County, Maryland and one branch located on Kent Island in Queen Annes County, Maryland. The Banks principal business consists
of originating loans and attracting deposits. The Bank originates commercial loans, commercial real estate loans, construction loans, one- to four-family real estate loans, home equity loans and consumer loans. The Bank also invests in U.S. Treasury
and U.S. Government agency securities and other securities including mortgage backed securities issued by or guaranteed by the federal government.

The
Bank conducts a general commercial and retail banking business in its market area, emphasizing the banking needs of small businesses, professional concerns and individuals. The Bank attracts most of its customer deposits from Anne Arundel County,
Maryland, and to a lesser extent, Queen Annes County, Maryland. The Banks lending operations are centered in Anne Arundel County, but extend throughout Central Maryland.

The Bank competes with numerous other financial intermediaries, commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance
companies, money market mutual funds and other financial institutions operating in Anne Arundel County and elsewhere. The Bank continually evaluates new products, and implements such new products as deemed appropriate by management.

The Banks Anne Arundel County service area is a highly concentrated, highly branched banking market. Competition in Anne Arundel County for loans to small
businesses and professionals, the Banks target market, is intense and pricing, service and access to decision-makers are important. Deposit competition among institutions in Anne Arundel County also is strong.

The Bank employed 79 full time and 10 part time individuals at December 31, 2005.

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The following is managements discussion and analysis
of the financial condition and results of operations of Annapolis Bancorp, Inc. on a consolidated basis with its wholly owned subsidiary, BankAnnapolis, for the periods presented, and should be read in conjunction with the consolidated financial
statements and the related notes thereto appearing elsewhere in this annual report.

The Company reported net income for 2005 of $3.0 million, an increase
of $809 thousand or 37.2% from 2004 net income of $2.2 million. The increase in 2005 earnings was primarily due to higher asset yields offset by an increase in interest expense. Earnings per diluted share were $0.71 compared to $0.52 per share in
2004.

The primary source of income of the Bank is interest on its loan and investment portfolios, while one of the principal expenses of the Bank is
interest on its deposit accounts and borrowings. The difference between interest income on interest earning assets and interest expense on interest bearing liabilities is referred to as net interest income. Net interest income was $11.5 million for
2005, an increase of $1.9 million or 19.3% compared to $9.6 million in 2004. Total assets were $304.9 million as of December 31, 2005, a $20.7 million or 7.3% increase over December 31, 2004 total assets of $284.2 million. The
Companys return on average assets was 0.97% and 0.84% for the years ending December 31, 2005, and 2004, respectively. The Companys return on average equity was 15.04% and 12.41% for the years ending December 31, 2005, and 2004,
respectively.

At December 31, 2005 the Banks gross loan portfolio totaled $204.5 million. Of this amount, $40.3 million or 19.7% were
commercial loans, $55.5 million or 27.1% were commercial real estate loans, $25.6 million or 12.5% were construction loans, $39.0 million or 19.1% were one- to four-family residential mortgage loans, $25.1 million or 12.3% were home equity loans,
and $19.0 million or 9.3% were consumer and other loans.



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Application of Critical Accounting Policies

The Companys consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industries in which
it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based
on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements may reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and
liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or
liability must be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain
assets and liabilities are either based on quoted market prices or are provided by other third-party sources, when available.

The most significant
accounting policies followed by the Corporation are presented in Note 1 to the consolidated financial statements which can be found on page 23 and continuing to page 26. These policies, along with the disclosures presented in the other financial
statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for credit losses to be the accounting area that requires the most subjective or complex
judgments, and as such could be most subject to revision as new information becomes available.

The allowance for credit losses represents
managements estimate of probable credit losses inherent in the loan portfolio as of the balance sheet date. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant
judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and
conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements found on page 24 describes the
methodology used to determine the allowance for credit losses and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in the Credit Risk Management section of this financial analysis.

Financial Condition as of December 31, 2005 and 2004 and Results of Operations for the Years then Ended

The Company, through its Bank subsidiary, functions as a financial intermediary, and as such its financial condition and results of operation can be examined in terms of
developing trends in its sources and uses of funds. These trends are the result of both external environmental factors, such as changing economic conditions, regulatory changes and competition, and also internal environmental factors such as
managements evaluation as to the best use of funds in these changing conditions.

Total assets increased by $20.7 million or 7.3% during 2005 to
$304.9 million from $284.2 million at December 31, 2005. Total deposits and securities sold under agreements to repurchase, the Companys primary sources of funds, increased $28.2 million or 12.0% to $262.9 million from $234.7 million at
December 31, 2005. Time deposits comprise the largest portion of the Banks total deposits, totaling $92.4 million or 36.9% of the Banks total deposits at December 31, 2005, compared to $91.7 million or 40.4% in 2004. Savings
and money market accounts totaled $75.9 million or 30.4% of the Banks total deposits at December 31, 2005, compared to $62.8 million or 27.6% in 2004. NOW accounts totaled $38.2 million or 15.3% and $32.8 million or 14.5% of total
deposits at December 31, 2005 and 2004, respectively. Demand, noninterest bearing accounts totaled $43.4 million or 17.4% of total deposits at December 31, 2005 and $39.5 million or 17.5% at December 31, 2004. Securities sold under
agreements to repurchase increased $5.1 million or 64.6% to $13.0 million from $7.9 million at December 31, 2005. Long-term borrowings were $15.0 million at December 31, 2005 compared to $25.0 million at December 31, 2004.

On March 26, 2003, Annapolis Bancorp Statutory Trust I (Statutory Trust I), a Connecticut business trust formed, funded and wholly owned by the
Company, issued $5,000,000 of variable-rate capital securities to institutional investors. The proceeds of the securities were used to provide funding for future growth and to improve the Companys capital ratios. The current cost of these
securities is 7.67%.

The Companys primary uses of funds are for loans and investments. Loans, excluding deferred fees/costs and discounts and the
allowance for credit losses, increased by $452 thousand or 2.2% to $204.5 million at December 31, 2005 from $204.1 million a year earlier. Real estate loan balances increased by $11.4 million or 10.4% offset by decreases in commercial loans of
$3.0 million or 7.1%, construction loans of $6.4 million or 20.0%, and; installment and other consumer loans of $1.5 million or 6.7%.



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Operating Results

The following discussion outlines some of the more important factors and trends affecting the earnings of the Company as presented in its consolidated statements of income.

Net Interest Income

Net interest income is the difference between interest income and interest expense and is
generally affected by increases or decreases in the amount of outstanding interest earning assets and interest bearing liabilities (volume variance). This volume variance coupled with changes in interest rates on these same assets and liabilities
(rate variance) equates to the total change in net interest income in any given period. The table on page 7 sets forth certain information regarding changes in interest income and interest expense attributable to (1) changes in volume (change
in volume multiplied by the old rate); (2) changes in rates (change in rate multiplied by the old volume); and (3) changes in rate/volume (change in rate multiplied by change in volume).

Net interest income for the year ended December 31, 2005, was $11.5 million, representing an increase of $1.9 million or 19.3% from net interest income of $9.6
million for the year ended December 31, 2004. The increase in net interest income is due primarily to increased average loan and investment balances. The net interest margin was 4.00% for each of the years ended December 31, 2005 and 2004,
respectively. Net interest income for 2005 includes $69 thousand of interest collected on a cash basis related to loans on nonaccrual status, compared to $44 thousand of interest collected on nonaccrual loans in 2004.

Interest Income

The Companys interest income increased $3.8
million or 29.0% for the year ended December 31, 2005. The increase in interest income can be attributed to an increase in loan volume and loan yield as average loans increased $19.2 million or 10.1%, and loan yield improved to 6.76% for the
year ended December 31, 2005 from 6.13% for the year ended December 31, 2004. Contributing to the increase in interest income is an increase in the investments and federal funds sold volume and an improvement in the overall portfolio
yield. Average federal funds sold, other overnight investments and investment securities increased $27.1 million or 52.8%, while the yield on federal funds sold, other investments and investment securities increased to 3.85% for the year ended
December 31, 2005 from 3.24% for the year ended December 31, 2004.

Interest Expense

The Companys interest expense increased $2.0 million or 54.7% to $5.6 million for 2005, compared to $3.6 million for 2004. The increase in interest expense for the
year ended December 31, 2005 can be attributed to higher deposit costs and an increase in the average balance of Federal Home Loan Bank borrowings rising to $23.0 million from $15.9 million for the year ended December 31, 2004. Offsetting
the higher average balances of Federal Home Loan Bank convertible advances was a lower cost of borrowing decreasing to 3.40% for the year compared to 3.82% for the year end December 31, 2004. Also contributing to the increase in interest
expense is an increase in the cost of long term borrowings in the form of junior subordinated debentures. Long term borrowings in the form of junior subordinated debentures had an average balance of $5 million for the years ended December 31,
2005 and 2004 with a cost of 6.45% for the year ended December 31, 2005 compared to 4.64% for the year ended December 31, 2004.

Provision for
Credit Losses

The Company recorded a provision for credit losses of $442 thousand for the year ended December 31, 2005 compared to $294 thousand
for the year ended December 31, 2004. The increase in provision was the result of higher loan volumes and net charge-offs of loans deemed uncollectible of $262 thousand for the year ended December 31, 2005 compared to net charge-offs of
$94 thousand for the year ended December 31, 2004. See the discussion under the heading Credit Risk Management for greater analysis regarding the Allowance for Credit Losses and related provision.

Noninterest Income

The Companys primary sources of noninterest
income are fees charged on deposit products, fees generated by the Banks VISA check card program, fees recognized on the origination of brokered residential mortgage loans and rental income from leasing space at the Banks headquarters
building. Included in noninterest income for the year ended December 31, 2005 is a one-time gain received of $201 thousand on the prepayment of a Federal Home Loan Bank convertible advance of $10.0 million compared to zero gains in 2004.
Including this gain, noninterest income increased $185 thousand or 9.1% to $2.2 million from $2.0 million in 2004. Fees charged on deposit products decreased $102 thousand or 7.8%, while mortgage banking fees totaled $329 thousand for the year ended
December 31, 2005, a 37.7% increase from fees of $239 thousand for the year ended December 31, 2004. The Company does not fund mortgage loans sold in the secondary market, but receives commissions from investors who fund the loans. Rental
income on the headquarters building totaled $178 thousand for year ended December 31, 2005 compared to $174 thousand for the year ended December 31, 2004.



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Noninterest Expense

Noninterest expense increased $676 thousand or 8.5% to $8.6 million at December 31, 2005, compared to $7.9 million at December 31, 2004. The increase in noninterest expense was primarily due to increases in personnel expense,
higher occupancy costs associated with a temporary trailer for Kent Island and higher legal collection expenses.

Personnel expense increased $221 thousand
or 4.8% to $4.8 million from $4.6 million, with $194 thousand related to salary increases, $105 thousand related to expensing stock options and the remainder related to payroll taxes and the higher costs of various employee benefit programs.

Occupancy and equipment expense increased $143 thousand or 14.9% due to costs associated with outfitting and occupying a temporary trailer during the
construction of a new branch at the current location on Kent Island.

Marketing expense increased $156 thousand or 64.5% as the Company launched a new
multi-media advertising campaign, while data processing expense increased $29 thousand or 4.5% due to increased account volumes and annual contractual increases from the Banks core processor. Other expenses increased $155 thousand or 7.2% due
to legal costs associated with collection efforts .

Provision for Income Taxes

The Company and the Bank file consolidated federal income tax returns and separate Maryland income tax returns. The Company recognized $1.6 million and $1.2 thousand in income tax expense for the years ended
December 31, 2005 and 2004, respectively, for an effective tax rate of 35.4% in 2005 and 36.2% in 2004.

Results of Operations for
the Years Ended December 31, 2004 and 2003

Net Income

Net income for the year ended December 31, 2004 totaled $2.2 million, a 29.8% increase from 2003 earnings of $1.7 million. Earnings per diluted share were $0.52 compared to $0.41 per diluted share for the year ended December 31,
2004.

Operating Results

The following discussion
outlines some of the more important factors and trends affecting the earnings of the Company as presented in its consolidated statements of income.

Net
Interest Income

Net interest income for the year ended December 31, 2004, was $9.6 million, representing an increase of $1.5 million or 18.6% from
net interest income of $8.1 million for the year ended December 31, 2003. The increase in net interest income is due primarily to increased loan and investment volumes offset by lower investment and loan yields.

Interest Income

Interest income increased $1.8 million or 15.5% in
2004 compared to 2003, primarily due to an increase in loan volume as average loans increased $34.1 million or 21.9% in 2004 while the loan yield decreased to 6.13% for the year ended December 31, 2004 from 6.48% for the year ended
December 31, 2004. Average federal funds sold, other overnight investments and investment securities increased $1.1 million or 2.2% with the yield on investment securities increasing to 3.24% for the year ended December 31, 2004 from 2.84%
for the year ended December 31, 2003.

Interest Expense

Interest expense increased $273 thousand or 8.1% to $3.6 million in 2004 compared to $3.4 million in 2003. The increase can be attributed to additional Federal Home Loan Bank borrowings and an increase in the cost of long term borrowings in
the form of junior subordinate debentures.



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Provision for Credit Losses

The Company recorded a provision for credit losses of $294 thousand for the year ended December 31, 2004 compared to $50 thousand for the year ended December 31, 2003. See the discussion under the heading Credit Risk
Management for greater analysis regarding the Allowance for Credit Losses and related provision.

Noninterest Income

Noninterest income decreased $59 thousand or 2.8% during 2004 to $2.0 million from $2.1 million compared to 2003. The decrease was attributable to lower fees collected on
deposit products and fees generated by the origination of brokered residential mortgage loans offset by, fees generated by the Banks VISA check card, and rental income from leasing space at the Banks headquarters building.

Noninterest Expense

Noninterest expense increased $413 thousand or
5.5% to $7.9 million in 2005 from $7.5 million in 2004. The increase in noninterest expense was primarily due to increases in compensation expense, higher occupancy costs and higher data processing expenses.

Selected Consolidated Financial Highlights

Selected Consolidated
Financial Data at and for years ended December 31,

(Dollars in thousands, except per share data)



|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|----------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                      |  | 2005 |           |   | 2004 |   |           | 2003 |  |   | 2002      |   |  | 2001 |          
|Selected Financial Data                               |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total assets                                          |  | $    | 304,916   |   |      | $ | 284,188   |      |  | $ | 231,338   |   |  | $    | 200,116   |   |  | $ | 166,681   |  
|Total loans, net                                      |  |      | 202,568   |   |      |   | 202,296   |      |  |   | 167,123   |   |  |      | 145,735   |   |  |   | 111,347   |  
|Total deposits                                        |  |      | 249,949   |   |      |   | 226,834   |      |  |   | 190,577   |   |  |      | 163,989   |   |  |   | 144,884   |  
|Securities sold under agreement to repurchase         |  |      | 12,986    |   |      |   | 7,901     |      |  |   | 8,745     |   |  |      | 10,500    |   |  |   | 7,674     |  
|Long-term debt                                        |  |      | 20,000    |   |      |   | 30,000    |      |  |   | 15,000    |   |  |      | 10,000    |   |  |   |          |  
|Stockholders equity                                  |  |      | 20,959    |   |      |   | 18,662    |      |  |   | 16,448    |   |  |      | 15,078    |   |  |   | 13,860    |  
|                                                      |  |      |           |   |     
|Selected Operating Data                               |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Interest income                                       |  | $    | 17,104    |   |      | $ | 13,260    |      |  | $ | 11,477    |   |  | $    | 10,858    |   |  | $ | 10,901    |  
|Interest expense                                      |  |      | 5,633     |   |      |   | 3,641     |      |  |   | 3,368     |   |  |      | 3,514     |   |  |   | 4,593     |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income                                   |  |      | 11,471    |   |      |   | 9,619     |      |  |   | 8,109     |   |  |      | 7,344     |   |  |   | 6,308     |  
|Provision for credit losses                           |  |      | 442       |   |      |   | 294       |      |  |   | 50        |   |  |      | 25        |   |  |   |          |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income after provision for credit losses |  |      | 11,029    |   |      |   | 9,325     |      |  |   | 8,059     |   |  |      | 7,319     |   |  |   | 6,308     |  
|Noninterest income                                    |  |      | 2,210     |   |      |   | 2,025     |      |  |   | 2,084     |   |  |      | 1,640     |   |  |   | 1,162     |  
|Noninterest expense                                   |  |      | 8,622     |   |      |   | 7,946     |      |  |   | 7,533     |   |  |      | 7,088     |   |  |   | 6,698     |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Income before income taxes                            |  |      | 4,617     |   |      |   | 3,404     |      |  |   | 2,610     |   |  |      | 1,871     |   |  |   | 772       |  
|Income tax expense                                    |  |      | 1,636     |   |      |   | 1,231     |      |  |   | 936       |   |  |      | 644       |   |  |   | 266       |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income                                            |  | $    | 2,981     |   |      | $ | 2,173     |      |  | $ | 1,674     |   |  | $    | 1,227     |   |  | $ | 506       |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|                                                      |  |      |           |   |     
|Key Financial Ratios and Other Data                   |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Return on average assets                              |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income divided by average assets                  |  |      | 0.97      | % |      |   | 0.84      | %    |  |   | 0.75      | % |  |      | 0.66      | % |  |   | 0.33      | %
|Return on average equity                              |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income divided by average equity                  |  |      | 15.04     | % |      |   | 12.48     | %    |  |   | 10.60     | % |  |      | 8.57      | % |  |   | 3.70      | %
|Equity to asset ratio                                 |  |      |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Average equity divided by average assets              |  |      | 6.46      | % |      |   | 6.73      | %    |  |   | 7.11      | % |  |      | 7.69      | % |  |   | 8.88      | %
|Diluted earnings per share (1), (2)                   |  | $    | 0.71      |   |      | $ | 0.52      |      |  | $ | 0.41      |   |  | $    | 0.30      |   |  | $ | 0.13      |  
|Book value per share (1), (2)                         |  | $    | 5.15      |   |      | $ | 4.61      |      |  | $ | 4.08      |   |  | $    | 3.75      |   |  | $ | 3.46      |  
|Tangible book value per share (1), (2)                |  | $    | 5.15      |   |      | $ | 4.61      |      |  | $ | 4.08      |   |  | $    | 3.75      |   |  | $ | 3.46      |  
|Number of shares outstanding (1), (2)                 |  |      | 4,072,800 |   |      |   | 4,050,480 |      |  |   | 4,031,932 |   |  |      | 4,022,947 |   |  |   | 4,009,183 |  
|Efficiency ratio                                      |  |      | 63.02     | % |      |   | 68.24     | %    |  |   | 73.90     | % |  |      | 78.90     | % |  |   | 89.67     | %
|Interest rate spread                                  |  |      | 3.65      | % |      |   | 3.71      | %    |  |   | 3.67      | % |  |      | 3.92      | % |  |   | 3.77      | %
|Net interest margin                                   |  |      | 4.00      | % |      |   | 4.00      | %    |  |   | 3.95      | % |  |      | 4.30      | % |  |   | 4.41      | %
|Risk based capital ratio  Tier 1                     |  |      | 12.31     | % |      |   | 11.14     | %    |  |   | 12.17     | % |  |      | 9.72      | % |  |   | 11.14     | %
|Risk based capital ratio  Total                      |  |      | 13.23     | % |      |   | 12.00     | %    |  |   | 13.09     | % |  |      | 10.74     | % |  |   | 12.64     | %

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|(1) | Adjusted to effect a four-for-three stock split in the form of a stock dividend issued on August 24, 2001.
|--- | ----------------------------------------------------------------------------------------------------------

|(2) | Adjusted to effect a four-for-three stock split in the form of a stock dividend issued on December 3, 2004.
|--- | -----------------------------------------------------------------------------------------------------------



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The following table presents a condensed average balance sheet as well as income/expense and yields/costs of funds
thereon for the years ended December 31, 2005, 2004 and 2003. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities for the periods shown. Average balances are derived from average daily
balances. The yields and costs include loan fees that are considered adjustments to yields. Net interest spread, the difference between the average rate on interest bearing assets and the average rate on interest bearing liabilities, decreased to
3.65% for the year ended December 31, 2005 from 3.71% at December 31, 2004.

Consolidated Average Balances, Yields and Rates

(Balances in thousands)



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|---------------------------------------------------------------- |  | ----------------- | ------- | -------- | ----------------- | ----------- |  | ----------------- | --------------- |  | -------- | ------- | ----------- | - | ------ | --------------- | ------ | -------- |  | ----------- | ------- |  | - | ------ |  | ------ | -
|                                                                 |  | Years Ended       |        
|                                                                 |  | December 31, 2005 |         |          | December 31, 2004 |             |  | December 31, 2003 |                
|                                                                 |  | Average Balance   |         | Interest |                   | Yield/ Rate |  |                   | Average Balance |  | Interest |         | Yield/ Rate |   |        | Average Balance |        | Interest |  | Yield/ Rate |        
|Assets                                                           |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Interest Earning Assets                                          |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Federal funds sold and other overnight investments               |  | $                 | 17,449  |          | $                 | 572         |  | 3.28              | %               |  | $        | 10,606  |             | $ | 157    |                 | 1.48   | %        |  | $           | 17,618  |  | $ | 191    |  | 1.08   | %
|Investment securities                                            |  |                   | 60,997  |          |                   | 2,446       |  | 4.01              | %               |  |          | 40,735  |             |   | 1,507  |                 | 3.70   | %        |  |             | 32,599  |  |   | 1,235  |  | 3.79   | %
|Loans                                                            |  |                   | 208,280 |          |                   | 14,086      |  | 6.76              | %               |  |          | 189,130 |             |   | 11,596 |                 | 6.13   | %        |  |             | 155,067 |  |   | 10,051 |  | 6.48   | %
|                                                                 |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Total interest earning assets                                    |  |                   | 286,726 |          |                   | 17,104      |  | 5.97              | %               |  |          | 240,471 |             |   | 13,260 |                 | 5.51   | %        |  |             | 205,284 |  |   | 11,477 |  | 5.59   | %
|Noninterest Earning Assets                                       |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Cash and due from banks                                          |  |                   | 8,586   |          |                   |             |  |                   |                 |  |          | 7,607   |             |   |        |                 |        |          |  |             | 6,540   |  |   |        |  |        |  
|Other assets                                                     |  |                   | 11,379  |          |                   |             |  |                   |                 |  |          | 10,693  |             |   |        |                 |        |          |  |             | 10,500  |  |   |        |  |        |  
|                                                                 |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Total Assets                                                     |  | $                 | 306,691 |          |                   |             |  |                   |                 |  | $        | 258,771 |             |   |        |                 |        |          |  | $           | 222,324 |  |   |        |  |        |  
|                                                                 |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Liabilities and Stockholders Equity                             |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Interest Bearing Deposits                                        |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|NOW accounts                                                     |  | $                 | 36,251  |          | $                 | 82          |  | 0.23              | %               |  | $        | 33,776  |             | $ | 78     |                 | 0.23   | %        |  | $           | 29,025  |  | $ | 58     |  | 0.20   | %
|Money market accounts                                            |  |                   | 49,534  |          |                   | 958         |  | 1.93              | %               |  |          | 36,392  |             |   | 354    |                 | 0.97   | %        |  |             | 27,926  |  |   | 273    |  | 0.98   | %
|Savings accounts                                                 |  |                   | 20,213  |          |                   | 77          |  | 0.38              | %               |  |          | 22,395  |             |   | 87     |                 | 0.39   | %        |  |             | 20,342  |  |   | 112    |  | 0.55   | %
|Certificates of deposit                                          |  |                   | 98.390  |          |                   | 3,105       |  | 3.16              | %               |  |          | 79,523  |             |   | 2,110  |                 | 2.65   | %        |  |             | 73,390  |  |   | 2,114  |  | 2.88   | %
|Repurchase agreements                                            |  |                   | 10,494  |          |                   | 290         |  | 2.76              | %               |  |          | 8,730   |             |   | 159    |                 | 1.82   | %        |  |             | 10,480  |  |   | 188    |  | 1.79   | %
|Long term borrowing                                              |  |                   | 23,027  |          |                   | 794         |  | 3.40              | %               |  |          | 15,907  |             |   | 617    |                 | 3.82   | %        |  |             | 10,000  |  |   | 456    |  | 4.50   | %
|Junior subordinated debt                                         |  |                   | 5,000   |          |                   | 327         |  | 6.45              | %               |  |          | 5,000   |             |   | 236    |                 | 4.64   | %        |  |             | 3,849   |  |   | 167    |  | 4.28   | %
|                                                                 |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Total interest bearing liabilities                               |  |                   | 242,909 |          |                   | 5,633       |  | 2.32              | %               |  |          | 201,723 |             |   | 3,641  |                 | 1.80   | %        |  |             | 175,012 |  |   | 3,368  |  | 1.92   | %
|                                                                 |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Noninterest Bearing Liabilities                                  |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Demand deposit accounts                                          |  |                   | 42,933  |          |                   |             |  |                   |                 |  |          | 38,705  |             |   |        |                 |        |          |  |             | 30,748  |  |   |        |  |        |  
|Other liabilities                                                |  |                   | 1,029   |          |                   |             |  |                   |                 |  |          | 937     |             |   |        |                 |        |          |  |             | 764     |  |   |        |  |        |  
|Stockholders Equity                                             |  |                   | 19,820  |          |                   |             |  |                   |                 |  |          | 17,406  |             |   |        |                 |        |          |  |             | 15,800  |  |   |        |  |        |  
|                                                                 |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Total Liabilities and Stockholders Equity                       |  | $                 | 306,691 |          |                   |             |  |                   |                 |  | $        | 258,771 |             |   |        |                 |        |          |  | $           | 222,324 |  |   |        |  |        |  
|                                                                 |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  
|Interest rate spread                                             |  |                   |         |          |                   |             |  | 3.65              | %               |  |          |         |             |   |        |                 | 3.71   | %        |  |             |         |  |   |        |  | 3.67   | %
|Ratio of interest earning assets to interest bearing liabilities |  |                   |         |          |                   |             |  | 118.04            |                 |  |          |         |             |   |        |                 | 119.21 | %        |  |             |         |  |   |        |  | 117.30 | %
|Net interest income and net interest margin                      |  |                   |         |          | $                 | 11,471      |  | 4.00              | %               |  |          |         |             | $ | 9,619  |                 | 4.00   | %        |  |             |         |  | $ | 8,109  |  | 3.95   | %
|                                                                 |  |                   |         |          |                   |             |  |                   |                 |  |          |         |             |   |        |                 |        |          |  |             |         |  |   |        |  |        |  



6



---

Rate/Volume Analysis

(Dollars in thousands)



|                                                   |  |                        |       |   |                  |   |       |      |  |   |                  |   |  |                        |     |   |        |   |       |      |  |   |              |   |  |    |      |   |  |    |      |  
|-------------------------------------------------- |  | ---------------------- | ----- | - | ---------------- | - | ----- | ---- |  | - | ---------------- | - |  | ---------------------- | --- | - | ------ | - | ----- | ---- |  | - | ------------ | - |  | -- | ---- | - |  | -- | ---- | -
|                                                   |  | 2005 vs. 2004          |       |   | 2004 vs. 2003    |  
|                                                   |  |                        |       |   | Due to Change in |   |       |      |  |   | Due to Change in |  
|                                                   |  | Increase or (Decrease) |       |   | Volume           |   |       | Rate |  |   | Rate/ Volume     |   |  | Increase or (Decrease) |     |   | Volume |   |       | Rate |  |   | Rate/ Volume |  
|Interest income on:                                |  |                        |       |   |                  |   |       |      |  |   |                  |   |  |                        |     |   |        |   |       |      |  |   |              |   |  |    |      |   |  |    |      |  
|Loans                                              |  | $                      | 2,490 |   |                  | $ | 1,174 |      |  | $ | 1,195            |   |  | $                      | 121 |   |        | $ | 1,545 |      |  | $ | 2,208        |   |  | ($ | 544  | ) |  | ($ | 119  | )
|Investment securities                              |  |                        | 939   |   |                  |   | 749   |      |  |   | 127              |   |  |                        | 63  |   |        |   | 272   |      |  |   | 309          |   |  |    | (30  | ) |  |    | (7   | )
|Federal funds sold and other overnight investments |  |                        | 415   |   |                  |   | 102   |      |  |   | 190              |   |  |                        | 123 |   |        |   | (34   | )    |  |   | (76          | ) |  |    | 71   |   |  |    | (29  | )
|                                                   |  |                        |       |   |                  |   |       |      |  |   |                  |   |  |                        |     |   |        |   |       |      |  |   |              |   |  |    |      |   |  |    |      |  
|Total interest income                              |  |                        | 3,844 |   |                  |   | 2,025 |      |  |   | 1,512            |   |  |                        | 307 |   |        |   | 1,783 |      |  |   | 2,441        |   |  |    | (503 | ) |  |    | (155 | )
|                                                   |  |                        |       |   |                  |   |       |     
|Interest expense on:                               |  |                        |       |   |                  |   |       |      |  |   |                  |   |  |                        |     |   |        |   |       |      |  |   |              |   |  |    |      |   |  |    |      |  
|NOW accounts                                       |  |                        | 4     |   |                  |   | 6     |      |  |   | (2               | ) |  |                        |    |   |        |   | 20    |      |  |   | 10           |   |  |    | 9    |   |  |    | 1    |  
|Money market accounts                              |  |                        | 603   |   |                  |   | 128   |      |  |   | 349              |   |  |                        | 126 |   |        |   | 81    |      |  |   | 83           |   |  |    | (1   | ) |  |    | (1   | )
|Savings accounts                                   |  |                        | (9    | ) |                  |   | (8    | )    |  |   | (1               | ) |  |                        |    |   |        |   | (25   | )    |  |   | 12           |   |  |    | (34  | ) |  |    | (3   | )
|Certificates of deposit                            |  |                        | 995   |   |                  |   | 501   |      |  |   | 399              |   |  |                        | 95  |   |        |   | (4    | )    |  |   | 176          |   |  |    | (166 | ) |  |    | (14  | )
|Repurchase agreements                              |  |                        | 132   |   |                  |   | 32    |      |  |   | 83               |   |  |                        | 17  |   |        |   | (29   | )    |  |   | (31          | ) |  |    | 3    |   |  |    | (1   | )
|Long term-borrowings                               |  |                        | 176   |   |                  |   | 276   |      |  |   | (69              | ) |  |                        | (31 | ) |        |   | 161   |      |  |   | 269          |   |  |    | (68  | ) |  |    | (40  | )
|Junior subordinated debt                           |  |                        | 91    |   |                  |   |      |      |  |   | 91               |   |  |                        |    |   |        |   | 69    |      |  |   | 50           |   |  |    | 15   |   |  |    | 4    |  
|                                                   |  |                        |       |   |                  |   |       |      |  |   |                  |   |  |                        |     |   |        |   |       |      |  |   |              |   |  |    |      |   |  |    |      |  
|Total interest expense                             |  |                        | 1,992 |   |                  |   | 935   |      |  |   | 850              |   |  |                        | 207 |   |        |   | 273   |      |  |   | 569          |   |  |    | (242 | ) |  |    | (54  | )
|                                                   |  |                        |       |   |                  |   |       |      |  |   |                  |   |  |                        |     |   |        |   |       |      |  |   |              |   |  |    |      |   |  |    |      |  
|Net interest income                                |  | $                      | 1,852 |   |                  | $ | 1,090 |      |  | $ | 662              |   |  | $                      | 100 |   |        | $ | 1,510 |      |  | $ | 1,872        |   |  | ($ | 261  | ) |  | ($ | 101  | )
|                                                   |  |                        |       |   |                  |   |       |      |  |   |                  |   |  |                        |     |   |        |   |       |      |  |   |              |   |  |    |      |   |  |    |      |  

Risk Management

The Board of Directors is the foundation for effective corporate governance and risk management. The Board demands accountability of management, keeps stockholders and other constituencies interests in focus, advocates the
upholding of the Companys code of ethics, and fosters a strong internal control environment. Through its Audit Committee, the Board actively reviews critical risk positions, including market, credit, liquidity, and operational risk. The
Companys goal in managing risk is to reduce earnings volatility, control exposure to unnecessary risk, and ensure appropriate returns for risk assumed. Senior management manages risk at the business line level, supplemented with
corporate-level oversight through the Asset Liability Committee, internal audit and quality control functions.

Liquidity Risk Management and Capital
Resources

The objective of liquidity management is to ensure that the cash flow requirements of depositors and borrowers, as well as the operating cash
needs of the Company are met, taking into account all on- and off-balance sheet funding demands. Liquidity management also includes ensuring that cash flow needs are met at a reasonable cost. Liquidity risk arises from the possibility the Company
may not be able to satisfy current or future financial commitments, or the Company may become unduly reliant on alternative funding sources. The Company maintains a liquidity risk management policy to address and manage this risk. The policy
identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements which comply with regulatory guidance. The liquidity position is continually monitored and
reported monthly to the Board of Directors.

Deposits, commercial reverse repurchase agreements, and lines of credit are the primary sources of the
Banks funds for lending and investing activities. During 2005 the Company repaid a $10 million convertible advance from the Federal Home Loan Bank of Atlanta. Secondary sources of funds are derived from loan repayments and investment
maturities. Loan repayments and investment maturities can be considered a relatively stable funding source, while deposit activity is greatly influenced by interest rates, general market conditions and competition.

The Bank offers a variety of retail deposit account products to both consumer and commercial deposit customers. The Banks deposit accounts consist of savings, NOW
accounts, checking accounts, money market accounts and certificate of deposit accounts. The Bank also offers individual retirement accounts. Time deposits comprised 37.0% of the deposit portfolio at December 31, 2005. Core deposits, considered
to be noninterest bearing and interest bearing demand deposit accounts, savings deposits and money market accounts, accounted for 63.0% of the deposit portfolio at December 31, 2005. This represents a 16.6% increase in the percentage of core
deposits to total deposits. Core deposits accounted for 59.6% of the deposit portfolio at December 31, 2004.

The Bank intends to continue to
emphasize retail deposit accounts as its primary source of funds. Deposit products are promoted in periodic newspaper advertisements, along with notices provided in customer account statements. The Banks market strategy is based on its
reputation as a community bank providing quality products and personal customer service.



7



---

The Bank pays interest rates on interest bearing deposit products competitive with rates offered by other financial
institutions in its market area, and in certain deposit categories may lead the market. Interest rates on deposits are reviewed by management which considers a number of factors including: (1) the Banks internal cost of funds;
(2) rates offered by competing financial institutions; (3) investing and lending opportunities; and (4) the Banks liquidity position.

Jumbo certificates of deposit are accounts of $100,000 or more. These accounts totaled $33.1 million at December 31, 2005 and consisted principally of time certificates of deposit. The following table sets forth the amount and maturity
of jumbo certificates of deposit at December 31, 2005:

(Dollars in thousands)



|                    |  |                                        |       |                                     |   |                       |  |       |        |  |   |       
|------------------- |  | -------------------------------------- | ----- | ----------------------------------- | - | --------------------- |  | ----- | ------ |  | - | ------
|Three Monthsor Less |  | Greater than Three Monthsto Six Months |       | Greater than Six Months to One
Year |   | Greater than One Year |  | Total
|$            5,625  |  | $                                      | 3,120 |                                     | $ | 7,479                 |  | $     | 16,908 |  | $ | 33,132
|                    |  |                                        |       |                                     |   |                       |  |       |        |  |   |       

Securities sold under agreements to repurchase represent transactions with customers for correspondent or
commercial account cash management services. These are overnight borrowing arrangements with interest rates discounted from the federal funds sold rate. Securities underlying the repurchase agreements are maintained in the Companys control.
For the years ended December 31, 2005 and 2004, the average cost of these borrowings was 2.76% and 1.82%, respectively.

The Bank maintains a secured
borrowing line with the Federal Home Loan Bank (FHLB) with the ability to draw up to $122.0 million, and may borrow up to $12.5 million under secured and unsecured lines established with correspondent commercial banks. In addition, the Bank has the
ability to borrow directly from the Federal Reserve Bank discount window. At December 31, 2005, the Bank had advances outstanding of $15.0 million under the Federal Home Loan Banks convertible advance program.

Potential adverse impacts on liquidity can occur as a result of changes in the estimated cash flows from investment, loan, and deposit portfolios. The Bank manages this
inherent risk by maintaining a portfolio of available for sale investments and through secondary sources of liquidity including FHLB advances and reverse repurchase agreements. In addition, the Bank has the ability to increase its liquidity by
raising interest rates on deposit accounts, selling loans in the secondary market or curtailing the volume of loan originations.

The Bank maintains the majority of the assets held for liquidity purposes in overnight federal funds.

Interest Rate Risk Sensitivity

Interest rate sensitivity is an important factor in the management of the composition and maturity configurations of the Companys interest
earning assets and funding sources. Additionally, the Banks profitability is dependent to a large extent upon its net interest income, which is the difference between its interest income on interest bearing assets, such as loans and
investments, and its interest expense on its funding sources, such as deposits and borrowings. Accordingly, the Banks results of operations and financial condition are largely dependent on movements in market interest rates and its ability to
manage its assets in response to such movements.

The Bank attempts to manage fluctuations in interest rates by matching the maturities of its interest
earning assets and interest bearing liabilities. The Banks current strategy to manage its sensitivity to interest rate fluctuations is to emphasize adjustable rate loans and to invest in short term U.S. Government agency securities with
maturities or call dates of five years or less. Prior to the most recent Federal Reserve rate changes the Bank increased its activity in fixed rate loans to stabilize the net interest margin. To reduce the negative impact of engaging in excessive
fixed rate lending in a volatile rate environment, the Bank uses a third party for settlement of the majority of long-term fixed rate loans.

The following
table summarizes the anticipated maturities or repricing of the Companys interest earning assets and interest bearing liabilities as of December 31, 2005, and the Companys interest sensitivity gap (i.e., interest earning assets less
interest bearing liabilities). A positive gap for any time period indicates that more interest earning assets will mature or reprice during that period than interest bearing liabilities. The Companys goal is to maintain a cumulative gap
position for the period of one year or less of plus or minus fifteen percent in order to mitigate the impact of changes in interest rates on liquidity, interest margins and operating results.

The analysis presented below represents a static gap position for interest sensitive assets and liabilities at December 31, 2005, and does not give effect to
prepayment or extension of loans as a result of changes in general market rates.



8



---

Interest Sensitivity Gap Analysis

December 31, 2005

($000)



|                                                                                     |  |                     |         |    |                                      |    |        |                                 |  |    |                  |    |  |       |        |   |  |   |        
|------------------------------------------------------------------------------------ |  | ------------------- | ------- | -- | ------------------------------------ | -- | ------ | ------------------------------- |  | -- | ---------------- | -- |  | ----- | ------ | - |  | - | -------
|                                                                                     |  | Within Three Months |         |    | After Three but within Twelve Months |    |        | After One but within Five Years |  |    | After Five Years |    |  | Total
|Assets                                                                               |  |                     |         |    |                                      |    |        |                                 |  |    |                  |    |  |       |        |   |  |   |        
|Federal funds sold and other overnight investments                                   |  | $                   | 3,400   |    |                                      | $  |       |                                 |  | $  |                 |    |  | $     |       |   |  | $ | 3,400  
|Investment securities (1)                                                            |  |                     | 31,201  |    |                                      |    | 7,858  |                                 |  |    | 6,074            |    |  |       | 27,022 |   |  |   | 72,155 
|Loans (2) (3)                                                                        |  |                     | 73,871  |    |                                      |    | 21,177 |                                 |  |    | 60,735           |    |  |       | 47,552 |   |  |   | 203,335
|                                                                                     |  |                     |         |    |                                      |    |        |                                 |  |    |                  |    |  |       |        |   |  |   |        
|                                                                                     |  | $                   | 108,472 |    |                                      | $  | 29,035 |                                 |  | $  | 66,809           |    |  | $     | 74,574 |   |  | $ | 278,890
|                                                                                     |  |                     |         |    |                                      |    |        |                                 |  |    |                  |    |  |       |        |   |  |   |        
|Liabilities                                                                          |  |                     |         |    |                                      |    |        |                                 |  |    |                  |    |  |       |        |   |  |   |        
|Interest bearing liabilities                                                         |  |                     |         |    |                                      |    |        |                                 |  |    |                  |    |  |       |        |   |  |   |        
|NOW accounts                                                                         |  | $                   | 38,161  |    |                                      | $  |       |                                 |  | $  |                 |    |  | $     |       |   |  | $ | 38,161 
|Money market accounts                                                                |  |                     | 57,333  |    |                                      |    |       |                                 |  |    |                 |    |  |       |       |   |  |   | 57,333 
|Savings accounts                                                                     |  |                     | 18,608  |    |                                      |    |       |                                 |  |    |                 |    |  |       |       |   |  |   | 18,608 
|Certificates of deposit (4)                                                          |  |                     | 15,253  |    |                                      |    | 25,011 |                                 |  |    | 52,135           |    |  |       |       |   |  |   | 92,399 
|Commercial repurchase agreements                                                     |  |                     | 12,986  |    |                                      |    |       |                                 |  |    |                 |    |  |       |       |   |  |   | 12,986 
|Long-term borrowings                                                                 |  |                     |        |    |                                      |    |       |                                 |  |    | 5,000            |    |  |       | 10,000 |   |  |   | 15,000 
|Junior subordinated debt                                                             |  |                     |        |    |                                      |    |       |                                 |  |    |                 |    |  |       | 5,000  |   |  |   | 5,000  
|                                                                                     |  |                     |         |    |                                      |    |        |                                 |  |    |                  |    |  |       |        |   |  |   |        
|                                                                                     |  | $                   | 142,341 |    |                                      | $  | 25,011 |                                 |  | $  | 57,135           |    |  | $     | 15,000 |   |  | $ | 239,487
|                                                                                     |  |                     |         |    |                                      |    |        |                                 |  |    |                  |    |  |       |        |   |  |   |        
|Interest sensitivity gap                                                             |  | ($                  | 33,869  | )  |                                      | $  | 4,024  |                                 |  | $  | 9,674            |    |  | $     | 59,574 |   |  |   | 39,403 
|Cumulative interest sensitivity gap                                                  |  | ($                  | 33,869  | )  |                                      | ($ | 29,845 | )                               |  | ($ | 20,171           | )  |  | $     | 39,403 |   |  |   |        
|Cumulative interest sensitivity gap as a percentage of total interest-earning assets |  |                     | (12.14  | )% |                                      |    | (10.70 | )%                              |  |    | (7.23            | )% |  |       | 14.13  | % |  |   |        

---

|(1) | Net of Federal Reserve Bank and Federal Home Loan Bank stock, by call date.
|--- | ---------------------------------------------------------------------------

|(2) | Loans scheduled by contractual maturities.
|--- | ------------------------------------------

|(3) | Net of non-accrual loans of $1.2 million.
|--- | -----------------------------------------

|(4) | Certificates of deposits scheduled by contractual maturities.
|--- | -------------------------------------------------------------

Investment Portfolio

At December 31, 2005, the Banks investment portfolio, which totaled $73.9 million, consisted almost
entirely of U.S. Government Agency securities and mortgage-backed securities. The Company invests primarily in state tax exempt U.S. Government Agency securities in order to minimize its state income tax liability. Additionally, the Company owns
$504,200 in stock of the Federal Reserve Bank of Richmond and $1,242,900 in stock of the Federal Home Loan Bank of Atlanta (FHLB). Management generally maintains an investment portfolio with relatively short maturities to minimize overall interest
rate risk. At December 31, 2005, approximately 62.6% of the investment securities portfolio had contractual maturities of five years or less.

Investment decisions are made within policy guidelines established by the Board of Directors. It is the Banks policy to invest in non-speculative debt instruments, particularly debt instruments that are guaranteed by the U.S.
Government or an agency thereof, to maintain a diversified investment portfolio which complements the overall asset/liability and liquidity objectives of the Bank, while limiting the related credit risk to an acceptable level. To meet the credit
risk objectives, non-government debt instruments must have a rating of B or better to be held in the portfolio. The Banks investment policy designates the investment portfolio to be classified as available-for-sale,
unless otherwise designated. At December 31, 2005, 100% of the investment portfolio was classified available-for-sale. The composition of securities at December 31, for each of the past five fiscal years was:

($000)



|                   |  |      |        |      |   |        |  |      |        |      |   |        |  |   |       
|------------------ |  | ---- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                   |  | 2005 |        | 2004 |   | 2003   |  | 2001 |        | 2000
|Available for Sale |  |      |        |      |   |        |  |      |        |      |   |        |  |   |       
|U.S. Agency        |  | $    | 44,315 |      | $ | 33,139 |  | $    | 28,167 |      | $ | 14,657 |  | $ | 23,346
|Mortgage-backed    |  |      | 27,840 |      |   | 19,209 |  |      | 8,798  |      |   | 4,692  |  |   | 4,931 
|Equity Securities  |  |      | 1,747  |      |   | 2,092  |  |      | 1,004  |      |   | 858    |  |   | 718   
|                   |  |      |        |      |   |        |  |      |        |      |   |        |  |   |       
|Total Securities   |  | $    | 73,902 |      | $ | 54,440 |  | $    | 37,969 |      | $ | 20,207 |  | $ | 28,995
|                   |  |      |        |      |   |        |  |      |        |      |   |        |  |   |       



9



---

The following table presents maturities and weighted average yields for investments in available-for-sale securities net
of Federal Reserve Bank and Federal Home Loan Bank stock.

December 31, 2005

($000)



|                      |  |                        |        |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  
|--------------------- |  | ---------------------- | ------ | ----- | ----------------------------- | - | ------ | ------------------------ | ------ |  | ---- | ------ |  | ----- | ----- |  | ---- | -
|                      |  | Years to Maturity      |       
|                      |  | Within One Year        |        |       | Within One Year to Five Years |   |        | Within Five to Ten Years |       
|                      |  | Amount                 |        | Yield |                               |   | Amount |                          | Yield  |  |      | Amount |  | Yield |      
|Available for Sale    |  |                        |        |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  
|U.S. Agency           |  | $                      | 996    |       | 4.23                          | % |        | $                        | 41,394 |  | 3.81 | %      |  | $     | 1,925 |  | 4.62 | %
|Mortgage-backed       |  |                        |       |       | 0.00                          | % |        |                          | 836    |  | 4.42 | %      |  |       | 691   |  | 4.68 | %
|                      |  |                        |        |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  
|Total Debt Securities |  | $                      | 996    |       | 4.23                          | % |        | $                        | 42,230 |  | 3.55 | %      |  | $     | 2,616 |  | 4.64 | %
|                      |  |                        |        |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  
|                      |  |                        |        |       |                              
|                      |  | Greater than Ten Years |        |       |                               |   |        |                          |        |  |      |        | 
|                      |  | Amount                 |        | Yield |                               |   | Total  |                          |        |  |      |        |  |       |      
|Available for Sale    |  |                        |        |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  
|U.S. Agency           |  | $                      |       |       | 0.00                          | % |        | $                        | 44,315 |  |      |        |  |       |       |  |      |  
|Mortgage-backed       |  |                        | 26,313 |       | 4.48                          | % |        |                          | 27,840 |  |      |        |  |       |       |  |      |  
|                      |  |                        |        |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  
|Total Debt Securities |  | $                      | 26,313 |       | 4.48                          | % |        | $                        | 72,155 |  |      |        |  |       |       |  |      |  
|                      |  |                        |        |       |                               |   |        |                          |        |  |      |        |  |       |       |  |      |  

Lending Activities

The types of loans that the Bank may originate are subject to federal laws and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans and the supply of money available for lending purposes and the
rates offered by competitors.

These factors are, in turn, affected by, among other things, economic conditions, monetary policies of the federal
government, including the Federal Reserve Board, and legislative tax policies.

Analysis of Loans

The following table presents the composition of the loan portfolio over the previous five years:

As of December 31,



|                                  |        |      |         |         |      |       |        |      |   |         |      |  |        |      |  |         |         |   |        |       |   |         |   |         |        |  |       |         |  |   |         |   |  |       |  
|--------------------------------- | ------ | ---- | ------- | ------- | ---- | ----- | ------ | ---- | - | ------- | ---- |  | ------ | ---- |  | ------- | ------- | - | ------ | ----- | - | ------- | - | ------- | ------ |  | ----- | ------- |  | - | ------- | - |  | ----- | -
|($000)                            |        | 2005 |         |         | 2004 |       |        | 2003 |   |         | 2002 |  |        | 2001 | 
|                                  | Amount |      |         | Percent |      |       | Amount |      |   | Percent |      |  | Amount |      |  | Percent |         |   | Amount |       |   | Percent |   |         | Amount |  |       | Percent | 
|Commercial loans                  |        | $    | 40,260  |         |      | 19.7  | %      |      | $ | 42,248  |      |  | 20.7   | %    |  | $       | 41,173  |   |        | 24.4  | % |         | $ | 32,445  |        |  | 22.0  | %       |  | $ | 24,368  |   |  | 21.5  | %
|Real estate loans                 |        |      |         |         |      |       |        |      |   |         |      |  |        |      |  |         |         |   |        |       |   |         |   |         |        |  |       |         |  |   |         |   |  |       |  
|Commercial                        |        |      | 55,479  |         |      | 27.1  | %      |      |   | 48,628  |      |  | 23.8   | %    |  |         | 44,214  |   |        | 26.2  | % |         |   | 41,219  |        |  | 28.0  | %       |  |   | 38,498  |   |  | 34.0  | %
|Construction                      |        |      | 25,646  |         |      | 12.5  | %      |      |   | 32,004  |      |  | 15.7   | %    |  |         | 24,713  |   |        | 14.6  | % |         |   | 25,060  |        |  | 17.0  | %       |  |   | 17,712  |   |  | 15.7  | %
|One-to four-family                |        |      | 39,018  |         |      | 19.1  | %      |      |   | 32,571  |      |  | 16.0   | %    |  |         | 18,869  |   |        | 11.2  | % |         |   | 20,233  |        |  | 13.7  | %       |  |   | 17,083  |   |  | 15.1  | %
|Home equity                       |        |      | 25,134  |         |      | 12.3  | %      |      |   | 28,194  |      |  | 13.8   | %    |  |         | 20,341  |   |        | 12.1  | % |         |   | 14,319  |        |  | 9.7   | %       |  |   | 6,568   |   |  | 5.8   | %
|Consumer loans                    |        |      | 18,977  |         |      | 9.3   | %      |      |   | 20,325  |      |  | 10.0   | %    |  |         | 19,431  |   |        | 11.5  | % |         |   | 14,140  |        |  | 9.6   | %       |  |   | 8,887   |   |  | 7.9   | %
|                                  |        |      |         |         |      |       |        |      |   |         |      |  |        |      |  |         |         |   |        |       |   |         |   |         |        |  |       |         |  |   |         |   |  |       |  
|Total loans                       |        |      | 204,514 |         |      | 100.0 | %      |      |   | 203,970 |      |  | 100.0  | %    |  |         | 168,741 |   |        | 100.0 | % |         |   | 147,416 |        |  | 100.0 | %       |  |   | 113,116 |   |  | 100.0 | %
|                                  |        |      |         |         |      |       |        |      |   |         |      |  |        |      |  |         |         |   |        |       |   |         |   |         |        |  |       |         |  |   |         |   |  |       |  
|Less:                             |        |      |         |         |      |       |        |      |   |         |      |  |        |      |  |         |         |   |        |       |   |         |   |         |        |  |       |         |  |   |         |   |  |       |  
|Deferred costs, (unearned income) |        |      | 66      |         |      |       |        |      |   | 158     |      |  |        |      |  |         | 14      |   |        |       |   |         |   | (103    | )      |  |       |         |  |   | (193    | ) |  |       |  
|Allowance for credit losses       |        |      | (2,012  | )       |      |       |        |      |   | (1,832  | )    |  |        |      |  |         | (1,632  | ) |        |       |   |         |   | (1,578  | )      |  |       |         |  |   | (1,576  | ) |  |       |  
|                                  |        |      |         |         |      |       |        |      |   |         |      |  |        |      |  |         |         |   |        |       |   |         |   |         |        |  |       |         |  |   |         |   |  |       |  
|Net loans receivable              |        | $    | 202,568 |         |      |       |        |      | $ | 202,296 |      |  |        |      |  | $       | 167,123 |   |        |       |   |         | $ | 145,735 |        |  |       |         |  | $ | 111,347 |   |  |       |  
|                                  |        |      |         |         |      |       |        |      |   |         |      |  |        |      |  |         |         |   |        |       |   |         |   |         |        |  |       |         |  |   |         |   |  |       |  

The Banks loan portfolio consists of commercial, commercial real estate, residential construction, one- to
four-family residential mortgage, home equity and consumer loans. At December 31, 2005 the Banks loan portfolio totaled $204.5 million, of which $40.3 million, or 19.7%, was commercial loans; $55.5 million, or 27.1%, was commercial real
estate loans; $25.6 million, or 12.5%, was construction loans; $39.0 million, or 19.1%, was one- to four-family residential mortgage loans; $25.1 million, or 12.3%, was home equity loans, and; $19.0 million, or 9.3%, was consumer and other loans.
All of the loans in the Banks portfolio are either adjustable-rate with terms to maturity of 30 days to 30 years or short- to intermediate-term fixed-rate loans.

Commercial Lending. The Bank offers commercial business loans to businesses operating in the Banks primary market area.



10



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These loans consist of lines of credit, which may require an annual repayment, adjustable-rate loans with terms of five
to seven years, and fixed-rate loans with terms of up to five years. Such loans are generally secured by receivables, inventories, equipment and other assets of the business. The Bank generally requires personal guarantees on its commercial loans.
The Bank also offers unsecured commercial loans to businesses on a selective basis. These types of loans are made to existing customers and are of a short duration, generally one year or less. The Bank also originates commercial loans which are
guaranteed by the Small Business Administration. The Bank has been an active participant in a variety of SBA loan programs.

As of December 31, 2005



|                  |  |                         |        |                                          |   |                      |  |                 |        |                 |   |       |  |   |     |  |   |        
|----------------- |  | ----------------------- | ------ | ---------------------------------------- | - | -------------------- |  | --------------- | ------ | --------------- | - | ----- |  | - | --- |  | - | -------
|($000)            |  | Due in One Year or
Less |        | Due after One Year but before Five Years |   | Due after Five Years |  | NonaccrualLoans |        | 90 DaysPast Due |   | Total
|Real estate loans |  |                         |        |                                          |   |                      |  |                 |        |                 |   |       |  |   |     |  |   |        
|Construction      |  | $                       | 23,471 |                                          | $ | 905                  |  | $               | 500    |                 | $ | 770   |  | $ |    |  | $ | 25,646 
|Mortgage          |  |                         | 6,466  |                                          |   | 18,914               |  |                 | 13,628 |                 |   | 10    |  |   |    |  |   | 39,018 
|Commercial        |  |                         | 16,296 |                                          |   | 23,061               |  |                 | 15,424 |                 |   |      |  |   | 698 |  |   | 55,479 
|Commercial loans  |  |                         | 20,705 |                                          |   | 16,663               |  |                 | 2,802  |                 |   | 90    |  |   |    |  |   | 40,260 
|Home equity loans |  |                         | 25,134 |                                          |   |                     |  |                 |       |                 |   |      |  |   |    |  |   | 25,134 
|Consumer loans    |  |                         | 3,082  |                                          |   | 1,759                |  |                 | 13,761 |                 |   | 375   |  |   |    |  |   | 18,977 
|                  |  |                         |        |                                          |   |                      |  |                 |        |                 |   |       |  |   |     |  |   |        
|Total loans       |  | $                       | 95,154 |                                          | $ | 61,302               |  | $               | 46,115 |                 | $ | 1,245 |  | $ | 698 |  | $ | 204,514
|                  |  |                         |        |                                          |   |                      |  |                 |        |                 |   |       |  |   |     |  |   |        



|                  |  |                    |        |               |   |        |  |   |        
|----------------- |  | ------------------ | ------ | ------------- | - | ------ |  | - | -------
|                  | 
|                  |  | Due After One Year
|($000)            |  | Fixed Rate         |        | Variable Rate |   | Total 
|Real estate loans |  |                    |        |               |   |        |  |   |        
|Construction      |  | $                  | 1,405  |               | $ |       |  | $ | 1,405  
|Mortgage          |  |                    | 14,911 |               |   | 17,631 |  |   | 32,542 
|Commercial        |  |                    | 17,658 |               |   | 20,827 |  |   | 38,485 
|Commercial loans  |  |                    | 12,808 |               |   | 6,657  |  |   | 19,465 
|Home equity loans |  |                    |       |               |   |       |  |   |       
|Consumer loans    |  |                    | 3,023  |               |   | 12,497 |  |   | 15,520 
|                  |  |                    |        |               |   |        |  |   |        
|Total loans       |  | $                  | 49,805 |               | $ | 57,612 |  | $ | 107,417
|                  |  |                    |        |               |   |        |  |   |        

Commercial Real Estate Lending. The Bank originates adjustable-rate commercial real estate loans that are
generally secured by properties used for business purposes such as small office buildings and retail facilities located in the Banks primary market area. The Banks underwriting procedures provide that commercial real estate loans may
generally be made in amounts up to 80-85% of the lower of the appraised value or sales price of the property, subject to the Banks current loans-to-one-borrower limit, which at December 31, 2005, was $4.2 million. These loans may be made
with terms up to 30 years if owner occupied and are generally offered at interest rates which adjust annually or annually after an initial three- or five-year period in accordance with the prime rate, or the 3 and 5 year U.S. Constant Maturity
Indices as reported in the Wall Street Journal. In reaching a decision whether to make a commercial real estate loan, the Bank considers the value of the real estate to be financed and the credit strength of the borrower and/or the lessee of the
real estate project. The Bank has generally required that properties securing commercial real estate loans have debt service coverage ratios of at least 1.2:1.

Loans secured by commercial real estate properties generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate
properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its
underwriting standards, which require such loans to be qualified on the basis of the propertys value, debt service coverage ratio, and, under certain circumstances, additional collateral. The Bank generally requires personal guarantees on its
commercial real estate loans.

Construction Lending. The Bank originates construction loans on both one- to four-family residences and on commercial
real estate properties. The Bank originates two types of residential construction loans, consumer and builder. The Bank originates consumer construction loans to build a primary residence, a secondary residence, or an investment or rental property.
The Bank will originate builder construction loans to companies engaged in the business of constructing homes for resale. These loans may be for homes currently under contract for sale, model homes from which other homes will be marketed within a
subdivision or, on a very limited basis, homes built for speculative purposes to be marketed for sale during construction. The Bank offers permanent end-financing to the Banks construction loan customers generally on a 3/1 or 5/1 ARM basis.

The Bank originates land acquisition and development loans with the source of repayment being either the sale of finished lots or the sale of homes to be
constructed on the finished lots. The Bank will originate land acquisition, development, and construction



11



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loans on a revolving line of credit basis for subdivisions whereby the borrower may draw upon such line of credit as lots are sold for the purpose of
improving additional lots. Construction loans are generally offered with terms up to twelve months for consumer and builder loans, and up to twenty-four months for land development loans.

Construction loans are generally made in amounts up to 80% to 90% of the appraised market value of the security property. During construction, loan proceeds are
disbursed in draws as construction progresses based upon inspections of work in place by independent construction inspectors.

At December 31, 2005,
the Bank had construction loans, including land acquisition and development loans, totaling $25.6 million, or 12.5% of the Banks total loan portfolio, of which $6.8 million consisted of one- to four-family residential construction loans, $9.0
million consisted of commercial real estate construction loans and $9.8 million consisted of land acquisition and development loans. Construction loans are generally considered to involve a higher degree of credit risk than long-term financing on
improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the security propertys value upon completion of construction as compared to the estimated costs of
construction, including interest. Also, the Bank assumes certain risks associated with the borrowers ability to complete construction in a timely and workmanlike manner. If the estimate of value proves to be inaccurate, or if construction is
not performed timely or accurately, the Bank may be faced with a project which, when completed, has a value that is insufficient to assure full repayment.

One- to Four-Family Residential Mortgage Lending. The Bank currently offers both fixed-rate and adjustable-rate mortgage loans, first and second mortgage loans secured by one- to four-family residences and lot loans for one- to
four-family residences located throughout the Baltimore-Washington Metropolitan area. It is currently the general policy of the Bank to originate for sale in the secondary market one- to four-family fixed-rate residential mortgage loans which
conform, except as to size, to the underwriting standards of Fannie Mae and Freddie Mac, and to originate for investment adjustable rate one- to four-family residential mortgage loans. The Bank generally does not retain the servicing rights of loans
it sells and sells such loans without recourse, with the exception of recourse in the event of breaches in any representations or warranties made by the Bank. The Bank recognizes, at the time of sale, the cash gain or loss on the sale of the loans
based on the difference between the net cash proceeds received and the carrying value of the loans sold. One- to four-family mortgage loan originations are generally obtained from the Banks loan representatives and their contacts in the local
real estate industry, direct contacts made by the Banks and the Companys directors, existing or past customers, and members of the local communities.

At December 31, 2005, one- to four-family residential mortgage loans totaled $39.0 million, or 19.1% of total loans. Of the one-to four-family mortgage loans outstanding at that date, $16.4 million were fixed-rate loans with terms of
up to three years with a balloon payment at the end of the term, and $22.6 million were adjustable-rate loans with terms of up to 30 years and interest rates which adjust annually from the outset of the loan or which adjust annually after a 3 or 5
year initial period in which the loan has a fixed rate. The interest rates for the majority of the Banks adjustable-rate mortgage loans are indexed to the one-year Treasury Constant Maturity Index. Interest rate increases on such loans are
limited to a 2% annual adjustment cap with a maximum adjustment of 6% over the life of the loan.

The origination of adjustable-rate residential mortgage
loans, as opposed to fixed-rate residential mortgage loans, helps to reduce the Banks exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as
interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. Although the Bank offers adjustable-rate loans at below market interest rates, all loans are underwritten to assure that the borrower is
qualified on a fully indexed basis.

Periodic and lifetime caps on interest rate increases help to reduce the risks associated with the Banks
adjustable-rate loans, but also limit the interest rate sensitivity of its adjustable-rate mortgage loans.

The Bank currently originates one- to
four-family residential mortgage loans in amounts typically up to 80% (or higher with private mortgage insurance) of the lower of the appraised value or the selling price of the property securing the loan. Mortgage loans originated by the Bank
generally include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the Banks consent. Due-on-sale clauses
are an important means of adjusting the yields on the Banks fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses.

Home Equity Lending. As of December 31, 2005, home equity loans totaled $25.1 million, or 12.3% of the Banks total loan portfolio. Fixed-rate, fixed-term home equity loans and adjustable rate home
equity lines of credit are generally offered in amounts up to 90% of the market value of the security property. Home equity lines of credit are offered with terms up to twenty years. Substantially all of the Banks home equity loans are
adjustable rate and reprice with changes in the Wall Street Journal prime rate.

Consumer Lending. The Banks portfolio of consumer
loans primarily consists of adjustable rate, personal lines of credit and installment loans secured by new or used automobiles, new or used boats, and loans secured by deposit accounts. At December 31, 2005, consumer loans totaled $19.0 million
or 9.3% of total loans outstanding. Consumer loans are generally originated in the Banks primary market area.



12



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Provision for Credit Losses and Credit Risk Management

Originating loans involves a degree of risk that credit losses will occur in varying amounts according to, among other factors, the type of loans being made, the
credit-worthiness of the borrowers over the term of the loans, the quality of the collateral for the loan, if any, as well as general economic conditions.

The Banks allowance for credit losses is established through a provision for loan losses based on managements evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for credit losses is
maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management. The Bank estimates an acceptable allowance for credit
loss based upon loan risk ratings, prior periods charge-offs and specific loss reserves. This methodology is appropriate as the Bank has at least ten years of loan loss history, has a sufficient number of loans for broader base estimation
processes to be meaningful and has a risk rating review system established for the purpose of maintaining accurate risk ratings on individual loans. The calculation of the allowance is based, in part, upon historical loss factors, as adjusted, for
the major loan categories over the prior eight quarters. The factors used to adjust the historical loss experience address various risk characteristics of the Banks loan portfolio including (1) trends in delinquencies and other
nonperforming loans, (2) results of independent loan reviews, (3) changes in the categories of loans comprising the loan portfolio, (4) concentrations of loans to specific industry segments, (5) changes in economic conditions on
both a local and national level, (6) changes in the Banks credit administration and loan portfolio management processes, (7) changes in the experience, ability and depth of lending management and staff, (8) the effect of the
recent and rapid escalation of local real estate values on the level of potential credit losses in the Banks portfolio and (9) the impact of unresolved collateral and documentation exceptions on the potential credit losses in the
Banks portfolio.

Management believes this approach effectively measures the risk associated with any particular loan or group of loans. The Board of
Directors engages an independent loan review consultant to evaluate the adequacy of the Banks allowance for credit losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the
Banks allowance for credit losses. Such agencies may require the Bank to make additional provisions for estimated loan losses based upon judgments different from those of management. The Bank recorded a total provision for credit losses of
$442 thousand for the year ended December 31, 2005 and $294 thousand in 2004. The aggregate provision was based upon the results of quarterly evaluations using a combination of factors including the ratio of the allowance for credit losses to
total gross loans, the Banks growth in total gross loans and the Banks net loan loss experience. Total gross loans increased by $500 thousand for the year ended December 31, 2005. The Bank recorded charge-offs of $300 thousand on
loans deemed uncollectible and recovered $38 thousand of previously charged-off loans. As of December 31, 2005, the Banks allowance for credit losses was $2.0 million or 0.98% of total loans and 100.25% of nonperforming loans as compared
to $1.8 million, or 0.90% of total loans and 305.8% of nonperforming loans as of December 31, 2004. The Bank had total nonperforming loans of $2.0 million and $599 thousand at December 31, 2005 and December 31, 2004, respectively, and
nonperforming loans to total loans of 0.98% and 0.29% at December 31, 2005, and December 31, 2004, respectively. The increase in nonperforming assets from December 31, 2004 is attributable to two commercial real estate loans to a
single borrower and two home equity lines of credit. All four loans are adequately secured.

The Bank places loans on a nonaccrual status after 90 days of
not having received contractual principal or interest payments unless the loan is well secured and in the process of collection. In addition the Bank maintains a watch list of loans on a monthly basis that warrant more than the normal level of
management supervision. At December 31, 2005 the Bank had approximately $7.2 million in watch list loans compared to $15.4 million at December 31, 2004.

The Bank continues to monitor and modify its allowance for credit losses as conditions dictate. While management believes that, based on information currently available, the Banks allowance for credit losses is sufficient to cover
losses inherent in its loan portfolio at this time, no assurances can be given that the Banks level of allowance for credit losses will be sufficient to cover future loan losses incurred by the Bank or that future adjustments to the allowance
for credit losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions at the time management determined the current level of the allowance for credit losses. Management may in the future
increase the level of allowance as its loan portfolio increases or as circumstances dictate.



13



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The following table presents a three-year history for the allocation of the allowance for credit losses, reflecting use
of the methodology presented above, along with the percentage of total loans in each category.

At December 31,

(Dollars in thousands)



|                      |  |        |       |          |       |   |        |      |          |  |       |        |  |          |       |  |       |  
|--------------------- |  | ------ | ----- | -------- | ----- | - | ------ | ---- | -------- |  | ----- | ------ |  | -------- | ----- |  | ----- | -
|                      |  | 2005   |       |          | 2004  |   |        | 2003 |         
|                      |  | Amount |       | Loan Mix |       |   | Amount |      | Loan Mix |  |       | Amount |  | Loan Mix |      
|Amount applicable to: |  |        |       |          |       |   |        |      |          |  |       |        |  |          |       |  |       |  
|Commercial            |  | $      | 586   |          | 19.7  | % |        | $    | 597      |  | 20.7  | %      |  | $        | 586   |  | 24.4  | %
|Real estate           |  |        |       |          |       |   |        |      |          |  |       |        |  |          |       |  |       |  
|Commercial            |  |        | 698   |          | 27.1  | % |        |      | 623      |  | 23.8  | %      |  |          | 629   |  | 26.2  | %
|Residential           |  |        | 81    |          | 31.6  | % |        |      | 79       |  | 29.8  | %      |  |          | 21    |  | 23.3  | %
|Construction          |  |        | 248   |          | 12.3  | % |        |      | 320      |  | 15.7  | %      |  |          | 246   |  | 14.6  | %
|Consumer              |  |        | 399   |          | 9.3   | % |        |      | 213      |  | 10.0  | %      |  |          | 66    |  | 11.5  | %
|Non specific          |  |        |      |          |      |   |        |      |         |  |      |        |  |          | 84    |  |      |  
|                      |  |        |       |          |       |   |        |      |          |  |       |        |  |          |       |  |       |  
|Total allowance       |  | $      | 2,012 |          | 100.0 | % |        | $    | 1,832    |  | 100.0 | %      |  | $        | 1,632 |  | 100.0 | %
|                      |  |        |       |          |       |   |        |      |          |  |       |        |  |          |       |  |       |  

Analysis of Credit Risk

Activity in the allowance for credit losses for the preceding three years ended December 31 is shown below:

(Dollars in thousands)



|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|--------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | --
|                                                          |  | 2005 |         |   | 2004 |   |         | 2003 | 
|Total loans outstanding - at December 31                  |  | $    | 204,580 |   |      | $ | 204,128 |      |  | $ | 168,755 |   
|Average loans outstanding for the year                    |  |      | 208,280 |   |      |   | 189,130 |      |  |   | 155,067 |   
|                                                          |  |      |        
|Allowance for credit losses at beginning of period        |  | $    | 1,832   |   |      | $ | 1,632   |      |  | $ | 1,578   |   
|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|Provision charged to expense                              |  |      | 442     |   |      |   | 294     |      |  |   | 50      |   
|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|Chargeoffs:                                               |  |      |         |   |      |   |         |      |  |   |         |   
|Commercial loans                                          |  |      | 26      |   |      |   | 5       |      |  |   | 8       |   
|Consumer and other loans                                  |  |      | 274     |   |      |   | 100     |      |  |   | 18      |   
|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|Total                                                     |  |      | 300     |   |      |   | 105     |      |  |   | 26      |   
|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|Recoveries:                                               |  |      |         |   |      |   |         |      |  |   |         |   
|Residential/commercial real estate loans                  |  |      |        |   |      |   |        |      |  |   |        |   
|Commercial loans                                          |  |      | 5       |   |      |   | 1       |      |  |   | 12      |   
|Consumer and other loans                                  |  |      | 33      |   |      |   | 10      |      |  |   | 18      |   
|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|Total                                                     |  |      | 38      |   |      |   | 11      |      |  |   | 30      |   
|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|Net chargeoffs (recoveries)                               |  |      | 262     |   |      |   | 94      |      |  |   | (4      | ) 
|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|Allowance for credit losses at end of year                |  | $    | 2,012   |   |      | $ | 1,832   |      |  | $ | 1,632   |   
|                                                          |  |      |         |   |      |   |         |      |  |   |         |   
|Allowance for credit losses as a percent of total loans   |  |      | 0.98    | % |      |   | 0.90    | %    |  |   | 0.97    | % 
|Net chargeoffs (recoveries) as a percent of average loans |  |      | 0.13    | % |      |   | 0.05    | %    |  |   | (0.02   | )%

Contractual Obligations

The Bank has various financial obligations, including contractual obligations and commitments that may require future cash payments.

The following table presents, as of December 31, 2005, significant fixed and determinable contractual obligations to third parties by payment date.

(Dollars in thousands)



|                                     |  |       |        |                    |   |                    |  |                     |       |                      |   |     |  |   |       
|------------------------------------ |  | ----- | ------ | ------------------ | - | ------------------ |  | ------------------- | ----- | -------------------- | - | --- |  | - | ------
|Payments due by Period               |  | Total |        | Less than one year |   | One to three years |  | Three to five years |       | More than five years
|Long-term debt obligations           |  | $     | 15,000 |                    | $ |                   |  | $                   | 5,000 |                      | $ |    |  | $ | 10,000
|Junior subordinated debt obligations |  |       | 5,000  |                    |   |                   |  |                     |      |                      |   |    |  |   | 5,000 
|Operating lease obligations          |  |       | 1,508  |                    |   | 166                |  |                     | 252   |                      |   | 224 |  |   | 871   
|Data processing contracts            |  |       | 642    |                    |   | 311                |  |                     | 277   |                      |   | 54  |  |   |      
|                                     |  |       |        |                    |   |                    |  |                     |       |                      |   |     |  |   |       
|                                     |  | $     | 22,155 |                    | $ | 477                |  | $                   | 5,529 |                      | $ | 278 |  | $ | 15,871
|                                     |  |       |        |                    |   |                    |  |                     |       |                      |   |     |  |   |       



14



---

Off-Balance Sheet Arrangements

As of December 31, 2005, the Company had a wholly-owned statutory trust formed for the purpose of issuing junior subordinated debentures in the form of trust preferred securities. The statutory trust has not been
consolidated with the holding company.

The Company does have significant commitments to fund loans in the ordinary course of business. Such commitments
and resulting off-balance sheet risk is discussed further in Note 5 to the consolidated financial statements.

Capital Management

During 2005, Stockholders Equity increased by $2.3 million or 12.3% to $21.0 million from $18.7 million at December 31, 2004. The increase was primarily due to
net income of $3.0 million and an increase in paid in capital of $185 thousand due to options exercised and expensed, offsetting the increase was a decrease in accumulated other comprehensive income of $869 thousand.

In April 1997, the Companys employee incentive stock option plan was approved by shareholders at the annual meeting. Under the plan, up to 177,777 shares of the
Companys common stock may be awarded under the direction of the Companys compensation committee. Incentive stock options vest over a five year period. During April 2000, a new Company incentive stock option plan was approved by
shareholders at the annual meeting. Under the plan, up to 355,554 shares of the Companys common stock may be awarded under the direction of the Companys compensation committee. Incentive stock options and grants vest over a five-year
period. During 2005, 66,664 shares of common stock were granted under the 2000 Stock Incentive Plan. During 2005, 16,353 shares granted in prior years were forfeited, 19,387 shares were exercised At December 31, 2005, the Company had a total of
307,512 options and 2,933 restricted shares granted and outstanding.

See Note 15 to the Consolidated Financial Statements
for more information on the Companys stock option plans.

A table of the Equity Compensation Plan Information is
shown below:



|                                                           |  |                                                                                               |  |                                                                                 |      |                                                                                                                                               |        
|---------------------------------------------------------- |  | --------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------- | ---- | --------------------------------------------------------------------------------------------------------------------------------------------- | -------
|Plan Category                                              |  | Number of securities to be issuedupon
exercise of outstandingoptions, warrants and rights (a) |  | Weighted average exercise price
of outstanding options, warrants
and rights (b) |      | Number of securities remaining available for future issuance under equity compensation plans excluding securities reflected in column
(a) (c)
|Equity compensation plans approved by security holders     |  | 307,512                                                                                       |  | $                                                                               | 5.75 |                                                                                                                                               | 112,091
|Equity compensation plans not approved by security holders |  |                                                                                              |  |                                                                                 |     |                                                                                                                                               |       
|                                                           |  |                                                                                               |  |                                                                                 |      |                                                                                                                                               |        
|Total                                                      |  | 307,512                                                                                       |  | $                                                                               | 5.75 |                                                                                                                                               | 112,091
|                                                           |  |                                                                                               |  |                                                                                 |      |                                                                                                                                               |        

Regulatory Capital Requirements

The Federal Reserves capital regulations require state member banks to meet two minimum capital standards: a 4% Tier 1 capital to total adjusted assets ratio (the leverage ratio), and an 8%
risk-based capital ratio. Tier 1 capital is defined as common stockholders equity (including retained earnings), certain non-cumulative perpetual preferred stock and related paid in capital, and minority interests in equity accounts of
consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships.

The risk-based capital standard
requires the maintenance of Tier 1 and Total capital (which is defined as Tier 1 capital plus Tier 2 capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, as assigned by the Federal Reserve capital regulations based on the risks the agency believes are inherent in the type of asset. The regulators have recently
added a market risk adjustment to cover a banks trading account, and foreign exchange and commodity positions. The components of Tier 1 capital are equivalent to those discussed above. Tier 2 capital may include cumulative preferred stock,
long-term perpetual preferred stock, mandatory convertible securities, subordinated debt, intermediate preferred stock, and the allowance for credit losses limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of Tier 2 capital
included as part of total capital cannot exceed 100% of Tier 1 capital.



15



---

Trust preferred securities are considered regulatory capital for purposes of determining the Companys Tier 1
capital ratios. Designation as a well-capitalized institution under these regulations is not a recommendation or endorsement of the Company or the Bank by federal bank regulators.

At December 31, 2005, both the Companys and the Banks Tier 1 and Total Risk-based capital ratios were 12.3% and 13.2%, respectively. The Bank was considered well capitalized for regulatory purposes.
See Note 20 of the Consolidated Financial Statements for more information on the Banks risk-based capital ratios.

Regulation and Supervision

The Company, by virtue of its control of the Bank, is a registered bank holding company as amended under the Bank Holding Company Act of 1956
(the Act). As a bank holding company, the Company is required to file certain reports with, and otherwise comply with the rules and regulations of, the Federal Reserve Board (FRB) under the Act.

Effective November 1, 2000, the Company changed the Bank charter from a national charter to a state charter. As a result, the Bank is now regulated by the State of
Maryland Department of Labor, Licensing and Regulation. The Bank is subject to extensive regulation, examination and supervision by the State of Maryland as its primary regulator, the Federal Reserve Bank of Richmond as its secondary regulator and
the FDIC, as the deposit insurer. The Banks deposit accounts are insured up to applicable limits by the FDICs Bank Insurance Fund (BIF). The Bank must file reports with the Federal Reserve and the FDIC concerning its
activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of other institutions. The state and the Federal Reserve conduct periodic examinations
to test the Banks safety and soundness and compliance with various regulatory requirements. Many aspects of the Banks operations are regulated by federal law including allowable activities, reserves against deposits, branching, mergers
and investments. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the State of Maryland, the Federal Reserve, the FDIC or Congress, could have a material adverse impact on the Company or the Bank and their
operations.

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley). Sarbanes-Oxley represents a
comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. It is applicable to all companies with equity or debt securities registered under the Securities Exchange Act of 1934. The provisions of
Sarbanes-Oxley took effect upon passage and are subject to rulemaking by the Securities and Exchange Commission and the self-regulatory organizations. Some of the changes included in the new, amended and proposed regulations:



| |  | Require accelerated annual and quarterly reporting and require CEOs and CFOs to certify their companys financial reports, filings and control systems;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Require increased disclosure and reporting obligations for the company, its officers and directors, and its affiliates;
|- |  | -----------------------------------------------------------------------------------------------------------------------



| |  | Require that the company comply with new audit committee independence and auditor independence requirements; and
|- |  | ----------------------------------------------------------------------------------------------------------------



| |  | Implement new corporate responsibility requirements and provide additional corporate and criminal fraud accountability.
|- |  | -----------------------------------------------------------------------------------------------------------------------

The Company is continuing to monitor the passage of the new and amended regulations and is taking appropriate measures to comply with them. Although the Company will
incur additional expense in complying with the various provisions of Sarbanes-Oxley and the new and amended regulations, management does not expect that such compliance will have a material impact on the Companys results of operations or
financial condition.

On February 8, 2006, President Bush signed into law the Federal Deposit Insurance Reform Act of 2005 (FDIRA), as
part of the Deficit Reduction Act of 2005, and on February 15, 2006, President Bush signed into law the technical and conforming amendments designed to implement FDIRA. FDIRA provides for legislative reforms to modernize the federal deposit
insurance system.

Among other things, FDIRA mergers the SAIF and Bank Insurance Fund into a single Deposit Insurance Fund (DIF). The merger will become
effective no later than July 1, 2006. All other substantive provisions of deposit insurance reform will not become effective until the FDIC issues final implementing regulations, which are due no later than November 5, 2006.

The USA PATRIOT Act of 2002, as amended (the Patriot Act), has imposed substantial new record-keeping and due diligence obligations on banks and other
financial institutions, with a particular focus on detecting and reporting money-laundering transactions involving domestic or international customers. The U.S. Treasury Department has issued and will continue to issue regulations clarifying the
Patriot Acts requirements. The Patriot Act requires all financial institutions, as defined, to establish certain anti-money laundering compliance and due diligence programs. The Company has complied with all requirements of the
Patriot Act.



16



---

Market Value and Dividend Information

The Companys common stock is listed on The NASDAQ Stock Market® under the symbol ANNB. The Companys stock began trading on October 1, 1997. At December 31, 2005 the closing price was $8.98 per share.

As of March 1, 2006 the Company has outstanding 4,081,630 shares of common stock held by approximately 227 shareholders of record and no preferred stock issued or
outstanding. The Company paid dividends for the first time to its stockholders during 1999. During 2004 a four-for-three stock split in the form of a stock dividend was paid on December 3, 2004. The 2004 split added 746,740 shares to those
previously outstanding.

The Company has no current plans to resume payments of cash dividends. Management believes it is in the best interest of the
Company to retain capital to support the growth of the Company.

Quarterly Average Stock Information*:



|        |  |                   |       |                    |   |                   |      |                    |        |  |   |      |  |   |      |  |   |       
|------- |  | ----------------- | ----- | ------------------ | - | ----------------- | ---- | ------------------ | ------ |  | - | ---- |  | - | ---- |  | - | ------
|        |  | 2005              |       | 2004              
|        |  | Stock Price Range |       | Per Share Dividend |   | Stock Price Range |      | Per Share Dividend
|Quarter |  | High              |       | Low                |   |                   | High |                    | Low    | 
|1st     |  | $                 | 11.49 |                    | $ | 9.03              |      | $                  | 0.0000 |  | $ | 8.14 |  | $ | 6.53 |  | $ | 0.0000
|2nd     |  |                   | 10.36 |                    |   | 8.80              |      |                    | 0.0000 |  |   | 7.71 |  |   | 6.95 |  |   | 0.0000
|3rd     |  |                   | 10.00 |                    |   | 8.95              |      |                    | 0.0000 |  |   | 7.65 |  |   | 6.83 |  |   | 0.0000
|4th     |  |                   | 9.48  |                    |   | 8.88              |      |                    | 0.0000 |  |   | 9.83 |  |   | 7.15 |  |   | 0.0000

---

|* | Gives effect to a four-for-three stock split in the form of a stock dividend issued on December 3, 2004.
|- | --------------------------------------------------------------------------------------------------------



17



---

ANNAPOLIS BANCORP, INC.

Report of Independent Registered Public Accounting Firm

Audit Committee of the

Board of Directors and Stockholders

Annapolis Bancorp, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Annapolis Bancorp, Inc. and Subsidiaries (the Company) as of December 31, 2005 and 2004 and the related consolidated statements of
income, changes in stockholders equity, and cash flows for each of the three years in the period ending December 31, 2005. These consolidated financial statements are the responsibility of the Companys management. Our responsibility
is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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 consolidated
financial statements referred to above present fairly, in all material respects, the financial position of Annapolis Bancorp, Inc. and Subsidiaries as of December 31, 2005 and 2004 and the results of their operations and their cash flows for
each of the three years in the period ending December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.



/s/ Stegman & Company


Baltimore, Maryland

February 15, 2006



18



---

ANNAPOLIS BANCORP, INC.

Consolidated Balance Sheets ($000)



|                                                                                                                                                    |  |      |         |   |      |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|December 31,                                                                                                                                        |  | 2005 |         |   | 2004 |  
|Assets                                                                                                                                              |  |      |         |   |      |   |         |  
|Cash and due from banks                                                                                                                             |  | $    | 9,603   |   |      | $ | 7,455   |  
|Federal funds sold                                                                                                                                  |  |      | 3,400   |   |      |   | 7,213   |  
|Investment securities available for sale                                                                                                            |  |      | 73,902  |   |      |   | 54,440  |  
|Loans, less allowance for credit losses of $2,012 and $1,832                                                                                        |  |      | 202,568 |   |      |   | 202,296 |  
|Premises and equipment, net                                                                                                                         |  |      | 8,550   |   |      |   | 6,998   |  
|Accrued interest receivable                                                                                                                         |  |      | 1,423   |   |      |   | 1,061   |  
|Deferred income taxes                                                                                                                               |  |      | 1,128   |   |      |   | 490     |  
|Investment in bank owned life insurance                                                                                                             |  |      | 3,638   |   |      |   | 3,510   |  
|Other assets                                                                                                                                        |  |      | 704     |   |      |   | 732     |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Total assets                                                                                                                                        |  | $    | 304,916 |   |      | $ | 284,195 |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Liabilities and Stockholders Equity                                                                                                                |  |      |         |   |      |   |         |  
|Deposits                                                                                                                                            |  |      |         |   |      |   |         |  
|Noninterest bearing                                                                                                                                 |  | $    | 43,448  |   |      | $ | 39,473  |  
|Interest bearing                                                                                                                                    |  |      | 206,501 |   |      |   | 187,361 |  
|Securities sold under agreements to repurchase                                                                                                      |  |      | 12,986  |   |      |   | 7,901   |  
|Long-term borrowings                                                                                                                                |  |      | 15,000  |   |      |   | 25,000  |  
|Guaranteed preferred beneficial interests in junior subordinated debentures                                                                         |  |      | 5,000   |   |      |   | 5,000   |  
|Accrued interest payable and other liabilities                                                                                                      |  |      | 1,022   |   |      |   | 798     |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Total liabilities                                                                                                                                   |  |      | 283,957 |   |      |   | 265,533 |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Stockholders Equity                                                                                                                                |  |      |         |   |      |   |         |  
|Common stock, par value $0.01 per share; authorized 10,000,000 shares; issued and outstanding 4,072,800 shares in 2005 and 4,050,480 shares in
2004 |  |      | 41      |   |      |   | 41      |  
|Paid in capital                                                                                                                                     |  |      | 13,171  |   |      |   | 12,986  |  
|Retained earnings                                                                                                                                   |  |      | 8,858   |   |      |   | 5,877   |  
|Accumulated other comprehensive (loss)                                                                                                              |  |      | (1,111  | ) |      |   | (242    | )
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Total stockholders equity                                                                                                                          |  |      | 20,959  |   |      |   | 18,662  |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  
|Total liabilities and stockholders equity                                                                                                          |  | $    | 304,916 |   |      | $ | 284,195 |  
|                                                                                                                                                    |  |      |         |   |      |   |         |  

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



19



---

ANNAPOLIS BANCORP, INC.

Consolidated Statements of Income ($000 except per share data)



|                                                                           |  |      |        |      |   |        |      |  |   |       
|-------------------------------------------------------------------------- |  | ---- | ------ | ---- | - | ------ | ---- |  | - | ------
|Years Ended December 31,                                                   |  | 2005 |        | 2004 |   |        | 2003
|Interest Income                                                            |  |      |        |      |   |        |      |  |   |       
|Loans, including fees                                                      |  | $    | 14,086 |      | $ | 11,596 |      |  | $ | 10,051
|Federal funds sold                                                         |  |      | 572    |      |   | 157    |      |  |   | 191   
|Mortgage-backed securities                                                 |  |      | 899    |      |   | 401    |      |  |   | 331   
|U.S. Treasury securities and obligations of other U.S. Government agencies |  |      | 1,547  |      |   | 1,106  |      |  |   | 904   
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Total interest income                                                      |  |      | 17,104 |      |   | 13,260 |      |  |   | 11,477
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Interest Expense                                                           |  |      |        |      |   |        |      |  |   |       
|Certificates of deposit, $100,000 or more                                  |  |      | 1,215  |      |   | 780    |      |  |   | 689   
|Other deposits                                                             |  |      | 3,007  |      |   | 1,849  |      |  |   | 1,868 
|Securities sold under agreements to repurchase                             |  |      | 290    |      |   | 159    |      |  |   | 188   
|Interest on long term borrowings                                           |  |      | 1,121  |      |   | 853    |      |  |   | 623   
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Total interest expense                                                     |  |      | 5,633  |      |   | 3,641  |      |  |   | 3,368 
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Net interest income                                                        |  |      | 11,471 |      |   | 9,619  |      |  |   | 8,109 
|Provision for Credit Losses                                                |  |      | 442    |      |   | 294    |      |  |   | 50    
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Net interest income after provision for credit losses                      |  |      | 11,029 |      |   | 9,325  |      |  |   | 8,059 
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Noninterest Income                                                         |  |      |        |      |   |        |      |  |   |       
|Service charges and fees on deposits                                       |  |      | 1,207  |      |   | 1,309  |      |  |   | 1,195 
|Mortgage banking fees                                                      |  |      | 329    |      |   | 239    |      |  |   | 448   
|Rental income                                                              |  |      | 178    |      |   | 174    |      |  |   | 170   
|Other income                                                               |  |      | 496    |      |   | 312    |      |  |   | 271   
|Net loss on sale of securities available for sale                          |  |      |       |      |   | (9     | )    |  |   |      
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Total noninterest income                                                   |  |      | 2,210  |      |   | 2,025  |      |  |   | 2,084 
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Noninterest Expense                                                        |  |      |        |      |   |        |      |  |   |       
|Personnel                                                                  |  |      | 4,807  |      |   | 4,586  |      |  |   | 4,217 
|Occupancy and equipment                                                    |  |      | 1,105  |      |   | 962    |      |  |   | 984   
|Data processing                                                            |  |      | 903    |      |   | 874    |      |  |   | 836   
|Marketing and advertising                                                  |  |      | 398    |      |   | 220    |      |  |   | 265   
|Other operating                                                            |  |      | 1,409  |      |   | 1,304  |      |  |   | 1,231 
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Total noninterest expense                                                  |  |      | 8,622  |      |   | 7,946  |      |  |   | 7,533 
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Income Before Income Taxes                                                 |  |      | 4,617  |      |   | 3,404  |      |  |   | 2,610 
|Income Tax Expense                                                         |  |      | 1,636  |      |   | 1,231  |      |  |   | 936   
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Net Income                                                                 |  | $    | 2,981  |      | $ | 2,173  |      |  | $ | 1,674 
|                                                                           |  |      |        |      |   |        |      |  |   |       
|Basic Earnings per Share                                                   |  | $    | 0.73   |      | $ | 0.54   |      |  | $ | 0.42  
|Diluted Earnings per Share                                                 |  | $    | 0.71   |      | $ | 0.52   |      |  | $ | 0.41  

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



20



---

ANNAPOLIS BANCORP, INC.

Consolidated Statements of Changes in Stockholders Equity ($000)

For the years ended
December 31, 2005, 2004 and 2003



|                                                                                |  |              |  |                 |    |  |                   |        |                                        |  |   |                            |  |    |                      |   |  |   |        |   |  |   |       |  
|------------------------------------------------------------------------------- |  | ------------ |  | --------------- | -- |  | ----------------- | ------ | -------------------------------------- |  | - | -------------------------- |  | -- | -------------------- | - |  | - | ------ | - |  | - | ----- | -
|                                                                                |  | Common Stock |  | Paid in Capital |    |  | Retained Earnings |        | Accumulated Other Comprehensive Income |  |   | Total Stockholders Equity |  |    | Comprehensive Income |  
|                                                                                |  | Shares       |  | Par Value       |    |  |                   |        |                                       
|BALANCE January 1, 2003                                                         |  | 3,010,393    |  | $               | 30 |  | $                 | 12,859 |                                        |  | $ | 2,030                      |  | $  | 159                  |   |  | $ | 15,078 |   |  |   |       |  
|Net income                                                                      |  |             |  |                 |   |  |                   |       |                                        |  |   | 1,674                      |  |    |                     |   |  |   | 1,674  |   |  |   | 1,674 |  
|Stock options exercised                                                         |  | 6,784        |  |                 |   |  |                   | 26     |                                        |  |   |                           |  |    |                     |   |  |   | 26     |   |  |   |       |  
|Issuance of restricted stock                                                    |  | 2,201        |  |                 |   |  |                   | 13     |                                        |  |   |                           |  |    |                     |   |  |   | 13     |   |  |   |       |  
|Unrealized loss on investment securities available for sale net of income taxes |  |             |  |                 |   |  |                   |       |                                        |  |   |                           |  |    | (343                 | ) |  |   | (343   | ) |  |   | (343  | )
|                                                                                |  |              |  |                 |    |  |                   |        |                                        |  |   |                            |  |    |                      |   |  |   |        |   |  |   |       |  
|BALANCE DECEMBER 31, 2003                                                       |  | 3,019,378    |  |                 | 30 |  |                   | 12,898 |                                        |  |   | 3,704                      |  |    | (184                 | ) |  |   | 16,448 |   |  |   | 1,331 |  
|                                                                                |  |              |  |                 |    |  |                   |        |                                        |  |   |                            |  |    |                      |   |  |   |        |   |  |   |       |  
|Net income                                                                      |  |             |  |                 |   |  |                   |       |                                        |  |   | 2,173                      |  |    |                     |   |  |   | 2,173  |   |  |   | 2,173 |  
|Four-for-three stock split in the form of a stock dividend                      |  | 1,012,554    |  |                 | 10 |  |                   | (10    | )                                      |  |   |                           |  |    |                     |   |  |   |       |   |  |   |       |  
|Stock-based compensation                                                        |  |             |  |                 |   |  |                   | 18     |                                        |  |   |                           |  |    |                     |   |  |   | 18     |   |  |   |       |  
|Stock options exercised                                                         |  | 16,347       |  |                 | 1  |  |                   | 65     |                                        |  |   |                           |  |    |                     |   |  |   | 66     |   |  |   |       |  
|Issuance of restricted stock                                                    |  | 2,201        |  |                 |   |  |                   | 15     |                                        |  |   |                           |  |    |                     |   |  |   | 15     |   |  |   |       |  
|Unrealized loss on investment securities available for sale net of income taxes |  |             |  |                 |   |  |                   |       |                                        |  |   |                           |  |    | (58                  | ) |  |   | (58    | ) |  |   | (58   | )
|                                                                                |  |              |  |                 |    |  |                   |        |                                        |  |   |                            |  |    |                      |   |  |   |        |   |  |   |       |  
|BALANCE DECEMBER 31, 2004                                                       |  | 4,050,480    |  |                 | 41 |  |                   | 12,986 |                                        |  |   | 5,877                      |  |    | (242                 | ) |  |   | 18,662 |   |  |   | 2,115 |  
|                                                                                |  |              |  |                 |    |  |                   |        |                                        |  |   |                            |  |    |                      |   |  |   |        |   |  |   |       |  
|Net income                                                                      |  |             |  |                 |   |  |                   |       |                                        |  |   | 2,981                      |  |    |                     |   |  |   | 2,981  |   |  |   | 2,981 |  
|Stock-based compensation                                                        |  |             |  |                 |   |  |                   | 123    |                                        |  |   |                           |  |    |                     |   |  |   | 123    |   |  |   |       |  
|Stock options exercised                                                         |  | 19,387       |  |                 |   |  |                   | 55     |                                        |  |   |                           |  |    |                     |   |  |   | 55     |   |  |   |       |  
|Issuance of restricted stock                                                    |  | 2,933        |  |                 |   |  |                   | 7      |                                        |  |   |                           |  |    |                     |   |  |   | 7      |   |  |   |       |  
|Unrealized loss on investment securities available for sale net of income taxes |  |             |  |                 |   |  |                   |       |                                        |  |   |                           |  |    | (869                 | ) |  |   | (869   | ) |  |   | (869  | )
|                                                                                |  |              |  |                 |    |  |                   |        |                                        |  |   |                            |  |    |                      |   |  |   |        |   |  |   |       |  
|BALANCE DECEMBER 31, 2005                                                       |  | 4,072,800    |  | $               | 41 |  | $                 | 13,171 |                                        |  | $ | 8,858                      |  | ($ | 1,111                | ) |  | $ | 20,959 |   |  | $ | 2,112 |  
|                                                                                |  |              |  |                 |    |  |                   |        |                                        |  |   |                            |  |    |                      |   |  |   |        |   |  |   |       |  

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



21



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ANNAPOLIS BANCORP, INC.

Consolidated Statements of Cash Flows ($000)



|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|Years Ended December 31,                                                          |  | 2005 |         |   | 2004 |   |         | 2003 | 
|Cash Flows from Operating Activities                                              |  |      |         |   |      |   |         |      |  |   |         |  
|Net income                                                                        |  | $    | 2,981   |   |      | $ | 2,173   |      |  | $ | 1,674   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                                     |  |      | 454     |   |      |   | 425     |      |  |   | 467     |  
|Provision for credit losses                                                       |  |      | 442     |   |      |   | 294     |      |  |   | 50      |  
|Proceeds from stock options exercised                                             |  |      | 55      |   |      |   | 66      |      |  |   | 26      |  
|Issuance of restricted stock                                                      |  |      | 7       |   |      |   | 15      |      |  |   | 13      |  
|Stock-based compensation                                                          |  |      | 123     |   |      |   | 18      |      |  |   |        |  
|Deferred income taxes                                                             |  |      | (190    | ) |      |   | 17      |      |  |   | 63      |  
|Earnings on life insurance policies                                               |  |      | (128    | ) |      |   | (154    | )    |  |   | (133    | )
|Amortization of premiums and accretion of discounts, net                          |  |      | 47      |   |      |   | 14      |      |  |   | 9       |  
|Loss on sale of securities                                                        |  |      |        |   |      |   | (9      | )    |  |   |        |  
|Increase in:                                                                      |  |      |         |   |      |   |         |      |  |   |         |  
|Accrued interest receivable                                                       |  |      | (362    | ) |      |   | (192    | )    |  |   | (137    | )
|Other assets                                                                      |  |      | (2      | ) |      |   | (218    | )    |  |   | (100    | )
|Increase (decrease) in                                                            |  |      |         |   |      |   |         |      |  |   |         |  
|Accrued interest payable                                                          |  |      | (44     | ) |      |   | 71      |      |  |   | (3      | )
|Accrued income taxes, net of taxes refundable                                     |  |      | 352     |   |      |   | (61     | )    |  |   | (31     | )
|Deferred loan origination fees                                                    |  |      | 92      |   |      |   | (144    | )    |  |   | (117    | )
|Other liabilities                                                                 |  |      | (84     | ) |      |   | 220     |      |  |   | 54      |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash provided from operations                                                 |  |      | 3,743   |   |      |   | 2,535   |      |  |   | 1,835   |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Cash Flows from Investing Activities                                              |  |      |         |   |      |   |         |      |  |   |         |  
|Proceeds from sales and maturities of securities available for sale               |  |      | 5,763   |   |      |   | 10,358  |      |  |   | 26,817  |  
|Purchase of securities available for sale                                         |  |      | (26,589 | ) |      |   | (26,922 | )    |  |   | (45,108 | )
|Net decrease (increase) in federal funds sold                                     |  |      | 3,813   |   |      |   | 801     |      |  |   | 7,515   |  
|Net increase in loans receivable                                                  |  |      | (806    | ) |      |   | (35,323 | )    |  |   | (21,321 | )
|Purchases of premises and equipment                                               |  |      | (1,976  | ) |      |   | (440    | )    |  |   | (262    | )
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash used by investing activities                                             |  |      | (19,795 | ) |      |   | (51,526 | )    |  |   | (32,359 | )
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Cash Flows from Financing Activities                                              |  |      |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in                                                        |  |      |         |   |      |   |         |      |  |   |         |  
|Time deposits                                                                     |  |      | 705     |   |      |   | 18,102  |      |  |   | 8,434   |  
|Other deposits                                                                    |  |      | 22,410  |   |      |   | 18,155  |      |  |   | 18,153  |  
|Securities sold under agreements to repurchase                                    |  |      | 5,085   |   |      |   | (844    | )    |  |   | (1,755  | )
|Long term borrowings                                                              |  |      | (10,000 | ) |      |   | 15,000  |      |  |   | 5,000   |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                                         |  |      | 18,200  |   |      |   | 50,413  |      |  |   | 29,832  |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |      | 2,148   |   |      |   | 1,422   |      |  |   | (692    | )
|Cash and cash equivalents at beginning of year                                    |  |      | 7,455   |   |      |   | 6,033   |      |  |   | 6,725   |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of year                                          |  | $    | 9,603   |   |      | $ | 7,455   |      |  | $ | 6,033   |  
|                                                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Supplemental Cash Flow Information                                                |  |      |         |   |      |   |         |      |  |   |         |  
|Interest paid, including interest credited to accounts                            |  | $    | 5,675   |   |      | $ | 3,569   |      |  | $ | 3,368   |  
|Income taxes paid                                                                 |  |      | 1,624   |   |      |   | 1,356   |      |  |   | 874     |  

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



22



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ANNAPOLIS BANCORP, INC.

Notes to Consolidated Financial Statements ($000 except share data)

For the years ended December 31,
2005, 2004 and 2003

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting and reporting policies in the financial statements conform with accounting principles generally accepted in the United States of America and to general practices within the banking industry. Management
makes 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. These estimates and assumptions may affect the reported amounts
of revenues and expenses during the reporting period. Actual results could differ from these estimates. Certain reclassifications have been made to the 2004 and 2003 consolidated financial statements to conform with the 2005 presentation.

Business

The Company was incorporated
on May 26, 1988, under the laws of the State of Maryland to serve as a bank holding company. The Company, registered as a bank holding company, formed Annapolis National Bank (the Bank), a nationally chartered financial institution.
Effective June 1, 2001 the Company changed its name to Annapolis Bancorp, Inc. Effective November 1, 2000 the Bank changed its charter from a national charter to a state charter and joined the State of Maryland and the Federal Reserve
banking systems. Also effective November 1, 2000 the Bank changed its name from Annapolis National Bank to BankAnnapolis. The Company (as a bank holding company) and the Bank are subject to governmental supervision, regulation, and control.

The principal business of BankAnnapolis is to make loans and other investments and to accept time and demand deposits. The Banks
primary market area is in Anne Arundel County, Maryland, although the Banks business development efforts generate business outside of the area. The Bank offers a broad range of banking products, including a full line of business and personal
savings and checking accounts, money market demand accounts, certificates of deposit and other banking services.

The Bank funds a variety
of loan types including commercial and residential real estate loans, commercial term loans and lines of credit, consumer loans, and letters of credit. The Banks customers are primarily individuals and small businesses.

Principles of consolidation

The consolidated
financial statements include the accounts of the Company and its wholly-owned subsidiaries, BankAnnapolis and Annapolis Bancorp Statutory Trust I. All significant intercompany balances and transactions have been eliminated in consolidation. The
financial statements of Annapolis Bancorp, Inc. (Parent only) include its investment in the Bank under the equity method of accounting.

Cash
equivalents

For purposes of reporting cash flows, cash and demand balances due from banks are considered cash equivalents
for financial reporting purposes.

Investment securities

As securities are purchased, management determines if the securities should be classified as held to maturity or available for sale. Securities which management has the intent and ability to hold to maturity are
recorded at amortized cost. Securities which may be sold before maturity are classified as available for sale and carried at fair value with unrealized gains and losses included in accumulated other comprehensive income, a separate component of
stockholders equity, on an after-tax basis. Investments in Federal Home Loan Bank and Federal Reserve stock are included with securities classified as available for sale and carried at cost.

Declines in the fair value of individual available for sale or held to maturity securities below their cost that are other than temporary result in
write-downs of the individual securities to their fair value. Factors affecting the determination of whether an other-than-temporary impairment has occurred include a downgrading of the security by the rating agency, a significant deterioration in
the financial condition of the issuer, or that management would not have the ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value.

Premises and equipment

Premises and equipment are
stated at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets. Useful lives range from three to 10 years for furniture,
fixtures, and equipment; three to five years for software, hardware, and data handling equipment; and 10 to 40 years for buildings and building improvements. Land improvements are amortized over a period of 15 years; and leasehold improvements are
amortized over the term of the respective lease plus the first optional renewal period, if applicable. Maintenance and repairs are charged to expense as incurred, while improvements which extend the useful life are capitalized and depreciated over
the estimated remaining life of the asset.



23



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Loans

Loans are stated at their principal balance outstanding, plus deferred origination costs, less unearned discounts, deferred origination fees, and the allowance for credit losses.

Interest on loans is credited to income based on the principal amounts outstanding. Origination fees and costs are amortized to income over the
contractual life of the related loans as an adjustment of yield. Discounts on the purchase of mortgage loans are amortized to income over the contractual lives of the loans.

Accrual of interest on a loan is discontinued when the loan is delinquent more than ninety days unless the collateral securing the loan is sufficient to
liquidate the loan. Management considers all loans where the accrual of interest has been discontinued to be impaired.

Loans are
considered impaired when, based on current information, it is probable that the Bank will not collect all principal and interest payments according to contractual terms. Generally, loans are considered impaired once principal and interest payments
are past due and they are placed on non-accrual. Management also considers the financial condition of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller balance
homogeneous credits such as residential real estate and consumer installment loans, which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during periods of minimal delay
in payment (usually ninety days or less) provided eventual collection of all amounts due is expected. Impaired loans are measured based on the present value of expected future cash flows discounted at the loans effective interest rate, except
that as a practical expedient, the Bank may measure impairment based on a loans observable market price or the fair value of the collateral, if the loan is collateral dependent. The Bank recognizes interest income on impaired loans on a cash
basis if the borrower demonstrates the ability to meet the contractual obligation and collateral is sufficient. If there is doubt regarding the borrowers ability to make payments or the collateral is not sufficient, payments received are
accounted for as a reduction in principal. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Credit Losses

The allowance for credit
losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans,
actual loss experience, current economic events in specific industries and geographic areas including unemployment levels and other pertinent factors including regulatory guidance and general economic conditions. Determination of the allowance is
inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience and consideration of
economic trends, all of which may be susceptible to significant change. Credit losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged
to operations based on managements periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary.

The allowance for credit losses consists of a specific component and a nonspecific component. The components of the allowance for credit losses represent
an estimation done pursuant to either Statement of Financial Accounting Standards (SFAS) No. 5 Accounting for Contingencies, or SFAS No. 114 Accounting by Creditors for Impairment of a Loan. The specific
component of the allowance for credit losses reflects expected losses resulting from analysis developed through credit allocations for individual loans and historical loss experience for each loan category. The credit allocations are based on a
regular analysis of all loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The historical loan loss element is determined statistically using a loss migration analysis that examines loss
experience and the related internal gradings of loans charged off. The calculation of the allowance is based, in part, upon historical loss factors, as adjusted, for the major loan categories based upon adjusted historical loss experience over the
prior eight quarters. The factors used to adjust the historical loss experience address various risk characteristics of the Banks loan portfolio including (1) trends in delinquencies and other nonperforming loans, (2) results of
independent loan reviews, (3) changes in the categories of loans comprising the loan portfolio, (4) concentrations of loans to specific industry segments, (5) changes in economic conditions on both a local and national level,
(6) changes in the Banks credit administration and loan portfolio management processes, (7) changes in the experience, ability and depth of lending management and staff, (8) the effect of the recent and rapid escalation of local
real estate values on the level of potential credit losses in the Banks portfolio and (9) the impact of unresolved collateral and documentation exceptions on the potential credit losses in the Banks portfolio.

The nonspecific portion of the allowance is determined based on managements assessment of general economic conditions, as well as economic factors
in the individual markets in which BankAnnapolis operates including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. This determination inherently involves a higher risk
of uncertainty and considers current risk factors that may not have yet manifested themselves in the Banks historical loss factors used to determine the specific component of the allowance and it recognizes knowledge of the portfolio may be
incomplete.



24



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Real estate owned

Real estate acquired in satisfaction of a debt is carried at the lower of cost or net realizable value. Costs incurred in maintaining foreclosed real estate and write-downs to reflect declines in the fair value of the
properties after acquisition are included in noninterest expenses.

Advertising Costs

Advertising costs are generally expensed when incurred.

Income taxes

The Company and its subsidiaries file a consolidated federal income tax return. The provision for income taxes
is based upon income in the financial statements adjusted for permanent differences, rather than amounts reported on the Companys income tax return.

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

Stock based compensation

The Company had previously accounted for stock based compensation using the intrinsic value method set forth in Accounting Principles
Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees. For disclosure purposes, pro forma net income and earnings per share are provided as if the fair value method has been applied, in accordance with
SFAS No. 148 Accounting for Stock-Based Compensation  Transition and Disclosure.

During 2003 the Company adopted
the prospective method of recognizing stock-based compensation provided by SFAS No. 148. Accordingly, expense is recognized for all employee awards granted, modified or settled after the beginning of 2003. Option awards granted in 2003 did not
vest until 2004.

SFAS No. 123, Accounting for Stock-Based Compensation, established new accounting and reporting
standards for stock-based employee compensation plans.

This standard defines a fair value-based method for measuring compensation expense
for stock-based plans to be recognized in the statement of income or disclosed in the notes to the financial statements.

The weighted
average fair value of options granted during 2005, 2004, and 2003 has been estimated using the Black-Scholes option-pricing model with the following assumptions:



|                        |  |       |   |  |       |   |  |       |  
|----------------------- |  | ----- | - |  | ----- | - |  | ----- | -
|                        |  | 2005  |   |  | 2004  |   |  | 2003  |  
|Dividend yield          |  | 0.00  | % |  | 0.00  | % |  | 0.00  | %
|Risk free interest rate |  | 3.86  |   |  | 3.94  | % |  | 3.77  | %
|Expected volatility     |  | 35.39 | % |  | 33.04 | % |  | 19.70 | %
|Expected life in years  |  | 7     |   |  | 7     |   |  | 7     |  

Had compensation been determined in accordance with the provisions of SFAS No. 123 and SFAS
No. 148, the Companys net income and earnings per share would have been reduced to the following pro forma amounts:



|                                                                                                                                                                    |  |      |       |   |      |   |       |      |  |   |       |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                                                                                                                    |  | 2005 |       |   | 2004 |   |       | 2003 | 
|Net income as reported                                                                                                                                              |  | $    | 2,981 |   |      | $ | 2,173 |      |  | $ | 1,674 |  
|Add: Stock option employee compensation expense included in reported net income, net of related tax effect                                                          |  |      | 81    |   |      |   | 18    |      |  |   |      |  
|Deduct: Total stock option employee compensation expense determined under the fair value method for all awards vested during the period, net
of related tax effects |  |      | (107  | ) |      |   | (55   | )    |  |   | (75   | )
|                                                                                                                                                                    |  |      |       |   |      |   |       |      |  |   |       |  
|Proforma income                                                                                                                                                     |  | $    | 2,955 |   |      | $ | 2,136 |      |  | $ | 1,599 |  
|                                                                                                                                                                    |  |      |       |   |      |   |       |      |  |   |       |  
|Basic earnings per share                                                                                                                                            |  |      |       |   |      |   |       |      |  |   |       |  
|As reported                                                                                                                                                         |  | $    | 0.73  |   |      | $ | 0.54  |      |  | $ | 0.42  |  
|Proforma                                                                                                                                                            |  | $    | 0.72  |   |      | $ | 0.52  |      |  | $ | 0.40  |  
|Diluted earnings per share                                                                                                                                          |  |      |       |   |      |   |       |      |  |   |       |  
|As reported                                                                                                                                                         |  | $    | 0.71  |   |      | $ | 0.53  |      |  | $ | 0.41  |  
|Proforma                                                                                                                                                            |  | $    | 0.70  |   |      | $ | 0.51  |      |  | $ | 0.39  |  



25



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Earnings per share

Basic earnings per common share are determined by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per share are calculated by including the
average dilutive common stock equivalents outstanding during the period.

Dilutive common equivalent shares consist of stock options,
calculated using the treasury stock method.

New Accounting Pronouncements

SFAS No. 154, Accounting Changes and Error Corrections, a Replacement of APB Opinion No. 20 and FASB Statement No. 3.
SFAS 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to a newly adopted accounting principle.
Previously, most changes in accounting principle were recognized by including the cumulative effect of changing to the new accounting principle in net income of the period of the change. Under SFAS 154, retrospective application requires
(i) the cumulative effect of the change to the new accounting principle on periods prior to those presented to be reflected in the carrying amounts of assets and liabilities as of the beginning of the first period presented, (ii) an
offsetting adjustment, if any, to be made to the opening balance of retained earnings (or other appropriate components of equity) for that period, and (iii) financial statements for each individual prior period presented to be adjusted to
reflect the direct period-specific effects of applying the new accounting principle. Special retroactive application rules apply in situations where it is impracticable to determine either the period-specific effects or the cumulative effect of the
change. Indirect effects of a change in accounting principle are required to be reported in the period in which the accounting change is made. SFAS 154 carries forward the guidance in APB Opinion 20 Accounting Changes, requiring
justification of a change in accounting principle on the basis of preferability. SFAS 154 also carries forward without change the guidance contained in APB Opinion 20, for reporting the correction of an error in previously issued financial
statements and for a change in an accounting estimate. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Corporation does not expect SFAS 154 will significantly
impact its financial statements upon its adoption on January 1, 2006.

SFAS No. 123, Share-Based Payment (Revised
2004).SFAS 123R establishes standards for the accounting for transactions in which an entity (i) exchanges its equity instruments for goods or services, or (ii) incurs liabilities in exchange for goods or services that are based
on the fair value of the entitys equity instruments or that may be settled by the issuance of the equity instruments. SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be
recognized as compensation cost in the income statement based on their fair values on the measurement date, which is generally the date of the grant. SFAS 123R was to be effective for the Corporation on July 1, 2005; however, the required
implementation date was delayed until January 1, 2006. The Corporation will transition to fair-value based accounting for stock-based compensation using a modified version of prospective application (modified prospective
application). Under modified prospective application, as it is applicable to the Corporation, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, compensation cost for the
portion of awards for which the requisite service has not been rendered (generally referring to non-vested awards) that are outstanding as of January 1, 2006 must be recognized as the remaining requisite service is rendered during the period of
and/or the periods after the adoption of SFAS 123R. The attribution of compensation cost for those earlier awards will be based on the same method and on the same grant-date fair values previously determined for the pro forma disclosures required
for companies that did not adopt the fair value accounting method for stock-based employee compensation.

Based on the stock-based
compensation awards outstanding as of December 31, 2005 for which the requisite service is not expected to be fully rendered prior to January 1, 2006, the Corporation expects to recognize total pre-tax, quarterly compensation cost of
approximately $40 thousand beginning in the first quarter of 2006, in accordance with the accounting requirements of SFAS 123R. Future levels of compensation cost recognized related to stock-based compensation awards (including the aforementioned
expected costs during the period of adoption) may be impacted by new awards and/or modifications, repurchases and cancellations of existing awards before and after the adoption SFAS 123R.

Financial Accounting Standards Board Staff Positions

FASB Staff Position (FSP) No. 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.FSP 115-1 provides guidance for determining when an investment is considered impaired,
whether impairment is other-than-temporary, and measurement of an impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. If, after consideration of all available evidence to evaluate the
realizable value of its investment, impairment is determined to be other-than-temporary, then an impairment loss should be recognized equal to the difference between the investments cost and its fair value. FSP 115-1 nullifies certain
provisions of Emerging Issues Task Force (EITF) Issue No. 03-1, The Meaning of Other-Than- Temporary Impairment and Its Application to Certain Investments, while retaining the disclosure requirements of EITF 03-1 which were adopted
in 2003. FSP 115-1 is effective for reporting periods beginning after December 15, 2005. The Corporation does not expect FSP 115-1 will significantly impact its financial statements upon its adoption on January 1, 2006.



26



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2. CASH AND DUE FROM BANKS

Banks are required to carry cash reserves of specified percentages of deposit balances. The Banks normal balances of cash on hand and on deposit with other banks are sufficient to satisfy these reserve
requirements.

The Bank normally maintains balances with other banks that exceed the federally insured limit. The average balance
maintained in excess of the limit, including federal funds sold to the same bank, was approximately $7.9 million.

3. INVESTMENT SECURITIES

Investment securities are summarized as follows:



|                             |  |                |        |                  |   |                   |  |                      |       |  |   |       
|---------------------------- |  | -------------- | ------ | ---------------- | - | ----------------- |  | -------------------- | ----- |  | - | ------
|                             |  | Amortized Cost |        | Unrealized Gains |   | Unrealized Losses |  | Estimated Fair Value
|December 31, 2005            |  |                |        |                  |   |                   |  |                      |       |  |   |       
|Available for sale           |  |                |        |                  |   |                   |  |                      |       |  |   |       
|U.S. Government agency       |  | $              | 45,342 |                  | $ |                  |  | $                    | 1,027 |  | $ | 44,315
|Mortgage-backed securities   |  |                | 28,497 |                  |   | 1                 |  |                      | 658   |  |   | 27,840
|Federal Home Loan Bank stock |  |                | 1,243  |                  |   |                  |  |                      |      |  |   | 1,243 
|Federal Reserve Bank stock   |  |                | 504    |                  |   |                  |  |                      |      |  |   | 504   
|                             |  |                |        |                  |   |                   |  |                      |       |  |   |       
|                             |  | $              | 75,586 |                  | $ | 1                 |  | $                    | 1,685 |  | $ | 73,902
|                             |  |                |        |                  |   |                   |  |                      |       |  |   |       
|December 31, 2004            |  |                |        |                  |   |                   |  |                      |       |  |   |       
|Available for sale           |  |                |        |                  |   |                   |  |                      |       |  |   |       
|U.S. Government agency       |  | $              | 33,340 |                  | $ | 36                |  | $                    | 237   |  | $ | 33,139
|Mortgage-backed securities   |  |                | 19,375 |                  |   | 26                |  |                      | 192   |  |   | 19,209
|Federal Home Loan Bank stock |  |                | 1,588  |                  |   |                  |  |                      |      |  |   | 1,588 
|Federal Reserve Bank stock   |  |                | 504    |                  |   |                  |  |                      |      |  |   | 504   
|                             |  |                |        |                  |   |                   |  |                      |       |  |   |       
|                             |  | $              | 54,807 |                  | $ | 62                |  | $                    | 429   |  | $ | 54,440
|                             |  |                |        |                  |   |                   |  |                      |       |  |   |       

No securities were sold during 2005. Proceeds from the sale of securities during 2004 were $1.9
million compared to zero proceeds in 2003. No losses were recognized in 2005. Net losses of $9 thousand and zero were recognized in 2004 and 2003 respectively. Gains and losses are determined using the specific identification method.

Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss
position at December 31, 2005 are as follows:



|                           |  |           |        |                                          |   |                    |  |                        |       |  |   |      
|-------------------------- |  | --------- | ------ | ---------------------------------------- | - | ------------------ |  | ---------------------- | ----- |  | - | -----
|                           |  |           |        | Continuous unrealized lossesexisting for |   |                   
|                           |  | FairValue |        | Less than 12 Months                      |   | More than12 Months |  | Total UnrealizedLosses
|December 31, 2005          |  |           |        |                                          |   |                    |  |                        |       |  |   |      
|Available for sale         |  |           |        |                                          |   |                    |  |                        |       |  |   |      
|U.S. Government agency     |  | $         | 44,315 |                                          | $ | 367                |  | $                      | 660   |  | $ | 1,027
|Mortgage-backed securities |  |           | 27,840 |                                          |   | 296                |  |                        | 362   |  |   | 658  
|                           |  |           |        |                                          |   |                    |  |                        |       |  |   |      
|                           |  | $         | 72,155 |                                          | $ | 663                |  | $                      | 1,022 |  | $ | 1,685
|                           |  |           |        |                                          |   |                    |  |                        |       |  |   |      

The available-for-sale investment portfolio has a fair value of approximately $72.2 million of
which all but $192 thousand show an unrealized loss from the purchase price. Of these securities, $44.3 million, or 61.4%, are government agency bonds and $27.8 million, or 38.6% are mortgage-backed securities. The unrealized losses that exist are
the result of market changes in interest rates since the original purchase. These factors coupled with the fact the Company has both the intent and ability to hold these investments for a period of time sufficient to allow for any anticipated
recovery in fair value substantiates that the unrealized losses in the available-for-sale portfolio are temporary.

The amortized cost and
estimated fair value of securities by contractual maturities are shown below. Actual maturities of these securities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment
penalties.



27



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|                                 |  |                    |        |                      |   |       
|-------------------------------- |  | ------------------ | ------ | -------------------- | - | ------
|                                 |  | Available for Sale
|                                 |  | Amortized Cost     |        | Estimated Fair Value
|December 31, 2005                |  |                    |        |                      |   |       
|Due within one year              |  | $                  | 1,000  |                      | $ | 996   
|Due after one through five years |  |                    | 43,191 |                      |   | 42,230
|Due after five years             |  |                    | 29,648 |                      |   | 28,929
|Equity securities                |  |                    | 1,747  |                      |   | 1,747 
|                                 |  |                    |        |                      |   |       
|                                 |  |                    | 75,586 |                      |   | 73,902
|                                 |  |                    |        |                      |   |       

At December 31, 2005, 2004 and 2003, investments available for sale with a carrying value of
$14.5 million, $13.2 million and $10.3 million, respectively, were pledged as collateral for certain government deposits and for other purposes as required by law.

4. LOANS AND ALLOWANCE FOR CREDIT LOSSES

Major classifications of loans are as follows:



|                                       |  |      |         |   |      |   |         |  
|-------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                       |  | 2005 |         |   | 2004 |  
|Real estate                            |  |      |         |   |      |   |         |  
|Commercial                             |  | $    | 74,288  |   |      | $ | 71,830  |  
|Residential                            |  |      | 70,989  |   |      |   | 69,567  |  
|Commercial                             |  |      | 40,260  |   |      |   | 42,248  |  
|Consumer                               |  |      | 18,977  |   |      |   | 20,325  |  
|                                       |  |      |         |   |      |   |         |  
|                                       |  |      | 204,514 |   |      |   | 203,970 |  
|Deferred loan origination costs (fees) |  |      | 66      |   |      |   | 158     |  
|Allowance for credit losses            |  |      | (2,012  | ) |      |   | (1,832  | )
|                                       |  |      |         |   |      |   |         |  
|                                       |  |      | (1,946  | ) |      |   | (1,674  | )
|                                       |  |      |         |   |      |   |         |  
|Loans, net                             |  | $    | 202,568 |   |      | $ | 202,296 |  
|                                       |  |      |         |   |      |   |         |  

The maturity and rate repricing distribution of the loan portfolio is as follows:



|                                      |  |   |         |  |   |        
|------------------------------------- |  | - | ------- |  | - | -------
|Repricing or maturing within one year |  | $ | 95,930  |  | $ | 107,973
|Maturing over one to five years       |  |   | 61,504  |  |   | 48,337 
|Maturing over five years              |  |   | 47,080  |  |   | 47,660 
|                                      |  |   |         |  |   |        
|                                      |  | $ | 204,514 |  | $ | 203,970
|                                      |  |   |         |  |   |        

Transactions in the allowance for credit losses are as follows:



|                                |  |      |       |      |   |       |  |   |      
|------------------------------- |  | ---- | ----- | ---- | - | ----- |  | - | -----
|                                |  | 2005 |       | 2004 |   | 2003 
|Balance, beginning of the year  |  | $    | 1,832 |      | $ | 1,632 |  | $ | 1,578
|Provision charged to operations |  |      | 442   |      |   | 294   |  |   | 50   
|Recoveries                      |  |      | 38    |      |   | 11    |  |   | 30   
|Charge-offs                     |  |      | 300   |      |   | 105   |  |   | 26   
|                                |  |      |       |      |   |       |  |   |      
|Balance, end of year            |  | $    | 2,012 |      | $ | 1,832 |  | $ | 1,632
|                                |  |      |       |      |   |       |  |   |      

The balance of nonaccrual and impaired loans is as follows:



|                                                      |  |      |       |      |   |      |  |   |   
|----------------------------------------------------- |  | ---- | ----- | ---- | - | ---- |  | - | --
|                                                      |  | 2005 |       | 2004 |   | 2003
|Total guaranteed by the Small Business Administration |  | $    | 65    |      | $ |     |  | $ |  
|Other nonaccrual loans                                |  |      | 1,245 |      |   | 599  |  |   | 27
|Total nonaccrual loans and impaired loans             |  |      | 2,007 |      |   | 599  |  |   | 27
|Average impaired loans                                |  |      | 1,144 |      |   | 141  |  |   | 86
|Related allowance for credit losses                   |  |      | 108   |      |   | 90   |  |   | 4 
|Interest collected                                    |  |      | 69    |      |   | 44   |  |   | 25
|Balance of accrued interest not recorded              |  |      | 119   |      |   | 8    |  |   |  

The Bank lends to customers located primarily in Anne Arundel County and surrounding areas of
central Maryland. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.



28



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Loans that were 90 days or more past due, including nonaccrual loans were $698 thousand at
December 31, 2005 and zero at December 31, 2004.

Certain officers and directors (and directors companies which have a 10%
or more beneficial ownership) have loans with the Bank. Such loans were made in the ordinary course of business on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties and are being repaid
as agreed.

A summary of the activity of these loans follows:



|                                      |  |      |       |   |      |   |       |  
|------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|                                      |  | 2005 |       |   | 2004 |  
|Beginning balance                     |  | $    | 5,107 |   |      | $ | 1,966 |  
|Advances                              |  |      | 2,527 |   |      |   | 2,626 |  
|Repayments                            |  |      | (200  | ) |      |   | (182  | )
|Change in officers and directors, net |  |      | 1     |   |      |   | 697   |  
|                                      |  |      |       |   |      |   |       |  
|Ending balance                        |  | $    | 7,435 |   |      | $ | 5,107 |  
|                                      |  |      |       |   |      |   |       |  

5. CREDIT COMMITMENTS

Loan commitments outstanding, unused lines of credit and letters of credit are as follows:



|                                     |  |      |        |      |   |       
|------------------------------------ |  | ---- | ------ | ---- | - | ------
|Dollars in thousands                 |  | 2005 |        | 2004
|Loan commitments and lines of credit |  |      |        |      |   |       
|Construction                         |  | $    | 23,848 |      | $ | 17,556
|Other                                |  |      | 39,780 |      |   | 42,192
|                                     |  |      |        |      |   |       
|                                     |  | $    | 63,628 |      | $ | 59,748
|                                     |  |      |        |      |   |       
|Letter of credit                     |  |      |        |      |   |       
|Deposit secured                      |  | $    | 382    |      | $ | 363   
|Other                                |  |      | 854    |      |   | 709   
|                                     |  |      |        |      |   |       
|                                     |  | $    | 1,236  |      | $ | 1,072 
|                                     |  |      |        |      |   |       

Loan commitments including lines of credit are agreements to lend to a customer as long as there
is no violation of any condition to the contract. Loan commitments generally have variable interest rates, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent
future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Loan commitments and lines and
letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss the Company will incur by the funding of these commitments.

6. INVESTMENT IN BANK OWNED LIFE INSURANCE

In 2002,
the Bank purchased single premium policies of Bank Owned Life Insurance (BOLI) amounting to $3,110,000. The increase in cash surrender value is recorded as other noninterest income. The Bank recorded $128,000 in BOLI income for 2005, $154,000 in
2004 and $133,000 in 2003.

7. PREMISES AND EQUIPMENT

A summary of premises and equipment and the related depreciation is as follows:



|                                     |  |      |        |      |   |      
|------------------------------------ |  | ---- | ------ | ---- | - | -----
|                                     |  | 2005 |        | 2004
|Land, land improvements and building |  | $    | 6,309  |      | $ | 6,079
|Leasehold improvements               |  |      | 678    |      |   | 657  
|Furniture, fixtures, and equipment   |  |      | 1,962  |      |   | 1,897
|Construction in progress             |  |      | 1,716  |      |   | 127  
|                                     |  |      |        |      |   |      
|                                     |  |      | 10,665 |      |   | 8,760
|Accumulated depreciation             |  |      | 2,115  |      |   | 1,762
|                                     |  |      |        |      |   |      
|Net premises and equipment           |  | $    | 8,550  |      | $ | 6,998
|                                     |  |      |        |      |   |      

Depreciation and amortization expense was $454 thousand for 2005, $425 thousand for 2004 and $467
thousand for 2003. For the year ended December 31, 2005 $13 thousand of interest was capitalized in association with the construction in progress. No interest was capitalized for the years ended December 31, 2004 and 2003.



29



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9. LEASE COMMITMENTS

Lease obligations will require rent payments as follows:



|                |  |                        |      
|--------------- |  | ---------------------- | -----
|Period          |  | Minimum Rentals $(000)
|2006            |  | $                      | 162  
|2007            |  |                        | 130  
|2008            |  |                        | 121  
|2009            |  |                        | 120  
|2010            |  |                        | 104  
|Remaining years |  |                        | 871  
|                |  |                        |      
|                |  | $                      | 1,508
|                |  |                        |      

The leases generally provide for payment of property taxes, insurance, and maintenance costs by
the Company. The total rental expense for all real property leases was $180 thousand, $178 thousand and $168 thousand for 2005, 2004 and 2003, respectively.

10. DEPOSITS

Major classifications of deposits are as follows:



|                                  |  |      |         |      |   |        
|--------------------------------- |  | ---- | ------- | ---- | - | -------
|                                  |  | 2005 |         | 2004
|Demand, noninterest bearing       |  | $    | 43,448  |      | $ | 39,473 
|NOW accounts                      |  |      | 38,162  |      |   | 32,844 
|Savings and Money Market accounts |  |      | 75,941  |      |   | 62,824 
|Time deposits, $100,000 and over  |  |      | 33,132  |      |   | 35,711 
|Other time                        |  |      | 59,266  |      |   | 55,982 
|                                  |  |      |         |      |   |        
|                                  |  | $    | 249,949 |      | $ | 226,834
|                                  |  |      |         |      |   |        

Time deposits mature as follows:



|                                      |  |   |        |  |   |       
|------------------------------------- |  | - | ------ |  | - | ------
|Repricing or maturing within one year |  | $ | 40,263 |  | $ | 38,800
|Maturing over one to three years      |  |   | 47,372 |  |   | 44,466
|Maturing over three to five years     |  |   | 4,763  |  |   | 8,427 
|                                      |  |   |        |  |   |       
|                                      |  | $ | 92,398 |  | $ | 91,693
|                                      |  |   |        |  |   |       

At December 31, 2005 and 2004 there were no time deposits with maturities in excess of five
years.

11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchase are securities sold to the Banks customers, at the customers request, under a continuing roll-over contract that matures in one business day. The
underlying securities sold are U.S. Treasury notes or Federal agencies that are segregated in the Banks correspondent safekeeping account from the Banks other investment securities.

The following table presents certain information for repurchase agreements:



|                                      |  |      |        |   |      |   |        |      |  |   |        |  
|------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                      |  | 2005 |        |   | 2004 |   |        | 2003 | 
|Balance outstanding, at year end      |  | $    | 12,986 |   |      | $ | 7,901  |      |  | $ | 8,745  |  
|Average balance during the year       |  |      | 10,494 |   |      |   | 8,730  |      |  |   | 9,870  |  
|Average interest rate during the year |  |      | 2.76   | % |      |   | 1.82   | %    |  |   | 1.79   | %
|Maximum month-end balance             |  | $    | 13,164 |   |      | $ | 10,538 |      |  | $ | 14,141 |  



30



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12. LONG TERM BORROWINGS

The Company had other long term borrowings at December 31, 2005 and 2004 as follows:



|                                                           |  |      |        |      |   |       
|---------------------------------------------------------- |  | ---- | ------ | ---- | - | ------
|                                                           |  | 2005 |        | 2004
|FHLB 4.25% Advance due May 2007, Callable May 2005         |  | $    | 5,000  |      | $ | 5,000 
|FHLB 4.75% Advance due May 2012, Callable May 2007         |  |      | 5,000  |      |   | 5,000 
|FHLB 2.85% Advance due March 2014, Callable March 2009     |  |      | 5,000  |      |   | 5,000 
|FHLB 2.37% Advance due October 2014, Callable October 2006 |  |      |       |      |   | 10,000
|                                                           |  |      |        |      |   |       
|Total                                                      |  | $    | 15,000 |      | $ | 25,000
|                                                           |  |      |        |      |   |       

Interest on these instruments is paid quarterly. FHLB advances are fully collateralized by pledges
of loans. The Company has pledged under a blanket lien all qualifying residential and commercial mortgage loans under the borrowing agreement with the FHLB.

13. GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES

On March 26, 2003, Annapolis Bancorp
Statutory Trust I (Statutory Trust I), a Connecticut business trust formed, funded and wholly owned by the Company, issued $5,000,000 of variable-rate capital securities to institutional investors in a private pooled transaction. The
variable rate on these securities adjusts quarterly based on the 90-day LIBOR rate plus 3.15%. The current rate is 7.67%. The proceeds were up-streamed to the Company as junior subordinated debt under the same terms and conditions. The Company then
down-streamed $4,875,000 to the Bank in the form of additional capital. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Statutory Trust Is obligations with respect to the capital
securities. These capital securities currently qualify as Tier I capital and are presented in the Consolidated Balance Sheets as Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures. The sole asset of the Statutory
Trust I is $5,155,000 of junior subordinated debentures issued by the Company. These junior subordinated debentures carry a variable interest rate of 3.15% over the 90 day LIBOR, payable semiannually, with a non-call provision over the first five
year period. Both the capital securities of Statutory Trust I and the junior subordinated debentures are scheduled to mature on March 26, 2033, unless called by the Company not earlier than March 26, 2008. Interest expense on the trust
preferred securities for the years ended December 31, 2005 and 2004 totaled $327 thousand and $236 thousand, respectively.

Costs
associated with the issuance of the trust preferred securities totaling $125,000 were capitalized and are being amortized through 2008. Amortization for the years ended December 31, 2005, 2004 and 2003 was $21 thousand.

14. PROFIT SHARING AND OTHER EMPLOYEE BENEFIT PLANS

The Company has a profit sharing plan, qualifying under Section 401(k) of the Internal Revenue Code, for those employees who meet the eligibility requirements set forth in the plan. The plan does not require the Company to match the
participants contributions. The Companys contributions to the plan were $107 thousand in 2005, $111 thousand in 2004 and $95 thousand in 2003.

The Company has entered into individual Supplemental Executive Retirement Agreements (SERAs) with certain of its executives. The SERAs are designed to provide certain post-retirement benefits to enable a targeted
level of covered retirement income to be met and to provide certain death benefits. The Company is accruing the present value of these benefits over the remaining number of years to the executives retirement dates. Benefit accruals included in
noninterest expense for 2005, 2004, and 2003 were $52 thousand, $41 thousand and $49 thousand, respectively.

15. STOCK OPTIONS AND RESTRICTED SHARES

In April 1997, the Company adopted a stock option plan, authorizing the issuance of 177,777 shares of common stock, intended to qualify
as incentive stock options under Section 422 of the Internal Revenue Code. The plan provided for granting options to purchase shares of common stock to the officers and other key employees of the Company and the Bank. Options granted under this
plan have ten-year expiration dates with vesting periods from immediate to five years. After April 2000 no additional options could be granted under this plan.

In April 2000, a new incentive stock option plan was approved by the shareholders at the annual meeting. Under this plan, the Companys compensation committee has discretionary authority to grant stock options,
restricted stock awards, and deferred share awards to employees and directors, including members of the committee. Under this plan, up to 355,554 shares of Company stock, as adjusted for the August 24, 2001 and December 3, 2004
four-for-three stock splits in the form of stock dividends, may be awarded under the direction of the committee. The plan provides for the awards to vest over a five-year period of time. Options have a ten-year expiration period.



31



---

A summary of the status of the Companys performance-based stock option plans follows:



|                                                       |  |                  |   |      |                                |      |                  |         |   |                                |   |                  |  |         |                                 |  |   |     
|------------------------------------------------------ |  | ---------------- | - | ---- | ------------------------------ | ---- | ---------------- | ------- | - | ------------------------------ | - | ---------------- |  | ------- | ------------------------------- |  | - | ----
|                                                       |  | 2005             |   | 2004 |                                | 2003
|                                                       |  | Number of Shares |   |      | Weighted Average ExercisePrice |      | Number of Shares |         |   | Weighted Average ExercisePrice |   | Number of Shares |  |         | Weighted Average Exercise Price
|Options Outstanding                                    |  |                  |   |      |                                |      |                  |         |   |                                |   |                  |  |         |                                 |  |   |     
|Outstanding, beginning of year                         |  | 276,588          |   |      | $                              | 3.75 |                  | 294,160 |   |                                | $ | 3.36             |  | 275,873 |                                 |  | $ | 3.08
|Granted                                                |  | 66,664           |   |      |                                | 9.30 |                  | 29,996  |   |                                |   | 7.77             |  | 27,330  |                                 |  |   | 6.05
|Exercised                                              |  | (19,387          | ) |      |                                | 2.87 |                  | (21,794 | ) |                                |   | 2.93             |  | (9,043  | )                               |  |   | 2.91
|Forfeited                                              |  | (16,353          | ) |      |                                | 7.37 |                  | (25,774 | ) |                                |   | 4.66             |  |        |                                 |  |   |    
|                                                       |  |                  |   |      |                                |      |                  |         |   |                                |   |                  |  |         |                                 |  |   |     
|Outstanding, end of year                               |  | 307,512          |   |      | $                              | 5.75 |                  | 276,588 |   |                                | $ | 3.75             |  | 294,160 |                                 |  | $ | 3.36
|                                                       |  |                  |   |      |                                |      |                  |         |   |                                |   |                  |  |         |                                 |  |   |     
|Weighted fair value of options granted during the year |  |                  |   |      | $                              | 3.86 |                  |         |   |                                | $ | 4.88             |  |         |                                 |  | $ | 2.51

These options expire as follows:



|                |  |                                 |      |                |         |           |        
|--------------- |  | ------------------------------- | ---- | -------------- | ------- | --------- | -------
|Expiration Date |  | Weighted Average Exercise Price |      | Options Vested |         | Nonvested
|2007            |  | $                               | 3.86 |                | 12,108  |           |       
|2008            |  |                                 | 6.13 |                | 6,221   |           |       
|2009            |  |                                 | 2.72 |                | 26,666  |           |       
|2010            |  |                                 | 2.42 |                | 53,328  |           |       
|2011            |  |                                 | 2.74 |                | 55,200  |           | 17,774 
|2012            |  |                                 | 4.12 |                | 26,000  |           | 17,333 
|2013            |  |                                 | 7.23 |                | 3,821   |           | 5,733  
|2014            |  |                                 | 7.62 |                | 3,332   |           | 13,332 
|2015            |  |                                 | 9.30 |                |        |           | 66,664 
|                |  |                                 |      |                |         |           |        
|                |  |                                 |      |                | 186,676 |           | 120,836
|                |  |                                 |      |                |         |           |        

A summary of the status of the Companys restricted share awards follows:



|                               |  |                 |   |      |                                |      |                 |        |   |                                |   |     
|------------------------------ |  | --------------- | - | ---- | ------------------------------ | ---- | --------------- | ------ | - | ------------------------------ | - | ----
|                               |  | 2005            |   | 2004
|                               |  | Number ofShares |   |      | Weighted Average ExercisePrice |      | Number ofShares |        |   | Weighted Average ExercisePrice
|Restricted Shares              |  |                 |   |      |                                |      |                 |        |   |                                |   |     
|Outstanding, beginning of year |  | 2,933           |   |      | $                              | 2.42 |                 | 5,866  |   |                                | $ | 2.42
|Granted                        |  |                |   |      |                                |     |                 |       |   |                                |   |    
|Exercised                      |  | (2,933          | ) |      |                                | 2.42 |                 | (2,933 | ) |                                |   | 2.42
|Forfeited                      |  |                |   |      |                                |     |                 |       |   |                                |   |    
|                               |  |                 |   |      |                                |      |                 |        |   |                                |   |     
|Outstanding, end of year       |  |                |   |      | $                              | 2.42 |                 | 2,933  |   |                                | $ | 2.42
|                               |  |                 |   |      |                                |      |                 |        |   |                                |   |     

16. LINES OF CREDIT

The Bank is a member of the Federal Home Loan Bank system and may borrow up to $122.0 million. If funded, this line is secured by one- to four-family residential and commercial mortgage loans held in the Banks
portfolio. In addition, the Bank has available secured and unsecured lines of credit of $12.5 million.

17. PREFERRED STOCK

The Company is authorized to issue up to 2,000,000 shares of preferred stock with a par value of $.01 per share. There were no preferred shares
outstanding at December 31, 2005 or 2004.



32



---

18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

THREE MONTHS ENDED



|                             |  |              |       |               |   |          |  |   |           |   |  |   |      
|---------------------------- |  | ------------ | ----- | ------------- | - | -------- |  | - | --------- | - |  | - | -----
|                             |  | December 31, |       | September 30, |   | June 30, |  |   | March 31,
|2005                         |  |              |       |               |   |          |  |   |           |   |  |   |      
|Interest income              |  | $            | 4,498 |               | $ | 4,440    |  | $ | 4,222     |   |  | $ | 3,944
|Interest expense             |  |              | 1,565 |               |   | 1,535    |  |   | 1,376     |   |  |   | 1,157
|Net interest income          |  |              | 2,933 |               |   | 2,905    |  |   | 2,846     |   |  |   | 2,787
|Provision for credit losses  |  |              | 149   |               |   | 73       |  |   | 75        |   |  |   | 145  
|Net income                   |  |              | 1,011 |               |   | 678      |  |   | 672       |   |  |   | 620  
|Comprehensive income (loss)  |  |              | 646   |               |   | 287      |  |   | 1,081     |   |  |   | 98   
|Earnings per share - basic   |  |              | 0.25  |               |   | 0.17     |  |   | 0.16      |   |  |   | 0.15 
|Earnings per share - diluted |  |              | 0.24  |               |   | 0.16     |  |   | 0.16      |   |  |   | 0.15 
|                             |  |              |       |              
|2004                         |  |              |       |               |   |          |  |   |           |   |  |   |      
|Interest income              |  | $            | 3,685 |               | $ | 3,364    |  | $ | 3,196     |   |  | $ | 3,015
|Interest expense             |  |              | 1,082 |               |   | 903      |  |   | 858       |   |  |   | 798  
|Net interest income          |  |              | 2,603 |               |   | 2,461    |  |   | 2,338     |   |  |   | 2,217
|Provision for credit losses  |  |              | 106   |               |   | 63       |  |   | 50        |   |  |   | 75   
|Net income                   |  |              | 755   |               |   | 548      |  |   | 457       |   |  |   | 413  
|Comprehensive income         |  |              | 638   |               |   | 1,000    |  |   | (183      | ) |  |   | 660  
|Earnings per share - basic   |  |              | 0.19  |               |   | 0.14     |  |   | 0.11      |   |  |   | 0.10 
|Earnings per share - diluted |  |              | 0.18  |               |   | 0.13     |  |   | 0.11      |   |  |   | 0.10 
|                             |  |              |       |              
|2003                         |  |              |       |               |   |          |  |   |           |   |  |   |      
|Interest income              |  | $            | 2,947 |               | $ | 2,867    |  | $ | 2,894     |   |  | $ | 2,769
|Interest expense             |  |              | 821   |               |   | 848      |  |   | 880       |   |  |   | 819  
|Net interest income          |  |              | 2,126 |               |   | 2,019    |  |   | 2,014     |   |  |   | 1,950
|Provision for credit losses  |  |              | 25    |               |   |         |  |   |          |   |  |   | 25   
|Net income                   |  |              | 510   |               |   | 438      |  |   | 402       |   |  |   | 324  
|Comprehensive income         |  |              | 424   |               |   | 48       |  |   | 564       |   |  |   | 295  
|Earnings per share - basic   |  |              | 0.13  |               |   | 0.11     |  |   | 0.10      |   |  |   | 0.08 
|Earnings per share - diluted |  |              | 0.12  |               |   | 0.11     |  |   | 0.10      |   |  |   | 0.08 

19. INCOME TAXES

The components of income tax expense are as follows:



|         |  |      |       |   |      |   |       |  |   |    
|-------- |  | ---- | ----- | - | ---- | - | ----- |  | - | ---
|         |  | 2005 |       |   | 2004 |   | 2003 
|Current  |  |      |       |   |      |   |       |  |   |    
|Federal  |  | $    | 1,559 |   |      | $ | 1,040 |  | $ | 715
|State    |  |      | 267   |   |      |   | 174   |  |   | 158
|         |  |      |       |   |      |   |       |  |   |    
|         |  |      | 1,826 |   |      |   | 1,214 |  |   | 873
|Deferred |  |      | (190  | ) |      |   | 17    |  |   | 63 
|         |  |      |       |   |      |   |       |  |   |    
|         |  | $    | 1,636 |   |      | $ | 1,231 |  | $ | 936
|         |  |      |       |   |      |   |       |  |   |    

The components of the deferred taxes are as follows:



|                            |  |      |     |   |      |    |     |      |  |    |     |  
|--------------------------- |  | ---- | --- | - | ---- | -- | --- | ---- |  | -- | --- | -
|                            |  | 2005 |     |   | 2004 |    |     | 2003 | 
|Provision for credit losses |  | ($   | 133 | ) |      | ($ | 70  | )    |  | ($ | 17  | )
|Deferred compensation       |  |      | (26 | ) |      |    | (14 | )    |  |    | (22 | )
|Depreciation expense        |  |      | (22 | ) |      |    | 55  |      |  |    | 37  |  
|Other                       |  |      | (27 | ) |      |    | 46  |      |  |    | 65  |  
|                            |  |      |     |   |      |    |     |      |  |    |     |  
|Deferred tax expense        |  | ($   | 190 | ) |      | $  | 17  |      |  | $  | 63  |  
|                            |  |      |     |   |      |    |     |      |  |    |     |  



33



---

The components of the net deferred tax assets are as follows:



|                                                 |  |      |       |      |   |      |  |   |    
|------------------------------------------------ |  | ---- | ----- | ---- | - | ---- |  | - | ---
|                                                 |  | 2005 |       | 2004 |   | 2003
|Deferred tax assets                              |  |      |       |      |   |      |  |   |    
|Allowance for credit losses                      |  | $    | 630   |      | $ | 494  |  | $ | 424
|Deferred compensation                            |  |      | 62    |      |   | 36   |  |   | 22 
|Unrealized loss on securities available for sale |  |      | 573   |      |   | 125  |  |   | 95 
|Other                                            |  |      |      |      |   | 23   |  |   | 23 
|                                                 |  |      |       |      |   |      |  |   |    
|Total deferred tax assets                        |  |      | 1,265 |      |   | 678  |  |   | 564
|Deferred tax liabilities                         |  |      |       |      |   |      |  |   |    
|Depreciation                                     |  |      | 115   |      |   | 137  |  |   | 82 
|Other                                            |  |      | 22    |      |   | 51   |  |   | 5  
|                                                 |  |      |       |      |   |      |  |   |    
|Total deferred tax liabilities                   |  |      | 137   |      |   | 188  |  |   | 87 
|                                                 |  |      |       |      |   |      |  |   |    
|Net deferred tax asset                           |  | $    | 1,128 |      | $ | 490  |  | $ | 477
|                                                 |  |      |       |      |   |      |  |   |    

The differences between federal income taxes and the amount reported by the Company follow:



|                                              |  |        |       |   |      |      |    |        |   |       |   |  |      |        |  |   |       |   |  |      |   
|--------------------------------------------- |  | ------ | ----- | - | ---- | ---- | -- | ------ | - | ----- | - |  | ---- | ------ |  | - | ----- | - |  | ---- | --
|                                              |  | 2005   |       |   | 2004 |      |    | 2003   |  
|                                              |  | Amount |       |   | %    |      |    | Amount |   |       | % |  |      | Amount |  |   | %     |  
|Income before income taxes                    |  | $      | 4,617 |   |      |      |    |        | $ | 3,404 |   |  |      |        |  | $ | 2,610 |   |  |      |   
|                                              |  |        |       |   |      |      |    |        |   |       |   |  |      |        |  |   |       |   |  |      |   
|Taxes computed at the federal income tax rate |  | $      | 1,570 |   |      | 34.0 | %  |        | $ | 1,157 |   |  | 34.0 | %      |  | $ | 887   |   |  | 34.0 | % 
|Increases (decreases) resulting from          |  |        |       |   |      |      |    |        |   |       |   |  |      |        |  |   |       |   |  |      |   
|State income taxes, net of federal benefit    |  |        | 226   |   |      | 4.9  | %  |        |   | 122   |   |  | 3.6  | %      |  |   | 90    |   |  | 3.4  | % 
|Nondeductible expenses                        |  |        | 8     |   |      | 0.1  | %  |        |   | 4     |   |  | 0.1  | %      |  |   | 4     |   |  | 0.2  | % 
|Nontaxable income                             |  |        | (168  | ) |      | (3.6 | )% |        |   | (52   | ) |  | (1.5 | )%     |  |   | (45   | ) |  | (1.7 | )%
|                                              |  |        |       |   |      |      |    |        |   |       |   |  |      |        |  |   |       |   |  |      |   
|Income tax expense                            |  | $      | 1,636 |   |      | 35.4 | %  |        | $ | 1,231 |   |  | 36.2 | %      |  | $ | 936   |   |  | 35.9 | % 
|                                              |  |        |       |   |      |      |    |        |   |       |   |  |      |        |  |   |       |   |  |      |   

20. CAPITAL STANDARDS

The Federal Reserve Board and the Federal Deposit Insurance Corporation have adopted risk-based capital standards for banking organizations. These standards require ratios of capital to assets for minimum capital
adequacy and to be classified as well capitalized under prompt corrective action provisions. The capital ratios and minimum capital requirements of the Company and the Bank as of December 31, 2005 and 2004 are as follows:



|                                         |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|---------------------------------------- |  | ------------- | ------ | ----- | ---- | - | ------------------------------- | - | ------ |  | --- | ----------------------------- |  | ----- | ------ |  | ---- | -
|                                         |  | Actual Amount |        | Ratio |      |   | Minimum Capital Adequacy Amount |   | Ratio  |  |     | To be Well Capitalized Amount |  | Ratio |       
|December 31, 2005                        |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|Total capital (to risk-weighted assets)  |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|Company                                  |  | $             | 29,082 |       | 13.2 | % |                                 | $ | 17,589 |  | 8.0 | %                             |  |       |        |  |      |  
|Bank                                     |  | $             | 28,966 |       | 13.2 | % |                                 | $ | 17,572 |  | 8.0 | %                             |  | $     | 21,965 |  | 10.0 | %
|Tier 1 capital (to risk-weighted assets) |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|Company                                  |  | $             | 27,070 |       | 12.3 | % |                                 | $ | 8,794  |  | 4.0 | %                             |  |       |        |  |      |  
|Bank                                     |  | $             | 26,954 |       | 12.3 | % |                                 | $ | 8,786  |  | 4.0 | %                             |  | $     | 13,179 |  | 6.0  | %
|Tier 1 capital (to average assets)       |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|Company                                  |  | $             | 27,070 |       | 8.8  | % |                                 | $ | 12,364 |  | 4.0 | %                             |  |       |        |  |      |  
|Bank                                     |  | $             | 26,954 |       | 8.7  | % |                                 | $ | 12,360 |  | 4.0 | %                             |  | $     | 15,450 |  | 5.0  | %
|                                         |  |               |        |       |      |  
|December 31, 2004                        |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|Total capital (to risk-weighted assets)  |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|Company                                  |  | $             | 25,736 |       | 12.0 | % |                                 | $ | 17,162 |  | 8.0 | %                             |  |       |        |  |      |  
|Bank                                     |  | $             | 25,576 |       | 11.9 | % |                                 | $ | 17,142 |  | 8.0 | %                             |  | $     | 21,427 |  | 10.0 | %
|Tier 1 capital (to risk-weighted assets) |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|Company                                  |  | $             | 23,904 |       | 11.1 | % |                                 | $ | 8,581  |  | 4.0 | %                             |  |       |        |  |      |  
|Bank                                     |  | $             | 23,743 |       | 11.1 | % |                                 | $ | 8,571  |  | 4.0 | %                             |  | $     | 12,856 |  | 6.0  | %
|Tier 1 capital (to average assets)       |  |               |        |       |      |   |                                 |   |        |  |     |                               |  |       |        |  |      |  
|Company                                  |  | $             | 23,904 |       | 8.4  | % |                                 | $ | 10,351 |  | 4.0 | %                             |  |       |        |  |      |  
|Bank                                     |  | $             | 23,743 |       | 8.4  | % |                                 | $ | 10,347 |  | 4.0 | %                             |  | $     | 12,933 |  | 5.0  | %

Tier 1 capital consists of capital stock, paid in capital, and retained earnings. Total capital
includes a limited amount of the allowance for credit losses. In calculating risk-weighted assets, specified risk percentages are applied to each category of asset and off-balance sheet items.



34



---

Failure to meet the capital requirements could affect the Banks ability to pay dividends and
accept deposits and may significantly affect the operations of the Bank.

21. FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of the Banks financial instruments are summarized below. The fair values of a significant portion of these financial
instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may
not reflect current or future fair values.



|                                               |  |                 |         |                      |   |                 |  |                      |         |  |   |        
|---------------------------------------------- |  | --------------- | ------- | -------------------- | - | --------------- |  | -------------------- | ------- |  | - | -------
|                                               |  | 2005            |         | 2004                
|December 31,                                   |  | Carrying Amount |         | Estimated Fair Value |   | Carrying Amount |  | Estimated Fair Value
|Financial assets                               |  |                 |         |                      |   |                 |  |                      |         |  |   |        
|Cash and due from banks                        |  | $               | 9,603   |                      | $ | 9,603           |  | $                    | 7,455   |  | $ | 7,455  
|Federal funds sold                             |  |                 | 3,400   |                      |   | 3,400           |  |                      | 7,213   |  |   | 7,213  
|Investment securities (total)                  |  |                 | 73,902  |                      |   | 73,902          |  |                      | 54,440  |  |   | 54,440 
|Loans, net                                     |  |                 | 202,568 |                      |   | 202,225         |  |                      | 202,296 |  |   | 201,937
|Accrued interest receivable                    |  |                 | 1,423   |                      |   | 1,423           |  |                      | 1,061   |  |   | 1,061  
|Bank owned life insurance                      |  |                 | 3,658   |                      |   | 3,658           |  |                      | 3,510   |  |   | 3,510  
|Financial liabilities                          |  |                 |         |                      |   |                 |  |                      |         |  |   |        
|Noninterest-bearing deposits                   |  | $               | 43,448  |                      | $ | 43,448          |  | $                    | 39,473  |  | $ | 39,473 
|Interest-bearing deposits                      |  |                 | 206,501 |                      |   | 206,549         |  |                      | 187,361 |  |   | 187,521
|Securities sold under agreements to repurchase |  |                 | 12,986  |                      |   | 12,986          |  |                      | 7,901   |  |   | 7,901  
|Long term borrowings                           |  |                 | 15,000  |                      |   | 14,814          |  |                      | 25,000  |  |   | 24,906 
|Junior subordinated debt                       |  |                 | 5,000   |                      |   | 5,000           |  |                      | 5,000   |  |   | 5,000  
|Accrued interest payable                       |  |                 | 125     |                      |   | 125             |  |                      | 162     |  |   | 162    

The fair values of U.S. Treasury and Government agency securities and mortgage backed securities
are determined using market quotations.

The fair value of fixed-rate loans is estimated to be the present value of scheduled payments
discounted using interest rates currently in effect. The fair value of variable-rate loans, including loans with a demand feature, is estimated to equal the carrying amount. The valuation of loans is adjusted for possible credit losses.

The fair value of interest-bearing checking, savings, and money market deposit accounts is equal to the carrying amount. The fair value of
fixed-maturity time deposits is estimated based on interest rates currently offered for deposits of similar remaining maturities.

22. EARNINGS PER
SHARE

A summary of shares outstanding for basic and fully diluted earnings per share is as follows:



|                                                                 |  |       |  |       |  |      
|---------------------------------------------------------------- |  | ----- |  | ----- |  | -----
|In thousands(000)                                                |  | 2005  |  | 2004  |  | 2003 
|Weighted average shares outstanding, basic                       |  | 4,063 |  | 4,050 |  | 4,028
|Common stock equivalents                                         |  | 124   |  | 96    |  | 79   
|                                                                 |  |       |  |       |  |      
|Average common shares and equivalents, fully diluted             |  | 4,187 |  | 4,146 |  | 4,107
|                                                                 |  |       |  |       |  |      
|Stock options outstanding that were antidilutive at December 31, |  |      |  |      |  |     
|                                                                 |  |       |  |       |  |      



35



---

23. PARENT COMPANY FINANCIAL INFORMATION

The balance sheet and statements of income and cash flows for ANNAPOLIS BANCORP, INC. (Parent Company only) follow:

Balance Sheets



|                                           |  |      |        |   |      |   |        |  
|------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|                                           |  |     
|December 31,                               |  | 2005 |        |   | 2004 |  
|Assets                                     |  |      |        |   |      |   |        |  
|Cash and due from banks                    |  | $    | 43     |   |      | $ | 68     |  
|Due from subsidiaries                      |  |      |       |   |      |   |       |  
|Investment in subsidiaries                 |  |      | 25,999 |   |      |   | 23,657 |  
|Deferred income taxes and other assets     |  |      | 82     |   |      |   | 97     |  
|                                           |  |      |        |   |      |   |        |  
|Total assets                               |  | $    | 26,124 |   |      | $ | 23,822 |  
|                                           |  |      |        |   |      |   |        |  
|Liabilities and Stockholders Equity       |  |      |        |   |      |   |        |  
|Junior subordinated debt                   |  | $    | 5,155  |   |      | $ | 5,155  |  
|Due to subsidiaries                        |  |      | 3      |   |      |   |       |  
|Other liabilities                          |  |      | 7      |   |      |   | 5      |  
|Stockholders Equity                       |  |      |        |   |      |   |        |  
|Common stock                               |  |      | 41     |   |      |   | 41     |  
|Paid in capital                            |  |      | 13,171 |   |      |   | 12,986 |  
|Retained earnings                          |  |      | 8,858  |   |      |   | 5,877  |  
|Accumulated other comprehensive (loss)     |  |      | (1,111 | ) |      |   | (242   | )
|                                           |  |      |        |   |      |   |        |  
|Total liabilities and stockholders equity |  | $    | 26,124 |   |      | $ | 23,822 |  
|                                           |  |      |        |   |      |   |        |  

Statement of Income



|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|---------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|Years Ended December 31,                       |  | 2005 |       |   | 2004 |   |       | 2003 | 
|Interest income                                |  | $    |      |   |      | $ |      |      |  | $ |      |  
|Interest expense                               |  |      | 327   |   |      |   | 236   |      |  |   | 166   |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Net interest income                            |  |      | (327  | ) |      |   | (236  | )    |  |   | (166  | )
|Equity in undistributed income of subsidiaries |  |      | 3,211 |   |      |   | 2,234 |      |  |   | 1,741 |  
|Dividends from subsidiary                      |  |      | 170   |   |      |   | 205   |      |  |   | 145   |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Total income                                   |  |      | 3,054 |   |      |   | 2,203 |      |  |   | 1,720 |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Noninterest expense                            |  |      |       |   |      |   |       |      |  |   |       |  
|Compensation                                   |  |      | 130   |   |      |   | 34    |      |  |   | 13    |  
|Legal                                          |  |      | 26    |   |      |   | 14    |      |  |   | 28    |  
|Shareholder communications                     |  |      | 123   |   |      |   | 119   |      |  |   | 114   |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Total expense                                  |  |      | 279   |   |      |   | 167   |      |  |   | 155   |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Income before income tax benefit               |  |      | 2,775 |   |      |   | 2,036 |      |  |   | 1,565 |  
|Income tax benefit                             |  |      | (206  | ) |      |   | (137  | )    |  |   | (109  | )
|                                               |  |      |       |   |      |   |       |      |  |   |       |  
|Net income                                     |  | $    | 2,981 |   |      | $ | 2,173 |      |  | $ | 1,674 |  
|                                               |  |      |       |   |      |   |       |      |  |   |       |  

Statements of Cash Flows



|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|Years Ended December 31,                                          |  | 2005 |        |   | 2004 |   |        | 2003 | 
|Cash flows from operating activities                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net income                                                        |  | $    | 2,981  |   |      | $ | 2,173  |      |  | $ | 1,674  |  
|Due from subsidiaries                                             |  |      | 3      |   |      |   | (2     | )    |  |   | 13     |  
|Tax benefit received                                              |  |      | (3     | ) |      |   | (15    | )    |  |   | (7     | )
|Undistributed net income of subsidiary                            |  |      | (3,381 | ) |      |   | (2,440 | )    |  |   | (1,886 | )
|Net Increase in other assets and liabilities                      |  |      | 20     |   |      |   | 31     |      |  |   | (99    | )
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash used for operations                                      |  |      | (380   | ) |      |   | (253   | )    |  |   | (305   | )
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Cash flows from financing activities                              |  |      |        |   |      |   |        |      |  |   |        |  
|Proceeds from issuance of junior subordinated debentures          |  |      |       |   |      |   |       |      |  |   | 5,155  |  
|Downstream of capital to subsidiary                               |  |      |       |   |      |   |       |      |  |   | (4,875 | )
|Investment in trust subsidiary                                    |  |      |       |   |      |   |       |      |  |   | (155   | )
|Dividends paid                                                    |  |      |       |   |      |   |       |      |  |   |       |  
|Dividends received from Bank                                      |  |      | 170    |   |      |   | 205    |      |  |   | 145    |  
|Proceeds from stock options exercised and restricted stock issued |  |      | 62     |   |      |   | 81     |      |  |   | 39     |  
|Options expensed                                                  |  |      | 123    |   |      |   | 18     |      |  |   |       |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash provided by financing activities                         |  |      | 355    |   |      |   | 304    |      |  |   | 309    |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Net (decrease) increase in cash                                   |  |      | (25    | ) |      |   | 51     |      |  |   | 4      |  
|Cash and equivalents at beginning of year                         |  |      | 68     |   |      |   | 17     |      |  |   | 13     |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Cash and equivalents at end of year                               |  | $    | 43     |   |      | $ | 68     |      |  | $ | 17     |  
|                                                                  |  |      |        |   |      |   |        |      |  |   |        |  



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